INTRODUCTION

Because the ability of the project company to produce revenue from project operation is the foundation of a project financing, the contracts constitute the framework for project viability and control the allocation of risks. Contracts that represent the cost of fuel and other inputs to the project company are of particular importance because these contracts affect cash flow.

Inputs needed for a project vary with the type of project. As such, the terms of input contacts vary widely. Nonetheless, some generalizations, discussed in this chapter, can be made.

Input contracts must not interfere with the expectation of debt repayment from project revenues. If risks are allocated in an unacceptable way from the project lender's perspective, credit enhancement from a creditworthy third party is needed, such as letters of credit, capital contribution commitments, guarantees, and insurance.

To the extent expense predictability is unavailable or the risks of dependability are allocated unacceptably, credit enhancement is necessary to protect the lender from external uncertainties, such as supply, transportation, product market instability, and changes in law. Sometimes, however, the project exists in an uncertain environment that subjects the project lender to some unallocated risks. The tolerance of the capital and debt markets for this type of residual uncertainty varies over time with changing market conditions.

Project financings generally require a long term, supply-or-pay contract for essential inputs, such as fuel. As discussed below, in some projects, the long-term contract is not necessary because supply and transportation are widely available.