The Singular Case of the Chad-Cameroon Pipeline

Presentation to the TJOGEL Symposium Stephen V. Arbogast, Executive Professor C.T. Bauer College of Business-UH January 23, 2009

Project Financing and Political Risk Mitigation

Discussion Topics

9/08: The World Bank quits the Chad-Cameroon Financing

Project Finance as a Political Risk Mitigation Tool First Trials: Exxon and Malaysia Chad-Cameroon: Unique Risks to be Managed by including ECA/MLAs in the Project Financing Chad-Cameroon: Chronicle of Events 2000-08 Evaluation & Implications:

Results for Chad Consortium, Implications for Private firms Lessons for World Bank, Implications for Other resource projects in risky places

The World Bank quits the Chad-Cameroon Pipeline Project Financing

September 9, 2008: World Bank (WB) announces withdrawal

Bank had lent Chad $65.7 M to finance countrys investment in pipeline Loans had been conditioned on Chads agreement to complex Revenue Management Plan (RMP)

Under RMP, WB had oversight over Chads spending of most project revenues, which were targeted towards specific development projects

WBs dissatisfaction w/Chads conduct prompted demand for loan repayments

Does WBs withdrawal signal failure for Oil Companies effort to mitigate project risk via WBs participating in financing? Does WBs withdrawal indicate RMP model is discredited for use in other energy projects in poor, risky locations?

Chad-Cameroon Pipelines: Project Background

Oil first discovered in southern Chad by Conoco early in 1970s

Initial consortium: Conoco, Exxon, Shell, Chevron Additional discoveries brought reserves to ~1 billion barrels

Chads unique risk profile

Landlocked country: oil must be pipelined to Atlantic coast for export

Best route: through Cameroon ranked 148/177 on poverty, 99/99 on corruption potential for pipeline to be held hostage

Chad: 30 year civil war after independence; ruled by Gen. Indris Deby since 1990; unstable borders; $300 per capita income; 173/177 poverty

Oil companies declined to develop Chads reserves

Conoco withdrew in favor of Exxon; Chevron sold to Elf-Acquitaine

Key to Unlocking Chads Reserves Risk Mitigation

Project Finance one of few Available Tools

1.

Project Finance can mitigate location/political risk in 3 ways:

Stake Reduction: limiting project sponsors capital at risk

Requires financing to be non-recourse to sponsor Also strengthens sponsors ability to resist host government pressure

2.

Deterrence: disrupting financing involves consequences that deter host government disruptive actions

Financing to include lenders which host governments dont want to offend

3.

Terms Clarification: project finance process forces host government to clarify/document commitments

Ties commitments to NY/UK law and/or offshore arbitration

Private firms want deterrence to avoid unilateral contract revision

First Test: Esso Production Malaysia (EPMI)1978

Concept: Cash flow allocated for debt service could be impacted by government changes in tax rates

Bank loan repayment at risk if government raises rates

Consortium: Top three international PF banks in lead

Citibank, JP Morgan, Chase Followed by top 3 Malaysian commercial banks

Result: Inconclusive

Malaysia raised rates, banks responded with mild protests Exxon repaid loans; Malaysia did not raise rates again

Result left Exxon disinclined to use PF for upstream risk mitigation

Special Risks in Chad-Cameroon led Oil Company Consortium to reconsider using PF

Chads acute revenue needs for poverty/security; lack of rule of law

Cameroons potential to hold pipeline hostage once built, demanding higher transit fees, equity participations Nothing about EPMI suggested PF by itself would deter such events Consortiums new concept: combine PF & World Bank deterrence

WBs status: concessionary lender, ties to IMF as lender of last resort Track record where few if any countries failed to repay WB loans Plan to combine WB participation with strategic ECA/MLA lenders

US Ex-Im, CoFACE, European Investment Bank (EIB)

Chad-Cameroon PF Deal Structure

$3.7 G project, divided $1.5 G for oil field development, $2.2 G for pipeline and export infrastructure
Private consortium (now ExxonMobil, Chevron and Petronas) financed oil field development on its own Pipeline financed with $1.4 G project finance debt, $800 M equity

WBs IFC lent $200 M of PF as A loan with banks providing similar amount as B loan Other ECA/MLAs and banks lent $600 M

Chad and Cameroon had equity in the pipeline companies

WB and EIB lent both governments funds for their equity contributions

WB adds Revenue Management Plan to the Deal

Concerned about Natural Resource curse, criticized by NGOs for enabling oil development to help authoritarian regime, WB conditioned its presence (and future loans to Chad) on RMP
RMPs terms:

Chads government anticipated $1.8 G in revenues over projects life 84% to be channeled to escrow accounts overseen by WB

10% to stay offshore in Fund for Future Generations 76% to go for projects in designated priority development areas 14% to go for projects in Doba oil producing region 2/9 members from civil society Annual independent audits

Oversight committee to review projects, annual budgets

Once approved, funds released from offshore accounts to Chad banks

Chad agreed to RMP

Recognized WB would not proceed without it and private consortium would not develop reserves w/o WB
Agreed also to 50% cut in armed forces and privatization of most state companies in 1998 After extensive environmental, social impact studies & consultations, and legal documentation, financing closed in mid-2000

WB: new model for resource development

NGOs: disappointing WB would participate; unlikely to help Chads poor

Project proceeds, completes in 2003; target oil thruput in 2004

Oil prices soar, how do PF & RMP perform?

Oil prices - $/B:

2004
14.29 37.66 23.37

2005
14.64 50.04 35.40

2006
14.78 58.50 43.72

2007
14.94 64.20 49.26

Project forecast Actual Differential

Strong test of PFs deterrence large incentive for host governments to try to extract more rents

Windfall also test of RMP

WB and Chad not ready to absorb revenues w/development projects Cash piling up in escrow Security threats on Chads eastern border

First Crisis: December 2005

Deby government unilaterally revises RMP

Law reduces funds escrowed for priority development Incorporates security spending into priority areas Chad repatriates Fund for Future Generations

WB response: freeze escrow accounts, suspend loans to Chad

Energetic WB diplomatic/publicity campaign; Kofi Anan urging Deby to show restraint

Deadlock ends in compromise deal, July 2006 Interim MOU

70% all government revenues to go to development More flexibility on security spending Strengthened Oversight Committee to submit new national development strategy to be enacted by new legislation

Conditions stabilized 2H06-2007

Over $440 M transferred to Chad for allocation to priority development sectors by end-2006
WB expands staff in-country, focusing on Chads petroleum sector and administrative challenges NGOs focus on minor oil spill off Cameroon Chad threatens, but does not implement insertion of Chads State oil company into private consortium

No general legislation finalized for 2006 MOU deal

February 2008 Rebels Attack and RMP Collapses

Early February: Rebels drive across desert from Darfur and attack NDjamena, Chads capital

250 die in several days of street fighting

End-February: Acting under State of Emergency, Deby empowers himself to approve state budgets by decree

Eliminates Oversight Committee, WB approval and audits

Another suspension of WB lending

But remittances of oil revenues to Chad government accounts continue In discussions, WB demands reversion to prior terms, and after Chad fails to agree, requests that loans be repaid

IFC loans to pipeline remain in place Conversations among WB and Chad continue re: basis for resumption of a Bank program

Public Assessments of WBs Withdrawal

Regrettably, it became evident that the arrangements that had underpinned the

Banks involvementwere not working. The Bank therefore concluded that it could not continue to support this project While the payment ends the Banks involvement in the pipeline project, the Bank has explained to the Government of Chad that it recognizes the countrys significant development problemsIf the Government of Chad wishes to focus its energies on a program to support inclusive developmentthe World Bank is willing to work with Chad to assist. World Bank press release, Sept. 9, 2008

The World Banks request [for loan repayment] amounts to an admission of failure
in one of its most controversial and disastrous projects once touted as a model for high-risk projects after the Chadian government repeatedly used its newfound oil wealth in contravention of its agreements to invest in poverty reduction.

Bank Information Center, Sept. 12, 2008

Assessment of Chad-Cameroon Financing as Risk Mitigation for Private Consortium

Essential deal terms survived period of peak oil prices

Fiscal terms essentially unchanged State oil company did not gain entry

WB deterrence did not work with Chad

Chad took unilateral actions twice in face of WBs opposition Cameroon was not provocative

RMP structurally insulated the private companies

Escrow account funds focused dispute between Chad and WB

WBs diplomacy and resistance were energetic

Contrast to banks in EPMI

Assessment of RMP as new WB Model for Resource Projects

First time results disappointing will WB care to repeat?

Little development accomplished, embarrassing withdrawal Severe test: security threats + peak oil prices

Enabled oil development to proceed:

We think that the project provides the best and perhaps only opportunity for Chad

to reduce the severe poverty of most of its populationChads development prospects can only be improved significantly through the use of this traditional energy source. James Wolfensohn, WB President

Chad-Cameroon project was carefully vetted and executed from environmental and human impact perspective

Fixable RMP design flaws

RMP: Lessons Learned

Tighten control over remittance from Offshore Escrow accounts

Chad able to secure enough funds for lengthy confrontations w/WB All oil revenues initially to flow through offshore accounts

RMP structure should be less comprehensive, more flexible

Target lower % revenues for priority development; anticipate security Anticipate revenue windfalls/shortfalls with specific arrangement

Immediate attention to enhancing development project capabilities

WB did little between financings close (6/00) & project startup (mid03) In-country staffing focused as much on execution as supervision

Dont overreach on next RMP escrow lower % of revenue tied to project execution capabilities

WB in Project Finance for High Risk Locations Where from Here?

WB continues to be interested in role in Resource projects

Sees energy supply as key to development

Chad-Cameroon financing successful in getting Chads oil developed and mitigating private firms high risks RMP model discredited within WB and NGO community Recognition of flaws, opportunity for improvement needed to rehabilitate RMP approach Scaled back RMP coupled with WB participation in financing would be best next step