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    Chad-Cameroon Petroleum Developmentand Pipeline Project

    Background

    Corporate finance vs. project finance

    Why is there a difference between financing of field and expsystems?

    The role of World Bank

    Assessment of project risks and returns Real options

    Project update

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    Background

    ExxonMobil, Chevron, and Petronas undertake a $4 Billion petroleumdevelopment and pipeline project in Chad, which presented a uniqueopportunity to stimulate Chads economic development, and yetentailed environmental and social risks.

    Corporate finance for the development of the field system andproject finance for the pipelines

    Debate on unstable political structure and how Chad would use its

    share of project revenues WBs introduction of Revenue Management Plan to target Chad

    Governments returns from the project for developmental purposes,and debate on the likelihood of effectiveness of such a plan

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    Corporate financing for the field system:

    The lead sponsor, ExxonMobil had AAA debt rating, very strong balasheet ($145M assets) and $16M cash flow Could afford the fieldinvestment in a less costly way relative to project financing

    ExxonMobil was actually a huge portfolio of upstream businesses(exploration, development, production of crude oil and natural gasdownstream businesses (transportation, marketing, and sales), as was chemical byproducts and operations in mining. With less thanperfect correlation among its assets, ExxonMobil might actually havbeen able to eliminate the idiosyncratic risks via adding a fielddevelopment project to its portfolio. Corporate financing as opposeto project financing helped ExxonMobil keep the project as part of portfolio and reduce the risks.

    Besides, the vertically integrated business model made it a naturallcost-efficient choice for ExxonMobil to hold the assets collectivelywith corporate financing rather than individually with projectfinancing

    Corporate financing probably also enabled managerial flexibility andiscretion over the use of oil wells, drilling equipment, etc. thatconstitute the field system

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    Corporate financing for the field system:

    Field development was the less risky part of the entire project for tsponsors, because upstream operations including field developmentand production was one of the core business areas where they werevery strong at. This reduced the cost of bearing these risks themselsince they were better equipped than anyone else.

    Project financing for a field development project would also not beviable financing option, as the lenders generally would be reluctantfinance until after all reserves are proven and capable of productio

    The crude oil prices for the last 18 months ranged from $9 to $42,averaging $20 per barrel, which, even after discounted for the lowegrade, was considerably higher than the projects $5.20 explorationand development costs. With a total proven plus probable reserves

    917M barrels, downside exposure to price and resource risk wasalready mostly eliminated No serious need to protect from thedownside risk (via risk sharing )with project finance and incurringhigher interest rates and loan fees.

    Corporate financing probably also helped save both the costly delayat the development stage of the project and the structuring costs,which would be incurred in project financing

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    Project financing for the export system:

    Export system was the riskiest part of the project. Project financingfor the export system mainly enabled the sponsors to spread thepolitical risks as much as possible via the presence of outside lendesuch as WB, IFC, ECAs.

    The expectation was that the Chad and Cameroon Govts would beless likely to take or tolerate adverse actions against the project infear of jeopardizing future funding from the WB and otherinternational financing institutions who were lenders of last resort

    Additionally, it facilitated alignment of Govts interests with theproject through equity ownership, which would not have been possotherwise as Govts could not afford on their own

    Project financing also created the opportunity for the pipelinecompanies (JV between Govts and the sponsors) to issue limited-recourse debt, guaranteed by the sponsors through completion

    Project financing enabled external monitoring from the lenders

    ExxonMobil also reduced total investment commitment to the projeunder the corporate/project finance structure, compared to thatunder a complete corporate finance structure

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    The role of World Bank:

    WB involvement assured sponsors the much needed protection against thepolitical risk

    Besides direct investment through A loans, it mobilized other funding sourcelike ECA and other banks through a syndicated B loan

    WBs extensive lending and policy experience with Chad offered the leveragthat sponsors did not have

    The project with potentially high returns and developmental impact for Chawas also aligned with WBs policy objectives

    WB facilitated extensive consultation process including supporters andopponents: The process helped sponsors restructuring the project to minimthe social and environmental impact (such as increasing the benefits toindigenous people and changing the pipeline route to protect the naturalhabitat)

    WB also initiated a Revenue Management Plan to help prevent probablemisuse of Chads revenues by the Govt, and target them for developmentapurposes to increase welfare

    Insisted on an open and transparent project planning process

    Established capacity building programs to develop the infrastructure for a wfunctioning petroleum industry and investment climate in both Chad andCameroon

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    The role of World Bank:

    WB involvement also ensured that sponsors did not abandon project due to huge political risks and looked instead for safe

    opportunities in other countries, leading to a missedopportunity for Chad

    Without the WB, the Govt might turn to neighboring countrisuch as Sudan and Libya for partnering in oil export. Thispotentially would have adverse consequences in case theproject revenues were utilized to finance non-developmentapurposes such as war.

    Such an alternative would mean longer and hence more expens

    pipelines The projects exposure to social risks would increase, as the

    pipelines would inevitably cross the northern part of the countrwith social unrest and upheavals.

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    Subjects of opposition:

    The environmental and social impacts were claimed to be irreversible

    The revenue management plan was claimed to be flawed and to lackeffective oversight

    Govt claimed to have little intention of allowing the plan to affeclocal practice

    Criticism on oversight committees composition and power

    The RMP was a concept untested

    According to Harvard Law School, Oil will not lead to development inChad without real participation, real transparency, and real oversight,none of which currently exists

    The revenue management plan also regarded as infringement of sovererights

    The sovereign rights controlled by undemocratic rulers versus peop The beneficiaries of the project were claimed more to be the corporate

    sponsors and commercial banks, as opposed to people of Chad

    Valuable funds could have been used in alternative causes, rather thanpotentially strengthening a corrupt Govt

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    Assessment of Project Risks and Returns:Chad

    Benefits:

    Project provides an important opportunity for Chad to reduce poverty, thoughcontingent on Govt commitment

    Receive up to $125M per year from the project, increasing Govt revenues by more than

    Chad has few other alternatives if any for development

    RMP provisions and future linking of developmental funds to Govt compliance madeter potential misuse of project revenues by the Govt

    Project helps leveraging WB and other financial resources which Govt could not hmobilized by itself

    Leveraging technical expertise of the reputable sponsors significantly reduces Chaexposure to operational risks

    Potential employment opportunities created for local people in operations

    Environmental/social concerns seem to be well addressed in contingency plans wiextensive public consultation

    Another positive externality may be WBs capacity building efforts to establish thesufficient infrastructure for a well-functioning petroleum industry and investmentclimate in Chad

    Greatest protection from downside risk (i.e. price or volume risk) compared tocorporate sponsors, probably because bulk of the revenues (royalties) independenfrom price or reserve levels.

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    Assessment of Project Risks and Returns:Chad

    Risks:

    The realization of the opportunity for economic development strictly

    dependent on Governments commitment in implementation of RMP RMP is claimed to lack credible oversight and enforcement

    mechanisms, which would work against the people of Chad due toundemocratic and oppressive Govt in power

    RMP was a concept yet to be tested with the project; even WBadmitted the project to be an experiment, which increasespeoples exposure to risk

    Chad has to put its only natural resource into the project under projectfinance structure and RMP, which considerably eliminates sovereigndiscretion and flexibility

    Impositions on the allocation of revenues may turn out to beconstraining for a future democratic government who wants toimplement other projects to the benefit of people of Chad

    Governments compliance to RMP is a requirement for future WBloans, which extends the potential influence of the project-specifiimpositions and commitments to non-project specific areas,increasing Chads exposure to risks

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    Assessment of Project Risks and Returns:Chad

    Risks:

    Even if the project generates promised revenues for Chad, Chad might not gon an incremental basis, as it will no longer be eligible to certain types of

    developmental funding due to increased revenues Current aid is around $188M (Exhibits 7 and 8), which exceeds the

    expected cash flow. Chad might not gain on an incremental basis due tdisplacement of existing aid, and yet lose control on its single naturalresource

    Environmental and social risks mostly remain with Chad

    Some adverse impacts are either irreversible or extremely hard to fix

    Despite contingency plans, there may be leakages in the pipeline thatwould go unnoticed for long time, due to limitations of even the mostadvanced technologies

    Less share of the gains in the upside (though balanced with the highest

    protection from downside risks) Although expected to be a highest priority issue from Chads perspective, th

    timing of cash flows were not negotiated to the advantage of Chad

    Considering the urgent need for funds, the allocation of cash flows shohave favored Chad more in the initial years

    Compared to the timing of cash allocations for other sponsors, the lateallocation might be perceived as unfair and might increase the chancesexpropriation

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    Assessment of Project Risks and Returns:Sponsors (Exxon Mobil)

    Benefits:

    The presence of WB/ECA/IFC along with participation ongovernments in equity financing significantly reduced political rexposure

    Project might have helped portfolio diversification

    Low construction risks (sponsors expertise and reputation in thindustry)

    Low operating risks (positive NPV under most scenarios in Exhibwith different price and reserve levels)

    Low financial risks, considering the DSCR (as high as 2:1) and lobreakeven finding and development costs compared to price

    The presence of WB/ECA/IFC in the deal, alignment of Govtinterests via equity ownership through project finance structurethe linking of installment of future development funds toGovernments compliance to the RMP significantly reducedpolitical risk exposure. However,

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    Assessment of Project Risks and Returns:Sponsors (Exxon Mobil)

    Risks:

    Back-loaded cash flows to Govt may be perceived as unfair and may result in

    expropriation

    Still chances are low, as Govt would not probably want to jeopardize future capital infloby risking its relations with WB and the rest of the financial community

    The Govt would not want to forego serious amount of revenues in the form of dividendstaxes, royalties.

    Any social or political instability in either Chad or Cameroon would adversely effethe export of oil through the pipelines across the two countries

    However, the construction of pipelines underground may have helped reduce the negativ

    consequences of being exposed to such risk

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    Real options

    Shadow costs: In case WB is not involved in the project, it is likely that the Govt go with Libya

    Temporary stop option if oil price drops

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    Project Update

    After WB approved the deal, President Deby used part of the proceeds to bweapons

    Huge criticism by social activists/interest groups against WB and sponsors

    WB responded by requiring that the proceeds should be repaid out of generrevenues, suspended new loan programs, and also set up a new oversight boheaded by external people

    After these reforms, WB and IMF permitted debt relief to Chad

    In December 2005, the National Assembly of Chad amended the countrysPetroleum Revenue Management Law in the following ways*:

    broadening the definition of priority sectors to include, among other areasterritorial administration and security; and by allowing that further changethe definition of priority sectors can be made by decree;

    eliminating the Future Generations Fund, thus allowing the transfer of mothan US$36 million already accumulated there to the general budget

    increasing from 13.5 % to 30% the share of royalties and dividends that canallocated to non-priority sectors that are not subject to oversight and contr

    * Chad-Cameroon Pipeline Project, World Bank Web Site

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    Project Update

    WB considered these changes a breach of contract, and on January, 200it suspended new loans and grants to Chad, as well as disbursementsunder eight ongoing IDA operations in the country.

    The suspension automatically freezed the flow of part of Chads oilrevenues within the offshore escrow account

    WB states in its web site that it remains in dialogue with the Chadianauthorities, and is determined to safeguard the oil revenues intended fpoverty reduction programs included in its original agreement with Cha

    while recognizing the fiscal strains currently experienced by thegovernment of Chad.