Project Finance in Theory and Practice

Introduction

This chapter introduces the theory and practice of project finance. It provides a general overview of everything that will be analysed in greater detail in subsequent chapters. We believe it is useful to start with a chapter describing the salient features of a project finance deal, essential project finance terminology, the basics of the four steps of risk management (identification, analysis, transfer, and residual management), together with the theory that financial economics has developed on this topic.

This chapter also helps to understand the reasons for using project finance as compared with more traditional approaches employed by companies to finance their projects.

Section 1.1 provides an exact definition of the term project finance so as to avoid confusion with other, apparently similar contractual structures. The impression is, in fact, that all too often corporate loans issued directly to the party concerned are confused with true project finance structures.

Section 1.2 analyzes the reasons why project finance is used by sponsoring firms and the advantages it can bring to sponsors and lenders, and it highlights the main differences between corporate financing and project financing.

Section 1.3 reviews the main categories of project sponsors and clarifies the different reasons why each category is interested in designing and managing a new project finance deal.

Section 1.4 introduces the basic terminology of project finance and illustrates the key contracts used in the deal to manage and control the risks involved in the project. This section is an introduction to the topic of risk management, which is discussed in greater detail in Chapter 3. Finally,

Section 1.5 reviews the theory of project finance and the most important concepts associated with the financial economics of project finance: 

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