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2 ’~
(Class 1)
Chapter 2
This chapter reviews the factors behind the recent rapid growth of project finance
(cf. §2.1), its distinguishing features (cf. §2.2), and relationship with privatization
(cf. §2.3), and also with other forms of structured finance (cf. §2.4). Finally, the
benefits of Using project finance are considered from the point of view of the vari-
ous project participants (el. §2.5).
§2.2 FEA
a relatively predictable cash flow, has played an important part in providing the
funding required for this change, Project f
Some successive waves of project finance can be identified: from deal tc
¯ Finance for natural resources projects (mining, oil, and gas), from which deal has its
modern project finance techniques are derived, developed first in the Texas lying th~
oil fields in the 1930s; this was given a considerable boost by the oil price in-
creases, and the development of the North Sea oil fields in the 1970s, as well * It is pr,
as gas and other natural resources projects in Australia and various nomic~
developing countries. compm
o Finance for independent power projects ("IPPs") in the electricity sector (pri- ° It is us
marily for power generation) developed first after the Private Utility Regula- though
tory Policies Act ("PURPA") in the United States in 1978, which encouraged o There i
the development of cogeneration plants, electricity privatization in the ¯ speakit
United Kingdom in the early 1990s, and the subsequent worldwide process ° There ;
of electricity privafization and deregulation. recour~
o Finance for public infrastructure (roads, transport~ public buildings, etc.) was for the
especially developed through the United Kingdom’s Private Finance Initia- , Lender
tive ("PFI") from the early 1990s; such projects are now usually known as for inte
public-private partnerships (’qPPPs"). sets or
¯ Finance for the explosive worldwide growth in mobile telephone networks o The m~
developed in the late 1990s. owners
An analysis by industry sectors of the project finance loan commitments pro- assets ~
vided by private-sector lenders in recent years illustrates these trends (Table 2.1). a defau
The effects of recent electricity deregulation in parts of the United States and the
upsurge in worldwide investment in mobile phone networks are especially evident t For examp
in these figures. The steady growth in PPP-related project finance (infrastructure at $145 billion,
§2.2 Featul~sofProjectFinance
and real estate) is also notable. (For a fuller analysis on a geographical basis, cf.
Chapter 3.)
2001
Assuming that debt averages 70% of total project costs, in 2001 on the basis of
these figures some $190 billion of new investments worldwide were financed with
64,528 project finance from private-sector lenders.
25,445 It should be noted that these statistics do not include direct lending for projects
14,473
12,638
by export credit agencies and multilateral development banks (cf. Chapter 11)
6,530 or other public-sector agencies. In addition, because (a) it is debatable whether
3,898 certain structured finance loans should be classified as project finance or not
3,646 (cf. §2.4), and (b) the borderline between project finance and financing projects
2,323 (cf. Chapter 1) is not always clear, market statistics compiled by different sources
133,481 can vary considerably;1 however, the overall trends in and scale of project finance
y 28, 1998), are reasonably clear.
,2002).
The project finance debt has first call on the project’s net operating cash flow; the either co:
equity investors’ return is thus more dependent on the success of the project. thi
The contracts entered into by the Project Company provide support for the st~
project finance, particularly by transferring risks from the Project Company to the rat
§2.3 Project Finance and Privatization
other parties to the Project Contracts, and form part of the lenders’ security pack-
age. The Project Contracts may include the following:
. A Project Agreement, which may be
either an Off-take Contract (e.g., a power purchase agreement), under which
the product produced by the project will be sold on a long-term pric-
ing formula
or a Concession Agreement with ~he government or another public au-
thority, which gives the Project Company the right to construct the
project and earn revenues from it by providing a service either to the
public sector (e.g., a public building) or directly to the general public
(e.g., a toll road)
port Alternatively, the project company may have a license to operate under the
terms of general legislation for the industry sector (e.g. a mobile phone
network).
o Other project contracts, e.g.:
. A" turnkey Engineering, Procurement and Construction (EPC) Contract,
under which the project will be designed and built for a fixed price, and
completed by a fixed date
,r O~h~r . An Input Supply Contract, under which fuel or other raw material for
u~ofity the project will be provided on a long-term pricing formula in agreed
quantities
¯ An Operating and Maintenance (O&M) Contract, under which a third party
will be responsible for the running of the project after it has been built
o A Government Support Agreement (usually in a developing country),
*f the con- which may provide various kinds of support, such as guarantees for the
~ the proj- Offtaker or tax incentives for the investment in the project.
Project Agreements are discussed in detail in Chapter 6 and other Project Con-
~arily lent tracts in Chapter 7. Of course none of these structures or contractual relationships
past cash are unique to project finance: any company may have investors, sign contracts, get
tsiness for licenses from the government, and so on; however, the relative importance of these
matters, and the way in which they are linked together, is a key factor in project
.11 of these finance.
e likely to
provides for services to be supplied by a private company that had pre- company-
viously been supplied by the public sector (e.g., street clemKng)u remains ~
again, this does not necessarily involve project finance: the private com- Build-transl
pany may not have to incur major new capital expenditure and so not ect, excep
require any finance at all, or may use a corporate loan to raise the finance ect until c
to make the investment required to provide the service. Build-own-,
ship rema
Project finance may come into the picture if a company needs finance for the con- a power s
struction of public infrastructure on the basis of a contract or licence, e.g.: work. Th~
An Off-take Contract, based on which a project will be constructed to sell its in the pro~
output to a public-sector body (e.g., construction of a power station to sell into this c
electricity to a state-owned power company) There are ot
A Concession Agreement under which a project will be constructed to pro- and the projec
vide a service to a public-sector body (e.g., provision of a public-sect.or hos- example, "BO~
pital building and facilities) as "BOOT."
A Concession Agreement under which a project will be constructed to pro- Clearly a Pr,
vide a service to the general public normally provided by the public sector whether or not
(e.g., a toll road) the short or the
A Concession Agreement or licence under which a project will be con- or is never hek
structed to provide new services to the public (e.g., a mobile phone project finance
network). in this way is nc
from the
Such Project Agreements with the public sector, which provide a basis for proj- importanc~.~
ect finance, can take several different forms: in a BOO but
Build-own-operate-transfer ("BOOT") projects: The Project Company vestors in asses
constructs the project and owns and operates it for a set period of time, earn-
ing the revenues from the project in this period, at the end of which owner-
§2.4 PROJI
ship is transferred back to the public sector. For example, the project com-
pany may build a power station, own it for 20 years during which time the
Although th
power generated is sold to an Offtaker (e.g., a state-owned electricity distri-
market calls "
bution company), and at the end of that time ownership is transferred back
"building bloc~
to the public sector.
example:
Build-operate-transfer (’’BOT") projects (also known as design-build-
finance-operate ["DBFO"] projects). In this type of project, the Project ° K the pro~
Company never owns the assets used to provide the project services. How- (e.g., oil),
ever the Project Company constructs the project and has the right to earn rev- * A toll-roa,
enues from its operation of the project. (It may also be granted a lease of the o A project
project site and the associated buildings and equipment during the term of date-terra
the project--this is known as build-lease-transfer ("BLT") or build-lease- * A mining
operate-transfer ("BLOT"). This structure is used where the public nature to extract ~
of the project makes it inappropriate for it to be owned by a private-sector the marke
§2.4 Project Finance and Structured Finance 11
h owner-
ect corn- §2.4 PROJECT FINANCE AND STRUCTURED FINANCE
time the
Although there are general characteristics or features to be found in what the
.ty distri-
a-ed back market calls "project finance" transactions, as already mentioned, all of the
"building blocks" shown in Figure 2.1 are not found in every project financing, for
example:
~-build-
~ Project If the product of the project is a commodity for which there is a wide market
es. How- (e.g., oil), there is not necessarily a need for an Off-take Contract.
earn rev- A toll-road project has a Concession Agreement but no Off-take Contract.
ase of the A project for a mobile phone network is usually built without a fixed price,
e term of date-certain EPC Contract, and has no Offtake Contract.
ild-lease- A mining or oil and gas extraction project is based on a concession or license
lJc nature to extract the raw materials, but the Project Company may sell its products into
ate-sector the market without an Offtake Contract.
12 Chapter 2 What Is Project Finance?
¯ A project that does not use fuel or a similar raw material does not require an Leverag~
Input Supply Contract ~:, This h
¯ Government Support Agreements are normally only found in projects in de- ~ busine
ve!oping countries. !i~i~ . 1S USU~
of its ~
There is, therefore, no precise boundary between project finance and other projec
types of financing in which a relatively high level of debt is raised to fund a busi- ect fin
ness. The boundaries are also blurred as transactions that begin as new projects Acquisi!
become established and then are refinanced, with such refinancing taking on more tion fil
of the characteristics of a corporate loan. .. debt. 1
Lenders themselves draw the boundaries between project finance and other combi
types of lending based on convenience rather than theory, taking into account that Asset fn
skills used by loan officers in project finance may also be used in similar types of easily
financing. Many lenders deal with project finance as part of their "structured nanch
finance" operations, covering any kind of finance where a special-purpose vehicle by the
(SPV) like a Project Company has to be put in place as the borrower to raise the Leasing
funding, with an equity and debt structure to fit the cash flow, unlike corporate financ
loans, which are made to a borrower already in existence (cf. §5.1). As a result,
project finance market statistics have to be treated with some caution, as they may
be affected by inclusion or exclusion of large deals on the borderline between proj- §2.5
ect finance and other types of structured finance.
Examples of other types of structured finance and their differences from proj- A pr.oie~
ect finance include the following: rather(
Receivables financing. This is based on lending against the established cash its avaa,,
flow of a business and involves raising funds through an SPV similar to credit line,’
a Project Company (but normally off the balance sheet of the true benefi- finance). P
ciary of the cash flow). The cash flow may be derived from the general busi- ings recorc
ne.ss (e.g., a hotel chain) or specific contracts that give rise to this cash flow and cheap
(e.g., consumer loans, sales contracts, etc.). The key difference with project A Proj~
finance is that the latter is based on a projection of cash flow from a project serve as th,
yet to be established. that they v
Although telecommunication financing is often included under the head- high level
ing of project finances it has few of the general characteristics shared by need to ha
other types of project finance. It could be said to come halfway between such time and
receivables financing and "true" project finance, in that the financing may (c) that th,
be used towards construction of a project (a new telephone network), but their debt
loans are normally not drawn until the initial revenues have been established cover any
(cf. §8.8.7). Thus tt
Securitization, If receivables financing is procured in the bond market (cf. these pro~
§5.2), it is known as securitization of receivables¯ (There have also been a tify the
few securitizafions of receivables due from banks’ project finance loan project
books, but so far this has not been a significant feature in the market.) or, where
Project Finance? §2.5 Why Use Project Finance? 13
hat the public tion), the umegulated business can be shown to be financed separately and
of economic or on an arm’s-length basis via a project finance structttre.
Additional inward investment. For a developing country, project finance
a long-term Pro- opens up new opportunities for infrastructure investment, as it can be used
is way is merely to create inward investment that would not otherwise occur. Furthermore,
[ therefore be in- successful project finance for a major project, such as a power station, can
~ument is a valid act as a showcase to promote fttrther investment in the wider economy.
[ormed real proj- Technology transfer. For developing countries, project finance provides a
way of producing market-based investment in infrastructure for wbSch the
risks of, for ex- local economy may have neither the resources nor the skills.
:e sector. It also
~ance objectives
~k that these are
br projects that
sector (cf. §2.3).
PP projects also
run such invest-
allowing for the
" "gold-
~t of project con-
)etter able to of-
n and operation
e project, rathei
. the availability
i.e., increases in
fications for the
~m the indepen-
~nders, who will
nent are clearly
a risk issues.
deals only with
lar project), the
,ured and moni-
power distribu-
introduction
The scope of project finance both changed and expanded in the 1990s. The growing need
for power and other infrastructure facilities increased the demand for project financing,
while the sources of project finance broadened to include the capital markets. Financial
tools such as pooling, securitisation and derivatives provided new ways to mitigate project
risks. As investors and lenders became more familiar with project finance, they showed
increasing risk tolerance. As a result, the boundaries of project finance have widened. In
the mid-1990s banks and institutional investors financed projects with structures and terms
that would have been hard to imagine just five years before. The total world_wide volume
of p)oject finance increased rapidly from 1994 to 1997, lessened after the ~sian financial
crisis in 1997 and then increased to a new high ~n 21300. Project finance then dechned once
again along with the collapse of equities, particularly in technology and telecommunica-
tions; the related decline in technology and telecom capital expenditures; and the Enron
bankruptcy and associated scrutiny of power companies’ trading activities and balance
sheets (see Exhibit A).
Project Finance: Practical Case Studies consists of 38 case studies of recent project
financings. This first volume covers power and water (irrigation) projects, and Volume II cov-
ers resources and infrastructure projects. The project case studies were selected to exhibit the
types of projects most frequently financed in a variety of countries. Because these case stud-
ies illustrate different aspects of project finance across the major geographical areas, the
nature of their content varies considerably. For example, some contain a detailed description
of project documentation while others do not cover documentation at all. Some power pro-
Exhibit A
Global facility-type breakdown for project financings closed, 1994-2002
Loan Bond Sponsors’ Average
amount Per amount Per equity Per Total Number deal size
(US$ cent (US$ cent (US$ cent (US$ of (US$
~ar millions) of total millions) of total millions) of total millions) deals millions)
Exhibit B
Summary of projects by industry and geographical area
Europe Latin
( inchtding America
the United (including North Multi-
Africa Asia Kingdom) Mex(co) America national
Power projects/portfolios 1 6
Power and water (irrigation) 1
Pipelines 1 ,3
Mines 3 2
Oil field 1
Refinery 1
Toll roads 3 1
Airports 1 1
Telecom 2 1
ject case studies are concerned primarily with negotiating contracts in countries that are just
beginning to privatise their electricity sectors, while others concentrate on ne@ financing
techniques and adapting to a merchant power environment.
The case studies in these volumes cover a broad range of industries and geographical
areas as illustrated in Exhibit B.
Industry sectors
Volume I- Power and Water covers issues such as the privatisation and deregulation of the
electricity industry, adaptation to merchant sales and pricing environments, negotiating initial
independent power projects in developing countries, political risk, recent financing innova-
tions, and the worldwide ripple effect of the California power crisis and the Enron bankrupt-
cy, including the pullback of large international power players.
In Vohtme I1 - Resources and Infrastructures, the pipeline project case studies discuss
the increasing willingness of both the bank and capital markets to take risks in a developing
country; the requirements for multilateral agency participation; and the need to address envi-
ronmental, social, and sustainability issues. The oil fieId production project case study
demonstrates how the credit rating of a solid export-oriented project with strong sponsors
can pierce the sovereign ceiling of a country with political difficulties. Similarly, the refin-
ery case study presents an example of a project with pure emerging-market risk that can sur-
vive in a difficult economic environment. The mining project case studies demonstrate
sensitivity to commodity price risk, the negotiation of a basic legal structure with a host gov-
ernment, and the construction and operating difficulties involved. The toll road project case
studies outIine bridge construction challenges, and issues related to the respective roles of
the government and the private sector in assuming construction and traffic risks, a flexible
repayment mechanism to cope with traffic risks, and problems when traffic does not meet
projections. The airport case studies present an example of a whole-business securitisation,
and describe difficulties related to lower-than-projected passenger traffic and ongoing nego-
tiations with the government on concession issues. Finally, the three telecommunications pro-
INTRODUCTION
For lenders and investors the essence of project finance is the analysis of project risks,
including construction risk, operating risk, market risk (applying to both inputs and outputs
of a project), regulatory risk, insurance risk and currency risk. These risks often are allo-
cated contractually to parties best able to manage them through construction guarantees,
power purchase agreements (PPAs) and other types of output contracts, fuel and raw mate-
rial supply agreements, transport contracts, indemnifications, insurance policies, and other
contractual agreements. However, with projects in all sectors, sponsors, lenders and bank
investors are exposed to significant market risk. Although recourse to sponsors is usually
limited, they often provide credit support to the project through guarantees or other con-
tractual undertakings. For example, an industrial sponsor of a cogeneration project may
contract to buy steam from a project and another sponsor may contract to sell power to it.
Sponsors’ economic interests in the success of a project make impressive contributions to
the project’s creditworthiness. ~"
Project financing generally is done without recourse to project sponsorsl, ancj projects
are often, but not always, off corporate sponsors’ balance sheets. As it does with a sub-
sidiary, a sponsor includes a project’s assets and liabilities on its balance sheet when a pro-
ject is consolidated. When the equity method of accounting is used the sponsor’s
investment in a project is shown as a single amount on its balance sheet, and/gains or loss-
es on the project are shown as a single amount on its income statement. A sponsor gener-
ally uses the equity method to account for an investment in a project where it owns less than
50 per cent but can still influence its operating and financial decisions. If a sponsor has less
than a 20 per cent interest in a project it is presumed to lack significant influence over the
project’s management and neither consolidation nor the equity method is required.
Presumably, a sponsor’s investment in a project and the related income or losses would be
combined with other items on its balance sheet and income statement. It would be consid-
ered good practice o.n the part of the sponsor to include some mention of the project invest-
ment in the footnotes, particularly given the emphasis on disclosure and transparency in
today’s post-Enron environment.
Sources of capital
Historically, commercial banks have provided construction financing for projects, while insur-
ance companies have provided take-out financing with terms of 20 years or more. Banks have
been relatively more comfortable with construction risks and short-term loans, while insurance
companies have been more comfortable bearing the long-term operating risks after construc-
tion has been completed and the project has demonstrated its capability to run smoothly.
In the early 1990s, however, the investor base for project finance began to broaden. It
now includes institutional investors, such as pension and mutual funds, and investors in tffe
public bond markets in a growing number of countries around the world. %vo~important
developments made institutional investors more receptive to project finance investments than
they had been in the past: a ruling by the US Securities and Exchange Commission (SEC),
and the issuance of project credit ratings by the major credit rating agencies. /
SEC Rule 144a allows the resale of eligible, unregistered securities to qualified institu-
tional buyers and eliminates the requirement that investors hold on to securities for two years
before selling them. Recently, sponsors of some large power projects have aimed their financ-
ing solely at the institutional 144a market. Others have been able to reduce their financing
costs by committing themselves to full registration for sale in the pubic markets within six
months after their 144a securities are issued, thereby providing a more liquid market for the
institutional investors that hold the securities.
With respect to project credit ratings, as the capital markets became an important source
of funding the amount of rated project debt grew rapidly. For example, in 1993 Standard &
Poor’s (S&P) portfolio of rated project debt was US$5.8 billion. The agency then established
a project rating team in 1994. By mid-1996 it had rated US$16.3 billion and. by the end of
2002 US$106 billion of project debt had been rated. Debt rated by the two other leading cred-
it rating agencies, Moody’s and Fitch Ratings, has grown in a similar fashion.
Privatisation
This is a worldwide trend that both reflects political currents and provides a way to supply
needed infrastructure in the face of government budgetary limitations. Variations on this
trend include public/private partnerships, notably the Private Finance Initiative in the
United Kingdom.
Financial innovation
As innovations are made in other financial disciplines, such as leasing, insurance and deriv-
atives-based financial risk management, they are applied quickly to project finance.
7
POWER AND WATER
Insurance
The role of insurance in project finance has increased steadily in. recent years. Historically,
the insurance industry has provided property and casualty coverage, and political risk cover-
age. Recently, insurers have become more active in covering completion risk, operating risk,
off-take risk and residual value risk.
Residual value insurance, for example, can help sponsors and lenders to refinance risk
when projects require loan pay-outs with longer terms than are available in the bank market.
If a balloon payment (the repayment of most or all of the principal at maturity) is not made,
or a project cannot be refinanced and the loan goes into default, the lender can seize the asset.
If liquidation proceeds are less than the amount of residual value coverage, a claim for the
difference can be made against the policy.2
Highly rated insurance companies with dynamic risk management capabilities can close
the gaps in capital structures of projects exposed to market risks. For example, in 1999 Centre
Group guaranteed the subordinated debt tranche for the Termocandelaria merchant power
project in Colombia. If the project’s cash flow was insufficient to make a debt payment, the
insurance company agreed to step in and make that payment. An insurer can provide a take-
out guarantee for project lenders when a PPA matures before a loan. Insurers can guarantee
that a project receives a minimum floor price, regardless of what happens to the market price
of its output. Insurers can provide standby equity and subordinated debt commitments and
residual-value guarantees for leases.3
The events of 11 September 2001 exacerbated an already difficult insurance market and
created a new problem for the insurance industry: how should exposure to terrorism be man-
aged? The combination of reduced capacity, underwriter defections and shock losses from 11
September has, at the time of writing, created one of the most difficult insurance markets in
history. Among the implications for project sponsors are increases in deductibles, which
require projects to assume additional risk; the reduced availability of coverage for terrorism,
new or unproven technologies, and catastrophic perils, such as earthquakes and floods; and
substantial premium increases.4
Over recent years the credit ratings of many infrastructure bond deals have been raised
to the ’AAA’ level by guarantees or ’wraps’ AAA-rated monoline insurance companies.
However, as the monoline insurers themselves have diversified from their US municipal bond
base their own risks have increased, beading to higher spreads on monoline-wrapped paper.
An emerging trend in project and concession financing is the use of targeted risk cover-
age, a structured financial mechanism that shifts specifically identified project risks to a third
party, such as a multiline insurance or reinsurance company, a designated creditor, or, con-
ceptually, any party that is willing to assume those risks, including project sponsors. The fol-
lowing have been among recent applications of targeted risk coverage:
INTRODUCTION
revenue risk mitigation, including coverage against commodity pricing risk, revenue
guarantees for toll road projects and coverage against default of offtakers;
substitutes for liquidity mechanisms, such as fully funded debt-service reserves and
standby letters of credit; and
political risk coverage.
Contingent capit~il is ~t form of targeted risk coverage that can reduce a project’s cost of
financing. The insurer provides a facility under which capital is injected into the project in the
form of debt, equity or hybrid securities upon the occurrence of a predefined trigger event or
set of dvents. In this way contingent capital allows the project to increase its capital base only
when necessary, thereby increasing its return on invested capital.5
Recent crises in Asia, Latin America and Eastern Europe have reminded lenders and
investors that political/economic events do not merely have the potential to cause losses, but
actually cause them, according to Gerald T. West, Senior Advisor at the Multildteral
Investment Guarantee Agency in Washington, DC.6 These events have stimulated the
demand for political risk insurance, leading to expanded coverage and new products from
multilateral agencies, national agencies and private insurance providers. In recent years pri-
vate insurers have lengthened the terms of their coverage and increased their shar~ of the
political risk insurance market. Recent innovations include capital markets political risk
insurahce, which can be used to raise the credit ratings of bonds that finance projects in
emerging markets.
Bank capabilities
The number of financial institutions with broad project finance syndication capabilities is
shrinking, as is the number with specialised project finance groups. Institutions with broad
geographical scope and with both Commercial and investmentbanking capabilities have a
competitive edge in today’s market.
Rating triggers
The fall of Enron and numerous recent power company defaults have been caused by ’rating
triggers’, which are provisions in loan agreements that define credit-rating downgrades below
certain levels, often the minimum investment-grade level, as events of default.
Merchant power
Because of power price volatility and other recent market events, merchant power business-
es have been downgraded by credit rating agencies and have had increasing difficulty in rais-
ing new financing.
Refinancing of mini-perms
In the past several years, numerous merchant power plants have been financed by four-to-six-
year ’mini perm’ bank loans. Refinancing these loans will be a challenge in the current envi-
ronment. S&P notes that to do so power companies may be required to put up increased
equity, structure cash sweeps and provide increased security.8
10
INTRODUCTION
Regulation of trading
As abuses such as power swaps transacted simply to inflate the revenues of counterparties
come to light, attempts are being made to reign in the largely unregulated energy trading mar-
ket. For example, in the summer of 2002 Richard Green, Chairman of Aquila, testified before
the US Senate Agriculture, Nutrition and Forestry Committee in favour of more regulation
and overseeing of the energy derivatives trading market, to remove uncertainty and increase
competitive power price transparency. He was in support of a bill introduced by Senator
Dianne Feinstein that would mandate the US Commodity Futures Trading Commission
(CFTC) and the Federal Energy Regulatory Commission (FERC) to oversee all energy trans-
actions with respect to fraud, and to require all energy derivatives trades to be subject to reg-
istration, reporting, disclosure and capital requirements. (It is noted in the Panda-TECO case
study, in Chapter 13, that later in 2002 Aquila decided to withdraw from energy trading and
return to its roots as a traditional utility, having acknowledged its own difficulty in managing
risk and malting a profit in this volatile and shrinldng market.)
11
POWER AND WATER
Telecoms meltdown
The bankruptcy described in the FLAG (Fiberoptic Link Around the Globe) case study (see
Voh, me H - Resources and Infrastructure) illustrates problems faced by highly visible under-
sea cable competitors, such as Global Crossing and other recent projects, throughout the
telecommunications industry. Aggressive network expansion financed with high leverage
may have been a viable strategy while internet use, telecom traffic and related capital spend-
ing were growing rapidly, but when the telecom market collapsed FLAG and many other tele-
com projects did not have the cash flow to service their debt.
Effect of Enron
Many trends in project finance over the past year have been related to the collapse of Enron.
The role of off-balance-sheet, special-purpose entities in Enron’s loss of confidence and sub-
sequent bankruptcy has led some to question what the proper boundaries of project finance
are. However, a survey that the author conducted for an article in The Journal of Structured
and Project Finance (Spring 2002) found traditional project finance to be alive and well, and
not adversely affected by the Enron debacle.
The Enron bankruptcy and related events have changed neither the nature nor the use-
fulness of traditional project finance, but they have led to a slowing down Of some of the
more innovative forms of structured project finance. Among the other direct and indirect
effects of Enron have been increased caution among lenders and investors about the energy
and power sectors; increased scrutiny of off-balance-sheet transactions; increased emphasis
on counterparty credit risk, particularly with regard.to companies involved in merchant
power and trading; and deeper analysis of how companies generate recurring free cash flow.
There is now increased emphasis on transparency and disclosure, even though disclosure in
12