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UNIVERSITY OF GHANA 
RISK MANAGEMENT IN OIL AND GAS PROJECT 
FINANCING 
NOBLE VAO AKABA 
THIS THESIS IS SUBMITTED TO THE UNIVERSITY OF 
GHANA, LEGON IN PARTIAL FULFILMENT FOR THE 
REQUIREMENT FOR THE AWARD OF MASTERS IN 
BUSINESS ADMINISTRATION (MBA) DEGREE IN FINANCE 
JUNE 2000 
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TABLE QF CONTENTS 
Contents 
vi 
List of tables 
vii 
Declaration 
viii 
Certification 
ix 
Acknowledgement 
x 
Abstract 
Chapter 1.0 Introduction 
1.1 Background of the study 1 
1.2 Problem statement 3 
1.3 Objectives of the study 4 
1.4 Hypothesis 5 
1.5 Significance of the study 6 
1.5 Scope of the study 6 
1.6 Methodology 7 
1.7.1 Population 7 
1.7.2 Sample size 7 
1.7.3 Method of selection of sample size 7 
1.7.4 Data collection instruments 7 
1.7.5 Data handling and presentation 8 
1.7.6 Problems encountered in data collection 8 
Chapter 2.0 Literature review 9 
2.1 Introduction 9 
2.2 Oil and gas financing structures 10 
2.3 Project financing and risk sharing 11 
2.4 Corporate lending and risk sharing 12 
2.5 Strength of project financing in energy investment - 13 
2.6 Risk management 15 
2.7 Risk management process 16 
2.7.1 Risk analysis 16 
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2.7.2 Risk control 
17 
Risk financing 18 2.7.3 
2.7.4 Administration of the risk management 19 
2.8 Risk manager's role 20 
2.9 Communications and co-operation of risks 21 
2.10 Risk administration 23 
2.11 Record keeping of risk 23 
2.12 Reporting 24 
2.13 Use of brokers to manage risk 24 
2.14 Monitoring risks management process 25 
2.15 Risks in oil and gas investment 26 
2.15.1 Commercial risks 26 
2.15.2 Country risks 29 
2.15.3 Force majeure risks 29 
2.16 Return and risk 31 
2.17 Portfolio theory 33 
2.17.1 Investors' preferences 35 
2.18 Hedging of financial risk 37 
2.18.1 Hedging in the futures market 37 
2.18.2 Basis in hedging 38 
2.19 Option pricing of products 38 
2.20 Conceptual framework 39 
References 
Chapter 3.0 Presentation and analysis 43 
3.1 Introduction 43 
3.2 Major project risks assessment and mitigation 43 
3.3 Objectives 44 
3.4 Construction risks 44 
3.4.1 Delay in construction risk 45 
3.4.2 How delay in construction risk is mitigated 46 
3.4.3 Cost overrun and its mitigation 47 
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3.5 Perfonnance risks 
47 
3.5.1 Perfonnance risk analysis 
47 
3.5.2 Perfonnance risk mitigation 
48 
3.6 Market risks 
50 
3.6.1 Market risk analysis 50 
3.6.2 Market risk mitigation 51 
3.7 Economic risks 52 
3.7.1 Economic risk analysis 52 
3.7.2 Economic risk mitigation 53 
3.7.3 Currency risk evaluation 54 
3.8 Environmental risks 57 
3.8.1 Environmental risk analysis 57 
3.8.2 Environmental risk mitigation 59 
3.9 Political risks 62 
3.9.1 Political risk analysis and mitigation 62 
3.9.2 MIGA political risk insurance 64 
3.10 Expected aggregate risk and returns 66 
3.11 Proposed Risk Matrix 70 
Chapter 4.0 Security packages analysis 74 
4.1 Objectives 74 
4.2 Implementation agreement 75 
4.3 Energy purchase agreement 78 
4.4 Land conveyance agreement 79 
4.5 Ownership structure agreement 80 
4.6 Fuel supply and transportation agreement 81 
4.7 Construction contract agreement 82 
4.8 Operation and maintenance agreement 83 
4.9 Strengthening project security packages 84 
4.9.1 Introduction 84 
4.9.2 Securing oil and gas assets 85 
4.9.3 Weak mortgage framework 85 
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4.9.4 Assigning project receivable 
87 
4.9.5 Escrow accounts 
87 
4.9.6 Sponsor's role 
87 
4.9.7 Sponsor equity commitment 
88 
4.9.8 Security from sponsors' shares 
89 
4.9.9 Deferring payment to sponsors 89 
4.9.10 Sponsor guarantees 90 
4.9.11 Project insurance 91 
4.9.12 Government guarantees 91 
4.9.13 Security for equity investments 92 
Chapter 5.0 Findings 93 
5.1 Introduction 93 
5.2 Main findings 93 
5.2.1 Construction risk 93 
5.2.2 Performance risk 93 
5.2.3 Market risk 94 
5.2.4 Economic risk 94 
5.2.5 Environmental risk 95 
5.2.6 Political risk 96 
5.2.7 Margin of safety 96 
Chapter 6.0 Summary. conclusion and recommendation 97 
6.1 Introduction 97 
6.2 Future of oil and gas investment financing 98 
6.3 Investor appetite for developing market risks 98 
6.4 Stronger local financial markets 100 
6.5 Mitigating oil and gas risk 100 
6.6 Test of hypothesis 102 
6.7 Improving security packages 104 
6.8 Recommendations 107 
Bibliography 
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LIST OF TABLES 
Table 3.1 Data on construction risk level 45 
Table 3.2 Delay risk arrangement 46 
Table 3.3 Data on performance risk level 47 
Table 3.4 Performance risk arrangement 49 
Table 3.5 Data on market risk level 50 
Table 3.6 Market risk arrangement 51 
Table 3.7 Data on economic risk level 53 
Table 3.8 Economic risk arrangement 53 
Table 3.9 Data on environmental risk level 59 
Table 3.10 IFe's environmental and social policies 60 
Table 3.11 Data on political risk level 63 
Table 3.12 Data on aggregate risk factor and retums 66 
Table 3.13 Data on spread determination 69 
Table 3.14 Proposed risk mitigation matrix 70 
Table 4.1 Key provision of fuel supply agreement 82 
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DEClARA110N 
I, Noble Yao Akaba hereby declare that I am the author of this thesis and that 
this work has never been presented for any other degree or purpose anywhere. 
~~ 
NOBLE YAO AKABA 
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CERTIFICATION 
We, the undersigned certified that we supervised and examined this thesis entitled 'risk 
management in oil and gas project financing'. A case study of international financial 
institutions, by Noble Yao Akaba and we recommend its acceptance to the School of 
Adm~on, University of Ghana for the award of Master in Business Admin-istration, 
Finance. 
Slgn.bJre~6J.~ ....... . 
~,B. 
DR. a:-e:vANKEY 
1ST SUPERVISOR 
2"D SUPERVISOR 
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ACKNOWLEDGEMENT 
I acknowledge the Almighty God for his mercy for my life. 
I am grateful to my supervisors Dr. B. D. Yankey and Dr. Reuben Atekpe for their support 
towards the success of the study. 
I also appreciate the cooperation of the management of IFe, Ghana, the World Bank, 
Ghana and USAID, and NIB (Ghana) Limited for providing the responses on the study. 
Furthermore, I thank my lecturers at the School of Administration, University of Ghana for 
imparting much knowledge to me in the course of my study at school. 
Nevertheless, I am solely responsible for any error or shortfall in this thesis. 
NOBLE YAOAKABA 
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ABSTRACT 
Securing adequate financing for oil and gas investments is a difficult task in the best of 
environments. In Africa, the task is more difficult on account of political, commercial and 
force majeure risks. These factors serve to limit the interest of international commercial 
banks, the main source of oil and gas finance in making long-term credit available for the 
region. 
This thesis examines the risk mitigation arrangements that can relief the fears of the 
international financial institutions. Issues of concern to potential lenders, such as 
completion risk, performance risk, market risk, economic risks, environmental risk and 
political risks are evaluated. 
Measures, which tend to minimize lenders risks, such as escrow accounts, political risk 
insurance, hedging programmes and standby fund facility, are examined. Security 
packages such as implementation agreement, land conveyance agreement, fuel supply 
and transportation agreement, and energy purchase agreement, ownership structure 
agreement and operation maintenance agreement are all examined. Also the various 
ways of strengthening these security packages to attract private financial institutions to 
finance oil and gas,projects. 
The study is an evaluation of the roles played by the international financial institutions 
namely: International Finance Corporation (IFC), the World Bank, Multilateral Investment 
Guarantee Agency (MIGA), United States Agency for International Development (USAtO) 
and NIB (Ghana) Limited. 
The findings of the study were gathered through structured personal interviews and 
questionnaires and are presented in tables and matrices. 
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The study addressed the following research problems: 
(1) How are oil and gas project risks identified, how are they analysed how are they 
allocated and what measures are taken to mitigate the risks? 
(2) What is the quality of security package available for lenders, are how are these 
security packages be strengthened. 
(3) Does the involvement of the intemational financial institutions in oil and gas 
financing serve as an additional security for private financial institutions? 
The findings of the study have been analysed within the researchers conceptual 
framework on risk management. The conclusions of the study are: 
The financial institutions that finance oil and gas projects do not use any scientific method 
to identify and analyse risk for oil and gas projects, but rather they base the risk 
identification on the poor infrastructure, debt burdens, refuge problems, war and civil 
conflicts and perceived political, commercial and force majeure risks of African countries, 
instead of assessing oil and gas project risks on the performance of the projecfs 
profitability and viability, generally. 
The security packages exist in almost all oil and gas projects financed but the difficulty is 
about how they should be enforced or strengthened to make them workable in the less 
developed financial markets in African countries. The World Bank has therefore taken the 
task of improving the finanCial markets so as to cushion the financial markets. When the 
financial markets functions very effectively with its legal systems, then security packages 
can work well. 
The involvement of the international financial institutions such Multilateral Investment 
Guarantee Agency (MIGA). the Work! Bank, International Finance Corporation (IFC), and 
United States Agency for International Development (USAID) serve as additional security 
package for private financial institutions since the risk is reduced by the surveillance of 
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these corporations. MIGA's political insurance also serves as additional financial tool 
used to cover risks expected by these lenders. 
In view of the findings of the study, the researcher has recommended some extra work to 
be done by these international financial institutions to help attract private financial 
institutions to finance oil and gas projects in Africa. 
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CHAPTER ONE 
INTRODUCTION 
1.1 BACKGROUND OF THE STUDY 
Africa is known to have significant resources of hydrocarbons in its own right. This only 
shows up partially on statistics of proven reserves of oil and gas; the levels of exploration 
in Africa are tiny compared with other parts of the world, and gas discoveries are often not 
even recorded. But even with what has been discovered and recorded, Africa has 
potential resources equivalent to several hundred years' consumption of hydrocarbons. 
Yet these remain in the ground or in the case of associated gas are flare into the 
atmosphere. 
There are several reasons why indigenous reserves have not been developed. First, the 
development of oil and gas is generally left to private sector companies; this is as it should 
be, for only those who have the knowledge and expertise necessary for these highly 
technical, risky and capital-intensive operations. The obvious reason why domestic 
resources have not been developed is that all too often, the fiscal terms available to the 
private operators have not been appropriate. The oil company must be able to make a 
decent profit to compensate it for its investment and geological risk. However, fiscal 
terms are not the only reason that resources remain undeveloped. Some Sub-Sahara 
African countries now have excellent fiscal terms, and while this may have triggered 
development of oil reserves for export, smaller oil fields for domestic consumption and 
more importantly, gas field, remain undeveloped. Fiscal terms are therefore not the only 
obstacle. 
A more serious obstacle, which prevents development of indigenous resources, is what 
we would like to call commercial, force majeure and political risk. This manifests itself in 
situations where investors are ready to invest but shy away from investments because of 
the impossibility of exchanging profits in local currency into foreign exchange and transfer 
these abroad. Also, concem about the objectiveness of the local judiciary system and the 
risks related to govemments "changing the rules of the game" as the project proceeds can 
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also be an obstacfe. The core problem concerns country risk. The researcher holds that 
development of Africa's natural resources is a task far beyond what governments; 
international financial institutions and other multilateral institutions can manage on their 
own. 
Importantly, the search for hydrocarbons in the oil importing developing countries has 
been the emerging role of international financial institutions. The level of finance required 
forms a formidable block for any under-developed country wishing to commence 
hydrocarbon exploration or production. The less developed countries find little solace in 
attempting to organize finance through traditional financial institutions. Assessment of 
energy loans by banks tend to be stringent with the following five questions requiring 
responses: 
• What are the recoverable reserves in place? 
• Is there a risk that the wells will not be completed? 
• Are there operational risks? 
• Will there be purchasers for the oil and gas produced? 
• Who is sponsoring the project? 
Assuming the responses to these questions encourages the bank to make the loan, the 
borrower may be faced with a loan document including various non-financial covenants, 
for instance: 
• The borrower will abide by the terms of the license. 
• He will arrange insurance cover acceptable to the bank. 
• He will not abandon the project during the period of the loan unless and until 
lenders are satisfied by means of a specified economic test that the project is no 
longer economic. 
• He will pay the sales proceeds of all production into a trustee account for 
distribution in accordance with the loan documentation. 
T~re are ~refore formidable obstacles to less developed countries in attracting foreign 
pnvate capital or in securing bank loans for oil and gas related programmes. Risk 
mitigation is the only way out to hold brief for the sponsor and project company in need of 
finance. 
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1.2 PROBLEM STATEMENT 
Securing adequate financing for oil and gas projects is a difficult task in the best of 
environments. In Africa, the tasks are even more difficult on account of the debt burdens, 
poor infrastructure, foreign exchange shortages and perceived political risk. These 
factors serve to limit the interest of international commercial banks, the main source of 
minerals resources, in making long-term credit available for oil and gas projects in Africa. 
Financing of oil and gas investments is based on a careful appraisal of the projecfs risks 
and potential returns and on sharing those risks, costs, and rewards among a group of 
sponsors and investors. 
It has therefore been the concern of host governments about the manner in which lenders 
and sponsors assess the risk associated with oil and gas projects located in their 
countries and the resultant level of security that would be required. It is the suspicion of 
most West African countries that risk assessment by most foreign lenders is based on 
popular sentiments regarding their countries generally, rather than on the basis of the 
likelihood of occurrence of adverse events based on actual historical facts about the 
countries. The questions therefore are that: how are oil and gas project risks identified, 
how are they analyzed, how are they allocated and what measures are taken to mitigate 
the risks identified or perceived? 
Another major concern of paSSive investors who normally provide much of the financing 
but do not have the capacity to control the operation of the project is the project structure 
and security package since these can help mitigate risk. If the type of structure and 
quality of security available are strong, the project becomes creditworthy, and a greater 
share of project costs can be financed. Thus, the research questions are: what is the 
quality of the security package available for lenders? Does the involvement of 
intemational financial institutions in oil and gas project financing serve as an additional 
security for the private investors? How can the security packages be strengthened? 
On the whole, the researcher is interested in finding out how the international financial 
institutions help to mitigate risk in oil and gas projects and how risks management help in 
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a successful financing. Other matters that the researcher cannot over look are the 
sponsors and the host government activities in the project inplementation. 
1.3 OBJECTIVES OF THE STUDY 
Capital investment is an important part of economic development. In economic terms, 
investment in any project is essentially a process, which involves a definite outlay of 
resources now, in order to obtain an anticipated inflow of resources in the Mure. 
Investment is therefore a riSky business, because future events will have an impact upon 
the benefits arising from it, although it is impossible at the onset to assess just how. 
Because of this, centuries of investment experience have evolved a whole series of 
financial tools aimed at mitigating project risk. 
The aim of the study is to establish flexible but stem and compromising guidelines that will 
be suitable for lenders, sponsors and host government taking into account the prevailing 
conditions in the developing countries. 
The objectives are: 
1. To evaluate the factors to be considered in determining the risk component of oil 
and gas projects in West Africa and how these risk factors can be mitigated to 
attract foreign private financial institutions to participate in financing through project 
finance. 
2. To examine the security packages of financial institutions and structure a 
suitable one for West African oil and gas projects that will encourage private 
financial institutions to partiCipate in the financing of these projects. 
These objectives will be achieved through the following means: 
(~ A study of the existing project finance structures and the risks that are 
factored into its discount rate. 
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(i) A study of the existing security packages available to local and international 
financial institutions to detennine how effective these security packages in 
minimizing risks in the oil and gas project financing. 
(iiQ Through the study, data will be collected from the key financiers in the oil and gas 
industry, which will be analyzed to detennine the risk factors and how they are 
mitigated. 
(iv) A risk mitigation matrix will be designed for various risk factors encountered in the 
oil and gas project financing. 
(v) An outline of measures to improve security packages for risks that are most feared 
by private financing institutions will be made. 
It is believed that this study will pennit a better and well-informed decision-making and 
thereby reduce the likelihood of unsuccessful investments. 
1.4 HYPOTHESIS 
From the foregoing trends, it may be hypothesized that: 
1. The key to a sound financial structure in oil and gas project financing is 
risk management. 
2. Successful mitigation of risks of commercial, pontical, technical and force majeure 
events are critical to a project's financial feaSibility. 
3. Multilateral Investment Guarantee Agency improves risk factors of oil and gas 
projects in less developing countries. 
4. The structure and security package help mitigate risk in oil and gas projects for 
lenders. 
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1.5 SIGNIFICANCE OF THE STUDY 
This study provides information on the complexity of the process, identifies and discusses 
areas in which financial institutions need additional information, support or both to 
facititate their negotiation. It also serves as a yardstick in determining whether the host-
country is attractive to sponsors and investors. In other words, it serves as a reference 
point for decisions relating to oil and gas projects in West African countries. 
The study will also be useful to Ghana National Petroleum Corporation (GNPC) and other 
future private oil and gas companies in their endeavour to embark on the development 
and exploration of oil and gas in the Tano basin. 
The work will serve as a guideline for sponsors and host governments of West African 
countries with minerals resources in the attempt to bargain for interest rates of finances, 
amount of loan required and foreign partnership share, especially, in joint venture 
relationships. 
Equity holders who are scared of debt holders taking over the project in the Mure will be 
able to assess their position and determine how much return they should demand on their 
investments. In other words, the study will determine an appropriate level of gearing that 
will be acceptable to equity holders. 
1.6 SCOPE OF THE STUDY 
This section delineates the boundaries of the study. It encompasses the major 
intemational financial institution that invests in oil and gas projects in Africa. The study 
covers risks encountered in the oil and gas development and operation, and mitig'!ltion 
arrangement that can be put in place to reduce the risk associated with the project. The 
study is expected to enhance the understanding of risk management and the financial 
tools that are use in the process. The study does not cover the measurement of risk and 
hedging process since these since will be too broad within the limited resources available 
to the researcher. However, hedging has been examined in the literature review as a 
method of mitigating risks. The study thus highlight the role of the World Bank, 
Intemational Finance Corporation, Multilateral Investment Guarantee Agency, United 
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States Agency for Intemational Development and National Investment Bank of Ghana in 
mitigating of risk in the 08 and gas project undertakings. 
1.7 METHODOLOGY 
This comprises the detail procedure to be used in executing the entire research work. 
1.7.1 POPULATION 
The research is conducted to cover all financial institutions involve in project 
financing in West Africa. Time and finance available will not allow the researcher to work 
with the total population hence the use of sample size. 
1.7.2 SAMPLE SIZE 
The sample size of this study is made up of key financial and investment analysts of the 
institutions selected, namely Intemational Finance Corporation, Multilateral Investment Guarantee 
Agency, United States Agency for Intemational Development, National Investment Bank of 
Ghana and the Wor1d Bank. 
1.7.3 METHOD OF SELECTION OF SAMPLE SIZE 
Purposive sampling was used because of the technical nature of the matter under 
discussion with a small number of key personnel directly involved. 
1.7.4 DATA COLLECTION INSTRUMENTS 
Data was collected from primary and secondary sources. Secondary sources covers 
academic journals, working documents of investment banks, conference papers and 
academic literature. Primary sources include data collected through interviews and 
questionnaires. Interviews were used because it gives the interviewer the opportunity to 
explain to the respondents what is really needed for the study. Interviews also broaden 
the scope of questions and answers. Questionnaires on the other hand were deSigned 
USing structured and open-ended questions. It was for the collection of guarantee 
statistical data from the officials who could not make time to meet the researcher for 
interview. 
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1.7.5 DATA HANDUNG AND PRESENTATION 
Secondary data shall be sorted, classified and edited. This is to ensure that all irrelevant 
responses are eliminated. For the purpose of analyzing, interpreting and presenting the 
data, tables and matrix presentation of risk will be used. In the risk matrix, risk factors 
shall be outlined, causes of the risks, remedies for each risk and the consequences of 
each risk factor for lenders and investors. 
1.7.6 PROBLEMS ENCOUNTERED IN DATA COLLECTION 
The major problem encountered is the attitude of respondents towards the research. The 
respondents felt the research topiC was too technical for the researcher to handle, hence 
was not wilting to give out data. The respondents were also too busy to attend to the 
researcher interview for the expected time. Questionnaires given out were responded to 
but not adequately. However the researcher made several follow ups to fill up gaps 
created in the responses. 
Financial constraints also limit the scope of the study to risk management without fully 
assessing the extent of risk in the oil and gas projects. 
These problems were however resolved in the following ways. 
The negative attitude of respondents towards the research eventually became positive 
during the last few days of data collection as the respondents got used to the researcher 
and the research. Even though this positive cooperation came quite late, it turned out to 
provide useful data. The financial constraints compelled the researcher to narrow down 
the research to the core issues in the study and data was collected from web sites of 
intemational financiers to cushion responses from questionnaires and intervieWS 
conducted in Ghana. 
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CHAPTER TWO 
LITERATURE REVIEW 
2.1 INTRODUCTION 
The impact of the recent upswing in the exploration activity in Africa and the likely Mure 
demand for capital as a consequence of exploration success call for attention. African oil 
production increased by an average of 3% between 1986 and 1996 and has surged 
forward in the last two years where growth rates of 5.6% and 5.9% have been almost 
double the world's average rate with countries such as Angola showing significant growth. 
This strong growth outlook is the result of a combination of factor such as: 
• Many African govemments have taken the initiative to open up new areas for 
foreign investment, particularly in deep water, and have amended economic 
terms to encourage this investment. 
• In addition, the balance sheets of major oil companies are strong and large 
energy and power budgets are being directed to Africa as companies seek to 
replace dectining reserves in North America and Northem Europe. 
• Technological advancement has also played its part in making the West African 
area economically viable; whereas even fIVe years ago, its cost relative to the 
quality of interpreted results limit its use. 
A survey of a sample of West African economies shows strong growth rates for many 
countries. Among them, Ghana and Cote d' Ivoire have growth rates of 5% and 6% 
respectively in 1997. West African economies are being driven forward in part by 
investment in the mining and industrial sectors, which can be energy intensive. This 
combined with rising domestic demand for power, has put pressure on the power 
resources of the region. 
The emergence of a domestic energy market, whose demand is constrained by supply, 
may change the fundamentals of some fields, particularly natural gas fields. In the past, 
fields that contained high levels of associated gas have been de-prioritized by many 
companies, due to flaring restrictions and the lack of a readily available market available 
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for gas. Converting gas into electric pov.ler has taken giant strides in the past ten ye~rs 
with strides in gas turbine technology making this process highly efficient. The question 
now is, how should the risks that militate against financing oil and gas investments be 
managed to alleviate the fear of investors and lenders from financing. 
2.2 OIL AND GAS FINANCING STRUCTURES 
Projects in developing countries can be generally be financed in one of three ways: 
• First, with the sponsor's equity, 
• Secondly on a project-finance basis, or 
• Thirdly as a combination of these bNo possibilities. 
Under the equity approach, sponsors, who may be from the public or the private sector, 
either fund oil and gas investments directly from their own pockets or fully guarantee the 
debt to be raised for the project completion. If debt financing is secured from third-party 
lenders, the lenders will base their decisions on the financial strength of the sponsors and 
not so much on the underlying economics of the project. 
In contrast, under project financing, a special purpose company is created to own and 
operate the project and to become the borrower of the project loans. The project lenders 
rely heavily on the strength of the projecfs cash flows, as there is generally no recourse to 
the project sponsors. 
A hybrid financing strategy incorporating both equity and project finance approaches, may 
be appropriate where there are divergent views among consortium members over a 
financing strategy. 
Project finance is a method of financing new investments by structuring the finanCing 
around the projecfs own operating cash flow and assets, without additional sponsor 
guarantees. This technique is able to alleviate investment risk and facilitate funding at a 
relatively low cost, to the benefit of sponsors and investors alike. 
The use of the above financing structures is not new in the business world. What is 
important is the combination of the two structures instead of the use of them individually in 
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the past two decades. Recent economic theory suggests that combing the two structures 
reduces investment risk drastically. This will be tested in the data analysis stage of this 
study. 
2.3 PROJECT FINANCING AND RISK SHARING 
Davis, Henry A. (1996) in his book "Project Financing" explains that, project financing is 
usually tailored to meet the needs of a specific project. Repayment of the financing relies 
on the cash flow and assets of the project itself, the risks of which are bome not by the 
sponsor alone but by different types of investors, equity holders, debt providers, and 
quasi-equity investors. Because risks are shared, one criterion of a project's suitability for 
financing is whether it is able to stand alone as a distinct legal and economic entity. Davis 
et al emphasizes that project assets, project related contracts, and project cash flows 
need to be separated from those of the sponsor. 
Scheinkestel, Nora (1997) identified two types of project finance: no recourse and limited 
recourse project finance. According to him, no recourse project finance is an arrangement 
under which investors and creditors financing the project do not have any direct recourse 
to the sponsors as might traditionally be expected. Although creditors' security will 
include the assets being financed, lenders rely on the operating cash flow generated from 
those assets for repayment. Before it can attract financing, the project must be carefully 
structured and provide comfort to its financiers that it is economically, technically, and 
environmentally feasible, and that it is capable of servicing debt and generating financial 
returns commensurate with its risk profile. 
Limited recourse project finance permits creditors and investors some recourse to the 
sponsors. This frequently takes the form of a precompletion guarantee during a project's 
construction period or other assurances of some form of support for the project. Creditors 
and investors, however, still look to the success of the project as their primary source of 
repayment. In most developing market projects with significant construction risk, project 
finance is generally of the limited recourse type. 
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2.4 CORPORATE LENDING AND RISK SHARING 
Thobani, Mateen (1996) in his book entitled Corporate Finance explained that, traditional 
finance is corporate finance, where the primary source of repayment for investors and 
creditors by the sponsoring company, backed by its entire balance sheet, not the project 
alone. Although creditors will usually still seek to assure themselves of the economic 
viability of the project being financed, so that it is not a drain on the corporate sponsor's 
existing pool of assets, an important influence on their credit decision is the overall 
strength of the sponsor's balance sheet as well as business reputation. Depending on 
this strength, creditors will still retain a significant level of comfort in being paid even if the 
individual project fails. In corporate finance, if a project fails its lenders do not necessarily 
suffer, as long as the company owing the project remains financially Viable. 
Risk under corporate lending is backed by the assets of the balance sheet of the 
sponsoring company and the project company unlike the project finance risk, which is 
backed by the project and its products. Davis, Henry et al. Project finance benefits 
prinarily sectors or industries in which projects can be structured as a separate entity 
apart from their sponsors. A case in point would be a stand alone production plant, which 
can be assessed in accounting and financial terms separately from the sponsor's other 
activities. Generally, such projects tend to be relatively large, because of the time and 
other transaction costs involved in structuring, and to include considerable capital 
equipment that needs long-term finanCing. In the financial sectors, by contrast, the large 
volume of finance that flows directly to developing countries' financial institutions has 
continued to be of the corporate lending kind. 
Traditionally, in developing countries at least, project finance techniques have shown up 
mainly in the mining and oil and gas sectors. Projects that depend on large scale foreign 
currency financing are particularly suited for project finance because their output has a 
global market and is priced in hard currency. Since market risk greatly affects the 
potential outcome of these projects, project finance tends to be more applicable in 
industries where the revenue streams can be defined and fairly easily secured. 
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The distinction between corporate lending and project finance is particUlarly important for 
this study because it encourages investors who will be willing to invest in projects such as 
mining and oil and gas sectors but for fear of the collapse of the sponsoring company 
which win mean that full repayment of their funds cannot be made. Literature review 
revealed that investors are more willing to put their funds into projects that are backed by 
the project itself and the project outputs, which is the main focus of project finance. It is 
therefore not surprising to find more international financial institutions investing in mining, 
oil and gas projects. 
2.5 STRENGTH OF PROJECT FINANCE IN OIL AND GAS INVESTMENTS 
In the appropriate circumstances, project finance has two important advantages over 
traditional corporate finance: it can (1) increase the availability of finance, and (2) reduce 
the overall risk for major project participants, bringing it down to an acceptable level. 
(Davis, Henry 1996). 
For a sponsor, a compelling reason to consider using project finance is that the risks of 
the new project will remain separate from its existing business. Then if the project, large 
or small, were to fail this would not jeopardize the financial integrity of the corporate, 
sponsor's core business. Proper structuring will also protect the sponsor's capital base 
and debt capacity and usually allow the new project to be financed without requiring as 
much sponsor equity as in traditional corporate finance. Thus, the technique enables a 
sponsor to increase leverage and expand its overall business, sharing the risk with other 
participants such as project contractors, insurance companies and host governments. 
By allocating the risks and the financing needs of the project among a group of interested 
parties or sponsors, project finance makes it possible to undertake projects that would be 
too large or would pose too great a risk for one party on its own. This was the case in 
1995 when Intemational Finance Corporation helped structure financing for a $1.4 billion 
power project in the PhHippines during a time of considerable economic uncertainty there. 
Sharing the risks among many investors was an important factor in getting the project 
launChed. 
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According to Ahmed, Priscilla (1999), raising adequate funding for a risky project brings to 
bear on the project sponsors, an obligation to settle on a financial package that both 
meets the needs of the project in the context of its particular risks and the avaDable 
security at various phases of development and is attractive to potential creditors and 
investors. By tapping various sources of finance (for example, equity investors, banks, 
and the capital markets), each of which demands a different risk/return profile for its 
investments, a large project can raise these funds at a relatively low cost. 
Also working to its advantage is the globalization of financial markets, which has helped 
create a broader spectrum of financial instruments and new classes of investors. By 
contrast, project sponsors traditionally would have relied on their own resources for equity 
and on commercial banks for debt financing. Particularly Significant is the increasing 
importance of private equity investors, who tend to take a long-term view of their 
investments. These investors are often willing to take more risk (for example, by 
extending subordinated debt) in anticipation of higher returns (through equity or income 
sharing) than lenders. A project that can be structured to attract these investors - to 
supplement or even to substitute for bank lending may be able to raise longer-term 
finance more easily. 
Further reasons given by the available literature for project finance over corporate lending 
are the increase in finding because of the willingness of financiers and the reduced overall 
risk for the major project participants. It is rational to increase funding for projects that 
have higher returns with reduced risks, no doubt there is increased funding for oil and gas 
projects that have their risks managed efficiently, especially, where experts such as MIGA 
and the World Bank are Involved in these activities. It can be deduced from the above 
that project finance is not suitable for small projects even though financiers have in the 
past released funding to small projects. The fact is that, project finance benefit large 
projects than smaH projects, which can rely on corporate lending. 
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2.6 RISK MANAGEMENT 
The word management can be defined in terms of the organization of activities and 
controlling the use of resources in such a manner as to achieve some desired 
objectiVe(s). For an industrial or commercial firm the objective may be to maximize 
profits, or it may be to increase revenue, net worth, or perhaps market share over a 
period, or to achieve a combination of several objectives, or just to stay in business. The 
govemment places certain social and financial objectives on nationalized industries, and 
local authorities must pay in regard to the costs of their operation. An individual, too, may 
seek to manage his own activities and resources in order to attain certain objectives. 
All such plans may be upset by the occurrence of unforeseen events, and it is the 
exposure to events, which cannot be predicted with absolute certainty that may broadly be 
thought of as risk. Therefore, in the broadest of terms, risk management is concerned 
with the planning, arranging, and controlling of activities and resources in order to 
mininize the impact of uncertain events. 
Benjamin Frank (1992) in his book U risk assessment, managerial emphasis" observed 
that in this world nothing could be said to be certain, except death and taxes'. Yet there is 
some uncertainty about even those two phenomena: no one can be sure when he will die, 
and tax rules and rates are frequenUy changed. In fact, life is surrounded by uncertainty. 
No individual, firm, organization, or society knows what the future holds in store. Life 
however is full of surprises, sometimes pleasant, at other times unpleasant, sometimes of 
minor importance, on other occasions catastrophic. Some unexpected events are the 
result of one's own actions, perhaps due to a failure to exercise care, or through tackling 
things for which one is ill equipped. Other experiences may be due to the actions of other 
individuals groups, or society as a whole, and sometimes nature is the culprit. In other 
words, whereas some of the uncertainties are within the control of the individual or firm, 
others are part of the environment in which one lives or operates. 
Benjamin Franklin et al gave the following examples: Individuals and families are 
exposed to the chances of loss due to disease, accidental injury and death, 
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unemployment, loss of possession, and many other events which may diminish their 
welfare. On the brighter side there can be unexpected gains too. such as a large win on 
the footbal pools. or a chance encounter that lends to a better job or a happy marriage. 
Firms, too. may suffer loss due to the destruction or loss of property either belonging to 
them or for which they are responsible. They may also incur large liabilities to third 
parties for accidents attributable to the wrongful acts of employees or agents, or defects in 
their products, or incorrect adVice. In addition, associated with the conduct of any 
business, there are other uncertainties, which may be classified as follows: production 
risks, making and distributing risks, financial risks, personnel risks and environmental 
risks. 
The issue of risk cannot be avoided. It can only be minimized and/or transferred. Oil and 
gas projects are more risky than other projects, especially in developing economics of 
Africa. Managing its risk encourages financiers to invest their funds into these risky 
projects. The colossal amount of money required by these projects and the long-term 
nature of the investments particularly makes its more risky and unless the uncertainties 
are minimized through efficient management, financiers will be unwilling to invest in these 
projects. 
2.7 RISK MANAGEMENT PROCESS 
The job of risk management can be broken down into three elements, which follow each 
other in a logical sequence: 
Risk analysis 
Risk control 
Risk financing. Brown (1995) 
2.7.1 RiskAnalysls 
The first step in the process is to analyze the risks of which an organization may be 
exposed. Risk analySis itself has two prime elements - the identification of risk and its 
evaluation. 
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Identification requires a knowledge of the organization, the market In which it operates, 
the legal, social economic, political. and climatic environment in which it does its business, 
its financial strengths and weakness, its vulnerability to unplanned losses, the 
manufacturing processes, and the management systems and business mechanism by 
which it operates. 
Any failure at this stage to identify any risk which may cause a major loss will eave the 
organization still exposed to the chance of bankruptcy, however thorough the rest of its 
risk management programme. Risk identifICation provides the foundation for risk 
management. 
Risk evaluation can be broken down into two parts - the assessment of: 
a) The probability of a loss occurring and 
b) Its severity. 
It is not sufficient just to know that an organization owns or is responsible for property, 
which is exposed, to damage by fire, explosion, windstorm, flood, or other perils or that it 
produces and/or sells products that could cause injury or damage. The formulation of 
sensible decisions about the way such risks should be handled also requires information 
regarding values at risk or potential liabHities, and the estimated frequency of losses of 
differing size, including losses caused by any interruption to its business. Only with such 
information is it possible to judge the cost effectiveness of spending on risk reduction or 
deciding whether a risk can be retained or should be insured and, in the latter, whether 
the premium required is an acceptable price to pay for the risk transferred. 
2.7.2 Risk Control 
Risk control according to Brown et ai, covers all those measures aimed at aVOiding, 
eliminating or reducing the chances of loss producing events occurring, or limiting the 
severity of the losses that do happen. Here, one is seeking to change the conditions that 
bring about loss prodUCing events or increase their severity. Though some measures call 
for litHe more than commonsense, often considerable technical knowledge is required, for 
which the risk manager will need to tum to experts in the particular field. 
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2.7.3 Risk Financing 
Brown et al argued that one is concemed with the manners in which the risks remaining 
after the risk control measures have been implemented is be taken care off. It has to be 
recognized that in the long run an organization wiD have to pay for its own losses. 
Therefore the primary objective of risk financing is to spread more evenly over time the 
cost of risk in order to reduce the financial strain and possible insolvency, which the 
random occurrence of large losses may cause. The secondary objective is to minimize 
risk costs. 
Essentially an organization can finance its risk costs In three ways: 
Losses may be charged as they occur to current operating costs; or 
Ex ante provision may be made for losses, either through the purchase of an 
insurance cover which losses can be charged, 
When losses occur they may be financed by loans, which are repaid over the 
next few months or years. 
The probabHity and severity of possible losses play an important part in the structuring of 
a risk-financing programme. It is axiomatic that in practice high probability of loss 
generaDy goes hand in hand with relatively low severity, and vice versa. If it were 
otherwise, exposure to a high probability of catastrophic losses would place any 
organization in an untenable position. For example, if a pharmaceutical company 
developed a new treatment for an unpleasant though not fatal complaint, but the drug 
caused a side effect which was almost certain to lead to the death of one in ten of the 
users, one can be sure that, regardless or any governmental controls, it would not be 
marketed. Any enterprise exposed to such a probability, high severity risk would have to 
be abandoned. 
Risk management may be expressed in the truth; 'prevention is better than cure', or, 'it is 
better never to have suffered a loss than to suffer and collect under an insurance policy.' 
The reason for this fundamental truth of risk management is that nothing can ever repair 
or put right the effects of a casualty. In fact, at the extreme, the enterprise might fail 
entirely notwithstanding that it has the finest risk-financing programme it would devise. 
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There is ample evidence, for example, that a significant proportion of firms never fully 
recover from the effects of a major fire and some have to be wound up within a short time 
even if fully insured. The main reason is that in a competitive industry it is almost 
impossible to recapture one's former share of the mafi(et after a prolonged interruption of 
business. 
Risk control and risk financing, however, are not independent parts of the whole risk 
management process. A reduction in loss expectancies brought about by risk control 
measures will usually also reduces the cost of the risk financing programme. 
Therefore, if one starts form the basic premise that transfers of risks by insurance or other 
means is no substitute for risk control then other means have to be employed. According 
to Donaldson et ai, regardless of the techniques that may be employed at each stage, or 
the eventual form of the risk handling arrangements, every risk management programme 
must proceed according to the following logical sequence of events if it is to stand any 
chance of success. 
All exposures to risk must be identified; 
All exposures need to be evaluated according to cause effect, the aim being 
to quantify probabHities and severities; 
The possibility of aVOiding or eliminating any of the risks should be 
investigated, and if feasible the appropriate steps should be taken; 
In the case of other risks, risk reduction measures need to be explored and 
implemented; 
The residual risks need to be evaluated so that decisions can be taken about 
the best methods of financing them; and finally 
The results of the whole programme need to be monitored and regularly 
reviewed in the light of changing conditions. 
2.7.4 Administration of the Risk Management Process 
The emergence of risk management as a separate specialist area of management has led 
to the appearance of risk managers in the management structure of an increaSing number 
of companies and other organisations. Broadly, every risk manager is charged with the 
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task of administering his organisation's risk management programme, but precisely what 
role risk manager's play and where he or she is placed in the management structure 
varies from organisation to organisation. 
2.8 RISK MANAGER'S ROLE 
Whether a risk manager's responsibilities are limited to dealing with the pure risks to 
which his organization is exposed, or extend to some of the speculative risks too, his role 
is likely to be both advisory and executive. 
Although the risk manager may be given primary responsibility for the identification of 
risks, to a significant extent, particularly in a multi-national corporation, much of that task 
may devolve upon local management. Indeed, that point takes one immediately to one of 
the most difficult features of risk management which is that no one man can posses all of 
the expertise required to carry out every part of the risk management process. Even a 
risk management department composed of individuals with different skills may still need t 
seek the advice and guidance of experts in particular fields. Arguably the best placed 
people in any organisation to discover hazards and identify major exposures are local 
operating management. 
Therefore, a risk manager must certainly obtain local co-operation and advice, and it may 
be that his risks identification task is limited to providing operating line management with 
the tools to research systematically the risk exposures within their own areas of operation. 
Likewise, in regard to the remainder of the risk management process, the risk manager's 
role may largely consist of advising top management, including, in a decentralized 
organization, the top management of the various operating divisions, on the techniques to 
be used for the evaluation, control and financing of risks. 
In that role, in conjunction with engineering, prodUction, financial, and other specialist 
colleagues, he may be drawn into the task of helping to establish for the organisation 
standards of feasible and sensible risk control compatible with the corporate objectives. 
He WIll also be expected to advise on the financing of residual risks. 
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Clark (1989) in his article communicating risk emphased that the extent to which risk 
managers are involved in executing agreed risk management poHcies varies considerably. 
Most are responsible for administering insurance programmes; though in some multi-
national corporations even that task may be wholly or partially undertaken locally, subject 
perhaps to advice and guidance from the central risk management department. If central 
contingency fund forms part of the risk financing programme, again the risk manager 
probably wi. play some part in its administration, though the investment of the funds may 
be outside his control. It is the physical risk control area which is far less likely to be 
placed under his control: by the very nature of the tasks involved in most organisations, 
responsibility for the administration of safety, product quality and security programmes 
tends to be given to other staff managers, such as works engineers quality control, and 
computing managers. 
Clearly, communication and co-operation with colleagues throughout an organization are 
essential ingredients of any risk manager's job whatever may be the precise terms of his 
duties. Clark et ai, goes so far as to argue that communication, co-operation, and 
motivating management in the advantages of risk management are essential elements of 
the work of a risk manager. "(Organizational relationships; co-coordinating risk handling 
activities); Handbook of risk management, Clark et al. 
2.9 COMMUNICATION AND CO-OPERATION OF RISKS 
If a risk manager is to do his job effiCiently he must gain the co-operation of all colleagues 
who possess information he requires and/or help is needed for carrying out risk handling 
decisions. Any department of an organisation may impinge on the risk manager's work in 
some way but usually there will be a more frequent, direct relationship with legal, finance, 
production, and personnel departments. For example, the legal department will be 
invotved in the preparation and the vetting of sales and purchasing contracts, the leasing 
of buildings and plant, and dealing with claims from contracts may involve the shifting of 
legal liabilities for damage or injury, or provisions regarding insurance, all matters on 
which the risk manager will need to be informed and consulted. In tum, he may want 
assistance from the legal department in the drafting of new insurance contracts or in 
setting up a captive insurance company. 
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Finance departments possess the information required to value potential losses, and 
inevitably will be involved in formulating the organisation'S risk handling policies. 
Production and works managers are directly involved in many of the activities that create 
risks and, may be given responsibility for the welfare of employees that will be involved in 
programmes to reduce industrial accidents, and the risk manager may be responsible for 
arranging and operating insurance schemes that form part of the package of employee 
benefits negotiated by the personnel department. 
It is not surprising that communication is seen not only by Clark but also by other writers 
and many risk managers as a major part of their work. Clark et al again stressed the need 
for the risk manager to educate himself in all of the major aspects of the organisation in 
which he works including the personalities of its members. Clark et al added that: 
The risk manager also needs to appreciate the limitations of 
his own knowledge. It is impossible for any man to acquire all 
of the knowledge and skill brought together in an organization. 
Therefore the risk manager must learn from whom he can acquire 
the technical information and advice he will require to identify 
and evaluate risks, and to formulate his own risk handling advice. 
A part of the risk manager's education process must also be directed at the management 
of his organization in order to dispel the idea that 'it can't happen to us', and to apprecia1e 
the benefits of a sound risk handling programme. The effective control of risk is only 
likely to occur if the measures taken have the full support of the top management. 
Apart from that education process is the preparation of a risk and insurance manual, not 
only for the risk manager's own use, but also for circulation to other managers throughout 
the organization who may be affected by or have some responsibilities for the handling of 
those risks that faU within the risk manager's province. 
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2.10 RISK ADMINISTRATION 
Exactly who is given responsibHity for carrying out the analysis, control and financing of 
risks is an organizational problem to which there is no uniquely correct solution. What, 
those tasks involve, and the principles and techniques, which may be applied to them, are 
the subject of the following discussion. There are, however, two other aspects of the job 
of a risk manager which need to be considered here: they are record keeping and the 
reporting of the activities of the risk management department. 
2.11 RECORD KEEPING OF RISKS 
Record keeping is essential to provide information, including statistical data, required for 
risk analysis and risk handling purpose. Records also provide the information required for 
the preparation of report for management. 
Among the records, which the risk management department should, either keep, or to 
which it should have access, are: 
A building and plant register recording buildings, plant machinery and other 
fixed assets owned by the organization or for which it is responsible, 
providing such details as date of purchase, purchase price, location and 
current value; 
A regularly updated record of stocks and other moveable assets, with a 
breakdown between locations; 
Insurance records, including a policy register, premium payments, claims 
data, inspection reports, and reports prepared on coverage, etc. 
Records of all losses including uninsured losses, showing date of loss, dates 
and amount of interim payments and of final settlement, nature of loss, cause 
of loss, steps taken to prevent any repetition; 
Risk analysis reports, recommendations made for the handling of risks. 
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2.12 REPORTS 
The risk manager should prepare, for both top management and departmental heads, 
annual reports on the activities of his department. The reports for top management could 
include such matters as changes in the costs, arrangement and scope of insurance 
coverage, highlighting changes in levels of retained risks; and analysis of claims and their 
relationship to premiums paid, and data on insured values and other measures of 
exposure to risk. An analysis of the cost of operating the risks management department 
should also be included, with estimates of the benefits it provides. 
Reports may be provided for other departmental heads dealing with matters under their 
control. For example, an analysis of vehicle accidents and costs may be prepared for the 
transport manager, and similar analyses of industrial injuries may be prepared for 
personnel and production departments. 
2.13 USE OF BROKERS AND CONSULTANTS TO MANAGE RISKS 
It is common practice for all types of organisation to employ outside consultants 
occasionally, or even on a regular basis, to help in dealing with all sorts of management 
problems. There can be various reasons for doing so, but in general such action in no 
way implies any criticism of internal management. Unless a consultant is employed 
regularly by a particular organization there is no way in which he can possess an in depth 
knowledge of its business, its management structure and personalities. and all of the 
other details that will be known and understood by intemal management. On the other 
hand. consultants can offer various advantages, such as: 
The resources to tackle an urgent problem quickly, free from the diffICUlties 
that internal managers have of attending to their normal duties at the same 
time; 
Specialist skills and knowledge which may not be available in the same depth 
inside the organization; 
Access to information which either may not be available to internal 
management or could involve very high search costs; 
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A breath of knowledge and experience in dealing with similar problems not 
possessed by internal management; 
Impartiality when dealing with and advising on issues that involve the 
interests of individual managers. 
It has long been the custom of the majority of firms to employ insurance brokers to assist 
in dealing with insurance matters, and as risk management has developed as a separate 
management function, so consultancy firms have been formed to assist and advise on 
other aspects of risk management programmes. 
If it is desired to place insurance business at Lloyd's then a broker has to be used but 
even if that special case is excluded the report by the AIRMIC study group. The status 
and techniques of insurance and risk managers in industry and commerce showed that 
over four-fifths of the 142 respondents employed insurance brokers for handling at least 
some of their risks. Donaldson (1989) 
2.14 MONITORING RISK MANAGEMENT PROCESS 
If organisations operate in an unchanging world, then once the controllers of an 
organisation had formulated their risk management objectives and had translated those 
into a set of policies which had been implemented, that would be the end of the risk 
management process, apart from the need to check that the results were in accord with 
the chosen objective. Life, however, is subject to change. Corporate controllers may 
change their attitudes to risk, either of their own free will (perhaps because of a change in 
the composition of a board of directors) or by force of circumstances. 
Risk conditions, too, alter over time, both within an organization (for Example, in 
consequence of product, process, or personnel changes) and in the outside environment 
in which it operates. And the constraints on risk handling choices also may change. 
Therefore the risk management process is a continuing process calling for action on two 
fronts: 
Results of policies adopted need to be monitored. Risk handling decisions 
are always concemed with the future, and one of the difficulties confronting 
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risk managers Is that decisions usually have to be taken on the basis of 
information which falls far short of perfect, and so policies may need to be 
reviewed in the light of fresh information: 
Policies need to be reviewed at regular intervals in the light of changing 
conditions. 
The techniques emplOyed in the monitoring and review process will be the same as those 
used in the initial risk analysis, control and financing processes. If results are to be 
monitored, then the appropriate records must be maintained on: 
Loss producing events and, ideally, of near misses too; 
The costs of risks and the benefits of risk handling programmes. 
2.15 RISKS IN OIL AND GAS INVESTMENTS 
Oil and gas projects involve risk for aM parties - the project developer and the lender. 
Project developers take risks that are foreseeable and manageable or for which they are 
adequately rewarded. However, when developers are unable to provide guarantees 
adequate to satisfy lenders, the lenders will seek govemment guarantees. The ability of 
the parties to agree on how risks will be shared is often the key to initiating a successful 
project. These risks fall into one of three categories, namely, commercial risks, political or 
country risks, and force majeure risks. 
2.16.1 Commercial Risks 
Donaldson (1989) saw commercial risks arising during the construction phase of projects 
and indicated that commercial risks relate to variations in costs, schedule, and ability to 
meet completion requirements. Donaldson (1989) classified these variations as 
completion risks. He explained further that commercial risks could also arise during the 
operating phase, operating risks). Donaldson relate this to the projecfs ability to generate 
projected revenues or cash flow and meet the needs of the market, supply or market 
risks. 
Donaldson et al also viewed country or political risks as those that are beyond the control 
of negotiamg parties, such as foreign exchange or expropriation risks. 
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According to Brown et ai, every project risk should be transferred or mitigated. Risk must 
be allocated properly among all parties through the various contracts, insurance policies, 
bonds, or letters of credit. Brown et al emphased that it is worthwhile sharing risk with 
local partners. This can involve equity participation in a joint venture project company or 
partnership or association with local construction or operating contractors. Brown 
concluded that such arrangements can also facilitate the negotiation of contracts, and can 
help to secure government commitments. 
Smith Andrew (1988) in his article "Risk in Energy Exploration" published in the Oil and 
Gas joumal volume 5, 1988 reiterated that the central contract in the oil and gas financing 
is the energy purchase agreement, and it is from the obligations set forth in this contract 
that the project generates revenues, and it is the sale of energy that provides the cash 
flow to meet debt service, operating costs, maintenance, and return on investment. For 
this reason the creditworthiness of the purchaser is a key factor in assessing commercial 
risk. So that the project needs to be structured around the purchaser that needs the 
energy, can fulfill payment obligations, and has demonstrated creditworthiness. What 
Smith (1988) implies is the uncreditworthiness of purchasers even state-owned utilities 
default in paying for supprles of energy. Typical of this situation is Tema Oil Refinery 
inability to pay for the oil purchase from Nigeria National petroleum Corporation for the 
whole of 1999 and 2000 financial year causing complete breakdown in the crude oil 
purchase agreement between Ghana National Petroleum Corporation and Tema Oil 
Refinery on one hand and Nigeria National Petroleum Corporation on the other hand. 
The researcher can conclude in this respect that this additional layer of risk can only be 
mitigated by sovereign govemment guarantee, multilateral support, or irrevocable letter of 
credit facility. 
In addition to these mitigation arrangements, it must be possible of the purchaser to pass 
all purchase costs in the form of tariffs to the final consumer of the energy product. The 
govemment of Ghana was unable to do this in the year 2000 for political expediency. 
Brown et ai, outline plant downtine, machinery breakdown and fuel risk as serious major 
commercial risks that have to be managed in risk mitigation. He explained that plant 
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downtime can expose the project to interruption in cash flow and therefore can disrupt 
debt-service payments. Because the producer is responsible for aU risk associated with 
the operation of the energy plant, adequate risk transfer and mitigation becomes 
necessary. The losses incurred because of scheduled maintenance should be covered 
by a well-funded sinking fund or reserve for maintenance. Brown et al indicated that 
machinery breakdown can cause extended downtime and substantial repair costs. This 
risk can be reduced by selection of experienced contractors and proven equipment, and it 
can be further mitigated by compressive insurance not only for repair of machinery but 
also for business interruption or loss of revenue. 
Brown et al also suggested fuel risk mitigation through long term fuel supply agreement 
guaranteeing quality, quantity, and delivery. Fuel price changes should be reflected in the 
energy component of the purchase price. 
Poor or inefficient operation and maintenance can cause plant performance to fall below 
levels stipulated. It can also cause premature wear and tear on plant components. The 
project company can mitigate this risk by entering into a longer-term operation and 
maintenance contract with a reputable operator. The guaranteed availability and 
minimum operating parameters stipulated in the agreement can be passed on to the 
operator. Their operation and maintenance contract should have incentives for 
encouraging good maintenance and high plant availability, and it should contain a 
significant penalty clause covering the operator's performance obligations. 
Technical quality also affects performance (Smith 1988). He illustrated oil and gas plant 
producing at less than expected capacity, for example, can have severe effects on the 
producer's ability to meet obligations. Having a strong engineering, procurement, and 
construction contract, which must have a fixed price and a firm completion date, 
substantially mitigates this risk. 
AcCOrding to Fenecher (1992) in his book Energy Financing, commercial and operational 
risk can be reduced largely by the quar.ty of construction contractors. Fenecher 
emphased that construction contractors can only reduce the risk if they possess the 
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technical, managerial and financial capabilities to assure completion of the project and itS 
continuing operation. He indicated that the sponsors must pre-qualify the contractors 
carefully by reviewing there past experiences on similar projects and commitment during 
construction. Fenecher concluded that the project Company should minimiZe risks 
through the quality of its own management and technical resources and through its ability 
to manage the contractors and the projecfs financial and commercial agreements. 
2.15.2 Country Risks 
Country or political risks are inherent to the country in which the project is being 
implemented and are of greatest concern to lenders because such risks could adversely 
affect the development and operation of the project. 
Donaldson et ai, view country risks as a prerequisite of a successful project risk 
mitigation. He emphases that the commitment by government to reforms that will 
encourage investment, and developers will specifically assess the degree of the 
govemmenfs commitment and the risk that the govemment will lack the political will to 
reform. Donaldson stated that primary political risks project developers will consider to 
include avaHabHity of foreign exchange to service the project debt and to pay dividends to 
offshore investors; potential for default on the part of govemment or its agencies in 
meeting contractual obligations; risks of expropriation; and possibilities of political turmoR. 
2.15.3 Force Majeure Risks 
Force majeure risks are caused by natural disasters or accidents such as fire, flood, 
storms, or earthquakes. Brown et al indicated that force majeure risk should be mitigated 
through commercial insurance. The project company should be responsible for obtaining 
and paying for the necessary insurance cover, which should be comprehensive 
throughout the construction and operation phases of the project. Brown (1995) emphases 
that the commercial insurance should cover not only any asset loss such as construction 
risk but also business interruption, including loss of revenues for delays in plant 
operations caused by natural disasters. He concluded that the insurance should cover at 
least six months to one year of debt service and fixed costs. 
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Comments 
The three broad categories of risk, commercial risks, political or country risks and force 
majeure risks are appropriate since all types of risks can be easily placed under at least 
one of the categories. Commercial risk is mainly business oriented. Without business, it 
will not arise, example of which as identified by Donaldson et al are the probability of the 
project to generate projected revenue or cash flow and to meet the needs of the market 
that is likely to exist for the products. Typical of every bUSiness, negotiation by parties 
involved in the business is necessary to facilitate smooth running of the business, so also 
is the commercial risks. Stakeholders in the oil and gas industry must haggle their 
positions in order to arrive at a compromise, which must be between both the local 
partners and the foreign partners. All the authors have ignored integrity of the 
stakeholders, which are one of the key issues in business negotiation and one of the 
determinants in risk assessment. The higher their integrity, the lower the levels of risks 
and vice .visa. 
Fenecher et al emphases that construction risks can be reduced drastically when the 
construction contractors have the necessary technical, managerial and financial 
capabilities to execute the project and ensure Its continuity. Fenecher et al however 
ignored the commibnent of the executors of the projects. In fact, if the executors are not 
committed, the project will not be undertaken according to specification. 
The researcher is of ~ opinion that commercial risks are more of trust, commitment and 
integrity of the parties involved in the project execution, financing and operation every 
activity that relate to the project. Country risks primarily relate governments and the 
nationals of the country. Their attitude towards the project has been the concern of the 
authors. This is important since any change in attitude negatively is likely to affect the 
project. This all the authors did not ignore in their write outs. Force majeure on the other 
hand primarily relates to act of God. Act of God in the sense that all the parties involved 
have no control over such acts and therefore cannot be negotiated. Its impact can 
however be reduced through insurance and other measures. The researcher is of the 
opinion that proper feasibility studies to determine the possibility of occurrence of such 
acts and when they are likely to occur can reduce their risk levels. 
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2.16 RETURN AND RISK 
The retum and on an investment are basic concepts in financing decisions. The retum on 
an investment refers to the financial outcome or reward on an investment made by the 
investor. For example, if someone invests ¢100 million in an asset and subsequently sells . 
that asset for ¢111 million, the cedi retum is ¢11 mUlion. Usually, an investmenfs cedi 
retum is converted to a rate of retum by calculating the proportion or percentage 
represented by the cedi retum. For example, a cedi retum of ¢11 million on an 
investment of ¢100million represents a rate of retum of ¢11 millionl¢100 milfion, which is 
0.11 or 11 percent. 
Risk on the other hand is present whenever investors are not certain about the outcomes 
that an investment will produce. Suppose an investor attaches a probability to each 
possible cedi retum that may occur. (Sometimes a distinction is drawn between "risks" 
and "uncertainty" where this is done, risk refers to situations where a probability can be 
assigned to each of the possible outcomes, whereas uncertainty refers to situations where 
so little is known that the assignment of probabilities is impossbJe. However, we do not 
draw this distinction and the words risk and uncertainty will be used synonymously). Let 
us assume that the probability distribution in the table below represents an investor's 
assessment of the cedi retums, x, that may be received from holding a share in a 
company for one year. 
Probability Cediretum 
(p) (x) 
--~ 
0.1 9 
0.2 10 
0.4 11 
0.2 12 
0.1 13 
Suppose the investor wishes to summaries this distribution by calculating two measures, 
one to represent the size of the cedis and the other to represent the risk involved. The 
obvious measure to represent the size of the cedi retums is the expected value of the 
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distribution. The expected value (x) of the cedi returns is given by the weighted average 
of an the possible cedi returns, using the probabilities as weights. 
That is x = n 
rxipi 
= (¢9) (O.1) + (¢10) (0.2)+ (¢11) (0.4) + (¢ 12) (0.2)+(¢13){0.1) = ¢11 
The choice of a measure of risk is less obvious. In the above example, risk is present 
because any one of five outcomes (¢9, ¢10, ¢11, ¢12 or ¢13) might result from the 
investment. If the investor has perfect foresight, then only one possible outcome would 
be involved and there would to be a probability distribution to be considered. This 
suggests that risk is related to the dispersion of the distribution. The more disperse or 
widespread the distribution, the greater is the risk involved. Statisticians have developed 
a number of measures to represent dispersion. These measures include the range, the 
mean absolute deviation and the variance. However, it is generally accepted that in most 
instances the variance (or its square root, the standard deviation, 0") is the most useful. 
Accordingly, this measure of dispersion will be adopted to represent the risk of a single 
investment. The variance of a distribution of cedi retums is the weighted average of the 
square pf each cedi return's deviation from the expected cedi return, again using the 
probabilities as the weights. 
That is: cI- = r (xi - X)2 pi 
i= 1 
= (9-11)2 {O.1)+(10-11)2 (0.2)+(11-1)2 (0.4)+(12-1)2 (0.2)+ (13-11)2 (0.1)= 1.2 
The standard deviation is therefore: 0" = "1.20 
= ¢1.095 
In these circumstances we have used cedi returns rather than rates of return. This is 
because it is generally easier to visualize cedi rather than rates and because it avoids 
calculations with a large number of SignifICant figures following the decimal point. 
However, there is no difference in substance, as may be seen from reworking the 
example using rates of return. If it is assumed that the sum invested is ¢100 million, than 
a cedi retum of ¢9 million, for example, is a return of 0.09 when expressed as a rate. We 
can now use xi to mean, "return" rather than "cedi return". 
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ProbabHity Return 
Pi xi 
0.1 0.09 
0.2 0.10 
0.4 0.11 
0.2 0.12 
0.1 0.13 
The expected retum, x, is : 
x = (0.09) (0.1)+(0.10) (0.2}+(0.11)(0.4) + (0.12) (0.2) + (0.13 (0.1) 
=0 .11 or =1 1% 
The variance of returns is: 
cI = (0.09 - 0.11)2(0.1)+(0.10 -11)2(0.2) + (0.11 - 0.11)2 (0.4)+(0.12 - 0.11)2(0.2) + 
(0.13-0.11)2 (0.1) = 0.00012 
The standard derivation is therefore: CJ vO.OO012 = 1.095% 
2.17 PORTFOLIO THEORY 
Portfolio theory was initially developed by Markowitz as a normative approach to 
investment choice under uncertainty. Two important assumptions of portfolio theory are: 
1. The returns from investments are normally distributed. Therefore two parameters, 
the expected return and the standard deviation, are sufficient to describe the 
distribution of retums. 
2. Investors are risk-averse. Therefore investors prefer the highest expected return 
for a given standard deviation and the lowest standard deviation for a given 
expected return. 
Given these assumptions it can be shown that it is rational for a utility 
maximizing investor to hold a welkliversified portfolio of securities. 
Let x be the expected return on the investment, and xp, be the expected return on a 
portfolio of securities. Then: n 
xp= IXiXi 
i= 1 
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Where xi = the proportion of the total current marKet value of the portfolio that 
the current marKet value of the ith securities constitutes. 
n =t he number of securities in the portfolio. 
Let us assume there are only two securities (1 and 2) in a portfolio and X1 =0 .08 and X2 = 
0.12. Also assume that the current marKet value of security 1 constitutes 60 percent of 
the total current market value of the portfolio (that is, X1 = 0.6 and X2= 0.4. Then: 
xp =( 0.6)(0.08)+(0.4)(0.12) 
=0.096 
The expected retum on a portfolio, therefore, is simply the weighted average of the 
expected returns on the securities constituting the portfolio. However, the standard 
deviation of the return on the portfolio (O'p) is not as simple to measure. This is because it 
depends not only on the riskiness of the individual securities but also on the relationship 
between those securities with respect to risk. 
The variance of the return on a portfolio is given by: 
n n 
~p= r I XiXjrijO'iO'j 
i =1 j=1 
where: 
xi = the proportion of the current marKet value of the portfolio that the ith 
security constitutes. 
xj = the proportion of the current marKet value of the portfolio that the 
jth security constitutes. 
rij = the correlation coefficient between the returns on securities i and j 
and by definition, rij = Iji and rii = 1 
ri = the standard deviation of the possible returns on the ith security 
Ij = the standard deviation of the possible returns on the jth security. 
n = the number of securities in the portfolio. 
The correlation coefficient, rij, depends on the relationship between returns on two 
securities, i and j. A correlation coefficient can take on a value between + and - 1. If the 
correlation coefficient between the returns on two securities is +1, the returns are said to 
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be perfecUy positive correlated. This means that if the return on security i is "high" 
(compared with its expected level), then the return on security j will, unfairly, also be "high" 
(compared with its expected level) to precisely the same degree. If the correlation 
coefficient is -1, the returns are perfectly negatively correlated; high (low) returns on 
security i will always be paired with low (high) returns on security j. A correlation 
coefficient of zero indicates the absence of a systematic relationship between the returns 
on the two securities. 
The return-risk relationship has shown that investors do not only consider the returns on a 
project in isolation. The risk, which is the standard deviation, is also considered. The risk 
is calculated from the returns and compared with the level of returns. This is considered 
fundamental to decision-making concerning investments in projects. No single investment 
decision can take place without return-risk analysiS even social projects take into account 
retum- risk relationships. 
2.17.1 Investors' Preferences 
Investors must choose an investment alternative (portfolio), which gives them a 
satisfactory balance between the expected returns from the portfolio and the risk that 
actual returns from the portfolio will be higher or lower than expected. Some portfolios will 
be more risky than others. Traditional investment theory suggests that rational investors 
wish to maximize return and minimize risk. Thus if two portfOlios have the same 
elements of risk, the investor will choose the one yielding the higher return. Similarly, if 
two portfolios offer the same return the investor will select the portfolio with the lesser risk. 
This is shown below: 
Expect 
retum 
y 
x Risk 
Investor's indifference curve 
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Portfolio A win be preferred to portfolio B because it offers a higher expected return for the 
same level of risk. Similarly, portfolio C will be preferred to portfolio B because it offers 
the same expected return for lower risk. A and C are said to dominate portfolio B. But 
whether an investor chooses portfolio A or portfolio C will depend on the individuars 
attitude to risk, whether he wishes to accept a greater risk for a greater expected return. 
The curve 11 is an investor's indifference curve. The investor will have no preference 
between any portfolios, which give a mix of risk, and expected return which lies on the 
curve, since he derives equal utility from each of them. Thus, to the investor the portfolios 
A, C, 0, E and F are all just as good and each other, and all of them are better than 
portfolio B. Remembering that the risk of a portfolio can be measured as the standard 
deviation of expected retums this may be expressed by saying that portfolio B is preferred 
on grounds of mean-variance inefficiency. 
An investor would prefer combinations of return and risks on indifference curve A to those 
on curve B in the figure below because curve A offers higher return for the same degree 
of risk (and less risk for the same expected returns). For example, for the same amount 
of risk x, the expected return on curve A is Y1, whereas on curve B it is only Y2. 
Expected 
return 
Y1'!-----
Y21-----
x Risk 
Indifference curve compared 
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2.18 HEDGING OF FINANCIAL RISK 
Hedging involves different parties come to an agreement to cancel one of the parties risk 
against the others. The different parties may be subject to similar but opposite risks which 
they wish to hedge. Alematively, one party may wish to hedge a risk while the other may 
wish to speculate. Shapiro and Titman (1985) in their text "Integrated Approach to 
Corporate Risk Managemenr describe hedging as a risk reducing technique. They stated 
that hedging makes financial planning easier and reduces the odds of an embarrassing 
cash shortfall. A shortfall might only mean an unexpected trip to the bank but in extreme 
cases, it could trigger financial distress or even bankruptcy. Hedging can in fact, reduce 
these shortfalls. 
The idea behind hedging is ideally to find two investments that are perfectly correlated, so 
that one investment is bought and the other sold for the net position to be safe in practice, 
the correlation is often not perfect, and therefore some residual risk remains despite the 
hedge. Shapiro and Titman et al contended that whether correlation is perfect or not, the 
techniques for setting up a hedge are the same. 
2.18.1 Hedging in the Futures Markets 
Concentrating on the price changes of the output of oil and gas product, hedging can be 
used to reduce this volatility. The futures contract is market-to-market in the sense that 
the product dealt in is valued at the closing price. If the price declines and the account 
goes below the prescribed minimum, additional margin is required in order to maintain the 
position. If the price rises, excess margin occurs and may be drawn out. The seller of the 
product also must maintain margin, again as a security deposit. If the price of the future 
contract declines, excess margin occurs for the seller if the price increases, the seller 
must put up additional margin. Thus, price movements of futures contracts affect the 
margin positions of the buyer and seller in opposite ways. Settlement occurs not at the 
encl of the contract, but daily. In other words, the winners and losers make daily 
adjustments in cash. 
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Hedging takes two forms, namely, long and short hedge. A long hedge involves buying a 
future contract. It is generaUy employed to lock in an interest rate that is believed to be 
high. A short hedge involves the opposite sort of transactions. The idea is to seR a 
futures contract now because of a belief that interest rates will rise. The sale of the 
futures contract is to use a substitute for the sale otan actual security held. 
2.18.2 Basis in Hedging 
In hedging, market participants are concemed with fluctuations in the basis, which 
portrays the risk to the hedger. Breeden Douglas (1981) argued that the basis of hedging 
is simply the price of a security in the spot market minus its futures price adjusted by the 
appropriate conversion factor. Hedgers, of course, are concerned about their net 
positions at the ctoseout of a futures contract. 
2.19 OPTION PRICING OF PRODUCTS 
It is possible to establish a riskless hedge position by buying a stock and by writing 
options. The hedge ratio determines the portion of stock held long in relation to the 
options that are written. In efficient financial markets, the rate of retum on a perfectly 
hedged position would be the risk-free rate. If this is the case, it is possible to determine 
the appropriate value of the option at the beginning of the period. If the actual value is 
above or below this value arbitrage should drive the price of the option toward the correct 
price. 
Breeden Douglas et al contended that the Black-Scholes option-pricing model provides an 
exact formula for determining the value of an option based on the volatility of the stock, 
the price of the stock, the exercise price of the option, the time to expiration of the option, 
and the short-term interest rate. The model is based on the notion that investors are able 
to maintain reasonably hedged position over time and that arbitrage will drive the return 
on such positions to the risk-free rate. As a result, the option price will bear a precise 
relationship to the stock price. The Black -Scholes model provides considerable insight 
into the valuation of contingent claims. 
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Comments 
The role of hedging in this study relates to the pricing of on and gas project outpu t. Oil 
and gas produc1s fluctuates more frequently in the international market, hence, calls for 
protection in a form of hedging to lock in Mure prices in other to stabilize the market and 
reduce loses. The direction of movement in prices is uncertain and thereby become a risk 
for the cash flow of the project company. Hedging takes place within the futures and 
option contract markets. From the write outs of the literature, it can be observed that 
these financial instruments are equally sound measures of reducing risks just like the 
insurance against other uncertainties. Future and options contracts are major risk 
reduction instruments for financial and market risks rather than political and force majeure 
risks. Financial and market risk hedging with Mures and option contracts demand high 
level technical expertise since the activities involved are complex and sophisticated. 
Thus, with such high level of expertise at the disposal of the project company and the 
financiers, they will be encouraged to invest their funds in oil and gas projects since they 
will be sure that the risk level associated with oil and gas business will be minimized 
2.20 CONCEPTUAL FRAMEWORK 
Upon reflection on the views of a number of scholars on the issue of risk management in 
general, the researcher came out with a conceptual framework for the study. 
In the opinion of the researcher, there is a negative attitude towards African countries, 
hence a very high perceived political, commercial and force majeure risks in the events of 
wars, poor infrastructure and debt burden. In other words, Africa is seen as too high a 
risk to invest in its oil and gas projects, thus, the African on and gas project risks are 
imagined and perceived negatively instead of being assessed assessing it scientifically. 
There is also the fear of the undeveloped financial markets, which are not likely to serve 
as the expected strength for the security packages available for the mitigation of their 
perceived high risk. In other words, there is low quality security package for lenders to 
rely on the account of weak financial markets in Africa, hence they are unwillingness to 
invest in 011 and gas projects, even if they did, the expected return is so high that the 
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project becomes unprofitable for the sponsors and the host govemment The ultimate 
effect is that oil reserves sit underneath the grounds and the natural gas flare in the 
atmosphere of the continent of Africa. 
The intemational financial institutions such as the World Bank, the International Monetary 
Fund, Intemational finance Corporation, Export Credit Agency, United States Agency for 
International Development, Multilateral Investment Guarantee Agency and other huge 
intemational financial institutions must take up the mantle despite the unimaginable and 
un-quantifiable risks perceived by them to invest in oil and gas projects in Africa. 
The strategy to be adopted by these international financial institutions is to try to develop 
the financial mari(ets, reduce war, improve infrastructure and educate Africans to 
understand the agreements that can survive projects, and then, invest their funds in a less 
risky environment. 
References 
1. Ahmed, Priscilla Risk Insurance Biddies Limited, 1999, Great 
Britain. 
2. Benjamin, Franklin Risk Assessment, Managerial EmphaSis. 
Pitman, 1992, United Kingdom. 
3. Brown, Wilkie Risk in Production Process. Ohio State Limited, 
1999, Britain. 
4. Clari(, M. W. G. Communicating Risk in Organization. Oxford 
Publishing Limited, 1989, Britain. 
5. Constantinople Pretoni. Oil and Gas Financing. Helmaine 
Publishing Limited. 1990, Canada. 
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6. Copefield, Samuelson Risk Financing Biddies Limited, 1992, Great 
Britain. 
7. Davis, Henry A. Project Finance. Free Press Limited 1996, 
Washington. D. C. U.S.A. 
8. Dixon, R. and Smith D. Strategic Management. Omega Joumal, 1993, 
U.S.A. 
9. Donaldson, Samuel Corporate Risk, Management Strategy. Oxford 
Limited. 1989. Britain. 
10. Fenecher, Williams Energy Financing. New York Publishing, 1992 
U.S.A. 
11. IFC. Environmental and Social Policy Guidelines. World Bank 
Publishing, 1998. Washing ton D. C. U. S. A. 
12. MIGA Insurance Policy Handbooks. World Bank 
Publishing, 1990. Washington D. C. U. S. A. 
13. Scheinkestel, Nora Rethinking Project Finance, Asia Law and 
Practice. Heven Publishing Limited, 1997, 
Hong Kong. 
14. Smith, Andrew Risk in Energy Exploration. Pitman Limited, 
1988, London. 
15. Thobani, Mateen Corporate Finance, Public Risk Analysis. 
Free Press Limited, 1996, Washington, D. C. 
U.S.A. 
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16. USAID Project Finance, Global Investment Policy. 
Pitman, 1997. Washington D.C. U.S.A 
17. West, Gerald T. Managing Project Political Risk: The Role of 
Investment Insurance. Journal of Project Finance. PP 
191 -193. Free Press, 1996. 
U. S.A. 
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CHAPTER THREE 
PRESENTATION AND ANALYSIS 
3.1 INTRODUCTION 
Successful project finance structuring rests on the strength of the project. Identifying the 
project risks, analyzing, allocating and mitigating the major risks are the essentials of 
project financing. Generally project developers take risks that are foreseeable and 
manageable or for which they are adequately rewarded. However, when developers are 
unable to provide guarantees adequate to satisfy lenders, the lenders seek govemment 
guarantees. The ability of the parties to agree on how risks will be shared is often the key 
to initiating a successful project. 
3.2 MAJOR PROJECT RISKS ASSESSMENT AND MITIGATION 
There are commercial risks, political or country risks and nonpolitical or force majeure 
risks. Successful mitigation of these risks is critical to a project's financial feasibility. The 
agreements, contracts, and measures associated with projects are deSigned to maximize 
risk mitigation and a risk matrix should be prepared by potential investors as a tool to 
analyze the extent of mitigating the residual risk. That residual risk together with the 
financial rewards, will determine investor interest in partiCipation in the project. 
The severity of each risk also needs to be assessed. For example, sponsors and creditors 
may need to assess the government's macroeconomics record while creditors would need 
to evaluate the technical and manageable competence of the sponsors. The risks for 
long-term lenders are different from those for equity investors, which are different again 
from those faced by contractors or suppliers. In addition, risk has a subjective quality, 
what represents an unacceptable risk to one investor may be routine or manageable for 
another, depending on their prior experience and knowledge. 
An effective mitigation of each risk is to identify the party that is in the best position to 
manage that risk, or whose actions have a bearing on its outcome. For instance, the 
project sponsor is the one best able to manage commercial risk. If the project will be 
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subject to significant government regulation, assurances will be sought from the 
government. 
The next step is to allocate, price or mitigate each risk between the parties via contractual 
agreements. In a successful financing, the risks do not disappear but are borne by the 
parties able to manage them. Risks that cannot be allocated can still be ameUorated 
through the selection of proper credit enhancement and monitoring methods. 
Data revealed that there is no wholesome risk mitigation arrangement for all the risks, but 
rather every risk has its own mitigation arrangement. In other worlds, each risk has each 
own mitigation profile. 
3.3 OBJECTIVES 
The first objective of this study is to evaluate the factors that are considered in 
determining the risk component of oil and gas investments in West Africa and how these 
risk factors can be mitigated to attract foreign private financial institutions to participate in 
financing the investments. 
The following risk factors are found to be crucial in the oil and gas investment 
conSiderations. 
Construction risks 
Performance risks 
Maf1(et risks 
Economic risks 
Environmental risks 
Political risks 
The above risk factors are analyzed and mitigated below. 
3.4 CONSTRUCTION RISKS 
An inquiry into what is construction risk and how it is assessed reveals that, it is the risk 
encountered during the construction stage of the project and includes the following: 
delays, and cost overrun and in assessing construction risk, it is helpful to look at the 
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various stages of the project separately, since each may have a different risk profile and 
finanCing requirement. Oil and gas projects consist of three main phases: development, 
construction and operation. 
In the development phase, risk is usually very high, and only equity capital from the main 
sponsors is generally used because it has low risk. During construction and start-up, risk 
is high and large volumes of finance are required, typically in a mixture of equity, senior 
debt, subordinated debt, and guarantees. In the operational phase, risk is generally low in 
capital markets with cheaper, less restrictive because outlook is less uncertain, and it may 
be possible to refinance with senior bank debt. 
Table 3.1 Data on construction risk level. 
Level of risk e :pected by institutions %} 
Type of construction risk IFC World Bank MIGA USAID NIBJGhant& 
Delays 2 2 2 2 2 
Cost overrun 2 2 3 2 2 
Total 3% 4% 5% 4% 6% 
Source: Field Data, May 2000 
From the table, MIGA has the highest construction risk of 5% among the international 
financial agencies while NIB (Ghana) top all with 6%. World Bank and the USAID 
revealed equal risk of 4% each and IFC has 3% as the lowest further enquiry revealed 
that IFC's lowest construction risk is due to its private sector orientation and therefore 
needs to be sympathetic to construction risk which is typical of private sector organisation 
especially the infant industries in the developing economies. 
Construction risk differs from performance risk in the sense that former deals with actual 
development of physical structures whiles the later deals with the level of commitment to 
contracts and actually undertaking them to meet agreed speCification. 
3.4.1 DELAYS: Why delay in project construction a risk 
In the development phase, the sponsor assesses the project's scope, seeks any 
necessary regulatory and concessional approvals from the government authorities, and 
attempt to attract financing. Risks sometimes arise because of unclear and arbitrary 
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government processes, which cause long delays and may even lead sponsors to abandon 
an otherwise sound project. In the construction phase, the major risk is that construction 
will not be completed on time or will not meet the specifications set for the project. 
An incomplete project is unHkely to be able to generate cash flows to support the 
repayment of obligations to investors and creditors. Long delays in construction may fail to 
reach completion for any of a number of reasons, ranging from technical design flaws to 
difficulties with sponsor management, financial problems or changes in government 
regulation. 
3.4.2 How delay in project construction can be mitigated. 
Table 3.2 Delay risk arrangement 
PROJECT COMPLETION 
RISK TO LENDERS RISK MITIGATION ARRANGEMENT 
Delays Tumkey contract; construction equipment supply contracts. 
Specify performance obligations with penalty clauses. Project 
agreement to oversee construction on behalf of lenders and 
minority investors. Obtain early regulatory environment approvals. 
Cost Overruns Include contingency and escalation amount in original cost 
estimates. Sponsor support completion certified. 
It was found that project companies hedge construction risk primarily by using fixed-price, 
certain-date construction contracts including tumkey contracts, with built-in provisions for 
liquidated damages if the contractor fails to perform, and bonuses for better than expected 
performance. 
Project companies also take out business start-up and other kinds of standard insurance, 
including a construction contingency in some excess capacity to allow for technical 
failures that may prevent the project from reaching the required capacity. Because lenders 
cannot control the construction process they seldom assume completion risk, which is 
usually the responsibRity of the project company, its sponsors, constructors, equipment 
suppliers, and insurers. 
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3.4.3 COST OVERRUNS 
How cost overrun affect project construction and how it Is mitigated. 
The most common threat to project completion is cost overruns. If costs significantly 
exceed the initial financing plan, they will affect the project's financial rate of return and, if 
they cannot be financed, may even lead those involved abandoning the project. In 10% of 
the International Finance Corporation supported energy projects reviewed for this study, 
project costs exceeded initial estimated and committed financing. 
To ensure that unexpected costs do not jeopardize project completion. most creditors and 
minority investors insist on a commitment for standby financing as part of the initial 
financing package. The sponsor usually provides this through contractual agreements, 
which is called project fund agreement facility. 
3.5 PERFORMANCE RISK 
3.5.1 Performance risk analysis 
Most oil and gas projects lasts ten years or more. During this time, significant changes 
undermine the project's viability, such as unavailability of project inputs. failure of 
technical performance. failure of management of the project. and volatile market demand 
for the projects output. 
Performance risk is therefore the uncertainty that project undertakers due to the above 
named bottlenecks will not perform some aspects of the project. The data revealed that 
following. 
Table 3.3 Data on performance risk level 
Type of perfonnance risk level of risks expected by institutions (%) 
IFe World Bank MIGA USAID NIB (Ghana) 
Sponsors commitment 4 4 4 4 6 
TechnolOQy 1 1 1 1 1 
Equipment perfonnance 1 1 1 1 1 
Inout availability 1 1 1 1 1 
Management perfonnance 2 2 3 2 2 
Labourperfonnance 1 1 2 2 2 
Total 10% 10% 12% 11% 14% 
Source. Field data May 2000 
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Table 3.3 reveals that level of risks of performance by undertakers due to the bottlenecks 
the undertakers face. It is apparent from the table that MIGA is most pessimistic among 
the international financial institutions about performance risk with as far as 12%. The 
researcher is of the opinion that MIGA is an insurance organisation, and typical of all 
insurance organisations, they are skeptical of risk more than all other organizations. IFe 
and the World Bank seem to have the same pattern of risk. Their attitude towards 
performance is practically the same, for oil and gas project financing. This is because IFe 
is an affiliate organisation of the World Bank and fonows the same policies. 
NIB risk level seems not to have followed any of the other four organizations. This is 
because it is a local financial institution and therefore varies its attitude towards 
performance risk. It is important to state that NIB (Ghana) have this risk attitude in theory 
and not in practice as it is yet to finance an oil and gas project, probably a stake in the 
propose gas pipeline for West Africa. USAID, which has been involved in financing oil, 
and gas feasibility and exploration work, seems to be on the borderline for performance 
risk assessment. On average, attitude towards performance risk is between the higher 
levels of MIGA and the lower levels of IFe and the World Bank. This exhibits the level of 
experience it has in oil and gas project finanCing. 
3.5.2 Performance risk mitigation 
All the institutions have some level of uncertainty towards performance risk except that 
the uncertainties vary from one institution to another. However, the risk arrangement for 
these institutions remains the same. Table 3.4 illustrates the various mitigation 
arrangements to the lenders for the various performance risks. 
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Table 3 4 Performance risk arrangement 
PROJECT PERFORMANCE 
RISK TO LENDERS RISK MANAGEMENT ARRANGEMENT 
Sponsors commitment Strong, experienced sponsors with significant quality stake share 
retention agreement to the sponsors of the project. 
Technology assurance Prefer tried and tested technologies. New technology can be used in oil 
and gas projects provided the obligation to repay debt is supported by a 
guarantee of technological performance from the participant that owns 
or licenses the technology. 
Equipment performance Performance guarantee from equipment suppliers on quantity and 
quality. Operation agreement linking completion. 
Input availability Supply contracts specifying quality, quantity and pricing, match term of 
supply contract to term-off take commitment. 
Management performance Experienced management. Team performance incentives and 
penalties. 
Skilled labour and operators Training provided by equipment suppliers and technical advisors. 
performance 
In oil and gas projects, sponsors attempt to pre-arrange long term purchase contracts of 
important inputs, for instance, raw materials or energy suppliers to limit the impact of price 
volatility. The project company will also ask its suppliers for performance guarantees on 
technical components and may sub-contract the project's operation and maintenance to a 
specialist company, with penalty payments if performance is not up to standard. 
Renewable contract tenure subject to satisfactory performance can be agreed with 
management team. Also successful performance incentives can be agreed upon while 
unsatisfactory penalties are pre-determined. Equipment supplies can be linked with 
training of operators by the suppliers. This will ensure proper handling of equipment. 
Supply contract of inputs specifying quality and quantity can be made with manufacturers 
of inputs, standard of performance of the inputs be agreed upon and penalties pre-
determined for failure to deliver according to speCification and on time. 
Tried and tested technologies are preferred to newly developed technologies had proven 
to be more reliable. New technologies can be used only if it is supported by 
manufacturers guarantee of performance and assumption of liability resulting from the 
failure of the new technology. 
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3.6 MARKET RISK 
3.6.1 Market risk analysis 
Market risk is the uncertainty of demand for the oil and gas output to meet the supply 
available. Changes in the demand for project output have been the leading cause of 
revenue and profitability problems in oil and gas projects. Often the appraisal of market 
demand is overoptimistic, perhaps because the strength of new trends is not fully 
appreciated, and project never achieves the sales and revenue volumes projected. 
Table 3.5 Data on market risk level 
Type of market risk Level of risks expected by institutions (%) 
IFC Wond Bank MIGA USAID NIB (Ghana) 
Demand potentials 2 2 3 2 2 
Payment 2 2 4 2 2 
Total market risk 4% 4% 7% 4% 4% 
Source: Field data, May 2000 
The table reveals very low level of market risk as compared with other risks discussed 
earlier. It is important to emphasis that no single country can operate without Oil and gas. 
High market demand exists and actual shortage is a common phenomenon for Oil and 
gas products in many economics both developed and developing. It is therefore not 
surprising to fin very low level of uncertainty in market demands and payment for them. 
Payment is definitely made except that is deferred into the future, which is a common 
feature of business in recent times. MIGA have a highest market risk of 7% whiles all 
other financial agencies have the same risk level of 4%. 
Market risk is difficult to hedge against specifically, unless there is a single buyer or small 
group of buyers for the output. Signing a purchase or sales agreement with the price and 
quantity clearly specified with a seller or buyer is an excellent way of hedging product 
price risk to ensure the project will generate revenues. 
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Market risk mitigation 
Table 3.6 Market risk arrangement 
MARKET RISK RISK MANAGEMENT ARRANGEMENT 
Demand potentials Undertake independence marKet assessment. Off take 
contract specifying minimum quantities and prices. 
Conservative financing structure support low-cost 
producers. 
Payment risk Sell output where possible to creditworthy buyers. If buyer 
not creditworthy, consider credit enhancements such as 
(1) govemment guarantees of contractual performance if 
buyer is state-owned; (2) direct assignment of part of 
the buyer's revenue stream; (3) escrow account covering 
several months' debt service. 
Sponsors of oil and gas projects have used several mechanisms to mitigate marKet risk notably 
Power Purchase Agreement (PPA), off-take agreements, call and out options, and forward 
contracts. 
A power purchase agreement (PPA) is a form of off-take agreement commonly used in 
power projects in emerging markets. The purchasing entity is frequently a govemment 
agency. A PPA specifies the power purchasing price or the method of arriving at it. 
Although the price may not be fixed explicitly in the agreement, as long as the variables 
determining the price are clearly spelled out, the sales agreement mitigates one important 
project risk. The researcher discovered that the PPA is the central contract, in that it is 
from the obligations set forth in this contract that the project generates revenues. 
The sale of energy provides the revenues or cash flows to meet debt service, operating 
costs, maintenance, and return on investment. For this reason the 
creditworthiness of the purchaser is a key factor in asseSSing commerCial risk. 
The researcher realized that an oil and gas project must first be structured around the 
purchasers (market) that need the energy, their ability to fulfi11 payment obligations, and 
their demonstrated creditworthiness. If purchasers have anything less than an impeccable 
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history of debt servicing and management as it is frequently the case with state owned 
utilities, for instance Ghana's Tema Oil Refinery (TOR) loss of three trillion cedis over the 
years to year 2000, then, a counter-guarantee must be required. This additional layer of 
risk mitigation can be provided through a sovereign guarantee of the purchaser's 
obligations, multilateral support, or irrevocable letter of credit facility. 
Sovereign guarantees are often needed to assure the project company that certain events 
within the governmenfs control will not occur. There should be the assurance that project 
companies and investors will be compensated or relieved from the consequences of the 
events if the assurance is breached. Most of these events are likely to be political, legal, 
regulatory and financial risk categories. 
Availability of government guarantees depend on the host government's commitment to 
the project, which depends on factors such as the size of the project, the energy supply 
and demand and the ability of the investors to finance the project without government 
guarantees. 
For the multilateral support, the perception of the host government about the project and 
its financial commitment will determine the extent and nature of financial commitment and 
guarantee to be pledged by the multilateral agencies. 
The irrevocable letters of credit from a credible international financial institution give some 
encouragement to the lenders and sponsors of the projects. 
3.7 ECONOMIC RISK 
3.7.1 Economic risk analysis 
A project's financial sustainability through all phases of its life can also be affected by 
broader risks arising from the economic and policy environment, particularly interest rate 
and foreign exchange risk. 
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Table 3.7 Data on economic risk level 
-
Type of economic risk Level of risks expected by institutions (o/~ 
IFe WortdB~ MIGA USAID NIB 1Q!!a~l_ 
5 
Current avaMability 3 3 3 4 
Interest rates 2 2 2 2 
4 
Exchange rates 2 2 2 2 
4 
Inflation 3 3 3 3 
5 
10% 10% 10% 11% 18% Total 
Source: Field data, May 2000 
Table 3.7 reveals the level of uncertainty associated with the various components of 
economic risk and the total economic risk for institutions under study. These risks are 
practically macro-economic parameters which affect the economics vis-a-vis the projects 
being financed. 
NIB (Ghana) has the highest economic risk of 18% followed by USAID with 11%. The 
rest of the institutions have 10% each. NIB (Ghana) is a local financial institution which is 
affected by the unfavourable local macroeconomic environment hence their economic risk 
is the highest among the selected institutions. Conversely the other four institutions are 
international agencies that operate with currencies that are comparatively stable, interest 
rates that are extremely low, exchange rates that are very negligent and inflation rates 
that affect business in a friendly manner. These, however, does not mean that provision 
should not be made for these risks. Provision has to be made for their occurrences. 
3.7.2 Economic risk mitigation 
Table 3.8 Economic risk arrangement 
ECONOMIC RISK RISK MANAGEMENT ARRANGEMENT 
Funds/currency availability Limit share of short-term financing to project. Long term 
finance to match project tenure. Stand-by financial facility. 
Interest rates Fixed rate financing, interest rate swaps. 
Exchange rates Match currency of project loans to project revenues, 
swaps and guarantees. 
Inflation Long-term supply contracts for energy and other 
important inputs; output prices indexed to local inflation. 
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3.7.3 CURRENCY RISK EVALUATION 
The question as to how currency risk and its component parts affect oil and gas 
investments and how it should be managed is analyzed below. 
Currency risk arises whenever foreign exchange funds, in the fonn of equity or 
debt is used to finance the project. Such risks are associated in part with foreign 
exchange convertibility and foreign exchange rate. Macroeconomic stability, the balance 
of payments situation and foreign exchange rate policy in the project country are 
important factors to consider in assessing currency risks. Foreign exchange risk can be a 
major concern particularly if the project generates revenue only in local currency. A 
shortage of local long-tenn funds caused by weak local financial markets often leaves 
project in developing countries with a large amount of foreign currency funding. 
Data from Multilateral Insurance Guarantee Agency (MIGA) and International Finance 
Corporation (IFC) revealed that foreign currency financing covered 77 percent of total 
project costs of energy projects. Such levels expose a project to foreign exchange and 
interest rate risks. It came to light that it is for this reason that most large project schemes 
that can generate revenues largely in hard currency, or a linked to a hard currency, or are 
taking place in countries where private investors and creditors are confident that 
convertibility will be maintained. 
The table above depicts the risk management arrangement that IFe and the USAID have 
at hand to resolve economic risk. MIGA on the other hand have reclassified currency risk 
mitigation into the following strategies: 
• Mix local currency and foreign currency loans. 
Oil and gas projects involve some local costs. Overall currency risk can be reduced by 
covering this cost with local funding to the extent poSSible, mixing local and foreign funds 
so that the project does not rely excessively on foreign funds. 
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• Index output prices to the exchange rate. 
Indexing can be used to shield an oil and gas project from exchange rate risk. Although 
currency conversion still poses a risk, being able to link project charges to the exchange 
rate can help limit project currency risks. I ndexing is often used in infrastructure projects, 
where revenues are mostly in local currency and project cycle is especially long. This 
arrangement is vulnerable to dramatic changes in the exchange rate as demonstrated In 
Ghana by linking the price of petroleum products with the exchange rate (dollar). 
However, it leaves the govemments unwilling to honour indexing if it would mean passing 
significant local price increases on to customers or consumers as done by the 
govemment of Ghana in the last quarter of the year 2000 and the first quarter of 2001. 
• Obtain contingency sponsor support. 
In some countries, foreign exchange may be available at project start-up but may not be 
guaranteed in the future, foreign sponsors should be made to pledge contingency foreign 
currency support in various ways. In one of IFe energy financing in Asia, a foreign 
sponsor has committed itself to the purchase, in US dollars, of enough cement to provide 
the local project company with sufficient dollars to service IFe's dollar-denominated loan if 
the project company is unable to purchase enough convertible hard currency in the local 
market. In West Africa, where foreign currency is scare, foreign currency support from the 
foreign sponsor is inevitable. 
• Establish an escrow account. 
Export of the output of oil and gas project eams convertible hard currency, these foreign 
earnings can be deposited in a special escrow account. For IFe and USAID supported 
projects, the deposit required at any given time is the minimum amount needed for debt 
service over the next six-month period. In projects with foreign currency revenues, an 
escrow account can also help the borrower avoid potential repatriation difficulties. 
• Obtain government guarantee of foreign exchange availability. 
Guarantees of convertibility are not routinely available for projects in developing counties, 
especially West African countries but may obtained in certain situation where foreign 
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exchange may be needed to import production materials, repay project debt, or repatriate 
the profits and dividends of foreign shareholders. A government guarantee is one way for 
a project company to help ensure that foreign exchange remains available. 
• Interest Rate Risk. 
Long term loans at floating or variable interest rates are the norm for project debt in 
intemational project financing. The average maturity of IFC's own loans to energy projects 
is 10 years; a majority of these (75%) are floating rate loans. The international interest 
rate environment can change dramatically during this maturity period. If interest rate is not 
properly hedged, financial projections based on initial rate assumptions can be 
significantly affected negatively. Project sponsors can use a variety of measures to 
mitigate against interest rate risk. 
MIGA's Interest rate risk mitigation strategies are as follow: 
• Negotiate a fixed interest rate. 
Fixed rate debt removes one source of risk from a project. Although commercial banks 
relying on short-term funding sources are reluctant to lend at a fixed interest rates for a 
long period, they may be able to arrange a mix of floating and fIXed rate funding which 
would reduce a projecfs interest rate risk. 
Some fixed-rate financing is also available from multilateral and bilateral lenders. For 
instance, IFC provided a fixed rate loan of $40 million for a power project costing about 
$350 million. The sponsor requested this arrangement because ECA financing, the 
prinCipal source of support, was at floating interest rates. In a few cases, a lender may 
actually prefer to lend at fixed rates. In another power project, the IFC 8-loan included a 
fixed interest rate portion that came from an institutional investor whose liabilities were 
also fixed. 
• Convert the interest rate. 
Oil and gas project sponsors can borrow at a floating interest rate to take advantage of a 
later expected fall in interest rats. IFC, as a matter of policy, allows borrowers to 
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effectively convert their IFC loans from floating to fixed interest rate by entering into 
interest rate swaps with borrowers. A borrower's new fIXed rate is equal to the market's 
swap rate plus the borroWer's spread over the fixed-rate plus a small conversion fee. This 
conversion feature have proved useful for a number of project sponsors, hence it can be 
adopted by oft and gas projects. 
• Swap Interest rate. 
Interest rate swaps are becoming a more and more popular hedge for projects. Although 
such swaps are readily available in the international risk management market, most 
developing markets projects do not have the necessary credit standing to be accepted as 
a counterpart in the market, at least at project start-up. IFC is frequently able to bridge a 
project company and the Intemational market with the floating to fixed rate conversion of 
IFC Loans. In addition, IFC may be able to provide swaps for the clients' non-IFC loans 
and to obtain longer-term interest rate swaps up to 15 years than a project company is 
Ii<ely to get from the international market directly. 
3.8 ENVIRONMENTAL RISKS 
3.8.1 Environmental risk analysis 
• The Need for Environmental due diligence. 
The inclusion of environmental risk factors into the project appraisal process is not a new 
discipline. Aware of the devalued collateral of contaminated land and possible lender 
liability for clean up, most large commercial banks factor basic environmental issues such 
as legal compliance, contamination, and outstanding compensation claims into their due-
diligence process when lending to industries. 
Research data indicates that environmental, health and safety, and social issues can 
have a negative impact on operating cash flow, divert management attention from other 
priorities, or generate adversarial relationships with employees, regulatory agencies, or 
the local community. In this sense, environmental due diligence for oil and gas projects is 
very much centered on seeking assurance that day-to-day operations will run smoothly 
during project design, construction and operation. 
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Depending on the country in which it is located, the same project with the same 
environmental issues may be subject to different regulatory standards. The degree of 
compliance monitoring and enforcement of regulatory standards may also vary widely 
from country to country. Sound financing of oil and gas project needs to be based on 
understanding the context in which the project must operate and ensuring that the right 
mechanisms are incorporated into the loan documentation in order that applicable 
environmental standards of performance are met. Data collected revealed that, without 
such mechanisms, attempts to verify smooth day-to-day operations might prove 
problematic. 
It is interesting to note that while these environmental factors motivate the World Bank, 
MIGA, IFC and USAID there is a different dimension to their approach to enVironmental 
due diligence in energy project finance. As international organizations whose missions are 
to promote sustainable private sector development, they examine whether each project is 
faithful to the missions. The scope of their due diligence include issues such as 
consultation with affected parties, development and implementation of resettlement action 
plans, and efforts to avoid degradation of natural habitats. 
These issues may well go beyond the legal requirements of the project country, or the 
traditional project boundary ending at the property line of a project. IFC and the World 
Bank will have failed in its goal of sustainable development if it does not address impacts 
to people and the environment whether inside or outside the traditional project 
boundaries. Upfront consideration of these issues could add value to the projecfs Iong-
term viability by reducing the risk that the project will get overtaken by changing political or 
regulatory agendas in the host country. Project developers and their financiers therefore 
have clear incentives to assess potential environmental and social risks to find ways to 
minimize their exposure and improve the long-term viability of the project. 
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• The process of environmental due diligence. 
Most intemational financial institutions environmental risk assessments focus on the 
potential impacts of project construction and operation against standards provided by 
applicable local law. But where regulatory standards are either non-existent or uncertain, 
well-accepted international standards may be substituted. 
Table 3.9 Data on environmental risk level 
Types of environmental risk Level of risks expected by institutions 
IFC World Bank MIGA USAID NIB (Ghana) 
Natural habitant destruction 1.0 1.0 1.0 1.0 1.0 
Child labour 0.5 0.5 0.5 0.5 0.5 
Involuntary resettlement 1.0 1.0 1.0 1.0 1.0 
Forest destruction 1.5 1.5 1.5 1.5 1.5 
Dams Dollution 0.5 0.5 0.5 0.5 0.5 
Environmental pollution 1.5 1.5 2.5 1.5 1.5 
Total environmental 6.0% 6.0% 7.0% 7.0% 6.0% 
Source: Field data, May 2000 
The above risk data shows that there is similar reaction to environmental risk by the 
financing institutions. The differences are practically insignificance. This is due to 
common environmental and social policies adopted at the United Nations, which all 
institutions must foUow in their industrialisation pursuit. Furthermore, environmentalists 
such as the Green Peace are always on the look out for breach of environmental policies 
by companies. Financing agencies therefore ensure that oil and gas project sponsors and 
undertakers comply with all environmental policies as a fundamental conditionality for 
finanCing. Environmental risk is however, very difficult and expensive to monitor by 
financing agencies, hence provision have to be made for them. 
3.8.2 Environmental risk mitigation 
The World Bank environmental guidelines are often used as the benchmark to measure 
environmental performance, as they represent widely accepted international standards. 
IFC, example, appraises each project to ascertain whether it could meet the applicable 
World Bank environmental guidelines. Furthermore, IFC gives consideration to whether 
the project could be implemented in accordance with its own environmental and social 
policies. 
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Table 3 10 IFe's environmental and social policies 
POLICY DESCRIPTION 
Environmental All IFC projects are assessed to ensure they are environmentally and socially 
Assessment sound and sustainable. This may include environmental impact assessments and 
an environmental action plan. Public consultation 
And disclosure may be required. 
Natural Habitants Promote and support all natural habitant conservation and improved land use, as 
well as the protection, maintenance, and rehabilitation of natural habitants and 
their functions. Views of affected stakeholders are considered in project design 
and implementation. 
Harmful child It avoids the employment of children that is economically exploitative, or 
labour and forced hazardous to, or interfere with the child's education, or to be harmful to the child's 
labour health, or physical, mental, spiritual, moral or social development. 
Involuntary Minimise economic and physical displacement, provide, restore their former living 
Resettlement standards, eaming capacity and production levels, compensate at full mat1(et 
value for land and other assets affected by the project, and to involve resettles in 
resettlement activities .. 
Forestry Reduce deforestation, enhance environmental contribution of forested areas, 
reduce poverty, and enhance economic development. 
Safety of dams Set out requirements for safety of dams, which must be designed by competent 
and experienced professionals. Reviews by a panel of Independent experts, 
detailed plans, and periodic safety inspections of dams. 
While both the IFe and the World Bank guidelines are in harmony, IFe policies are more 
closely aligned to the private sector participation in the oil and gas industry. 
The above environmental and social policies of IFe ensure that the environment is not 
degraded by oil and gas projects. Importantly, it considers forestry, resettlement of 
affected people, water pollution and wildlife protection. These give a clearer guidance to 
its Clients. 
It can be concluded here that both the World Bank environmental guidelines and IFe 
environmental and social policies provide a framework for addressing broad, 
cross-sectoral development issues. 
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Data from IFe, the World Bank and MIGA indicates that project developers and other 
stakeholder's incorporate environmental issues in the project design stage. This 
approach factors the capital cost associated with the environmental upgrades into the 
financial appraisal of the project, and the risks of environmentalist actions affecting cash 
flow later in the project's life are minimized. 
It was revealed that early efforts to establish and promote a transparent relationship and 
meaningful dialogue with affected people and communities frequently bring benefits of 
good community relationship and operation without disruptions. To this end, IFe and the 
World Bank required disclosure of key project information including environmental 
assessment reports and social reports, such as resettlement action plans. It is important 
to note that disclosure of information to local stakeholders and public consultation 
enhances the project ability to coexist with the surrounding community and to contribute to 
this social development. 
Once the environmental and social risks associated with a project are identified, the risk 
must be allocated to the parties best suited to bear them. In the world of complex projects, 
with complex environmental and social impacts spilling over the traditional project 
boundary and into a wider area of influence, risk allocation becomes a difficult task, 
sometimes the parties capable of addressing such risks, such as the host government, 
remain outside the traditional contractual relationships between the financiers and the 
sponsor of the project. In these cases, IFe attempts to draw parties outside the project 
boundary to a multiparty discussion in an attempt to broker mitigation and management 
measures that are acceptable to all parties concerned. With its relationship with the host 
government and close ties with the World Bank and MIGA, IFe often delivers unique 
solution, to complex environmental and social problems. 
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3.9 POLITICAL RISKS 
3.9.1 Political risk analysis and mitigation 
One of the challenges passed by oil and gas projects in emerging maJi(ets lies in 
assessing and managing political risks over the long life that most projects have. Political 
risk arises from the fact that some unforeseen political events may change the projecfs 
prospects for profitability. This might be an act of govemment, for instance a change in a 
law, regulation, or administrative decision, or general instability in the political or social 
system as a result of war, strike or frequent changes in government. 
Political risk insurance, the main way of directly protecting against potential political risks, 
is provided by Export Credit Agency (ECA) and MIGA. Although risk insurance and 
guarantees are available in private maJi(ets, the government backing of multilateral and 
bilateral agencies enables them to absorb risk not acceptable to private insurers or 
guarantors. 
By far the largest of the multilateral agency programmes offered is by MIGA. Established 
in 1988 with capital of $1 billion, MIGA's role is to fill the gaps in political risk coverage for 
foreign investment in developing maJi(ets. MIGA's political risk guarantees cover primarily 
equity and related debt investments including shareholder loans and loan guarantees, as 
well as technical assistance and management contracts. MIGA generally insure 
investments in new energy projects, modernization, privatization or financial restructuring 
of existing oil and gas projects. The risks covered are expropriation, war and civil 
disturbance, currency transfer, and breach of contract, provided the claimant is denied 
appropriate judicial or arbitration relief. MIGA also has developed a Cooperative 
Underwriting Programme (CUP), under which it issues a contract for the entire amount of 
insurance requested by an investor but retains only a portion of the exposure for its own 
account, with the remainder underwritten by private insurers. 
Through MIGA's guarantee programme, an investor in oil and gas contemplating 
investment in a MIGA member developing country can obtain long-term insurance 
coverage against specified political risks, which may arise in connection with the 
investment. The basic insured risks include: 
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• Cu"ency Transfer: 
Protects against losses arising from the investor'S ability to convert local currency returns 
(profits, principal, interest, royalties, capital and other remittance), into foreign exchange 
for transfer outside the host country. Currency transfer coverage insures against 
excessive delays in acquiring foreign exchange caused by host government action or 
failure to act, by adverse changes in exchange control laws or regulations, and by 
deterioration in conditions governing the conversion and transfer of local currency. 
• Expropriation: 
Protects against partial or total loss of the insured investment as a result of acts by the 
host government, which may reduce or eliminate ownership of control over, or rights to 
the insured investment. In addition to outright nationalization and confiscation, 
expropriatory effect is also covered. 
• War and Civil Disturbance: 
Protects against losses from damages to, or the destruction or disappearance of, tangible 
assets caused by politically motivated acts of war or civil disturbance in the host country, 
including revolution insurrection, coup d'tat, sabotage and terrorism. War and civil 
disturbance coverage also extends to such events that for a period of one year, result in 
an interruption of project operations essential to overall financial viability. The business 
interruption feature is effective when the investment is considered a total loss. 
Table 3.11 Data on political risk level 
Type of political risk Level of risks expected by institutions (%) 
IFC World Bank MIGA USAID NIB (Gh) 
Currency transfer 2 2 2 2 1 
Expropriation 3 3 3 3 2 
War & civil disturbance 4 4 5 4 4 
Total political risk 9% 9% 10% 9% 7% 
Source. Field data, May 2000 
Although political risk arises from several sources such as those discussed in the 
literature review (chapter 3), the study narrow down the risk mitigation to currency 
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transfer, expropriation of profit and war and civil disturbance by the community affected by 
the oil and gas facility. The risk numbers in the above table indicate that MIGA is so 
concemed about political risk with the highest risk factor of 10%. This means that MIGA 
insures up to 90% of loans and loans guarantees taken up, with the investor left with the 
10% risk uninsured NIB (Ghana) has the lowest risk factor of 7% due to its local 
orientation and scope of operation. 
For each risk category, MIGA insure equity investments for up to 90 percent of the 
investment contribution, plus an additional amount of up to 180 percent to cover earnings 
attributable to the investment. 
For loans and loan guarantees, MIGA insure up to 90 percent if the principal as well as 
interest that will accrue over the tenn of the loan. For technical assistance contracts and 
similar agreements, MIGA insures up to 90 percent of the total value of payments due 
under the agreement. Regardless of the nature of the project the investor is required to 
remain at risk for at least 10 percent of any loss. 
Although MIGA only insure new investments, it is not limited to new projects. The agency 
also considers application for coverage of new investments applied to the expansion, 
modernization or privatization of existing oil and gas projects. For any new investment, the 
investor must file an application for MIGA coverage before actually making or committing 
to make, the investment. 
3.11 BENEFITS OF MIGA POLITICAL RISK INSURANCE 
As to whether MIGA's political risk Insurance benefits stakeholders in an oil and 
gas project investments revealed the following Issues 
Foremost amount them is a certain peace of mind. By purchasing insurance an investor 
exchanges the uncertainty of financial loss arising from the insured hazard for a certain 
cost in the fonn of insurance premium. 
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MIGA invesbnent insurance not only provides the benefit of financial compensation, but 
some additional valuable services to both the investor and the host country of oil and gas 
projects. Through the risk transfer process, MIGA's coverage's encourage and facilitate 
productive private invesbnent that contributes to the economic development of its member 
countries. With the pervasive negative image of Africa as a hostile business environment, 
MIGA's ability to ameliorate fears about political risks can be critical to many investor 
project decisions, especially oil and gas investments. An additional benefit to oil and gas 
investors is inherent in MIGA's multinational ownership. 
MIGA has the ability to act as an honest broker in the early stages of an investment 
disagreement between an investor and a host government. MIGA's positive relationship 
with both the contending parties of an investment disagreement will hopefully contribute to 
its reconciliation rather then its escalation into a more serious dispute or claims situation. 
The availability of MIGA investment insurance gives a skilled financial engineer 
assembling a non-recourse finance package a remarkably flexible instrument, which can 
be wielded, in a variety of fashions. 
For instance: 
• MIGA coverage of oil and gas investor's equity investment can be used to bring in a 
necessary, but somewhat reluctant partner, who is concerned about political risks; 
• MIGA is uniquely capable of covering, with a standard policy, a group of equity 
investor who come from multiple countries. This avoids conflicting policy language 
or 'gaps' in coverage under different policies; 
• MIGA covers shareholder loans to the project or parent company loan guarantees; 
• MIGA covers bank loans to projects, provided that some equity in the project is also 
concurrently insured; 
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• MIGA also covers other forms of investment, including technical assistance and 
management contracts, and franchising and licensing agreements; 
• Finally, MIGA has broad flexibility under its convention to write other forms of 
political risk coverage, on a case by case basis, to suit an investor's needs, this is 
particularly important and valuable to investors in the oil and gas projects. 
3.10 Expected Aggregate Risk Profile and Returns on Investments. 
Putting the expected risk data collected from the field of all the areas concerned together, 
we can generate an expected risk profde of the international financial agencies as follows: 
Table 3.12 Data on aggregate risk factor and returns 
IFC World Bank MIGA USAID NIB (Ghana) 
% % % % % 
Construction risk 3 4 5 4 6 
Performance risk 10 10 12 11 14 
Market risk 4 4 7 4 4 
Economic risk 10 10 10 11 18 
Environmental risk 6 6 7 6 6 
Political risk 9 9 10 9 7 
Other risks 2 2 2 2 2 
Aggreaate risk factor 44% 45% 53% 46% 57% 
Expected return 60% 60% 70% 55% 75% 
Margin of safety of 
retums over risks 16% 15% 17% 9% 18% 
It can be seen form the above table that expected returns exceed the aggregate risk 
factors for the various agencies. The point to not is that, it is economically unsound to 
invest in a project that have expected return exceeded by aggregate risk factor, such that 
all oil and gas projects must have their expected returns higher than their aggregate risk 
factors for the financing to take place. This is evident in the analysis above where there is 
a margin of safety, which is the difference between the expected return and the aggregate 
risk factor for all financing agencies. The wider the margin of safety the higher the 
probability of the financier to invest in the project. This means that NIB (Ghana) will be 
more willing to invest its resources in an oU and gas projects than USAID. It is important 
to state that the absolute risk and return figures do not matter so much but the spread 
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between the risk and return numbers profile theory can be used to estimate the level of 
risk from the expected returns by the agencies. The questionnaire revealed the following 
figures. 
IFC wo~Bank 
I 
I I I J 
ProbabUity Retums (%) Probability Retums(%) 
0.4 15 0.4 20 
0.4 45 0.4 25 
0.2 75 0.2 60 
MIGA World Bank NIB (Ghana) 
I I I 
~robability I I I Returns (%) pr6bability Retums (%) pro~ability Retums (%) 
0.4 20 0.4 18 0.4 20 
0.4 25 0.4 30 0.4 30 
0.2 75 0.2 72 0.2 65 
Using the risk-return equation. we can derive the expected return and risk factor 
(standard deviation) from the above data. 
IFC 
e x ex x-x e(x.:x}2 
0.4 15 6 (24) 230.4 
0.4 45 18 6 14.4 
0.2 75 15 36 259.2 
x=39 variance =504.0 
Risk = standard deviation = 22.45%. 
Expected retum = 39% with a risk factor of 22.45%. 
World Bank 
e x ex 
0.4 20 8 (10) 40 
0.4 25 10 (5) 10 
0.2 60 12 30 180 
x=3O variance = 230 
Risk = standard deviation = 15.17%. 
Expected retum = 30% with a risk factor of 15.17%. 
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X p(X-X)2 
p x px 
0.4 20 8 (13) 67.6 
0.4 25 10 (8) 25.6 
0.2 75 15 42 352.8 
x=33 variance = 446.0 
Risk = standard deviation = 21.19%. 
Expected retum = 33% with a risk factor of 21.1%. 
USAID 
p x px 
0.4 18 7.2 (15.6) 97.344 
0.4 30 12.0 (3.6) 5.184 
0.2 72 14.4 38.4 94.912 
x =33.6 variance =397.440 
Risk = standard deviation = 19.94%. 
Expected retum =3 3.6% with a risk factor of 19.94%. 
NIB (Ghana) 
p x px 
0.4 20 8 (13) 67.6 
0.4 30 12 (3) 3.6 
0.2 65 13 32 204.8 
x= 33 variance =276.0 
Risk = standard deviation = 16.6%. 
Expected retum =3 3% with a risk factor of 16.6%. 
The above financial figures manipulations revealed that no investor or sponsor will have 
anything to do with the project that have its risk (standard deviation) higher or equal to the 
expected returns. All the agencies have returns on their investments higher than the risk 
factor. However, it is the difference between the expected returns and the risk that is 
taken into account in making investment decision. This means that the risk factor can be 
high but if the expected return is proportionately higher, then the project can be 
considered for investment. 
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Summary of portfolio theory figures 
Table 3.13 Data on spread determination 
IFe World Bank MIGA USAID NIB (Ghana) 
% % % % % 
Expected retums 39.00 30.00 33.00 33.60 33.00 
Risk factors 22.45 15.17 21.19 19.94 16.60 
Spread 6.55 14.83 11.81 13.40 16.40 
It can be seen from the table that the spread determined using portfolio theory is similar to 
the spread derived from the empirical data in table 3.13 above. This emphasized the fact 
that irrespective of the method used to analyze risk, the result will not be different, except 
that the same figures will not be arrived at, the variances in figures will be purely due to 
data collection errors. 
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Table 3.14 PROPOSED RISK MITIGATION MATRIX 
RlSK.ITIGAT.ON ANALYSIS 
IC ONSEQUENCES I CONSE
RISK I REASON REMEDY FOR
Q UTHENEC ES 
I FOR THE LENDER INVESTORS 
CONSTRUCTION PERIOD 
Cost Overrun Insured event Proceeds of Draw on standby Retum eroded by 
insurance finance if insurance servicing of standby 
policy policy exhausted. finance 
including Debt cover factors 
business reduced if standby 
interruption debt used 
insurance 
Uninsured Draw on Debt cover factors Retum eroded by 
force majeure standby reduced if standby servicing of standby 
finance debt used finance 
Ground Draw on Return eroded by 
conditions standby servicing of standby 
finance finance 
ONner Draw on Debt cover factors Return eroded by 
variations standby reduced if standby serving of standby 
orders finance and debt used finance 
limit scope of 
variations by 
owner 
Changes of Standby Debt cover factors Return might be 
law, delays in fnance drawn reduced if standby reduced because of 
obtaining pending tariff debt used timing effects 
approvals or adjustment 
pennit 
Delays in Within Penalties on Debt cover factors No effect, except 
completion construction a daily basis, reduced if standby loss of opportunity 
consortium sufficient to debt drawn to earn bonuses, 
control cover interest unless penalty fully 
due to spent 
lenders and 
fIXed 
operatina cost 
Insured force Process from Standby finance To extent ability to 
majeure business drawn if insurance pay dividend is 
interruption policy exhausted, postponed, retum 
insurance debt cover factors eroded 
policy reduced if standby 
debt finance used 
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Capacity Penalties No effect Retum reduced if Failure of 
plant to meet shortfall payable by penalties from 
performance construction construction 
specification consortium consortium 
at completion supplemented exhausted 
insurance 
Heat rate Penalties Debt cover factors Retum reduced by 
shortfalls from reduced if cost of addition 
construction construction residual fuel oil less 
consortium consortium fails to penalties receipts 
remedy defect 
Operating Costs exceed Standby Debt cover factors Return reduced by 
costs overrun original finance drawn slightly reduced serving of standby 
estimates not depending on finance 
insured or timing effects 
force majeure 
event 
Insurance Standby Debt cover factors No effect 
costs exceed finance drawn slightly red uced 
original pending tariff depending on 
estimates adjustment timing effect 
Increased Interest rate Standby Debt cover factors No effect 
finanCing increase finance drawn slightly reduced 
costs pending tariff depending on 
reopened timing effect 
Adverse Standby Debt cover factors No effect 
exchange rate finance drawn slightly reduced 
change pending tariff depending on 
reoDened timing effect 
Minor changes Tariff Standby finance No effect on debt 
Government intax,law, adjustment, if could be required. service factor 
customs, legal during 
requirements construction 
environmental period, 
standards standby 
finance drawn 
Expropriation, Owner If owner terminates If government 
nationalisation, entitled to loan repayment defaults and owner 
consents terminates as terminates, 
withdrawn government compensation paid 
interference defaults for termination 
causing 
severe 
i prejudice 
Fundamental Owner If owner terminates, If government 
breach by entitled to loan repayment defaults and owner 
government terminates as terminates, 
government compensation paid 
defaults for termination 
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OPERATION PERIOD 
Operating As a result of Tariff No effect No effect 
costs overrun changes in adjustment 
regulations 
At owner's No Debt cover factors Return reduced 
request adjustment to reduced 
tariff 
As a result of No Debt cover factors Return reduced if 
failure by the adjustment to reduced if penalties penalties exhausted 
operator tariff, exhausted 
penalties 
payable by 
the operator 
Inflation, Tariff Debt cover factors Possibility of 
adverse adjusted by could be reduced or erosion or increase 
changes in indices. Small increase in return 
cost of possibility that 
finance, movements in 
exchange rate indices do not 
interest rate exactly match 
changes in 
actual costs 
Foreign Govemment Loan repaid or No effect except 
exchangel non guarantees assumed as loss of opportunity 
convertibility available compensated to earn bonuses if 
foreign government paid 
exchange. If under guarantee. If 
government government defaults 
defaults, under guarantee, 
owner can then owner 
terminates terminates and 
compensation paid 
for termination 
Demand fall Failure of Govemment No effect if No effect except 
purchaser of guarantee government pays loss of opportunity 
energy to demand. under guarantee. If to earn bonuses if 
perform Govemment government government paid 
obfigation defaults defaults under under guarantee. If 
under guarantee and government defaults 
guarantee, owner terminates, under guarantee, 
then owner loan repaid then owner 
can terminate terminates and 
compensation paid 
for termination 
Temporal Owner fault Penalties If penalties Any penalty paid will 
energy payable by completely erode erode retum for 
shortfall owner shareholders retum investors 
fall 
Increase fuel Increase in Tariff No effect No effect 
costs price of energy adjustment 
for operation 
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Failure of Operator Penalties Debt cover factors Retum reduced 
operator to 'breach of payable by reduced if the 
perform operations and the operator operator's penalties 
obligation maintenance exhausted and 
agreement standby debt 
finance used up 
Environmental Operator Indemnity Debt cover factors Retum reduced 
incidents 'breach of from the reduced if the 
caused by operations and operator operator's penalties 
operator maintenance exhausted and 
agreement standby debt 
finance used up 
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CHAPTER FOUR 
SECURITY PACKAGES ANALYSIS FOR LENDERS AND INVESTORS 
4.1 OBJECTIVE 
The second objective of this study is to examine the security packages financial 
institutions use to secure oil and gas investments from high risks and propose ways to 
strengthen these security packages for West African oil and gas investments. This, it is 
believed will encourage private financial institutions to participate in the financing of these 
projects. 
This chapter examines the security packages available for lenders and Investors in oil and 
gas projects. A security package (SP) for oU and gas projects is established through the 
various contractual arrangements, and comprises the key agreements, contracts, and 
government undertakings. These seek to reduce lenders' and investors' risk by 
establishing legally binding obligations, financial structures, and operational procedures. 
Before loan fund can be disbursed, the lenders will wish to be satisfied that all main 
agreements meet their requirements and have been executed. Lenders may want legal 
opinions, independent engineering reports, and copies of govemment approvals. In 
addition, they will want to confirm that the parties to each agreement are creditworthy and 
capable of performing under the terms of their respective contracts. lenders therefore 
look to the SP to provide security for the loan, and in the event of a breach of the 
agreements they may seek the right to take over the company and install their own 
managers within the framework of the agreements. 
It therefore implies that the quality of the security package is particularly important to 
passive investors, who normally provide much of the financing but do not have the 
capacity to bear significant operating risks. Once their money is disbursed, they usually 
have little control over the project It can be agreed that if the type and quality of security 
available are strong, the project becomes creditworthier, and a greater share of project 
costs can be funded through borrowings. 
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The main agreements that contain the security packages according to the World Bank 
and USAID documentation and working papers are: 
Implementation Agreement 
Energy Purchase Agreement 
Land Conveyance Agreement 
Ownership Structure Agreement 
Supply Agreements 
Construction Contract 
Operations and Maintenance Agreement 
4.2 IMPLEMENTATION AGREEMENT 
The major problem with project in West Africa is the Implementation process. The 
question is whether there is any implementation agreement and how committed are 
the parties to the agreement 
For a secured commitment, the World Bank and the USAID ensures that there is an 
implementation agreement between the project company and the government agencies 
that have the authority to provide the guarantees, assurances, and support necessary for 
energy power development and oil development. The implementation agreement (IA) may 
contain a variety of commitments, inducements, and guarantees that can be given only by 
the recognized governmental authority. 
As to the content of the list of commitments, the World Bank and USAID put forward the 
following: 
Govemment Commitments 
• Authorization to do business in the country is a basic prOVision that recognizes and 
authorizes the project company to implement an energy generating facility. 
• Authorization to generate, transmits, and distributes energy. 
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• Authority to obtain permits aHows Project Company to secure construction permits, 
operating permits, if in compliance with related laws and regulations. 
• Guarantee of performance of Project Company, fuel supplier, or other public sector 
entity that are party to the implementation and operation of the project. This means 
that the government, via a sovereign guarantee compensates the project company 
for failure of one or more of the public sectors entities to perform per agreements. 
• Currency protection to the energy supplier for a variety of currency issues; including 
convertibility, availability of foreign exchange, devaluation and repatriation. 
• Tax and duty incentives lowering tax rates exemption from tax and duty obligation. 
• Legislative protection against changes in the law and regulations, which would 
adversely affect or potentially affect the participants in the project. 
• Financial protection against certain force majeure events such as war insurrection, 
and general strikes. 
• Work permit authorizing import and use of specified foreign work force. 
011 and Gas Provider Commitments 
• Comply with laws and regulations; 
• Undertake project development; 
• Obtain project financing and achieve financial close within specified parameters 
including time; 
• Describes form of company, ownership registration, terms of ownership; 
• Project insurance to be obtained. 
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Mutual Obligation/Commitments 
• Termination defines under what conditions one party or the other can terminate the 
implementation agreement and recourse should termination occur. 
• Penalties define type, form, value of penalties imposed should a party fail to 
perform; 
• Governing law and arbitration; 
• The government and Project Company wi" mutually secure the other party against 
loss and damage arising from the performance of contractual obligations within 
certain limitation. 
It is clear that a typical implementation agreement covers issues ranging from 
authorization to do business to granting of certain tax benefits or exemptions from 
customs duty. If government policy has not been established in areas that could affect the 
project company, lenders wi" require that government make appropriate commitments. 
Often, the IA should contain terms and conditions necessary to ensure the effectiveness 
of other key project agreements such as Energy Purchase Agreement (EPA). In effect, 
the IA seeks to guarantee the performance of government entities involved in the project. 
All of these agreements have interlocking terms and conditions and need to be supported 
by the lA, since lenders are particularly concerned about government actions that might 
jeopardize their loans or investments. Moreover, in projects with long payback periods, 
this concern is compounded in host countries that lack a record of strong support for 
political regulatory, economical, and financial reforms. 
It is important to indicate that in a country where the legal, institutional, political, and 
regulatory environment is conducive to private energy development, the IA may be 
relatively simple and straightforward. 
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Moreover, if the pubHc sector were not a party directly involved in the obligations to private 
energy developers, an IA would not be required. However, in such a case the risks that 
would have been transferred to the public sector must be shared, in some form, between 
the private producer and the purchaser. Even if the government purchases a portion of 
the power generated, a welt.structured project with the private sector as a purchaser may 
not require an IA. 
4.3 ENERGY PURCHASE AGREEMENT 
There is the risk and uncertainty that energy produced will not be purchased and 
also, that demand will not be met. The question thus arises whether there Is an 
agreement relating to supply, demand, pricing, penalties and bonuses. 
The Energy purchase agreement (EPA) establishes the energy sales obligations between 
the producer and the purchaser and identifies the type of transaction, for instance, BOST. 
This agreement commits the producer to specified conditions, (for example, maximum 
output, kilowatt hours) over a defined period and commits the purchaser to compensate 
the producer by an established amount and tariff rates whenever the facility is available 
and capable of generating energy. 
Because the EPA provides the revenue stream for repayment of debt and retum to 
investors, it is important to the lender. Consequently the terms and conditions of this 
agreement will be heavily influenced by the lender's desire to enhance potential revenue 
and minimize risk. In this case, the risk to be avoided is the reduction or termination of the 
revenue stream, regardless of the cause. The greater the real or perceived risk to the oil 
and gas producer, the higher the price the producer can expect to pay. 
In reality, the producer can reduce or even terminate the revenue stream under some 
conditions. For example, if the purchase has fulfilled all obligations and oil or gas is not 
being provided, the purchase has the right to decrease or suspend payment until the 
situation is remedied. However, depending on the insurance carried by the producer, debt 
service may be maintained for some period. The EPA should therefore provides for the 
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producer to compensate d1e purchaser should production cease or fall below a specified 
level agreed in the EPA. 
The task of establishing specific performance guarantees, future adjustments to the tariff, 
and penalties or bonuses for exceeding or failing to meet performance guarantees are the 
heart of the EPA and usually require lengthy discussions. These discussions should 
include the purchaser, producer, and lending institutions but also the construction 
contractor, equipment supplier and operations and maintenance organizations. Each 
participant which activity affects the facility's performance should provide an acceptable 
undertaking with respect to its respective obligations. 
For example, the construction contractor may offer a turnkey project. The price and 
construction period effect will be fixed and constructor's performance guaranteed. Each of 
these items affects the cost of production and the purchase price. Even though the 
producer may have obtained certain preliminary commitments and guarantees from the 
contractor modifications should be required based on negotiations between the producer 
and the purchaser. 
4.4 LAND CONVEYANCE AGREEMENT 
The land tenure problem In Africa is aggravated when It comes to 011 and gas 
project development A case In point Is the Ogonl lands in the Niger Delta of 
Nigeria. The question is whether there Is an agreement and measures put In place 
to forestall the risk of local people blocking the development and operation of the 
project 
The land conveyance agreement (LCA) transfers land ownership to the project company, 
which purchases the land or executes a long-term lease. The LeA covers the land 
required for the plant and those required for the pipelines. 
Land use must be exclusive to project purposes and must be assignable to the lenders so 
that they can take over the facility in case of default by the producer. The LCA tenn 
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commences no later than the start of construction, and the duration should be at least 
commensurate with the term of the EPA. 
The LeA generally divides the responsibilities for the installation of water, sewer, gas, 
electricity services, fuel transmission and fuel storage. Existing or newly required 
covenants, easements, or other restriction are identified, along with the responsibility to 
conform to applicable zoning laws, buildings codes, regulations, and other requirements. 
In addition, the parameters and procedures for access to the site by personnel other than 
the project owner and operator are agreed upon. 
The LeA also identifies the party responsible for payment of government charges or taxes 
levied on the site, equipment, structures or other personal property. Responsibilities for 
existing and future conditions at the site such as suitability of soil conditions, 
environmental contamination, are agreed upon in the LeA. Finally, arrangements for 
disposition at the termination of the LeA, of the land, energy generation facilities, and 
other related constructions are specified. 
4.5 OWNERSHIP STRUCTURE AND AGREEMENTS 
The ownership structure should be a limited liability company with equity and debt 
finance. The question is what ownership structure Is commendable and what are I1s 
obligation and consequences. 
Ownership agreements describe the structure and obligations among the owners 
compriSing an entity, often referred to as the project company. This company is separate 
from its sponsor so that liability and risk to the project are limited. Project ownership can 
be structured in a number of ways, depending on host-and home country tax laws, 
customs duties, and liability environments. 
In a typical project finance structure, the entity formed by the ownership agreement is the 
central point to which all project documents connect and is where the ultimate recourse to 
the lenders and other parties lies. Consequently, the entity is limited in aU matters relating 
to its business and is referred to as a single purpose. 
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The project company is obliged to cause all other parties to perform under the project 
agreement, limit other parties' indebtedness and investments, and furnish documentation 
required by the company or lenders. 
Similarly, the operational limitations imposed on the company; on its financial, tax and 
liability structure; and on its ability to continue its obligations under the project documents 
are designed to protect assets from the actions of any of the project parties. 
Equity investment in a project can be protected using appropriate all-risk, machinery 
breakdown, general liability, and political insurance in the market. All risk and machinery 
breakdown coverage should be slightly more than the value of the asset to account for 
legal and other indirect expensed related to the adjustment of a claim. 
Political risk insurance usually covers less than the full value of assets to provide a 
parallel incentive for project parties to prevent insurable events and commit to their 
resolution. 
The unique advantages of a project finance structure are not without substantial risk in 
allocation and mitigation, all of which are embodies in the structure and obligations of the 
project company to protect the assets and the resulting cash flows. 
4.6 FUEL SUPPLY AND TRANSPORTATION AGREEMENT 
Energy conveyance is expensive In recent times and failure to deliver on time could 
bring a whole nation to standstill. The question Is how this can be dealt with 
Investors and lenders will require firm and reliable long-term fuel supply and 
transportation agreements before financing is provided and construction commences. 
They also will request evidence of the existence and dedication of fuel reserves sufficient 
to meet the project's needs for the duration of the contract. 
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If the supplier or transporter is govemment entities, additional sovereign guarantees of 
their obligations may be required. 
Table 4.1 Key provision of fuel supply agreement 
Delivery Supplier must guarantee fuel availability. If delivery delays result in noncompliance 
in providing energy, the supplier must pay penalties to cover lost revenues and I or 
the price difference of substitute fuel. 
Supplier and purchaser must agree on the amount of fuel to be purchased and 
Take determine whose responsibility it is to redirect fuel if the purchaser's need is 
reduced. 
Price Because of the purchaser's limited risk-bearing abilities, fuel price increases are 
passed to the purchasers in the energy component of the EPA tariff. Long-term 
supply contracts include a pre-specified indexation principal to regulate periodic 
price adjustment to reflect changes in supplier cost. 
Quality Change in fuel quality could cause substantial losses to the purchaser because of 
early degradation of equipment, outages, or reduced performance. Therefore, it is 
paramount to have a guaranteed fuel quality, heat rate etc. enforceable by penalties 
for noncompliance. 
Transportation Transportation availability and cost must be agreed on. 
4.7 CONSTRUCTION CONTRACT AGREEMENT 
The risk of sub-standard design and poor construction are high and expensive in 
oil and gas project development. The question is what measures are put In place to 
forestall this problem 
The project company usually enters into a contract with a reputable contractor for design, 
equipment procurement, and construction in accordance with the energy supply 
requirements of the EPA. This is usually written as a tumkey contract for complete supply, 
erection and commissioning. The turnkey contract provides a single source for all 
responsibilities and guarantees associated with plant performance, project schedule, plant 
warranty and project completion. Depending on the financing arrangements, schedule, 
and technical specifications, larger projects may require a construction consortium or 
award of a number of separate contracts with contractors and equipment suppliers. 
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The terms, conditions, and obligations of the construction contract support those 
contained in the EPA unless the project company has other means to limit risk. 
Consequently, although discursions between the project company and the construction 
contractor establish cost schedule, performance, and other standards and criteria the 
construction contract cannot be finalized until after the EPA has been negotiated. 
The construction contractor should try to limit risk by obtaining favourable terms and 
passing along as much risk as possible to material and equipment suppliers and 
subcontractors. Generally, for a project to be finance, the construction contractor will need 
a fixed - price contract with a specified completion date and a guarantee of performance. 
Failure of the contractor to meet obligations results in substantial financial penalties. 
4.8 OPERATIONS AND MAINTENANCE AGREEMENT 
For a long-term project of oil and gas nature, there will be the need for a permanent' 
maintenance and operations contractor. 
The project company may choose to enter into an operations and maintenance 
(0 & M) agreement with a reputable operations and maintenance contractor to run and 
maintain the facility. This arrangement has the advantages of a single responsibility of 
professional personnel and experience with required spare parts and consumables. 
Because of the importance of operations management and maintenance practices to the 
long-term performance of the facility, the energy purchaser also has a keen interest in the 
ability of the 0 & M contractor. Reserving in the EPA a right to approve the contractor may 
protect that interest. 
Whether the 0 & M contractor is affiliated with the developer or Project Company, the 
agreement should: 
• Reflect the obligations of the developer under the IA and EPA 
• Specify price components tied to the tariff under the EPA and provide an explanation 
and adequate information for future adjustments. 
• Be specific in regard to spare parts and consumables, responsibilities and 
requirements. 
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• Establish commitments necessary to commission and operate the plant. 
• Address future improvements and additions. 
• Provide for operations during emergencies. 
• Specify that operations and maintenance will be consistent with the standards set forth 
in the PPA. In the event of failure to do so, the 0 & M contractor will be required to pay 
damages sufficient to cover a percentage of the liquidated damages assessed under 
the EPA. 
• Establish standards for plant availability, heat rate, and performance efficiency. 
• Establish requirements for maintenance, outage management, and necessary 
equipment overhaul. 
• Clarify whether a performance bond should guarantee the 0 & M contractor's 
performance or whether a corporate guarantee is sufficient. 
• Reflect lines of communications with the energy purchaser for plant dispatch and 
operation. 
4.9 STRENGTHENING PROJECT SECURITY PACKAGES 
4.9.1 INTRODUCTION 
The first step to encouraging the lender and the investor of oil and gas investment is to 
ensure clear contractual arrangements between all parties involved In the project 
performance, which serve as a memorandum of understanding. Technically, the security 
packages are merely contractual agreements and assurances provided by the various 
parties involved in the project to mitigate risk. 
The second step is to strengthen the security packages provided in the framework of 
agreements so that the project becomes creditworthier, and a greeter's hare of project 
cost can be funded through borrowings if the type and quality of security packages 
available are strong and attractive to the lender. 
The above analysis of security packages and agreements are healthy for the survival of 
an oil and gas investments. But these security packages alone hardly work. In the opinion 
of the researcher, there, is the need for these security packages to be strengthened for 
then to work effectively. It is believed that the strengthening of these packages will 
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reduce the political, commercial and force majeure risks associated with oil and gas 
investments and encourage financial institutes to put their funds at the disposal of the 
sponsor. 
There are several ways to strengthen the security packages of oil and gas projects, which 
make these investments not only attractive but also less risky. These are presented and 
analyses below. 
4.9.2 SECURING OIL AND GAS PROJECT ASSETS 
Oil and gas Project debt is should be secured by a first mortgage lien on project assets, 
as well as the direct assignment to lenders of the projects right to receive payments 
under various contracts, such as purchase and sale contract or a financial support 
agreement. Security could also include covenants restricting the project company's scope 
of activity to protect creditors' interests, for instance, by limiting their ability to pay 
dividends to equity investors, or their ability to expand the project without permission. 
Data from IFC revealed that, about 67% of alllFC loans are secured by a mortgage on 
the project assets. The value of this mortgage depends, however, on the nature of the 
project and the project's financial structure. For an oil and gas project, the value of the 
mortgaged land, plant, and equipment can generally secure a substantial amount of the 
project loan. In general creditors try to assure themselves that the expected realizable 
value of the assets secured by a mortgage comfortably exceed their loans. 
In practice, IFC frequently requires that the value of the mortgage assets equal 150 
percent of the loan's principal value. This increases the quality and strength of security 
package arrange for the loan. 
4.9.3 WEAK MORTGAGE FRAMEWORK 
Some countries perhaps for historical reasons prevent project lenders from creating 
adequate mortgages for their loans. Under Indonesian law, land cannot be mortgaged to 
foreigners. In other countries where land belongs to the state and no private land 
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ownership is allowed, project sponsors can then only lease land user rightS for a specific 
period of time, and a mortgage on the land user right may also not be legal. 
In other countries, restrictions may exist that may affect the structuring of project security. 
In Sri Lanka, for instance, the law stipulates that once a lender takes a company's fixed 
assets as security, it will only have recourse against such assets. The lender with security 
on the fixed assets will have no recourse against any of the company's other assets, even 
if the value of secured fIXed assets is not suffICient to repay the secured debt, in addition, 
security on such other assets is not enforceable. 
In 1996, IFe helped finance Sri Lanka first independent power projects, a new $63 million 
project to build, own, and operate a medium-size diesel power plant. Since the company's 
fixed or immovable assets such as land and plant were not adequate to provide loan 
security for all lenders and since the most important assets of the company were in fact 
the arrangements with the government and the power purchase, the senior lenders, 
including IFe, took the following loan security. 
• First mortgage over the movable assets of the company. 
• First assignment of all insurance policies 
• First pledge of sponsors' and other key shareholders' shares in the company. 
• First assignment by way of security of government approvals and agreements, 
including the energy purchase agreement, the implementation agreement, the fuel 
supply agreement, and the government undertaking. 
• First assignment by way of security of the company's rights under project agreements 
such as project funds agreement, retention agreement, and shareholder agreement. 
• First charge on the company's bank account, including offshore accounts. 
To ensure that the company will not crate security on its fixed assets in favour of third 
parties, the lenders, IFe and USAID required that the company's articles of incorporation 
be amended to require the prior approval of a qualified majority of shareholders for the 
company to be able to create security on its fixed assets. This allows the senior lender, in 
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their capacity as shareholder, to ensure that if they enforce the security the fixed assets of 
the company remain available. 
4.9.4 ASSIGNING PROJECT RECEIVABlE AND PROJECT AGREEMENTS 
Another common way to achieve loan security for oil and gas projects is to obtain an 
assignment of project receivables. This enables creditors to determine how project funds 
are used if the project runs into difficulty. A project usually has many other kinds of 
agreements covering such matters as government concession, management, and supply. 
Premature termination of any of these agreements could adversely affect the project. As a 
common business practice, the party terminating an agreement prematurely has to pay for 
the damages caused to the other parties. In view of the harm to the project, lenders will 
make sure that they are assigned the damage payments. This again enhances the 
various agreements signed between lenders and project companies and attracts investors 
to finance the project. 
4.9.5 ESCROW ACCOUNTS 
Escrow accounts can be used not only to mitigate foreign currency risks but also to 
ensure that contract obligatiOns can be met. In particular, they can help control project 
expenditure. Although a project may generate suffICient cash flows to pay its debt, 
sponsors could divert these flows to serve other purposes within or outside the project. To 
make sure that the project's free cash flows are used first of all for debt service or other 
pre-agreed expenses, lender often require that an escrow account be established with a 
reputable bank. An escrow account collects all or part of the project cash flow to be used 
for expenditures as agreed. If the escrow account is also pledged to lenders, it has the 
added advantage of improving the project's overall security package. 
4.9.6 SPONSOR'S ROLE 
A project's best support usually comes from its sponsors, namely, the parties who have 
developed and designed the project and also are the primary beneficiaries of its success. 
Sponsors play a central role even in non-course and limited-recourse financing, where 
they may cover only a relatively small portion of a project's overall cost and may rely on 
other creditors and investors to finance the project. Their experience, commitment, and 
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energy will still be crucial to the success of the project in an its dimensions and through all 
its stages. 
Strong sponsors typically provide a sound equity base at the outset of the project, 
additional funding or other support as needed during the construction period and on going 
technical and managerial support during project operations. Even more importantly, 
sponsors must be able to provide effective support whenever it Is needed. Frequently, 
sponsor support extends beyond direct financial assistance to supplying inputs or 
purchasing project outputs to help ensure operational and financial viability. It has been 
uncovered that recourse to the main sponsors is frequently the preferred means of 
mitigating risk. 
4.9.7 SPONSOR EQUITY COMMITMENT 
Every project needs a strong a equity base. The largest equity share, typically held by the 
majority sponsor, is frequently a majority share. In 64 percent of IFC's Greenfield projects, 
the sponsor held 51 percent or more ofthe equity. 
For all the projects, sponsor equity represented 26 percent of total project cost at the time 
of commitment. A substantial commitment by the main sponsor can helps ensure project 
success by: 
a) Making it expensive for the sponsors to abandon the project, thus encouraging them to 
take a strong and lasting interest in the project and to seek to remedy difficulties that 
will arise. 
b) Expediting decision making, particularly where the sponsor holds a majority share, and 
c) Increasing the confidence of other parties in the project. 
As a project lender, IFC almost without exception requires that sponsors maintain a 
certain level of project ownership. This requirement typically lasts for the entire period of 
the loan agreement. The specific level and duration of share ownership are usually 
specified in a share retention agreement between major creditors and investors and the 
main sponsor. 
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4.9.8 SECURITY FROM SPONSORS' SHARES 
Lenders can require sponsor to pledge their shares in the project company as part of the 
loan security package. This is particularly important if lenders fell that the value of the 
mortgaged assets is insuffICient or that there is uncertainty about the enforceability of the 
mortgage. Effecting a pledge of shares is usually a relatively simple procedure and, once 
obtained, can be a useful negotiating tool for lenders. When sponsors pledge their shares 
to lenders, lenders can take control of the company in the event of default and can also 
take whatever steps necessary to protect their investment. A pledge of sponsor shares to 
improve security is used in about half of all of IFC's projects. 
4.9.9 DEFERRING PAYMENTS TO SPONSORS 
It is not uncommon for a sponsor to enter Into suppRer relations with a project. For 
example, the sponsor may purchase part of the project's output or supply raw materials or 
service. In one of IFC projects in Algeria to increase hydrocarbon production for existing 
oil and gas \'IleUs, the local sponsor guaranteed to provide a certain number of 011 \'IIe11s for 
the company to operate on. Deferring raw material payments or services fees to the 
sponsor in the case of project cash shortages helped strengthen the project's financial 
robustness. 
Reducing repayment risk. In another example, IFe supporled a $330 
million project to produce methanol for exporl, an imporlant element 
in the govemment's programme to reduce dependency on crude oil 
exports. The project mw material, natuml gas, is supplied by the local 
sponsors, while export sales are handled by the foreign sponsors. 
IFe helped provide loans and equity funds of about $130 million. Loan 
security was in the form of a mortgage, insurance, and sponsor supporl 
for project completion. In addition IFe required that two other conditions 
be met from the time of the project completion until the IFe senior loan 
was fully repaid. First, the local sponsors would, if needed defer a porlion 
at the payment due to it for gas supplied to the project. Any such deferral 
would be structured as subordinated debt to the project company so that 
the project company could first use cash flows to service its senior debt. 
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Second, the foreign sponsors, if needed, would defer a portion of 
sales commissions, also in the form of subordinated debt to the project 
company, so that the project company could first service its senior 
debts. The project has been performing well since it began production. 
The IFC loan is current and is not expected to face repayment difficulties. 
4.9.10 SPONSOR GUARANTEES 
Project finance is normally structured without direct recourse or guarantees from the 
sponsor, they may be necessary on occasion, especially when some aspect of the project 
risk cannot be mitigated or is considered beyond the creditors ability to absorb. The most 
common form of this arrangement is a precompletion guarantee. Because project risk is 
usually very high before project completion and diffICult to assess or control in certain 
respects, sponsor guarantees may be extended to creditors before the completion of the 
project. In most oil and gas projects, they take the form of a partial loan guarantee, which 
guarantees only a portion of the loan, principal and interest payment. This reduces the 
lender's exposure somewhat but still leaves them with a share of the risks. The main 
purpose of partial guarantees give lenders an additional inducement to finance a project. 
Partial guarantees vary greatly in form and can be adapted to suit many situations. 
Occasionally, a fuR guarantee may be needed before financing can be attracted. 
A Full Sponsor Guarantee. When Project Risk Was Too High 
A pipeline project planned in 1992 to enable Colombia to 
expand its crude oil exports Ulustrates that standard loan security 
arrangements may not always provide sufficient protection for lenders. 
A state-owned oil company held 49 percent of the project and a group 
of major intemational oil companies 51 percent. IFe was the main 
project lender. The economics of the project seemed sound at the 
time of loan negotiation but the project was exposed to the risk of 
guem7/a attacks. Although the Colombia army had agreed to provide 
protection, attacks occurred even during the loan negotiation. IFe was 
prepared to accept any political risk except guerrilla attacks. During loan 
negotiation, IFe and the sponsors could not come to an agreement 
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on how to separate the risk from general political risks. Because 
the sponsors wanted to move forward with the project and because 
other sources of reasonably priced long-term debt were not available 
at that time, a full sponsor loan guarantee was given to IFC. Despite 
the guerrilla problems, the project has performed well financially. 
The company without any problems has seNiced IFC's loans. 
Consequently, the guarantee has never been invoked. 
4.9.11 PROJECT INSURANCE 
Of the numerous risks, that on and gas project are likely to face, many can be allocated to 
parties wilHng to accept them via contracts but force majeure risks cannot be contractually 
allocated. These risks are associated with fire and natural disasters, and they have to be 
dealt with by the purchase of insurance. IFC and USAID require that all its projects have 
adequate insurance to cover such risks. Data revealed that there is no oil and gas 
projects that IFC and USAID have finance without adequate insurance cover for force 
majeure risks. 
Broadly, there are two types of force majeure risks. One affects the project directly, as in 
the case of an earthquake or fire; the other indirectly, as in the case of a natural calamity 
that prevents a supplier from fulfilling its commibnents to the project. Market insurance 
can usually be purchased to mitigate against these risk. The insurance proceeds are used 
to restore production or repay loans that are bad as a result of the force majeure. 
4.9.12 GOVERNMENT GUARANTEES 
Government can directly guarantee the default risk of a state entity, that is, party to a 
project. This form of guarantee is most often seen in countries where the economy of the 
country depends heavily on the import of oil and gas and the crude oil for refined fuel is 
imported by a state-owned distributor through EPA, example Tema Oil Refinery (TOR) in 
Ghana purchasing crude oil from Nigeria National Petroleum Corporation (NNPC) and it is 
crucial that Terna Oil refinery be able to pay for the supply. This agreement between 
NNPC and TOR is supported by Ghana government guarantee. The extent of guarantee 
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wiD be full payment for debts that may arise from non-payment of supply and penaly that 
may arise. 
4.9.13 SECURITY FOR EQUITY INVESTMENTS 
The principal objective of project security is to protect project debt, because debt 
generally constitutes the largest share of the financing package from passive investors 
and bears a fixed return, with no potential for higher returns if the project is very 
successful. But minorities investors with equity or quasi-equity investments in the project 
will also seek some form of exist. For projects that are not publicity listed on any 
exchange, this frequently includes a put option for their shares. 
In view of IFe's and USAID minority shareholders status in many projects, most of which 
are not listed on a stock exchange at the time of its investment, the agencies need to 
ensure an appropriate exist strategy from the investment. The purpose of IFe and USAID 
and the World Bank investment in equity is primarHy to ensure that the company has a 
solid start. In principle, IFe and the World Bank consider their developmental role fulfilled 
when a project reaches the stage of mature and profitable operation, at which point it will 
usually try to exist the project as soon as possible. With a put option lFe and the World 
Bank exist without difficulty and use its funds in other new projects. Indeed at times a 
properly structured put option may be critical to limiting the downside risk of an equity 
investment. In other cases, IFe and the World Bank may seek a best-effort commitment 
from the main sponsor to list the project on the local exchange within a certain number of 
years. This form of commitment, while not having the same force as a legal agreement, 
helps further IFe's and World Bank's developmental objective by strengthening local 
capital markets. 
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CHAPTER FIVE 
FINDINGS 
5.1 INTRODUCTION 
This chapter focuses on the main findings from the study. Specially, it outlines the ma;or 
issues that came up in the analysis stage of the research. 
It identifies the major risk factors in oil and gas's projects that financiers face, the 
magnitude of such risk factors and the various mitigation arrangements in place to 
minimize them. 
5.2 MAIN FINDINGS 
5.2.1 Construction risk 
It has been discovered that risk is very high at the development phase, which can be 
financed by equity capital from the main sponsors. Construction phase has a high risk, as 
more finance is required, hence a mixture of equity and debt is appropriate. Operational 
phase has a low risk with less restrictive covenant hence bank loan is appropriate. There 
is a positive correlation coefficient between the risk of delay and cost overrun. This 
means that, the higher the risk of delay in constructing the project, the higher the cost 
overrun. The level of uncertainty of construction Is not as high as that of performance 
risk. This is because performance risk is broader in scope than construction risk. The 
theoretical contention that construction risk is part of performance risk Is not true as a 
clear distinction is easily drawn between them. Uncertainty is found to be relatively low 
ranging from 4% to 6%. Major mitigation arrangements include fixed price for materials 
and equipment, certain date construction contracts such as turnkey contracts with built-in 
provisions for liquidated damages and contingency allocation is made for uncontrolled 
price escalations. 
5.2.2 Performance risk 
The long-term nature of oil and gas project permits it to be disrupted by performance 
factors such as failure of equipment, management, market demand and many others. 
The study revealed that the level of uncertainty of performance in oil and gas projects is 
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between the range of 10% and 14%. The lowest for the World Bank and its affiliate IFe 
and the highest for a local financial institution, NIB (Ghana). In fact, there is no absolute 
certainty of performance in oil and gas projects. Mitigation arrangements include relying 
on tried and tested technologies rather than newly developed technologies. Also, 
performance guarantee from equipment suppliers on quantity and quality are sought and 
equipment suppliers and technical advisors provide training. 
5.2.3 Market risk 
Fluctuations in the demand for oil and gas project output have been the leading cause of 
revenue and profitability problems. Cartels make decision to cut supply or increase 
supply affect market price and prediction Significantly. Nevertheless, market risk is found 
to be the lowest among the various risks encountered in financing oil and gas project 
because there is ample market demand for the products and demand also exceed supply 
especially when there is a threat of war against a major supplying country. Market risk is 
difficult to hedge against specifically, unless there is a single buyer or small group of 
buyers for the output. However, signing a purchases or sales agreement with the price 
and quantity clearly specified with the seller or buyer is one way of hedging product price 
risk. Power Purchases Agreement (PPA), off take agreements, call and put options and 
forward contracts are equally appropriate means of mitigating market risks. Sovereign 
guarantees are no longer workable as new governments openly declare their 
unwillingness to pay the accrued by the previous govemments; irrevocable letters of credit 
from credible intemational financial institutions give some encouragements to the lenders 
and sponsors of the oil and gas projects. 
5.2.4 Economic risk 
Macroeconomic stability balance of payment situation and foreign exchange rate policy in 
the project country are of concern to economic risk. Foreign exchange risk particularly 
can be a major concern if the project generates revenue only in local currency. Analysis 
revealed that international financial agencies that finance oil and gas projects are not 
significantly affected by economic risks because of the strength of the currencies in which 
they operate, the stable exchange rate of their currencies, the low inflation rates in their 
economics which are not affected by the inflation levels unfavourably in the economics in 
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which they operate, and the retatively low interest rates at which they source finance for 
their operations. Mitigation arrangements such as mixing local with foreign funding so 
that the project does not rely excessively on foreign funds, index output prices to the 
exchange rate especially in a situation where revenue is mostly in local currency and 
project cycle is long, this is vulnerable to dramatic changes in prices of oil and gas product 
in line with the exchange rate. This is however a very difficult for any govemment to 
undertake as it wiN mean pushing price increases on to consumers anytime there is a 
significant change in the exchange rate. Government guarantee to obtain foreign 
exchange for the project company is one way to ensure that foreign exchange is always 
available. Escrow accounts in which foreign currency revenues can be deposited will help 
the borrower avoid potential repatriation difficulties. Interest rate risks can be managed 
when they borrow at fixed interest rates even though commercial banks are reluctant to 
borrow at fixed rates on long-term basis. Converting floating interest rates to fixed interest 
rates and swapping the same are equally good mitigation arrangements for interest rate 
risks. 
5.2.5 Environmental risk 
Environmental risk assessment is as important as economic risk. Health safety and other 
issues can have negative impact on oil and gas projects, particularly its cash flow. 
Environmental assessment is to give the optimum assurance that day-to-day operations 
will run smoothly during project design, construction and operation. Environmentalists 
and 'Other pressure groups such as Green Peace and Friends of the Earth conSistently 
monitors oil and gas companies to ensure that the environment is not affected by their 
activities. Financing agencies therefore considers environmental due diligence as a 
fundamental conditionality for financing their projects. They ensure that development and 
implementation of resettlement action plans and efforts to avoid degradation of natural 
habitats. In many cases, public consultation and disclosure is required for harmonious co-
existence of all parties, importantly, the views of affected stakeholders are considered in 
project design and implementation to avoid excessive economic and physical 
displacement of natural habitats. 
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A case in point is the consideration of forestry, resettlement affected people, water 
pollution and Wildlife protection in the course of constructing the West Africa Gas Pipeline 
project. Early efforts to establish and promote a transparent relationship and meaningful 
dialogue With affected people and communities frequently bring benefits of excellent 
community relationship and operation without disruptions. 
5.2.6 Political risk 
Political risk arises from unforeseen political events that may change the projecfs 
prospects from profitability. It might be the act of government to change the natural 
resource exploration law, regulation or general instability in the political or social system 
as a result of war, strike or frequent changes in government. Currency transfer and 
expropriation difficulties are typical examples of political risks. War, civil disturbances, 
coup d' tat, terrorism are frequent and typical of developing economics. Political risk is of 
paramount importance to investors such that adequate undertakings supported by 
intemational C(H)perative Underwriting Programme (CUP) is taken to back it. Empirical 
evidence suggests that political risk can be very high in the developing economiCS than in 
the developed economics. This is evident In the Ogoni State of Nigeria where several 
interruptions took place in the operation of oil companies by the local people in the 2000 
and 2001. Several hundreds of lives were lost in attempts to maintain law and order. The 
battle between oil companies, governments and the local people are on the increase 
which raises the risk factor demanded by the financiers of 011 and gas projects in 
developing economics particularly, Africa. 
5.2.7 Margin of safety 
Significantly, oil and gas project financiers consider the difference between the expected 
returns and the aggregate risk factor, known as the margin of safety or spread. This 
forms the basis of their decision to invest or not to invest. The absolute risks and returns 
numbers do not count as much as the magnitude of spread between the risks and return. 
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CHAPTER SIX 
SUMMARY, CONCLUSION AND RECOMMENDATION 
6.1 INTRODUCTION 
Over the past decade, oil and gas financing has entered the mainstream of investments in 
developing markets. It has gained new impetus in the dynamic environment created by 
the increasing globalisation and sophistication in financial markets, on the one hand and 
by policy reforms that have stimulated private sectors investment, on the other. 
As a result, the volume of flows related to oil and gas investments project finance 
expanded dramatically during the 1990's and formed a large part of the overall increase in 
developing markets. This growth was matched by greater competition in financial markets, 
which reduced funding costs and lengthened the periods of support, while the gradual 
convergence of the debt markets for bonds, syndicated loans, and private placements 
enabled projects to gain access to finance through a broader spectrum of instruments. 
The growing use of securitisation techniques also increased the liquidity and 
attractiveness of projects debt to a wider range of investors in developed countries, and to 
a more limited extent in developing markets. A relatively long period of macroeconomic 
stability and policy reform in major developing markets increased investors' wiHingness to 
support more complex projects and broader range of country and market-related risks. 
The crisis that began in East Asia in mid-1997 has brought about a significant pause in 
the oil and gas investment market. The crisis has dampened growth and investment 
opportunities in most countries, causing sponsors, investors and governments to reassess 
the financial and economiC viability of proposed projects, and investors to re-evaluate the 
risks, particularly with regard to foreign exchange, market demand, and contract 
enforcement. Liquidity in the commercial bank and broader securities markets also 
contracted significantly, reducing access dramatically for most borrowers, including those 
seeking finance for and gas investments. 
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6.2 FUTURE OF OIL AND GAS INVESTMENTS FINANCING IN DEVELOPING 
MARKETS 
The problems created by the financial crisis teach a valuable lesson: greater care must be 
exercised in structuring projects and assessing their risks. The investment needs in many 
developing markets remain enormous. World Bank estimates for new oU and gas 
investments alone over the next decade are in excess of $250 billion per year- and 
pursuing them is essential to development. Yet few companies in the sector have 
sufficient financial resources in developing markets to undertake these projects e.g the 
West Africa Gas pipeline project. Sharing the risks through project finance will get these 
projects off the ground. 
But for these risks to be shared among the interested parties, credit analysis has to be 
done. Credit analysis by lenders required assessment of the risk of the project, 
commercial, technical and political, as opposed to balance sheet risk analysis. which is 
based on the assets and finances of the utility as a whole rather than of the project alone. 
Credit analysis requires a complex and time-conslming assessment by lenders and credit 
rating agencies. Often, lenders will require a developer to contribute a certain level of 
equity. 
This equity is usualy not contributed until the construction phase is completed so that at 
least initial financing of the construction costs must be secured through borrowing. The 
exact level of equity required would depend on the lender's perceived risk for the project 
in the country where it is to be implemented. In general, equity requirements for projects 
in developing countries tend to be in the range of 20 to 25 percent. The remaining 75 to 
80 percent must then be provided by borrowings that can be raised from a mix of sources, 
both commercial and official. In practice developers have experienced few problems in 
obtaining equity finanCing but have found access to commercial bank funding very limited. 
6.3 INVESTOR APPETITE FOR DEVELOPING MARKET RISK 
Globalization and the liberalization of financial markets during the 1990s encouraged 
many investors to enter developing markets. These forces also helped created the 
instruments to mitigate or control the risks inherent in on and gas projects, such as 
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interest rate changes or price movements in products and currencies, although these 
hedging instruments have had limited availability to date in developing markets. 
In IFC, the World Bank and MIGA experience, the success of oil and gas investment 
financing depends in large measure on good risk management. Though time-consuming 
and complex, this strategy offers enormous benefits. For projects in which the risks have 
been identified, clarified, and appropriately mitigated up front, private financiers are 
frequently wilHng to provide significant amounts of funding and will bear project-specific 
commercial risks. In more stable country environments, private financiers have also borne 
some nonspecific commercial risks, including Inflation or currency risks. At times, 
however, such risks can have serious repercussions. 
The major commercial risk underlying most oil and gas projects is that of non-completion. 
All financing packages should contain rigorous standards and obligations to ensure that 
the relevant parties will help bring the project to completion. After completion, market risk 
is the main concem of most projects. This is often difficult to assess accurately, yet critical 
to the outcome of the project. Projects need to be able to withstand adverse 
developments such as new competitors or overall declines in demand If they are to be 
successful. 
The sponsor provides support or guarantee to ensure project completion and will seek 
contractual marketing arrangements or other means by which to hedge market risk. Even 
in projects that have no financial recourse to the sponsor, strong, experienced, and 
committed technical and financial partners can be critical to a projects success, not only 
during the construction period but also during ongOing operations. In addition, 
conservative financial structuring can help a project withstand a wide variety of risks, both 
expected and unexpected. 
Continued innovation in the packaging and diversification of oil and gas investment risk for 
example, through securitisation and the pooling of risks-will also help expand sponsor and 
investor awareness. Because of the current risk-averse enVironment, a number of 
sponsors are combining several projects into one financing pool to help diversify risk. 
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6.4 STRONGER LOCAL FINANCIAL MARKETS 
The extent to which project finance can be used in individual countries also depends on 
the depth of local financial market. In recent years project finance techniques have been 
used mainly to attract international financing to developing markets. With the growing 
popularity of project finance, these techniques have helped finance Oil and gas projects 
that have no obvious way to eam hard currency to repay foreign loans. 
Although instruments for hedging foreign currency are available in financial markets, they 
are difficult to obtain against long-term obligations or are often very expensive. That is 
why many projects failed to have protection against the substantial depreciation in a 
number of local currencies, including the Ghanaian cedi, in the late 2000. 
Project finance techniques and structures can be equally appropriate for raiSing local 
financing for local oil and gas investment projects. Local funding can help mitigate the 
significant interest rate and foreign currency risks many projects face. The local market 
must have some depth, however, and lenders must be able to invest over the long-term. 
Such conditions currently exist in only a few developing markets, especially in Africa. 
Financial markets, both local bond and equity markets, both need to be well developed, 
and reforms directed at creating a transparent and effICient local banking network must be 
in place before project finance can be widely used in individual markets to support new oil 
and gas investment. Governments can help meet these prerequisites by encouraging the 
deepening and broadening of local financial markets. 
6.5 MmGATING OIL AND GAS RISK 
For Oil and gas investment financing, there is bound to be risks, ranging from the 
development, exploration and distribution stages of oil and gas. Typical are construction, 
performance, market, and economic, environmental and political risks. 
It is important that construction risks be analyzed carefully to determine the extent of 
associated delay in construction and its related cost overrun. The danger is that. if these 
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risks are not anticipated and factor into the initial agreement by the sponsors, investors 
and lenders, there will be serious difficulties during the project development; typically, 
there wi" be shortage of funds. 
Mitigating construction risk through tumkey contracts, specifying performance obngations 
with penalty clauses are very essential for a successful oil and gas investment operation. 
Including contingency and escalation cost into project estimates are very important to a 
successful completion of projects. IFe usually incorporate not less than 10% of original 
cost into oil and gas project cost to take care of cost overrun. This is to ensure that 
unexpected cost rise do not jeopardize project completion, and this is normally taken care 
of by a standby financing as part of the initial financing package. 
Another important risk factor encountered is performance risk. This is the failure of 
management of the project to perform according to specification, causes of which are 
unavailable project inputs and failure of technical expertise to function effectively. To 
mitigate this risk, there is the need to hire strong, experienced sponsors with Significant 
quality of past performance with remuneration tied to performance, and bonus paid 
according to output. In other words, team performance incentives and penaltieS be 
attached to their positions. Also, tried and tested technologies are preferred to new 
technologies that are yet to prove their resistance to time. 
Market risk is another uncertainty about oil and gas investments financing. It is a risk 
because of the uncertainty of demand for the supply or vice versa. Market risk is difficulty 
to hedge against specifically, but for oil and gas products, the situation is quite mild in the 
intemational market where demand is always pulUng supply. Signing a sales or purchase 
agreement with price and quantity clearly specified with the seller or buyer is an excellent 
way of militating against market risk, hence the cash flow expectations. 
Economic risk is another important problem facing oil and gas investments. This includes 
foreign currency availability; interest rates fluctuations, exchange rate fluctuations and 
inflation. It has be advocated that currency unavailability should be managed through 
long term finance to match project turner and provision be made for a standby financial 
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facility. Interest rates risks be managed through fixed rate financing and interest rate 
swaps. Exchange rates risk is managed by matching currency of the project loans to 
project revenues; and inflation risk be mitigated by indexing energy output prices to local 
inflation rates. 
There is a need for environmental risk analysis to ascertain the environmental impact of 
oil and gas project; specifically on the natural habitants, child labour resettlements, and 
forestry and water bodies. Cost-benefit analysis of the environmental impact and benefits 
of the projects is an essential element of project assessment. Social cost of projects is in 
recent times a key factor considered by lenders for investment. Resettlements of human 
beings, animals, and other wildlife are the key mitigation arrangement for environment risk 
management. 
Political risk is the unforeseen political events that are likely to change oil and gas 
project's prospects for profitability. Example, a change in law, regulation or general 
instability in the political system. Mitigation arrangements concluded on are that of MIGA 
political risk guarantee to cover primarily equity and related debts. MIGA also provides 
Cooperative Underwriting Programmes to take care of political risks. There is also an 
avenue for political risk to be mitigated at the WTO under arbitration relief. 
It can be concluded that the above risk factors and their mitigation arrangements are 
crucial for a successful development and operation of oil and gas projects. 
6.6 TEST OF HYPOTHESIS 
Hypothesis 1: The key to a sound financial structure in oil and gas investment 
financing is risk management. 
Test It is shown from the analysis that without an adequate mitigation 
arrangements for oil and gas project risks, no single lender will be 
prepared to release its funds to the project company. That, the 
financial structure of the project will be a blend of equity and debt 
capital from both international financial institutions such as the World 
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Bank, International Finance corporation and the United States Agency 
for International Development. Of course, every financial analyst will 
attest to the fact that a mixture of equity and debt capital to an oil and 
gas project company is the most appropriate under every 
circumstance. 
Hypothesis 2: Successful mitigation of risks of commercial. political. technical and 
fOICe majeure events are critical to a project's financial feasibility. 
Test: It has been shown that commercial, political, technical and force 
majeure risks are critical to the survival of oil and gas projects 
development, and operation. The test Is that, any of these risks being 
SignifICant without any serious mitigation arrangement causes the 
lender to withhold its financing. The good news is that, international 
financial institutions such as Multilateral Investment Guarantee 
Agency, the World Bank and International Finance Corporation's 
involvement give some encouragement to the private investors and 
bilateral lenders. It can be concluded that the existence of the 
international financial institutions in oil and gas projects attracts 
laudable private finance into the project and that their presence 
reduces political risk significantly. 
Hypothesis 3: Multilateral Investment Guarantee Agency (MIGA) improves risk factolS 
of oil and gas projects in less developing countries. 
Test MIGA's political risk insurance for oil and gas projects in developing 
countries where country risk is high alleviates the fear of private 
financial partiCipants. The pervaSive negative image of Africa as a 
hostile business environment is ameliorated by the MIGA. MIGA's 
skAted financial engineers ensure that they're a remarkably flexible 
financial tool for all fashions of risks in the developing countries. 
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It can be summed up that this huge insurance investment company 
(MIGA) improves risks of oil and gas projects. 
Hypothesis 4: The structures of security package help mitigate risk in oil and gas 
projects for lenders. 
Test: These security packages commit the parties to contracts under the 
project to perform and incentives and penalties are specified and 
legally enforced. It can be concluded that a weak security package 
increases the risk of non-perfonnance while a strong security package 
strengthened with financial instrument will definitely help mitigate risks 
in the oil and gas projects for lenders interested in investing in oil and 
gas projects. 
6.7 IMPROVING SECURITY PACKAGES 
Security packages are sets of contractual agreements and memorandum of 
understanding between interested parties to a contract stating the implementation criteria, 
incentives and penalties. Sets of security packages include implementation agreement, 
energy purchase agreement, land conveyance agreement, ownership structure 
agreement, supply agreement, construction agreement, and operation and maintenance 
agreement. 
Implementation agreement ensures that there is a secured commitment from all parties 
that are undertaking the development and operation of the project. This includes 
govemment commitments to authorization of the project company to do business in the 
host country, license to generate, transmit and distribute energy. 
Energy purchase agreement ensures that there is an arrangement relating to supply, 
demand, pricing, penalties and bonuses. It also ensures that energy supply meet energy 
demand, prices are within the limit of the pockets of the host government, bonus 
accredited to higher performance than expected and penalties inflicted on the poor 
perfonnance. 
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Land conveyance agreements transfers land ownership from the owners to the project 
company. This agreement ensures that there is no litigation about the land occupying the 
project and forestall the risk of local people blocking the development and operation of the 
project. Strengthening agreement could include employing the local people into the 
project. It will be sad for employees of projects to litigate project land for possible 
abandonment of the project. 
The ownership structure concluded on is the combination of equity and debt finance. This 
mixture of ownership interest and debt finance holders who are interest in the security of 
their funds. Otherwise, project finance is appropriate since the financiers look at the cash 
flow from the project and the sponsors or project company's assets. Since oil and gas 
project are fun of risks, it is advisable project financing is preferred. 
Fuel supply for the plant are equally important as transporting the energy products to the 
refinery or end users. Fuel supply must be regular otherwise; the plant workflow will be 
erratic. The mitigation arrangement is that of supplies guaranteed fuel availabirrty. If 
delivery delays result in noncompliance in providing energy, the supplier must pay 
penalties to cover the lost revenues or the price difference of substitute fuel. Transporting 
energy could also be contracted and Similar mitigation arrangements apply. 
Construction contract agreement is a major problem in the oil and gas project 
development. The design, equipment procurement and the quality of construction are the 
main risk areas. The mitigation arrangement available is that of turnkey contracts which 
has the sole responsibility of guarantee plant performance, project schedule, plant 
warranty and project completion. The contractors will do all Within their powers to ensure 
quality construction if penalties and incentives are attached to the agreements. 
Operations and maintenance agreement could also be subcontracted to responsible 
professional personnel who can install durable spare parts and consumable. 
With the security packages in place there is bound to be alertness by all parties involve in 
the project development and operation. Risks will therefore be reduced if not completely 
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eliminated. This will entice financiers both international and private to fund the projects. 
For a complete elimination of risks, the security packages must be strengthened. 
Strengthening security packages in the oil and gas investment implies that the various 
agreements be protected with financial tool to make the project more creditwOrthy. 
Typical of strengthening security packages are securing project assets with first mortgage 
lien as well as direct assignment to lenders of the project right to receive payments. Also, 
there can be assignment of project receivable which will enable project creditors to 
determine how project funds will be used if the project runs into difficulty. Escrow account 
is another way to strengthen security packages. 
A percentage of the revenues from the sale of energy will be paid into an offshore account 
to take care of emergencies and unforeseen situations. Project insurance, govemment 
guarantees, sponsor guarantees and deferment of payment are all additional methods of 
strengthening security packages. 
It is the believe of the researcher that risk if not eliminated completely through 
strengthening security packages, will at least reduce to the bearest minimum to attract all 
financiers even local financial institutions. 
In conclusion, the issue of risk mitigation of oil and gas projects is no easy task since risk 
itself is an uncertainty which in truth and in fact cannot be foreseen prior to its occurrence. 
But the way out is to make sufficient provision for its occurrence. This will protect huge 
sums invested in projects. 
It important to mitigate risk in financing projects but for oil and gas investments, it is a 
difficult task that needs expert financial engineers to manage. Most risks are transferred 
but there exist some residual risk, which attract the retum on the investment. A lower 
retum can be welcome by lenders if this residual risk can be managed through 
strengthening the security packages and agreements. 
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More importanUy MIGA is confident and prepared to assist large energy projects in Africa, 
it has the demonstrated abHity to help African countries to become oil and gas investment 
giants through its invesbnent insurance programmes. It is hope and believed that risk by 
its very nature will not scare financial institutions to invest in African oil and gas projects. 
6.8 RECOMMENDATIONS 
Africa's energy sector is entering a determinant phase of its development, which, if the 
new and evolving ground rutes are mastered and taken into account, should provide it 
with an opportunity for recovery. This implies that conditions conducive to private 
investments must be created. 
The African Development Bank (ADS) Group could participate significantly in the sector's 
restructuring by causing efficient management to the sector while preserving its 
developmental aspect. 
Resumption of growth is indeed crucial in attracting capital from project finance source. 
Therefore, there must be support for the structural adjustment programme. In this regard 
rehabilitation and restructuring of the energy sector must be given priority in terms of: 
a) Re-definition of the structures of the sector where necessary with due regard for 
solutions of integration or sectioning off activities. 
b) Establishment of regulatory bodies 
c) Determination of the extent of private capital involvement, 
d) Improvement of management systems and performance, and 
e) Establishment of legal, economic and financial framework conducive to private 
investment so as to win the confidence of investors. 
ADS Group and other African institutions should pilot decision-makers without prejudice, 
through the major stages of the process and prepare sound terms of reference for project 
finance i1 broad terms. Stakeholders' interests should be meticulously safeguarded to 
avoid serious consequences of faHures. These stages are: 
a) Study the feasibility of the common projects to harness and supply energy resources; 
b) Study the viability of networks interconnections and execution of regional biased or 
inter-regional facilities; 
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c) Determine the most suitable inter-rountry institutional and organizational frameworks 
for energy resources development; 
d) Assistance in mounting appropriate financing packages and concurrently establishing 
mechanisms for mobilizing local savings and more concessional financing institutions 
for the corporations. 
e) Progressive definition of common standards in the sector to facilitate trade between 
bilateral and multilateral organizations and developing countries. 
A prerequisite for finance from the private sector is the need for the legal, institutional and 
regulatory structures to be in place to define the economies of an oil and gas project at 
the outset. Early involvement in multilateral agencies (MLA's) and Export credit agencies 
(ECA) tends to provide private sector financial institutions with comfort that there will be 
no unreasonable interference from government. MLAs and ECAs can play an especially 
important role when a project crosses national boundaries. It is important to say that when 
a project crosses an international boundary the political risk is not doubled, but curbed. It 
therefore, makes much sense when we involve the MLA's and ECA's In oil and gas 
project financing from the onset to help curb the risks. 
In this new world the preposition is that, it is wise for sponsors to keep a" doors open with 
regard to financing options for as long as possible. They should consider utilizing a 
financial advisor early in the process to assist with factoring in all the necessary provisions 
for a successful financing before key commercial agreements are finalized. The massive 
investment requirement of oil and gas pipeline and power projects will undoubtedly 
require a non-traditional approach and will challenge historical financing yardsticks. 
Experienced advisors bringing skills learned in the trenches for other groundbreaking 
transaction can provide invaluable assistance to sponsors. 
International oil companies need to feel that they are working in close long-term 
partnership with governments and not just "under contract." If companies believe that 
governments understand the need for long-term stability in energy policy and are 
committed to providing a supportive regulatory, legal and economic framework, then those 
companies could continue to invest in this resource rich region. 
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Govemments of developing countries need to provide an environment of confidence and 
security for financial investors. This is where financial intermediaries such as Chase 
Manhattan's investment Bank can work both with oil companies and with host 
govemments to overcome the painful legacy of the past All too often, poorly structured 
and understood deals have collapsed prematurely, leaving bittemess on all sides. The 
result has been for the cutting off of countries from the intemational markets and banks 
and non-bank investors staying away from African deals, seeing them as being too 
complicated or too difficult. 
It will be better if oil and gas projects financing are structured to be equal in security, 
documentation and legal protection to similar deals in other parts of the world. The vast 
hydrocarbon developments in Former Soviet Union, Latin America and the Middle East 
make tremendous demands for private capital. For Africa to compete effectively for these 
funds, investors in Los Angeles, London or Tokyo must see the same quality of financing, 
legal and security structures and risk reward ratios. 
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11. IFC. Environmental and Social Policy Guidelines. World Bank 
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