Different strokes
Project financing has undergone significant shifts over the last
several years. International crises, currency meltdowns and
political turmoil have changed the appetite for cross-border
project financings, the foundation of solid projects has not been
altered so much as refined in view of the new realities. Underlying
economics are the foundation. Lacking that basic strength, no
amount of structuring can fix a weak project.
All projects share numerous similar risks but the effect on any given project can, and does, vary dependent upon a host of factors. Despite the seemingly similar characteristics among certain types of transactions in the market, such as the heavy-oil financings in Venezuela, Moody's views all projects as unique. The intent of this paper is to compare two single-asset, stand-alone, cross-border oil and gas project financings recently completed with no political risk insurance (PRI) or other forms of third-party, non-sponsor, external risk support mechanisms and determine their implications for future deal structuring.
The difference between the risk mitigation typically associated with structuring as opposed to risk transfer, which occurs with third-party guarantees or specific insurance, is an important distinction when structuring transactions for the lending markets. The recent Hamaca heavy oil financing in Venezuela (Baa3) and the Oleoducto de Crudos Pesados (OCP) pipeline in Ecuador (Baa1) are good examples. Both illustrate key project finance issues and different approaches to addressing those considerations. The blurring of the lines between structured and project financing will become quite apparent.
Hamaca and OCP
The Hamaca heavy oil project in Venezuela was the fourth and final heavy oil project approved under the Appertura legislation in Venezuela in the mid-1990's which opened up the oil sector once again to foreign interests. The project comprises exploration for and development of heavy oil reserves and minor processing (upstream E&P), diluting and shipping the crude to an upgrader (midstream), building and operating an upgrader to produce the final offtake product (downstream) and marketing the product. The E&P is an ongoing process to produce the crude required as feedstock for the downstream coker that produces the syncrude for sale. Analysis of the project economics must take into account the ongoing costs of development, shipping, upgrading and marketing of the syncrude.
The OCP project consists of the building and operating of a blended stream, heavy oil pipeline system from the Oriente Basin to Ecudaor's Pacific coast at Balao, where it will also construct and operate related storage facilities and an offshore loading facility. It is important to note that the project is an export project, not internal to the country of domicile. Neither the project economics or project obligations include the development of the reserves (upstream) or the marketing of the crude coming out of the pipeline (downstream). The pipeline receives its revenues from ship-or-pay contracts and transportation charges on whatever volumes may be shipped on the line. The pipeline must be handed over to the Ecuadorian government at the end of the 20-year operating period.
The first consideration of a project by its sponsors and those looking to invest is the strategic nature of the project to the parties involved. Any project, in emerging markets or otherwise, draws strength from its being viewed as part of a larger design among the participants. To the extent that it is viewed as part of a bigger picture development plan for those involved, it is considered stronger due to the lesser likelihood that a sponsor company would walk away from the transaction during a difficult time or sell out to a less-interested third party.
Crude production of the sponsors in the OCP project has been shut in due to a lack of pipeline capacity in that country. The sponsors, who are also the shippers under the Initial Shipper Transportation Agreements (ISTA's)(ship-or-pay contracts) have large undeveloped interests in the Oriente basin. In the Hamaca transaction, both Phillips and ChevronTexaco have significant portions of their respective crude reserves in Venezuela due to the project and can move these to the US Gulf Coast (USGC) at lower cost than from other regions of the world. The USGC is the largest single area capable of refining the heavy crudes that will come from both projects. Both projects monetize heretofore underutilized assets.
The project sponsors themselves are carefully analyzed for their experience with this type of project. In addition, their own credit ratings are reviewed in the analysis to determine the strength of support for the equity going into the project as well as ongoing support that could reasonably be expected for issues beyond legal obligations. Much time and consideration is given to sponsor transfer rights language to help avoid a degradation in the creditworthiness and expertise of sponsors supporting the project. Under the Hamaca heavy oil financing in Venezuela, transfer restrictions include minimum holdings by each original sponsor and aggregate minimums, ratings minimums of A3 on Chevron Texaco and Baa3 on Phillips and PdVSA, and transferee must be in oil/gas business. In the Oleducto de Crudos Pesados (OCP) pipeline project in Ecuador, an initial shipper may only transfer to a party with a guarantee from a party rated Baa1, the performance guarantor (an affiliate of the initial shipper) remains in place or a rating reaffirmation is obtained. The terms of these transfer restrictions is further broken down between pre- and post-construction phases, noting to higher risk during the construction phase. The ongoing nature of the Hamaca project capital expenditures and obligations as well as the ongoing obligations of the performance guarantors to cover numerous risks under OCP mandate such restrictions.
Before getting to the construction phase the sponsors have to review the feedstock costs of and energy supply availability to the project to determine its overall viability. The contracts defining both costs and availability are key cornerstones of any project, energy-related or otherwise.
Creating a tight project
Projects generally consist of three phases: input, process and offtake. The more these three can be tied together, the tighter the project and the better a rating is likely to be. Contracts should be long term, supporting the needs of the project throughout the life of the debt. Alternatively, if not contracted for but owned, the production costs including exploration and production viewed against a backdrop of expected product pricing over the life of the project must place the project in a competitive position looking forward.
This element is similar to reviewing the complexity ?ranking? of a refinery on an efficiency scale. The economics and profitability of the project are dependent on these and the other operating expenses, notwithstanding the marketability of the product itself. Lacking an energy supply to run the facilities or a competitive reserve position to feed the pipeline or plant, as the case may be, the project would be unable to attain a solid rating. The ?sensitivity? or ?stress? cases run by Moody's overlay historical prices, among others, in the projected financials to determine resiliency of the project during a down cycle and to help understand what amount of debt service reserve account would be necessary to support a given rating level.
The OCP project deals with this particular issue by having ?ship-or-pay? tariff agreements, obligating the shippers to pay regardless of whether any actual oil volumes are shipped through the pipeline or not. Tariff increases to cover increased costs may be imposed, however only annually, leaving open the potential for a timing differential between the cost increase and the ability to recover those costs. Once a pipeline is built, power costs represent a large share of overall operating costs and increases can have a material impact on cash flow as was seen in early 2000 in North American pipelines when power costs spiked. Regardless of whether the reserves in Ecuador are developed or not, the project should continue to receive revenues sufficient to pay debt service. Instead of take-or-pay offtake contracts for the pipeline volumes, the ship-or-pay contracts were utilized to support the rating.
The Hamaca project approach was different. Firstly, only 10% of the reserves in the Orinoco belt which are dedicated to the project are required to support the current level of debt service. Secondly, very little initial leverage was placed on the project (30%) with any supplemental project debt allowed to be incurred after meeting a minimum 1.95x debt service coverage ratio (DSCR) test with either a ratings reaffirmation of the project or majority lenders' consent. A minimum DSCR test is most commonly used as opposed to averages as averages are too easily ?managed?. This is particularly important in cyclical industries with wide price swings that could lead to coverages below 1:1. Project ratings are based on likelihood of default on any given payment date, not probability of eventual recovery where average DSCR's might be more appropriate. The Jose complex in Venezuela, where the Hamaca upgrader is located, not only has its own shared source of electrical generating capacity but is tied into the national grid with signed supply agreements. Offtake agreements are in place with the sponsors, however at market price, leaving the important consideration of resiliency in the face of market price fluctuations a critical credit analysis component.
The construction phase of an oil and gas project brings with it its own set of challenges. Some of the myriad issues reviewed for ratings purposes during this phase include:
? the history of the contractor in building these types of facilities in the past;
? was the contractor on budget and on schedule in other facilities of this type it has constructed?
? is it a fixed-cost engineering, procurement and construction (EPC) contract?
? what is the financial position of the contractor to support this undertaking particularly if there are liquidated damages payable by the contractor for failure to meet its obligations under an EPC contract?
? how material are the portions of the project potentially not covered by the EPC contract?
? is the technology being utilized in the particular project a standard or is it untested?
? what sponsor support is there for debtholders during this phase?
Sponsor support can come as a guarantee to complete the project or a guarantee to repay the debt for non-completion.
The Hamaca project is far more complex than the OCP project in all phases, but construction highlights this well.
The overall challenge in Hamaca is to manage two different construction projects, upstream and downstream (the pipeline was built by and will be shared with the Cerro Negro project) and their respective timing. The oil fields in the Orinoco belt have been found to be far less contiguous than had been expected leading to far more complicated drilling techniques than had been envisioned. In this regard, Hamaca has benefited from the earlier oil projects by being able to better understand the conditions and more appropriately budget for them. The design, building and operating of a coker (the crude upgrading facility) uses known technology but is infinitely more complicated than running a pipeline. Many phases of this 4-year process have different contracts with different parties. This pre-completion phase for the project is ultimately supported by joint and several sponsor obligations to cover the equity cash calls of a defaulting sponsor and several, but not joint, sponsor guarantees of debt repayment for non-completion.
OCP faces its own challenges constructing a pipeline through the Andes but the technology is relatively straight-forward and the EPC contractor has built lines through the Andes numerous times. The sponsors of the project are committed to capital contributions of 110% of the total budgeted pipeline cost less debt raised and the tariffs are payable beginning at a date certain regardless of whether the pipeline is complete or not. Advance tariff payments to pay off accelerated debt maturities are also mandatory due to non-completion of the project by date-certain, prolonged force majeure and expropriation, among others.
The process or operating risk of a project goes back to the sponsors or their respective transferees, a point made earlier. It is essential that the operators of the facility or operation have significant experience in those types of operations to insure efficient operations and realistic cost estimates in line with project expectations. Again, that is why the transfer restrictions play such an important role in the overall structure of the project. It is similar to the need for experienced EPC contractors to build the facility at the outset. The sponsors of both the Hamaca and OCP projects are well known in their respective markets and have operating contracts with the projects to insure consistency and proper management of their respective operations.
The legal and sovereign risks facing any project are as numerous and varied as there are projects in the world. In emerging markets or those with less clearly developed legal systems than in the United States and Western Europe, what appears to be a legal claim may well not give the same rights to the counterparty as first appears. This is why it is essential in cross-border financings to have the security and finance documents enforceable under New York or UK law. Project operating documents and related issues are, necessarily, under the laws of the country of domicile.
Security packaging
It is also seen occasionally that certain provisions are essentially pulled out of locally enforceable documents and overridden in the finance or security documents. The attachment of collateral is often seen as problematic in cross-border transactions. For the same reason, one of the other numerous guidelines for projects to ?pierce the sovereign ceiling? (piercing) of the country in which the project is physically located, is that accounts are expected to be held in US dollars, offshore by a trustee, with irrevocable payment instructions under the documents. Other essential ingredients to piercing include: the waiver of any sovereign immunity the project may have under the Foreign Sovereign Immunities Act against adjudication and other legal process; a particular strategic importance to the sovereign as well as the sponsors themselves; an export product with low diversion risk; extra-territorial relationships, either economic or political, between the country of domicile and sponsor or offtake countries; and, sovereign history and precedent.
In OCP's case, a number of traditional items are not included in the security package including the shares of the holding company and pipeline, physical assets, commitments to make equity contributions and the subordinated debt held by the sponsors/affiliates. A payment waterfall also does not exist until an event of default. The sponsor equity/subordinated loans will largely be contributed only near project completion. The accounts, while held offshore in US dollar revenues as in the case of Hamaca, does not have a payment waterfall controlled by a trustee until a payment default. The project is quite important to Ecuador, roughly doubling its oil export capacity and significantly increasing its hard currency export revenues. Its key offtake market is the US due to its capacity for heavy crudes that have a limited market due to upgrading constraints.
The Hamaca transaction has most of the security package items with the exception of PdVSA's (the national oil company of Venezuela) physical assets which are under negative pledge restrictions by the World Bank. Sovereign history and precedent, after the nationalization, for compensation, of all oil activities in the early 1970's shows foreign exchange controls imposed in the mid 1990's did not affect any export-related activities as the country recognized the importance of hard currency. The hydrocarbons industry in Venezuela represents 88% of all exports and over 50% of all government revenue, thereby giving Venezuela little incentive to interfere with the project. The heavy oil projects are necessary to bring in the foreign capital and expertise required to develop the Orinoco belt region that holds the world's largest heavy crude reserves. PdVSA's Citgo operations in the US have over $5 billion of assets while the US remains the key importer of PdVSA's crude, as well. The new Hydrocarbons Law in Venezuela, further, does not impact the existing projects but is addressed to new investments going forward.
As numerous articles have been written separately on oil and gas (including petrochemicals), power and infrastructure projects it is important to point out key differences in those with respect to the sovereign ceiling. Oil and gas export project markets are global, not customarily subject to any regional or state regulatory authority, are denominated in US dollars and receive payments offshore. They are driven by global prices and markets. These criteria get those projects to first base with the potential for piercing the sovereign ceiling of an emerging market country or one with a non-investment grade rating.
The hydrocarbons industry in a number of countries produces a material amount of hard currency export revenue and makes up a material portion of a country's revenues and GDP. Power, toll road and other infrastructure projects have very little chance of piercing as they fail those criteria, typically with revenues in local currency, feeding into a local/national power grid and collecting monies onshore. An exception may be a power plant located on a border, producing power to export to a neighboring country denominated in US dollars or a foreign currency hedged into US dollars to match the debt obligations, thereby avoiding currency risk. It still might not, however, avoid exchange risk. Power and other infrastructure projects remain subject to the vagaries of regulatory authorities and politicians concerned over rate increases that might make them look bad in front of their constituents. It has been witnessed many times that political support is a fair weather friend.
Conclusion
The Hamaca and OCP projects highlight both the similarities and differences between oil and gas projects and pipeline projects. LNG projects are quite similar to the analysis of oil and gas projects except for the need for offtake contracts from creditworthy offtakers similar to those of pipeline projects due to the very specific requirements for LNG movement and use that limit its marketability as a true ?commodity?. With the construction of more ships and regassification facilities, the acceptance of ?spot? LNG revenues may become more acceptable a credit risk in the future.
Oil export projects are global by nature and have commodity prices quoted worldwide into which to market their product, albeit differentiated between heavy and light crudes. Analysis of these markets and the competing sources and transportation differentials embedded in the economics of those sources remains one of the key competitiveness components analyzed from a credit ratings perspective. The markets are still open to projects with sound economics that are carefully structured. Hamaca was able to accomplish its financing through low leverage, strong DSCR's, strict waterfall and dividend limitations, and strategically important place in the Venezuelan economy. The OCP project succeeded through tight ship-or-pay contracts that covered most project and political risks associated with the project as well as the importance of the project to Ecuador.
All projects share numerous similar risks but the effect on any given project can, and does, vary dependent upon a host of factors. Despite the seemingly similar characteristics among certain types of transactions in the market, such as the heavy-oil financings in Venezuela, Moody's views all projects as unique. The intent of this paper is to compare two single-asset, stand-alone, cross-border oil and gas project financings recently completed with no political risk insurance (PRI) or other forms of third-party, non-sponsor, external risk support mechanisms and determine their implications for future deal structuring.
The difference between the risk mitigation typically associated with structuring as opposed to risk transfer, which occurs with third-party guarantees or specific insurance, is an important distinction when structuring transactions for the lending markets. The recent Hamaca heavy oil financing in Venezuela (Baa3) and the Oleoducto de Crudos Pesados (OCP) pipeline in Ecuador (Baa1) are good examples. Both illustrate key project finance issues and different approaches to addressing those considerations. The blurring of the lines between structured and project financing will become quite apparent.
Hamaca and OCP
The Hamaca heavy oil project in Venezuela was the fourth and final heavy oil project approved under the Appertura legislation in Venezuela in the mid-1990's which opened up the oil sector once again to foreign interests. The project comprises exploration for and development of heavy oil reserves and minor processing (upstream E&P), diluting and shipping the crude to an upgrader (midstream), building and operating an upgrader to produce the final offtake product (downstream) and marketing the product. The E&P is an ongoing process to produce the crude required as feedstock for the downstream coker that produces the syncrude for sale. Analysis of the project economics must take into account the ongoing costs of development, shipping, upgrading and marketing of the syncrude.
The OCP project consists of the building and operating of a blended stream, heavy oil pipeline system from the Oriente Basin to Ecudaor's Pacific coast at Balao, where it will also construct and operate related storage facilities and an offshore loading facility. It is important to note that the project is an export project, not internal to the country of domicile. Neither the project economics or project obligations include the development of the reserves (upstream) or the marketing of the crude coming out of the pipeline (downstream). The pipeline receives its revenues from ship-or-pay contracts and transportation charges on whatever volumes may be shipped on the line. The pipeline must be handed over to the Ecuadorian government at the end of the 20-year operating period.
The first consideration of a project by its sponsors and those looking to invest is the strategic nature of the project to the parties involved. Any project, in emerging markets or otherwise, draws strength from its being viewed as part of a larger design among the participants. To the extent that it is viewed as part of a bigger picture development plan for those involved, it is considered stronger due to the lesser likelihood that a sponsor company would walk away from the transaction during a difficult time or sell out to a less-interested third party.
Crude production of the sponsors in the OCP project has been shut in due to a lack of pipeline capacity in that country. The sponsors, who are also the shippers under the Initial Shipper Transportation Agreements (ISTA's)(ship-or-pay contracts) have large undeveloped interests in the Oriente basin. In the Hamaca transaction, both Phillips and ChevronTexaco have significant portions of their respective crude reserves in Venezuela due to the project and can move these to the US Gulf Coast (USGC) at lower cost than from other regions of the world. The USGC is the largest single area capable of refining the heavy crudes that will come from both projects. Both projects monetize heretofore underutilized assets.
The project sponsors themselves are carefully analyzed for their experience with this type of project. In addition, their own credit ratings are reviewed in the analysis to determine the strength of support for the equity going into the project as well as ongoing support that could reasonably be expected for issues beyond legal obligations. Much time and consideration is given to sponsor transfer rights language to help avoid a degradation in the creditworthiness and expertise of sponsors supporting the project. Under the Hamaca heavy oil financing in Venezuela, transfer restrictions include minimum holdings by each original sponsor and aggregate minimums, ratings minimums of A3 on Chevron Texaco and Baa3 on Phillips and PdVSA, and transferee must be in oil/gas business. In the Oleducto de Crudos Pesados (OCP) pipeline project in Ecuador, an initial shipper may only transfer to a party with a guarantee from a party rated Baa1, the performance guarantor (an affiliate of the initial shipper) remains in place or a rating reaffirmation is obtained. The terms of these transfer restrictions is further broken down between pre- and post-construction phases, noting to higher risk during the construction phase. The ongoing nature of the Hamaca project capital expenditures and obligations as well as the ongoing obligations of the performance guarantors to cover numerous risks under OCP mandate such restrictions.
Before getting to the construction phase the sponsors have to review the feedstock costs of and energy supply availability to the project to determine its overall viability. The contracts defining both costs and availability are key cornerstones of any project, energy-related or otherwise.
Creating a tight project
Projects generally consist of three phases: input, process and offtake. The more these three can be tied together, the tighter the project and the better a rating is likely to be. Contracts should be long term, supporting the needs of the project throughout the life of the debt. Alternatively, if not contracted for but owned, the production costs including exploration and production viewed against a backdrop of expected product pricing over the life of the project must place the project in a competitive position looking forward.
This element is similar to reviewing the complexity ?ranking? of a refinery on an efficiency scale. The economics and profitability of the project are dependent on these and the other operating expenses, notwithstanding the marketability of the product itself. Lacking an energy supply to run the facilities or a competitive reserve position to feed the pipeline or plant, as the case may be, the project would be unable to attain a solid rating. The ?sensitivity? or ?stress? cases run by Moody's overlay historical prices, among others, in the projected financials to determine resiliency of the project during a down cycle and to help understand what amount of debt service reserve account would be necessary to support a given rating level.
The OCP project deals with this particular issue by having ?ship-or-pay? tariff agreements, obligating the shippers to pay regardless of whether any actual oil volumes are shipped through the pipeline or not. Tariff increases to cover increased costs may be imposed, however only annually, leaving open the potential for a timing differential between the cost increase and the ability to recover those costs. Once a pipeline is built, power costs represent a large share of overall operating costs and increases can have a material impact on cash flow as was seen in early 2000 in North American pipelines when power costs spiked. Regardless of whether the reserves in Ecuador are developed or not, the project should continue to receive revenues sufficient to pay debt service. Instead of take-or-pay offtake contracts for the pipeline volumes, the ship-or-pay contracts were utilized to support the rating.
The Hamaca project approach was different. Firstly, only 10% of the reserves in the Orinoco belt which are dedicated to the project are required to support the current level of debt service. Secondly, very little initial leverage was placed on the project (30%) with any supplemental project debt allowed to be incurred after meeting a minimum 1.95x debt service coverage ratio (DSCR) test with either a ratings reaffirmation of the project or majority lenders' consent. A minimum DSCR test is most commonly used as opposed to averages as averages are too easily ?managed?. This is particularly important in cyclical industries with wide price swings that could lead to coverages below 1:1. Project ratings are based on likelihood of default on any given payment date, not probability of eventual recovery where average DSCR's might be more appropriate. The Jose complex in Venezuela, where the Hamaca upgrader is located, not only has its own shared source of electrical generating capacity but is tied into the national grid with signed supply agreements. Offtake agreements are in place with the sponsors, however at market price, leaving the important consideration of resiliency in the face of market price fluctuations a critical credit analysis component.
The construction phase of an oil and gas project brings with it its own set of challenges. Some of the myriad issues reviewed for ratings purposes during this phase include:
? the history of the contractor in building these types of facilities in the past;
? was the contractor on budget and on schedule in other facilities of this type it has constructed?
? is it a fixed-cost engineering, procurement and construction (EPC) contract?
? what is the financial position of the contractor to support this undertaking particularly if there are liquidated damages payable by the contractor for failure to meet its obligations under an EPC contract?
? how material are the portions of the project potentially not covered by the EPC contract?
? is the technology being utilized in the particular project a standard or is it untested?
? what sponsor support is there for debtholders during this phase?
Sponsor support can come as a guarantee to complete the project or a guarantee to repay the debt for non-completion.
The Hamaca project is far more complex than the OCP project in all phases, but construction highlights this well.
The overall challenge in Hamaca is to manage two different construction projects, upstream and downstream (the pipeline was built by and will be shared with the Cerro Negro project) and their respective timing. The oil fields in the Orinoco belt have been found to be far less contiguous than had been expected leading to far more complicated drilling techniques than had been envisioned. In this regard, Hamaca has benefited from the earlier oil projects by being able to better understand the conditions and more appropriately budget for them. The design, building and operating of a coker (the crude upgrading facility) uses known technology but is infinitely more complicated than running a pipeline. Many phases of this 4-year process have different contracts with different parties. This pre-completion phase for the project is ultimately supported by joint and several sponsor obligations to cover the equity cash calls of a defaulting sponsor and several, but not joint, sponsor guarantees of debt repayment for non-completion.
OCP faces its own challenges constructing a pipeline through the Andes but the technology is relatively straight-forward and the EPC contractor has built lines through the Andes numerous times. The sponsors of the project are committed to capital contributions of 110% of the total budgeted pipeline cost less debt raised and the tariffs are payable beginning at a date certain regardless of whether the pipeline is complete or not. Advance tariff payments to pay off accelerated debt maturities are also mandatory due to non-completion of the project by date-certain, prolonged force majeure and expropriation, among others.
The process or operating risk of a project goes back to the sponsors or their respective transferees, a point made earlier. It is essential that the operators of the facility or operation have significant experience in those types of operations to insure efficient operations and realistic cost estimates in line with project expectations. Again, that is why the transfer restrictions play such an important role in the overall structure of the project. It is similar to the need for experienced EPC contractors to build the facility at the outset. The sponsors of both the Hamaca and OCP projects are well known in their respective markets and have operating contracts with the projects to insure consistency and proper management of their respective operations.
The legal and sovereign risks facing any project are as numerous and varied as there are projects in the world. In emerging markets or those with less clearly developed legal systems than in the United States and Western Europe, what appears to be a legal claim may well not give the same rights to the counterparty as first appears. This is why it is essential in cross-border financings to have the security and finance documents enforceable under New York or UK law. Project operating documents and related issues are, necessarily, under the laws of the country of domicile.
Security packaging
It is also seen occasionally that certain provisions are essentially pulled out of locally enforceable documents and overridden in the finance or security documents. The attachment of collateral is often seen as problematic in cross-border transactions. For the same reason, one of the other numerous guidelines for projects to ?pierce the sovereign ceiling? (piercing) of the country in which the project is physically located, is that accounts are expected to be held in US dollars, offshore by a trustee, with irrevocable payment instructions under the documents. Other essential ingredients to piercing include: the waiver of any sovereign immunity the project may have under the Foreign Sovereign Immunities Act against adjudication and other legal process; a particular strategic importance to the sovereign as well as the sponsors themselves; an export product with low diversion risk; extra-territorial relationships, either economic or political, between the country of domicile and sponsor or offtake countries; and, sovereign history and precedent.
In OCP's case, a number of traditional items are not included in the security package including the shares of the holding company and pipeline, physical assets, commitments to make equity contributions and the subordinated debt held by the sponsors/affiliates. A payment waterfall also does not exist until an event of default. The sponsor equity/subordinated loans will largely be contributed only near project completion. The accounts, while held offshore in US dollar revenues as in the case of Hamaca, does not have a payment waterfall controlled by a trustee until a payment default. The project is quite important to Ecuador, roughly doubling its oil export capacity and significantly increasing its hard currency export revenues. Its key offtake market is the US due to its capacity for heavy crudes that have a limited market due to upgrading constraints.
The Hamaca transaction has most of the security package items with the exception of PdVSA's (the national oil company of Venezuela) physical assets which are under negative pledge restrictions by the World Bank. Sovereign history and precedent, after the nationalization, for compensation, of all oil activities in the early 1970's shows foreign exchange controls imposed in the mid 1990's did not affect any export-related activities as the country recognized the importance of hard currency. The hydrocarbons industry in Venezuela represents 88% of all exports and over 50% of all government revenue, thereby giving Venezuela little incentive to interfere with the project. The heavy oil projects are necessary to bring in the foreign capital and expertise required to develop the Orinoco belt region that holds the world's largest heavy crude reserves. PdVSA's Citgo operations in the US have over $5 billion of assets while the US remains the key importer of PdVSA's crude, as well. The new Hydrocarbons Law in Venezuela, further, does not impact the existing projects but is addressed to new investments going forward.
As numerous articles have been written separately on oil and gas (including petrochemicals), power and infrastructure projects it is important to point out key differences in those with respect to the sovereign ceiling. Oil and gas export project markets are global, not customarily subject to any regional or state regulatory authority, are denominated in US dollars and receive payments offshore. They are driven by global prices and markets. These criteria get those projects to first base with the potential for piercing the sovereign ceiling of an emerging market country or one with a non-investment grade rating.
The hydrocarbons industry in a number of countries produces a material amount of hard currency export revenue and makes up a material portion of a country's revenues and GDP. Power, toll road and other infrastructure projects have very little chance of piercing as they fail those criteria, typically with revenues in local currency, feeding into a local/national power grid and collecting monies onshore. An exception may be a power plant located on a border, producing power to export to a neighboring country denominated in US dollars or a foreign currency hedged into US dollars to match the debt obligations, thereby avoiding currency risk. It still might not, however, avoid exchange risk. Power and other infrastructure projects remain subject to the vagaries of regulatory authorities and politicians concerned over rate increases that might make them look bad in front of their constituents. It has been witnessed many times that political support is a fair weather friend.
Conclusion
The Hamaca and OCP projects highlight both the similarities and differences between oil and gas projects and pipeline projects. LNG projects are quite similar to the analysis of oil and gas projects except for the need for offtake contracts from creditworthy offtakers similar to those of pipeline projects due to the very specific requirements for LNG movement and use that limit its marketability as a true ?commodity?. With the construction of more ships and regassification facilities, the acceptance of ?spot? LNG revenues may become more acceptable a credit risk in the future.
Oil export projects are global by nature and have commodity prices quoted worldwide into which to market their product, albeit differentiated between heavy and light crudes. Analysis of these markets and the competing sources and transportation differentials embedded in the economics of those sources remains one of the key competitiveness components analyzed from a credit ratings perspective. The markets are still open to projects with sound economics that are carefully structured. Hamaca was able to accomplish its financing through low leverage, strong DSCR's, strict waterfall and dividend limitations, and strategically important place in the Venezuelan economy. The OCP project succeeded through tight ship-or-pay contracts that covered most project and political risks associated with the project as well as the importance of the project to Ecuador.
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