Coal Project Financing
Authors: Page Garnet T. 
Published: March 2010

Introduction

Coal projects are generally large, with high capital needs, long-term payback, and a number of significant risks. They can have very complex ownership and sales agreements.

Project financing is a technique used to enable the adequate underwriting of the construction, expansion or acquisition of a viable project, based primarily on its future ability to generate a cash flow, with the terms of repayment tailored to that cash flow stream. It is a limited recourse form of financing and, provided the project has been completed and is operating satisfactorily the lenders look solely to the economic outcome of the project, and not beyond it to the income or other assets of the sponsor. It is also a flexible method of financing, requiring a complete review of the technical and commercial aspects of a project, and provides for the integration of various sources of finance and the sponsor's needs, usually resulting in a financing structure which is both unique and flexible, to accommodate the project's nature and probable future.

What must not be forgotten by the sponsor, however, is that the lenders provide funds to a project on a temporary basis, and that they expect to be repaid according to a specified" schedule. They cannot provide such funds until they are satisfied that the project is economically sound, that it will operate as planned, and that it will be able to pay its debts.

Approach

The usual approach to project financing, regardless of the availability of an acceptable financial guarantee, is to ensure that the project is structured so that it can be tailored to the project revenues to cover operating costs and debt service obligations, and to provide a return to investors.

This involves a very comprehensive analysis of the project to verify its technical, commercial, economic and financial viability, together with an assessment and preliminary structuring of the risks associated with the project. This has the advantage of permitting an independent and objective risk/return assessment before the sponsor is required to commit significant funds to the project, and in some circumstances may limit the sponsor's financial commitment to significantly less than that of a conventionally secured loan; and identifies these minimum commitments at an early stage.

After the viability of a project has been established by such a comprehensive and detailed analysis, the investigation, negotiation and optimization of multi-source funds is undertaken, with the objectives of minimizing the financing cost and matching the loan repayment schedule to the project's cash flow, consistent with the sponsor's other financing objectives.

Another advantage of this approach is that it enables a comprehensive and professional approach to be made to export/import credit agencies and other financial institutions which might become involved in the transaction.

Sponsor Commitment

A typical project requires the sponsor to have a minimum participation of an equity contribution, say about 25 to 30% of the capital cost, plus several construction completion guarantees of each sponsor which assure the lenders that the project is not abandoned during construction and of cost control, with cost overruns being the sponsor's prime responsibility.