TOPIC:

MAIN PROJECT FINANCE MECHANISMS IN

THE UPSTREAM OIL & GAS INDUSTRY,
RISK AND PROJECT LIFE CYCLE EFFECTS
OF USING VENTURE CAPITAL FINANCE

Presentation By:
John K. Arthur
Theophilus Tawia

PRESENTATION OUTLINE
Introduction
Upstream Oil & Gas Industry
Project Finance Mechanism
Project Life Cycle in Oil & Gas Industry
Venture Capital Finance
Risk
Conclusion
References

INTRODUCTION
The Oil and Gas industry continues to face new
challenges in the search and development of new
production
The upstream Oil and Gas industry is very
capital intensive venture
Workforce diversity
Risky operations and Investment
High rewards

UPSTREAM OIL & GAS INDUSTRY

Exploration & Appraisal

i.
ii.
iii.

Beginning of cycle
Discover the oil and / or gas; ascertain
commerciality
Involves seismic data acquisition,
exploration and appraisal well drilling

UPSTREAM OIL & GAS INDUSTRY

(CONT.)

Development and Production

i.

Comprises field development planning;

development activities and full scale
production to surface

PROJECT FINANCE MECHANISM

What is Project Finance?

Project finance involves:

The creation of a legally independent project

company
Financed with
i.
Non-recourse debt
ii. Equity from one or more sponsoring
firms
For the purpose of financing an investment
in a single purpose capital asset.
Usually with a limited life

PROJECT FINANCE MECHANISM

(CONT.)
Why Project Finance?

1) To minimise the net cost associated with

market imperfections such as
a. Taxes
b. Incentives conflicts
c. Financial distress
d. Transaction cost
2) To manage risk more effectively and more
efficiently

PROJECT FINANCE MECHANISM

(CONT.)
Partners Involved
1.
2.

3.

Sponsors and investors involved in the

construction and management of the project.
Lenders needed finance is generally raised
in the form of debt from a syndicate of
lenders such as banks.
Government project company needs to
obtain a concession from the host
government.

PROJECT FINANCE MECHANISM

(CONT.)
Partners Involved
4.

Suppliers and Contractors role of

turnkey contract to make sure that
construction is completed within cost and on
schedule.

5.

Customers depending on the contract,

multiple or single contractor.

PROJECT FINANCE MECHANISM (CONT.)

Common Features of Project Finance

Capital Intensive
ii. Highly Leverage (15 20 years)
iii. Independent Entity with a finite Life
iv. Non-recourse or Limited Recourse Financing
v. Controlled Dividend Policy
vi. Many Participants
vii. Allocated Risk
viii. Favourable Task Treatment
ix. Special Purpose Vehicle
i.

PROJECT LIFE CYCLE

The Key Stages of a Project Life

(Petroleum Operations) are:
i.
ii.
iii.
iv.

Explore: to find it in the first place

Develop: the infrastructure to get it out
Produce: the petroleum you have found
Abandoned: when it runs out and
cleanup (decommission)

VENTURE CAPITAL FINANCE

This is a long term fund in equity to finance hi-tech
project (Upstream Oil & Gas)
It involves high degree of risk
Venture capitalist earns his returns from capital
gains
The objectives is to earn a high rate of returns

VENTURE CAPITAL FINANCE (CONT.)

Characteristics Features
i.
Investments are made in equity in hi-tech
industry and waits for 5-7 years to recap the
benefit of capital gains.
ii.
Investors do not interfere in day-to-day business
affairs but closely watches the business unit.
iii. The claim over the management is decided on the
basis of proportion to investment.

RISK
What is a risk?
1. The chance of lost
2. Dangerous element
3. Expose to danger
.

The analytic task begins with a broad spectrum

of risks to which lenders might be exposed.
Determining which risks the project can avoid
through allocation of those risks elsewhere

THREE MAJOR RISKS IN UPSTREAM

OIL & GAS INDUSTRY
1.

Commercial Risk:
i.
ii.
iii.
iv.
v.
vi.

Completion risks
Operating risks
Revenue risks
Input supply risks
Force Majeure risks
Sponsor Support Risk

THREE MAJOR RISKS IN UPSTREAM

OIL & GAS INDUSTRY (CONT.)
2.

Financial Risk:

Exchange Rate
ii.
Interest Rate
iii. Other Market Risk not directly related to the
project
i.

THREE MAJOR RISKS IN UPSTREAM

OIL & GAS INDUSTRY (CONT.)
3.

Political Risk:
i.

ii.

Role of expropriation, currency convertibility and

transferability, political violence (war, sabotage and
terrorism).
Risk of unanticipated changes in regulations or
failure by the government to implement tariff
adjustment because of political consideration.

ALTERNATIVES SOURCES OF RISK

MITIGATION
RISK

SOLUTION

Completion risk

Contractual guarantees from

manufactures, selective vendors
of repute.

Price risk

Hedging

Resource risk

Keeping adequate cushion in

assessment

Operating risk

Making provision, insurance

Environmental risk

Insurance

Technology risk

Expert evaluation and retention

accounts

CONCLUSION
This type of funding is not right for everyone.
Those companies who have high growth potential
such as Oil and Gas and other hi-tech ventures
are the ones who fare best with venture capital
funding.
Project finance, as an organisational risk
management tool, reduces the potential collateral
damage that a high risk project can impose on a
sponsoring firm, i.e risk contamination. It also
reduces the costs of financial distress and solves
a potential under investment problem.

REFERENCES
Amit, A.R., J. Brander, and C. Zott (1998). Why do
venture capital firms exist? Theory and Canadian
evidence, Journal of Business Venturing 13, 441-466.
Bascha, A., and U. Walz (2001a). Convertible securities
and optimal exit decisions in venture capital finance,
Journal of Corporate Finance 7, 285-306.
Black, B.S., and R.J. Gilson (1998). Venture capital and
the structure of capital markets: banks versus stock
markets, Journal of Financial Economics 47, 243-277.
Casamatta, C., and C. Haritchabalet (2003). Learning
and syndication in venture capital investments,
Working paper 3876. CEPR.

REFERENCES (CONT.)

Rajan, R.G., and L. Zingales (1995). What do we know

about capital structure? Some evidence from
international data, Journal of Finance 50, 1421-1460.

THANK YOU