RMC Discussion Paper Series, Number 119 Power Project Finance Experience in Developing Countries Suman Babbar John Schuster Project Finance and Guarantees Department Resource Mobilization and Cofinancing Vice Presidency January 1998 1a31 The World Bank CFS/RMC DISCUSSION PAPERS 101 - Privatization in Tunisia, Jamal Saghir, 1993. 102 - Export Credits: Review and Prospects, Waman S. Tambe, Ning S. Zhu, 1993. 103 - Argentinas Privatization Program, Myrna Alexander, Carlos Corti, 1993. 104 - Eastern European Experience with Small-Scale Privatization: A Collaborative Study with the Central European University Privatization Project, 1994. 105 - Japan's Main Bank System and the Role of the Banking System in TSEs, Satoshi Sunumura, 1994. 106 - Selling State Companies to Strategic Investors: Trade Sale Privatizations in Poland, Hungary, the Czech Republic, and the Slovak Republic, Volumes 1 and 2, Susan L. Rutledge, 1995. 107 - Japanese National Railways Privatization Study II: Institutionalizing Major Policy Change and Examining Economic Implications, Koichiro Fukui, Kiyoshi Nakamura, Tsutomu Ozaki, Hiroshi Sakmaki, Fumitoshi Mizutani, 1994. 108 - Management Contracts: A Review of International Experience, Hafeez Shaikh, Maziar Minovi, 1995. 109 - Commercial Real Estate Market Development in Russia, April L. Harding, 1995. 110 - Exploiting New Market Opportunities in Telecommunications: Lessons for Developing Countries, Veronique Bishop, Ashoka Mody, Mark Schankerman, 1995. 111 - Best Methods of Railway Restructuring and Privatization, Ron Kopicki, Louis S. Thompson, 1995. 112 - Employee Stock Ownership Plans (ESOPs), Objectives, Design Options and International Experience, Jeffrey R. Gates, Jamal Saghir, 1995. 113 - Advanced Infrastructurefor Time Management, The Competitive Edge in EastAsia, Ashoka Mody, William Reinfeld, 1995. 114 - Small Scale Privatization in Kazakhstan, Aldo Baietti, 1995. 115 - Airport Infrastructure: The Emerging Role of the Private Sector, Recent Experiences Based on Ten Case Studies, Ellis J. Juan, 1995. 116 - Methods of Loan Guarantee Valuation andAccounting, Ashoka Mody, Dilip Patro, 1995. 117 - Private Financing of Toll Roads, Gregory Fishbein, Suman Babbar, 1996. 118 - Financing Pakistan's Hub Power Project: A Review ofExperience for Future Projects, Michael Gerrard, 1997. JOINT DISCUSSION PAPERS Privatization in the Republics of the Former Soviet Union: Framework and Initial Results, Soo J. Im, Robert Jalali, Jamal Saghir; PSD Group, Legal Department and PSD and Privatization Group, CFS - Joint Staff Discussion Paper, 1993. MobilizingPrivate Capitalfor the Power Sector: Experience in Asia and Latin America, David Baughman, Matthew Buresch; Joint World Bank-USAID Discussion Paper, 1994. OTHER CFS PUBLICATIONS Japanese National Railways Privatization Study, World Bank Discussion Paper, Number 172, 1992. Nippon Telephone and Telegraph Privatization Study, World Bank Discussion Paper, Number 179, 1993. Beyond Syndicated Loans, World Bank Technical Paper, Number 163, 1992. CFS Link, Quarterly Newsletter. RMC Information Center, phone: 202-473-7594, fax: 202-477-3045 Copyright (© 1998 The World Bank 1818 H Street, NW. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured and printed in the United States of America The findings, interpretations, and conclusions expressed herein are entirely those of the authors and should not be attributed in any manner to CFS, the World Bank, or to members of the Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication, and accepts no responsibility whatsoever for any consequence of their use. The paper and any part thereof may not be cited or quoted without the author's expressed written consent. RMC DISCUSSION PAPER I 19 Power Project Finance: Experience in Developing Countries Suman Babbar John Schuster Contents Foreword vi Abstract vii Acknowledgments viii Abbreviations and Acronyms ix 1 Background 1 Focus 1 Power Sector Needs 1 Key Issues 2 Notes 4 2 Market Trends (239 Projects) 5 Capital Contributions 5 Market Participation and Competition 5 Project Finance 7 Fuel Choice 8 Regional Trends 8 3 Independent Power Project Finance (72 Projects) 9 Power Project Finance Characteristics 9 Market and Project Structure 11 Finance Trends 12 Development Lead Times 14 Notes 14 4 Case Study Project Profiles (10 Projects) 15 Project Characteristics 15 Project Development Times 15 Project Sponsors 16 Project and Financial Structure 18 Notes 19 5 Risk Allocation (10 Projects) 20 Project Risk Management 20 Case Study Overview 20 Predominant Risk Assumption by Sponsors, Lenders, and Contractors 21 Shared Risk: Fuel 23 Host Government Risk Assumption 25 Relationship of Project Risk Environment and Government Risk Assumption 32 Notes 33 iii 6 Conclusions 34 Encouraging Factors 34 Challenges Ahead 35 Meeting Future Challenges 37 Sumnmary 38 Notes 38 Appendixes A Background Tables 39 B Note on Source Material 42 C Glossary of Terms Used in the Study 43 Figures Figure 1 Study overview 3 Figure 2 Project closures in developing countries, 1992-96 5 Figure 3 Market equity participation, 1994-96 6 Figure 4 Financial closures of competitively bid projects as share of total private power dosures in developing countries, by capacity 7 Figure 5 Project finance 7 Figure 6 Regional and fuel mix of the power project finance market, 1994-96 9 Figure 7 Largest power project finance markets, 1994-96 10 Figure 8 Effect of project and market structure on average power purchase agreement length 11 Figure 9 Power project finance debt sources, 1994-96 12 Figure 10 Uses of risk debt capital 13 Figure 11 Case study project development time 17 Figure 12 Equity participation in case study projects 17 Figure 13 Sources of debt in case study projects 18 Figure 14 Fuel supply alternatives 23 Figure 15 Government risk assumption and utility performance 27 Figure 16 Relationship between country risk environment and government risk assumption 33 Tables Table 1 Private power equity participants, selected years 5 Table 2 Fuel type, 1994-96 8 Table 3 Regional trends, 1994-96 8 Table 4 Debt terms 14 Table 5 Factors influencing time to financial closure 14 Table 6 Project profiles 16 Table 7 Project and financial structure 18 Table 8 Risk management mechanisms used by sponsors and govemment entities 21 Table 9 Equity interests by project participants 22 Table 10 Government risk assumption case study projects 25 Table 11 Govemment power purchase agreement termination guarantees 28 Table 12 Comparison of Aguaytia and Ave Fenix power projects 30 Table 13 Summary of govemment risk assumption for case study projects 32 Table 14 Participant roles in promoting private power in developing countries 38 Table A.1 Case study project sponsors 39 iv Table A.2 Sources of debt for case study projects 40 Table A.3 Governrnent foreign exchange risk assumption in case study projects 40 Table A.4 Economic and political risk environment in case study countries 41 Table A.5 Independednt power producer regulatory framework in case study countries 41 Table A.6 Overall risk environment in case study countries 41 Table A.7 Largest power project finance markets, 1994-96 41 v Foreword T his study examines the experience of private greenfield power project finance in developing countries in 1994-96. During this period, private power made a significant contribution toward meeting the power needs of develop- ing nations. Private power projects financed during this period will provide an increasing proportion of the gen- erating capacity that developing countries will need for the rest of the decade. The recent involvement of the private sector represents a significant departure from years of public sector dominance in the finance, ownership, and operation of generating capacity in developing countries. This study was motivated by the need to reevaluate power project finance trends and issues discussed in the 1994 study "Mobilizing Capital for the Power Sector" (sponsored jointly by the World Bank and the U.S. Agency for International Development). That study evaluated project structure, risk allocation, and other issues based on information available in 1994 for eight projects in Asia and Latin America. The 1994 study was somewhat constrained by the limited amount of private power experience prior to 1994. This study benefits from a substantially greater base of activity to systematically evaluate power project finance sources, project and financial structures, and other factors for the entire market. The objectives of this study were to evaluate trends in private greenfield pcwer project finance and to examine the risk-sharing arrangements between private investors and host governments that enable private power projects to obtain limited recourse finance. This study will help policymakers in developing countries structure and finance new private power projects. This study focuses on Asia, Latin America, and the Middle East, where most private power finance has occurred. Because the basic issues faced by the private sector and governments are common, the insights provided by this study will be of help to most of the countries in the developing world in enhancing the role of private power. This study evaluates the private power market in developing countries, exaniining trends in power projects financed and the number and types of market participants. A key objective was to assess financing structures, sources of funds, and regulatory trends for a subset of the private power market involving limited. recourse finance of power projects that sell power to utility off-takers but that are not majority-owned by the off-takers. For this subset of the market, referred to as "power project finance (PPF)," this study analyzes trends in private power regulation, project structure, debt sources and terms, and development times. The study reviews risk management trends by analyzing private power projects in 10 countries: China, Colombia, Honduras, India, Indonesia, Mexico, Pakistan, Peru, Philippines, and Turkey The projects examined reflect the trend in the power project finance market in terms of fuel type, size, and other characteristics. The risk allocation among partici- pants in these case study projects reflects many important trends in risk managerment in the market as a whole. Hiroo Fukui Nina Shapiro Vice President Director Resource Mobilization and Cofinancing Project Finance and Guarantees Department The World Bank The World Bank vi Abstract P rivate power is beginning to make large contributions to power sectors in developing countries. The nearly 50 gigawatts (GW) of private greenfield generating capacity financed between 1994 and 1996 is three times greater than all the private power capacity financed before 1994. The annual rate of private power project investment during the 1994-96 period is approximately 30 percent of the total projected annual investment needs for new genera- tion in developing countries. Private power is introducing new sources of financing to developing country power sectors, providing new services, and creating competitive power markets. This study analyzes the 1994-96 private power market to assess trends in market competition, financing structures and sources, and risk allocation. This analysis will provide insights to help governments and investors maintain or expand the role of private power in developing countries. Nearly two-thirds of all the capital raised for new private power projects between 1994 and 1996 was provided under project finance structures, in which project cash flows and assets, rather than sponsors' balance sheets, provide security to lenders. This study focuses on one part of the project-finance market-power project finance (PPF)-where privately controlled projects sell power to off-takers for distribution in public grids. This study examines trends in regulation, project structure, debt sources, and development times. From a regulatory per- spective, a strong commitment to private power is a key determinant of PPF activity in a country. Structurally, power pro- ject finance has involved largely build-own-operate (BOO) project structures and long-term contracts. Merchant power plants are rare. The vast majority of debt has involved direct finance or credit enhancement from export credit agencies and mul- tilateral development banks. Development times average two to three years, and is less in countries with PPF experience. A major emphasis of this study is to evaluate trends in risk management by examining 10 case studies, PPF deals in Asia, Latin America, and the Middle East. The projects largely reflect a rational allocation of risks among public and private par- ticipants based on the parties' relative risk management abilities. Private sponsors and lenders generally assume risks for completion and performance that are within their control. Governments assume substantial risks in nearly all projects, mostly in areas in which they have control, such as utility performance, currency convertibility, fuel costs, inflation, uninsur- able force majeure, and political events. The level of risk governments assume is largely commensurate with the project envi- ronment. They assume greater responsibilities in high-risk environments and less risk in more secure environments. The private sector uses a variety of mechanisms for managing risks. In half of the projects examined, it relied on central gov- ernment guarantees. In the rest, it relied on alternative mechanisms such as government loans, public insurance, local govern- ment support, and strong commitments by utility off-takers. As markets open and become commercial, central governments are likely to assume fewer risks. Instead, the private sector will rely more heavily on alternative sources of project security. Private power finance for greenfield generating capacity should continue to make substantial capital contributions to power sectors in developing countries. The 1994-96 market experience shows that governments and investors have mutual interests in a strong private power industry. A competitive market, fair project risk allocation, and reasonable debt terms will help provide private power at low prices. The substantial amount of capital provided to developing country power sectors is evidence of growing investor confidence. Private power continues to face many challenges in developing countries. Protracted contract renegotiations and a lack of adequate govemment risk assumption may erode investor confidence and restrain private investments. Continued growth may require greater private debt capital risk taking. Governments, developers, institutional banks, private lenders, and financiers all have a role in helping to meet future challenges. vfi Acknowledgments T his study was commissioned by the World Bank's Project Finance and Guarantees Department. The analysis and writing was performed by John Schuster of Hagler Bailly Consulting, Inc. under the direction and advice of Suman Babbar of the Project Finance and Guarantees Department of the World Bank and the analytical and technical assistance of Sonali Shah of Hagler Bailly Consulting, Inc. John Sachs and Susan Finch Moore of Latham & Watkins provided legal advice and commentary. David Baughman of the Project ]Finance and Guarantees Department of the World Bank initiated the study. Several others made contributions to the study, including Scott Sinclair, Alejandro Mirkow, and Farida Mazhar of the World Bank; Andrew Bartley and Surya Sethi of the International Finance Corporation; Maria Elena G. Barrientos of the Inter-American Development Bank; Diane M. Rudo, an independent project finance specialist and formner vice president of project finance at the U.S. Export-Import Bank; and Alain Streicher, Amit Dalai, Steve Wlliaams, Heather Vierbicher, Sarah Milius, and Mark Symonds of Hagler Bailly Consulting, Inc. This study relied heavily on Hagler Bailly Consulting, Inc.'s International Independent Power Knowledge Base and the information pro- vided by developers, lenders, and others associated with case study projects. viii Abbreviations and Acronyms ABB Asea Brown Boveri Ltd. ADB Asian Development Bank AIF Asian Infrastructure Fund APSEB Andhra Pradesh State Electricity Board BLT Build, lease, transfer BOO Build, own, operate BOT Build, own, transfer BPCL Bharat Petroleum Corporation, Ltd. CDC Commonwealth Development Corporation (U.K. development agency) CEPA Consolidated Electric Power Asia CFE Comision Federal de Electricidad (Mexico) ClTlC China International Trust and Investment Corporation CONITE National Committee on Foreign Investment and Technology ECA Export Credit Agency ELCOSA Electricidad de Cortes S.R.L. de C.V ENEE Empresa Nacional de Energia Electrica EPC Engineering, Procurement, and Construction EPSA Empresa de Energia del Pacifico, S.A. (Colombia) FEN Financiera Energetica Nacional (Colombia) GAIL Gas Authority of India, Limited GW Gigawatts HECO Honduras Electric Corporation IDB Inter-American Development Bank IFC International Finance Corporation IIP International Independent Power IP Independent Power IPP Independent Power Producer JEXIM Japan Export-Import Bank LIBOR London interbank offered rate LOI Letter of Intent LOS Letter of Support MDB Multilateral Development Bank MIGA Multilateral Investment and Guarantee Agency MOU Memorandum of Understanding MW Megawatts NCPG North China Power Group NPC National Power Corporation (Philippines) O&M Operation and maintenance lx OECD Organisation for Economic Co-operation and Development OGDC Oil and Gas Development Corporation (Pakistan) OPIC Overseas Private Investment Corporation (U.S.) PEC Pangasinan Electric Corporation (Philippines) PICC Peoples' Insurance Company of China PLN Perusahann Listrik Negara PPA Power Purchase Agreement PPF Power Project Finance TCW Trust Company of the West (U.S.) TEAS Turkiye Electrik Uretim Eletim USEXIM U.S. Export-Import Bank WAPDA Water and Power Development Authority (Pakistan) x SECTION 1 Background T he finance of private power projects in developing Focus countries has emerged as a large, dynamic indus- try. A total of 47 gigawatts (GW) of new private An important focus of this study is project finance deals power capacitywas financed in developing countries between (private power projects that are financed on a limited 1994 and 1996, an amount nearly three times greater than recourse basis), in which lenders' primary or even exclu- the cumulative capacity of private projects financed in devel- sive sources of security are the cash flows and assets of the oping countries before 1994. This newly established mar- project. Creditors do not receive additional security in the ket is helping countries in Asia, Latin America, and the form of unlimited access to the assets of the project spon- Middle East to meet their growing electricity needs. It is sors. In contrast, under balance sheet finance, lenders also introducing new companies to developing countries, have recourse to both the borrower's assets and the pro- which is creating a more dynamic and competitive market. ject's cash flows. In both project and balance sheet finance As private power activity in developing countries has deals, lenders can benefit from many different sources of increased, investors and host countries have established security provided by host country governments, multilat- practices for allocating project risks among private and pub- eral and bilateral institutions, and commercial providers. lic sector participants in these projects. This study analyzes the newly established market for Power Sector Needs greenfield private power projects in developing countries. It describes trends in market competition, risk allocation, This study assesses the contributions of the private power and financing structures and sources, providing a detailed industry to meeting the new generating capacity needs of picture of today's market and the market that is likely to developing countries. emerge in the near future. Capital investment for new generation capacity is one This study also considers the relationship between mar- of the fundamental needs of developing countries' power ket, finance, and risk management trends and the differ- sectors.Accordingtothe Intemational EnergyAgency, devel- ent project risk environments found in the developing world. oping countries are projected to invest nearly $60 billion a Each region and country is realizing the potential of pri- year in new generation capacity: $40 billion in Asia alone, vate power at its own pace, and each is finding its own $7 billion in Latin America, and more than $5 billion in approaches for attracting investment and completing pri- Africa and the Middle East. With the exception of a few vate power transactions. For example, while most countries countries in East Asia, developing countries lack sufficient have encouraged the development of build-own-operate domestic capital to support this level of investment on their (BOO) structures, some have relied on build-own-trans- own. fer (BOT) structures. Most projects have long-term con- Not addressed in this study are other energy needs of tracts. However, a few Latin American countries have developing countries that cannot be met by private green- merchant power plants, that forgo long-term contracts and field generating projects. Nuclear and many hydroelectric compete for markets instead. While most countries rely on power projects will likely remain the domain of the public financing and credit enhancement from export credit agen- sector because they affect important public interests in safety cies (ECAs) and multilateral development banks (MDBs), and irrigation. Nuclear projects, in particular, are usually a few projects in Asia have been able to obtain private risk considered too risky for private development. Developing capital without them, relying instead on local finance. countries also need capital for transmission and distribu- 1 tion systems. Finally, they require capital for privatization throughout this study as power project finance. These are to improve the efficiency of existing power sector assets. private power projects that are financed on a limnited recourse basis, that will sell at least a portion of their power to pub- Key Issues lic utility companies and power grids, and that are not con- trolled by utility off-takers. This segment has three major This study evaluates the issues for three segments of the elements which require further definition. private power market in developing countries: First, this study focuses only on project finance. Balance * Overall trends for the private power market in devel- sheet deals are excluded because their sources of debt, oping countries, with an emphasis on project financed terms, and project structures do not reflect the country and deals (section 2). project risk environment as accurately as project finance * Finance and project structure trends for a subset of deals. In making loans to balance sheet projects, lenders project-financed deals (section 3). may be less concerned about country and project risks * Project risk allocation for 10 project-financed case because they have access to the sponsors' assets if the study projects (sections 4 and 5). project defaults. In a balance sheet project, discerning Section 6 lays out some projections based on analysis of whether the source of finance, the length of finance terms, these issues. Figure 1 provides an overview of the analysis the level of debt, the interest rate, or the allocation of pro- performed for each portion of the market. ject risk resulted from the individual project's character- istics or from the creditworthiness of the project sponsor Private power market trends is virtually impossible. Under project finance, where the only source of recourse to lenders is the project itself, there The starting point for this study is an evaluation of market is no such ambiguity. Excluding balance sheet projects trends with respect to all private power projects in devel- leaves a project finance market of 87 projects with a gen- oping countriesbetween 1994 and 1996. Duringthis period erating capacity of 27 GW during the 1994-96 period 239 projects were financed, totaling 47 GW of capacity (see (see figure 1). figure 1). Section 2 of this study evaluates the following pri- Second, the study examines financing trends for pro- vate power market issues to assess the aggregate contribu- jects with sales for distribution within an electric utility sys- tions of private power to developing countries. tem, and screens out within-the-fence deals in order to focus * Totalproject volume. How much private power capac- upon developing countries' commercial power sectors. ity has been financed in developing countries? What Within-the-fence deals under which power is generated and portion of developing countries' generation capacity used on-site do not necessarily reflect prevailing power sec- needs did private power capacity meet? tor conditions within a country. Excluding within-the-fence * Participants and competition. How many and what types projects further limits the private power finance focus of of private companies are participating in private power this study to 77 projects totaling 26 GW (see figure 1). markets? Is competition increasing? To what extent Third, projects that are owned by the off-takers are also are formal bidding systems leading to greater com- excluded because they do not reflect private power finance petition among developers and financiers? conditions, but rather private investment in publicly owned * Types of private power capacity. How much of the projects. Furthermore, because these projects are self-dealt, total project volume was limited recourse finance and (the same entity sells and purchases the power), the risk how much was balance sheet finance? What were allocation is very different from that on arms-length trans- the fuel types and sizes of these projects? In what actions. Excluding off-taker-owned projects leaves a remain- regions were most of the balance sheet and project- ing market of 72 projects and 21 GW finance deals developed?' Section 3 also evaluates the following types of finance trends: Finance trends Marketandprojectstructure. Whattype of project struc- tures prevail in today's market? How much of PPF Section 3 evaluates trends in financing structures, sources, sales are tied to long-term contracts, and what por- and terms for a portion of the market that is referred to tion are sold on a merchant basis? What is the length 2 FIGURE I Study overview Total greenfield generation Project Power project finance private power In developing finance excluding (finance excluding Case study countnes, 1994-96 Project finance within-the-fence off-taker owned projects) projects . .. ... . ~~~~~~~~~~~~~~.'........... Study l l Ill focus Market trends Power project finance trends Case study risk analysis Source: Hagler Bailly International Independent Power (WlP) Knowledge Base. of power purchase agreements? How is the length project development? What approaches are project affected by project and market structure? sponsors using to manage construction, fuel supply, 3 Finance sources. What types of debt to equity ratios and other risks? To what extent are these approaches prevail in today's market? What debt sources are being becoming standard in the industry? used for PPF? What is the importance of private risk * Government risk assumption. What level of government debt capital and finance relative to ECA and MDB support and guarantees on specific risks is required finance? To what extent are private borrowers in devel- for project finance in particular countries? What mech- oping countries able to raise debt for power projects anisms do developing countries use to mitigate risk? from domestic sources of capital? - Ability to replicate risk management approacbes. To what * Debt terms. What are typical maturities and interest extent are the case study projects typical of the overall rates for debt in developing countries? How do debt private power market in developing countries between terms offered by ECAS, MDBs, commercial banks, 1994 and 1996 in terms of fuel sources, project sizes, and capital markets differ? Are these terms affected finance sources, development lead times, and other by local conditions? characteristics? To what extent are these projects typi- * Development lead times. How long does it take to cal of the projects that will be concluded in the next develop a project from inception to financial closure? few years? Is the level of governrment risk assumption Does it take less time to finance smaller projects? in future projects likely to be higher orlower? How does Does it take more timne to close a developing coun- the level of risk-sharing compare with that in new mar- try's first time deal than subsequent deals? What other kets that are likely to emerge in the next few years?' factors influence the time required to close a deal?2 Conclusions and future trends Case studies: risk allocation and mitigation Conclusions about the prospects of the private power indus- From the 72 PPF deals, 10 projects were selected for analy- try in developing countries are based on findings from sec- sis of the allocation of risks among public and private sec- tions 2 through 5. tor project participants. These 10 projects are representative * Market volume. Will private power finance in devel- of the overall market. Sections 4 and 5 focus on the fol- oping countries remain at its current level or increase? lowing issues: WIll investors maintain a high level of interest in devel- * Participant roles. To what extent are fuel and equip- oping greenfield private power projects? ment suppliers, construction and O&M contractors, * Roles offinanciers. Will loans and credit enhancements and other project participants taking equity stake in from ECAs and MDBs continue to be responsible the project? How does this risk assumnption affect for a high portion of debt needed for private power 3 in developing countries? How can the role of private which provided information on the capacity, cost, timing, and risk debt capital be expanded? fuel type of private power projects. It also provided information Governmentchallenges. Howcandevelopingcountries on the number and types of developers active in developing maintain a high level of investor interest? Can viable countries during the 1994-96 period. alternatives to sovereign guarantees be found? 2. Analysis of finance trends was based on Hagler Bailly's IIP Knowledge Base, plus additional research on project debt sources, Notes debt finance terms, power purchase lengths, development lead times, insurance coverage, and other factors. 1. The analysis of market trends was performed using Hagler 3. Risk analysis of case study projects was based on the sources Baily's International Independent Power (IIP) Knowledge Base, listed in the "Note on Source Material" in appendix B. 4 SECTION 2 Market Trends (239 Projects) P rivate power made a significant contribution to previous years. Prior to 1994, 107 projects totaling 17 developing countries' power sectors between 1994 GW of capacity had received financing in developing coun- and 1996. It provided a significant share of coun- tries. By 1996 an additional 239 projects with 47 GW of tries' capital investment needs and brought new private capacity had been financed (figure 2). The annual volume investors to the market. Moreover, the entrance of new of financial closures also increased steadily, from 45 pro- investors is increasing market competition, which should jects and 8 GW in 1994 to 97 projects and 23 GW in help provide developing countries with reasonably priced 1996. sources of power. The 47 GW of private power financed between 1994 Project finance accounts for most private power debt in and 1996 represents significant private investment in devel- developing countries, in part because project finance facil- oping countries' power sectors. This capacity has an esti- itates the financing of larger projects. Most projects, both mated construction cost of more than $50 billion-nearly balance sheet and project-financed, have been oil, gas, or $17 billion a year. This average level of investment repre- coal-fired, with East Asia accounting for more than half of sents approximately 30 percent of the annual investments total private power finance. that developing countries are projected to make in new gen- eration capacity between 1995 and 2005. Capital Contributions Market Participation and Competition Private power finance in developing countries emerged as a major business between 1994 and 1996. The volume of Another contribution of the private power industry has been projects financed during this period was nearly three times to introduce new investors to the market. In 1991 only 13 greater than the total volume of projects financed in all independent power producers (IPPs) owned equity in pri- vate power projects in developing countries (table 1). By FIGURE 2 1993, 51 IPPs had acquired equity in developing country Project closures in developing countries, 1992-96 projects. In 1996 the number increased to 217. An addi- (gigawatts) tional 112 entities for which private power is not a line of 50 business (such as local industrial firms) also acquired equity in private power projects. 40 Increased equity participation has brought in new types of private investors that were not previously active in devel- 30 oping country power sectors. As of 1991 global utility affil- iates and developers were virtually the only private investors 20 with equity interests in developing country private power TABLE I I10 | | iil [ |Private power equity participants, selected years 0 Participants 1991 1993 1996 Cumulative 1994 1995 1996 1994-96 Independent power producers 1 3 5 1 217 prior to 1994 Total participants 31 97 329 Source: Hagler Bailly IIP Knowledge Base. Source: Hagler Bailly IIP Kncwledge Base. 5 projects. By 1996 global developers and utility affiliates Competition were still strong market players. However, equity partici- pation as of 1996 reflected significantly greater diversity, The strong response by private investors to the growing IPP as existing firms began new ventures and new companies industry in developing countries has two powerful impli- emerged (figure 3). cations for market competition. First, growing market par- Perhaps the most significant development in market par- ticipation has prevented any one company from achieving ticipation has been the emergence of firms dedicated to dominance in the power sector of any country or region. developingprivatepoweronaregionalbasis.Therearenow Second, the increased number of market players has 51 regional developers, which control 13 GW of capacity, made it difficult for companies to expand their power port- or about 20 percent of the total project equity in develop- folios. In 1993 the average IPP controlled 153 megawatts ing countries. East Asia accounts for more than half of all (MW) of capacity, yet the average interest of each partici- regional developer activity, in terms of both the number of pant grew by only 7 percent a year through 1996, to 189 participants (26) and the amount of capacity controlled (7.2 MWE Private companies would prefer greater growth poten- GW). While most of these firms are locally controlled, tial, but to be successful, companies need to enhance their such as Tenaga Nasional Bhd. in Malaysia, some of these competitiveness by reducing prices, offering new services, companies are likely to emerge as truly global developers, or raising finance at more attractive terms. While this sit- through both growth and industry restructuring. For exam- uation is difficult for investors, it is favorable for develop- ple, Consolidated Electric Power Asia (CEPA), a strong ing countries, which are increasingly able to seek and obtain regional developer in East Asia, will be consolidated into better deals. the global power development organization of Southern Electric International (SEI), a major U.S. electric utility Competitive bidding affiliate that recently acquired CEPA. Another significant development has been the decision Competitive solicitations for private power first emerged by fuel companies, equipment suppliers, and engineering in most parts of the world in 1992. However, competitive and construction firms to launch new IPP ventures. As of bidding was slow to make a mark on the private power 1991 none of these companies owned any equity in a devel- industry, and many initial solicitations encountered diffi- oping country project. By 1996, 27 fuel companies had 4 culties. In Mexico the Merida solicitation had to be re-bid GW of project equity, 23 equipment suppliers had 3.7 GW several times before finally being awarded in early 1997. In and 10 engineering and contractor firms had 1.4 GEW the Philippines, an initial award to the Batangas Project had :to be re-bid because of the involvement of an equipment FIGURE 3 Market equity participation, 1994-96 supplier that was temporarily barred from doing business Total IPP players-67% in the country. In Inclia competitive bidding had to contend Global fiuel with a large number of projects already awarded under nego- companies tiated agreements, many of which were rescinded so that Regional players projects could be re-bid. In Turkey two competitively Global developes 2l% awarded projects were delayed because of legal uncertain- ties surrounding the country's BOT law. Infrastructure Because of these problems, competitively bid projects Equipmnt f.unds......d.id1 not result in any significant financial closures until 1994, equipment I m lb%tl suppliers . .when 1.5 GW of competitively bid projects achieved clo- 9% S t w. Global utiftey sure. In that year, competitively bid projects represented .~i~1 affiliates 16% about 15 percent of all financial closures (figure 4). Public sector Competitive bidding became a sizable part of the pri- 12% sl NSN .21YO lll | vate power market in 1996 when 4.5 GW of competitively Local industry hr bid projects achieved financial closure. Most of this growth 7% 14% occurred in East Asia as the result of four closures totaling 5 wrre- Haoler Railfv IIP Knr)wlerls R Pi. 3.3 GW In the Middle East, however, competitive bidding 6 FIGURE 4 Competitively bid projects promise to be an important Financial closures of competitively bid projects as source of power throughout the developing world. Overall, share of total private power closures in developing 68 pending solicitations for 45 GWof capacitywere released countries, by capacity (percent) in 1996 and thus far in 1997. In Mexico, the bids received 25 by Comision Federal de Electricidad (CFE) were so low that the country is now considering developing additional 20 BOO projects under competitive solicitations rather than i 5 | ll proceeding with additional BLT projects. In Thailand the 15IL | electric utility EGAT concluded its first and second com- 10 petitive bidding phases, and is now negotiating terms and conditions with 11 bidding consortia for more than 4,100 5 MW During the third phase of its program, which started in mid-1997, EGAT plans to issue solicitations totaling 1992 1993 1994 995 1996 4,000 MW of power projects. In India more than half of Source: Hagler Bailly IIP Knowledge Base. all power projects now in an advanced stage of develop- ment have been competitively bid. In China, a new policy accounted for nearly three-quarters of the region's private now requires all major IPP projects to be competitively power finance. Competitively bid projects have now been bid. Laibin B was the first project solicited under this new financed in virtually every region of the developing world. policy. In countries that have developed IPP programs, com- petitive bidding can greatly expedite the development and Project Finance finance process by establishing contract conditions and a rational framework within which development can occur. Limited recourse project finance has been responsible for In Thailand, for example, a 700 MW combined-cycle power the majority of IPP market growth in developing countries plant sponsored by Thai Oil, Unocal, and Westinghouse since 1993 and has allowed developers to finance larger received corporate financial commitments in 1996 (the same projects. Although fewer than 40 percent of the 239 finan- year that the project was bid) and sought project finance cial closures that occurred between 1994 and 1996 were in 1997. In the Philippines the Sual project reached agree- project financed (the rest were balance sheet closures), pro- ment on a power purchase agreement only a few months ject finance has accounted for about 58 percent of total clo- after the bid was awarded and reached financial closure less sures in terms of MW capacity (figure 5). This is because than eighteen months later. the average size of a project finance deal (300 MW) is FIGURE 5 Project finance Number of closures (I1994-96) Capacity (I 994-96) Transaction value (I1994-96) 239 47 GW $50 billion 36% of projects 58% of closures by capacity (megawatts) 62% of transaction value ~~~~u ((A iCC -~~~~~~~~~~~~~~~~~~~~~~~P (( cti C I PI0-' Of"rce V ~~~Balance sheet \ Balance sheet '\ Balance sheet Source: Hagler Bailly IIP Knowledge Base. 7 more than twice the size of a typical balance sheet deal (130 relatively large. The average size of a project financed MW). The relatively large size of project financed deals coal-fired power plant was greater than 600 MW Oil reflects a clear preference by sponsors not to assume bal- and gas projects averaged more than 250 MW per project. ance sheet risks for large projects. More than 10 percent of private power capacity was Projectfinance accounts for aneven greaterportion (62 financed on a contingent basis (currently financed on percent) of the total dollar amount of private power clo- the sponsors' balance sheets but in the process of seek- sures because project finance deals tend to have higher ing project finance). Approximately two-thirds of the con- capital costs per kilowatt. Though large deals would be tingent capacity was coal-fired. The rest was oil- or expected to achieve economies of scale and therefore drive gas-fired. costs down, project financing is often used to pay for coal-fired plants and integrated power plants that tend to Regional Trends have higher capital costs. For example, in Peru, the lim- ited recourse financed Aguaytia project involved a 155 MW More than half of all private power finance occurred in East power plant, gas field development, a natural gas pipeline, Asia, where there is a large need for power (table 3). Nearly petroleum refining facilities and a 400 km, 220kv trans- half of this capacity was in China, and virtually all of the mission line. In addition, project finance deals are usually other private power finance in the region occurred in four fully loaded with overhead transaction costs and interest countries: Indonesia, Malaysia, the Philippines, and during construction. Under a balance sheet arrangement, Thailand. Of the remaining capacity financed since 1993, development, finance, and other costs are often consid- almost 20 percent is 'located in India and Pakistan, while ered corporate expenditures and therefore are not included Latin America accounts for about 23 percent. as part of a project's total reported capital costs. In this East Asia is particularly dominant in project finance, regard, project finance more accurately reflects a project's accounting for 60 percent of the total during the period. true cost. Asia as a whole represented 80 percent of all project finance activity. By contrast, in Latin America most private power Fuel Choice capacity was balance sheet financed, mainly because many of the projects have been relatively small (less than 130 MW Oil- and gas-fired projects have accounted for 53 percent on average). The lack of project finance in Latin America of all private power capacity financed in developing coun- also reflects the fact that Argentina, historically the region's tries since 1993 with over two-thirds of this capacity bal- largest private power market, has a competitive (or mer- ance sheet financed. Coal-fired power projects accounted chant) market with lititle or no reliance on long-term agree- for 36 percent of all private power capacity since 1993, while ments. In such a setting, the price and quantity of power hydro capacity accounted for only 7 percent (table 2). is determined by the market rather than by long-term power Among project finance deals, the mix of coal and oil purchase agreements (PPAs). Creditors have been reluc- and gas projects is relatively even: 44 percent of all capac- tant to lend to merchant power deals because of uncertainty ity was coal-fired, while 48 percent was oil or gas fired. about project revenues. Both oil and gas and coal-fired project finance deals were TABLE 3 TABLE 2 Regional trends, 1994-96 Fuel type, 1994-96 (percent of GW) (percent of GW) Project Balance Fuel Project Balance Region finance Contingent sheet Total type finance Contingent sheet Total Latin America IS 14 43 23 Coal 44 61 10 36 East Asia 60 86 29 54 Oil/Gas 48 35 68 53 South Asia 20 0 22 19 Hydro 5 4 13 7 Afrca/Middle East 5 0 5 4 Other 3 0 9 4 Central/Eastem Europe 0 0 1 0.2 Total 100 100 100 100 Total i00 i00 100 100 Total(GWM 27.3 5.4 14.0 46.7 Total(GWV) 27.3 5.4 14.0 46.7 Source: Hagler Bailly IIP Knowledge Base, Source: Hagler Bailly IIP Knowledge Base. 8 SECTION 3 Independent Power Project Finance (72 Projects) T he Power Project Finance (PPF) market, as defined Largest markets in section 1, represents an important segment of the total power market in developing countries. PPF has been heavily concentrated in a few countries, the As construction is completed over the next several years, 10 largest PPF markets accounting for all but 1.6 GW of the 72 deals that were concluded between 1994 and 1996 the total capacity financed between 1994 and 1996 (figure will provide 21 GW of power to countries'commercial power 7). Five countries had nearly 70 percent of the capacity sectors. financed: Pakistan (the largest market), China, Indonesia, Examination of the PPF market shows the following reg- Malaysia, and the Philippines. ulatory and financial trends: * A strong commitment by the host government to FIGURE 6 private power is a key determinant of activity in a Regional and fuel mix of the power project financ country. market, 1994-96 * Most projects have BOO structures and long-term con- (percentage of total market) tracts. Other structures and merchant pricing are rare. Total capacity-21 GW * Most debt is provided through finance and credit Fuel type enhancement from ECAs and MDBs. * There is relatively little private risk debt capital. Oil/Gas * Countries with strong domestic capital markets pro- 60.4% vide a large portion of their own debt requirements. * Project development time is considerably shorter in countries with private power experience than in coun- 3O.8% the tries without it. Power Project Finance Characteristics 5.6% 30.2% The 1994-96 PPF market included 72 greenfield genera- tion projects with 21 GW of capacity, accounting for about Region three-quarters of all project financed private power capac- - - ity. The characteristics of PPF capacity closely resemble East Asia those of the total project finance market in terms of fuel 52.9% sources, regional distribution, and size, with only a few exceptions. East Asia accounts for only 53 percent of PPF Middle East/Africa . capacity (figure 6) and 60 percent of total project finance. 6.4% Coal capacity represents 30 percent of PPF capacity and 44 percent of total project financed capacity. These differ- ences arise largely because 5 GW of coal-fired capacity is Latin America South Asia excluded from the PPF market, as it is majority-owned by entities of the Chinese Ministry of Power. Source: Hagler Bailly IIP Knowledge Base. 9 FIGURE 7 Largest power project finance markets, 199496 IBRD 29360 Rr,,ge. MW ,N-be, of YoTwa Cout-s MW - n2,00 MW 5 14,759 This mop wos produced by the Mop Desi'g Unit of The World Book. 00 1999 MW 5 4.630 The boundories. colors' denorninotions and ony other information 10 -399 MW 1 3 1.609 shown on this mop do not imply on the port of The World Bork Group, ony iudgment on the legol stolus of any teritory, or any endorsement or acceptcnce of such boundories S.uroe: Hagler Baily IIP Knowledge Bae. FEBRUARY 1998 Features of major markets The experience of these 10 countries demonstrates that sophisticated regulatory and market structures that shield The 10 major PPF markets share three regulatory and private power developers from the dominance of large, market features that together represent a commitment to state-owned utility companies are not prerequisites for private power participation. These three features are poten- PPF. As long as countries enable private project sponsors tial prerequisites for other countries to emulate as they to sell power under long-term PPAs, countries do not embark upon private power programs. have to make additional regulatory and market reforms to * Rules for private greenfield capacity development. All reduce the dominance of state-owned companies. Of the of the countries have established rules for greenfield 10 major PPF markets, only Colombia has made signifi- capacity development. With a few possible excep- cant reforms in establishing an independent regulatory tions, most of the countries provide clear guidelines commission, privatizing state-owned utility assets, and and laws that facilitate private power development.' ensuring that no one state company owns a preponderance * Private power track record. With the exception of of the country's generating assets. Only a few of the 10 Mexico, private power projects were financed in all countries have achieved progress in any one of these three 10 countries prior to 1994. While only a few of these areas. pre-1994 projects involved PPF as defined in this In spite of thisfinding, there are manyreasonswhycoun- study, this experience with private power ownership tries should reduce the dominance of state-owned utili- allowed them to test private laws and to demon- ties. Private power investors consistently assert that reducing strate to investors a commitment to private power. government dominance over the power sector improves the * Establishment of an organized solicitation process. All environment for private power investments.2 By reducing 10 countries have begun using formal power project regulatory risks, developing countries can encourage pri- solicitation processes, many of which involve inter- vate investors to accept other risks such as utility perfor- national competitive bidding. mance or foreign exchange. 10 Market and Project Structure years less than the term of the PPA. After repayment of a project's original debt, power prices negotiated under the The overwhelming majority of PPF between 1994 and 1996 PPAs often decrease. involved projects with BOO structures and long-term power There appears to be little relation between the length of sales contracts, with the length of power purchase agree- PPAs and a country's consideration of market restructuring. ments depending largely upon a project's structure. One might expect shorter length agreements in countries that are considering restructuring. Once markets are sepa- Project structure rated into generation, transmission, and distribution com- ponents, power prices are likely to be determined by a Of the 72 PPF deals, 59 involved BOO structures, (or agree- competitive market rather than by long-term contracts. The ments that were similar to BOOs such as build-own-oper- existence of long-term contracts may impede a transition to ate-maintain), 12 involved BOT structures, and Samalayuca competitive markets by creating portions of the market that in Mexico was the only BLT. are noncompetitive or by requiring power purchasers to buy This relative abundance of BOO projects, as opposed out these contracts. In countries that are considering mar- to BOT and BLT structures, reflects an increasing ket restructuring (such as Colombia, Indonesia, Pakistan, commitment on the part of developing countries to trans- and Thailand), however, PPAs with BOO projects are actu- fer long-term control of the power industry from the pub- ally longer than PPAs in countries that are not actively con- lic sector to the private sector. Even in countries that began sidering market restructuring (China and India; figure 8). performing projects on a BOT basis (the Philippines and There is some evidence to support the contention that China), many recent projects have been BOO. market restructuring considerations shorten the length of BOT PPAs. In countries that are considering restructuring Market structure (for example, the Philippines) the length of BOT agree- ments is shorter than in countries that are not actively pur- TheoverwhelmingmajorityoftheseBOOprojectshavepower suing restructuring (for example, Turkey; see figure 8). purchase agreements that stipulate quantity, pricing, and other However, the total number of BOT projects (12) is too conditions for the long-term sale of power from the project small to derive any strong conclusions on this issue. to the off-taker. In Latin America there were five BOO pro- Regionally, power purchase agreements averaged about jects without long-term PPAs that sold power to national 25 years in Asia, generally ranging from 20 to 30 years, power grids. None of these projects, however, relied on power grid sales for 100 percent of their revenues. For example, FIGURE 8 two projects in Argentina obtained some of their revenues Effect of project and market structure on average from sales of steam under long-term contracts with on-site power purchase agreement length industrial facilities, and the Aguaytia project in Peru will rely (years BOO BOT on petroleum sales for nearly one-third of its revenue. 25 (59 projects) (12 projects) PPA length 20 Among projectswith PPAs, the length of agreements ranged I 5 from 15 to 30 years, with an average of about 21 years for I0 BOO projects and an average of 15 years for BOT projects. For both types of projects, the length of the agreement is 5 largely determined by the need to amortize debt. Project sponsors typically try to negotiate debt terms that are as 0 Actively Not Actively Not long as possible, but lenders, as a rule, will not extend considering considering considering considering loans for periods that are longer than the term of the pur- restructuring restructurng restructuring restructurng chase agreements. To allow for unexpected problems, lenders Note: No BOT projects in restructured markets. 00 PPA length in restructured markets is zero. usually provide debt terms that are at least one to two Source: Hagler Bailly lIP Knowledge Base. 11 and about 17 years in Latin America, ranging from 15 to Export credit agencies were responsible for nearly half 21 years (excluding merchant power projects). The longer of all PPF debt between 1994 and 1996, providing the length of PPAs in Asia reflects the larger size and com- largest volume of finance in all regions. This money repre- plexity of projects as well as their longer expected useful sents funds provided directly to power projects or guaran- lives. Many of the shorter-term projects in Latin America tees on money lent by commercial banks. ECAs provided were smaller-scale oil and gas or diesel projects with shorter a smaller share of total debt to projects in Asia (42 percent), useful lives. where project risks were moderate, and a higher percent- age of total debt in emerging private power markets in the Finance Trends Middle East and Africa (70 percent). Multilateral development banks provided $2 billion in Debt has supplied about three-quarters of all the money project finance debt, and bilateral development institutions needed for PPF in developing countries. The overwhelm- provided $800 million. This debt involved either direct ing majority of this debt has involved ECA or MDB direct finance (IFC and :[DB A loans) or loan syndication (IFC finance orprivate debtwith credit enhancement fromECAs and IDB B loans), in which debt is provided by a private or MDBs. Largely as a result of this credit enhancement, lender, usually a commercial bank. Typically, multilateral developing countries with relatively high-risk environments debt finance to a single project involves both direct finance have been able to obtain financing at terms similar to those and syndication. The bank serves as the lender of record in developing countries with less risky project environments. for direct and syndi.cated loans, both of which benefit from the preferred creditor status and other advantages associ- Debt to equity ratios ated with this type of lending. T'hese loan syndications involve some political risk to The average debt to equity ratio in PPF was 74/26, which private lenders, but are generally considered more secure is comparable to ratios in recently concluded power deals than uncovered private debt. While the MDB does not gen- in the U.S. market. There is little variation in average debt erally provide loan guarantees for syndicated debt, its par- among regions. Average ratios range from 70/30 in Latin ticipation in a project as a lender provides an important America to 75/25 in Asia and 80/20 in Africa and the Middle source of security. Still, defaults on syndicated loans nearly East. During 1994-96 there was no appreciable time trend always affect direct loans provided by the MDBs, which are toward higher or lower debt to equity ratios. typically paid pari passu with syndicated loans or are even Power projects with some or all of their revenue affected subordinated to syndicated loans. Especiafly in poorer coun- bymerchant powerprices have exhibited muchlowerratios tries, where MDBs provide a large amount of a country's than those with purchase agreements. Among the 72 pro- jects in this group, the only one with a debt to equity ratio FIGURE 9 of less than 50/50 is Argentina's San Miguel power project. Power project finance debt sources, 1994-96 Trotal debt-$18 billion Sources of debt financing Commercial, Bilateral uninsured 4% 59/6 A very small portion of foreign PPF debt financing comes Capital markets Export from private lenders without any guarantees or credit credit agencies enhancement from ECAs or MDBs. Most debt (90 per- Co.mmercial, 48% insured cent) was provided either by host country sources or by 9% one or more of the following types of finance and credit enhancement from MDBs and ECAs (figure 9).3 Multilateral * Direct funding ll/o * Guarantees (for example, World Bank guarantees) * MDB loan syndication, such as International Finance Local Corporation (IFC) B loans 1796 * Political risk insurance. Source: Hagler Bailly IIP Knowledge Base. 12 total debt, government-owned power off-takers are con- antees, or any other multilateral or bilateral support. Nearly sidered to be less likely to default on debt from an MDB all of this risk debt capital was provided to only a few coun- than on private debt. tries, mostly in East Asia, which had a better investment Local capital provided nearly $3.1 billion of debt financ- climate than other developing regions and was therefore ing for PPF projects. All but about $400 million of this was able to attract private debt risk capital (figure 10). raised bybanks in Malaysia, Indonesia, and Thailand, where About $970 million in capital markets lending with no capital markets grew during 1994-96. In Malaysia and direct guarantees, political risk insurance, or other cover- Thailand local financing sources have provided nearly all age accounts for half of this at-risk financing. Nearly all of of the debt financing needed for PPF. The $1.9 billion of this moneywas provided to Indonesia, the Philippines, China, locally raised debt in Malaysia supplied all but $200 mil- Chile, and Colombia, countries with investment grade for- lion of the debt financing needed for three large power pro- eign debt ratings. While capital markets provided only about jects, including the 1,303 MW Lumut Perak natural gas 6 percent of PPF debt finance in 1994-96, they provided project. In Thailand $300 million in local funding pro- an increasing amount of debt each year in 1994-96. Several vided three-quarters of the necessary debt. important deals recently closed in East Asia mean that cap- Only $2 billion, or slightly more than 10 percent of the ital markets will provide a large amount of debt finance in debt financing used for PPF during 1994-96, may be con- 1997. Furthermore, capital markets have provided a larger sidered private risk debt capital in that it did not have MDB proportion of debt for within-the-fence and off-taker con- or ECA debt coverage, political risk insurance, loan guar- trolled projects not included as part of the PPF market. The remaining half of the at-risk funds originated from FIGURE 10 $950 million of commercial bank lending. More than 90 percent of this money was lent to two countries) China, Commercial bank debt-$950 million where some ECAs do not operate and where the economic 5% risk environment is considered relatively low, and Malaysia, Indonesia a country that has a high per capita income and does not receive World Bank loans. China ~Debt terms 24% 62% The length of debt terms and the interest rate have signif- icant implications for the cost of private power in devel- oping countries. Debt is the most important source of capital for PPF, accounting for 74 percent. Thus a project's debt terms can influence the cost of power by more than Capital markets-$970 million $0.01/kWh.4 Colombia kstan Among the projects analyzed in the PPF market, debt Cooba2% 83 O/C _ terms ranged from 6 to 17 years and averaged 13 years. There China 1 1 _ is relatively little difference in the length of loans offered by ffi % f _ 55Qno ECAs, MDBs, and commercial lenders (table 4). Not sur- prisingly then, the length also did not vary substantially among Philippines regions or even among countries with favorable credit rat- ings (or among those with unfavorable credit ratings). Interest rate margins ranged from 1.5 percent to 4.0 per- Chile cent over LIBOR, with an average of about 2.7 percent. 17% Rates do not vary substantially among debt sources, nor among low-risk and high-risk project environments. Note: This debt is financed with no guarantee, political risk insurance, Developing countries with low-risk project environments or other coverage. Source: Hagler Bzilly IIP Knowledge Base. tend to pay a 2.0-2.5 percent premium over LIBOR. 13 TABLE 4 TABLE S Debt terms Factors influencing time to financial closure Interest rate percentage Lead time Term length points over LIBOR' Factor (years) Finance source Range Average Range Average Average time 2.5 Direct ECA 12-16 13 1.5-3.0 2.8 Size Direct MDB 10-15 13 2.0-4.0 3.0 Large (>600 M\W) 2.7 Commercial-covered 6-16 12 I.5-3.0 2.8 Small (< ISO MM 2.0 Commercial-uncovered 8-15 13 1.5-3.0 2.5 Foreign capital markets 12-19 14 2.0-3.0 2.5 Country experience Local 9-17 14 - Firsttime 3.6 Overall 6-19 13 1.5-4.0 2.7 Second deals 1.9 - Not available. Type a. Including commitment and exposure fees. Fossil fuel 2.4 Source: Hagler Bailly IIP Knowledge Base. Hydropower 3.7 Countries with riskier project environments pay a premium Source: Selected transactions in Hagler Bailly I1 P Knowledge Base. of slightly more than 3 percentage points. The relatively small amount of variation among debt size on development lead times is slight. Small projects of terms and interest rates evidenced during the 1994-96 150 MW or less have reached closure in about two years, period means that PPF debt is being provided at relatively only slightly quicker than average, while large projects of reasonable terms in all countries. The major factor account- 600 MW or more have reached closure in 2.7 years, slightly ing for these reasonable terms is the significant amount of slower than average. lending and credit enhancement by ECAs and MDBs to Fossil fuel projects have reached closure in about 2.4 the market. These institutions are willing to lend to projects years. There is a small difference in the times needed to in risky environments without charging a significant pre- close coal projects and oil or gas projects, but these are mium relative to that paid in less risky environments. explainable by project size. Hydropower projects have reached closure in an average of 3.7 years, much longer Development Lead Times than is typical in the market. However, this longer lead time should be expected, given the complexities of sur- The average development time for PPF deals was 2.5 years. veying physical conditions at the plant site and of decid- The largest single factor influencing the speed with which ing resettlement issues and water rights. There is not a project proceeds to financial closure is the experience base enough evidence to support any strong conclusions about of the country in which the transaction is being completed the development times of other renewable energy (table 5). First time deals tend to take about twice as long projects. as subsequent transactions. The only exceptions to this were deals arranged when the host country governmentwas expe- Notes riencing a severe power shortage. For example, the ELCOSA project in Honduras reached financial closure quickly, in 1. In Turkey BOT laws were challenged in the courts. In Mexico part because it was developed during that country's power private power laws have been recently revised. The legal enforce- crisis in 1994. ability of contracts in China is uncertain. The fact that project experience typically leads to faster 2.USAID 1996, Privatization Options for the Power Industry, closures should mean that closures should occur more concludes that an independent regulatory commission is the quickly in the future. So far, however, there is no evidence most important regulatory factor for private investors. that lead times in the market as a whole are being reduced. 3. Most host country sources are publicly owned or raised Many of the projects that achieved financial closure in 1996 through local capital markets. were first time deals in countries such as Mexico and Turkey 4. Based on the difference between debt financed with a six- and had been under development for some time. yearterm and a 1 percerlt premium over LIBOR and debt financed There is some evidence that small projects can be devel- with a 17-year term anda 3 percent premium over LIBOR. Assumes oped faster than large ones. However, the effect of project a $ 1,000/kW baseload plant. 14 SECTION 4 Case Study Project Profiles (10 Projects) T en case study projects were selected for detailed from its status as a merchant plant in Peru, where electricity examination of their risk allocation (section 5). Four prices are expected to decline (from their current level of 5-6 are located in Latin America, five in Asia, and one cents/kWh to about 4 cents/kWh) as the spot market matures inthe Middle East. The purpose of this chapter is to describe and new, low-cost projects come on-line. the general characteristics of these case study projects and ELCOSA has the highest tariff at 8.5 cents/kWh. This to assess the degree to which these projects reflect the over- high tariff can be attributed to several factors, including the all 1994-96 PPF market. use of imported heavy fuel oil, a 35 percent import tax on Overall, these projects were found to reflect the regional this fuel, a low debt to equity ratio (66/34), a high-risk envi- market trend with regard to structure, fuel type, size, debt ronment, and a desperate need for power in Honduras at the terms, and types of sponsors. The case study projects are time ELCOSA was negotiated. While this project was not atypical of the market, however, in at least one respect. solicited through a formal competitive bidding system, the More than half of the projects represent the host coun- tariff of 8.5 cents/kWh was based on the lowest tariff bid of tries' initial experience in PPF. Therefore they required a two other independent power producers (IPPs) that were longer than average time to finance and relied on MDBs competitively bid at the same time that ELCOSA was nego- and ECAs for a greater portion of debt than was typical of tiated. The urgent need for power and the high-risk envi- the 1994-96 market. The significant amount of debt and ronment gave developers the leverage to demand relatively credit enhancement provided by these organizations reflects high rates of return. ELCOSA sponsors were asked to build the high level of risk of first time deals and of some of the the plant quickly and to take full construction risk in order countries involved. to do so. They also accepted the regulatory risks associated with a system that had little or no private power laws and Project Characteristics regulations. While the cost of this project to Honduras is high, it is arguably lower than the economic cost that would The size and fuel type of the case study projects are largely have resulted from the continued power shortage. typical of the 1994-96 PPF market (table 6). The projects In general, power prices are contractually guaranteed in in Latin America and South Asia use oil and gas, while those the power purchase agreements (PPAs). However, in China's in East Asia use coal. Similar to the overall market, case Tangshan project, the project's off-taker, North China Power study projects in Latin America are smaller than those in Grid, does not have the authority to establish power prices. Asia, with two exceptions: Samalayuca, a 580 MW project The authority to set prices rests with the Tangshan Municipal in Mexico, and Tangshan, a 100 MW project in China. Commodities Pricing Bureau, which is not a party to the Installed costs vary widely among the case study pro- deal. The tariff of 5.5 cents/kWh is based on an estimate jects. Aguaytia, at $450/kW, has the lowest capital cost, of the capacity and energy price that would provide an while Birecik, at $2,370/kW, has the highest cost. The cost adequate rate of return under the PPA as well as a long- per kW is fairly typical of coal and oil and gas projects in term forecast of coal prices (table 6). the overall market. While capital costs for hydro projects are site-specific, they tend to be higher than those of fos- Project Development Times sil fuel projects. With the exception of Aguaytia and ELCOSA, the tariffs Project development times range from less than two years range from 4.5 to 6.5 cents/kWh. Aguaytia's low tariff resulted to seven years (figure 1 1). l As described in section 3, coun- 15 TABLE 6 Project profiles Total project cost Installed Approximate tariff Country, project MW/fuel (millions of dollars) cost ($/kW) (cents/kWh), China, Tangshan 100/Coal 183 1.827 5.5 Colombia, Termovalle 240/Gasb 148 617 4.5 Honduras, ELCOSA 80/ Imported heavy fuel oilc 90 1,168 8.5 India, jegunrpadu 216/Gas,Naphtha 228 1.055 s.5 Indonesia, PT jawa 1,220/Coal 1,705 1,398 6.5 Mexico, Samalayuca 700/Gasd 647 924 Pakistan, Uch 586/Low Btu gas 653 1,1 14 5.5 Peru, Aguaytia 155/Gas 705e 450 4.0 Philippines, Sual ,200Amported Coal 1,352 1,127 5.0 Turkey, Birecik 672/Hydro 1,593 2,370 5.5 - Not applicable. a. No costkWh for Samalayuca computed as this is a lease; Aguayba estimated based on spot mar-ket price projection. b. Capacity is ISO conditions. Capacity as site is 199 MW Grid off-take is 160 MW, project also has 1 0 and 20 year power purchase agreements with ndustrial customers. c. Grid off-take is 55 MW d. Capacity is ISO conditions. Capacity at site is 580 MW due to altitude. e. This figure includes only the costs for the power portion of the integrated project. Source: Case study project sponsors and lenders. try experience is the main factor affecting the time from was so great that the gove:rnment asked the ELCOSA spon- project inception to financial closure. For the case study sors to build a temporary plant. Initially generating 24 MW projects, the average development time was 3.2 years. This it began operating six months prior to final financial closure was higher than the market average of 2.5 years mainly and was later expanded to 60 MW and then to 80 MW because many of these projects were the countries' first- Projects that were able to benefit from experience took time private power projects. Birecik, Samalayuca, Aguaytia, less time to develop. Indonesia's PT. Jawa was able to reach Jegurupadu, ELCOSA, and Uch all began negotiations prior financial closure quickly because of precedents established to the establishment of standard documents orto any finan- by PT Paiton. Many of the Paiton documents, including cial closings of other projects in their respective nations. the comfort letter, were used for PT. Jawa. In the case of Jegurupadu and Birecik had the longest development the Philippines' Sual, five private power projects had already times. AlthoughJegurupadu was promised a sovereign guar- achieved financial closure before Sual's development began. antee, the project took more than five years to reach finan- This experience, in addition to the government's commit- cial closure. The PPA was redrafted several times, and the ment to private power and its willingness to guarantee all central government guarantee required lengthy negotia- of National Power Corporation's (NPC) commitments, tions.2 The fact that the project began operation prior to helped to expedite negotiations. financial closing is attributable to the strong commitment of the sponsors and the contractor, Asea Brown Boveri Project Sponsors (ABB). The Birecik hydropower project in Turkey took almost eight years to reach financial closure. As is often Information on the case study project sponsors and their the case in a nation's first IPP, at the time negotiations began, equity participation at the time of financial closure is pro- the legal framework was insufficient. Clarifications and vided in figure 12 and table A. 1. Five observations can be development of the legal framework required additional made from this data. First, projects involve a wide variety time, which extended the development period. In addition, of sponsors, including host government public sector enti- because of their technical complexity, hydropower pro- ties, regional IPP players, global utility affiliates, global jects are generally more difficult to negotiate. developers, fuel companies, equipment suppliers and EPC Although ELCOSA was Honduras's first IPP, it had the contractors, infrastructulre funds, multilateral and bilateral shortest development time of all the case study projects development agencies, and other organizations. (1.5 years). This short development time can be attributed Second, the sponsors are not typical of the private power to many of the same factors that were responsible for the market in developing countries. EPC contractors and equip- project's relatively high tariff. The country's need for power ment suppliers have the largest equity share of the case 16 FIGURE II Case study project development time (years) Projectl start date China, Tangshan El $ , El PPA/contracts signed May 1994, Joint Venture Agreement s Construction begins $ Final financial closure Colombia. Termovalle a $ Al Commercialization (if before 7/97) August 1995, Bid Award Honduras, ELCOSA A A $ July 1993. Bid Award India, Jegurupadu | X $ February 1992. GOAP Selection Indonesia. PT.Jawa E $ Apinl 1994, GOl Mandate Mexico, Samalayuca Els$ December 1992, Bid Award Pakistan, Uch E7$ July 1993, MOU Signed Peru, Aguaytia b_$_ March 1994, Project Development Philippines. Sual E1 $ s April 1994, Bid Award Turkey, Birecik | E7 $ April 1989, MNER Mandate 0 1 2 3 4 5 6 7 Years a. Bridge financing was obtained prior to construction. b. No PPA. Source: Case study project sponsors and lenders. study projects (27 percent), yet these companies control the highest equity stake in ELCOSA (30.6 percent), but less than 10 percent of the equity in the private power Wartsila was the lead developer. TEAS has the highest equity market as a whole. Global developers have only 7 percent stake in Birecik (30 percent), yet Holzmann was the lead of the case study project equity, but 14 percent of the total private power market. Although there is only one regional Equity participation in case study projects player in the 10 case study projects (CEPA), it controls 20 Global developers Global utility percent of the equity because it owns 92 percent of the 6.6% affiliates second largest case study project, Sual. Local industry Third, in more than half the projects, one of the lead 8.6% developers is a major supplier (table A. 1). In five projects Public sector. _ (Samalayuca, ELCOSA, PT. Jawa, Birecik, and Uch) an 6.9% Other ~ equipment supplier is one of the main developers. In one 3.3% (Aguaytia), the fuel supplier is the main developer. The pro- ject company owns the gas and Maple Gas is the operations and maintenance contractor for gas production and trans- Regional lEntrsppir/ players 27.2%pier portation. 20.4% l2 e Fourth, the lead developer is usually the party with the Global fuel largest equity stake. There are some exceptions, however. Infrastructure funds companies Scudder Latin American Trust for Independent Power has Source: Case study project sponsors and lenders. 17 developer. Also PanEnergy International Corporation and power in spot market. The capacity payments to EPSA will El Paso Energy International Company have the highest be sufficient to cover the clebt service, fixed costs, and return stakes in Aguaytia (24.3 percent each), while the lead devel- on equity even in the event that the plant is not dispatched. oper, Maple Gas, has only 12 percent. The average debt ternm is 13 years. Debt terms are gen- Fifth, the lead developer rarely retains more than 50 per- erally related to a lender's country limits and willingness to cent of the project equity. This small share reflects a need accept risks, and they are also limited by the PPA term to diversify risks, especially in first time projects where risks length. PT. Jawa, Uch, and Sual, the projects with the longest tend to be greater, though an exception is CEPA, which PPAs, have the longest debt terms. ELCOSA and Birecik holds 92 percent of the equity in Sual. have the shortest PPAs. ELCOSA has the shortest debt term of all of the case study projects (10 years), while Birecik's Project and Financial Structure (14 years) is one year longer than the case study average. The case study projects reflect a greater amount of credit Seven of the 10 projects use a BOO structure (table 7). enhancement than is found in the market as a whole. More BOO sponsors permanently own the project and usually than 80 percent of all debt raised for the 10 case study pro- sell power to off-takers under long-term PPAs. Two pro- jects is either financed or guaranteed by an ECA, a MDB, jects (Sual and Birecik) have BOT structures, in which own- or a bilateral institution (figure 13). Samalayuca, Sual, and ership of the project is transferred to the off-taker at the Birecik received the majority of this debt from ECAs, while end of the PPA term. Samalayuca uses a BLT structure in ELCOSA and Termovalle MDBs provided or syndicated under which the sponsors lease the plant to the off-taker most of the financing. All. four of the case study projects in (CFE). The sponsors retain possession of the plant until Latin America rely, to some degree, on funding from the the end of the lease, when ownership is transferred to CFE. IDB. Only Tangshan has no debt from an ECA or multi- In nine of the 10 case studies, revenue is secured through lateral. long-term PPAs or lease agreements (see table 7). The aver- This significant amouint of credit enhancement reflects age PPA length for the case study projects is 21 years, the high level of risk among the case study projects, many ranging from 15 years (Birecik and ELCOSA) to 30 years of which are first time projects. ECAs, multilaterals, and (PT. Jawa). On average, projects in Latin America have bilaterals lend credibility to a project and are often instru- shorter purchase agreement terms than those in Asia. mental in bringing it to financial closure. The Samalayuca Termovalle sells most of its capacity to EPSA through a project in Mexico provides a good example of the impor- long-term agreement, but it also has shorter contracts with tance of these lending institutions in emergingmarkets. U.S. industrial customers. In the future it may sell some of its Export Import Bank (U.S. EXIM) provided more that 80 percent of the debt financing for this project. The sponsors TABLE 7 planned to raise debt from capital markets, but were unable Project and financial structure FIGURE 13 Power purchae Sources of debt in case study projects agreement Ttl$. ilo lengths Debt/equity Debt term Total-$5.4 billion Project Structure (years) ratio (years) Foreign capital markets Mexico. Samalayuca BLT 20 80/20 14 B[ateral 4 Honduras, ELCOSA BOO IS 66/34 10 6.4% Export credit Colombia, Termovalle BOO 21a 72/25 13 agencies Peru, Aguaytia BOO - 62/38k 12 . ! l . -. 60.6% India, jegurupadu BOO 1 8 70/30 12 Mul4 lateral Pakistan, Uch BOO 23 80/20 15 5..4. t Indonesia, PT Jawa BOO 30 80/20 IS .i Philippines, Sual BOT 25 75/25 15 China, Tangshan BOO 20 70/30 10 Foreign Turkey, Birecik BOT 15 85/15 14 commercial Average 21 74/26 13 bank 10% - Not applicable-merchant power plant. Local a. Length of EPSA PPA only 2.5% b. After funding of second tranche of IDB debt. Source: Case study project sponsors and lenders. Source: Case study project sponsorls and lenders. 18 to do so when the 1994 peso crisis eroded investor confi- a small role in the case studies is that none of the case dence in the Mexican market. The IDB stepped in and study projects are located in Malaysia or Thailand, where provided the debt that could not be raised in the capital mar- domestic sources of funding have been the most active. kets. Multilaterals are also becoming instrumental in pro- ject development. For example, the IFC played an important Notes role in renegotiating the PPA in the Jegurupadu project. Only 10 percent of the total project debt came from 1. The project inception date is based on the bid award date commercial banks without any coverage from ECAs, bilat- if the project was competitively bid. If the project was not bid, erals, or multilaterals. In mature markets, commercial banks then the inception date is the date that the MOU, LOS, or LOI are willing to provide uncovered debt to IPPs, but in places was signed. The date that the feasibility study was completed is where there is still a considerable amount of risk, many com- not used as the project inception date. mercial banks continue to insist on some sort of political 2. Central government guarantees for the fast track projects or commercial risk coverage. The reason local debt played are not uniform. 19 SECTION 5 Risk Allocation (10 Projects) R isk management is critical to the financing of pri- exchange to specific projects. Governments can also con- vate power projects. Lenders' primary or, in some trol the activities and influence the financial condition of cases, only source of security is a project's cash flow, public sector power off-takers. Sovereign guarantees can which is subject to considerable technical, economic, polit- provide a way to ensure the performance of off-takers to ical, and foreign exchange risks. Improper management of the satisfaction of lenders. these risks places a project's cash flow in jeopardy and makes Sponsors, governments, and power off-takers can man- lenders unwilling to provide project finance. age fuel supply and price risks, depending on the circum- This section explains the principles of risk management stances of a project's fuel supply. Sponsors can import fuel and describes how the 10 case study projects allocate risk from established international suppliers under long-term between government and private parties. contracts or obtain access to alternative sources. The assessment is based on an analysis of documentable Governments generally control national fuel sources and risk allocation and does not address intangible factors, such fuel import licenses. Power off-takers are best able to absorb as developer judgment, that may influence how project risks fuel price risk bypassing cost increases on to their customers. are allocated under actual circumstances. Case Study Overview Project Risk Management To a large extent, the 10 cases examined for this study fol- Effective risk management depends on a fundamental prin- lowed the risk allocation rnodel outlined above (see table ciple: risks should be allocated to those most able to man- 8). Sponsors, lenders, and contractors (collectively referred age them. The parties accepting risks must have both the to as the project) assume(d nearly all completion, perfor- capability to manage risks and the means to enforce risk mance, and financing risks, while host governments assumed management roles legally. Amodel of howrisks maybe allo- most inflation, foreign exchange, utility performance, and cated to governments and sponsors under this principle is political risks. Fuel risks were shared among private and provided in table 8. public sector participants. Six projects follow this model Project sponsors are best able to manage the risks that closely: Tangshan (China), Sual (the Philippines), PT. Jawa projects will be completed within budget and on schedule (Indonesia), Jegurupadu (India), Uch (Pakistan), and and that theywill perform as technically specified. Sponsors ELCOSA (Honduras). can retain capable contractors whose performance can be Typically, the overall level of government risk assump- contractually enforced, and can use hedging mechanisms tion is commensurate with a country's project risk envi- to manage financing risks. Sponsors can also manage some ronment. In uncertain environments, governments assume foreign exchange and political risks by purchasing political more risk; in more secure environments, they assume less. risk insurance. However, they have little control over polit- The nature of project finance, however, precludes exclu- ical instability, foreign exchange rate fluctuations, and other sive reliance on standard approaches. Projects deviate from economic and political developments. Therefore, they have the model because of varying risk environments and other little ability to assume these risks (see table 8). project-specific circumstances. For example, the govern- Host governments can better manage economic and ment of Mexico assumed substantial performance risks political risks. Foreign exchange and inflation risks can be for Samalayuca, while the Turkish government took respon- addressed by fiscal policy and the allocation of foreign sibility for completion risk on the Birecik hydropower pro- 20 TABLE 8 Risk management mechanisms used by sponsors and government entities Risk Sponsors/lenders/contractors Government entities Predominont risk assumption by project sponsors/lienders/controctors Complebon Project ownership/control Granting of permits/consents Turmkey EPC contracts Development expertise/resources Technical performance Project ownership/control None except for BLT Turnkey O&M contracts Financing Interest rate hedges Off-taker ability to pass-through finance costs Shored risks Fuel availability and prices Control fuel supply for the project Control of local fuel resources, import licenses. Storage/altemative sources Off-taker ability to absorb price increases Predominant risk ossumption by host govemments Foreign exchange Hedge foreign exchange rates Fiscal policy Foreign exchange reserves Inflation Indexed contracts Off-taker ability to pass through price increases Utility performance None Control over off-taker Ability to cover utility's payments Political/change in law Political risk insurance Domestic policy ject. Sponsors of the Aguaytia merchant plant in Peru runs, construction delays, and poor operating performance. assumed substantial economic and exchange rate risks. In addition, all projects purchase insurance to cover nat- Through a loan to the Termovalle project by Financiera ural force majeure risks during plant construction and Energetica Nacional (FEN, a financial institution owned operation. by the Colombian government), the government of Colombia assumed greater technical risks and fewer eco- Project completion nomic and political risks than the model would suggest. While the case studies largely reflect a rational model of All case study projects relied on EPC contractors to com- risk allocation among public and private participants, they plete projects through fixed price and date certain contracts also reflect many unique approaches. Governments and with delay damages. If the delay is not caused by a force sponsors assume different degrees of risk and use differ- majeure event or by a change order from the sponsor, the ent mechanisms for allocating it (table 9). Most important, contractor must pay damages for completion delays. only half the projects rely on central government guaran- Damages are usually equivalent to the amount that the spon- tees as the primary source of government risk assumption. sor would pay to the off-taker for delays under the PPA, The other half rely on nontraditional sources. plus interest. In all projects, however, contractors' poten- tial damages are limited to a specified amount, ranging from Predominant Risk Assumption by 15 percent to 35 percent of the EPC contract value after Sponsors, Lenders, and Contractors certain minimums are met. Sponsors and lenders bear risks to the extent that project completion damages exceed Project sponsors, lenders, and contractors in the case study this limit. projects generally mitigate the risks associated with project While projects generallybear a great portion of the com- completion, technical performance, and operations through pletion risk, host governments may assume a small amount the retention of capable EPC and O&M contractors. of risk through national utility off-taker agreements to Projects are increasingly standardizing the management of help the developers obtain the consents and permits required these risks through the use of standard EPC and O&M to build the plant. This level of government risk assump- practices, which allow sponsors to manage risks of cost over- tion is minimal, however, because these agreements often 21 TABLE 9 Equity interests by project participants Construction Major equipment O&M Fuel Project Off-taker contractor supplier contractor supplier China, Tangshan Colombia, Termovalle Honduras, ELCOSA 0 * India, Jegurupadu * * Indonesia, PT Jawa Mexico, Samalayuca Pakistan, Uch * Peru, Aguaytia Philippines, Sual Turkey, Birecik * Source: Hagler Bailly IIP Knowledge Base. specify no penalties for the off-taker's failure to provide although major defects remain the responsibility of the EPC such support. contractor or equipment manufacturer. The operator often Governments assumed a reasonable amount of com- agrees to a specified heat rate and output schedule over pletion risk in three case study projects. First, in the Birecik the life of the project, putting fees and bonuses at risk if project, the Turkish government is arranging the necessary the guarantees are not met. As with completion, O&M dam- land acquisition and resettlement of people. In addition, ages are typically limited to a specified annual amount.' the government will provide subordinated loans to the Therefore, sponsors and Icnders assume considerable risks project to cover cost overruns. This assumption of risk was to the extent that damages exceed this limit. considered necessary under the physical and economic Termovalle sponsors and lenders assumed even greater uncertainties associated with construction of the large-scale risks. In this project the O&dM contractor receives an annual hydropower project. Second, in Mexico's Samalayuca pro- budget. Any additional expenses require approval by the ject, CFE takes completion risk, having agreed to provide sponsors, who generally consent in order to keep the plant additional funds if inflation, domestic labor problems, or operating. Sponsors' only means of ensuring adequate O&M other factors increase construction costs. Third, in Colombia, performance is to threaten to discharge the operator before FEN assumes the same completion risk as do other lenders. the end of the contract. Governments assumed technical performance risk in Technical performance only two projects. In the Samalayuca project, the Mexican utility CFE is the plant operator and is obligated to make Sponsorsmitigatemajortechnicalperformanceriskbyrely- lease payments regardless of plant performance. FEN ing on outside contractors. All equipment is tested for heat assumes some technical performance risk for the Termovalle rate and output during the testing phase, which immedi- project in Colombia by virtue of its loan to the project. ately precedes commercialization. If the heat rate and out- In addition to sharing responsibility for completion and put are insufficient, the EPC contractor must pay damages. technical performance, sponsors can reduce their risks by After commercialization, the EPC contractor provides a including contractors and equipment suppliers as equity warranty on the equipment, which generally covers the pro- participants. Eight of the 10 case studies involve equity par- ject's first year or two of operation. Unique or specially ticipation by reputable construction contractors, equipment designed equipment may have much longer warranty suppliers, or O&M operators with a great deal of experi- periods. ence (table 9). After the warranty period, the O&M operator takes Equity investments by project participants serve the inter- responsibility for the project's technical performance, ests of both the participants and the project. Equity can guar- 22 antee contractors and suppliers a market for their goods or ments regardless of fuel availability However, Termovalle services, while the project can benefit from a contractor's or does take risks on sales to non-EPSA customers, which are supplier's vested interest in exceptional technical performance not covered by this guarantee. The Uch project will receive (completing a project on time, ensuring that equipment per- capacity payments only if the fuel is not supplied due to forms well, providing low-cost, reliable sources of fuel). Of force majeure events. the four projects that began construction prior to financial With the exception of Sual, the government party assum- closure Jegurupadu, Uch, Termovalle, and ELCOSA) all ing the fuel supply risk obtains fuel from domestic sources. involved equity participation by an EPC contractor.2 These sources are often government-controlled, facilitat- ing government management of these risks. In Uch for Shared Risk: Fuel example, the government of Pakistan guarantees the oblig- ations of the state-owned Oil and Gas Development The major fuel risks involve: Corporation (OGDC). In the Philippines, the government * Supply: Failure to deliver a specified quantity and utility NPC imports coal at international market prices quality of fuel according to a schedule. and supplies Sual under an energy conversion agreement. * Price: Higher than expected prices for fuel. The government is well positioned to obtain coal at a fair Sponsors and governments shared supply risks in the case price, as it may participate in international sales negotia- study projects. Governments assumed most price risks. tions with coal suppliers and other East Asian governments. Fuel supply risks Third-party sales agreement. The second option involves an agreement between the project and a fuel supplier that Sponsors and governments assumed varying levels of fuel is not a party to the PPA. The supplier may be a govern- supply risks using three different alternatives (figure 14). ment entity, but the state does not give any guarantees. Compared to off-taker guaranteed fuel supply, third-party Government or off-taker assumed risk. In the Uch, Sual, sales agreements involve a higher level of risk. Projects and Termovalle projects, a government entity or power forfeit capacity payments and incentive payments if fuel off-taker assumed fuel supply risk.3 supply interruptions prevent the generation and delivery This option represents the lowest level of risk for pro- of power. This type of agreement entails varying degrees of ject sponsors. If fuel is not delivered, the project continues risk, depending on the reliability of the third-party con- to receive its capacity payments. In Colombia the off-taker tractor, the availability of alternative fuel supplies, and the provides fuel to Termovalle, which receives capacity pay- terms of fuel supply contracts. FIGURE 14 Fuel supply alternatives Method of fuel supply Tangshan (coal) Fuel supplier Aguaytia (gas) equity participant ELCOSA (fuel oil)a Third-party agreement P.T. Jawa (coal) Jegurupadu (naptha, gas) ---------------------------------------------------------------_ Sual (coal) Govemment/off-taker Tenmovalle (gas) risk assumption Uch (low btu gas) Low High Project risk a. Fuel import opton. Source: Case study project sponsors and lenders. 23 The Jegurupadu project in India employs this method ply, projects can lose capacity payments if fuel interruptions of fuel supply in acquiring both naphtha and gas for its three do not allow plants to perform as contractually obligated. turbines. One turbine is intended to operate on naphtha, However, equity participation can also reduce risks, as the other two on gas. The gas supply agreement with Gas long as fuel suppliers effectively manage their obligations. Authority of India, Ltd. (GAIL) is only a best efforts con- Moreover, as equity participants, fuel suppliers have a vested tract without penalties for failure to deliver gas. The spon- interest in ensuring that the project receives the required sors are contractually obligated to make some payments to quantity and quality of fuel. GAIL even if gas is not supplied to the project. The Tangshan project in China faces a relatively high In contrast, the naphtha agreement with Bharat Petroleum level of risk, most of which is borne by Tangshan Power by Corporation, Ltd. (BPCL) provides greater security. If BPCL virtue of its relationship to Tangshan West, the proj ect's fuel is unable to deliver naphtha, the project may recover the supplier. If Tangshan West is unable to meet its obliga- cost of delivering replacement fuel. The contract also allows tions, Tangshan Power must indemnify the project. While the project to obtain enough fuel to operate all three tur- this arrangement entails significant exposure, it does not bines on naphtha if gas is unavailable. The plant can store preclude the local government from assuming fuel risks, as enough naphtha to operate all three turbines for 50-60 days Tangshan West and Tangshan Power are owned by the at the minimum level required under the PPA. Tangshan municipal government. The naphtha contract compensates for many of the weak- The Aguaytia project also faces significant risk exposure. nesses inJegurupadu's gas supply agreement. However, the In this integrated gas and power project, the sponsors are gas supply agreement is still a source of project risk, because responsible for developing a gas field, building pipelines, incentive payments under the PPA depend on the type of constructing a power. plant, and installing transmission lines. fuel used. IfJegurupadu operates only one turbine on naphta, The lenders agreed to bear these risks for three reasons. the project may receive incentive payments by maintaining First, there are opportunities as well as risks. About 30 a higher than promised level of availability, even if the plant percent of the project's revenues are expected to come from is not dispatched. If more than one turbine is operated on the sale of natural gas and natural gas liquids. Second, the naphtha, the project may only be eligible for incentive pay- sponsors have signii'icant experience in gas field develop- ments if it is dispatched. This risk is considered important, ment. Third, the sponsors' equity interests provide a strong because the project expects to maintain a high level of avail- incentive to fulfill their role as fuel suppliers. ability and therefore to be eligible for incentive payments. ELCOSA involves a substantially lower level of project Fuel price risk risk. It has a long-term contract for fuel oil with Texaco, a strong, internationally recognized fuel supplier. If Texaco Government power off-takers generally assumed fuel price is unable to provide fuel oil, the project may purchase fuel risks by passing on cost increases under the PPA. Assuming from other international suppliers. that plants produce power at an agreed-on efficiency level, PT. Jawa faces a moderate level of risk. Coal will be sup- sponsors recover all fuel costs. In only three case study plied by PT. Berau and PT Kideco Jaya Agung from mines projects, did sponsors accept price risk. The Aguaytia mer- located 850 kilometers from the plant. Lenders did raise chant plant in Peru receives payments based upon market concerns about the complex logistical arrangements required prices for power, which do not necessarily reflect the pro- for coal delivery and about the economic viability of one of ject's gas costs. However, the cost of power may reflect gas the mine operators. Eventually, the lenders agreed to assume prices in general. the risks, in part because the project has the option of obtain- Tangshan's fuel costs are to be passed along to the pro- ing coal from other foreign and domestic sources.4 ject's off-taker, No:rth China Power Grid (NCPG), but NCPC has provided no price guarantees. Therefore, Fuelsupplierasequityparticipant. Underthethirdoption, Tangshan Power has provided a guarantee that prices will the fuel supplier is an equity participant. Project sponsors allow the project to earn an acceptable rate of return. Under face a high degree of risk exposure in this option, because a termination agreement, failure to implement a tariff adjust- they are exposed to possible losses from both their fuel sup- ment for more than 90 consecutive days represents a default, ply and power project roles. As with third-party fuel sup- in which case Tangshan Power may have to make termina- 24 tion payments. These payments are, in turn, guaranteed by Economic and financial risks the People's Insurance Company of China (PICC). P.T. Jawa accepts a minor amount of price risk. In this Foreign exchange. Power projects face three types of for- project fuel prices are renegotiated annually. While the gov- eign exchange risks: exchange rate, convertibility, and repa- ernment power off-taker, PLN, has no specific obligations triation. With the exception of Termovalle, host with respect to the price of fuel, it has agreed to establish governments assume one or all of these risks in all of the prices that allow the project to earn an acceptable rate of case studies. The Colombian government assumes no for- return. PLN has also agreed to absorb any additional costs eign exchange risk in Termovalle, because the off-taker, to pay for imported coal should the government supplier EPSA, was scheduled for privatization at the time of finan- fail to provide enough fuel. cial closure. At privatization in May 1997, exchange rate risks assumed by EPSA shifted from the government to Host Government Risk Assumption the new owners.5 Some assumption of risk appears warranted based Host governments assumed a substantial amount of risk in on governments' ability to manage foreign exchange all but one case study project, the Aguaytia merchant power issues. Governments often directly establish a local cur- plant in Peru. The major role of host governments is to rency's value. In other cases, they indirectly determine assume risk for lenders in the areas of foreign exchange, its value through fiscal and monetary policies that affect inflation, utility performance, and political stability (table foreign currency flows into the exchange reserves. 10). Govermnents generally assume clly minor project com- Governments also decide how foreign exchange is allo- pletion and technical performance risks, plus some fuel sup- cated and how much of a company's profits must remain ply risks, as discussed above. in the country. TABLE IO Government risk assumption case study projects Technical Economic and financial Project Political Project technical Fuel supply Foreign Inflation Utility changes Country, project completion performance and price exchange interest rate performance in law China, Tangshan 0 0 4 4 4 4 4 Colombia, Termovallea 4 4 4 4 4 4 4 Honduras, ELCOSA 0 0 Q 4 4 * 0 India, jegurupadu 0 0 4 4 4 4 O Indonesia, P.T. Jawa 0 Q 4 4 4 4 O Mexico, Samalayuca 4 4 0 0 0 0 4 Pakistan, Uch 4 0 0 0 4 ) 0 Peru, Aguaytia 0 0 0 4 0 0 4 Philippines, Sual 0 0 * * 4 * Turkey, Birecikb 4 0 n.a. * 0 * Substantial government risk assumption C Partial government assumption 0 Little government risk assumption n.a. Not applicable. a The government assumes partial risk in all categories, except for foreign exchange, as a result of FEN's loan to the project. No other govemment entity assumes risk in the Termovalle project. b. Government risk assumption in the Birecik project is not strictly comparable to that of other projects because of the nature of hydroelectric plants. Source: Case study project sponsors and lenders. 25 With respect to the host governmnents' assumption of * Government assumption ofexchange rate risks only. The foreign exchange and convertibility risks, the case study Indian government assumed no currency convert- projects may be organized into three groups: ibility risks and only a portion of the foreign exchange Government Assumption of Exchange Rate and rate risks in the Jegurupadu project. In this project, Convertibility Risks. In seven of the 10 projects, the only a portion cf the tariff is linked to the U.S. dCl- host government assumed risks for both foreign lar. The termination payment is calculated in dollars, exchange rates and convertibility: Uch, PT. Jawa, Sual, but along with PPA payments, it is paid in rupees. Tangshan, Birecik, Samalayuca, and ELCOSA (table Thus the project bears a risk between the time that A.2). In these projects the governments either indexed payments are received and the time when they can payments to, or made payments in, foreign currency. be converted. Lenders and sponsors were willing to In four projects (Uch, Sual, Birecik, and ELCOSA) take this risk because they believe that India has sat- the risk assumption is supported by a guarantee from isfactory foreign exchange reserves and that the goV- the central government. ernment's manaigement of them has been sound. In two of these projects (ELCOSA and Tangshan) Government assumption of foreign excbange convert- governments assume onlypartial foreign exchange risks. ibility only. Aguaytia is the only case where foreign In the ELCOSA project, government entities took full exchange rate risk is not passed on to the off-taker risk for foreign exchange rates but only partial risk for under a PPA. As a merchant plant, Aguaytia has no currency convertibility and repatriation. Payrnents are such contract. The sponsors believe that the power indexed to the dollar but are paid in lempiras. The market prices in Peru that determine the project's Honduran government is committed to providing for- payments will mitigate foreign exchange risks. Tnese eign currency for relevant fuel payments.6 However, it prices are influenced by international oil and gas prices, gives no assurances of foreign currency convertibility which are denorninated in dollars. for the project's fixed payments. Furthermore, foreign The central bank, however, does guarantee exchange must usually be put in a Honduran bank Aguaytia's conversion of local currency into foreign before it can be transferred out of the country. currency, and the project has the right to freely trans- These risks are mitigated by an agreement with fer funds abroad. In addition, all of the debt and a the project's industrial off-takers and local partners, portion of the equity are covered by currency incon- which makes foreign currency available to the pro- vertibility insurance issued bythe U.S. Overseas Private ject if the government is unable or unwilling to do Investment Corporation (OPIC). This coverage comr- so. The sponsors and some of the lenders have fur- pensates investors if new restrictions prevent the con- ther purchased convertibility insurance from the version and repatriation of remittances from insured Multilateral Investment Guarantee Agency (MIGA). investments. OPIC coverage does not protect against In Tangshan, government entities provide only par- foreign exchange rate fluctuations or devaluations. tial guarantees for both the rate and the convertibility * Foreign exchange repatriation. This study does not focus of foreign exchange. The project's tariff is adjusted only extensively on foreign exchange repatriation. In most if foreign exchange rate fluctuations exceed 5 percent cases, the guarantee of earnings repatriation is cov- in any year. Convertibility and repatriation risks to the ered by each cotntry's foreign business laws rather sponsors and lenders are mitigated but not eliminated than by specific project guarantees. For exarnple, by an "undertaking" by China International Trust and the governments of India and Pakistan allow spon- Investment Corporation (CMTIC). In spite of this under- sors to repatriate all profits. India provides no addi- taking (which does not constitute a formal guarantee), tional guarantees to any specific projects. Similarly, China maylimit sponsors' and lenders' abilityto obtain the government of Mexico gives no specific guaran- and transfer foreign exchange. This undertaking does, tees of repatriation to the Samalayuca project. however, show the government's high level of support * Inflation and interest rates. In general, governments and commnitment to the project. Furtherrnore, under a assume inflation rate risk and sponsors assume inter- special risk insurance policy, PICC has agreed to make est rate risk. In eight projects (all but Aguaytia and any termination payments in dollars. Termovalle), government off-takers allow cost 26 increases caused by inflation to be passed along under Off-taker performance PPAs or lease agreements. In the Birecik project, the Turkish government will bear additional inflation risks The off-taker's ability to perform as contractually obligated by providing subordinated debt if the project expe- may be the single most important risk facing private power riences cost overruns. While this arrangement was projects. All projects require off-takers to make payments not established specifically to guard against infla- according to an agreed-on arrangement. For nonmerchant tion, it does cover cost overruns that may be caused projects, the primary or even sole source of value is the PPA. by inflation. It governs the quantity and price of power, and allows prices In these same eight projects, sponsors assume risk for to adjust for inflation and exchange rate fluctuations. PPAs floating interest rate loans. However, sponsors typically mit- also govern political and force majeure risks and contain igate this risk by purchasing swaps that convert floating rate provisions for contract termination and assignment. loans into fixed interest rate loans. Merchant power projects do not have this security. Rather, In the Samalayuca project, the government-owned util- they must depend on expectations of power market sup- ity CFE assumes both interest rate and inflation risk. As in ply, demand, and prices. the Birecik project, if Samalayuca experiences cost over- For projects with PPAs to be financed on a limited- runs, CFE will provide additional funds, in the form of recourse basis, lenders require security from the utility either direct contributions toward completion or higher responsible for meeting those obligations. In industrial coun- lease payments. CFE also assumes interest rate risk in this tries, where lenders recognize most utilities as commercially lease because lease payments are not fixed until the time viable entities, the utility's balance sheet and a favorable of lease conversion. Higher interest rates will mean higher and predictable regulatory environment can provide an ade- lease payments from CFE to the project. InAguaytia, spon- quate source of security in most project finance. In devel- sors assume risks for both inflation and interest rates. oping countries, where utilities are either unknown entities Because the project is a merchant plant and so has no power or unacceptable credit risks, lenders typically seek to have purchase agreement, there is no vehicle for passing increased utilities' obligations secured by government entities with costs along to the customer. Still, the sponsors' inflation good credit. Weak government credits in Pakistan's Uch and interest rate risks may be mitigated to the extent that project were strengthened by a World Bank guarantee. higher inflation and interest rates will also tend to increase Lenders' traditional source of security for utility per- market power prices in Peru. In the Termovalle project, formance has been central government sovereign guaran- the privatized EPSA bears inflation and interest rate risk, tees. This form of security is in fact comrmon in the case while FEN assumes the same risk as any other lender. studies (figure 15). Six of them have some form of central FIGURE 15 Government risk assumption and utility performance Central governme t Other government risk assumption Primary form Sovereign Partial Comfort Strong Weaker Little/no of government guarantees guarantees letter government govermnent government support entities entities risk assumption Government/ off-taker risk High D> Medium D Low assumptiona Case study Birecik Jegurupadu PTJawa Termovalle Aguaytia projects ELCOSA Samalayuca Uch{{Ta1a Sual Tangshan a. Govemment risk assumption of utility performance determined by the degree to which government enates, other than the power off-taker, guarantee utlity performance. Source: Case study project sponsors and lenders. 27 government assurances. Of the projects with central gov- prehensive guarantee of off-taker obligations that includes ermnent assurances, one has only partial guarantees and a waiver of sovereign irmmunity (figure 15). The central gov- one received only a pledge of government support rather ernments of Honduras, Pakistan, the Philippines, and Turkey than a specific guarantee. Of the four projects without provided guarantees of utility performance under the Pr-A. central assurances, two rely on security from government These governments also guaranteed repayment of debt and entities other than the central government. Two projects some equity upon terrnination. have no performance guarantees from any entity other than The Jegurupadu project in India received only a partial the power purchaser. guarantee. The central government does not guarantee payments from the Andhra Pradesh State Electricity Board Traditional central government risk assumption. Central (APSEB) to the project, but only guarantees foreign debt government assurances are the traditional mechanism by upon the project's termination. This guarantee is consider- which governments secure utility performance. They are ably less comprehensive than that provided to the Dabhol the major source of utility performance security in six of project, which did guarantee utility performance under the the case studies: PT. Jawa, Sual, Jegurupadu, Uch, Birecik, PPA as well as a termination guarantee. To compensate for and ELCOSA. this deficit, Jegurupadu also received state guarantees from There is, however, significant variation in the scope and the government of Anclhra Pradesh for APSEB's payments strength of guarantees provided by governments. The PT. and for all debt and equity upon termination (table 11). Jawa project in Indonesia has no guarantee but has a letter of support (a comfort letter) from the government of Indonesia. Alternative sources of government risk assumption. In the This comfort letter, like that provided to PT Paiton, con- Tangshan and Termovalle projects, utility performance risk firms the government's support for the project. It represents was assumed by government entities other than the central a strong commitment by the government to ensure that PLN government. Assurances for Tangshan were provided by a will honor its financial and contractual obligations. However, combination of local and central government entities, sim- the comfort letter is not a binding guarantee of PLN's oblig- ilar to those in India'sJegurupadu project. Through Tangshan ations. Therefore, it may lack legal enforceability. Power, the municipality of Tangshan guarantees the quan- While the other five projects with central government tity of power sold to NCPG. It further guarantees that the assurances received specific assurances, there is great vari- price paid by NCPG will give the project an adequate rate ation in the scope of the guarantees. The strongest is a com- of return. Though comprehensive, the Tangshan munici- TABLE I I Government power purchase agreement termination guarantees Power Termination guarantees Country, project payments Debt Equity India, Jegurupadu Government of India C APSEB Is Pakistan, Uch c* Philippines, Sual c* China, Tangshan PICC Tangshan Municipal Turkey, Birecik * 0 Honduras. ELCOSA * cc1 * Full guarantee C Partial guarantee a Foreign debt only. b. Senior debt only. c Fixed payment guarantee only implicitly covers debt and equity. Source: Case study project sponsors and lenders. 28 pal guarantee was not considered financeable because Third, the presence of the IDB and U.S. EXIM helped lenders believed that the municipalitylacked sufficient finan- to mitigate utility performance risk. IDB is a major lender cial strength. Therefore, the project purchased insurance to Mexico, and the United States is an important trading from the central government insurance company, PICC, partner. The participation of these financial institutions to cover outstanding debt payments in the event that reduces the likelihood that CFE will default on its payments. Tangshan Power should be unable to perform as specified Sponsors and lenders assumed even greater risks for in the PPA. power payments in the Aguaytia project. Payments will be In Colombia FEN assumes the same off-taker perfor- made to Aguaytia from generators that are members of the mance risks as other lenders through its $15 million, 12- Committee for Economic Operation of the System, which year, limited recourse loan to Termovalle. FEN's is responsible for dispatching generating units in Peru, but participation reassured lenders and sponsors that the com- no government entity supports these payrnents. In addition pany acquiring EPSA under its scheduled privatization to these risks, Aguaytia's sponsors and lenders accepted would be able to meet EPSAs obligations. The project, risks for price fluctuations in Peru's competitive power however, has no specific guarantees from any government market. entity for EPSA's power payments. Termovalle was the Lenders' acceptance of these risks is exceptional in that first IPP in Colombia that did not receive a government few merchant power projects have been project financed. guarantee of power payments and the first to receive a Other merchant projects such as Ave Fenix, a 160 MW loan from FEN. gas-fired plant project in Argentina, were balance sheet financed.7 There are six reasons why lenders were more Littleornosupportofutilityperformance. Governmentspro- willing to accept these risks in the Aguaytia project than in vided little or no support of utility performance in two pro- Ave Fenix (table 12). jects, Samalayuca in Mexico and Aguaytia in Peru. Given the Non-power revenues. Aguaytia expects to earn 3 0 per- irnportance of a PPAin securing project finance, and the expe- cent of its revenues from the sale of natural gas and rience of the eight other projects in which strong govern- natural gas liquids, which have value in Peru and in ment support was essential to financial closure, the fact that international markets. This anticipated revenue was these two projects were financed on a limited- recourse basis important to Aguaytia's project finance. In contrast, seems unusual. However, both of these projects have excep- Ave Fenix relied entirely on merchant power revenues. tional characteristics that explain why financing was possible C Competitive capacity costs. Aguaytia was able to con- without government support of utility performance. These struct its power facilities for a cost of about $450/kW factors indicate that the absence of government support is Ave Fenix had capacity costs that were higher by about likely to be the exception rather than the rule. $150/kW. Developers and lenders to Samalayuca agreed to accept * Strong MDB support. The presence of the IDB, a sig- risk for CFE's performance for three reasons. First, CFE nificant lender to Peru, reassures both the sponsors is a large and powerful institution in Mexico and was con- and other lenders about important political risks. sidered by some lenders to be a better credit risk than the High power pices. Power prices in Peru are currently government. That the lease payments to Samalayuca will about 5-6/kWh, which is very high relative to the constitute only about 3 percent of CFE's total capital and project's expected costs and in comparison with costs operating costs is indicative of CFE's size. in other merchant markets. Given the country's Second, utility performance presented the only major reliance on expensive oil-fired generation, power risk. Under the project's BLT structure, CFE assumes all prices are unlikely to fall below 3.5¢/kWh for the fore- operating risks other than major mechanical defects. Even seeable future. if CFE has difficulty obtaining fuel supplies or experiences * Favorable power pricing rules. Under Peruvian dispatch operating problems, it is still obliged to make lease pay- rules, merchant power projects can receive capacity ments to the sponsors. In BOO and BOTprojects the spon- payments regardless of whether power is dispatched.8 sors assume many of these risks in addition to utility These rules provide a source of revenue that is not performance risk. CFE also accepted the risks for inflation, affected by spot power prices. These rules also pro- interest rates, and foreign exchange. vide no incentive for projects to underbid their energy 29 TABLE 12 Comparison of Aguaytia and Ave Fenix power projects Aguaytia, Peru Ave Fenix, Argentina Characteristics 155 MW gas-fired turbine 160 MW gas-fired turbine Revenues Hydrocarbons: 29% Merchant power: 100% Capacity payments: I 1% Merchant power: 60% Capacity cost $450AW $600/KW Lenders Capital markets Commercial lenders IDB Power prices 5-6¢A/kW 20/kWh Pricing rules Two-price formula One pnce formula: capacity payments made based on dispatch Project stucture/payment priority Integrated Conventional I. Gas and power operating costs I. Gas and other operatng costs, 2. Debt payments (including debt and equity on gas) 3. Gas and power equity 2. Power plant debt 3. Power plant equity Note: Approximated estimated prices as of first quarter 1997. Power pnces in Peru expected to decline to about 3-4¢/Wh. Source: Case study project sponsors and lenders. prices, as Argentinian rules have sometimes done Within their borders, governments are responsible for main- under the country's "one price" rule. During the time taining political order and making changes in the law. that Ave Fenix was being financed in 1996, some Sponsors' only recourse for mitigating political risk is through power plant operators in Argentina were selling energy political risk insurance. They have few mechanisms for man- at prices below their variable costs in order to obtain aging changes in the law other than relying on host coun- dispatch priority and thereby receive capacity pay- try governments. Foreign sponsors often fear that they are ments.9 At that time, the pricing rules were a major easy targets for discriminatory changes in law. factor in explaining lower power prices in the Argentine market. Today, other factors, such as increased effi- Political. Political risks include expropriation, insurrec- ciency, new plants, and low gas prices available to gen- tion, political violence, and changes in law that adversely erators have kept prices low. affect a project. Although governments provided assurances * Integrated project structure. In contrast to most power for many or all of these risks in the case study projects, many plant finance, Aguaytia's integrated project struc- project sponsors still chose to purchase coverage from MDBs ture provides preferential treatment for lenders. In or ECAs against expropriation, insurrection, and political conventional finance of nonintegrated projects, debt violence. and equity for fuel supply is paid before power pro- Central governments assumed sizeable political risks in ject debt. In Aguaytia debt to finance both gas and five of the case study projects: Uch,Jegurupadu, Samalayuca, power-related assets must be repaid before any equity Sual, and Birecik. In these projects the utility is obligated is paid. Because of this preferential treatment, lenders to make capacity payments if force majeure or other polit- estimate that debt can be fully repaid even with power ical events prevent the project from generating power or prices that are less than half their current levels. the off-taker from receiving it. There are limitations, how- ever, on the types of political events for which govern- Political risk and changes in law ments will assume risk. For example, the government of Pakistan will pay Uch its full capacity payment only if cer- Governments generally assumed the risk for both political tain political force ma;jeure events occur inside Pakistan or events and changes in tax and environmental law that could directly involve the country (war, insurrection, loss of gov- increase costs or interfere with the project operation. This ernment authorizations, nationwide strikes, changes in law). finding is consistent with expectations, given the relative In some cases this payment will also include an amount ability of sponsors and governments to manage these risks. sufficient to repair any damage to the power plant. 30 In two of the study projects, governments limit their may be obligated to repay Sual's outstanding debt and equity assumption of political risk to events that prevent off-tak- investments if the sponsor's investment is materially reduced ers from receiving power. In Indonesia PLN is required to by new or modified laws or regulations. The Philippine gov- make capacity payments to PT. Jawa if political force majeure emient supports NPC obligations under its guarantee. prevents PLN from accepting delivery of power. It must Change in law termination provisions negotiated for also pay if a change in environmental law, a government Termovalle state that the privatized EPSA can exercise an denial of a consent, or natural events prevent PT. Jawa from option to terminate the project if changes in environmen- delivering power. PLN does not, however, have to provide tal law increase the project's capacity costs by more than capacity payments for acts of war, public disorder, strikes, 10 percent. EPSA must then make a termination payment or natural events that prevent PT. Jawa from supplying that is sufficient to cover outstanding debt balances and power but do not affect PLN's ability to accept delivery. equity returns. Similarly, in the ELCOSA project, Empresa Nacional The only form of government risk assumption in the de Energia Electrica (ENEE) is obligated to make capac- Aguaytia project is a government guarantee of tax stability ity payments even if it cannot accept power, but not if the for 30 years on hydrocarbon revenues and 10 years on power project cannot generate power because of a political force revenues. majeure event. In several projects government entities are obligated to Summary: govemment risk assumption buy out the project and make a termination payment in the event of expropriation or extended political violence. The level of government exposure in the case study pro- Termination payments in these projects cover most or all jects suggests three important condusions about both tra- project debt and in some cases include equity as well. For ditional and alternative forms of government risk example, in the Tangshan project, the Chinese off-taker is assumption. not obligated to make any payments under force majeure First, traditional, central government guarantees con- events. If, however, a force majeure event lasts for more stitute the strongest form of government risk assumption. than 90 days, the sponsors can exercise an option to ter- In the five projects with central government guarantees, ninate the project. Tangshan Power must then repay out- governments assume the greatest level of risk (table 13). standing debt but no equity. This obligation is supported This is a logical finding given the fact that adequate assur- by a special risk insurance policy from PICC. ance to a project depends not only on the comprehensive- In Pakistan either the project company or the govern- ness, but also on the strength of the entities assuming risks ment can terminate the Uch project if political force majeure and the enforceability of guarantees. events inside Pakistan, or directly involving Pakistan (war, Second, for some projects, nontraditional forms of gov- insurrection, loss of government authorizations), continue ernment risk assumption can provide adequate security for for more than 180 days. In such a case Pakistan must pay project finance. Market participants seem to be exploring Uch an amount sufficient to repay the debt. In most cir- new methods for allocating risk among various government cumstances, termination payments also cover equity invest- entities. In five projects, the primary or even sole source of ments. For force majeure events that do not incur inside government risk assumption was provided by creditworthy Pakistan or directly involve it, the governrnent is not oblig- entities other than the central government. These bodies ated to make capacity or termination payments. included local governments (Tangshan and Jegurupadu), development banks (Termovalle), and insurance companies Changes in law. Changes in tax and environmental laws (Tangshan). In two projects (PT. Jawa and Samalayuca) the can greatly increase project costs. In most of the case stud- government entity primarily responsible for government risk ies the power purchase agreement specifies that cost increases assumption was the off-taker itself. Only in Aguaytia did resulting from changes in these laws may be passed through government entities assume very little risk. to the utiiity under the power tariff. In some cases project Third, the trend in government risk assumption is to pro- sponsors can exercise options to terminate the project, trig- vide subsequent projects with either the same level of gov- gering the obligation by the utility or host government to emient risk assumption or an even lower level. To a large buy out the project. For example, in the Philippines, NPC extent, this trend reflects a decision to extend fewer com- 31 TABLE 13 Summary of government risk assumption for case study projects Overall Government risk Central Other government government assumption trend Country, project government entity risk assumption or future projects China, Tangshan 0 C Colombia, Termovalle C c Honduras, ELCOSA c C LI. India, Jegurupadu C * L I Indonesia, PT. jawa 0 C C Mexico, Samalayuca - * O Pakistan, Uch 0 C C Peru, Aguaytia 0 0 0 r Philippines, Sual * 0 * Turkey, Birecika C 0 *. Substantial government risk assumption C Partial government risk assumption 0 Little government risk assumption 3 Decreasing government risk assumption, E: No change. - No government risk assumption. a. Government risk assumption in the Birecik project is not stricty comparable to that of other projects because ofthe natre of hydropower plants. Source: Case study project sponsors and lenders. prehensive central government guarantees to future projects. The project risk environment varies widely among the Five countries that offered such guarantees (Philippines, countries examined (table A.6). In the Philippines and Pakistan, India, Turkey, and Honduras) are considering reduc- Indonesia a combination of favorable regulations and low ing or eliminating them in the future (table 13). There is also economic and political risk translates into a low project risk a trend toward less government risk assumption in coun- environment. Conversely Honduras has high perceived eco- tries that do not offer central government guarantees. Many nomic and political risks and an uncertain regulatory envi- future projects in Mexico will have BOO rather than BLT ronment, and therefore has a high project risk environrnent. structures. In BOO structures, governments assume fewer In Turkey a high level of project risk and the particular operation and technical risks. In Colombia future projects construction and technical risks associated with hydropower will likely operate in merchant power markets without PPAs. projects led to greater government risk assumption for the Birecik project (figure 16). So too in Honduras and Pakistan Relationship of Project Risk Environment do relatively high-risk environments lead to fairly signifi- and Government Risk Assumption cant government risk assumption. In Indonesia a low per- ceived level of project risk was matched by the relatively Government risk assumption in each of the case study pro- slight government risk assumption for PT. Jawa. jects is largely commensurate with the country's risk envi- In only a few case study projects is the level of govern- ronment. More support is given in high-risk environments ment risk assumption not commensurate with the project than in low-risk environments. A country's project risk envi- risk environment. These exceptions do not indicate a mis- ronment depends on both regulatory risks and on political calculation. Rather, they reflect legitimate project-specific and economic risks. (Euromoney's Political and Economic considerations by governments and sponsors. The Philippine Scores and Standard and Poor's Long-Term Foreign Currency government provided comprehensive guarantees to the Sual Ratings are some of the better indicators of these risks; see project despite a low-risk environment in order to expedite table A.4). The regulatory risks for IPPs depend on favor- the project during a period of acute power shortages. Sual's able policies and laws, independent regulatory arrangements, development time of 1.5 years was exceptionally fast. In con- transparent competitive bidding frameworks, and a lack of trast, the government of Peru assumed little risk for the dominance by state-owned utilities (table A.5). Aguaytia project in a medium-risk environment. The pro- 32 FIGURE 16 2. Termovalle did, however, receive limited recourse bridge Relationship between country risk environment financing to begin construction. and government risk assumption 3. Hydroelectric resources to the Birecik project are not Govemment considered fuel for the purposes of this discussion. In this risk assumption project, the Turkish government guaranteed water levels for High Birecik Birecik and the sponsors receive capacity payments regardless * Sual 'Uch * ELCOSA of hydrological conditions, except in the case of a force majeure *Jegurupadu event. Medium *Samalyuca MediumSm*Tangshan 4. The project's harbor is sufficiently deep to accomodate large P.T. Jawa Targshan vessels that can economically transport coal from a variety of 'P.T. Jawa ITermovalle sources. Low *Aguaytia 5. EPSAs payments to the Termovafle plant are indexed to dollars. Sponsors and senior lenders mitigated foreign exchange Low Medium High risks through political risk insurance and arrangements with a Country risk environment Note: The assessment of the risk environment and government risk Colombian trustee. assumption in the Birecik project, to some extent, reflects the 6. Honduras gives fuel importers favored access to foreign specific nature of hydroelectrc project risks. Source: Assessment of risk environment (tables A.4, A.5, and A.6) and governmer exchange. As the country's largest fuel importers, the ELCOSA risk assumption (table 3). sponsors have first rights to foreign exchange. ject sponsors and lenders bore all the risks except for changes 7. Lenders did offer project finance terms to Ave Fenix. in tax law and foreign exchange convertibility and repatri- However, the sponsors chose to obtain better loan terms avail- ation. Lenders felt comfortable assuming these risks because able for balance sheet finance. of the project's strengths, which were described earlier. 8. Capacity prices in Peru are based on the cost of a peaking plant and are adjusted to reflect the supply-demand balance. Plants Notes receive lower capacity payments under excess capacity and higher payments during supply shortages. 1. Damages caused by O&M failures could exceed the value 9. Argentia's one price system was recently amended, of the O&M contract. O&M contractors are unwilling to assume however, to eliminate these incentives to under bid energy this risk and thus their penalties are limited. prices. 33 SECTION 6 Conclusions P rivate power in developing countries is experienc- A solid base of experience ing an unprecedented boom as countries' need for power has expanded more rapidly than their abil- The amount of capital invested in private power projects ity to finance it using public funds. Private power finance grew from $6 billion in 1993 to $23 billion in 1996. A total realized some $50 billion in investment during 1994-96, of 329 equity participants financed more than 239 projects, nearly two-thirds of it was project-financed. The number generating 47 GW in 48 countries. Awide variety of sources of equity participants more than quadrupled. have provided the debt for this newly established market, This boom in financing is attributable to several factors: including traditional lenders such as ECAs, MDBs, and the development of mechanisms allowing projects to be commercial banks and new ones such as international cap- solicitedand negotiated fairly (international competitive bid- ital markets and local financiers. Many projects iniclude ding), the willingness of governments to provide projects with complex arrangements, relying on the integrated finance of levels of security, and the provision of credit enhancement power and non-power assets. by ECAs and MDBs. The 1994-96 project finance experi- Private and public sectors in developing countries will ence provides a favorable base on which the market can be able to build on this solid base of experience. This study develop furither. While the private power growth is slowing shows that as countries gain private power experience, in many countries, large new markets are opening in others. they are likely to seciare financing for new private power The future also holds many challenges, including the projects more quickly specter of contract renegotiation, a decrease in sovereign guarantees, the emergence of alternative investment oppor- Large number of projects under development tunities in the power sector, and the threat of fewer investors willing to participate in the market. There are currently more than 1,400 projects under devel- In addition, the new market may offer increased scope opment with a capacity of 550 GW Experience suggests for merchant powerwith project payments determined by the that about one in five of these projects will succeed. If this market rather than by long-term power purchase contracts. success rate continues, the projects now under develop- Because of the unreliability of the revenue stream, lenders ment will make a sigrificant contribution toward meeting have been reluctant to provide project finance for merchant the power demands of developing countries for the next power projects, which could substantially inhibit their growth. several years. Sustaining the spectacular growth in private power finance That private power finance has already given some co,n- in developing countries will require contributions from all tries (Pakistan, Malaysia, Indonesia, the Philippines) the major private power stakeholders. Governments, lenders, capacity they will need over the next few years does not and developers need to find new ways to give projects the diminish growth prospects. Many more countries still need security they need under rapidly changing conditions. power, including several large countries such as Brazil, China, India, and Mexico. Encouraging Factors Increasing number of equity participants Several encouraging factors indicate that project-financed power plants will continue to provide a substantial amount The number of participants in the market has kept pace of developing countries' power needs. with the growth in capacity that has been financed. New 34 players, including equipment and fuel suppliers as well as developed procedures for allocating political and commercial engineering and construction firms, have entered the mar- risks to those most able to assume them. As governments ket, offering greater competition and new services that can seek to reduce their risk assumption in private power finance, help develop projects creatively commercial lenders will likely need greater support from ECAs and MDBs. Increased competitive bidding Suitable government risk assumption International competitive bidding has become an estab- lished part of IPP policy in many developing countries. It Evidence from the projects examined in this study reveals accounted for nearly one-fourth of all private power capac- that governments in developing countries are becoming ity financed in 1996 and is likely to become more impor- increasingly adept at allocating risk. They are assuming tant in the future. Private investors have shown their levels of risk proportional to the risk environment and are willingness to participate in competitive solicitations, and no longer relying exclusively on central government guar- many countries with significant growth prospects (China, antees for project security. Other government entities, such India, Mexico, and Turkey) have implemented competi- as national banks, government insurance agents, local gov- tive solicitations. ernments, fuel suppliers, and electric utility off-takers are The trend toward competitive bidding is by itself a pos- assuming major project risks. In addition, other forms of itive development, as it sustains market growth in devel- financial security, such as escrow accounts and letters of oping countries, offers utilities the opportunity to rationalize credit are also being used for short-term credit support. the project selection process, and expedites project devel- As governments increasingly come to accept suitable lev- opment. Competitively bid projects can also increase the els of project risk, they are more likely to embrace private transparency and fairness of the decisionmaking process, power as an equitable way of meeting long-term needs. helping to eliminate perceptions of unfairness that might While sponsors and lenders would prefer traditional forms lead subsequent governments to question project selec- of security, they largely seem to accept these alternative tion or renegotiate project contracts. measures in many countries. Continuing need for project finance Increased standardization of risk allocation Developers have sought project fnance for most deals rather IPP developers have achieved a high degree of standard- than risking their balance sheets. In many cases sponsors ization, especially in the general approach to risk alloca- cannot carry debt for such large projects, so reliance on pro- tion in turnkey construction and O&M contracts. The result ject financing is likely to continue. In addition, many devel- is that investors and governments can better focus on issues oping countries continue to experience power shortages. that are specific to the project and the country, such as the With favorable economies of scale and commercial effi- level of government support for power payments, fuel sup- ciencies, large projects can deliver power at competitive ply, and foreign exchange. rates. Challenges Ahead Catalytic role of credit enhancement In addition to these encouraging factors, however, there are ECAs, MDBs, and bilateral development agencies are several threats to the continued growth of private power responsible for more than two-thirds of all private power finance. debt finance. Credit enhancement has been instrumental in providing access to capital under reasonable terms. Threat of contract renegotiation Moreover, nearly all privately financed projects involve some form of multilateral or bilateral political risk insur- The specter of contract renegotiation threatens to under- ance. Private power developers and lenders now have expe- mine the confidence of private investors. The decision by rience working with credit enhancement providers and have the government of Maharashtra in India to first repudiate 35 and then to renegotiate Enron's Dabhol project was the However, this solution required significant commitments single most visible event in private power finance during from the project's Chinese sponsor and the purchase of 1994-96. Other countries, including Pakistan, the largest costly insurance. The Tangshan model will be difficult to PPF market between 1994 and 1996, are considering a replicate, especially for large projects, as it required that the review of some essential arrangements for ongoing projects. project's U.S. sponsors accept no compensation in the event In many countries there is always the threat that public mis- of termination. trust of foreign investment will lead politicians to question In India the capacity that has been financed represents the private power decisions of political rivals. only a small fraction of the projects under development. Perhaps the chief obstacle to a greater amount of project Competing sources of investor interest finance is the unwillingness of the Indian government to provide even partial guarantees, such as those given to the While the number of equity holders in developing country Jegurupadu project. The alternatives to sovereign guaran- power projects has grown with the market, competing inter- tees identified by the Indian government will help finance ests are emerging that may reduce the number of investors only a small part of the capacity that India will need.' and divert attention from greenfield power investments. * Increased prvatization activity. The privatization that Limited role of private risk debt capital has occurred thus far in the power sector is only a fraction of the potential that may be realized in the Commercial banks and the capital markets have shown lit- next few years. Countries that are just beginning to tle willingness to take extensive political risks in develop- privatize will greatly expand this market. ing country private power finance. They have provided * Secondary market activity. The experience with pri- uncovered finance in only a few, mostly low-risk countries vate power in industrial countries suggests that and only 10 percent of the total debt needed between investors will begin selling interests in the projects to 1994 and 1996. So far, other sources, such as ECAs, MDBs, earn quick profits. As a short-term strategy to obtain and developing countries themselves have shouldered the a market presence, new equity participants may focus debt burden. However, as the need for private investment on buying these assets rather than investing in new in both greenfield projects and privatization continues to power projects. grow, the ability of these financing sources to continue tak- * Deregulation in industrial countries. As the power sec- ing risks may soon becorne limnited. To sustain market growth, tors in the United States and Europe continue to private risk debt capital needs to assume a larger role. deregulate, investors are devoting increased atten- tion to mergers, asset acquisition, and restructuring Merchant power plant risk within these markets. As of the end of 1996 no merchant plant project had received Limits on alternatives to central government limited recourse finance purely on the basis of revenues from guarantees power sales. PPAs have traditionally been the main source of security for limited recourse loans. The absence of PPAs The case study projects show that developing countries are in merchant systems has meant the absence of assurance of finding alternatives to central government guarantees in future tariffs. Projects such as Aguaytia in Peru have received order to provide the security projects needed to obtain financingbeause of specific circumstances, the most impor- financing. However, the experience in two of these coun- tant being the ability to generate non-power revenue. tries demonstrates some of the limits of these alternatives. In light of this fact, developing countries that are con- In China, privately owned projects have had difficulty sidering merchant power systems face a dilemna. If they obtaining limited recourse finance because off-takers have establish merchant power markets, they will inevitably reduce provided no firm price commitments and strong govern- access to limited recourse finance. In a country like ment entities have made few or no guarantees. The Tangshan Argentina, where balance sheet finance has provided suf- project sponsors did succeed in finding a creative solution ficient capital, adopting a competitive power system may to finance their project without sovereign guarantees. be logical. 36 There are, however, limitations to such an approach. For must be clear, and government decisions need to be expe- many borrowers, balance sheet finance may be available ditious and fair and not subject to reversal. Governments only at high interest rates and short debt terms. Reliance should make expeditious rulings on security packages that on balance sheet finance is also likely to inhibit the ability will be adequate for deals seeking project finance. to finance large projects. Small plants may be an accept- able way to meet power needs in countries such as Argentina, Implementing effective competitive bidding which has sufficient capacity to meet near-term demand. Countries facing severe shortages, however, may prefer Off-takers in developing countries need guidance in using larger projects. Moreover, developers have been willing to competitive bidding to avoid controversy and select the best risk balance sheets in Argentina because of its low-risk envi- projects. Multilateral and bilateral assistance agencies can ronment. Sponsors may be unwilling to take such chances give impartial advice on competitive bid solicitations and in higher-risk environments, even for small projects. evaluations. And ECAs and private lenders can advise on how to choose projects that can be financed, and devel- Meeting Future Challenges opers can show support by participating in competitive bids. Developers, lenders, multilateral institutions, ECAs, and Finding alternatives to sovereign guarantees developing country governments all have roles in helping the market meet these challenges. This study has shown that adequate private power project security need not always involve sovereign guarantees, yet Avoiding contract renegotiation until off-takers become commercially viable and recognized, many countries will need to continue offering a substantial Sponsors, private investors, and institutional lenders all bear amount of security. Therefore, governments, official lenders, responsibility for avoiding power contract renegotiation. and private investors all have roles in exploring viable alter- Sponsors need to foster professional business relation- natives to sovereign guarantees. ships that are in the long-term interests of both develop- Governments in developing countries will need to offer ing countries and private investors. Governments will then alternatives such as cofinance by local development banks. be more willing to support the long-term commitments that The same type of cofinance that Colombia's FEN provided developers make. to Termovalle can be made available in other countries with Governments can conduct project solicitation and con- strong development banks (Brazil, China, India). tract negotiation in a fair and transparent manner. Politicians Governments that are unwilling to offer comprehensive need to communicate clearly and frequently with their guarantees can offer partial ones, such as debt repayment own citizens so that voters will be supportive of their gov- only in the event of termination. They can further enhance ermnent's IPP policy. the project security environment by making development Official lenders such as ECAs and MDBs are well-posi- processes clear and expeditious and by accepting certain tioned to mediate the interests of developing countries and project risks (inflation and foreign exchange). private developers by promoting private investment through Official lenders can improve project security by contin- mutually beneficial mechanisms. For example, competitive uing to provide credit enhancement, and private investors bidding can help developing countries obtain power at a rea- can fashion creative alternatives to sovereign guarantees. sonable cost while simultaneously reducing perceptions of unfairness that may lead to contract renegotiation. Expanding the role of risk debt capital Maintaining investor interests There is some evidence that private risk debt capital may accept greater levels of risk in the future. Global capital Policy makers in developing countries need to recognize markets are expanding as institutional and other investors that new competing demands for global power capital will look for new investment opportunities. As a result, private decrease investments in markets where private power devel- risk debt capital from commercial banks grew in each year opment is cumbersome. Therefore, solicitation processes from 1994 to 1996. 37 TABLE 14 Participant roles in promoting private power in developing countries Host govemments * Execute dear, fair, stable, and expeditious IPP development policies * Communicate private power strategies to consumers * Provide adequate project security - Deregulate energy sectors, thus encouraging the development of integrated projects * Implement merchant power pricing policies that encourage investrment Developers * Foster long-term relationships with developing countries * Participate in competitive bid solicitations * Find creative altematives to sovereign guarantees Private risk debt capital - Provide financial advice on competitive bidding processes * Increase lending to low rsk countres * End opportunities to lend to projects in high risk markets with ECA and MDB participation Official lenders * Mediate interests of developing countres and private investors * Provide unbiased source of advice on competitive bid solicitations * Continue strong roles in lending and credit enhancement * Provide political rsk enhancements, especially for merchant power projects * Offer advice on power sector reform Private risk debt capital can play an important role in the Summary future by providing a minority share of the debt in projects that receive financing from ECAs or MDBs. From 1994 to Achieving private power's potential in developing countries 1996 such minorityparticipationinrelativelylow-risk nations requires contributions from all market participants (table represented the primary use of funding from capital mar- 14). Solving some problems will require coordinated actions kets for PPF. Private risk debt capital can also expand its by host country governments, official lenders, private role by providing a larger share of finance for projects in financiers, and project developers. In this regard, meeting both high- and low-risk markets. future challenges will indeed be difficult. Developing countries can encourage greater levels of pri- Nonetheless, there is reason for optimism. All partici- vate risk debt capital by giving projects adequate security pants have interests in maintaining strong private power packages. The Tangshan project demonstrated that, even markets (see table 14). Host governments that execute without assurances from official lenders, private commer- clear and fair policies and provide adequate security will cial banks may agree to lend to projects where a strong gov- be more likely to attract private investment. Developers erinment entity guarantees debt in the event of termination. who foster long-term relationships with host countries and find creative solutions to security problems are most Financing merchant power projects likely to succeed in today's competitive markets, Private risk debt capital can take advantage of new opportunities Countries establishing merchant power systems can take by finding ways to invest safely in both high- and low-risk several steps to improve the risk environment for project environments. Official lenders can continue to provide finance. First, pricing rules can be structured so that pro- credit enhancement and mediation, maintaining strong jects are compensated based on the full market value of roles in markets that will increasingly rely on private both capacity and energy. Second, countries can establish investment. two-tiered markets in which a portion of power sales can By realizing their interests in private power investment, be sold under long-term contracts. Third, by deregulating all market participants can help ensure that private power their energy sectors, countries can encourage the develop- continues to make strong contributions to developing ment of integrated fuel and power projects that maybe eas- countries in the future. ier to finance. Official lenders can promote merchant power projects Note by providing loans, political risk insurance, and other forms of credit enhancement that reduce concerns about politi- 1. See USAID/Center for Environment, Office of Energy, cal risk. A lower level of political risk will encourage pri- Environment, and Technology, The Financing Capability of Indian vate investors to invest in merchant power markets. Institutions to Provide Sovereign Guarantees. 38 APPENDIX A Background Tables TABLE A I Case study project sponsors Country, project Lead developers Type Origin Other sponsors China, Tangshan Sithe Energies: 23% Global developer Germany AlI, Gov. of Singapore Investment Corp., Muni. of Tangshan Colombia, Termovalle KMR Power Group: 70%' Global developer United States Marubeni Honduras, ELCOSA Wartsila Diesel Development: 15% Equipment suppber United States Scudder. Illinova, IFC India, Jegurupadu GVK Group: 13.5%b; Local developer/utility India AIF, IFC, ABB, APSEB, CMS: 25.3%c Vintage Investments Indonesia, PT. Jawa Siemens Power Ventures: 50%; Equipment supplier Germany PT Bumipertiwi Tatapradipta Powergen: 35% Mexico, Samalayuca GE Capital: 40% Equipment supplier United States Intergen, ICA-Fluor Daniel, El Paso Plakistan, Uch Midlands Power: 47%; Utility! equipment United Kingdom Hawkins, Hasan Associates GE Capital: 22%; Tenaska: 23% supplier Peru, Aguaytia Maple Gas Corp. de Peru: 1 1.7% Fuel companies United States PanEnergy, El Paso Energy, Illinova, Scudder, Power Markets Development Co. Philippines, Sual CEPA: 92% Regional developer Hong Kong IFC, CDC Turkey, Birecik Holzmann Anlagen: 16.9%; Equipment supplier/ Turkey TEAS, Strabag Osterreich. GECAlsthom: 10.5% contractor ACEC Energie, Cegelec, Sulzer Hydro, Verbund Plan, Gama Endustri, TGT Elektrik a. Includes KMR Corporation, Florida Power and Light, and Scudder Latin America Power Fund. b. Indudes funds from GVK Group Public Shareholders. c. indudes funds from Classic Investments, which is funded by CMS. Note: All ownership shares are as of the time oSf dosure. Source: Case study projed sponsors and lenders. 39 TABLE A2 Sources of debt for case study projects (millions of dollars) Foreign Foreign Country, project ECA Multilateral Bilateral commercial banks capital markets Local Projects without privote risk debt capital Colombia, Termovalle 97 1 5 Honduras, ELCOSA 56 6 India, jegurupadu 68 10 103 Mexico, Samalayuca 430 75 Pakistan, Uch 246 200 80 Philippines, Sual 786277 Projects vyith privote risk debt capitol China,Tangshan 128 Indonesia, PT Jawa 834 250 82 200 Peru, Aguaytia 60 78 20 Turkey, Birecik 985 33C Total 3,281 833 346 54C 278 138 Percentage of total debt 61 1 5 6 IC0 5 3 Source: Case study project sponsors and lenders, TABLE A.3 Government foreign exchange risk assumption in case study projects Country/project Government risk assumption Central government role Government assumption ofexchonge rote and convertobility risks China, Tangshan Tariff adjusted for exchange rate changes over 5 percent/year. CITIC undertaking, but no specific Currency convertability and repatration risks mitigated. guarantees Honduras, ELCOSA Fixed financial and operation and maintenance components of tariff Central govemment PPA guarantees indexed to U.S. dollar. Fuel import costs a pass-through. Currency convertability only assured for fuel costs. Indonesia, PT. jawa Foreign exchange rate changes a pass-through under PPA. PLN No specific guarantees foreign currency indemnity of convertability. Mexico, Samalayuca Payments are denominated and paid in U.S. dollars. None Pakistan, Uch Portion of payment indexed to dollar. Central govemment Central govemment guarantees of PPA guarantees currency convertability and transfer.a Philippines, Sual Payments are made in U.S. dollars, deposited into a New York Central government PPA guarantees bank account. Turkey, Birecik Payments denominated and paid in deutsche marks. Central govemment PPA guarantees Govemment assumption of exchange rate risks only India, jegurupadu Portion of tariff indexed to the U.S. dollar. Termination payment Central govemment guarantee calculated in dollars. PPA and terminabon payments paid in rupees. of termination payment Government assumption of convertobility risks only Peru, Aguaytia The central bank guarantee of currency conversion and nght to Gas revenues covered for 30 years, freely dispose funds abroad. power revenues for 10 years a. Exchange rates are recalculated as least quarterly and may be recalculated monthly if exchange rates change by more than 5 percent. Note: The government of Colombia assumes no foreign exchange risk in the Termovalle project. Source. Case study project sponsors and lenders. 40 TABLE A4 Economic and political risk environment in case study countries Euromoney political Standard and Poor's and economic score Euromoney rank long-term foreign Country, project (U.S.= 100) (I = lowest risk) currency rating China, Tangshana 71 45 BBB Colombia, Termovallea 64 52 BBB- Honduras, ELCOSA 37 104 NR India, Jegurupadu 65 50 BB-- Indonesia, PT Jawaa 71 43 BBB Mexico, Samalayuca 64 51 BB Pakistan, Uch 49 82 B+ Peru, Aguaytia 48 83 NR Philippines, Sual 63 54 BB+ Turkey, Birecik 53 67 B a. Investment grade. Source: Euromoney and Standard & Poor's, 1996. TABLE A.5 Independent power producer regulatory framework in case study countries Independent Competitive Predominant Overall regulatory bidding utility regulatory Country, project IPP policies / law environment framework ownership risk China, Tangshan Limited No No Public High Colombia, Termovalle Favorable Yes Yes Mix Low Honduras, ELCOSA New No No Public High India, Jegurupadu Slow/complex No No Public Moderate Indonesia, PT Jawa Favorable No No Public Moderate Mexico, Samalayuca New Yes Yes Public Moderate Pakistan, Uch Favorable No Yes Public Moderate Peru, Aguaytia New Yes N/A Mix Moderate Philippines, Sual Favorable No Yes Public Low Turkey, Birecik Limited No No Public High Note: Assessment of the regulatory framework is based on conditions as of the time of project development. In some countries, such as Turkey, the project environment may have improved after the time of project development. Source: Hagler Bailly Services, Inc. TABLE A.6 Overall risk environment in case study countries TABLEA.7 Largest power project finance markets, 1994-96 Economic/ Country, project political Regulatory Overall Financial closures, 1994-96 China, Tangshana 0 * 3 Country Number Capacity (MW) Colombia, Termovallea O Q O/O Pakistan 14 4,236 Indonesia 6 3,060 Honduras. ELCOSA * * China 7 2,850a India,Jegurupadu O O Malaysia 4 2,513 Philppines 9 2,100 Indonesia, PT jawaa 0 I O/OP India 3 1,221 Mexico, Samalayuca * * O/ Turkey 2 1,150 Colombia 3 1,1 14 Pakistan, Uch * O O Mexico 1 700 Peru, Aguaytia * O Thailand 3 445 Subtotal 52 19,389 Philippines, Sual 3 0 0 All others 20 1,609 Total 72 20,998 0 High rsk 3 Moderate risk 0 Low risk a. Comprising mostly projects that are majority-owned by municipalties and other public sector entities, these figures exclude projects that are majority-owned by off- a. Investment grade. takers. Note: Risk environment assessment based on information from table A.4 and A.S. Source: Hagler Bailly IIP Knowledge Base. 41 APPENDIX B Note on Source Material T his study drew information from numerous sources. * China: Deutsche Morgan Grenfell (lender), Asian The tables, figures, and text provide some refer- Infrastructure Fund (sponsor) ence citations. Information on market trends with * Colombia: Chase Manhattan (lender), KMR Power respect to the total volume of project finance, identities (sponsor) of participants, and finance trends was drawn from Hagler * Honduras: Wartsila Power (sponsor), Scudder Latin Bailly's Intemational Independent Power (HP) Knowledge American Power Fund (sponsor), Inter-American Base. For this study, the knowledge base was enhanced Development Bank (lender) using additional statistical information on project debt * India: International Finance Corporation (lender) sources and terms, development times, and project struc- * Indonesia: Powergen (sponsor), Credit Suisse First ture. Boston (lender), Teachers Insurance and Annuity Information on case study project structure and risk man- Association (lender) agement was based on three types of sources: loan docu- * Mexico: GE Capital (sponsor), Inter-American mentation from the World Bank and the IFC; publicly Development Bank (lender), Union Bank of available information from conference speeches, magazines, Switzerland (lender) and journal articles and other publicly available sources; * Pakistan: World Bank (lender) and personal interviews with project sponsors and lenders * Peru: Maple Gas (sponsor), Scudder Latin American and export credit and investment insurance agencies. Based Power Fund (sponsor), Trust Company of the West on this infornation, a profile and a risk allocation assess- (lender) ment was derived for each project. Major investors associ- * Philippines: Citibank (lender) ated with each project were given the opportunity to revise - Turkey: Cegelec (sponsor), Chase Manhattan (lender), and comment on this information. Philipp Holzmann (sponsor) The following entities provided personal interviews and/or Several glossary definitions are courtesy of Electric information with respect to the case study projects: Generation Association. 42 APPENDIX C Glossary of Terms Used in the Study Build lease transfer (BLT) Development period Structure in which a private sponsor finances and builds a The time it takes to complete all studies, conclude negotia- project and then leases it to an off-taker during a defined tions, and arrange financing. The starting date depends on period. The private sponsors own the project until the end how the project is initiated (bidding process, issuance of let- of the lease, at which time it is transferred to the off-taker. ter of intent). The ending date occurs at financial closure. The off-taker is responsible for operating and maintaining the project, both during and after the lease period. Dispatching Ability of the utility power purchaser to operate an inde- Build own operate (BOO) pendent power producer (IPP) project in a manner con- Structure in which a private sponsor finances and builds a sistent with the utility's load requirements. For utilities project and then owns it indefinitely. BOO power projects operating an integrated electric system, the ability to assign may sell electricity to a utility off-taker or other customer generation to specific plants for reliability and economic under a long-term contract, or they may sell power into a reasons, control operations of transmission systems, oper- competitive market as a merchant power plant (see below). ate an interconnection, or schedule energy transactions with The private sponsors continue to own the project after the other interconnected electric utilities. conclusion of any long-term contracts and are responsible for all operations and maintenance. Energy conversion agreement Power sales agreement whereby fuel is delivered to the Build own transfer (BOT) off-taker in exchange for capacity payments and other con- Structure in which a private sponsor finances, builds, owns, version fees. and operates a project for a defined period of time before transferring it to another entity. While BOT power pro- Financial closing jects do not have to sell electricity under long-term con- The conclusion of the development period (usually a spe- tracts, in practice they have always done so. cific date). It occurs when the legal documentation for all project agreements are in place, all permits and govern- Commercial risk ments approvals have been obtained, and all financing doc- Risk subject to the influence of the project owner. This uments (debt and equity) have been executed. In most cases may include project development, construction of the plant the lender makes the initial disbursement of funds soon within budget and on time, profitable operation of the plant, after financial closing. Construction and commercialization and availability of qualified personnel. may occur prior to financial closure. Debt service coverage ratio Force majeure The ratio of cash available for servicing debt (after all oper- Risks arising from circumstances, generally outside the con- ating and other expenses are paid) and the amount of debt trol of the parties, which entitle one or another party to due (principal, interest, and fees). refrain from performing its contractual obligations. 43 Investment grade ing on the circumstances and the perceptions of project Indication that a long-term debt instrument is of adequate participants. quality for the obligor to meet the debt service obligations. It is normally indicated by assigned rating from credit rat- Private risk debt capital ing agencies such as Moody's Investors Service (a minimum Private-sector financing that does not receive guarantees, rating is Baa3) or Standard and Poor's Corporation (BBB- political risk insurance, or other assurances from multilat- or higher). eral development banks, export credit agencies, or bilateral development agencies. Limited recourse financing A financing arrangement in which lenders have little or no Project finance recourse for repayment of their loans beyond the project A financing approach. in which debt is secured on the basis assets that are pledged to secure the financing. Limited of the expected performance of a specific project rather recourse financing is used to raise the majority of inde- than on the strength of an existing company's balance sheet. pendent power project debt. It involves an assessment of the project's expected cash flow performance under various scenarios to ensure a high prob- Liquidated damages ability of repayment: on the project's debt. Sometimes A form of security in various construction, fuel, and power referred to as nonrecourse or limited recourse financing. purchase contracts that stipulates penalty payments for fail- ure to meet certain contractual terms. Power Project Finance (PPF) Private power projects that are financed on a limited recourse Merchant power plant basis, will sell at least a portion of their power to national A project without a long-term power purchase agreement, utility companies and power grids, and are not controlled in which the price and quantity of power sold are deter- by utility off-takers. mined in a competitive market. Senior debt Off-taker The financing component of a project (usually the largest) A party that purchases power from the IPP In developing that has priority over other creditors and equity in the event countries, the off-taker is usually government owned. of liquidation. Pari-passu clause Sponsor A covenant whereby the borrower agrees to ensure that its A party that takes equity in a project and plays a role in debt payments shall rank at least equally with all its other structuring the project, negotiating the project agreements, unsecured debt. arranging the financing, negotiating and securing the con- struction contract, and performing other tasks associated Political risk with project developrnent. Risk that may include the performance of government- owned entities (including the purchasing utility in most Subordinate debt developing countries), changes in law, issuance of critical Financing component that is junior to senior debt in the permits (customs, environment), wars or insurrections, event of liquidation. expropriations, and foreign exchange convertibility and transferability. These risks, which can generally be con- Term (Loan) trolled or influenced by host governments, vary depend- Number of years until a loan is completely repaid. 44 The World Bank Headquarters 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. 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