Project finance and international energy development
Section snippets
Defining project finance
The term project finance is potentially ambiguous since it encompasses two non-mutually exclusive concepts. Thus, it can refer to any set of financial structures used to fund project development, or to limited recourse loans, the subset of financial options that are commonly referred to as project finance loans.5
Project sponsors
The relevant literature stresses precisely those themes we have already identified as the defining characteristics of project finance, namely, that sponsors are attracted to limited recourse structures because they can shift or share risk and are able to maximise financial leverage. Several recent studies, by contrast, address such issues within the context of formal financial models thus eliminating the circularity inherent in more traditional explanations. In particular, these newer
Commercial banks
Commercial banks have long been providers of limited recourse loans, though it is equally true that the project finance market is dominated by a subset of the largest multinational banks that historically have accounted for the bulk of such lending. Moreover, the market is partitioned into banks that are predominately arrangers and those that are mainly providers of funds.10
Host governments
Host governments are attracted to project finance for the same reasons as are foreign direct investors, namely, it maximises leverage, transfers risk from sponsors to lenders, is self-contained and off-budget (Blaiklock, 1993, Blaiklock, 1998). In simplest terms, governments can acquire needed infrastructure (roads, ports or power stations) or other local projects without having to bear any or only minimal cost backed up by a higher degree of technical or operational efficiency than would
Project finance as a strategic option
The preceding discussion highlights the limitations inherent in traditional approaches to assessing the value-enhancing potential of project finance structures. Generally speaking, the best such approaches can achieve is to define the conditions under which limited recourse financing either makes sense or does not. Value creation potential is thus derived obliquely: if it makes sense to use project finance structures then implicitly the value to the sponsors must be greater than if alternative
Conclusion
In this paper we have tried to show that the more common explanations for choosing project finance over other debt options, either individually or collectively, are unconvincing. True, these approaches have succeeded in identifying a wide range of benefits connected with the use of project finance. But these are typically ancillary, not paramount. The main attraction of limited recourse loans in our opinion is the risk management features, in the narrow sense used above, that are inherent in
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This article is adapted from a set lectures given at the Institute of Banking Studies, Kuwait, May 1997. The author would like to thank Paul Dawson and Alan Webber, both of the City University Business School, for helpful comments on an earlier version of this paper. Dr Pollio has just completed a book on project analysis and financing with special reference to the energy and mineral industries.