Financing upstream developments

generally large companies and abandonment was a distant prospect. As the North
Sea basin matured, that type of financing largely became inappropriate for the
smaller fields which were then being developed. As long ago as the early 1990s
financing a portfolio of assets by way of a borrowing base facility began to become
established in the UK market as a more feasible and less cumbersome approach.
Funding a portfolio of assets is attractive to lenders as it de-risks the asset base; a
deterioration in reserves at one field may be offset by upside from another.
2.3

Continued appeal of the classic borrowing base facility

The borrowing base facility remains popular with borrowers today primarily because
of the flexibility and relatively favourable pricing that it provides. It enables
borrowers to raise financing based on the value of their assets, generally in the
United Kingdom on a P50 basis for producing assets and on a P90 basis for
development assets (see Section 3.3). In the US market, account is generally only ever
taken of P90 reserves. But that is at least partially balanced out as UK banks make
their calculations based on post-tax cash flows, whereas the US market looks at pretax cash flows. Borrowing base facilities are also attractive in that the facility is
revolving (ie repaid amounts can be re-borrowed) and will often permit expenditure
for general corporate purposes, so that the funds do not always have to be spent on
the assets supporting the financing. The net present value (NPV) of future cash flows
projected to be generated by the assets being financed is of central importance in
setting the amount of debt available. Assuming the net present value is adequate to
support the financing, the rest of the representation and covenant package is
relatively light compared to what would be found in a full-blown project financing.

3.

Basic principles of reserve-based lending

3.1

Cash-flow financing
The riskier a project, the more suitable it is for equity financing as opposed to debt
financing. Debt providers will only lend to projects with a sufficiently low risk profile
and clear cash flows to justify their expected fixed returns, whereas borrowers have
a higher and uncapped potential return on their equity contributions with a greater
appetite for risk. Borrowers can use hedging arrangements to underpin the cash flows
upon which a project depends, including hedging interest rates, currency exchange
rates or commodity prices, to make the financing more attractive to lenders.
Debt financing is dependent on stable cash flows and traditionally is not
appropriate for exploration and appraisal projects. With debt providers being keen to
secure relationships with new market entrants at an early stage in their business
cycle, in recent years pre-development assets have become capable of being debt
financed.

3.2

Calculation of net present values and related projections

RBL transactions essentially involve financiers lending against the net present value
of future cash flows projected to be generated from independently audited oil and
gas reserves of included fields. Calculation of the net present value and key financial

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