Project Finance: How it works and major projects

Link I posted in a previous post Reinsurance is used as risk management in  Project Finance. There are 2 main types of Reinsurance Treaty and Facultative.

Before let me cover some basic terms. Reinsurance is used by insurance companies as a means of risk management where a  primary insurance company sells a policy or policies to a reinsurance company. This is used to prevent risk, move out of risky markets, protect the primary’s credit ranking and stock price, and allow the coverage of lager risky projects.

Primary Insurer: The company that originally wrote the insurance policy.

Reinsurer:  The company that buys the policy from the Primary Insurer.

Treaty Reinsurance: An agreement in advance where all the lose exposures are cover that fall within the Treaty. It is a portfolio of loses. So this can be the whole construction process of a project. Lets say that a primary insurer covers the construction process for a nuclear power plant in Japan, but feels that Japan is too risk and wants to cover all of its polices for the project. Treaty reinsurance allows this so that not one insurance company takes the whole risk, but Two or more cover the losses (you can have more than one reinsurance company cover the losses).

Facultative Reinsurance: This is a separate agreement that the primary insurer wants covered. This covers one aspect. Using the Japan example above lets now say that the primary insurance company wants to cover the transportation of material rather than the whole construction process. Facultative Reinsurance will be used which just covers that single part.

If you would like to learn more about reinsurance I suggest buying the book Reinsurance Principles and Practices 1st Edition by Connor M. Harrison

Picture from: http://www.flickr.com/photos/ian_munroe/3384156664/sizes/m/in/photostream/

I have created a slide show about the history of project finance which can be found by the link at the bottom. Project finance was used over hundreds of years ago and did not become widely used until the late 1980′s earl 1990′s. The main reason for the massive gap is a lack of technology. Today there are more sophisticated computers that can predict cash flows and risks which make project a good solution for infrastructure.

Slide Show

Information in the slide is based on information found at http://www.navigatorpf.com/tutorials/what-project-finance

Picture From: http://www.flickr.com/photos/baroquem/3745789971/

Today I will talk about news with the European Banks with information provided by the blog Dealbreaker.com written by Matt Levine.

Europe has been a hot topic for a while. With new technology and the financial crash in 2008 people are noticing just how sensitive markets are. Notice that in the past news about Greece would affect stock prices in the United States and all over the world. This affects project finance too because investors are pulling all of their money out risky investments and moving to safer alternatives.

In the article Europe Will Try To Make Its Banks’ Creditors Play Nicer With Each Other explains “bail-in”.

the best way to preserve value not only for the enterprise but also for the creditors is to write down some of the debt to allow the company to continue as a going concern that can pay off the rest of the debt.

This is why we have bankruptcy, but bankruptcy seems to be too slow and scary for banks. The worry is, you have a bank and it’s got like $15 of equity and $100 of debt and its assets go from $115 to $90 and all of the debt holders start looking at their watches and being all “hey this has been fun but I’m actually late for this thing so would it be too much trouble for you to give me my money back?” and the bank has to sell a bunch of stuff to meet those demands…

This causes banks to operate at lower level and loss lager amounts of capital which has a ripple affect on markets all over the world.
The article explains 3 ways to make a bail-in work.

(1) insured deposits (obvs),
(2) secured liabilities to the extent of security, including repos and stuff (also obvs), and
(3) liabilities with an original maturity of less than one month, which, much less obvs, but you can see the point of it, which is basically that banks fund cheaply

Hopefully this system works and stocks continue to rally like today.
http://dealbreaker.com/2012/03/europe-will-try-to-make-its-banks-creditors-play-nicer-with-each-other/

Photo from: Mkaldani at interfacelift.com  http://interfacelift.com/wallpaper/D1b115b8/02876_bluehour_1280x1024.jpg

Here is a Tree List of the different types of Reinsurance the two main ones are Treaty and Facultative. I will go more in-depth with the differences of these 2 types in another post. Reinsurance allows risk management for various types of projects and gives investors and insurance companies a less likely chance of experiencing massive losses.

Why do they matter?

Because they are in almost everything you use like computers, lighting, cars, cell phones, TVs, and so on. Most of earth’s rare metals come from China, about 97%. In a previous blog post I talked about Mongolia and the mining that is going to happen there. One of the main buyers of Mongolia’s earth metals will be China.

I figured to talk about rare earth metals, because there is a lot of debate about them. One, mainly in the computer industry, because China has so many and there are only a limited number. Two, in most places the mining of them does more damage than good to the local people.

List of all the Rare Earth Metals:

21. Sc – Scandium – used in aerospace

39. Y – Yttrium – Microwave filters and colors in TV

57. La – Lanthanum – Hydrogen storage

58. Ce – Cerium – Polishing powder

59. Pr – Praseodymium – Flint products

60. Nd – Neodymium – Violet colors in glass and ceramics

61. Pm – Promethium – Nuclear batteries

62. Sm – Samarium – neutron capture

63. Eu – Europium – mercury vapor lamps

64. Gd – Gadolinium – Computer memories

65. Tb – Terbium – Fluorescent Lamps

66. Dy – Dysprosium – Rare earth magnets

67. Ho – Holmium – Lasers

68. Er – Erbium – Vanadium steel

69. Tm – Thulium – X-ray machines

70. Yb – Ytterbium – Infrared lasers

71. Lu – Lutetium – PET scan detectors

Photo from: http://www.flickr.com/photos/home_of_chaos/5161384110/

Now let’s look at Project Finance from a different point of view, from the insurance companies. As you can image there are all sorts of catastrophic losses involved with Project Finance whether it is a space station, nuclear power plant, water utility, and so on. About a year ago Japan was hit by a massive earth quack that destroyed a lot of projects like nuclear power plants. Imagine that one insurance company covered all of these nuclear power plants in Japan. The company would go bankrupt and investors in the project will lose everything they have put in. One way to prevent this is with reinsurance.

Reinsurance is a way for insurance companies to protect themselves from massive losses by selling their policies. Their are companies that deal with reinsurance such as Willis Re, Towers Watson has a massive department, TOA Re, and so on. These companies buy insurance policies after analyzing them.

There are six principal functions of reinsurance:

1. Increase large line capacity – A max amount that an insurance company can accept in polices.
2. Provide catastrophic loss – If a loss, like in Japan, happens then the loss is spread over the primary insurance company and the reinsurance or multiple reinsurance companies.
3. Stabilize loss experience – protects companies from losing stock value or losing their credit rating.
4. Provide surplus relief – during periods of rapid growth some insurance companies may be forced to slow down because they cannot cover all of their polices. Reinsurance allows them to grow by selling off some of their policies.
5. Facilitate withdrawal from a market segment – If a market becomes too risky, like Japan, an insurance company can sell all of its policies.
6.  Provide underwriting guidance – insurance and reinsurance companies working together to value risks.

I will talk more about types of reinsurance in other blog posts. Its good to understand how risk is managed behind the scenes.

Picture from: http://www.flickr.com/photos/martini_dk/369891979/

This is a water utility plant sponsored by Latinaguas in the country of Argentina. Latinagues is a pioneer in the private management of public water and sanitation. They serve over 130 locations in Latina America. This company is very big in Latina America and Aguas de la Rioja is just on of its projects. Aguas de la Rioja was start in April 2002 and its termination year is in 2032. This project will require funding until its end in 2032. The investment commitments in physical assets are 67 million dollars US. This is not including upkeep and so on. Latinagues owns 100% of the utility and is responsible to damages and moving the project forward. Aguas de la Rioja gives clean water to over 280,000 people in 2005 and is in an area where water is very scarce.

This project is very helpful to the people in the region of Rioja by providing fresh water and sewerage services. This project is an example of how important Project Finance is for people of less fortunate areas. This project should make the area more stable and prevent the spreading of disease.

It is always important to understand who is creating projects and why they are being created. Sometimes you have to read in between the lines to understand why some projects are in place. This project is an example of something positive that is for the elevation of mankind.

If you are interested in the company Latinagues I have attached a link to their website at the bottom. I have also attached another link to a question and answer with Raul Martinez Aguas de la Rioja general manager.

http://www.latinaguas.com/empresa_rioja.php

http://www.bnamericas.com/news/waterandwaste/Q*A:_Aguas_de_la_Rioja_general_manager_Raul_Martinez

Picture From: http://www.flickr.com/photos/thejourney1972/3474219882/

This video explains how to create a Project Finance model.

Key ingredients in a Project Finance Model are the following: 1. Assumptions 2. Construction related assumptions 3. Operations 4. Financing 5. Cash flow. This video also provides some Excel tips can be very useful down the road.

These video should make it easier to understand some of the planning and understanding involved in Project Finance. This is a very basic financial model.

Videos from: http://www.youtube.com/watch?v=FnFmO2dPqDQ

http://www.youtube.com/watch?v=yCKwg8fuyW8

Milbank a leading international law firm founded in New York in 1866. This is where some of the main players in Project Finance go to for laws around the world. This law firm has offices all over the world from the New York to Tokyo Japan. One of the most difficult tasks in Project Finance is understanding the law, especially international laws. Failure to understand international laws can result in a loss of the whole project and will hurt every party involved. These laws can be very complex and require multiple teams of lawyers to tackle.

As you can see on Milbank’s website (link below) here are some of the issues that they deal with:

• Oil and Gas – including multiple stages of production and supply
• Petrochemicals
• Power and Energy – including as many types of energy and people anyone can think of
•  Infrastructure and Water – including the stages in the process
• Telecommunications – including any form
• Space and Satellite – for any type of company involved in broadcast, communications, and so on
• Waste Disposal and Recycling – all stages involved
• Mining and Metals – all processes involved
• Natural Resources – all processes involved
• Pulp and Paper
• Transportation – air, land, or sea

It can be seen that this law firm is deeply involved in project finance. The law entity is very confusing because every project, location, and propose are different.

http://www.milbank.com/ (main page)

http://www.milbank.com/practices/areas/finance/project-finance.html (project finance page)

Picture From: http://www.flickr.com/photos/59937401@N07/5857192202/