Contract Risks and Credit Spread Determinants in the International Project Bond Market
International bond markets have become an increasingly important source of long-term capital for infrastructure projects in emerging market economies over the past decade. The Ras Laffan Liquified Natural Gas (Ras Gas) project represents a mileston...
| Main Authors: | , |
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2001/11/1631789/contract-risks-credit-spread-determinants-international-project-bond-market http://hdl.handle.net/10986/19496 |
| Summary: | International bond markets have become
an increasingly important source of long-term capital for
infrastructure projects in emerging market economies over
the past decade. The Ras Laffan Liquified Natural Gas (Ras
Gas) project represents a milestone in this respect: its
$1.2 billion bond offering, completed in December 1996, has
been the largest for any international project. The Ras Gas
project has the right to extract, process, and sell
liquefied natural gas (LNG) from a field off the shore of
Qatar. The principal off-taker is the Korea Gas Corporation
(Kogas), which resells most of the LNG to the Korea Electric
Power Corporation (Kepco) for electricity generation. In
this clinical study the authors analyze the determinants of
credit spreads for the Ras Gas project in terms of its
contractual structure, with a view to better understanding
the role of contract design in facilitating access to the
global project bond market. Market risk perceptions have
long been recognized to be a function of firm-specific
variables, particularly asset value as embodied in
contracts. The authors therefore study the impact of three
interlocking contracts on the credit spreads of the
project's actively traded global bonds: the 25-year
output sales and purchase agreement with Kogas-Kepco, the
international bond covenant, and an output price-contingent
debt service guarantee by Mobil to debt holders. Using a
sample of daily data from January 1997 to March 2000, the
authors find that the quality of the off-taker's
credit-and, more important, the market's assessment of
the off-taker's economic prospects-drive project bond
credit spreads and pricing. In addition, seemingly unrelated
events in emerging debt markets spill over to project bond
markets and affect risk perceptions and prices in this
segment. Judicious use of an output price-contingent debt
service guarantee by shareholders can significantly reduce
project risks, and markets reward issuers through tighter
credit spreads. Bondholders and shareholders share residual
risks over time, despite covenants meant to preempt risk
shifting. This type of risk shifting originates from
incomplete contracts and the nonrecourse nature of project
finance. It does not necessarily result from a deliberate
attempt by management to increase shareholder value at the
expense of debt holders by pursuing high-risk, low-value
activities, although project managers and shareholders could
still exploit their informational advantages by leaving
output supply contracts incomplete in ways beneficial to
their private interests. The results hold important lessons
for global project finance. Projects incorporating certain
design features can reap significant financial gains through
lower borrowing costs and longer debt maturities: Judicious
guarantees by parents that enjoy a particular hedging
advantage enhance a project's appeal, as reflected in
favorable pricing. Pledging receivables rather than physical
assets as collateral and administering investor cash flows
through an off-shore account offers additional security to
debt holders. Projects should use their liability structure
to create an implicit option on future private debt
financing that matches the real option of a project
expansion. The finding that bondholders bear residual risks
means that shareholders can reduce their risks arising from
bilateral monopolies and buy insurance against unforeseen
and unforeseeable events. |
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