How to Answer Law Examination Questions under Pressure

How to Answer Law Examination Questions under Pressure

To give you an idea of how to answer law examination questions under pressure, we have put together some sample first-class answers to law exam questions.

Why is energy financing so important to the energy sector?

The rapid growth of emerging market nations, such as China, India and Russia, has placed a great strain on their energy infrastructure. To support their growth, these nations have tended to commission a mix of renewable, cleaner gas and nuclear powered generation assets, all needing investment. As more developing nations eye up global economic opportunities, so a similar strain will be placed on their energy infrastructure, requiring the need for yet more investment. Similarly, with the conventional energy sources becoming more limited and to ensure the continuity of energy supply as hydrocarbons become more limited, there has been a shift towards unconventional energy sources such as wind power and shale gas. This unconventional source of energy collectively requires large investments (especially in the R&D stages). Equally, there has been an increase in offshore hydrocarbon explorations which require advanced technology and consequently, larger investments (for example, the failed joint venture between Rosneft and BP in 2012 illustrates just how costly such explorations are).

How do energy companies deal with this high risk of energy projects?

Project finance can raise larger amounts of long-term, off balance sheet (this can also be very important) foreign equity and debt capital for a project.  It protects the project sponsor’s balance sheet.  Through properly allocating risk, “it allows a sponsor to undertake a project with more risk than the sponsor is willing to underwrite independently.”   It applies strong discipline to the contracting process and operations through proper risk allocation and private sector participation.  The process also applies tough scrutiny on capital investment decisions. By involving numerous international players;  thus spreading the risk among many and making it less onerous on one particular party;   including the multilateral institutions, it can provide a kind of de facto political insurance.  Kensinger and Martin further argue that the finite life and fixed dividend policy aspects of project finance “mean that investors rather than managers get to make the decisions about reinvesting the cash flows from the project.”

The crux of every project finance transaction is the proper allocation of risk. It might also be the most difficult aspect of putting together a transaction.  Traverso argues that, “the most significant characteristic of project finance is the “art” of minimizing and apportioning the risk among the various participants, such as the sponsors, contractors, buyers and lenders.” The principal instruments for allocating the risks and rewards of a project financing are the numerous contracts between the project company and the other participants.  According to World Bank, while often the cause of delay and heavy legal costs, efficient risk allocation has been central to making projects financeable and has been critical to maintaining incentives to perform.

How are energy financial transactions structured?

Project finance can be described as the raising of funds to finance a project in which the providers of the funds look primarily to the cash flows from the project as the source of repayment and a return on the equity invested in the project. According to Nevitt and Fabozzi it means financing a particular economic unit in which a lender is satisfied to look initially to the cash flows and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan.

Project finance is usually tailored to meet the needs of a specific project. The risks and the returns from the project are not borne by the sponsor alone but by different parties to the project be they equity holders, governments, and the lenders. 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. Project assets, project related contracts and project cash flows need to be separated from those of the sponsor. These will be key to attracting the much needed funding.

Apart from natural resource ventures such as mines and oilfields, project finance has been employed to fund capital intensive facilities such as power plants, refineries, toll roads, pipelines, telecommunications facilities, airports and industrial plants.

What is a political guarantee and who provides these in energy finance transactions?

Political risk insurance or guarantees issued by the Multilateral Investment Guarantee Agency (MIGA) can help investors manage the unusual and unpredictable non-commercial risks in many markets. MIGA is a member of the World Bank Group with a mandate to promote foreign direct investment into emerging economies by providing political risk insurance or guarantees. The agency’s guarantee coverage can protect investors and lenders against the risks of expropriation, currency inconvertibility and transfer, breach of contract, and war, terrorism and civil disturbance.

MIGA’s structure as an international organisation, whose shareholders are the governments of 171 member countries gives it the weight necessary to deter many a government action that could disrupt business operations in emerging economies. The agency’s status as a World Bank Group entity ensures that it has a good and productive working relationship with host governments.

To date, MIGA has issued over USD 800 million of guarantees in the oil and gas sector. The agency’s outstanding oil and gas portfolio currently stands at USD 339 million. MIGA’s extensive experience in the sector has led to the development of guarantees specially designed to target oil and gas-related concerns, such as the revocation of leases or concessions, tariff, regulatory, and credit risks arising from a government’s breach or repudiation of a contract, and disputes related to take-off agreements, production sharing, exploitation, and drilling rights.

what is the role of export credit agency?

The first of these organisations are known as Export Credit Agencies (ECA). Examples of ECAs include Hermes in Germany and NEXI in Japan. Unlike regular banks, an ECA only recovers the initial operating and financing costs, not a profit or return.

Export Credit Agencies (ECAs), are public agencies and entities that provide government-backed loans, guarantees and insurance to corporations from their home country seeking to do business overseas in developing countries and emerging markets that are considered too risky (commercially or politically) for conventional corporate financing. Unlike commercial banks that seek a market return on their loans or insurance, ECAs only seek to recover their operating and financing costs. ECAs are part of a broader government policy context of industrial policy, trade and investment promotion. Examples of ECAs include Hermes in Germany and NEXI in Japan.

For providing financial services, ECAs charge premiums and/or interest from clients, usually at a lower rate than those of commercial players for comparable risks. The majority of ECAs provide insurance and other services for medium-term and long-term, transactions which are usually associated with large projects. When providing export credit guarantees they lower the risk of private lending and consequently, they have emerged as one of the leading players in project finance, particularly for large infrastructural and industrial projects, which are risky, highly capital intensive and have long gestation periods.

What are the main features of ‘reserve base lending’?

Reserve-based finance is a generic term used to cover finance where the loan is collateralised by the value of a company’s (or project’s) reserves and where repayment of the debt comes from the revenue derived from sale of the field or fields’ production.

RBL market standards contrast between different upstream markets in terms of the acceptability of asset categories, gearing, lending structures and security packages. Divergences in the aforementioned are dictated by the market in question, the history of the market, how advanced the legal framework is in the market, the nature of security and, for the purposes of syndication, the liquidity of the market.

In a basic RBL structure, assets are ring fenced to provide the lender with security for the facility. The lender advances the RBL facility when they have carried out legal, financial and technical due diligence. Technical due diligence is fundamental and it was US lenders that were among the first to recruit engineers to produce detailed forecasts, based on an estimated value of available reserves and other economic and technical factors.

In RBL, the term of a loan is typically shorter than the expected production life of the reserves and devised according to a production regime. Typically, financial ratios and models are made against certain base cases which are variable, meaning that if a cash surplus exists, there would be a provision to apply the surplus against the outstanding loan.