Bp Amoco !

BP Amoco (A): Policy Statement on the Use of Project Finance

Capital expenditures are necessary to extend growth for companies. These projects can be funded by either corporate or project finance. Shortly after BP and Amoco merged, David Watson (CFO) asked Bill Young (Head of Specialized Finance) to prepare a recommendation on when and in what circumstances the newly merged company should use external project finance. The difference between project and corporate finance is that under project financing, a project is totally reliant on the assets and cash flows of that project for interest and loan repayment. It is a separate independent project company. Therefore, the loan is nonrecourse and the parent company is not held responsible for the debt. However, in corporate finance lenders can rely on the cash flows and financial strength of an entire corporation entity for repayment. This, in turn, can make corporate finance more risky since lenders can pursue the parent company’s assets.

Bill Young formed a team with Mike Wrenn, from the America’s Finance Group in Chicago, and Adam Wilson, from the Specialized Finance Group in London to analyze project finance and figure out a recommendation. They ultimately decided to limit project financing except in three very particular circumstances: (1) mega projects, (2) projects in politically volatile areas, and (3) joint ventures with heterogeneous partners.

Mega projects are hard to quantify but can be defined as those large enough to cause “material” harm as defined by senior management. These projects should be funded by project finance so risks can be hedged. Projects in politically volatile areas are also good candidates for the same reason. However, these projects should also be large in size (comparable to mega projects) because it is more cost-effective for companies to risk absorbing the costs of smaller projects over pursuing the extra costs associated with corporate financing. The final exception is for...