14 March 2011
Energy projects have found funding hard to come by since the 2009 crisis. John Balsdon and Martin Kavanagh look at where the market stands now
After the credit crunch in 2009, liquidity for energy transactions for all but the most creditworthy borrowers and sponsors dried up.
The impact on emerging market debt was even more pronounced. Some banks weathered the storm better than others. French banks in particular seemed to manage their balance sheets and continued to lend.
Two years on from those dark days, banks have by and large significantly shored up their balance sheets. Oil prices are rising fast, competition for energy resources remains keen and the appetite by borrowers for debt to fund energy projects or energy companies’ activities appears to be on the rise. However, despite these positive factors, there has been a number of trends in energy transactions across a range of emerging markets that seems to indicate that the ready availability of debt will remain a challenge.
The capital cost of operating in the energy sector remains high and the likelihood is that these costs will continue to escalate, particularly as new projects are located in increasingly remote locations and construction material costs soar.
After the credit crunch many projects, due to bank liquidity constraints, were financed by equity from sponsors, but these projects have now been developed up to or near the point of production and sponsors are seeking to ’refinance’ these projects to release some of their equity.
However, the scale of the financing required is such that the liquidity in the international commercial bank debt remains insufficient and, as a consequence, local bank debt is being sought.
This raises interesting issues, such as the fact that the interest rates that apply to each tranche can be significantly different, raising tensions between the international lenders and the local banks. Whether local banks can enjoy the same voting rights as international lenders, which can be an issue when local banks may be connected to the borrowers, is also up for debate. Local banks may also have a very different approach to documentation than that of international lenders.
Another trend that is becoming more prevalent, and which provides further evidence of the trend towards multisourcing in emerging markets, is the desire of many borrowers to keep open the option of a future bond financing tranche alongside debt finance. Often this tranche is not put in place contemporaneously because of the perceived and actual difficulties of negotiating a bond alongside debt.
Several issues arise when trying to combine bank debt and bond financings, which probably mean, for the time being, that this sort of multisourcing will remain an option only for the larger projects or those with the strongest balance sheets. In particular, the differences in the way bondholders and banks behave and view the risk on projects and borrowers mean the two are not always easy bedfellows for a borrower to manage, and intercreditor issues are likely to be substantial.
Banks tend to seek meaningful controls over the behaviour of the borrower and are often asked to approve or waive particular actions or events. Bondholders are much harder to organise and to obtain responses from and therefore will behave in quite a passive way, with the consequence that if there is any need to seek indulgence from bondholders, the borrower will be hard-pressed to obtain any concessions from bondholders.
Significant thought and structuring is needed in advance to enable bank debt and bond financing to sit side-by-side, with the likelihood that the borrower will need to give up on some of the flexibility they enjoy from a bank debt-only structure.
The impact of the Deep Water Horizon disaster on BP has meant a number of borrowers have sought to clarify the impact of such an incident under their facilities. In some cases they have sought to amend their facilities in an effort to minimise the impact to try to ensure certainty of funding. The Equator Principles are also becoming more relevant, adding to the complexity in the documentation, as lenders seek controls over projects in emerging markets with an environmental impact.
Due to restraints on capital, few, if any, banks are able or willing to underwrite large loans. As a consequence we are seeing club deals, whereby the underwriting and documentation roles are effectively shared between the banks. This creates a more dynamic process for lawyers, as they now need to engage in a consultative process with those banks, which takes more time.
As borrowers and lenders seek to maximise debt and create as much flexibility as possible, we are seeing structures that are bespoke and complex, requiring increasingly senior resources. Managing fees and the process with bank groups is challenging - particularly as borrowers are resistant to fee structures where no caps exists.
However, for the foreseeable future, particularly with the impact on capital arising from Basel III, this is likely to be the reality that we will all need to embrace and, ultimately, master.
John Balsdon and Martin Kavanagh are partners in the energy finance group at Herbert Smith