Is this fair deal to all parties in

regarding returns and risk?

Project Finance
Case #1, Q4
2013-04-13
BY SHARKHUU MUNKHBAT, JUNGON LEE
(, )
Cost of Equity vs. WBs 10% NPV 2/8

Discount Rate
CAPM (calculate cost of equity)
E(Re)=Rf+(E(Rm)-Rf)* e =0.0594+0.06*0.801282=0.107477
Risk free assets return, Rf: 0.0594 (U.S. Treasury Yields with maturity of
30 years, ex-6b)
Risk premium, E(Rm)-Rf): 0.06
Average beta of oil field and pipeline asset, A: 0.5
Beta of (E), e Beta of Asset, A *V/E: 0.5*1/0.624=0.801282

World Banks 10% NPV discount rate is appropriate, when we

consider only financial risk and business risk. But when we
consider other risks such as political risks, environmental risks,
and so on, it seems under estimated.
Main Sources of Output Sensitivity: 3/8

Oil Price & Reserve (1/3)

Oil price estimates of $12~18.5 are under-estimated
compared to last 18-year average price of $20.43 and
projected prices for World Oil (around $20~29). Because of its
low quality: Acidic, corrosive nature.
The expected volatility of oil price is also under-estimated. (it
varied $8.75~41.9 last decade)
Estimated reserve is not accurate. It varies quite widely.
(595~1,038mm bbl, while its financial projections based on 883
mil. Barrels)
Private sponsors and Chad are strongly sensitive to oil price
and reserves (high risk)
 Main Sources of Output Sensitivity: 4/8

Oil Price & Reserve (2/3)

%Change of NPV to Price change
Reserve Price Private
Chad Cameroon
(mm bbl) (mil.) sponsor
$12~15.25 90% 13% -62%
595
$15.25~18.50 61% -3% -168%
$12~15.25 41% -3% -820%
917
$15.25~18.50 78% -2% 93%
$12~15.25 79% -2% 428%
1,038
$15.25~18.50 94% -1% 54%
Main Sources of Output Sensitivity: 5/8

Oil Price & Reserve (3/3)

%Change of Average NPV to Reserve Change
Reserve Private
Chad Cameroon
(mm bbl) sponsor
599~917
(54%) 143% 45% -292%

917~1,038
(13%) 35% 10% 45%

599~1,038
(73%) 229% 61% -378%
 Timing of Returns 6/8

(Cum. Returns @ proven reserve)

volume) Chad Cameroon Private Sponsors
Cum.
Extraction Cum.
by period Cum. Cum. Cum. Cum. Cum.
Return
(mm bbl) Return Return NPV Return Return NPV Return NPV
(Nomin
(Nominal) (PV) (Nominal) (PV) (PV)
al)
600mm 782 363 216 399 192 122 4,570 2,146 416
(2012) (43.9%) (66.3%) (77%) (74.6%) (87.3%) (82%) (79.4%) (89.8%) (65%)
855mm
1,780 548 281 535 219 147 5,753 2,390 638
(2027)
share
22% 17% 26% 7% 7% 14% 71% 76% 60%
(2027)
Other Risks 7/8

Construction risk: very low with super majors in the oil industry.
Operating risk: low. But can be influenced by sovereign risk.
Financial risk: low. (Very high debt service coverage ratio, ex-4a).
but high country credit rank (country default chance), high total
debt % of GDP, volatile exchange rate are somewhat worrisome.
Sovereign risk: High. Civil unrest, threat from rebel groups, high
corruption perception index (Cameroon). (All stakeholders)
Mitigated by WB?
Environmental risk: high. Groundwater contamination from oil
leak (Cameroon)
Other social risk: human rights issues from resettlement of local
residence. (Chad & Cameroon)
Conclusion: Is it fair deal to all 8/8

parties in regarding returns and risk?

NPVs discount rate of WB, 10% is estimated low when including
other risks especially, high sovereign risks. Estimated NPV of the
project can be smaller.

Private sponsors bear most oil reserve risk in terms of its NPV till
2012, while private sponsors get the largest portion of projected
return and NPV.

The return and risk distribution to Cameroon seems appropriate,

but most environmental risk should be borne by them.