United States: International Project Finance Chapter - The Projects And Construction Review, Eighth Edition

As the population of the world continues to grow, global consumer demand for a full range of products increases commensurately, notwithstanding the storm of other macroeconomic events and forces at play. The foundations for satisfying this demand are built in the oil and gas, natural resources, petrochemicals, telecommunications, transportation, and power sectors. Recent oil and other commodity price volatility, and an extraordinary expansion in oil and gas production as a result of fracking and shale technology, may give investors and developers cause for reflection, at least in the short term, but large-scale investment remains very much necessary across a broad spectrum of industries on an ongoing basis. Neither governments nor private sources on their own can meet that need in full. To be successful, investment projects have to amass funding and other commitments from a combination of public and private sector participants, and involve increasingly sophisticated financing arrangements.

As the speed of development accelerates, the scale of individual projects has had to keep pace. At the same time, uncertainty of supply has driven exploration for resources to more remote locations, often requiring innovative technology, and the cost of extracting and processing resources has therefore risen. The development of 'megaprojects' has exacerbated the competition for funding. The result? Ever larger financings occurring at a time when traditional commercial bank sources continue to face market and regulatory constraints. As any successful sponsor must call on a widening variety of finance sources, there is a continuing need for lawyers capable of structuring the most innovative and complex transactions.

Before examining the role of project finance (and project finance lawyers) in this context, it is useful to consider the more basic question of what we actually mean by the term 'project finance'.


In essence, project finance is simply a form of secured lending involving intricate (but balanced) risk-allocation arrangements, and much of the legal expertise is drawn from the discipline of banking. Transactions are characterised by lenders extending credit - often, very large amounts - to newly formed, thinly capitalised companies whose principal assets at the time of closing consist of little more than collections of contracts, licences and ambitious plans (hence the focus on prudent legal analysis).

To reduce the discipline to its constituent parts is, however, to miss the magic - or alchemy if you prefer - of project finance: the conversion of an assortment of paper assets into a viable economic undertaking. The process is akin to creating an economic 'ecosystem' in which inputs are sourced and processed, and outputs are sold and consumed, with the resultant revenues allocated carefully to predetermined uses, all pursuant to contracts generally entered into before the project has even been constructed.

Project financing has evolved significantly since it emerged in its modern incarnation in the 1980s. Then, it was a tool used principally by commercial banks to finance the construction of natural gas extraction projects and power plants, largely in North America and Europe. Even when projects were financed in the southern hemisphere, lenders and sponsors were generally based in (or near) London, New York or Tokyo. In recent years, this concentration has diluted, with the increased pressure on traditional sources of credit (which is likely to be amplified by the application of the ever more stringent Basel standards) providing an opportunity, and a need, for commercial lenders across Asia, the Middle East and Latin America, together with export credit agencies, multilateral development organisations and (for stronger projects) the capital markets, to plug the resultant gap. Similarly, more geographically diverse sponsors are now driving the development of projects, in some cases to provide their home markets with access to natural resources and, in others, because they are often able to supply equipment and skilled labour at competitive prices.

In virtually all regions of the world, concerns over climate change are leading to investment both in low carbon power and in energy efficiency. In some countries, such as the United Kingdom, Finland, the UAE and Turkey, this involves a renewed focus on nuclear power, but elsewhere, such as in Japan and Germany, reactions to the Fukushima Daiichi nuclear disaster are driving demand for wind and solar generation, and in a number of regions this has led to growth in gas-fired generation, giving rise to demand for new gas pipeline and liquefied natural gas supply arrangements. Meanwhile, ever-increasing urbanisation globally necessitates investment in utilities as well as infrastructure. In recent years, economic growth has been particularly rapid in Brazil, India and China, leading to demand for a broad range of commodities, goods and services. Significant investment has also been seen over recent years in Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa, and other emerging economies. As has been the case throughout history, emerging markets will frequently, of course, face cyclical variances in growth and shorter-term, event-driven, volatility. Although these disruptions to stability and economic growth are inevitable, the long-term outlook for at least many emerging markets remains strong. Moreover, as the more established economies of North America and Europe come out of recession, and as US industry continues to benefit from the 'shale revolution' in domestic natural gas prices, one can anticipate that focus will turn again to addressing their long-postponed infrastructure needs, thereby offsetting disruptions in the emerging markets.


1 Phillip Fletcher is a partner and Andrew Pendleton is a senior associate at Milbank, Tweed, Hadley & McCloy LLP.

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Originally published by Law Business Research Ltd

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