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Principles of Project Financing

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Construction Finance

Columbia University

4.7 (432 ratings) | 10K Students Enrolled

Course 4 of 4 in the Construction Management Specialization

The final course of the specialization expands the knowledge of a construction project manager to include an understanding of economics and the mathematics of money, an essential component of every construction project. Topics covered include the time value of money, the definition and calculation of the types of interest rates, and the importance of Cash Flow Diagrams.

Skills You'll Learn

Financial Modeling, Project, Finance, Real Estate

Reviews

4.7 (432 ratings)

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SG

Mar 15, 2017

Very nice course, Just the Excel sheet of Professor Anthony Webster is a big question mark, where we can get this file so we can follow up with him during the class

BO

Aug 20, 2018

Excellent course led by esteemed people with many years of experience in the industry. Very practical and thorough survey of concepts and tools in the industry.

From the lesson

Project Finance

Professor Bob Dewing discusses project finance and provides an overview of Global Project Finance. The roles of stakeholders in project finance is reviewed in depth.

Global Project Finance Overview and by Sector8:25

Stakeholders in Project Finance6:00

Stakeholder Roles9:48

Principles of Project Financing8:54

Risk and Risk Allocation16:16

Categories of Risk Allocation7:23

Sponsor Perspectives - Structuring and Documentation11:54

Completion Risks / Government Perspectives15:23

Contract Parties9:54

Contracts and Agreements17:32

Taught By

Ibrahim Odeh, Ph.D., MBA
Instructor, Department of Civil Engineering and Engineering Mechanics, Columbia University

Transcript

So I now get to the key page in this presentation.

I'm an engineer by heart and engineers like to have those principles.

There are basic principles of project financing.

And these are paramount and you can build your whole project

financing skills on these four paramount premises.

Project financing is structured and driven by cash flow.

Project financing is cash flow.

Yes, later on, we're going to talk about balance sheets and

income statements and so on.

But at the end of the day, the very first and

foremost concept to project financing is cash flow.

It's about measuring cash flow.

It's about controlling cash flow.

And ultimately, it's about using that cash flow to be able to put in debt and

equity in the most appropriate form.

Project financing is Cash flow.

The next point is project structure, which is the contract parties

in the contracts that we just talked about, should allocate risk to those

parties most capable of controlling and bearing such risks.

So as you're putting a project financing together, and

we'll get around to the structure in a moment.

Is the parties best able to control and

manage those risks that the contracts should be drawn up with.

If you're going to be selling copper from a copper mine,

you should be selling copper to the open market.

But if you're selling electricity, you need to have an off-taker for

that electricity.

Somebody who can take that electricity and

has the capacity to be able to distribute it to consumers of that electricity.

So the party that's best capable of managing or accepting such risks.

And some of the risks, if you have a copper mine again,

copper price risk, you can hedge a little bit of it perhaps.

A copper price risk is taken by the sponsors.

The sponsors are generally mining companies.

They're in the business of their shareholders are expecting to take copper

price risk.

They're structured such that they got enough capital to manage the ups and

downs in the copper market.

Proper price risk is given to the sponsors.

Their equity trends will be driven by the copper price and

the debt holders will be looking for a fixed return and a reasonably constant

return whereas the copper mining sponsors and will expect a very volatile return.

So allocating the risk to those parties most capable

of managing those risks is a key component.

The next one is slightly tougher.

Project finances accept term risk and avoid principle risk.

What do I mean by that?

Term risk is the risk that you will be repaid but

you might not be repaid exactly on the time that you expect to be repaid or

you expect to get a distribution from a project.

Principal risk is the risk that you're not going to get your capital back at all.

Project financiers, the debt holders, equity holders too for

that matter, would like to get their capital back.

But they're willing to accept that they may not get their capital back

exactly on the timeframe that they were anticipating.

These are standalone businesses, and if you go into a project financing and

you're expecting over a long period of time to have no changes in cash flow,

it's not really a realistic expectation.

It doesn't matter how clever we all are as project financiers,

we can't know everything about everything in the future.

And sure enough something is going to happen some way and

it's an aspect to project financing that these structures.

These project finance structures and their special purpose vehicles,

stand alone vehicles have the capacity and capability

to be able to accept those changes in those unexpected changes.

And not have a large event of default then the whole project falling over.

So project financiers accept term risks.

They may get repaid early, they may get repaid a little bit later, but

they will get repaid and they'll get a return on their capital,

it's just that they don't know exactly when that's going to be.

And the final one is the project drives the financing, not the reverse.

One puts a project together.

One puts the cash flow models together, one looked at the cash flows.

And then, when you've looked at these cash flows and

you've analyzed the cash flows and you've looked at the sensitivity of

those cash flows, then you can determine what the financing should look like.

There may be some rules of thumb that you've got going into a project financing.

But at the end of the day,

the project has drive the financing not the other way round.

Some of the biggest calamities in project financing

is where people have taken a financing and

imposed it on the project irrespective of the strict cash flows on the project.

They beat the project into submission trying to get it to

conform to what they think is the formulaic basis for

what a financing should look like for that sort of project.

And that is a wrong way around it as a failure.

The project should be operating on its own best Interest and

operating on this most efficient basis.

And the financing should not compromise the best operation to the project.

Project drives the financing and not the other way around.

So just to bring these four tenants again together

because these are the most important aspects of project financing.

Project finance and structure are driven by cash flow.

This is a cash flow business.

Project structures should allocate risks to those parties

most capable of controlling and bearing such risks.

This is a contract business.

We're going to pass the risks out to contract parties, and they should

go to those parties that are best able to control or manage those risks.

Project financiers accept term risk and try and avoid principle risk.

Project financiers have to be willing to accept the fact that they

may be paid early or late and this should not be a problem.

Then finally, the project should drive the financing, not the reverse.

So now that we've determined that there are these basic tenants and

project financing.

What does a project financing structure look like?

Here we have a typical project financing structure.

This is just a very diagrammatic one.

But we're going to discuss all of these entities around here, and

we're going to talk about how they participate in a project financing.

We have a standalone project company in the center.

Again I repeat, this has to be special purpose vehicle, this is a corporate

entity but it's not the corporation at the center it's a big corporate business.

It is a very specific enterprise.

Around the periphery at the top of course we have the sponsors and investors,

they are the key components here.

You need somebody had to have the vision to be able to put this together and

to provide the equity.

The suppliers and the offtakers are on the left and the right.

They drive the cash flows for the business.

And then, of course, the financiers at the bottom.

But around the periphery, and there may be other parties too

around the periphery and maybe the other parties too, we have the top left hand

corner, we have the contractors who are going to build this, the EPC contractors.

We have operators, somebody has to operate this or

somebody has to at least put the operations in place.

So we have operations and management agreements.

The bottom right hand corner of any projects have technology suppliers.

Somebody has to be able to provide and support that technology.

And finally, the government is involve in the bottom left hand corner here.

And the government will be involved in some formal fashion.

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