BPZ's $100 million gas-to-power project in Peru benefits from multilateral financing

Sept. 1, 2005
Financing an international drilling program is a very challenging task, particularly for a small company. There are many different layers of risk - political, financial, geological, and operational. Even if the project consists primarily of development or exploitation of known oil and gas resources, the potential financing sources can be very limited and expensive.

Steve Goff
Moyes & Co. Inc.

Randall Keys
BPZ Energy Inc.

Financing an international drilling program is a very challenging task, particularly for a small company. There are many different layers of risk - political, financial, geological, and operational. Even if the project consists primarily of development or exploitation of known oil and gas resources, the potential financing sources can be very limited and expensive.

After the initial risk capital has been invested, the next step is generally to target debt financing for the development of the reserves. In some areas of the world, local capital markets may be able to provide financing. Based on the expected rate of return and the risk profiles of the project and the country, project financing with large international banks or strategic investors may be an option. But another important alternative is multilateral project finance with such agencies as the International Finance Corp. (IFC), a member of the World Bank group, and similar regional agencies, such as the European Bank for Reconstruction and Development (EBRD), the Inter-American Development Bank (IDB), and the Andean Development Corp. (CAF).

Why multilateral project finance?

There are a number of reasons why companies, both large and small, use multilateral project finance for international development projects. The reasons include:

Scarce Capital Sources. Debt capital can be scarce in emerging markets because of the perceived risks, particularly political risk. Multilateral finance provides a capital source when others are not available or are reluctant to be a lead lender/investor. Also, multilateral support in a project financing can be a catalyst for attracting other funding sources, including international banks. Multilateral investors frequently provide funding for their own account with maturities exceeding those available in the banking market and thereby induce syndicated lenders to stretch the maturity of the overall financing.

Political Risk Protection. Multilateral institutions provide political risk comfort to sponsors. Their involvement mitigates the risks of expropriation and unilateral changes to agreements with host government agencies. Their involvement can also facilitate agreements in cross border projects. An example of this is the Baku-Tblisi-Ceyhan pipeline project. The many large sponsors of the project, including BP, SOCAR, Amerada Hess, and ConocoPhillips, could have funded this project from their own balance sheets at lower cost and with fewer restrictive covenants. However, partly because of the complexities and risks involved in constructing and operating a cross border pipeline, the companies elected to use multilateral and bilateral financial institutions.

Funding Mechanism for Partners and State Companies. Project finance provides a mechanism for a small partner or a state company to finance its share of development costs. In the Chad-Cameroon pipeline project, both governments held equity positions in the pipeline. The project finance structure provided them with the means to fund their share of capital costs.

Enhanced Credibility. The involvement of a large multilateral investor in a project enhances the credibility of the project and the sponsor. The various counterparties to the project, including state agencies, contractors, product purchasers and others take comfort in a multilateral's involvement and stamp of approval.

Recent case study - BPZ Energy Inc.

In May 2005, BPZ Energy Inc., a public small cap company, signed a Mandate Letter with the IFC to finance part of the company's $100 million initial development program for its offshore natural gas assets in Block Z-1 in northwest Peru. IFC is the largest multilateral source of loan and equity financing for private sector projects in the developing world.

The Mandate Letter, which is an important first step in securing IFC financing, specifies that the IFC will appraise BPZ's project in Peru to determine the feasibility and structure of a potential financing package of up to $70 million toward the $100 million project. The IFC's appraisal will include a review of the technical, economic, commercial, financial, environmental and legal aspects of the project.

Project Background

The principals of BPZ Energy have many years of experience in the international oil and gas business, particularly in Peru. The chairman, Dr. Fernando Zuniga y Rivero, began his career with Exxon in Peru and later served as chairman of PetroPeru, the national oil company of Peru. The CEO, Manolo Zuniga, holds a masters degree in petroleum engineering from Texas A&M University and has been focused for the past 15 years on oil and natural gas projects in Peru and Latin America.

BPZ acquired a working interest in offshore Block Z-1 in 2001 and in 2004 became operator with a 100-percent working interest in the license. The offshore block of some 740,000 acres is located in average water depths of 200-300 feet. The northern limit of the block is the maritime boundary with Ecuador. To date, two natural gas fields have been assessed with independently certified proved gas reserves of 133 bcf and total proved, probable and possible reserves exceeding 4 tcf.

The company intends to install its own 140-megawatt simple-cycle electric generating plant, to be supplied by the reserves in Block Z-1. The plan to develop these reserves includes the refurbishment of the existing CX-11 platform, rehabilitation of an existing gas well and the drilling of six new wells, and the construction of a 10-mile offshore pipeline, gas processing, and surface facilities. A separate 40-mile gas pipeline to Arenillas, Ecuador, is expected to supply third-party generators with low-cost gas to replace expensive diesel and fuel oil for power generation.

Financing strategy

BPZ evaluated many options for debt financing of the $100 million development project, including large international banks, mezzanine lenders, and other project finance sources. The goal was to keep the capital structure as simple as possible to allow maximum flexibility to finance later expansions of the project. BPZ recognized that it would be necessary to raise a sufficient amount of equity capital to support the senior debt financing, while trying to limit dilution of its existing shareholders.

In July 2005, working with Morgan Keegan as a placement agent, BPZ completed a successful private placement of $34.4 million in common equity. For the senior debt component, the company concluded that the IFC offered the best combination of project credibility, political risk protection, and the greatest probability of successful execution of any of its alternatives.

Key elements in financing plan

There are a number of key components that are considered by multilateral financial institutions in developing an upstream financing plan.

Reserves. Adequate reserves certified by a credible independent engineering firm are necessary to support the financing. Forecasts of both the amount and timing of production and cash flows are critical factors.

Development plan. The development plan, including the drilling program, facilities, pipeline, capital costs, and operating costs, must stand up to a thorough review and due diligence. Risk assessment is important. Cost overruns and delays could result in a shortfall in funding to complete the project. There have been several examples of aggressive development plans and production forecasts which were not achieved and led to problems with the financing plan and the financier. The development plan must be realistic and achievable.

Transportation and marketing. To consider financing a project, the lenders need to see a clear path from production of reserves to generation of cash flow. Firm contractual rights to transportation at reasonable tariffs and solid off take commitments are required.

Environmental. Projects in which multilateral institutions are involved must comply with strict environmental, social and health and safety standards. Sustainable development is a key objective for IFC in particular, and environmental and social reviews are a significant component of the IFC's evaluation of any project. An environmental impact assessment and a workable environmental action plan are all part of a successful development. This process, which includes proper community consultation and involvement, is critical for the long-term viability of the project. While the process can be tedious and time-consuming, the long-term benefits in risk mitigation to the project can more than outweigh the upfront investment of time and money.

Legal. Project finance is based on cash flows from the project. This financing structure is underpinned by contracts that support all phases of the development and cash generating aspects of the project. In addition to the contracts supporting development, the host government agreements and license contracts that establish the legal and tax framework for the sponsor are critical as they form the legal foundation for assets pledged as collateral to the lender. The documentation of any project financing, whether through private equity, commercial banking or multilateral institutions, is an intensive process and requires the help of experienced legal counsel.

Other considerations of multilateral financing

As with any financing alternatives, there are potential challenges in seeking project financing with a multilateral institution.

Timing. The length of time from signing a Mandate Letter to closing and funding a project financing can take as long as 12 to 18 months, although some projects may be closed sooner depending on the specifics of the transaction. This timeline can try the patience of the sponsor and complicate the successful execution of the project.

Transaction expenses. Transaction expenses in putting together a project financing can be substantial. As noted above, this type of financing is contract and collateral intensive. Legal expenses can be high and the costs of outside consultants can be significant and difficult to control. In the case of BPZ's project, the company expects to draw on IFC's substantial in-house legal, technical and social and environmental expertise to help mitigate these costs.

Restrictive covenants. Any project financing will typically include restrictions on the use of project cash flows. Cash is collected in bank accounts pledged as security. There is generally a priority schedule on how this cash can be used. In addition, financial ratio covenants tend to be strict and there are covenants covering ownership, budgets, and information reporting.


International project finance with a multilateral institution can be a complex and time consuming effort. However, in many cases it offers the best path to successful financing of the project.

The BPZ project is more complex than a typical E&P project, as the company intends to use its equity gas to produce and sell electricity from its own power plant. It also proposes to sell gas for third-party power generation in Ecuador, adding cross-border aspects to the project.

On the positive side, BPZ believes its project is well-suited for IFC financing, as it promotes economic development of the region and replaces less efficient and environmentally detrimental fuel sources such as diesel and fuel oil with more efficient and cleaner natural gas. In the case of BPZ, the IFC financing is expected to be a key component of its plan to successfully execute the project.

The authors

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Steve Goff is a managing director with Moyes & Co. Inc., an international advisory firm that assists clients throughout the world with oil and gas project evaluation, business development, and project financing. Prior to joining Moyes, he was vice president finance with Frontera Resources Corp. and before that served in various finance and business development positions with Conoco Inc. He has negotiated and closed project finance transactions with the IFC, EBRD, and OPIC. He holds an MBA from the University of Denver and an MS in geology from Louisiana State University.

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Randall D. Keys is the CFO of BPZ Energy Inc. Previously, Keys served as a consultant and CFO of TransMeridian Exploration Inc., an Amex-listed oil and gas company with operations in Kazakhstan. He also has experience as CFO of Core Laboratories NV and held senior financial management positions with Santa Fe Energy Inc., Adobe Resources Corp., and Norcen Explorer Inc. Keys began his career with KPMG Peat Marwick. He earned a BBA in accounting from the University of Texas and is a CPA. He also serves as chairman of the audit committee of Far East Energy Corp., a public company with coalbed methane operations in China.