Current Developments In Project Finance

Wednesday, December 1, 2004 - 00:00

Editor: Mr. Haddad, would you begin by describing for us the scope of Jones Day's Global Projects practice?

Haddad: Jones Day ranks as one of the leading project finance firms in published surveys. Our Global Projects group engages in a variety of energy and infrastructure projects. As the project finance marketplace has evolved, we have expanded our practice to include asset dispositions and acquisitions, restructurings, portfolio securitizations, credit enhancement and other risk mitigation techniques.

Editor: How is the project finance market doing globally?

Haddad: According to Dealogic, global volume was up 19% in the first nine months of 2004 compared to the same period last year, with 255 transactions at a reported value of $90 billion. Europe was the most active region with $35 billion in transactions and the U.S. was the most active country with 29 deals at a value of $13 billion. Power was the best performing sector with 81 projects, followed by infrastructure and oil & gas.

Editor: What trends are you seeing in the U.S. market?

Haddad: We have seen several noteworthy trends. One of the most significant is the rapid development of the Term B market. While the investment grade market remains within the province of relationship banks, the non-investment grade and institutional markets have embraced a "capital markets model." Given the shrinking pool of investors and capital in the traditional loan market, the Term B market has become an important, and sometimes the only, option for non-investment grade projects and refinancings. Over the next few years, the Term B market will be necessary to bridge the liquidity gap, particularly in the merchant power sector.

Editor: What is driving this market?

Haddad: The Term B market is yield-driven. The investors, namely insurance companies, prime rate mutual funds and hedge funds and other investment vehicles, such as CDOs and CLOs, are oriented toward risk-return models, taking, for example, double-B risk to get a double-B return.

Editor: Can you compare the Term B market to the traditional market?

Haddad: Term B loans tend to be more expensive than traditional bank loans, and extensive cash sweeps and call premiums encourage Term B borrowers to refinance early. Another disadvantage is that investors in B Loans typically look for large, liquid deals over $100 million, and ratings are often required. On the upside, a Term B covenant package typically is less restrictive and more flexible as a result of longer tenders and minimal amortization in the early years. The secondary market for B Loans is very active.

Editor: Were you involved in any recent notable Term B or other financing transactions?

Haddad: Several. We represented AEP in the sale of a portfolio of Texas plants to Sempra Energy Partners and Carlyle/Riverstone, one of the marquee acquisitions of the year. Citigroup arranged a Term B loan as part of the financing for Coleto Creek, the "crown-jewel" of the portfolio. We also acted for Union Fenosa in the $600 million financing of the 1000 MW gas-fired generation facility in Mexico and closed the project bond financing of eleven Calpine combustion turbine peaking plants at nine sites in northern California, which was named Project Finance Magazine's Project Bond Deal of the Year.

Editor: You mentioned other trends?

Haddad: Yes. Two other interesting developments are increased activity in renewables and private investments in roads. Jones Day ranked #1 in Dealogic's most recent survey in number of renewable energy projects and was second in dollar volume. We represented the Royal Bank of Scotland as lender to the 300 MW Stateline project, the largest wind power project in the world; American Electric Power, the country's largest electricity generator, as developer of several successful projects, including the 160.5 MW Desert Sky project in Texas ( Project Finance Magazine's North America Renewables Deal of the Year); and Banco Español de Crédito, as lender to Proyecto Noroeste, the owner of three wind power projects and two mini hydraulic plants in Spain.

Editor: What is the anticipated level of investment in U.S. wind power now that the Production Tax Credit has been renewed?

Haddad: With high gas prices and renewal of the PTC, better wind forecasting techniques, improving technology and Renewables Portfolio Standards now adopted in 20 states, most recently New York and Colorado, industry experts are expecting capital investments in the range of $1.5 to 2.0 billion through December 2005. New York's program seeks to increase the amount of renewable energy purchased by consumers from 19.3 percent to at least 25 percent by the end of 2013, representing an increase in generation capacity of 3,700 MWs.

Editor: Have you been doing any new work with clients as a result?

Haddad: We are working with clients and members of the American Wind Energy Association on the development of an Edison Energy Institute approved standard power purchase agreement for the wind industry. We also represent utilities that have issued RFPs for the purchases of wind power to help address the challenges of global climate change and stabilize or reduce atmospheric greenhouse gas concentrations. As part of all of this, our firm is very active in the development of new markets and innovative economic instruments designed to create incentives to reduce emissions, including renewable energy credit and emissions trading schemes in the U.S. and Europe.

Editor: Can you tell us anything about transmission issues for wind?

Haddad: The industry is working on how to better integrate wind into wholesale power markets. At a recent FERC technical conference in Washington, industry panelists talked about interconnection of large and small wind projects. Most of the panelists agreed that interconnection requirements for wind projects and other non-synchronous generators should be different from those of large synchronous generators. We also see tariff reforms. The California Independent System Operator has adopted a protocol exempting wind from hourly imbalance penalties and substituting monthly netting of imbalances in return for centralized wind delivery forecasting. Similar provisions have been proposed to be included in the Midwest ISO tariff.

Editor: You mentioned transportation?

Haddad: We see Federal and state governments turning to the private sector to help build or finance roads and bridges. Billions of dollars of private funds have already been invested in U.S. roads projects. At last count, 14 states had adopted enabling legislation supporting public-private partnerships (called "PPP") involving toll roads.

Editor: What does this legislation do?

Haddad: Enabling legislation varies in the number of projects authorized and the scope of private sector participation. Broad-style PPP legislation, such as Texas, contemplates concession-type arrangements that allow private sector developers to charge, collect and retain tolls to repay project loans and earn an equity return. Narrow legislation may limit the number of projects or require legislative or other approvals and limit the role of the private sector participant to design-build construction contractor or toll road operator.

Editor: Have you been involved in any roads projects outside the U.S.?

Haddad: This month we closed the Americo Vespucio Sur Toll Road in Santiago, Chile, one of four parts of a road system that will form a ring around Santiago. We acted for the sponsors, Spanish construction giants Sacyr Vallehermoso and Acciona, and their jointly-owned Chilean subsidiary, Sociedad Concesionaria Autopista Vespucio Sur. The project is the fourth of the Santiago urban toll road projects to reach financial close and achieved the lowest pricing in the history of Chilean infrastructure financing. The project company issued project bonds at a record-low interest rate of 4.59 per cent and was oversubscribed by 20 per cent.

Editor: What was unique about the project?

Haddad: The bonds were insured under a financial insurance policy issued by XL Capital Assurance, and formed part of a multi-tranche financing structure involving a direct loan from Instituto de Crédito Oficial of Spain, a discounted sale to Banco Santander-Chile and Santander Investment Chile of payment obligations of the Ministry of Public Works and a value-added tax credit line provided by Banco Santander-Chile. Project costs are estimated at a total of U.S. $670 million, with debt arrangements covering more than U.S. $500 million. The financing is also notable for the participation of Instituto de Crédito Oficial as a direct, senior lender and Banco Santander-Chile, as VAT credit line provider, in each case without the wrap of the financial insurance policy.

Editor: Have you been involved in other transportation projects?

Haddad: We acted for JFK International Air Terminal in the financing and construction of the $2.8 billion Terminal 4 Redevelopment Project at JFK. We represented Continental in a $730 million project bond issue for the expansion of its hub operation at Newark International. Our lawyers acted for London Regional Transport on the financing of the £1.2 billion communications and control system for the London Underground and in the £7 billion public private partnership for London's Underground Rail Network.

Editor: Can you tell us a little about what's going on in the Asian markets?

Haddad: Our Asian offices have been active in the energy sector. Governments are tapping into the expertise and resources of the private sector. The PPP model, first introduced in the UK, has expanded into countries in Asia, including Australia, Japan and Singapore. Following on the initial public offering of shares of China's three largest oil & gas firms, natural gas and LNG have been attracting attention. We recently closed the financing of the $900 million Guangdong LNG Terminal and Trunkline Project, China's first LNG import project. Natural gas was not traditionally a major fuel for power generation in China, but given the level of domestic reserves, the environmental benefits and desire to diversify fuel sources, the country has embarked on a major expansion of the gas sector. The firm is also engaged in gas pipeline projects in Indonesia, China and Russia.

Editor: You mentioned Russia. Can you tell us about that?

Haddad: Russia is important to world energy markets because it holds the world's largest natural gas reserves, the second largest coal reserves and the eighth largest oil reserves. Russia is also the world's largest exporter of natural gas. Our Moscow office has been involved in significant transactions, including the representation of Alfa Group and Access-Renova Group in the formation of TNK-BP, the largest corporate transaction in Russian history to date. The transaction involved the contribution of oil and gas assets valued at U.S. $18 billion and a balancing payment by BP of U.S. $2.6 billion in cash and U.S. $3.75 billion in BP ordinary shares. We also acted for Alfa Group in the $3.7 billion monetization of their rights to future delivery of BP ordinary shares.

Editor: As you look ahead, do you have any observations for our readers on utilizing counsel to support their projects?

Haddad: From a client's perspective it's important to work closely with counsel at an early phase to assess the technical and economic feasibilities and financing considerations relevant to a particular project. An understanding of the development approach, ownership structure and financing plan for a project, together with experience in the sector, allows counsel to conduct cost-effective and targeted due diligence to assess project risks and financing issues from the outset. This may mean helping developer clients to obtain permits and regulatory approvals and analyze security and other issues in trying to close a successful bid. For lenders, it may mean help in negotiating financing agreements that balance borrower needs with market standards and syndication considerations.

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