The ChadCameroon Petroleum Development and Pipeline Project

1
The Chad-Cameroon Petroleum Development and
Pipeline Project

• Professor Doug Cerf
• Donald Bren Graduate School of Environmental
  Science and Management
  
• Financial Management (ESM 209)
• Winter 2007

2
What has been accomplished by the Chad Cameroon
Project?

• Very interesting consortium of parties to
  accomplish
  
• Economic development in a developing country
• Shared financial returns
• Sharing of risks
• Poverty alleviation
• Project development with concern for sustainable
  development
  
• Partnership of Governments, Private Corporations,
  Private Banks and The World Bank
  
• How much risk is acceptable in economic
  development situations that have severe
  environmental and social issues?

3
How did the financing differ?

• Review Corporate Structure in Exhibit 3a
• Review Sources / Uses of Cash Exhibit 3b
• Field System
• Oil wells and drilling equipment
• Export System
• Pipeline and off-shore loading system

4
Corporate Finance for the Field System

• No debt all equity
• 3 sponsors (upstream consortium)
• Exxon/Mobil exposure 608m
• 40 of 1,521m
• Market value of equity 280b
• High discretion over cash flows
• Monitoring is done internally
• As opposed to the external monitoring similar to
  the equator principles

5
Equator Principles

• A new voluntary framework to guide project
  financing decisions
  
• Endorsed in 2003 by ten leading banks
• Non government organizations (NGO) wanted
  financers of large projects to take legal and
  moral responsibility for the social and
  environmental impact on local communities and
  host nations caused by the projects that they
  financed

6
Project Finance

• Project finance involves the use of limited or
  fully non-recourse debt by a corporate partner
  (the sponsor or sponsors) to finance investment
  in and ownership of a legally independent, single
  purpose industrial asset usually with a limited
  life.

7
Key elements of the project finance agreement

• Key elements
• An investment in an industrial asset
• An organizational decision to create a new,
  legally-independent entity
  
• Financing decision involving non-recourse debt
• The project financing arrangement is limited
  non-recourse debt because it provides a guarantee
  for debt repayment through completion
  
• After completion there is no recourse to
  sponsors
  
• The debt is an obligation of the project
  companies, Techad (TOTCO) and Cameroon (COTCO)
  pipeline projects
  
• Repayment is a function of project cash flows

8
Key elements of the project finance agreement

• By creating a legally-independent entity the
  borrowing entities (the sponsors) are able to
  protect their balance sheets
  
• Off balance sheet financing
• Exxon/Mobil has a debt to equity capital ratio on
  its balance sheet of 23
  
• Export system debt to equity ratio is 62-64
• Would Exxon/Mobil do this deal on their balance
  sheet?

9
Risk Management

• Reason for using project finance
• Risk sharing and risk mitigation
• Risk sharing
• Lead sponsor Exxon/Mobil brought in other
  sponsors (Chevron and Petronas)
  
• Diversified borrowing through banks, bond holders
  and the World Bank

10
Risk Mitigation

• Risk mitigation
• Inclusion of the World Bank /IFC to help mitigate
  political and reputation risk
  
• The world bank ..
• as the lender of last resort for impoverished
  countries the World Bank has leverage over these
  countries that private sponsors do not have.
  
• has the experience and technology to deal with
  environmental, social and political risk that is
  superior to that of a private sponsor
  
• the world bank can sort through the propaganda to
  determine the actual behavior on environmental
  and social issues
  

11
How much risk mitigation is needed?

• How much involvement by the world bank is needed
  to get the risk mitigation benefits that
  Exxon/Mobil (sponsors) are looking for?
  
• Generally, for highly rated companies like
  Exxon/Mobil project finance is more expensive
  than corporate finance
  
• The extra costs are in the costs to structure and
  fund the project finance (15 million of
  preparation costs)
  
• See quote under financial projections on page 3
  of case
  

12
The World Banks role

• Sponsors want World Bank involvement for risk
  mitigation
  
• The world bank is primarily interested in
• Poverty alleviation
• Sustainable economic development
• There is no better place than Chad for poverty
  alleviation
  
• The World Bank has the expertise to understand
  and impact the risk issues
  
• Corporate sponsors could not take on a project
  with these risks because they do not have this
  expertise
  
• The World Bank loans to projects it does not loan
  to companies.

13
The World Banks role

• World Bank Group played four key roles
• It appraised the project for sponsors and other
  outside lenders to uncover important information
  
• It assisted with the environmental assessment
• It structured the project to ensure fairness
  and to minimize social and environmental impact
  
• Policy advice to ensure long term sustainability
• It made direct investments and mobilized other
  funding sources
  
• Deter government interference

14
Is this deal fair to Chad?

• Investment of capital is very low 47 million
• Equity investment is funded by loans
• Chad is using up one of its only natural
  resources
  
• Net present value (Low/High scenarios from Table
  5)
  
• Low expected oil price and low volume 108
  million
  
• High expected oil price and high volume 1,170
  million
  
• Expected value 463 million
• Internal Rate of return
• Relatively low investment therefore IRRs are
  high
  
• Low 42
• High 90
• Chad makes more than the private sponsors in all
  of the low volume/low price scenarios
  
• Chad has the greatest downside risk protection

15
Is this deal fair to Cameroon?

• Equity investment in pipeline project
• Returns are essentially invariant to the price of
  oil
  
• It is most sensitive to volume changes
• Net present value (Low/High scenarios from Table
  5)
  
• Low expected oil price and low volume 92
  million
  
• High expected oil price and high volume 156
  million
  
• Internal Rate of return
• Relatively low investment therefore IRRs are
  high
  
• Low 34
• High 40
• Much less variation than for Chad

16
Is this deal fair to Private Sponsors?

• Very sensitive to the change in oil price and
  volume
  
• Net present value (Low/High scenarios Table 5)
• Low expected oil price and low volume (917)
  million
  
• High expected oil price and high volume 1,614
  million
  
• Internal Rate of return
• Low less than zero
• High 27
• The largest upside in dollar return

17
Fairness and the distribution of project returns

• Timing of the returns
• Chad, Cameroon and private sponsors get 29.2,
  51.4 and 56.3 of its undiscounted cash flows
  respectively in the first 10 years
  
• Chads receipts are back-loaded to protect
  against sovereign interference
  
• This approach may be inappropriate given Chads
  needs to alleviate poverty
  
• Chad is assuming reserve risk
• Proven reserves last through year nine
• If probable and possible reserves do not
  materialize then Chad suffers

18
Fairness and the distribution of project returns

• Division of the returns
• Total 1.78 billion
• Chad, Cameroon and private sponsors get 22, 6.6
  and 71.4 of the total distributable cash flows
  
• Looks pretty good for Chad based on the amount
  invested
  
• Chads position is driven by their inability to
  raise external capital
  
• If they could raise external capital would they
  have needed the private sponsors (Exxon/Mobil
  etc.)?
  
• Cash flows would have tripled without the private
  sponsors (assumes inclusion of Cameroon)

19
Fairness and distribution of project risks

• Construction risk
• Construction risk is low
• Sponsors know how to develop oil fields
• They have certified variables related to the
  amount of reserves with independent consultants
  
• Financial risks (excluding sovereign risk)
• Low given the debt service reserve fund
• Debt service coverage ratio is 2.1 or higher
• Low finding and development costs of
  5.20/barrel
  
• Risk of oil price fluctuations
• Risk of quality of the oil extracted

20
Fairness and distribution of project risks

• Sovereign Risks
• Political risk
• Potential to disrupt the project
• Dependent on the political situation in both Chad
  and Cameroon
  
• Environmental and social risk fall on the host
  nations
  
• Sponsors bear the environmental and social risk
  indirectly through reputation damage
  
• Could be large has shown by Exxon Valdez

21
Is the sharing of the risks and returns fair?

• Is World Bank involvement evidence of fairness?
• Would you approve the deal as a World Bank/IFC
  board member?
  
• Three slides follow on why the plan should be
  approved
  
• Three slides follow on why the plan should not be
  approved
  
• What are the alternatives?

22
Reasons for the World bank to approve the deal

• Opportunity and need to alleviate poverty
• Chad has few opportunities to alleviate poverty
  and spur economic development
  
• Chad situation has deteriorated over the last
  decade
  
• Chad situation is bad compared to other African
  nations
  
• Opportunity to leverage 177 million from the
  World Bank for a 3.7 billion project (5 of the
  funding)
  
• Commercially attractive project with conservative
  oil price and volume assumptions
  

23
Reasons for the World bank to approve the deal

• In the view of some the project fairly allocates
  project risks and returns
  
• Chad puts in very little and stands to pull out a
  lot
  
• Social and environmental issues have been
  adequately addressed
  
• 19 volumes of environmental assessment documents
• Hundreds of meetings with experts, indigenous
  people and NGOs
  
• Numerous contingency plans
• The World Bank knows how to structure projects
  for success

24
Reasons for the World bank to approve the deal

• The Revenue Management Plan will work
• Future lending to Chad is contingent on the
  Revenue Management Plan
  
• Built in auditing and oversight mechanisms

25
Reasons for the World bank to oppose the deal

• Pipeline revenues may displace existing aid
• Chad will have used up the natural resource and
  be in the same aid position
  
• Current aid is 188 million per year
• Expected project cash flows are about half during
  the main part of the project
  

26
Reasons for the World bank to oppose the deal

• Key participants have troublesome records
• Exxon/Mobil
• Exxon Valdez
• Chairman spoke against strict environmental
  standards in developing countries
  
• The World Bank
• Has not been successful structuring deals to
  manage oil booms
  
• Revenue Management Plan is an experiment
• Chad and President Deby
• Civil war has stopped economic development on
  several occasions in the past
  
• has a poor record on human rights
• Can not be trusted to implement the revenue
  management plan

27
Reasons for the World bank to oppose the deal

• Revenue management plan has serious flaws
• Lacks specificity
• Does not provide detailed expenditure guidelines
• Lacks effective oversight mechanisms
• Is the oversight committee unbiased?
• Is the money that goes to the Chadian banks
  guaranteed to be used for the appropriate
  purpose?
  
• Lacks credible enforcement mechanisms
• No subpoena power or investigatory powers

28
Reasons for the World bank to oppose the deal

• Revenue management plan has serious flaws
  (continued)
  
• Represents an invasion of sovereign rights
• Chad owns the oil reserves and should be allowed
  to spend the countrys wealth as it sees fit
  
• Analogy few employees would agree to employment
  contracts that dictated how they should spend
  their disposable income
  
• Portion of funding to alleviate poverty is not
  enough
  
• Portion of cash for restricted investment is 60
  over the life of the project
  
• Chad receives the bulk of its returns in later
  years in the form of upstream taxes
  
• These flows are not subject to oversight and
  control

29
Reasons for the World bank to oppose the deal

• Revenue management plan has serious flaws
  (continued)
  
• Environmental and Social risks are excessive
• Distribution of project returns is not fair
• Chads returns are in distant years
• Chads returns may not materialize if probable
  reserves do not materialize
  
• Chad needs poverty alleviation now
• Commercial viability
• How high can the discount rate go before the
  NPVs turn negative

30
What has been accomplished by the Chad Cameroon
Project?

• Very interesting consortium of parties to
  accomplish
  
• Economic development in a developing country
• Shared financial returns
• Sharing of risks
• Poverty alleviation
• Project development with concern for sustainable
  development
  
• Partnership of Governments, Private Corporations,
  Private Banks and The World Bank
  
• How much risk is acceptable in economic
  development situations that have severe
  environmental and social issues?

31
Case questions

• How are the sponsors financing this deal? How
  does the financing of the Field System differ
  from the financing of the Export System?
  
• What is the World Bank/IFCs role in this deal?
  Are they likely to be successful?

32
Case questions

• Analyze the risks and the returns to Chad,
  Cameroon, and the Private Sponsors. How were the
  returns calculated? Are the risks and the returns
  fair from each partys perspective?
• Will the Revenue Management Plan work? Are there
  aspects of the plan that you think should be
  changed?
  
• Would you approve the deal as a World Bank/IFC
  board member?