Project Finance in Construction

Anthony Merna is senior partner of Oriel Group Practice, a multidisciplinary research and consultancy practice based in Manchester and a visiting lecturer to Manchester Business School at the University of Manchester. He has been teaching Project Finance for the last 14 years to a number of UK and overseas universities, businesses and government agencies. Yang Chu is a graduate of the School of Mechanical, Aerospace and Civil Engineering at the University of Manchester and a research consultant with Oriel Group Practice specialising in the areas of project finance and risk modelling. He is currently carrying out risk management research at Manchester Business School.Faisal Al-Thani is Senior Development Manager, Middle East for Maersk Oil based in Doha and a board member of the Marsh International Risk Council.

• List of Illustrations xiList of Tables xiiiAbout the Authors xvPreface xvii1 Introduction 11.1 The development of project finance 11.2 Financial assessment 6What is financial assessment? 6Why perform a financial assessment? 6Who is involved in the risk assessment process? 7Where should a financial assessment be performed? 7When should a financial assessment be performed? 8What data are to be used? 8How should assessment outputs be presented? 81.3 Purpose of this guide 91.4 Scope of the guide 92 Project finance 112.1 Introduction 112.2 Definition of project finance 112.3 The key characteristics of project finance 13Special project/purpose vehicle 14Contractual arrangement 14Non-/limited recourse 17Off-balance sheet transaction 18Robust income stream of the project as the basis for financing 192.4 Legal and financial considerations in project finance 20Legal 20Financial 223 Financial instruments and cash flow modelling 253.1 Introduction 253.2 Debt finance 25Senior debt 273.3 Mezzanine finance 28Subordinate debt 28Bond finance 293.4 Equity finance 313.5 Sources of debt and equity 343.6 Cash flow modelling and project financing 344 Risk management 394.1 Introduction 394.2 Risk 394.3 Risk management process 41Risk identification 42Risk analysis 44Risk response 474.4 Typical risks in project financing 495 The financial assessment process 515.1 Introduction 515.2 The financial assessment structure 51SPV assessment 51Lenders’ assessment 54SPV and lender final assessment 556 Case study 576.1 Introduction 576.2 Independent power project 576.3 Supply and offtake contracts 58Supply contracts 60Offtake contracts 61Applications of supply and offtake contracts 646.4 Assumptions for initial assessment 657 Developing the base case model 697.1 Introduction 697.2 SPV’s initial assessment 697.3 Identify the estimated activities, time, costs and revenues of the project 707.4 Development of the base case model 717.5 Identify major project risks 737.6 Assessment of base case model incorporating risks 748 Initial economic assessment by lenders 778.1 Introduction 778.2 Financial package assessment 77Finance package (1) 78Finance package (2) 82Finance package (3) 838.3 Conclusions 879 Financial engineering 899.1 Introduction 899.2 Financial instruments used in financial engineering 90Forward rates 90Financial futures 90Swaps 91Options 92Caps, floors, collars, swaptions and compound options 92Asset-backed securities 939.3 Refinancing 949.4 Reappraising public–private partnerships 949.5 Techniques applied in the reappraisal of PPP concession agreement 959.6 Other financial engineering techniques 9610 Final assessment to determine project commercial viability 10110.1 Introduction 10110.2 Detailed risk assessment 10110.3 Financial engineering 105Tax holiday 105Financial collar 107Extending the concession 107Increasing debt 107Grace period 108Phasing construction and operation 108Upfront payments 108Existing concession revenues 10810.4 Summary 10911 Financial close 11111.1 Introduction 11111.2 Due diligence 111Technical 113Legal due diligence 114Trigger step in rights 116Model audit and sensitivity analysis 116Risk valuation 117Term sheet 117Inter-creditor agreement 117Hedge strategy 118Letters of credit 118Reserve account 119Escrow and ring-fenced facilities 119Economic indicators 120Taxation 120Insurance 12111.3 Financial close 122Credit committee approval process 123Due diligence report 124Technical closure 124Financial close 124Technical commencement 124Execute interest rate swaps 12512 Islamic finance and project finance 12712.1 Introduction 12712.2 Islamic finance 12712.3 Shariah 129Qiyas and Litihad 12912.4 Core principles of Islamic finance 130Sharing (profit/loss and risk) 130No unfair gain 130No speculation 130No uncertainty 130No investments that are not in the public interest 131No hoarding of money 131Deception 131Islamic financial institutions 131Shariah supervisory boards 13212.5 Project finance 132The Ijara principle 133Ijara Mawsufah Fi Al Dhimmah (forward lease) 133Istisna’a 133Sukuk 134Sukuk al Istisna’a 135A typical SAI deal 135Hedging 136Swaps 13712.6 Other Islamic finance techniques for projects 137Musharaka (equity financing) 137Bai salam (forward financing) 13812.7 Risks and liabilities 13812.8 Summary 13913 Conclusions and recommendations 14113.1 Review 14113.2 Conclusions 14213.3 Recommendations 144Appendix 147Glossary 159References 161Index 167

“Overall, the short book is simple to read and understand.”  (Construction Management and Economics, 2012)"This guide is for project managers, students, and academics involved in structuring and assessing project finance." (Book News Inc, November 2010)