MAKERERE UNIVERSITY

SCHOOL OF LAW

NAME: NAKUYA SHARITAH

REGISTRATION NUMBER: 2022/HD09/4956U

STUDENT NUMBER:2200744956

COURSE: INTERNATIONAL FINANCIAL INSTITUTIONS (IMF AND WORLD BANK

GROUP)

LECTURER: FR. BAGYENDA EMMANUEL

PROJECT FINANCE LAW AND PRACTICE: IDENTIFICATION, ALLOCATION AND

MITIGATION OF PROJECT RISKS IN THE EAST AFRICAN CRUDE OIL PIPELINE
PROJECT

1
Introduction

Project finance is deployed most commonly in the development of large infrastructure projects
(e.g. power generation, toll roads, telecommunications), social infrastructure (such as hospitals
and schools), and the exploitation of energy and other natural resources, but it can be used to
finance a broad range of assets and services.

The rating agency Standard & Poor’s defines it as: “…non-recourse financing of a single
asset or portfolio of assets where the lenders can look only to those specific assets to generate the
flow needed to service its fixed obligations, chief of which are interest payments and repayments
of principal. Lenders’ security and collateral is usually solely the project’s contracts and physical
assets. Lenders typically do not have recourse to the project’s owner, and often, through the
project’s legal structure, project lenders are shielded from a project owner’s financial troubles.
Project-finance transactions typically are comprised of a group of agreements and contracts
between lenders, project sponsors, and other interested parties who combine to create a form of
business organization that will issue a finite amount of debt on inception, and will operate in a
focused line of business over a finite period.”

A number of pertinent issues ought to be put into consideration by the borrower and lender which
include; political uncertainty, volatility of commodity prices, un-stable economies, and high
levels of sovereign (public) debt, low tax revenue, corruption in public procurement and projects
are liable to cost overruns.

For a project to subsist a number of key players are involved in the process of and there interests
must be put into consideration to have a workable solution to the project these include;

a) The host government of the country where the resources are located,
b) Lending institutions (banks) looking to avail loans for the project
c) Private investors looking to enter into a public-private partnership with the government
over the project.
d) Suppliers of goods and services necessary to support the project (land for Project
company offices, food for staff of the company, medical services etc.)

2
Review of the East African Crude Oil Pipeline Project

The East African Crude Oil Pipeline Project (EACOP) is a pipeline development project that will
transport oil produced from Uganda’s Lake Albert oilfields to the port of Tanga in Tanzania
where the oil will then be sold onwards to world markets. 1 The EACOP project is being
developed and will be operated by EACOP Ltd, a company composed of Total Energies SE,
UNOC, the Tanzania Petroleum Development Corporation (TPDC), and the China National
Offshore Oil Company (CNOOC).2 The EACOP Project will be managed and operated by a
special purpose vehicle formed of: the Government of Uganda (GoU) represented by the Uganda
National Oil Company (UNOC), the Government of Tanzania (GoT) represented by the Tanzania
Petroleum Development Corporation (TPDC) and the Upstream Partners.

This paper assesses the potential project risks in the initiation, development, commissioning, and
operation of the ECCOP project and how they may affect the project’s bankability.

Identification of Potential project risks associated with the EACOP project

Risk is an inherent component of any project finance. Risk has been defined as ''uncertainty in
regard to cost, loss, or damage. 3 Uncertainty is an important aspect of risk and project finance
abhors it. In project finance, the project participants are exposed to diverse risk factors.

Project finance s entails lenders extending large amounts of credit to a newly formed thinly
capitalized company whose principal assets at the time are not physical but rather merely
contracts, licenses, and ambitious plans. The estimated cost for the EACOP project ranges
between $3.5 billion and $4 billion, with a 40 to 60 percent equity-to-debt ratio. 4 About $2.4
billion will be secured as debt, while $1.6 billion will be equity financed by shareholders.5

Dewer states that in identification of risk in a project, such due diligence must address the
following issues;

1
https://eacop.com/ > accessed on 23rd May 2023
2
https://pau.go.ug/the-east-african-crude-oil-pipeline-eacop-project/ accessed on 23rd May 2023
3
Adegoke Adedoyin and Ayodeji Jolaoso, ‘Project Finance: Identification, Allocation And Mitigation Of Risk Factors
4
EACOP to Close Oil Pipeline Project Financing by Year-end,
<https://www.pipeline-journal.net/news/eacop-close-oil-pipeline-project-financing-year-end#:~:text=The
%20estimated%20cost%20for%20the,be%20equity%20financed%20by%20shareholders> accessed on 23rd May,
2023
5
Ibid
https://eacop.com/project-brief-september-16th-2022/ id

3
 a) Whether the facility can be construed and operated within the projected budgets
b) Whether the project Companuy has the requiste skills and experience to operate and
maintain the project
c) The acceptability of the facility site
d) The environmental and social impact of the project
e) The availability and cost of utilities such as gas, water, electricity and waste treatment
and disposal; and
f) Whether the project can meet the terms and conditions of operating licences
environmental approvals, and construction permits.

Below is a discussion of the project risk to be associated with the EACOP in light of project
financing

The Completion Risk

Completion is also known as development, delay, cost overrun or construction risk which
addresses the possibility that the project will not be constructed on time, on a budget or to the
required specifications.6 A project finance lender’s focus on completion risk is important since
the project company’s cash flow is all (predominately) outgoing during the construction or pre-
completion stage and its security over the project assets is limited (or no) value before the project
is completed.7

The construction risk is the necessity of a change in the work that is not contemplated in the
construction price.8 Such risks which may occur during this stage of the project include; price
changes caused by inflation or fluctuation of currency; shortage of raw materials; design changes
occasioned by policy change; construction delays etc. Typically, if a project is unsuccessful
during the construction phase, the project assets will not likely be of sufficient value to repay the
construction loan.

The EACOP project is estimated to be complete by 2025. The land acquisition process is
expected to be complete by 2023 and oil production will start to run in 2025. Between 2022 and
2025, the project is expected to undertake land acquisition, contract award, detailed engineering,

6
Dewer
7
ibid
8
N5

4
procurement, construction, and commissioning, including hydro-testing, and first oil from
upstream facilities.9 But as of May, it has been stated that there has not been a clear schedule
when the contractors will get the green light to start construction.10

The degree of completion risk inherent in a project is a function of three factors;

a) The level of technical risk involved in the project (projects with simple and well proven
designs and technical carry lower risks)
b) The technical capability and financial strength of the construction co0ontractor and;
c) The level of guarantees and sureties provided by the construction contractor or third
parties and their parties and their respective capacity to perform under those obligations
d) This risk is to be allocated to Uganda and Tanzania being the Host Governments of the
project.

Without the successful completion of EACOP, Total and CNOOC Ltd as sponsors of the project
and as equity owners will not be able to begin commercial production at two oil fields in the
Albertine Graben in Uganda.11

The resistance from civil society, owners of the land that is to be used to construct the project
and the global continues resistance of the construction of the project on grounds of human rights
violations and climate change factors are likely to pose a risk to the Governments of Uganda and
Tanzania as host governments as these issues are to cause a substantial delay in the completion of
the project which in the end is to affect the lenders from materializing and gain from the project’s
cash flow.

The Completion risk in the EACOP project is thus likely to be allocated to the Governments of
Uganda and Tanzania as host governments and EACOP Ltd as the Project Company.

Mitigation Measures

i. Turnkey Construction contract structures

Dewer argues that in a number of projects. Completion risk is usually allocated to a contractor
through a turn-key construction contract and in such a contract the contractor undertakes to build

9
https://www.monitor.co.ug/uganda/news/national/china-takes-over-eacop-funding-4226716
10
ibid
11
https://www.banktrack.org/download/crude_risk/cruderisk_eacop_briefing_nov2020_1.pdf

5
a fully operational facility for a fixed (subject to limited exceptions) price by a specified date
certain.12 A pre-committed project financing package will often be required by the relevant
procuring authority and a turn key construction contract itself will be accepted by banks for
known sponsors, familiar equipment and systems and safe locations without further sponsor
support for delay or costs overruns.

The China Petroleum Pipeline Engineering Company Ltd (CPP), was contracted to construct the
Pipeline and Above the Ground Installations (AGI) in Uganda and Tanzania. CPP undertook a
pre-construction survey of the whole EACOP route and AGI locations in March and April 2022.
This step helps in the identification of possible delays in the completion of the project and
mitigation of the same.

However, Dewer notes that contractors in construction contracts are not willing to build projects
on a turn-key basis at a commercially acceptable price because they may be too many risks
(including the reliability of the local workforce, local content requirements, import restrictions
on commodities or price instability to enable the contractor to have confidence that the project
can be built for a specified price.

The completion risk in EACOP has been observed by the different preliminary agreements and
licenses obtained procured by the host governments (Uganda and Tazania) in the implementation
of the project. The legal and commercial framework for EACOP have been established in the
Host Government Agreements signed on 11th April 2021 and 20th May 2021 between EACOP
and the Governments of Uganda and Tanzania respectively.13

The Host Government Agreements(Governments of Uganda and Tazania) set out the relationship
between EACOP and the Host Governments on issues such as land acquisition, health, social and
safety standards, human rights, local content, fiscal regime, authorizations, and dispute
mechanisms.14

i) Delay risk

There are many factors that could delay the scheduled completion of a project including the
strength and experience of the contractors, the length of the projected construction period, the
12
John Dhewer, ‘ International Project Finance’, Oxford University Press, page 82
13

14
ibid

6
availability of building materials and supplies, the terrain over which the project is being
constructed, the risk of not receiving permits as and when required, exposure to labor problems,
the connection of required infrastructure, dispute resolution and political risks.

TOTAL Energies Ltd as the project’s sponsor awarded the construction contract to China
Petroleum Engineering Company. This transfers the completion and construction risk from the
governments of Uganda and Tanzania to China Petroleum Engineering Company as an EPC
contractor for any damages arising from delay of completion of the project within the stated
timeframe.

However there still exists a problem with the land acquisition and compensation processes of the
local population occupying the intended project location/site. 5,300 hectares of land will be
needed for the construction and operation of the pipeline, which means that around 14,000
households will lose land. Of these, roughly 200 households in Uganda and 330 households in
Tanzania will have to be resettled, and approximately 3,200 to 3,500 households in Uganda will
be economically displaced, which means they will lose land essential to their livelihoods. 15 There
is a possibility of resistance from the local population in the whole process of land acquisition
which is likely to delay the project and thus impacting on the cashflow returns of the lenders.

The valuation and compensation process for land taken by the project has been characterized by
delays, insufficient provision of information to communities, harassment, and irregularities.
Affected people have stated that they had only a basic understanding of the project’s stakeholder
engagement process, and felt that the project subcontractors had pressured them into signing
valuation forms without ensuring their full understanding of this process. Community
representatives also report having been harassed, forced to sign different forms without clear
explanation, stamp and sign empty forms, and fill valuation forms using a pencil but sign-in ink.

It is imperative to note that the construction contract awarded to CPP should have been
structured in a way to incentivize timely completion and include appropriate liquidated damages
for delay.

ii) Completion guarantees

15
https://www.banktrack.org/download/crude_risk/cruderisk_eacop_briefing_nov2020_1.pdf

7
Dewer proposes that to avoid the incurrence of a turnkey premium that might render the project
uneconomic, the completion risk may be directly assumed by either the sponsor or a government
entity (or both) through completion guarantees issued to the lenders. There has not been tangible
guarantees issued by the host government to the lenders in the EACOP project, however the
government through parliament has since amended the Public Finance Management
(Amendment) Act 2021 which seeks to ensure that the UNOC as the Government of Uganda’s
nominated state participant for oil activities across the upstream and midstream sectors of the
value chain can meet the related obligations. The Act allows UNOC to have access to the
proceeds from the sale of interest from the crude oil due to it to meet its various financial
obligations in relation to its participation in the upstream and midstream projects. These include
obligations in the Production Sharing Agreements, the Joint Operating Agreements, the Host
Government Agreement, and the Tariff and Transportation Agreement among others.

The East African Crude Oil Pipeline (EACOP) Project and the Government of the United
Republic of Tanzania have today together signed the Host Government Agreement (HGA) on the
11th April and the 20th March respectively.16 This document establishes the legal and commercial
framework for EACOP to be financed, constructed and operated. This follows the signing of the
equivalent Ugandan HGA on 11 April 2021 together with key Project documents (Shareholders
Agreement and Transportation and Tariffing Agreement) and therefore formalizes the milestone
of each State Party having concluded its respective HGA for the Project and concludes the main
EACOP legal and commercial framework.17

It has been argued that the passing of this enabling legislation will therefore ensure the lawful
implementation of the EACOP project in Uganda, guarantee and give re-assurance to the
investors of the government’s commitment to fulfilling its obligations under the HGA, and give
confidence to the Government of the United Republic of Tanzania of Uganda’s commitment to
the project. This enabling legislation will also ensure alignment of the work schedule between
the Upstream (Tilenga and Kingfisher projects) and Midstream (EACOP project) to spur
Uganda’s oil and gas industry. This will, in turn, facilitate the achievement of the First Oil target
of 2025.18
16
ibid
17
https://eacop.com/host-government-agreements-signed/
18
Opinion: EACOP bill to spur development phase, < https://ulii.org/akn/ug/act/2021/23/eng@2021-12-24 >
accessed on 23rd day of May 2023

8
iii). Insurance:

Construction risk insurance protects against property damage and is effective from the
commencement of procurement to transportation to the project site through completion of
construction and performance testing. Risks covered include pandemics, acts of God and
standard perils (fire, lightning). Others may include employer's liability, architect errors and
omissions, and force majeure insurance, which can cover losses due to strikes, contractor
insolvency, and delays in obtaining permits.

Environmental and Social risks

Both the oil extraction and the EACOP pose serious environmental and social risks throughout
Uganda and Tanzania. These risks include physical and economic displacement and the impacts
of a mismanaged and delayed compensation process; threats to livelihoods from oil spills; the
loss or destruction of sites of spiritual value; and significant habitat disturbance to nearly
2000km2 of protected wildlife habitat.19

The EACOP also poses significant climate risks. Accordingly, the project is facing widespread
resistance. A global petition against the project gained over 1 million signatories. 20 Members of
civil society and journalists who have highlighted these risks have been intimidated and even
arrested. This has led to scrutiny from UN Special Rapporteurs. 21 Controversy is likely to follow
Total - already facing court proceedings in France3 - and the financial institutions backing the
project as it progresses

The legal requirement associated with environmental and social risks gives rise to five primary
risks;

a) The liability for the discharge of contaminants into the environment

b) Liability for non-compliance with environmental, health and safety laws and permits
c) Uncertainty in environmental permitting
d) Changes in laws and enforcement priorities that tend to make environmental
requirements more stringent overtime

19
https://www.banktrack.org/download/crude_risk/cruderisk_eacop_briefing_nov2020_1.pdf
20
ibid
21
Ibid

9
 e) Potential exposure to challenges brought against the project by the affected
populations or interested non-government organizations on their behalf.

Non-compliance risk

In addition to spill risk, the EACOP poses significant risks of degrading or polluting these water
sources where pipes are buried under them. Rather than using horizontal directional drilling to
cross watercourses, which is considered the industry’s best practice, Total and its partners have
opted for the lowest cost option, open-cut trenching, for almost all water crossings. According to
experts, this technique has the potential for significant negative impacts, particularly to wetlands.
They state that “this seems to be ignored and the [Environmental and Social Impacts Assessment
(ESIA)] report does not make clear that the proposed technology is acceptable and for what
reasons.” The expert reviewers concluded that “the issue is strongly underrated and specific
plans and alternatives should be presented.22

The EACOP project has to date failed to address some of the environmental and social concerns
arising from the construction and operation of the project and this poses a threat to the liability of
the project sponsors and lenders. In November 2022, the Climate Accountability Institute
published the first detailed analysis of the lifetime climate emissions of the ECOP project, the
analysis found that the project would result in emissions of 379 million tonnes of CO2 equivalent
during the 25-year project lifetime including the full value chain of emissions.

The Government of Uganda also did not oversee the possibility of the potential exposure of the
project brought against by the project to the local population and the legal resistance by the civil
society and NGOs over its implementation. Over 1 million people have signed an international
petition opposing EACOP24 and protests have taken place at Standard Bank.23

EACOP Ltd as a project Company (Total Energies SE, UNOC, the Tanzania Petroleum
Development Corporation (TPDC) and the China National Offshore Oil Company (CNOOC) are
likely to face liability over hazardous spills and waste which give rise to environmental risks.
EACOP Ltd will has to comply with the International Finance Corporation regulations, World
Bank and other environmental social guidelines.

22
https://www.banktrack.org/download/crude_risk/cruderisk_eacop_briefing_nov2020_1.pdf
23
ibid

10
The International Finance Corporation has since detailed standards defining a borrower’s
environmental and social responsibilities in managing its project. A large range of other financial
institutions have also adopted a voluntary set of guidelines known as the equator principles that
call for such organizations to require compliance with guidelines similar to those of multinational
lenders and it requires that every large-scale project seeking access to the financial markets must
evidence a high level of environmental and social compliance.

Non-compliance with the environmental and social risks in the EACOP project will also expose
the Chinese lenders to liability under the Equator principles.

Managing the environmental and social risks may help assure the long-term acceptance of the
project by the affected parties. The lenders of the ECOP project will generally require the project
company to undertake to comply with all the environmental and social laws and regulations
binding on it and also require the development of and compliance with an agreed environmental
and social risk management plan.

Uganda being the host government for the EACOP project needs not only to comply with the
national laws on environmental safety but also with the international legal frameworks. Two of
the project’s financial advisors and potential lenders, Standard Bank and Sumitomo Mitsui, are
signatories of the Equator Principles. They declined to extend funds to the EACOP unless it
complies with the principles of environmental protection.

The lenders and sponsors in the EACOP project will need assurance that their involvement in the
said project will not expose them to liability for hazardous discharges, waste, or any type of
environmental problems or give rise to reputational risk for environmental issues failure to attend
to this risk will expose the lenders and sponsors of the project to liability for meeting the costs.

Political Risk

Political risk may arise from actions by the host government that have negative impact on the
financial performance or commercial viability of a project ( as is the case with acts of
expropriation of imposition of restrictions on the repatriation of a project’s foreign currency
earnings

11
The EACOP Ltd as a project Company is likely to be exposed to changes in the tax regime
applicable in Uganda. This being a long term venture project and requiring upfront investment
before revenue generation commences, this raises concerns with regard to the future legal and
fiscal charges that can dilute the value of the project participants

Corruption

Uganda ranks 140th and Tanzania ranks 38 in transparency international’s corruption perception
index an indication that corruption is a risk in the EACOP project. Such corruption is likely to
manifest during procurements.24 Contract negotiations, tariff and taxation calculations and
recruitment of employees. The lenders and investors must be guaranteed and assured that the
underlying concession or other project documents were not procured through corruption or fraud.

As reported in our August 2021 update, several key agreements around the EACOP have not
been made public, contravening Uganda’s and Tanzania’s commitment to contract transparency
as signatories to the Extractive Industries Transparency Initiative (EITI). 25 Now, as reported in
June, the EITI Uganda chapter has made clear that continued refusal to disclose documents could
lead to penalties being imposed on Uganda’s oil and mining sectors by the initiative, including
Uganda’s possible suspension from the EITI.26 This could result in disruptions of cash flows as a
result of the resulting social discomfort and possible unrest.

Uganda as one of the host governments has since implemented the Anti-Money Laundering
legislation. These laws require such lenders to undertake detailed know-your-customer
procedures with respect to each borrower and other project participants. These regulations will
help in ensuring that the lenders have undertaken sufficient due diligence and the host
Government ensuring that such persons are not funding the project through the proceeds of
unlawfully gained money.

As a legal counsel, representations, and warranties in respect of specific corrupt practices ought
to be included in the project financing documents.

Mitigation of Political Risk in The EACOP project

24
Https://tradingeconomics.com/Tanzania/corruption-rank > accessed on 27th May, 2023
25
https://www.banktrack.org/download/
the_east_african_crude_oil_pipeline_eacop_finance_risk_update_no_3/220628eacopbriefingjun2022.pdf
26
ibid

12
 i. Foreign Exchange Guarantees

Another risk-mitigation instrument is by foreign-exchange undertaking. Basically, loans made

available for projects in developing countries are generally in hard currency. Investment returns
should therefore be in hard currency to mitigate the currency risk. One of the major problems in
infrastructure projects in developing countries is that they do not generate income in hard
currency. Thus, remittance guarantees are necessary to enable the project sponsors to remit freely
all the project revenues. Guarantees of foreign-exchange convertibility and availability should
also be obtained from the host government to reassure the lenders and investors. (McCarthy,
1991). However, where the loan is generated locally, this protection may be needless.

All said, project financing is a veritable developmental tool adopted by countries of the world to
finance capital-intensive projects. Whilst project finance is best known for its complexity and
diverse risks inherent in its use, a proper identification, assessment, and allocation of these risks
are key to achieving a successful developmental project.

ii). Transfer restriction insurance

The Project Company may take out this insurance to cover for loses arising from its inability to
convert funds that are available to it in a local currency into foreign exchange for transfer outside
the Uganda or Tanzania being host governments. According to Dewer, this coverage may also
insure against excessive delays in acquiring foreign exchange caused by the host government’s
actions or failure to act.27

iii). Stabilisation clauses.

These are clauses that may be included in international investment agreements under which the
government agrees not to take certain actions or to compensate investors for the costs of certain
actions they take.28 These clauses provide stronger protection than a government comfort letter in
that they at least purport to bind any future, as well as the present, government to a particular
regulatory regime. Sponsors and lenders will therefore be focussed on the form of language and
commitment made from an enforceability perspective, but may in any event need to take a view

27
John Dewer, ‘International Project Finance’, Oxford University Press, page 96
28
Project Finance: Identification, Allocation and Mitigation Of Risk Factors
<https://www.mondaq.com/nigeria/project-financeppp-amp-pfi/1177538/project-finance-identification-allocation-
and-mitigation-of-risk-factors>

13
on the likely future political climate in the relevant jurisdiction. 29 The use of stabilisation clauses
is not without controversy – future governments may argue that the clauses were entered into
under duress, and many multilateral finance institutions involved in a financing may not be
comfortable with attempting to limit the scope for legislative development, particularly in the
areas of environmental and social regulation. For more on stabilisation clauses.

Operating Risk

According to Dewer, this risk entails ;

a) The costs of operating and maintain the project will exceed budgeted forecasts
b) The facility will be unable to perform consistently at a level sufficient to meet the
required performance critea and/or
c) The project’s operation will be interrupted by the acts or omissions of the operator.

Risks during this stage are likely to be borne by the EACOP Ltd as the project
Company and permanent loan lenders. If a project is unsuccessful during the early years
of project operation, the assets of the project will not likely be of sufficient value to repay the
project loans, and the participants like Total Energies SE, UNOC, the Tanzania Petroleum
Development Corporation (TPDC) and the China National Offshore Oil Company
(CNOOC)will not have received the equity return for which they helped in managing the
project.

Mitigating measures

 Engage a competent project operator.

The operator, who may be the project company, is responsible for the operation and
maintenance of the project. In exchange for a fee if it is a third party, the operator
provides certain services the project needs to ensure the project’s operational viability. To
ensure the operator is invested in the success of the project, the operator is sometimes the
project sponsor or one of its affiliates.

• Obtain insurance;

29
ibid

14
The project is typically insured against property damage and may also obtain third party
liability and business interruption insurance. However, insurance may not be available for the
full, often very large, value of the project or, even where it is available the cost may be
prohibitive.

• Agree to extensive reporting obligations and inspection;

Project finance agreements typically include extensive inspection rights and very broad
reporting obligations increasing the likelihood that the lenders will be aware of any problems
or issues with the project promptly or pre-emptively (and can apply commercial pressure or
assist in finding solutions accordingly).

Conclusion

The importance of identifying, allocating and mitigating project risks in project finance is
underpinned by John Dewar who argues that both sponsors and lenders require assurances
that the project is technically and economically feasible and that it will be built and operated
according to the agreed specifications and in compliance with the laws and regulations of all
governmental authorities.

This paper has analyzed the major project risks likely to be faced in the East African Crude
Oil Pipeline Project. The paper has further allocated the major risks identified with a view of
having significant parties that are best suited and most motivated to assume such risks and
also reduce the residual risks that the sponsors and lenders can ably manage.

The paper has also attempted to show that the project is bankable from a risk mitigation
perspective and how the same can be structured.

15
16