Principles of Project Finance

Chapter 1: Introduction

OVERVIEW

Project finance is a method of raising long-term debt financing for major projects through "financial engineering," based on lending against the cash flow generated by the project alone; it depends on a detailed evaluation of a project's construction, operating and revenue risks, and their allocation between investors, lenders, and other parties through contractual and other arrangements. Project finance is a relatively new financial discipline that has developed rapidly over the last 20 years. In 2001, some $190 billion of investments in projects around the world were financed using project finance techniques (cf. 2.1).

"Project finance" is not the same thing as "financing projects," because projects may be financed in many different ways. Traditionally, large scale public-sector projects in developed countries were financed by public-sector debt; private-sector projects were financed by large companies raising corporate loans. In developing countries, projects were financed by the government borrowing from the international banking market, multilateral institutions such as the World Bank, or through export credits. These approaches have begun to change, however, as privatization and deregulation have changed the approach to financing investment in major projects, transferring a significant share of the financing burden to the private sector.

Unlike other methods of financing projects, project finance is a seamless web that affects all aspects of a project's development and contractual arrangements, and thus the finance cannot be dealt with in isolation. If a project uses project finance, not only the finance director and the lenders but also all those involved in the project...