BP Amoco (a): Policy Statement on the Use of Project Finance; BP Amoco (B): Financing Development of the Caspian Oil Fields
HBS Case Nos.: A Case: 201-054; B Case: 201-012; Teaching Note No.: 5-202-089; Note on the Caspian Oil Pipelines No.: 299-044
Posted: 21 Mar 2002
SUBJECT AREAS: project finance, emerging markets, risk management,
CASE SETTING: March 1999, petroleum industry, $4 billion investment
Following the BP Amoco (hereafter "BPA") merger in December 1998, the new CFO, David Watson, asked Bill Young to create a policy statement recommending when the firm should use project finance instead of corporate finance for new capital investments. Young and his team created a new policy statement recommending that BPA always use corporate finance with three exceptions: mega projects, projects in politically volatile areas, and joint ventures (JV's) with heterogeneous partners. Essentially project finance would be a tool for managing project risk. In the A case, students must assess the economic rationale for the policy and the exceptions.
The B case presents an interesting natural experiment involving two firms from the same industry financing the same asset in two different ways. Prior to their merger, BP and Amoco joined the Azerbaijan International Oil Consortium (AIOC), an 11-firm consortium that was developing oil fields in the Caspian Sea at a cost of $10 billion. As of March 1999, AIOC had completed the $1.9 billion Early Oil Project. BP used internal corporate funds to finance its share of the project while Amoco was one of five AIOC partners that raised $400 million of project finance. The managers in BPA's newly merged Finance Group must reassess the Early Oil financing strategy in light of the new policy statement and determine the best way to finance its share of the remaining $8 billion Full Field Development Project. Should it use corporate finance, project finance, or a combination of the two?
While these cases were written for a course on project finance, they make an effective introduction to the field of project finance for advanced corporate finance, international finance, or emerging markets courses. The cases have four pedagogical objectives. First, the cases describe what project finance is and why it creates value-project finance reduces the net cost of financing certain assets. For BP Amoco, separate incorporation for investment purposes (project finance) reduces expected distress costs. For other firms in the consortium, project finance allows them to raise capital when they otherwise could not (it solves a debt overhang problem). Second, in conjunction with the teaching note, the cases present a framework based on portfolio theory that explains why large, risky, tangible assets are the best candidates for project finance. Third, the B case not only gives students an opportunity to apply the new policy statement in a real investment decision, it also illustrates the benefits of staged investment and multi-lateral support. Finally, the cases build appreciation for the complexity of merger integration, particularly horizontal mergers between former competitors.
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