Slide 1

BP Amoco (A) : Policy statement on the use of Project Finance

Manish ( 014epgp2014 ) Bhupinder Singh ( 007epgp2014)

ContentOrganization structurePost Merger StructureAssignmentsProject Finance vis--vis Corporate finance AdvantagesDisadvantagesStructureSourcesInstitutionsBP Amocos PF vs CF Model

Organization StructureBritish PetroleumUK based worlds 3rd largest Oil & Gas giant

Operations in 70 countries

56,000 employees

CEO Sir John Browne

Assets $ 54.6 bn.

Revenues $ 71.3 bn.

Profits $ 4.1 bn. (1997)

Amoco CorporationUS based worlds 6rd largest Oil & Gas giant

Operations in 25 countries

43,000 employees

CEO H Lawrence Fuller

Assets $ 32.5 bn.

Revenues $ 31.9 bn.

Profits $ 2.7 bn. (1997)

In spite of corporate rivalry between BP & Amoco Corp., both merged in 1998 to form BP Amoco to create financial synergies required to fund capital intensive projects.

Why Merge ?What prompted the merger of the two arc rivals?

Belief that success in capital intensive Oil and Gas Industry was becoming increasingly dependent on scale.

Scale and Synergies

See Case page 3.

The best investment opportunities, in terms of rates of return on capital employed, will be ones that, because of location and complexity, will be available only to companies with greatest financial resources.

The risks are high and capital cost enormous as are the potential riches if a huge oil field is discovered. Only well capitalized firms big enough to afford the time, money and risk required to play poker game can hope to thrive.

Post Merger Organization Structure (Exhibit 4)Global HQ in London with Sir John Browne (BP) as CEO

H Lawrence Fuller (Amoco) & Peter Sutherland (BP) as non exe co-chairman

Finance Group:

CFO: John Buchanan (BP) Treasurer: David Watson (BP) Head Specialized Finance: Bill Young (Amoco)

Both companies had highly centralized finance functions with preference for corporate financing over project financing.

AssignmentGoal:

To work out new financing policy for the merged entity. Process:

Watson & Bill sought opinion of finance executives of both the firms regarding their take on project finance vis-a-vis corporate finance.

BP sparingly used project finance

Amoco too, believed in corporate finance more. But they sometimes used project finance.

Issues

Finance Organization Structure

Project Finance Concepts

Cost and benefits of PF

Decision on Corporate Finance/Project Finance

Oil Industry economics

Type of Projects Basics (Development, Exploration, Refining, Marketing, Power Plants)

What is Project Finance ?Project Finance involves creation of a legally independent entity financed with non recourse debt for the purpose of investing in a industrial asset, Usually with a limited life. Characteristics :Future Cash FlowsProject Asset as collateralFinite LifeNon recourse debt

Corporate Finance v/s Project Finance

Corporate Financing Project FinancingCorporate structureCorporate structureOrganisation-Large businessesCash flows only fromCash flows from differentProject assetsControl &Monitoringassets are mingledControl vested inStringent monitoringmanagement, Investorsrole minimalRisk AllocationFull recourseLimited/Non- recourseDiversified acrossassetsContractual arrangementsfor risk distribution

Project Financing Vs Corporate Financing

Corporate Financing Project FinancingCriteria [On Balance Sheet] [Off Balance Sheet]FinancialEasy/fastDifficult and timeFlexibilityconsuming, highlystructuredFree cash flowCan be freelyMust follow cash waterfallused. Commingledand allocated as perCorporate PolicyCash Flow SweepDebt ContractsLenders seekLenders recourse to allrecourse all assetsproject assetsTypically unsecuredSecuredDebt capacitySeen in entiretyOnly out of project assets plus Credit support from other sources High leverage Possible

Corporate Financing Project FinancingCriteria [On Balance Sheet] [Off Balance Sheet]BankruptcyCostly and time consumingFinancial distress can be avoidedBeneficial to lenders as they have access to entire assetCost of resolving financial distress lower, Bankruptcy remote, more risky to lenders

TransactionCostsLowerHigherAgency CostEquity Investors exposedManagement Incentive projectSpecific is difficultAgency Cost GreaterAgency cost for FCF reduced Incentive can be tided to PF Closer monitoring by investor Under investment mitigated Agency cost lower

MARKETPROJECT FINANCECORPORATE FINANCEIMPERFECTIONSTransaction CostProject finance has higher costHigher structuring cost to set up projectLower structuring Costcompany (lawyers, independent consultants,financial advisors etc)Harder to obtain operating synergy as project may be economically independentEasier to obtain operating synergyDistress CostUnclear advantageLess threat of risk contamination (isolateGreater threat of risk contaminationlosses at the project level)Greater potential for co insuranceLittle benefit from co coinsuranceTaxesLess ability to use interest tax shields and netoperating lossesGreater ability to use interest tax shield andnet operating lossProject Finance has higher taxesInformation CostBetter information about project assets andLess information on multiple, Co mingledProject Finance has higherinformation costcash flows (more transparent)assets and cash flowsGreater disclosure can be costly from acompetitive perspectiveAgency costUnclear advantageLittle managerial discretion (more disciplineGreater managerial discretion- depends ifcan be value enhancing)discretion is beneficialRestrictions on use of cash flowsGreater risk of leverage induced underinvestmentLittle risk of under investment (projects havelimited investment needs)Better defense against sovereign interference(expropriation and hold up)

Project Finance Model

SupplierGovernmentSupport AgreementConcessionsSPVEquityContractorFinanceProject Finance DebtSponsorsLendersOff takers

Corporate Finance Model

BP Amoco TreasurySubsidiaryProjectFundsPartner 1Partner 2Cash from sourceLiabilities

Cash Back to sourceCompany Finance Structure:Debt 30%Equity 70%

Operating Cash Bus Long term finance Short term finance Money Market Inst. 25% Share35% Shareshare

Project Finance Model ( BP Subsidiary )

BP Amoco Business UnitsBP Amoco TreasurySubsidiaryLendersCompany Finance Structure:Debt 30%Equity 70%Partner 1Partner 2ProjectDebt ServiceCollateral40% share25% Share35% Share

Project Finance Model (used in Projects)

DebtCollateral40% shareProjectPartner 2

BP AmocoTreasuryCompany Finance Structure:Debt 30%Equity 70%

Partner 1SubsidiaryLendersBP Amoco Business Units25% Share35% Share35% Share

Project Finance vs Corporate Finance: Payoffs (hypothetical)

Project FinancePay-offsCorporate FinancePay-offsProject ValuePut PremiumWalk away PutOption

Debt LevelDebtSponsors Equity

Financial Comparison (1998)

TexacoChevron MobilBP Amoco ExxonShell20%40%60%80%100%

Debt/Capital Revenues

Net Income

Market Cap

Capex

Exceptions for using Project FinanceMega projects

Projects in Politically Volatile Area

Joint Ventures with Heterogeneous Partners

Project Finance used as important risk management tool

Risk Sharing

Transfer of risk to other parties that can bear and risk more cheaply and effectively

Large investment for several years requires partners

Risk Mitigation (Reduction)

Through Structuring and participation of Multilateral agency

What are the Cost and Benefits of Project Finance ?

CostsHigher fees and Interest rates/Spreads

Increased time

Reduced Flexibility

Increased Information Disclosure (Compromise on Privacy/ Confidentiality)

BenefitsSharing of Risk

Risk Management

Put Option (if walk away)

Expand Firms debt capacity

Interest Tax shield

Tax Holidays (if separate entity required)

Better risk allocation with various parties

Suitable for high risk, first time investments, new industries etc. Partners bring the needed know how