The current situation around the Caspian is sometimes compared with the nineteenth-century "Great Game." However, it differs on at least three accounts: the players are more numerous, the stakes are not control of territory but access to resources, and the decisive players are multinational-financial bureaucracies rather than state-political structures. Also, the financial environment is unstable and constantly changing. This week's commentary begins a two-part series on the latter theme. This week I discuss the need for strategic alliances and their strengths, and selected issues of financing and feasibility. Next week I argue that financing is not everything, and conclude on the relationship between financing and other forms of engineering.
1. Strategic Alliances
From a management standpoint, strategic alliances allow profound knowledge of the market to be combined with the best technical practices. From a political standpoint, strategic alliances represent the bringing-together of capital, technology, and resources so as to address the organisation of the post-Cold War international system. From an economic standpoint, strategic alliances capture the integration of the oil industry with financial needs.
Forming alliances is not a choice but a necessity for achieving an appropriate pace of development. To be successful, alliances must share goals, risk, control, and decision making, through clearly defined processes. Western firms often do not have the long-term perspective required to make strategic alliances work. They frequently have trouble adapting to different cultural environments. When Western companies invest, this is by and large in order to secure the energy resources, rather than to deal with social problems.
Strategic alliances are extremely difficult to put together. They encompass much more than partnerships, which are of limited duration with specific objectives. They are more open-ended. This leads to at least two problems. First, the relationship can become unstable because relative strengths and weaknesses of the partners can change over time. Second, simply arriving at an objectively agreed evaluation as a basis for negotiation sometimes can be difficult; and even just identifying the common interests of companies interested in co-operating, is not always simple. Third, reaching ultimate solutions is difficult.
Strategic alliances should be pursued step by step, such that a collection of specific projects leads over time to a fully-fledged alliance, as the relationship develops. Only in this way can a whole range of pertinent issues be addressed, such as managing tax issues, legal issues, and transport: not to mention the ongoing process of aligning cultures, dealing with nationalism, and co-ordinating time horizons. Finding once-and-for-all solutions in an alliance is unlikely.
Western firms consider that they are in the business to secure energy, rather than to deal with social problems. However, firms in the Caspian region are often are both capitalistic and civic entities having enormous social obligations. The keys to co-operation both upstream and downstream are an historical presence in the region and the management of good relationships. However, Western firms often do not value the long lead-time necessary for these relationships.
2. Financing and Feasibility
Financing growth has become harder since the Asian crisis. Risk has been re-priced and sovereign spreads have jumped higher. Equity capital is more expensive and value is lower. People who finance projects have to take the long view of things. Yet also, since markets are interrelated, they must quickly translate lessons learned from one market to another. It is important for those who finance projects to develop close relations with major institutions such as the IBRD and IFC.
Project financing will play an increasingly important role, and the market will continue to be largely bank-driven. Risk management, the involvement of international agencies in the early stages, and proper structuring will be critical. Export-backed financing, which seeks to structure financing in a cost-effective manner by exporting receivables, will work. However, it will consume the host countries' debt capacity; it is like corporate debt in this respect.
Recourse financing should expand, allowing more complicated structures among sponsors while limiting any single sponsor's liability. It simplifies risk analysis to investors, leads to high credit quality, and reduces country risk (by matching payments offshore to borrowing in dollars). But it too eats into the debt capacity of the host countries. Limited recourse financing looks to future revenues. For this, a consortium has to commit to a complete project.
Bond financing is now occurring, but it is too soon for project funds to come to market, because political risk coverage and certain other requirements still need to be developed. Both limited recourse financing and bond financing can use relationships with IFC and IBRD to mitigate risks. Indeed, until now, it is in general only the bilateral and multilateral financial institutions that have been capable of dealing with political risks.
However, it is export-backed financing and recourse financing that will work best at present. With all the resources in the Caspian region, it is possible to use technology together with new alliances and partnerships to make things happen. The question remains, how to bring capital into play to make a return on the projects. Private equity will not be sufficient, so joint ventures will have to turn to debt-capital markets (either bank or institutional).
Financing of oil pipelines presents three difficulties. First, it is necessary to co-ordinate production and pipeline development. This is not happening at present: financiers will not do it; shippers have to be involved as partners. This is the only way to solve problems of pipeline timing.
Second, the fact that consortia have many different members means that it is hard for them to act on a financing strategy. In large mature fields which are still essential to the country's economy and where there is an established skill base, the strategy should be to address fixed costs and to optimize the infrastructure. In immature, partially developed fields and satellite fields, it is still necessary to establish a good legal framework and reasonable tax law.
Third, if a pipeline goes through two or more countries, the question arises, how to split up financing on projects. The answer emerging today is to split the project into segments, each of which is justifiable on its own merits.
To conclude: Pipelines will not be independent profit centres because there is not enough rent in the oil. Producers will not trust a for- profit oil company, so these pipelines will have to be run as service operations. That is another reason why it is good to take a phased approach.
Projects should generate foreign exchange or help to reduce the drain of foreign exchange, and they should have a good economic return in order to interest potential investors. The Western partner should seek to involve local engineering and construction companies, and to maximize the use of local materials. This will reduce costs and generate jobs, helping to assure political support in the host country.
Copyright © Robert M. Cutler
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URL: http://www.robertcutler.org/blog/1999/07/finance_issues_in_eurasian_ene.html
First published in FSU Oil & Gas Monitor, No. 41 (20 July 1999): 2.
