The cost of projects in the extractive industries has soared in recent years. At the same time companies are asking commercial banks to finance more of the total costs of the projects. Banks have been obliged to recognize projects. Banks have been obliged to recognize project financing as a special discipline and project financing as a special discipline and to augment their staff and use new techniques to analyze risk.
Lenders and equity owners evaluate project risks from different vantage points. project risks from different vantage points. This paper explores these differences by focusing on the concept of coverage as used by banks in evaluating risk. Coverage analysis is contrasted with rate of return analysis used by companies.
The general areas of risk in project financing are enumerated and several of these are discussed. Finally, this paper deals with the level of coverage that is acceptable to banks and why it is difficult to quantity. Coverage is a reference point from which a lender may make a judgment about a project's ability to service debt.
One of the most important economic restraints on the mineral industry is the ability to finance future capital requirements. We would like to focus our discussion on the nature of the financing needs and the process of evaluating financing proposals.
The Bank has seen a change in the financing needs of natural resource companies. During the post war period up until the mid 1960's a large portion of the western world's mining capacity was financed by corporate entities. Although these mining projects were large rarely was a single project so large that it could damage a corporation's credit standing if it were not successful. Internally generated funds - that is, cash flow from operations - provided the major portion of the financing requirements. To the extent that there were external borrowings, they were predominantly for short-term working capital predominantly for short-term working capital needs.
Today things are quite different in the extractive industries. The future capital requirements are huge. In 1974 Morgan Guaranty roughly estimated the capital required to develop the capacity needed to meet demand for the remainder of this century for a group of selected minerals. We projected that cumulative requirements could be as high as $750 billion for the western world, excluding capital needed to replace existing capacity. Perhaps more challenging for the mining companies than the aggregate investment is the fact that today individual projects are larger and more complex.