Financing pulp mills: an appraisal of risk assessment and safeguard procedures

104 Pages·2006·0.85 MB·English

by  Spek, M.

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Machteld Spek

Financing Pulp Mills:
An Appraisal of Risk Assessment
and Safeguard Procedures
Machteld Spek
National Library of Indonesia Cataloging-in-Publication Data
Spek, Machteld
Financing pulp mills: an appraisal of risk assessment and safeguard procedures/ Machteld Spek
Bogor, Indonesia: Center for International Forestry Research (CIFOR), 2006.
86p.
ISBN 979-24-4612-5
1. pulp and paper industry 2. risk assessment 3. investment planning 4. environmental impact 5. social impact. I. title
© 2006 by CIFOR
All rights reserved. Published in 2006
Printed by SUBUR printing
Cover photo by Christian Cossalter
Design and layout by Catur Wahyu
ISBN 979-24-4612-5
Published by
Center for International Forestry Research
Jl. CIFOR, Situ Gede, Sindang Barang,
Bogor Barat 16680, Indonesia
Tel.: [phone]; Fax: [phone]
E-mail: [email protected]
Web site: http://www.cifor.cgiar.org
Contents
Preface v
Executive Summary viii
Acknowledgements xiii
Introduction 1
Trends in pulp investment: Capacity and financing 4
Pulp production process and impacts 4
Pulp production capacity and industry structure 5
Investments in pulp capacity after 1995 10
Financing raised by pulp producers 12
Conclusion 15
Principal sources of funding for pulp mills 16
Development funding from multilateral development banks 16
World Bank 17
IFC 20
MIGA 23
ADB 24
EIB & EBRD 24
Other multilaterals 26
Export credit agencies 26
Commercial financings 28
Market access 31
Lending cost 33
Domestic banks 35
Equity 36
Conclusion 37
Financial risk assessment 39
Credit risk assessment 39
Due diligence 42
Ongoing (risk) analysis 45
Credit rating agencies 45
Securities research 49
Corporate disclosure 51
Conclusion 52
iv
Impact assessment and safeguards 53
Equator Principles 53
Safeguard implementation 55
Implementing safeguards in transactions in the international capital markets 59
Improving standards and implementing safeguards in existing operations 59
The Global Reporting Initiative 61
Conclusion 64
Key findings and recommendations 66
Key findings 66
Recommendations 70
Sources 72
Appendices 75
Glossary 83
Preface
In October 2003, the World Bank hosted the Forest Investment Forum, a two-day conference
which brought together 150 senior executives of forest product companies, private and public
sector financial institutions, and conservation organizations. The Forum’s central aim was “to
explore opportunities for private sector companies, the World Bank, the IFC, and other financial
institutions to invest in environmentally, socially, and economically sustainable forest enterprises
in developing and economic transition countries.”
Perhaps not surprisingly, much of the discussion at the Forest Investment Forum focused on
anticipated capacity expansion in the global pulp and paper sector. It was projected that some
128 million tonnes of new paper and paperboard capacity will likely be needed to meet growing
world demand by 2015. While much of this new capacity will be fed by recovered paper, it is
estimated that 36 million tonnes of new wood pulp capacity will be installed over the next decade,
including 22 million tonnes of hardwood kraft pulp. This expansion of wood-based pulp capacity
is likely to require approximately US$ 54 billion in capital investment through 2015. Several
billion dollars more will be needed to develop millions of hectares of fast-growing pulpwood
plantations.
Even if only a fraction of this is ultimately realised, these projections suggest that a new wave
of pulp mill financings may soon be underway. Existing plans indicate that much of the new
capacity will be brought online in Brazil, China, Indonesia, the Mekong region of Southeast Asia,
and the Baltic states.
Several speakers at the Forum – including Masya Spek, the author of this study – emphasised
that such projections underscore the need for investment institutions to employ stronger practices
in assessing the financial risks, legal compliance, and social and environmental impacts of pulp
and plantation investments. Pulp mills require special attention for a number of reasons: First,
the enormous scale of modern pulp mills means that they consume very substantial volumes of
wood. A single BHKP mill with an annual capacity of 1.0 million tonnes, for instance, will typically
require between 4.5 – 5.0 million cubic meters of roundwood per year – roughly equivalent to 15
percent of the total annual timber harvest from the Brazilian Amazon. Large-scale pulp mills can
also place considerable pressures on natural forests when production capacity is installed before
supporting plantations are brought online, as prior CIFOR research in Indonesia has shown. In
countries or regions with poor forest governance, demand for pulpwood can be a significant
vi
factor driving illegal logging. Plantation development, too, is often associated with displacement
of forest communities and social conflicts.
The present study examines how pulp mill projects – including both the development of
greenfield mills and capacity expansions – get financed. The analysis is based on a close review
of 67 pulp projects, with a combined 25.5 million tonnes/year of planned new capacity, that were
proposed between 1995 and 2003. Spek, a Chartered Financial Analyst who has covered markets
in Southeast Asia for over 13 years and worked in the financial sector for over 20 years, traces the
sources of financing available, respectively, to producers seeking to expand existing operations
and those planning to build new mills. She assesses why some projects got financed and why
some ultimately did not. This analysis illuminates the fact that most pulp capacity expansions are
funded through commercial financings – that is, through loans, bonds, or equity issues – while
greenfield mill projects generally require government or multilateral support.
The study also examines how financial institutions assess the risks and potential impacts of
the pulp mill projects they fund. The picture that emerges suggests that most export credit
agencies, merchant banks, and other private sector investment institutions have little in-house
expertise related to forestry issues and/or social and environmental impact assessment. Many
prefer to rely on information provided by the project sponsor and, whenever possible, on the
participation of the IFC or other multilateral agencies, which have stronger capacity to carry out
such evaluations. In practice, this often means that a range of issues which may have critical
importance to the success of a proposed project-- such as growth rates and productivity levels
at supporting plantation sites; the legality of wood to be consumed by a proposed mill; and the
likely impacts of a project on local livelihoods -- are poorly assessed.
The good news is that a growing number of financial institutions have, in recent years, adopted
stronger safeguards to limit negative social and environmental impacts of forest- related
investments. In 2001, for instance, Dutch banks ABN AMRO and Rabobank introduced policies
that explicitly prohibit making loans for projects that involve conversion of primary forest,
purchase of illegally harvested timber, or displacement of indigenous peoples. Moreover, since
2003 some 33 lending institutions have endorsed the Equator Principles, an initiative led by
the IFC to enhance the use of social and environmental safeguards for project financings in all
industry sectors, including forestry. That same year, many of the world’s leading export credit
agencies adopted the OECD ‘Common Approaches on Environment’, which require environmental
impact assessments to be conducted before most forest-related projects can be approved.
In this study, Spek examines the relevance of such initiatives to pulp mill finance, giving particular
attention to the Equator Principles. She rightly applauds signatory banks for taking an important
step towards incorporating social and environmental considerations into lending practices. Yet
she points out that the Equator Principles cover only project finance – and, therefore, apply only
to a very small portion of total bank funding for pulp mill projects. There is clearly considerable
room to expand the relevance of the Equator Principles to pulp investments if they could be
broadened to include other types of financial arrangements, as well.
This study also emphasises the importance of improved corporate reporting practices on the
part of pulp producers and associated plantation and forestry companies, in order to enhance
transparency and accountability. In particular, Spek highlights the potentially important role that
the UNEP-sponsored Global Reporting Initiative could play in establishing an industry standard
for corporate reporting on key operational variables, including fiber supply.
vii
This study is being published by CIFOR, with support from the DFID-funded Multi-stakeholder
Forestry Programme and from the European Commission’s Asia Pro Eco Programme, with the
aim of improving risk analysis and due diligence practices on the part of financial institutions
involved in funding pulp mill projects globally. We sincerely hope that the analysis and
recommendations presented here will help financial institutions to better assess the risks and
impacts of the projects they fund – and, in doing so, to support more environmentally, socially,
and economically sustainable investments in this important sector.
Christopher Barr
Senior Policy Scientist, CIFOR
December 22, 2005
Executive Summary
This study was conducted to see how investors and lenders assess the financial risks and social
and environmental impacts associated with pulp mills. Despite the large amounts of capital tied
This study looks at how investors up in these projects, it has been apparent that there are weaknesses in the risk assessment system
and lenders assess pulp mills… that allow poor practice to go undetected. As a result, highly unsustainable pulp producers can
often obtain funding, even though the existence of safeguards should make this impossible.
Once they begin operating, the high capital cost of such mills means that they are unlikely to be
closed down, while their scale frequently poses a challenge to remedial action. Moreover, once
pulp projects are in existence, they can generally continue to obtain funding irrespective of the
standard of their operations. Efforts to tighten the quality net so that the poorest operators do
not obtain financing will therefore need a two-pronged approach, with one focusing on ensuring
minimum standards are effectively upheld in new projects, and another focusing on raising
standards in existing projects.
To better understand to how pulp projects obtain funding, and to what extent financiers can and
…with reference to transactions do assess the quality of the proposed project and borrower, a sample of transactions proposed
proposed between 1995 – 2003. between 1995-2003 was studied. Over this period, 25.5 million tonnes of annual new pulp
production capacity was proposed, of which 41% is now going ahead.
Capacity additions proposed by existing players in the pulp sector have the highest chance of
Two-thirds of proposed capacity going ahead with a 66% success rate. Where projects did not go through, this tended to be the
additions succeeded, as compared result of changed corporate strategies as opposed to an inability to obtain funding. 27.1% of
to only 27% of proposed new mills. proposed greenfield mills went on to being realised. Funding forms a bigger barrier for greenfield
projects in the absence of an existing business that provides the cashflows. Increasing comfort
levels is critical to obtaining financing, and the level of sponsor-provided capital plays an
important role.
Since 2000, pulp producers raised US$ 215.5 billion in funding from commercial sources.
The majority (82.7%) of this took the form of loans typically extended to existing producers in
traditional producing centres (North America, Western Europe and Japan). Narrowing the focus
to producers in developing countries and in countries with transitioning economies, US$ 37.8bn
in debt and equity financing was found for the period covering 1990 - 2004.
Funding is a key barrier to entry for proposed pulp mills, and funding institutions jointly and
Before start-up is the time to weed singly hold significant power with regard to determining which projects are ultimately realised.
out poor projects. Smaller scale pulp mills will typically be financed by banks in their home markets. Mills with
annual production capacities in excess of 200,000 tonnes will generally find themselves