Written by Michael Clarke – Director, NAB Advisory

Parallels and differences between agri and resources

Financing greenfield development projects is never easy, and financing large scale projects in the $1 billion+ range tends to complicate the risks exponentially. Add in the fact that Australian financing markets have not seen projects of this scale in the agri commodity space and you end up with a lot of questions about the right approach.

The overall Australian project finance market has deep experience and expertise when it comes to assessing and structuring the financing of greenfield development risk of this scale – and our local project finance market is widely considered a world leader in this aspect of risk assessment. However, this expertise has only rarely been applied to the agri sector.

In this article, we provide an overview of the key risk allocation factors that project debt financiers consider in large-scale greenfield development projects and discuss the ways these factors could match agri greenfield development needs. We also draw some parallels between resource-related financings and lessons that can be applied to agri sector – in particular implications of exposure to price and quantity risks and how the debt market often assesses those sources of risk.

It’s important to note that every major project is different, and the ultimate optimal package of risk allocation will be situation and project dependant – as such, please consider this only a preliminary discussion paper.

The most important thing to note is that the financing structure is directly a function of the commercial structure of the project. All else equal, reducing the project’s exposure to commercial risks and sources of cash flow volatility will increase the leverage potential and decrease the weighted average cost of capital of the project. Importantly, the flip side is also true – retaining exposure to risk typically results in a requirement for additional equity funding. A well-worn phrase in project financing is ‘risk should be allocated to those best able to bear it’, and debt financiers, who do not participate in economic upside, typically have limited appetite to bear much risk.

The importance of the commercial structure to the financing structure also highlights the need for early engagement with financiers, to ensure that commercial agreements and technical studies will ultimately meet bankability standards. In general, we think engagement should begin after ‘pre-feasibility’ studies have passed initial stage viability filters and as the so-called ‘bankable feasibility’ process begins – with your financial advisor assisting in shaping the technical, market and commercial work-streams within the ‘bankable’ feasibility to meet the ultimate requirements of the debt investors in a timely fashion.

Project delivery model

Delivery or completion risk remains a key focus of project assessment. Completion risk is the level of certainty that the project will be built/delivered on time and therefore produce the outputs and revenue required to service the debt. The last position debt investors want to be in is an almost-finished project which can’t produce the cash flows to service the principal and interest. The bank market therefore generally views completion risk as a risk that equity sponsors should bear in one form or another. For bearing the completion risk, equity does typically participate in upside upon completion in the form of ‘development profits’, reflected via reduced cost of capital in secondary or refinance markets, whereas debt does not share in that upside.

The project delivery model has a lot of trade-offs. For example, appointing an overall fixed-time fixed-price wrap contractor over the entire project can create a high degree of completion certainty, reducing requirements for contingency funding and potentially influencing the nature of equity completion guarantee required.

However, this comes at the direct cost of paying additional contractor wrap margins on top of sub-contractor costs. The trade-offs in balancing and optimising this factor is often one of the most difficult and contentious issues that project sponsors face; the ‘optimal’ solution is a function of both the cycle for external market risk appetite in contractor and finance markets) and sponsor appetite and capacity for risk.

For large-scale greenfield agri projects, we see direct parallels in the completion risk structuring that banks require for mining (and infrastructure) greenfield project financing.

Project economic model/revenue model

The proposed economic/revenue model is of at least equal importance to the delivery model, with the cash flow structure (including tenor and volatility risks) ultimately driving the debt sizing and the debt sizing methodology adopted (e.g. sculptured debt service cover ratio (DSCR).

In addition, sources of operating volatility may mean requirements of greater or lesser reserve funding accounts to ensure the project retains sufficient liquidity.

There are important risk similarities in the economic model of large-scale agri projects compared with mining/resource projects – most importantly, commodity volume and price risk.

Consequently, the lessons and structures generally adopted for resources projects may apply to greenfield agri projects.

With the projected growth in demand for agricultural commodities, Australia will be challenged to bring on new supply at meaningful scale – and this may ultimately involve larger projects than have historically been contemplated by the agricultural sector, and therefore require different financing models.

It’s a useful exercise to consider the potential parallels in risk and funding structuring lessons for financing these projects from the greenfind mining/resources space where there is significant precedents for successfully financed large scale development.

This article was first published in Corporate Finance Insights – February 2014.  Read more of this article and other articles.

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