Risk Shifting and Long-Term Contracts : Evidence from the Ras Gas Project
Risk shifting and incomplete contracting lie at the heart of the agency relationship inherent in the procurement and financing of large-scale projects such as power plants, oil and gas pipelines, and liquefied natural gas (LNG) facilities. Resolvin...
| 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/2000/11/717455/risk-shifting-long-term-contracts-evidence-ras-gas-project http://hdl.handle.net/10986/19764 |
| Summary: | Risk shifting and incomplete contracting
lie at the heart of the agency relationship inherent in the
procurement and financing of large-scale projects such as
power plants, oil and gas pipelines, and liquefied natural
gas (LNG) facilities. Resolving this agency problem is
critical in structuring the nexus of long-term
contracts--construction, operating, output sale, and
financial contracts--commensurate with the project's
underlying tehcnological and market organization. By
investigating the Ras Gas bonds--the largest and most liquid
global project bonds ever issued in an emerging market
economy--the authors provide empirical evidence of the
risk-shifting consequences of contractual incompleteness.
They relate the credit spreads of Ras Gas bonds to the bond
spreads of the Korea Electric Power Company (Kepco), the
major customer, in the context of a 25-year supply
agreement, the oil price index used to price the LNG,
emerging debt market returns, and various systematic and
unsystematic risk variables. Consistent with theoretical
predictions, they find that the risk factors affecting the
sales and purchase agreements drive perceptions of market
risk for Ras Gas bonds. In particular, Ras Gas yield spreads
reflect the market's risk assessment of Kepco. Other
priced risks are energy price and foreign currency exposure
(which influence Ras Gas credit spreads through their impact
on Kepco), Korean economic variables, and spillovers from
turbulence in European and Latin American emerging debt
markets. The authors' analysis shows that the design of
each contractual arrangement is not independent, because
risk factors relevant to one contract determine the price
and risk premium of the other. Despite heavy capitalization
and partial guarantees by the parent companies of Ras Gas,
the off-take agreement essentially determines the riskiness
of the bonds. The authors interpret this as evidence of the
nexus-of-contracts view of the firm in the presence of
contractual incompleteness: Investors bear all residual
risks and price their financial claims accordingly. |
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