Project Finance: Practical Case Studies

degree of financial difficulty. The reasons for

financial difficulty fall into eight categories.

Exhibit E lists these categories and shows the

number of projects in each. For many of the

projects, there were several reasons for finan-

cial difficulty.

By far the most frequent cause of finan-

cial difficulty was market risk, which relates

to passenger traffic, vehicle traffic or cus-

tomers’ capital expenditures not meeting pro-

jections; a decline in power or commodity

prices to uneconomic levels; and financial

market conditions that made refinancing dif-

ficult. Currency risk was evident in four

infrastructure projects that generated local-currency revenues but had to service US dollar-

denominated debt. Counterparty risk was evident in the case of three power project off-tak-

ers and one bank issuer of a standby letter of credit. High leverage was a problem with three

projects; in two of these cases the sponsors took on high debt to acquire the projects for prices

that some observers considered excessive. The need for political risk insurance to attract

lenders to developing countries is evident in many of the case studies. For two of the projects

political risk materialised when government entities refused to honour contract obligations.

For another a deteriorating political situation was the primary cause of a depressed economy.

Construction and operating risks are apparent in the financing of most projects, but measures

to protect against them are usually successful. Each of these risks materialised in just a sin-

gle case study.

The reasons for financial difficulty in 11 of the case studies are summarised below.

Market risk

Vehicle traffic for the PYCSA toll road in Panama did not meet the projections made at the

time of the project financing. Similarly, air passenger traffic through the Arturo Merino

Benitez International Airport in Santiago, Chile, did not meet projections made by the airport

concessionaire, SCL Terminal Aéreo Santiago, at the time of the project financing. See

Volume II – Resources and Infrastructurefor more on these projects.

Market risk, high leverage, high purchase price

Among others, Ofgem, the UK power industry regulator, warned that electricity prices

would decline when the New Electricity Trading Arrangements (NETA) were implemented.

Despite these warnings international power companies such as AES continued to pay high

prices for assets such as Drax. The effects of NETA on the Drax power plant in the United

Kingdom were underestimated. After a fixed-price contract for 60 per cent of its output was

cancelled Drax faced the prospect of operating on a merchant basis with a heavy debt load

in an unfavourable electricity-price environment. When default on its debt became

inevitable Drax entered into restructuring negotiations with its bondholders and lenders. As

a high-growth, high-leverage company Drax’s parent AES was vulnerable to the combina-

POWER AND WATER

Exhibit E

Reasons for financial difficulty

Cause of difficulty Number of projects

Market risk event 8

Counterparty risk event 4

Currency risk event 4

High leverage 3

Political risk event 3

High purchase price 2

Construction risk event 1

Operating risk event 1

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