Due diligence is a key requirement for efficient risk allocation.  Due diligence, broadly defined as, “the care a reasonable person should take before entering a transaction”, is carried out as part of the financial risk assessment of an investment or loan.

Lenders who provide financing are interested in the potential downside of the transaction. They are most concerned with answering the question ‘Will my money get paid back?’

Investors want to know about the upside; or ‘How much more money can I get back than I am putting into the project?’.

The basic due diligence has technical, commercial and financial components and generally covers the same ground for both types of clients.

There are many ways of approaching due diligence, and the areas of emphasis will vary case-by-case. Whatever methods are used, the objective is always to identify and evaluate the risks of the transaction and then allocate those risks in the proper manner.

Allocating Risk Properly

Financial risk goes beyond the ability of a borrower to repay a loan. There is also the risk of increasing interest rates, foreign exchange and commodities – required as inputs to the project – volatility, to name just a few. How can these risks be mitigated or reduced for the investors and lenders? The general rule is that risks are allocated to the project party that is best able to bear it.

Risk allocation strategies include the use of derivatives to manage market risk and specific insurances, and consequent re-insurances, may be available for other risks.

Risk may also be mitigated to commercial lenders to some extent by the use of Export Credit Agency cover: Point Three Political Risk cover, Extended Political Risk Guarantees and Comprehensive Cover.

Other questions that investors in a new project or prospective buyers of assets should ask in their investigation include:

• Has the facility been maintained?
• Is it likely to last for its useful life?
• What are the price forecasts for input and outputs?
• What are the market and regulatory forces that will affect the revenue stream and profitability?
• What parameters in the financing and operation of the facilities are most like to affect the performance and what are the upsides / downsides / Most Risk Averse Cases of those parameters?
• What of the various operating contracts with vendors, unions or suppliers?

Site Visits

Site visit may not be a requirement in a developed economy with regulated assets. These companies are reviewed and audited by many different parties and regulators so there is comfort available in these environments. In addition, the largest scale infrastructure company assets many have hundreds or thousands of principle sites so it may be impossible to review the assets in a meaningful time period. However, the need for a site visit could depend on the risk profile of the buyer and the period of exposure that the investors anticipate he will be involved in owning the asset. Generally speaking, the review is conducted as a desktop study based on regulatory information and other documents.

Nevertheless, during a site visit you may see enough to be satisfied that the assets all, say, appear to be: at the same level of being maintained; the equipment that is working properly; that it’s clean and painted; bulletin boards have the right material posted; people are wearing their hard hats and use their safety equipment.

Technical Due Diligence Process

When investing in projects and assets, owners, operators, investors, insurers and developers need to understand and mitigate a variety of technical, legal and socio-environmental risks before committing to lending or investing in an undertaking.

Risks which might compromise a project’s profitability in the short, medium and long term usually originate during the initial stages of project development. As such, independent technical advisors, and the management of those advisors, are crucial in evaluating the technical feasibility of the project during the Technical Due Diligence review.

This process entails identifying both the probability of occurrence of risks as well as their potential impact on the project. The goal is to ensure that:

• The technical feasibility of the project makes for a sound investment
• All factors have been accounted for in the development process

These objectives are achieved by way of a thorough review of all available assets and data in order that potential areas of concern are revealed.

STEP 1: The process begins with an initial review of the project to gain an understanding of how Eldrich can assist the client in developing and conducting the investigation so as to maximize its value.

STEP 2: Discussions with the client on the manner in which to proceed with the investigation to ensure that the clients’ expectations will be met.

STEP 3: Scope out a work package so that an appropriate team of experts required to undertake the investigation, executed in accordance with previously agreed clients requirements, may be appointed.

For Projects Under-Development:

• Detailed document review of design plans, building permissions, installation schedule and planned O&M schedules
• Review of sub-surface conditions and other site conditions
• Specific risk that arise through the type of project, for example: turbine assessment, track record and wind availability and strength evaluation with focus on track records of the particular wind turbine model and class, certification status and site suitability
• Review of predicted development and installation costs
• Evaluation of the expected availability and profitability, using the wind power example: the projects net annual energy production of turbines as well as the entire wind farm

Projects in Operation

• Asset inspection covering the main technical components of the assets
• Inspection of control and protection systems, electrical systems, lifting equipment and personnel safety installations
• Assessment of actual track record of the asset’s specific performance against its predicted performance
• Review of O&M records for to verify adherence to the maintenance philosophy and procedures and an assessment of their adequacy for the installations
• Comparison of expected performance with actual operational data

STEP 4: Review and report the findings of the investigation to the client and ensure that any technical issues identified are adequately addressed.

STEP 5: Eldrich is committed to providing exemplary customer support and would remain available to support the clients at meetings, discussions, consultations or enquiries with respect to Eldrich’s work.

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Eldrich Capital provides financial advisory, capital structure, project development, project commercial due diligence and  project technical due diligence services to the energy, infrastructure and natural resources industries.

Anthony Lavery the Principal of Eldrich Capital has circa 20 years experience in private equity direct investment and structured debt finance in the energy, infrastructure, food and agriculture, telecoms and other natural resources.

Anthony Lavery is also a professional chemical engineer (a corporate member of the Institution of Chemical Engineers) and project manager with 14 years experience in upstream oil & gas, power, LNG, refining and petrochemical industries; with broad experience in troubleshooting and novel solution.