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Project Finance Structure
Tianjin Plastics power project was extremely valuable for both parties. Taking into consideration the fact that at that time People’s Republic of China (PRC) required 21 gigawatts of electric power capacity each year for a period of ten years, there was an enormous market opportunity (Thunderbird, n.d.). Therefore, Maple Energy was particularly interested in the project. Tianjin Plastics was also attracted by the project because of its promise to provide Tianjin with a power supply source capable of powering not only extrusion process for the production of plastics and local electrical power grid but also generating enough electricity to transmit it to the regional electric power grid for profit (Thunderbird, n.d.). Taking into consideration the fact that PRC at the time, did not have enough capital resources to finance the project and was not able to easily attract foreign resources to electrify the republic, they were interested in venture partnership with Maple Energy.
The project was associated with the predictable cash flow from the production of a homogeneous commodity product, thereby eliminating some of the financial risks. At the time of the project negotiation, Maple Energy had already made a power purchasing agreement (PPA) with the PRC’s Ministry of Power Industry (MOPI); therefore, the venture could have been significantly debt-financed thus decreasing Maple Energy’s risk of financial sourcing (Thunderbird, n.d.). Moreover, one of the features of the contract was “the provision for free coal feedstock for the life of the power plant” (Thunderbird, n.d., p.4). Taking into consideration the fact that an average company’s project started receiving payback six years after the commencement of a plant’s operations, the power station could have provided Maple Energy with cash flow by 2000 thereby marking the beginning of the economic life of its project (Thunderbird, n.d.).
Tianjin Plastics and PRC’s government expected that under a build-operate-transfer (BOT) agreement, the plant would be managed by Hebei province in twenty years. However, Maple Energy faced significant currency risks related to a partially convertible currency of PRC. Moreover, project finance of the joint venture with Tianjin Plastics/MOPI was far riskier than a joint venture under conventional corporate finance conditions (Thunderbird, n.d.). Offshore projects are associated with a certain degree of risk elements such as currency conversion risk, counterparty risk, market risk, and residual value, tax risk, financial risk, force majeure risk, political risk, and completion risk among others (Morrison, 2012; Thunderbird, n.d.). Therefore, even though a standard hurdle rate of Maple Energy was 15 percent, the company had to increase it in order to compensate for the risks mentioned above (Thunderbird, n.d.).
Joint Venture Structure and Capitalization
The ownership of the joint structure was planned to be shared in such a manner that Maple would end up owning the controlling interest while the other two parties would split the level of control among themselves. Specifically, Maple Energy wanted to hold a 49 percent stake, which translated into Tianjin Plastics and MOPI, holding 46 percent and 5 percent stakes, respectively (Thunderbird, n.d.). The US company preferred this kind of joint venture structure because, under these conditions, they were in control of operations. Moreover, even though Maple Energy reserved for itself ownership and control of the joint venture, Tianjin Plastics and MOPI were contributing almost half of the financing and providing local participation that could be more valuable than money in an offshore project (Thunderbird, n.d.). The project required $110 million in total capital. Equity stake was not planned to exceed 15 percent of the whole funding. Due to the fact that Maple Energy’s stake amounted to 49 percent, the company should have provided more than $8 million in equity (Thunderbird, n.d.).
Taking into account that the project was designed as project finance ventures, the majority of its stand-alone investments had to come from a cash flow generated after the power plant has become fully operational. Maple Energy had to provide 49 percent or the total project equity; therefore, the question of project finance had to be carefully considered (Thunderbird, n.d.). The total capital for the construction of the power plant was $93.5 million. It was provided through a loan from Tianjin Plastics that amounted to $7.59 million, $8.085 million loans from Maple Energy, and $22 million loans from the equipment vendors (Thunderbird, n.d.). A bridge loan from a West Coast US bank amounted to $55 million. All loans were scheduled to be converted into equity upon completion of the project.
One major disadvantage of the loans was associated with the fact that ten percent of them were in the local currency. It meant that the company faced 14 percent rate while similar construction loans in the United States carried only 9 percent rate (Thunderbird, n.d.). The loans provided by the sponsors of the power plant project, the bank, and equipment vendors were scheduled to be drawn down during the first year, over the span of two years, and at the beginning of the final year respectively. The interest was planned to be paid out by the banks after the period of four years. The rest of the financing for the project had to come through a club syndication. The major advantage of the syndication loan has to do with the fact that its tranches were priced at 1.75 percent and 0.95 percent whereas the loan from the Bank of China “was provided at a fixed rate of 13 percent for 12 years” (Thunderbird, n.d., p. 7).
Morrison, R. (2012). The principles of project finance (1st ed.). Farnham, England: Ashgate Publishing.
Thunderbird. (n.d.). Tianjin Plastics (China). Case study. A06-97-0014.