There are few resources that can benefit the public as broadly and as effectively as access to power. From schools to hospitals and homes to offices, the existence of abundant, affordable, and dependable power is the cornerstone of growth. Electricity demand is closely correlated with GDP growth and other socio-economic advancements. As such, power investments demonstrate a clear and quantifiable economic return upon completion.
Host Government Financing takes place with the country using its balance sheet to fund a project by lending funds to or contributing additional equity to, the off-taker so that the off-taker may develop the project. The cost of funding varies based on the source of the funding and the creditworthiness of the country. Development Finance Institutions may provide lower-income countries with financing at significantly lower costs, and possibly at longer tenors, than financing provided by the private market. This financing is typically referred to as concessional financing. Procurement is usually governed by national rules so the parties selected to construct the project will typically be selected by the off-taker through a transparent and competitive process. Every dollar that a sovereign uses to finance a project is a dollar that cannot be used for education or other infrastructure.
Developer Financing occurs when large private companies can use the strength of their balance sheets to fund a project by contributing in the form of equity all of the funds that are required by the project company. These funds may be derived from retained earnings or may be borrowed by the developer from banks or raised through the issuance of corporate bonds. Developer financing can be one component of a public-private partnership (PPP) depending on the project structure. Developer financing limits the number of funding parties that must be coordinated and avoids the complexity that is often associated with multiparty financings, especially sovereign guarantees.
Resource-Based Financing entails a host country retaining a third-party contractor, typically a state-owned enterprise, to design, construct and commission a project in exchange for rights to natural resources granted by the host country. In this structure, the third-party contractor is obligated to fund its design, construction, and commissioning with the contractor’s ultimate reimbursement coming from its sale or use of the pledged natural resources. This structure limits the number of funding parties with which a host country can deal and avoids the complexity that is often associated with multi-party financing. It also presents the added benefit of not taking away a sovereign’s available cash reserves or its access to third-party lending. Host countries may not be able to calculate the true costs of the transaction for several years due to the volatility of commodity prices and timeline. While not directly impacting the balance sheet of the host country, this financing structure does require a sovereign to give up potential future revenues from natural resources that could be used to pay for other products, services, or initiatives for future generations.
In project financing structures, the host country grants certain concession rights related to the building, ownership, and operation of a project to a special purpose company whose sole business is the building, ownership, and operation of the project. Project finance avoids capacity constraints, opportunity costs, and balance sheet financing by a sovereign. The project company is obligated to finance the project using: funds injected by its owners as equity investments or loans provided by commercial banks, export credit agencies, development finance institutions, multilateral development banks, and export-import banks. Lenders typically lend the majority of the funding required by the project company on a limited-recourse basis. This means that loans are secured by all of the assets of the project company (including their contractual rights under the project agreements). Organizing a separate project company ensures that the borrower’s ability to repay the debt obligations will not be affected by lines of business that are unrelated to the project, but will instead be affected only by the performance of the project.
If there is no alternative source of financing available, project finance will allow the project to move forward and the host country to benefit from the economic benefits of having a power project without spending or leveraging its resources. Project finance transactions will carry more up-front costs due to the multiple private parties, environmental impact studies, legal, and fees for the coordination of the financing. Project finance adds layers of complexity to a transaction relative to balance sheet financing.