PROJECT FINANCING AND THE NORDIC GAS GRID THESIS AT

FEDERAL EMERGENCY MANAGEMENT AGENCY PROJECT WORKSHEET OMB NO
DATE INDIANA DEPARTMENT OF TRANSPORTATION ATTN INDOT PROJECT MANAGER
LYNLEY SHIMAT LYS MIAP INTRO FINAL PROJECT HADASSAH FILM

---

PROJECT NAME NJDOT SCOPE STATEMENT TSM LIMITED SCOPE FINAL
[PROJECT NAME] PARTNERSHIP STORY AGENCY PROJECT CONTACT NAME LOCATION
UNDP PROJECT DOCUMENT GOVERNMENTS OF

---

PROJECT FINANCING

Thesis at the School of Business, University of Stockholm

Author: Per Sundén-Cullberg

Tutor: Sten Köpniwsky

Autumn 1998

Kandidatuppsats vid Företagsekonomiska institutionen, Stockholms Universitet

Författare: Per Sundén-Cullberg

Handledare: Sten Köpniwsky

Ht 1998

1 Summary

1.1 Project financing

In project financing a project is set up as a separate entity legally distinct from the parent company. The company then seeks lenders who are willing to provide the new company with funds for the completion of the project. These lenders will find the economics of the project so convincing that they lend money with the future cash flows from the project and the project's assets as collateral. This is called pure project financing. However, normally the lenders will require credit support through commitments by third parties. These parties will assign contracts and guarantees.

Project financing can be defined as follows:

"A financing of a particular economic unit in which a lender is satisfied to look initially to the cash flows and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral to the loan".

When large amounts of capital are needed for a project, project financing often is the only possible financing alternative. This is often the case in capital intense industries such as energy, resource recovery, mining and transport.

The major differences between project financing and traditional financing are:

• A separate entity is created.

• This entity is a legal person, which is responsible for the borrowed capital.

• Commitments by third parties - suppliers, customers and government agencies - and the sponsor make up important elements of credit support.

1.2 The Nordic Gas Grid

The Nordic Gas Grid is a pipeline grid through Finland and Sweden, whose feasibility is under investigation. Its purpose is to integrate the natural gas networks and storage facilities in the Nordic member states of the European Union - Finland, Sweden and Denmark - with secured, diversified supplies from Denmark, Norway and Russia. Further it would create a potential northern transit route for supply of Russian gas to Western Europe. The Nordic Gas Grid would also be a contributor to reducing atmospheric emissions in the region, by replacing coal and oil with natural gas.

A feasibility study has been performed and presented by an international consulting group in cooperation with the contracting partners. The contracting partners are all energy companies within the three Nordic EU member states. They have agreed to jointly study the possibilities to develop and integrate the natural gas markets in the Nordic countries. The group has not made investment commitments to the final project and the investment partners are still to be identified.

The Nordic Gas Grid is an EU Trans-European Network (TEN) project of common interest and the European Commission (DG XVII) has co-financed the feasibility study.

1.3 Analysis of project financing and conclusions

Some of project financing's advantages for the Nordic Gas Grid are:

Project financing makes it possible to attract large debt with minimum risk. Due to the magnitude of the Nordic Gas Grid this is very important for the realization of the project.

In project financing the recourse nature of the financing can be limited or eliminated. This enhances the possibility to find investors.

In giant projects, project financing might be the only possible alternative. The magnitude of the Nordic Gas Grid might very well prove project financing to be the only possible alternative.

Some of project financing's disadvantages for the Nordic Gas Grid are:

Project financing requires complex documentation.

Project financing involves many parties with diverse interests. The tension between lender and sponsor about the degree of recourse might result in extensive and time-consuming negotiations, which can be quite costly.

The main problem for the completion of the Nordic Gas Grid seems to be to attract the large sums of debt and equity, which will be needed. This is due to the magnitude of the project. Therefore, the main reason for using project financing for the Nordic Gas Grid is that the technique provides ways to solve this problem. The main reason for not using project financing is the complex and costly documentation which will be needed. However, it seems that project financing's disadvantages for the Nordic Gas Grid are small compared with the advantages. Therefore, project financing seems to be a useful technique for financing the Nordic Gas Grid.

2 Formality

2.1 Motif

• The motif for this research is to assist the responsible at Vattenfall Naturgas and other potential participants in the Nordic Gas Grid in deciding whether their companies shall be part of the possible building of the Nordic Gas Grid or not.

• The research shall also assist the interested parties in finding a well working way of financing the Nordic Gas Grid and thereby increase the chances for a completion of the project.

2.2 Purpose

The objective of this dissertation is:

1. To define and describe the concept project financing.

2. To describe some of the important properties of project financing and to provide a schedule for the creation of a project financing.

3. To examine the advantages and disadvantages of project financing, compared to traditional financing.

4. To examine what factors indicate that project financing should be used when financing the Nordic Gas Grid, and what factors do not.

5. To examine whether project financing should be used for the Nordic Gas Grid, or not.

6. To examine what should be done next in the Nordic Gas Grid project.

7. To provide an example of a completion of the Nordic Gas Grid, using project financing.

2.3 Questions at issue and hypothesis

The questions at issue are:

1. How can project financing be defined and what does the concept involve.

2. What are the advantages and disadvantages of project financing.

3. Is project financing a good way of financing the Nordic Gas Grid.

The hypothesis is that the summation of pros and cons of project financing will show that it is a suitable way of financing the Nordic Gas Grid.

2.4 Delimitation

The following delimitations apply:

1. No detailed description of the different kinds of instruments used when raising funds for a project.

2. No details about the different sources of risk capital.

3. No accounting considerations.

4. No tax considerations.

2.5 Method

The methods of research are descriptive and analytical.

Part I

Description of the Nordic Gas Grid and

the technique project financing

and how it is applied

3 Properties of the Nordic Gas Grid

In order to make it possible to examine what factors indicate that project financing should be used when financing the Nordic Gas Grid, it is essential to investigate the characteristics of the pipeline system. The facts that form the base for this investigation are taken from the feasibility study on the Nordic Gas Grid performed by Tebodin B.V. and Arthur D. Little Limited.

3.1 Supply

In the future, gas may be delivered by many parties. These could be producers or traders and it is expected that countries such as Denmark may be able to supply modulated gas. However, the two major suppliers of gas to the Nordic Gas Grid will be Norway and Russia.¹

• Norway. The Norwegian supplies are organized by the GFU (gas negotiating committee) which has representatives from the Norwegian oil and gas companies, Statoil, Norsk Hydro and Saga Petroleum. Gas is sold in generic, not field-specific contracts, then allocated to fields later. It is assumed that gas will be sold mainly on a long-contract basis.

• Russia. The Russian gas sales are usually negotiated with Gazexport, a gas sales arm of Gazprom. It is assumed that contracts will be long-contracts with 90% load factor.

3.2 Demand

The countries from which the lion's share of demand will come, are the so-called target and transit countries:²

Target countries: Sweden, Denmark and Finland.

Transit countries: Belgium, France, Germany, the Netherlands and the United Kingdom.

3.3 Phasing

The Nordic Gas Grid will be built in phases that meet the forecast demands of the markets. The target markets will be reached in the first stages and the transit markets in the final stage of the construction of the grid. This means that the capital costs also will be phased.³

3.4 Capital expenditure

The Nordic Gas Grid requires high initial investments. Estimated capital expenditure for the pipeline alone ranges from 3.5 to 3.8 billion USD. Also, to enable sale of gas in Sweden and Finland branch lines will have to be built. The additional expenditure for the branch lines is assumed to amount to 480 million USD in Sweden and 90 million USD in Finland.⁴

3.5 Risks

• The main risks of the Nordic Gas Grid project are market related, and pertain to volume and price especially. It might be difficult to have sufficient long-term ship-or-pay agreements for the transit years before the start of the project. A large part of the market risk is due to the fact that gas prices generally are linked to the price of oil, as oil is the most important competing fuel. A lasting low oil-price would render gas through the Nordic Gas Grid a less competitive energy alternative, resulting in a decrease in the pipeline's sales.⁵

• A technical feasibility study is currently being performed by North Transgas (NTG). The main purpose of NTG is to provide Russian gas to Western Europe and a materialization of this pipeline would therefore mean competition to the Nordic Gas Grid.

• Scheduling and cost estimates.

3.6 Financing

It should be expected that the banking sector will recommend phasing of the construction of the Nordic Gas Grid and will carefully analyze each of the main components/pipeline sections of the project separately on its viability. Due to its size, the complete Nordic Gas Grid will require the formation of a banking syndicate of some 20 banks.

This syndicate will consist of some or all of the following:⁶

• commercial banks;

• the European Investment Bank (EIB);

• the Nordic Investment Bank (NIB);

• the European Bank for Reconstruction and Development (EBRD);

• the International Finance Corporation (IFC) of the World Bank.

The EIB could participate in the financing of the project if sufficient political support can be generated. The European Investment Fund could, apart from providing loans, support with guarantees for the lending and might also provide equity for some time.

During preparatory meetings with the banking industry, it stated some issues that are of certain importance for their eventual participation.

The banking industry mentioned, amongst other, the following issues:

• Shareholder's structure;

• Management structure;

• Equity participation;

• The export capabilities and priorities of Gazprom.

Issues which the feasibility study deem as important for the materialization of Nordic Gas Grid are:

• Identification and establishment of a sponsor group;

• Securitization of long-term shipping contracts, 10-15 years, between pipeline company and gas shippers, to secure cash flows and reduce risk.

4 Description of project financing

The purest form of project financing is the financing of a separate project, in which the lender is satisfied to look to the revenue stream of the project. The larger the amount of different types of guarantees, recourses and securities given by the borrower or his associates the financial structure contains, the more the financing resembles traditional financing.⁷

When using project financing, the project, its assets, its contracts, its inherent economics and its cash flows are segregated from its promoters or sponsors in order to permit a credit appraisal and loan to the project, independent from the credit sponsors.⁸ A company which applies project financing sets up the project as a separate entity legally distinct from the parent company.⁹ In other words, in project financing, a company registers a new company specifically for the purpose of materialization of a certain project. So, in project financing, the company segregates the new undertaking from its general operations. The initiating company, the so-called sponsor, then seeks lenders who are willing to provide the new company with funds for completion of the project. These lenders will find the economic feasibility of the project so convincing that they lend money with the future cash flows from the project and the project's assets as collateral. In other words, in project financing, lenders base credit appraisals on the projected revenues from the operation of the facility to which it lends, rather than on the general assets or the corporate credit of the sponsor. The lenders rely on the assets of the facility, including the revenue-producing contracts and cash flows as collateral for the debt. This is project financing in its simplest form. A 100% non-recourse financing based solely on the merits of a project and in which the credit appraisal is made with the cash flows from the project as the single variable. However, project financing is seldom this simple and lenders normally require some security from the sponsor or other party in the form of guarantees and contracts.

Project financing is especially useful in capital-intensive industries such as mining, petroleum, forest products and transportation. Some energy projects are so massive that joint development through the use of a jointly owned project company is necessary. This type of ventures particularly lends itself to project financing.¹⁰ Also, when large amounts of capital are needed to finance a project, the possibility to raise funds is strained. The strained possibilities and the risks involved in project development, often makes a project financing one of the few financing alternatives in the above mentioned industries.¹¹

4.1 The differences between traditional financing and project financing

Another way to describe project financing is to look at the differences between project financing and traditional financing. The differences are that in a project financing:

• A separate entity is created.

• This entity is a legal person, which is responsible for the borrowed capital.

• Commitments by third parties - suppliers, customers and government agencies - and the sponsor make up important elements of credit support.

The exhibit below illustrates these differences.

4.2 Definitions of project financing

There are several definitions of the concept project financing, and a banker is supposed to once have said: "Put three people in project financing together and you'll end up with nine definitions of it".¹²

However, the different definitions do not seem to be far apart.

Peter Nevitt gives the following definition of project financing:¹³

"A financing of a particular economic unit in which a lender is satisfied to look initially to the cash flows and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral to the loan”.

This defines pure project financing, which is 100% nonrecourse, and in which the sponsors, therefore only risk their equity investment. However, this definition should be viewed as somewhat theoretical. For, as Nevitt points out, it would be very advantageous if it were possible to arrange a 100% nonrecourse financing for projects. However, Nevitt writes, "lenders...are not in the venture capital business. They are not equity risk-takers. Lenders want to feel secure that they are going to be repaid either by the project, the sponsor or an interested third party".¹⁴

Other prominent persons in project financing choose other broader definitions:

Larry Wynant seems to be a bit more practically oriented. He adds commitments to his definition, and takes the above mentioned problem of 100% non recourse into consideration.

Wynant - "Project financing is a financing of a major independent capital investment that the sponsoring company has segregated from its assets and general purpose obligations. The economic prospects of the project, combined with the commitments from the sponsor and third parties, provide the support for extensive borrowings carrying limited financial recourse to the parent company".¹⁵

Marcel Sarmet chooses to elaborate Wynants definition one step further by pointing out that the techniques regarding recourse and distribution of risk vary.

Sarmet - "Project financing may be defined as the financing of an economic unit which is viable technically, commercially and whose future cash flow is judged high enough to cover, with a safety margin, operating costs, debt servicing and an adequate return on investment. All viable projects have these characteristics but, the financing techniques employed can differ considerably from one project to another, and vary according to:¹⁶

• the degree of recourse which lenders may have to the sponsors of the project.

• the type of risk which the lenders are ready to bear".

A very simple and according to the author of this thesis, well-concluding definition, is provided in the title of Hoffman's article: "Project financing: Loans Based on Cash Flow and Contracts".¹⁷

4.3 Challenges and goals of project financing

In addition to definitions of project financing, Nevitt also provides definitions of the challenges (1) and goals (2) of project financing:¹⁸

1. The key to a successful project financing is structuring the financing of a project with as little recourse as possible to the sponsor, while at the same time providing sufficient credit support through guarantees or undertakings of a sponsor or third party, so that lenders will be satisfied with the credit risk.

2. The ultimate goal in project financing is to arrange a borrowing for a project which will benefit the sponsor and at the same time be completely non recourse to the sponsor, in no way affecting its credit standing or balance sheet. Indeed, project financing is sometimes called off-balance sheet financing.

4.4 Properties of a successful project financing

According to Nevitt, a successful project financing has the following properties:¹⁹

1. a professional and thorough feasibility study and financial planning;

2. experienced operators and contractors with good track-records;

3. an assured market for the project's products;

4. political and country-risk problems under control;

5. a project manager with clear identity, authority and continuity;

6. a sponsor, motivated by adequate projected profits to make the project succeed;

7. a sponsor with past experience in successful project financings and who is aware of the kinds of problems which may arise.

4.5 Project financing and interest rates

There is confusing information on interest rates in the literature. According to some authors, the advantages of project financing are the lower interest rates, whereas others state that rates are higher in project financing than in traditional financing.

According to Reuterberg²⁰ one advantage of project financing is the lower interest rates. These are, according to him, achieved by the allocated nature of the project's cash flow. Since the cash flows from a project financing go straight to debt service and are not mingled with cash flows of other activities, as they often are in traditional financing, the lenders feel more secure and accept lower rates. According to Reuterberg, lenders tend to view the lack of accurate information and the problems of accounting legibility of commingled cash flows as detrimental to their positions. This should, according to Reuterberg, be viewed as the ultimate reason why project financing may be economically justified.

On the other hand, commingled cash flows from different activities mean less variance and thus less risk. This implies that lenders would require higher rates from project financings. However, if lenders finance a number of projects with low or negative correlation, then according to portfolio theory this enables them to achieve higher return-to-risk ratios. In this case lenders could settle with lower interest rates. Therefore, one can draw the conclusion that a borrower should choose a lender who has:

• experience in project financing;

• thorough knowledge of portfolio theory and therefore, hopefully has a well diversified project financing portfolio;

• a project financing portfolio, in which the borrowers project fits in well as regards size and correlation.

5 The participants in project financing

There are generally three different types of participants in a project:²¹

• sponsors;

• lenders;

• third parties.

The composition of the interested parties differs from project to project, both with regard to the number and the participants.

5.1 The sponsors

The sponsors are the parties who initiate the project. Normally the sponsors will also acquire an equity interest in the project, i.e. become the owners. However, this does not necessarily have to be the case. For example, a petrochemical plant might want to initiate and promote the construction of a gas pipeline, to ensure supplies of raw-material. For some reason, for example lack of knowledge of pipeline operation, it might not want to take an equity position. The plant could then cooperate with an experienced pipeline operator who becomes the owner of the facility.

Established, well-capitalized corporations can select a project financing structure which allows them to take large debt commitments at minimum risk. Entrepreneurial developers, on their hand, can use project financing to enable themselves to go forward with several projects at once. Each project is then based on its own merits and is independent of the financial obligations of the other projects. For both types of developer it is advantageous that each project can be performed with minimal equity at stake.

Borrowers have several different objectives for using project financing:²²

• elimination of, or limitation on, the recourse nature of the financing of a project;

• off-balance sheet treatment of debt financing;

• leverage to debt to avoid dilution of existing equity;

• avoidance of restrictive covenants in other debt or equity arrangements that would otherwise preclude the project development;

• attractive debt financing and credit enhancement that is available to the project itself, but unavailable to the project sponsor as a direct loan.

The sponsor of a project financing is responsible for the planning, promotion and implementation of the project. Therefore, if the sponsor doesn't have thorough knowledge of project financing he is wise to seek the assistance of a financial advisor in arranging financing. The advisor could preferably participate in, and/or lead the project through the entire process of materialization of the project.

The following parties are some possible financial advisors:²³

• commercial banks

• merchant banks or investment banks

• major contractors

• major finance companies

• independent consultants

When selecting a financial advisor the sponsor should consider the following characteristics of the candidates:

• reputation

• standing in the marketplace

• knowledge of the industry

• past relationships with the sponsor

• technical experience

• familiarity with any country risk

• compatibility with the officers of the project

5.2 The lenders

Lenders are the parties who provide the project with loans. Generally lenders are banks and finance companies and investors who buy bonds issued by the project entity. It should be pointed out that sponsors and owners also can be lenders. Owners then often lend money in the form of quasi-equity, described below.

A project financing presents several advantages for the lenders. For example, fee income can be increased as compensation for agency responsibilities, letters of credit and assistance in closing the transaction. Also, lenders can maximize the availability of financing options by offering borrowers project financing as an alternative.²⁴

5.3 The third parties

Third parties are purchasers of goods from the project, sellers of products to the project and other parties who are interested in seeing the project materialized. They can assist the project by issuing guarantees and signing contracts.

Some possible third parties are:²⁵

• Contractors, who construct or operate a project company's assets.

• Governments. Government involvement ranges from public-private partnerships, where governments participate directly, to private-private deals, where governments act as regulators.

• Customers who want to purchase the project's products.

• Faciliators/advisers, who assess a project and prepare legal and financial structures.

In complex project financings lenders may require a clearly creditworthy party, a guarantor, to provide various types of guarantees for the project.²⁶

The motive for someone to become a guarantor, might be that he wants to:²⁷

• Sell a product to be used in the project.

• Sell a service in connection with the project.

• Acquire an equity interest in the project.

• Assure a source of supply of raw materials like oil, gas, ore and agricultural products.

As regards governments and international agencies, they are motivated by economic, social and political needs.

Possible guarantors are:²⁸

• An agency of a government, interested in getting the project built.

• Export agencies supporting export of products to be used in the project.

• The World Bank

• Area development banks like: African Development Bank, European Investment Bank, Asian Development Bank.

• Users of products which are to be manufactured by the project.

• Sellers of products which are to be used by the project.

6 The risks in projects

6.1 Generic risk profile

All projects face many risks and a generic risk profile includes:²⁹

Commercial risks

• Project-specific risks. Involves developing and constructing the project, operating and maintaining the assets and finding the market for the products.

• Economic environment risk. Include interest rate changes, inflation, currency risk and price movements of material and other inputs.

Non commercial or policy risk

• Project specific. Includes expropriation, changes in the regulatory regime and the failure of the government to meet its contractual obligations.

• Political risk. Political instability and extreme events such as war and civil disturbance.

6.2 The information risk

The financing of projects is quite different from that of a financially sound company as part of its continuing investment program.³⁰ The analysis of the project and the suitable financing will be based on the project alone and the risk involved. The financiers cannot base their decisions on historical earnings. It is always to the borrower's advantage to avoid surprises for the lenders. Therefore, it is vitally important that the lenders are kept well informed. If they feel that they are badly informed they will most likely begin assuming and start imagining the situation more problematic than is the case. Under such circumstances lenders might start to act precipitously, which can incur severe damage and high costs for the project and all its participants.

7 The steps in project financing

The materialization of a project financing can be broken down into four phases:³¹

1. preliminary studies

2. planning

3. arranging financing

4. monitoring and administering the loan agreement

Each of these phases will are described below in the order, which should be followed during the materialization of a project financing. As the reader works his way through the description of the phases new conceptions will be encountered. These are described in connection with their first place of appearance.

7.1 Phase I: Preliminary studies

The first step in a project financing is to prepare a preliminary study for the project. The purpose of the study is to investigate the viability of the project. The study, which should be quick and inexpensive to prepare, should examine the broad effects of the scheme, including economic justification, finance and grants and the effect on the local environs.

If the sponsors deem the project as feasible after having evaluated the results of the preliminary study then, the next step is to prepare a more thorough study, the feasibility study.

The purpose of the feasibility study is to give the sponsors more thorough information about the project. Obviously, the reason for this is to make it possible to decide whether or not the proposal has sufficient merit to warrant further expenditure of time, effort and money.

The feasibility study shall:³²

• identify the basic aims of the project

• prepare the outline designs of various alternative options

• identify the initial capital and operational costs of the various schemes

• prepare an outline programme covering the design, construction and commissioning phases including any period for public consultations

• prepare a budget for the project

• identify sources of funding, grants and taxation provisions

• recommend an appropriate course of action

The economic evaluation should involve comparing different schemes and alternatives in order to identify the most appropriate scheme. It is essential that a full economic evaluation and financial feasibility study are undertaken already at this early stage of the process. Otherwise the sponsor risks:³³

• spending large amounts of money on engineering feasibility studies, on a project that is not financially feasible;

• incorrect rejection of a feasible project at an early stage on the grounds that financing cannot be arranged.

At the end of this stage it should be decided whether the project should be proceeded with, or not.

7.2 Phase II: Planning stage

The planning stage ranges from an initial review of the feasibility study to arranging of the financing. The planning stage includes an analysis of the project, in which all the relevant factors of the complete feasibility study are evaluated.

During this stage the project's managers, or professionals appointed by them, should:³⁴

• make assumptions for factors such as interest rates, currency exchange risks and inflation risks;

• seek the best way to arrange financing of the project. Considerations should be made as to what currencies the project will generate, its location and the capital needed.

• set up a plan for the amount of equity and borrowing, which will be required;³⁵

• prepare proposed loan terms. These should be based on the project's cost, the expected interest and inflation rates and the anticipated cash flows;

• initiate negotiations with government agencies, suppliers and the private debt markets.

• review appraisals for accuracy;

• prepare different risk case scenarios;

• prepare financial plans for the project;

• test the feasibility of the financial plans in the various risk case scenarios.

It should be mentioned, that the risks should be considered in three stages:³⁶

1. The severity of each risk needs to be assessed. Here, things like outcome of other projects and the governments macro economic record should be taken into consideration.

2. The party which is in the best position to manage each risk is identified.

3. Each risk is allocated, priced or mitigated between the parties, via contractual agreement.

This way, risks deemed as insuperable by one party can be transferred to some other party, for whom they do not impose such a large problem, enabling participation of the first party.

7.2.1 Capital and debt

One of the most important tasks during the planning stage is to find the best ways to raise funds for the project. In most project financings funds are provided by a combination of the following three types of capital and debt:

• equity;

• senior debt;

• quasi-equity.

When seeking financing, one general goal is to ensure that the sum of the debt, quasi-equity and equity is sufficient to finance the entire cost of the project. This is important, because it eliminates later need for new lenders or equity participants with different lending or participation requirements.³⁷

7.2.1.1 Equity

The equity investment represents the risk capital and forms the basis for advancing more senior forms of capital to the project. Since equity investments are the last in priority for repayment, they are risky investments. However, positions in equity are justified by their substantial upside potential.

Lenders look upon equity as providing a margin of safety and have two primary motivations for requiring equity investments in projects they finance:³⁸

1. Lenders expect cash flows generated by the project to be sufficient to pay all expenses including debt service. More equity and thus a lower debt-to-equity ratio lowers the debt service, which reduces the risk of default.

2. Lenders want investors to have enough at stake to ensure that they will be motivated to make the project a success.

7.2.1.2 Senior debt

The most typical component in a project financing is the senior debt and most funds from lenders will be in this form. By definition, senior debt is debt that is not subordinate to other loans or equity in either repayment or security.³⁹ This means that it is first in priority of payment, should the borrower get into financial difficulty. Senior debt is divided into three categories:

1. Unsecured loans

2. Secured loans

3. Other secured loans

• Unsecured loans. Senior debt is referred to as unsecured loans if it is backed by the general credit of the borrower. Projects are new enterprises and have to rely upon the reputations of their sponsors, owners and managers. Therefore, unsecured loans from external sources would typically only be available to projects supported by well-renowned participants. Unsecured loans are often provided by sponsors, especially if the project intends to raise a significant amount of capital by secured loans or leasing.⁴⁰ Unsecured loans may include stock warrants or stock conversion rights to increase the lender's upside potential.

• Secured loans. Senior debt is referred to as secured loans if it is secured by a perfect security interest in an asset, or pool of assets. A secured loan is superior to an unsecured. Secured loans are available to most projects where the assets securing the debt have value as collateral, i.e. they can be sold and converted to cash. Real property, personal property, payments due under contracts etc. are used as collateral in project financing. A security interest permits the senior lenders to take control of the project, if it would get into financial trouble. Investors may also be asked to pledge their equity shares.⁴¹

• Other secured loans. Other secured loans than senior debt, that may be used to finance equipment and properties of the project are:⁴²

• mortgages on real estate

• equipment loans on items of equipment

• leases of real estate

• leases of equipment

7.2.1.3 Quasi-equity: subordinated loans

When project economics are sufficient to permit the payment of senior debt and all operating costs, project sponsors sometimes arrange quasi-equity financing as a surrogate to equity.⁴³ Quasi-equity consists of loans that are senior to equity-capital but junior to senior debt. It may be advanced by an investor as part of its original investment in the project. Its purpose is often to support senior borrowings from third party lenders by providing capital.⁴⁴ Quasi-equity is often used for advances to cover construction overruns or other payments necessary to uphold guarantees such as a certain debt-to-equity ratio. Since quasi-equity comes after senior debt in order of repayment, it is of a subordinated nature. Subordinated debt can be generally subordinated or subordinated to some specific senior third party loans.

According to Nevitt⁴⁵ subordinated debt provided by sponsors has some of the following advantages compared to capital contribution through equity:

1. As debt, the borrowed amount will be repaid without tax consequences.

2. Debt has a specific schedule for payments of interest and principal, whereas stock dividends are optional and may be subject to restrictions.

3. The advantages of equity can be preserved by the sponsor lender through stock warrants or stock conversion rights.

4. There exists a greater market for risk debt funds than for equity.

5. An investor might be hindered to take equity positions, due to regulating statues such as anti trust laws.

6. Interest paid on debt is deductible for income tax purposes.

7. A sponsor, e.g. a government agency, who cannot take an equity position for policy reasons, may be able to provide subordinated debt as seed capital to attract senior debt.

7.2.2 Appropriate debt-to-equity ratio

As mentioned, during the planning stage, management should set up a plan for what amounts of debt and equity which should be used, i.e. find the appropriate debt-to-equity ratio. The appropriate debt-to-equity ratio is a matter of negotiation between the sponsors and senior lenders. Many factors are taken into consideration, including customary debt-to-equity ratios for the particular industry involved, market expectations and risks. If lenders are protected by various kinds of guarantees from third party sources, they are inclined, and justified, to accept higher debt-to-equity ratios.⁴⁶ However, unless the guarantees available are from very creditworthy guarantors, lenders will always require a substantial equity investment in a project. As mentioned earlier, they want to make certain that sponsors have substantial interest in making the project a success.

One could expect that lenders would accept higher debt-to-equity ratios if they were compensated by higher interest rates. This might be the case up to a certain point. However, lenders generally limit their rates to a base rate, for example LIBOR, plus a fixed premium.⁴⁷ This is due to the fact that with an increasing premium follows a higher risk of default. Therefore, at a certain point, the effective return, as a function of the charged premium, starts to decline.⁴⁸ Obviously, neither lender nor sponsor would want to the premium set above this point.

7.3 Phase III: Arranging the financing

If, after the planning stage, the sponsors are of the opinion that the economics of the project justify further expenditure of effort and capital, then it is time to start arranging the financing. When the project has reached this stage, managers should continue with the preparation of a presentation of information regarding the project to prospective lenders.

Typically, a so called offering memorandum is prepared.

7.3.1 The offering memorandum

The purpose of the offering memorandum is to enable prospective lenders to make a preliminary credit decision. Therefore, the document is also called the financing memorandum or prospectus. Since the memorandum is the marketing tool for raising funds, it is very important that it be well prepared and professionally displayed. The assumptions underlying the business plan in the memorandum should be realistic and the financial projections attainable. Statements of the projected cash flows and financial condition will demonstrate the ability of the project to service its debt. The offering memorandum should contain information on the following items:⁴⁹

1. Proposed financing and summary of terms;

2. Project company;

3. Capitalization;

4. Products/markets;

5. Marketing;

6. Competition;

7. Manufacturing and production;

8. Management/personnel;

9. Business risk;

10. Historical and other information;

11. Plans and forecasts.

1. Proposed financing and summary of terms. A brief description of the proposed financing and a summary of the requested terms for each of the different types of financing sought. The terms shall be described with the following variables:

• amount, timing and purpose

• the type of the financing, such as secured and unsecured debt, equipment leases, subordinated debt etc.

• securities offered

• proposed interest rates

• proposed currency

• maturity, repayment schedule

• brief description of the proposed covenants in the loan agreement.

2. Project company. A summary of important background information regarding the project company, its date and state of incorporation etc. Description of the project's organization, with names, locations and proposed lines of business. If the project company exists, its recent and expected financial results should be briefly described.

3. Capitalization. All proposed long-term loans and obligations should be described. Provide a breakdown of existing and/or proposed bank lines. State and explain any contingent liabilities or guarantees. Give a complete breakdown of equity ownership, including percentage ownership of officers, directors and other major stockholders, emphasizing that of financially strong stockholders.

4. Products/Markets. Describe the project's products and markets, their historical and projected growth, also describe any plans for new products and the company's research and development programme.

5. Marketing. Describe and discuss the project's marketing strategy, how it plans to sell, distribute and price its products. Analyze the company's customers, any sales contracts, take-or-pay, take-and-pay and other similar agreements.

6. Competition. Describe the project's competition, naming the major competitors and describing their strengths and weaknesses. If available, industry trade growth publications should be included.

7. Manufacturing and production. State the location, nature, size, capacity and utilization of the project company's existing and proposed production facilities, and state whether they are owned or leased. Give details on proposed coming expenditures for the next five years. The company's manufacturing methods and costs, and the availability and the cost of the used raw materials and components. Describe the status under environmental regulations. Any existing and/or proposed contracts regarding the above mentioned variables should be described.

8. Management/personnel. Provide a chart of the organization. The chart should state the names of the directors and the salaries for important management staff. State the project company's proposed labor force and briefly describe its unionization, strike history, skill-level etc.

9. Business risk. Describe the major business risks, which the project face and indicate what steps management is taking to minimize them and their potential impact.

10. Historical and other financial information. If the project company has an operating history the following information should be included in the memorandum:

• Audited income statements, balance sheets and related statistical data for the past five years.

• Explanation of any abrupt changes or sustained deterioration in the financial statistics, e.g. abrupt declines in sales and earnings. Description of what steps management has taken to resolve them.

• Explanation of the rationale for any acquisitions made during the last five years. Stating the price and the form of transaction and with financial information on the acquired companies enclosed.

• Description of the project company's financial policies regarding properties like dividends, capital structure, IRR etc. Description of existing loans and significant leases.

• If the project will be supported by guarantees from sponsors, their annual reports and adjacent financial information for the last five years should be provided.

11. Plans and forecasts.

• Provide forecasts of income statements, balance sheets and sources of funds statements for the coming five years. Include detailed assumptions. The proposed financing should be included in the forecasts.

• The use of the proceeds of the financing should be explained in detail. If the proceeds are to be used for construction of a facility the presentation should include the following information regarding the facility:

• projected cost

• amount of initial investment

• estimated future investment

• expected earnings and cash flows

• chosen contractor

• Describe the project company's future direction including any plans for major changes in the organization and the like.

• State future capital requirements and describe how financing for them is planned.

Even if not all information outlined above may have to be included, a project financing following this approach would improve its chances of successful completion.

7.3.2 Inter-creditor agreement

As the financing starts to materialize, it is likely that many lenders will become involved. If the financing of the project involves a number of separate lenders an inter-creditor agreement should be considered. The purpose of the agreement is to provide procedures, agreements and understandings regarding:⁵⁰

• coordination of priorities of loan repayment;

• acceleration of the maturity of loans;

• establishment of loss sharing;

• offset sharing;

• coordination of foreclosure of any collateral security for the benefit of all lenders.

In an inter-creditor an agent bank or lender is appointed to act on behalf of the lenders to the project. The purpose of the agreement is to prevent arising disputes between lenders to jeopardize the interests of all lenders and sponsors. If a project runs into financial difficulties and defaults, lenders will try to protect their position by gaining some advantage over other lenders. Without inter-creditor agreements the mechanisms of the Nash-equilibrium⁵¹ can drive the lenders to start to accelerate their loans in order to be one step ahead of the other. This will start a chain reaction between lenders, and the arisen scramble for money can ruin an otherwise viable project, which has run into a state of occasional lack of liquidity. The outcome of this is bad for all of the project's participants, who will end up in a worse position than they had, had the project been given a chance to recover. An inter-creditor agreement prevents this outcome by not allowing the lenders to take legal action outside the agreement.

Another advantage of the inter-creditor agreement is that it is much easier for the borrower, i.e. the project company, to deal with lenders through the agent bank or agent lender, instead of having a large number of parties to deal with.

Project financings tend to involve many lenders and be more complex than usual commercial loans, so an inter-creditor agreement is especially valuable in project financing. It should be pointed out that the inter-creditor agreement should be established at an early stage, since it becomes very difficult to establish one after problems have occurred.

7.3.3 Contracts in project financing

The cash flows of a project are partly governed by the underlying contracts. Therefore, lenders hold contracts that oblige someone to make a payment to the project on delivery of some product, as vitally important. A large number of contracts are used in business transactions. There are some that are of certain importance for project financing and for pipelines in particular. Some of them are described below. Source, Nevitt II.⁵²

• Take-or-pay contracts. Take-or-pay contracts are indirect guarantees. They are unconditional contractual obligations to make periodic payments for fixed or minimum amounts or quantities of products, goods or services at fixed or minimum prices. The obligation to make minimum payments is unconditional and payments must be made irrespective of the product's actual delivery. Take-or pay contracts are not cancelable, or cancelable only with consent of the party delivering the goods. The take-or-pay obligor can protect its interest by retaining the right to take over the project in the event of failure by the supplier to perform. Take-or-pay contracts are widely used as guarantees in financing.

• Through-put contracts. Where the project is to provide a service, such as the transmission of oil or gas through a pipeline, the long-term take-or-pay contract for the transmission service is called a through-put contract. In this type of contract, the obligor pays, whether the service is used or not.

• Put-or-pay contracts. Put-or-pay contracts are assigned by suppliers of products to a project which needs an assured supply over a long period and at a predictable price. Under a put-or-pay contract, the obligor must either supply the products or pay the project company the difference in costs incurred in obtaining them elsewhere.

7.3.4 Guarantees

The cash flows are dependent on underlying contracts such as those described above. If the lender doesn't find the contracts satisfactory, and deem lending to the project too risky, he will require credit enhancement, such as guarantees from a creditworthy third party, to be arranged.⁵³ As this will normally be the case, guarantees are very important for project financing. Guarantees make it possible to transfer financial risks to a third party, who does not want to be a lender or in any other way be involved with the operation activities.⁵⁴ A guarantee can be of any kind, e.g. a guarantee to complete a construction work before a certain date and at a certain cost.

7.3.5 Recourse

When lending to projects, as in most loan transactions, the bank or other lender, will normally require a security guaranteeing repayment. As mentioned earlier, in project financing, the security mainly comes from the assets and cash flows generated by the project company. However, the sponsors may also provide their own assets and cash flows as security.

Recourse is the lenders right to demand pecuniary compensation from the provider of securities. Lenders choose between three different levels of commitment, where limited recourse is a continuous variable:⁵⁵

1. Nonrecourse

2. Limited recourse

3. Full recourse

• Nonrecourse. In a nonrecourse commitment, the lenders completely rely on the projects own assets and cash flows as security. If the project defaults from its loan obligations the lenders are authorized to raise an action against the project but not against the sponsor. The lenders thus take full risk for all external capital. This type of financing is also called pure project financing and is, as mentioned earlier, of a somewhat theoretically oriented nature.⁵⁶

• Limited recourse. In a limited recourse agreement, the sponsor or a third party provides guarantees, which lessens the lender's risk. The sponsor's own assets and revenues may be used as security. The security may be limited in time. If, for instance, a completion guarantee is given by the sponsor, the project financing is deemed to be nonrecourse after completion. The sponsor may also provide guarantees valid through the project's lifetime, called full guarantees. These can for example be take-or-pay contracts, through-put agreements and cost sharing arrangements.

• Full recourse. With full recourse the lenders ultimately may claim payment via the assets and cash-flows of some other creditworthy entity than the project. Full recourse financing is a total recourse on the sponsor and/or third parties through agreements. As mentioned earlier, a full recourse agreement, resembles traditional financing.⁵⁷

7.4 Phase IV: Monitoring and administering the financing

When the financing has been arranged, it is time to start the last phase of the project. During this phase the arranged financing is used to pay for the expenditures necessary to complete the project and to put it in operation. The tasks of the phase is therefore the monitoring and administration of the financing.

Monitoring and administration of the financing break down into three time frames:⁵⁸

1. Construction

2. Startup

3. Operations

7.4.1 Construction

The typical construction loan is dispersed in intervals over time, with the total of the draws and the interest on the draws making up the loan balance.⁵⁹ Obviously, the borrower does not want to take down the debt - have the bank transfer parts of the total loan to the borrower's account - before it is needed, since this increases the interest payments. In other words, debt should be taken down using just-in-time principles. Therefore, monitoring during construction entails matching the takedown of debt to the financial and construction schedule. If the loan-terms permit, alternation between different currencies and financial strategies can be applied. Hedging might also be advantageous.

7.4.2 Start-up

During the start-up phase, the actual operating costs, markets for the products, revenues realized and economics of production must be monitored and compared with those of the original financial plan.

7.4.3 Operations

When the start-up phase is complete and the project starts to operate to the costs and volumes projected, it assumes the character of a going concern, rather than a project. Therefore, at this stage the duties for management become the traditional responsibilities of monitoring operations, cash flows, ratios and other items that may affect the company.

One could say that this is the end of the project financing, the project entity has become a going concern.

Part II

Analysis of project financing and

its advantages and disadvantages for

the Nordic Gas Grid

8 The advantages and disadvantages of project financing

8.1 The advantages of project financing

From the description above the following advantages of project financing can be derived.

The advantages of project financing are that the technique makes it possible to:

• attract large debt with minimum risk;

• set up and run several projects simultaneously;

• minimize equity outlay, and thus to maximize debt-to-equity ratio. Increased leverage makes it possible to maximize NPV;

• limit or eliminate the recourse nature of the financing;

• attract debt financing and credit enhancement that is available to the project itself, but unavailable to the project sponsor as a direct loan;

• obtain a higher degree of involvement from third parties;

• increase involvement of guarantors;

• isolate the project's assets and liabilities, which enhances accounting legibility;

• advance quasi-equity;⁶⁰

• make the project entity the main supplier of securities;

• raise funds at all. In giant projects project financing might be the only alternative. This applies especially for projects in the extractive and energy industries.

8.1.1 Some advantages of project financing not derived from the text

Some advantages of project financing are that:

• lenders lend more money per currency unit asset and at lower interest rates;⁶¹

• legal limitations and regulations to the sponsor may be circumambulated by allocating undertakings to project entities;

• investments in international projects may be protected by forming joint-ventures with international partners, thus lessening the sovereign risk;

• more favorable working contracts may be formed by separating the operation from other activities of the sponsor.

8.2 The disadvantages of project financing

The following disadvantages of project financing can be derived from the text:

The disadvantages of project financing are that:

• They require complex documentation. Project financings involve many participants with diverse interests. The tension between lender and sponsor about degree of recourse, between contractor and sponsor about nature of guarantees etc. often result in extensive and time-consuming negotiations, that can be quite costly;

• they require additional equity outlay;

• projects are new enterprises and lack history and reputation;

• sponsors run the risk of loosing control over the project.

8.2.1 A disadvantage not derived from the text

• The lender's risk in project financing is not insignificant. This may result in higher fees.⁶²

9 Project financing for the Nordic Gas Grid

Some of the advantages and disadvantages of project financing, enumerated above are of a general nature, e.g. the possibility to attract large debt with minimum risk, and apply to all business undertakings. However some, e.g. involvement of guarantors, vary in respect to applicability for different projects. Therefore, to investigate if project financing is a suitable means of financing the Nordic Gas Grid an exposition based on the properties of the pipeline and the advantages and disadvantages of project financing described above, is required.

9.1 Advantages for the Nordic Gas Grid

1. Project financing makes it possible to attract large debt with minimum risk. This is an advantage of general nature. All investors like the concept. The risks in a project are a crucial variable when attracting investors. Due to its magnitude, the Nordic Gas Grid might have trouble attracting investors and the possibility of project financing to minimize risk might prove to be very important for the realization of the Nordic Gas Grid.

2. Several projects can be set up and run simultaneously. This possibility might prove to be of importance. Firstly, potential sponsors will probably have projects running and/or in the construction phase. Secondly, and perhaps as important, the possibility to set up and run several projects simultaneously, makes it possible to divide the pipeline, as regards ownership, in several extensions, with a different project company owning each extension. This can have several advantages:

• Different sponsors can own and be responsible for different parts of the grid. For example Finnish companies could own and operate the Finnish stretchings, Swedish companies the Swedish and so on. This enables them to focus on their home markets which will enhance their insight into their customers needs.

• The banks will probably want to review the grid section by section. A division of the pipeline gives clearer legibility of the special circumstances of each stretching and makes it possible to have different loan terms and agreements for each section.

• The sponsors will probably have comparative advantages in borrowing money in their home countries. A division of the Nordic Gas Grid enables them to maximize the benefits of this advantage.

• A close ownership makes each sponsor company directly responsible for the condition of the pipeline stretching in its area. Therefore, a division guarantees good maintenance.

• A division lessens the risks that contradictory opinions of the sponsors become harmful to the project. For example, in a section disputes could arise whether more branch lines should be built or if gas should be shipped to the transit markets. A division would mean fewer owners per section, which would make mutual understanding easier.

• The possibility to raise funds from the capital markets, e.g. the Stockholm Stock Exchange might be improved. A division gives investors more influence for their capital. This fact would probably be appreciated by investment companies.

• The disadvantages of a division, e.g. the risk of inferior maintenance of a section, resulting in problems for other operators, can be solved through cross-owning, guarantees and contracts. As for construction, the Nordic Gas Grid could be built as one project and then split and transferred to different project companies.

3. Debt-to-equity ratio can be maximized. Increased leverage makes it possible to maximize NPV. This advantage is of a general nature and the risk reduction achieved through minimization of equity might prove to be crucial for the possibility of finding investors.

4. The recourse nature of the financing can be limited or eliminated. Again the possibility to lessen risk might be very important when attracting investors. This item and item two will be of large importance for their participation.

5. Attraction of debt financing and credit enhancement that is available to the project itself, but unavailable to the project sponsor as a direct loan. As mentioned earlier, the European Investment Bank, the Nordic Investment Bank, the European Bank for Reconstruction and Development and the International Finance Corporation are possible partners in the Nordic Gas Grid. These banks are all subject to political intentions, so this item might prove important for their participation.

6. Higher degree of involvement from third parties. This might prove to provide several advantages for the Nordic Gas Grid.

• Government involvement gives governments increased insight in the gas industry. This could lessen the risks for political decisions counteracting gas as an energy source. As regards Sweden, participation could make the government inclined to view gas from the Nordic Gas Grid as a possible way of replacing energy from the Swedish nuclear plants, which the Swedish government intends to shut down.

• In the feasibility study, market is considered as the paramount risk for the Nordic Gas Grid. Involvement of potential gas customers could lessen the risks of insufficient demand. Further, it could bring forward gas demand, which would lessen the problem of the Nordic Gas Grid operating for long times below capacity. Also, project financing makes it easier to secure long term contracts.

• Constructors who are involved in the Nordic Gas Grid would be more inclined to finish construction work within scheduled time and cost.

• The possibility of involvement could attract new customers of gas, e.g. new petrochemical plants and large energy consumers such as paper mills and metallurgical plants.

• Involvement of guarantors. Obtaining guarantees is stated as a large problem in the feasibility study, so this item would probably be important for the Nordic Gas Grid. Apart from this, this item principally offers the same advantages as item six.

7. Isolation of the project's assets and liabilities enhances accounting legibility. Because of more distinct information this can result in lower interest rates. Due to the size of the Nordic Gas Grid this item might be of certain importance. Also, see item two.

8. Possibility of advancement of quasi-equity. Again, the advantage for the Nordic Gas Grid is enhanced possibilities to raise funds. Also, if the division discussed under item two should be applied, quasi-equity would enable sponsors to ensure themselves of cash-flow from other sections of the pipeline. This way, a sponsor could reduce risks by taking part of other stretchings of the Nordic Gas Grid via quasi-equity.

9. The project entity can be the main supplier of securities. Principally offers the same advantages as item four.

10. Can lessen the sovereign risk in international projects. Companies from several countries will be involved in the Nordic Gas Grid, so the possibility to form joint-ventures with parties from other countries might prove important. As regards the Russian component in the Nordic Gas Grid, Gazprom has used project financing in earlier pipeline projects, and is thus familiar with the technique.⁶³

11. In giant projects project financing might be the only possible alternative. Last but not least. The magnitude of the Nordic Gas Grid might very well prove project financing to be the only possible alternative. Also, with traditional financing the Nordic Gas Grid would probably jeopardize the owner's entire existence.

9.1.1 Other advantages of project financing for the Nordic Gas Grid

The following advantages are based solely on the properties of project financing and deals with some issues stated in the feasibility study of the Nordic Gas Grid. Therefore, the advantages listed here do not have correspondents among the general advantages of project financing.

12. The risk of competition from the possible North Transgas can be lessened through project financing. The sponsors behind NTG could be invited to participate in the Nordic Gas Grid. Hopefully, this would make them abandon their project which would diminish competition.

During the making of the feasibility study, contacts were taken with the banking industry. The banking industry deemed the following issues as important:⁶⁴

• shareholder's structure;

• management structure;

• equity participation;

• the export capabilities and priorities of Gazprom

The use of project financing would increase the possibilities to find solutions, that all parties find acceptable:

13. Shareholder's structure is flexible in project financing;

14. Management structure will also be flexible since the new project company would be able to seek the personnel needed from "scratch". Also, management will vary with shareholder structure. There will thus be an immense number of combinations of shareholder and management structures available.

15. Project financing enhances the possibilities to find equity investors. Therefore, project financing increases the possibilities to raise the amount of equity capital, which the banking industry will require before giving loans.

16. Gazprom could be made interested in prioritizing exporting gas through the Nordic Gas Grid by being offered the possibility of participation, e.g. through ownership.

9.2 Disadvantages for the Nordic Gas Grid

In the enumeration below, each disadvantage is followed by a possible way of circumambulating the problem.

1. Project financings require complex documentation. Due to its magnitude, the Nordic Gas Grid will require complex and extensive documentation regardless of the financing technique used. Therefore, this matter might not disfavor project financing. Also, the economies of scale would probably make cost for documentation a minor post and a very small reduction of the interest rate would probably pay for the documentation and justify the use of project financing.

2. Project financings involve many participants with diverse interests. The tension between lender and sponsor about degree of recourse, between contractor and sponsor about nature of guarantees etc. often result in extensive and time-consuming negotiations, that can be quite costly. Probably, what has been said on the problem under item one, applies for this disadvantage as well. Further, the division, discussed under item two, advantages, would lessen the number of participants of each stretching, making it easier for the parties to find solutions.

3. Projects are new enterprises and lack history and reputation. This is item fully valid for the Nordic Gas Grid. Further, as regards Sweden it has little experience of natural gas as energy source. Therefore, it might be especially important for the Nordic Gas Grid that the it is backed by guarantors who have very good reputation and are of some substance.

4. Project financings require additional equity outlay. Investors will have to either use their funds to take equity in the Nordic Gas Grid or to take loans to achieve funds for the equity outlay. Due to the high leverage of project financings, the latter alternative probably would be a difficult undertaking. Due to lack of funds or for accounting reasons, an additional equity outlay might be problematic for some prospective investors. However, investors who have problems on this matter, probably do not possess the financial stability required for equity-takers in a project such as the Nordic Gas Grid. Exclusion of such investors would therefore probably not be very disadvantageous.

5. Investors run the risk of loosing control over the project. Investors might be forced to pledge their equity in the Nordic Gas Grid as security. Indeed, it would be very distressing for the investors to loose control of the grid. This is especially true for investors who are also customers, i.e. who ship gas through the pipeline or buy gas delivered through it. They would then loose their influence on the price-policy of the pipeline company. It should be mentioned that such investors probably would be found especially within the sponsor group. However, it is likely that not may companies would manage to materialize a project the size of the Nordic Gas Grid through traditional financing. Also, instead of risking the control of the project the company would then probably jeopardize its entire existence. Again, this is due to the large proportions of the project.

10 Conclusions

With the advantages and disadvantages of project financing for the Nordic Gas Grid stated above as basis, it is possible to draw a conclusion as to whether or not project financing would be a suitable means of financing the pipeline.

The magnitude of the Nordic Gas Grid seems to run like a red thread through project financing's advantages for the Nordic Gas Grid. The core of most of the advantages are that they make it easier to attract investors, third parties and sponsors. Project financing also provides possibilities for good solutions to the issues that the bank industry has mentioned as important. Further, the use of project financing can lessen the risk of harmful competition from a second gas pipeline, i.e. the North Transgas. On the side of disadvantages the problem of complex and costly documentation and negotiations seems to be the main issue. Therefore, one can draw the conclusion that project financing should be used if raising funds would become the major issue and, that if legal matters or documentation costs become insuperable some other method of financing has to be used. However, there seems to be possible ways to circumambulate most of the disadvantages. Therefore, one can draw the conclusion that project financing's advantages for the Nordic Gas Grid are superior to the its disadvantages and that project financing is a useful technique for financing of the Nordic Gas Grid.

11 The next steps for the Nordic Gas Grid project

As mentioned earlier, a feasibility study has been prepared for the Nordic Gas Grid. However, it seems that the study has been completed following some other schedule than the one provided here. The feasibility study is more covering than a preliminary study, but lacks investigation of some of the issues which, according to this thesis, should be investigated in a feasibility study.⁶⁵ Also, the study recommends the making of an in-depth feasibility study as the next step and enumerates some subjects for further studies. Many of these correspond to those which, according to the schedule provided here, should have been included in the feasibility study. Since the completed feasibility study doesn't cover all the issues that should be included, according to the schedule provided here, the Nordic Gas Grid project could be deemed as still in the phase of preliminary studies. However, if the so called in-depth study is completed, all the issues of the phase of preliminary studies will have been investigated. The Nordic Gas Grid can therefore be deemed as being at the end of the phase of preliminary studies and well on its way toward the planning stage.

As mentioned earlier, sponsors should be cautious to move on to the demanding and expensive planning stage, before a full evaluation of the Nordic Gas Grid has been executed in the phase of preliminary studies. It is essential that a full economic evaluation and financial feasibility study is undertaken already at this early stage of the process. Otherwise the sponsor risks:⁶⁶

• ending up spending large amounts of money on engineering feasibility studies, on a project that is not financially feasible;

• incorrect rejection of a feasible project at an early stage on the grounds that financing cannot be arranged.

Because of this, it is important to investigate what issues will have to be covered to complete the phase of preliminary studies. In order to determine what should be done next, i.e. what issues should be studied next, an investigation is provided, which compares which of the issues proposed here, have been investigated, and which have not.

For convenience, the issues that should covered in the feasibility study are stated again:

The feasibility study shall:

• identify the basic aims of the project

• prepare the outline designs of various alternative options

• identify the initial capital and operational costs of the various schemes

• prepare an outline programme covering the design, construction and commissioning phases including any period for public consultations

• prepare a budget for the project

• identify sources of funding, grants and taxation provisions

• recommend an appropriate course of action

The following of the issues enumerated above have been covered in the feasibility study:

• identify the basic aims of the project;

• prepare the outline designs of various alternative options;

• recommend an appropriate course of action;

• prepare an outline programme covering the design, construction and commissioning phases including any period for public consultations.

The following two issues have been partly investigated:

• identify the initial capital and operational costs of the various schemes;

• identify sources of funding, grants and taxation provisions.

The initial capital requirements have been identified. The operational costs have not.

Sources of funding have been investigated. Grants and taxation provisions have not.

The following issue has not been completed:

• prepare a budget for the project

11.1 Conclusions

The first four issues above have been investigated and can therefore, for now, be put aside. The initial capital costs have been identified. However, their phasing has not been identified, or is at least not stated in the study. Therefore, more investigation might be needed on this issue. The same thing applies for the operational costs. They have not been investigated at all, or are at least not presented in the study. Therefore, more work will have to be done here. Sources of funding, grants and taxation provisions have been partly investigated. Sources of funding have been investigated, whereas grants and taxation provisions have not been discussed. These issues therefore need to be more thoroughly inspected. A budget has not been prepared, or is at least not present in the study. Since a budget is of paramount importance for an evaluation of the economic viability of any project a lot of energy should be used on this matter.

After investigation of the above mentioned issues and a thorough financial feasibility study, the sponsors should decide whether to move on to the planning stage or not.

12 Completion of the Nordic Gas Grid

The purpose of this chapter is to illustrate how the Nordic Gas Grid could be completed using project financing. The chapter has been constructed under the following assumptions:

1. The possible studies of the Planning stage on the Nordic Gas Grid have rendered a positive result, i.e. the sponsors view the project as economically viable.

2. Permits for construction and operation of the pipeline have been issued.

3. A project entity has been registered and equity has been raised.

The assumptions mean that the project has reached the Arranging the financing stage. Therefore, the sponsors start working on the completion of the project and start to try raising loans for the Nordic Gas Grid. This chapter will briefly illustrate the financing process. It also briefly touches the construction phase of the Monitoring and administering stage.

12.1 Financing with support from through-put contracts

The Nordic Gas Grid will most likely be financed with support from through-put contracts. This means that the project company tries to raise funds by arranging a borrowing based on the assignment of contracts to the lenders. The contracts will come from the sponsor group and/or third parties. The parties sign through-put contracts, i.e. they enter into long-term contracts to ship certain minimum amounts of gas through the pipeline at periodic intervals and at fixed prices. The revenues which the contracts guarantee is sufficient to pay the debt service and operating expenses of the pipeline. Each party is unconditionally obliged to ship a certain minimum amount during each time period and a party who fails to ship sufficient amounts during a period must nevertheless pay for a minimum shipment. However, he may not be required to pay if revenues are sufficient to service debt and pay operating expenses. If revenues are not sufficient, the coparties are obligated to make up the deficiency in proportion to ownership. In the case of insolvency of one of the parties, the other parties become liable for the insolvent party's obligations.

12.2 Construction of the Nordic Gas Grid

A guarantee of completion of the construction of a project to be financed by a through-put contract is typically provided by a completion guarantee from the sponsors or some third party. The completion guarantee covers cost overruns and guarantees that the project will be completed in a certain frame and perform in accordance with specifications.

12.3 The steps of the completion of the Nordic Gas Grid

The steps of the completion of the Nordic Gas Grid are the following. Each step is marked in exhibit II below.

1. The sponsor companies enter into through-put contracts with the project company.

2. The sponsor companies might want to, or have to, have other parties assign backing contracts. Some possible sponsors are the following:

• Sponsor I is a gas producing company, e.g. Gazprom, which wants to sell gas via the Nordic Gas Grid. The company contacts large consumers of gas and/or trading companies, which want to buy gas. These companies assign take-or-pay contracts. This guarantees the producing company sales of the gas it guarantees to ship through the Nordic Gas Grid. N.B. Gas producing companies which themselves consume all of the gas they ship through the Nordic Gas Grid would not need a take-or-pay contract.

• Sponsor II is a company which sells gas directly to small consumers. It has a quite certain and stable demand. To give its through-put-contract greater weight, or for its own safety, it contacts a gas producer, who assigns a put-or-pay contract. This guarantees the company that it will receive the gas, which it according to the through-put contract must ship via the Nordic Gas Grid.

• Sponsor III is a company trading in gas. It backs its through-put-contract with both put-and-pay and take-or-pay contracts. This guarantees the company both supply and demand. This type of company acts as sort of broker in gas.

3. The project company enters into loans with lenders and assigns the through-put contracts as security.

4. Contracts are signed with constructors.

5. Proceeds from the loan are used to build the pipeline.

6. The through-put-contracts become effective, the pipeline starts to operate and payments under the through-put contracts are paid to the trustee. The trustee uses the payments for debt service and pays the excess cash flow to the project company.

Glossary

Branch line Pipeline connecting a main transport pipeline with a main consumer area.

Debt service Repayment of principal and interest on debt.

Default To failure servicing debt in accordance with agreements.

Entity A separate organization, created solely for financing and operation of a project.

Hedging To make investments to lessen the risks connected with currency and/or interest rate fluctuations.

Investor Here: Person or institution, which could consider buying shares, or which owns shares in the project entity.

Lender The organization, which provides a project with loans.

LIBOR London interbank offered rate. The interest rate which banks active in London charge, when giving each other loans overnight.

Load factor The ratio between annual average daily gas throughput and daily peak gas throughput.

Modul. gas Gas, which has been adapted to the low load factors typical for market demands.

Natural gas A naturally occurring complex mixture of hydrocarbons and non-hydrocarbons that at room temperature and under atmospheric pressure is entirely in the gaseous phase.

Obligor Person or institution that binds itself to another party by contract.

Recourse The right to demand pecuniary compensation from some party.

Sponsor The organization responsible for planning and implementing a project.

Takedown Takedown of debt - the activity of exercising a loan agreement by having the bank transfer a part of the agreed loan to one's account.

Upside pot. Upside potential - the possibility of an investment to increase in value.

References

Andriotis, Katherine, 1997, Project Finance Woos the Capital Markets, Global Finance, Feb. 1997

Project & Trade Finance, 1995, Russia's Pipe Dream, Project & Trade Finance, Jan. 1995

Bond, Gary and Carter Laurence, 1994, Financing Private Infrastructure Projects - Emerging Trends form IFC´s Experience, Discussion Paper No 23, IFC

Girard, Jacques and Hurst, Christopher, 1997, The Capital Structure of Private Infrastructure Projects and the Risk of Default, Cahiers Papers Vol 2 No 1, European investment Bank, 1997 Hoffman, Scott L., 1989, Project financing: Loans based on cash flow and contracts, Commercial Lending Review, Vol 4, iss. 4, fall 1989

Jaffe, J. Austin and C.F. Sirmans, 1995, Fundamentals of real-estate investment, Prentice Hall

Nevitt, Peter K. 1983, Project financing, fourth edition, Euromoney Publications, (Nevitt I)

Nevitt, Peter K. 1989, Project financing, fifth edition, Euromoney Publications, (Nevitt II)

Pindyck & Rubinfeld, 1998, Microeconomics, fourth ed., Prentice Hall

Potts, Keith, 1995, Major Construction Works - Contractual and Financial Management, Longman Group limited

Reuterberg, Lennart, 1986, Project Financing - investment for the future, Exam Thesis, Stockholm School of Economics

Tebodin B.V. and Arthur D. Little Lmtd., 1998, The Nordic Gas Grid, Feasibility Study

Yates, J. K., 1990, Innovative Construction Financing Techniques, Cost Engineering, Vol 32, No. 1, January 1990

CHOOSES A COLLEGE PROJECT RUBRIC (FILL IN
REVISION CONTROL INFORMATION PROJECTSHSISCVSUTILITIESARRAYARRAYDOCV
14 NOVEMBER 2005 PATRINA BUCHANAN PROJECT MANAGER INTERNATIONAL

Tags: financing and, construction financing, nordic, thesis, project, financing

---

• 4807CCL AGENCY HOME RANDOM SAMPLING 7 4424 SELECTING CPA
• FORO DE GÉNERO DE LAS AMÉRICAS – BUENOS AIRES
• NAJWAŻNIEJSZE INFORMACJE O SPOSOBIE ORGANIZACJI I PRZEPROWADZANIA EGZAMINU MATURALNEGO
• PIRCĒJA LĪGREĢNR PĀRDEVĒJA LĪGREĢNR IEPIRKUMA LĪGUMS RĪGĀ 2021GADA
• THE BILCO COMPANY GUIDE SPECIFICATIONS IN CSI FORMAT WWWBILCOCOM
• ESPAÑA SEMINARIO MICROBIOLOGÍA Y SEGURIDAD ALIMENTARIA EN LA RESTAURACIÓN
• LIVERPOOL CITY COUNCIL EMERGENCY MANAGEMENT AND BUSINESS CONTINUITY GUIDANCE
• VORDRUCK FÜR DIE MELDUNG DER INBETRIEBNAHME IMMATRIKULIERUNG HEBEMITTEL
• FORMULARZ RECENZJI ARTYKUŁU PRZEZNACZONEGO DO PUBLIKACJI W CZASOPIŚMIE „IUS
•  UNIVERSIDAD TECNOLÓGICA NACIONAL FACULTAD REGIONAL CÓRDOBA DIRECCIÓN DE
• DODATAK 10 ZAHTJEV ZA ODOBRENJE ZA PROMJENU PROJEKTA
• JUEVES 12 DE AGOSTO DE 2004 DIARIO OFICIAL (PRIMERA
• SEND INFORMATION ADVICE SUPPORT SERVICE SCHOOL ALLOCATION LIST FOR
• OZNACZENIE SPRAWY DRUK ZP – 1PO PROTOKÓŁ POSTĘPOWANIA
• A LEVEL GEOGRAPHY SAME MAGNITUDE DIFFERENT RESULT
• TC MARDİN ARTUKLU ÜNIVERSITESI BILIMSEL ARAŞTIRMA PROJELERI BAŞVURU FORMU
• ANZAC RESEARCH INSTITUTE HOSPITAL ROAD CONCORD (SYDNEY) NSW
• PERSONAL BIODATA NAME PROFESSOR DR MUNASIB KHAN PHONE +9294576344142
• HYPERLIENS DE L’ÉMISSION DÉCOUVERTE L E LAC TANGANYKA SE
• EL INGENIERO INTENTA CONSTRUIR EL SOFTWARE PARTIENDO
• PETIZIONE POPOLARE A TUTELA DI AMBIENTE ECONOMIA E VOCAZIONI
• AAN BETREFT EXPLOITATIEVERBOD VANWEGE NIET NALEVEN AANWIJZING GEACHT BESTUUR
• PROCEDIMENTOS PARA AVALIAÇÃO O PROCESSO DE AVALIAÇÃO É
• ETERNIDADES (1918 ) DE JUAN RAMÓN JIMÉNEZ INTELIJENCIA DAME
• ÉLŐFEJ VAGY ÉLŐLÁB MÓDOSÍTÁSA AZ ELSŐ OLDALON LEHETŐSÉG VAN
• 27072020 PORTARIA SECRETARIA MUNICIPAL DE DIREITOS HUMANOS E CIDADANIA
• BOIL WATER ADVISORY FOR WATER SYSTEM COUNTY
• E L DIA DE LOS MUERTOS INTRODUCCIÓN ¿SABES QUÉ
• 2 2 AUTORISATION PARENTALE DE CESSION DE DROITS
• ANALISIS BERBAGAI PERAN PARA PIHAK DALAM KEMITRAAN PEMANFAATAN SUMBERDAYA

• NA TEMELJU ČLANKA 12 STAVKA 1 TOČKE 5 ZAKONA
• CuestionarioHonorabilidadESI
• YVETTE GOSS EDUCATION AND TRAINING WORKFORCE SCHOOLS PRODUCTIVITY COMMISSION
• ISKUSTVO RODITELJA DAROVITOG DJETETA KAKO JE BITI RODITELJ DAROVITOG
• CARTA ALBĂ A BUNEI GUVERNĂRI 1 PROPUNERI PRIVITOARE LA
• COLEGIO PRÍNCIPE SAN CARLOS CÓDIGO FGF03 GESTIÓN DE FORMACIÓN
• REZIME PROGRAMA OBUKE NAZIV PROGRAMA OBUKE ”STRATEGIJA SUZBIJANJA VRŠNJAČKOG
• GSI ITALIA VIALE TRENTO E TRIESTE 65 06049 SPOLETO
• RES 379118 RESOLUCION ADOPTADA POR EL TRIBUNAL DE CUENTAS
• PROGRAMA DE ACOMPAÑAMIENTO PARA LA REALIZACIÓN DE LAS
• 4 STRENGTHENING THE INSTITUTIONS FOR REGIONAL WATER MANAGEMENT IN
• ENLACE KUTXA GAZTEDI – IZANEZBERDIN JARDUERAK – ACTIVIDADES
• CREO CREO EN MIS PROPIAS DUDAS Y EN MIS
• STUDENT STUDY TEAM RED FOLDER PROCESS EARLY INTERVENTION FOR
• TEST PSU FÍSICA 1 UNA ONDA ARMÓNICA SE PROPAGA
• HART’S CONCEPT OF LAW AND JUSTICE RAVINDRA KUMAR SINGH
• DEPARTMENT OF STATE GROWTH SECTION 610 STRUCTURAL CONCRETE
• SRA JIMÉNEZ TEL (206) 2306331 EMAIL EVELYNJIMENEZMISDWEDNETEDU
• REVISTA DIM NÚM 10 RESUMEN CRÍTICO DE LIBROS “ANATOLI
• HONORABLE ASAMBLEA LOS SUSCRITOS DIPUTADOS IRMA DOLORES ROMO SALAZAR