Privatesector P U B L I C P O L I C Y F O R T H E Note No. 208 May 2000 Private Participation in Energy Ada Karina The past decade has seen a wave of liberaliza- investment allowed the rapid increase in private Izaguirre tion and privatization of infrastructure activities infrastructure activity in developing countries. in developing countries. By the end of the 1990s Long-term foreign capital flows to developing the private sector had become an important countries—as foreign direct investment, foreign financier and long-term operator of infra- debt, or equity investment—more than quadru- structure activities—in water, transport, energy, pled between 1990 and 1997 before falling in the and telecommunications—in those economies. late 1990s as a result of the financial crises in In 1990–98 it had undertaken the operating or developing economies (figure 1). This influx of construction risk (or both) of about 1,700 infra- foreign capital has made foreign investors the structure projects in developing countries.1 main sponsors of private infrastructure in devel- Those projects involved investments of almost oping countries. In 1990–98 global developers US$500 billion.2 were the top fifteen sponsors, measured by investment, in the infrastructure business in The availability of long-term foreign capital and developing countries and were involved in a the opening of infrastructure sectors to private tenth of the private infrastructure projects in those FIGURE 1 NET LONG-TERM PRIVATE CAPITAL FLOWS TO DEVELOPING COUNTRIES, AND TOTAL INVESTMENT IN INFRASTRUCTURE PROJECTS WITH PRIVATE PARTICIPATION IN DEVELOPING COUNTRIES, 1990–98 Investment (billions of 1998 U.S. dollars) Capital flows (billions of 1998 U.S. dollars) 150 350 300 120 250 Capital flows 90 200 150 60 Investment 100 30 50 0 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 Source: World Bank 2000; World Bank, PPI Project Database. The World Bank Group ▪ Private Sector and Infrastructure Network 2 Private Participation in Energy TABLE 1 TOP TEN SPONSORS OF ENERGY PROJECTS WITH PRIVATE PARTICIPATION IN DEVELOPING COUNTRIES, 1990–99 Total investment Sponsor Projects (billions of 1998 U.S. dollars) AES Corporation 35 12.7 Enron Corp. 23 12.5 Electricité de France 22 11.5 Endesa (Spain) 11 9.1 Southern Energy Inc. 10 7.6 CMS Energy Corporation 17 6.7 Cia. Naviera Perez Companc 8 6.2 Endesa (Chile) 15 5.7 Tractebel 17 5.6 Enersis 7 5.3 Total 156 68.2 Note: Table includes projects in which the sponsor has at least a 15 percent stake. The data do not sum to totals because in some cases more than one sponsor is involved in a project. Source: World Bank, PPI Project Database. The World Bank Group 3 countries. These projects accounted for almost a ▪ Investment in energy projects with private par- third of total investment in such projects. ticipation declined in 1998 and 1999 from a peak in 1997, falling most in East Asia and the The energy sector, which in this analysis covers Pacific and Latin America and the Caribbean. electricity and natural gas transmission and dis- ▪ Latin America and East Asia have led in private tribution, has been at the center of the liberal- activity in energy, each following a different ization and privatization activity. (Oil and approach. upstream natural gas activities are excluded from ▪ Private activity in energy—whether measured this Note.) As in other infrastructure businesses, by countries, projects, or investment—has in energy private activity has been driven by the been concentrated more in electricity than in need to expand capacity and increase reliability natural gas. in an environment of tight public budget con- straints. Private participation and competition Rapid growth in private activity have also been propelled by new technological developments that have reduced the minimum Private activity in energy, measured by total size of competitive power plants, lowered trans- investment (private and public contributions) in actions costs, and increased the efficiency of grid projects with private participation, boomed in utilization. 1990–97, rising from less than US$2 billion to US$46 billion (figure 2). It then fell to US$25 bil- In 1990–99 seventy-six developing countries lion in 1998 and to US$15 billion in 1999—its introduced private participation in energy (elec- 1993 level—as a result of the financial crises in tricity and natural gas transmission and distribu- developing countries in 1997–99. The economic tion). These countries awarded the private sector downturns dampened the growth in energy more than 700 energy projects, representing demand. Annual growth in electricity demand in investments of almost US$187 billion (map 1). developing countries (excluding transition Foreign capital has been a major source of funds. economies) dropped from 6.5 percent in 1990–96 In 1990–99 global developers were the top ten to 4 percent in 1996–2000 (U.S. Department of sponsors of private energy projects, measured Energy 2000). The financial crises also made by investment, in developing countries and were international financial markets reluctant to invest involved in a fifth of those projects. Their pro- in developing economies. According to prelimi- jects accounted for just over a third of total nary World Bank estimates, net long-term capital investment (table 1). flows to developing countries declined by a fifth between 1997 and 1999 (box 1). This Note draws on the World Bank’s Private Participation in Infrastructure (PPI) Project Most affected were Latin America and East Asia. Database to provide an overview of trends in the In Latin America investment fell from a high of private energy projects in developing countries. US$23 billion in 1997 to US$7 billion in 1999, The PPI Project Database tracks infrastructure mostly because of the deferral of generating projects, newly owned or managed by private facility sales and new power plants in Brazil (fig- companies, that reached financial closure in ure 3). In East Asia private activity dropped from 1990–99 (box A.1). US$12 billion to US$3 billion as a result of the cancellation of many high-profile projects in cri- Four main trends have emerged in private sis countries and reduced activity in China. In energy projects in developing countries during Malaysia, the Philippines, and Thailand annual the past decade: private activity in energy in 1998–99 was only a ▪ As in other infrastructure businesses, private fourth that in 1993–97. Indonesia, the country participation in energy grew rapidly during the most affected by the crisis, had no new private 1990s. energy activity in 1998–99. 4 Private Participation in Energy FIGURE 2 TOTAL INVESTMENT IN ENERGY PROJECTS WITH PRIVATE PARTICIPATION IN DEVELOPING COUNTRIES, 1990 – 99 Billions of 1998 U.S. dollars 50 40 30 20 10 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Source: World Bank, PPI Project Database. BOX 1 CHANGES IN PROJECT FINANCE FOR ENERGY The big decline in long-term private capital flows to devel- rose from 500 basis points at the end of 1997 to more than oping countries since 1997 reflects a sharp change in 1,100 basis points in late 1998, declining in 1999 only in major mood—from the excessive optimism of the precrisis 1990s to East Asian economies and Brazil. the conservatism of the late 1990s. Before the crisis large The scarcity and high cost of foreign resources forced amounts of financing were chasing marginal projects in the some power sponsors to finance acquisitions on their bal- electricity sector. This frenzied approach to lending ance sheets. U.S.-based firms such as AES Corporation, Duke “resulted in lenders downplaying the role of sponsor equity Energy Corporation, and CMS Energy Corporation opted to through overleveraging of projects, the loosening of project purchase existing assets in Latin America on their own bal- structure, and a failure to adequately assess the fundamen- ance sheets in 1999, hoping to refinance them later under tals of long-term country risk and to take a sufficiently long- more favorable market conditions (Gelinas 1999). term view of the nature and values of such assets” (Lack In the long term international capital flows will return to 1999, p. 7). developing countries as major economies recover from the In the short term international financial markets’ conserva- crises. But lenders will become more cautious, focusing tive approach to developing countries has made financing more on project quality and taking a more realistic view of scarce and expensive. According to preliminary World Bank long-term project risks, including macroeconomic, political, estimates, net long-term funds from international capital mar- and regulatory risk. Project financiers will expect local and kets to developing countries dropped from a peak of US$151 regional capital to play a greater role in project financing billion in 1996 to around US$40 billion in 1999 (World Bank (Lack 1999). Sponsors will be expected to assume a greater 2000). The biggest drop was in net lending from international share of project risk by accepting lower debt-equity ratios banks, which turned negative in 1999. The cost of debt (Gelinas 1999). Ratios of 60:40 and 50:50 will be more likely increased sharply. Secondary market spreads on Brady bonds than the precrisis ratios of 80:20. The World Bank Group 5 Latin America and East Asia lead ity expansion and a few operations and manage- ment contracts for integrated utilities. Latin America and East Asia have led the growth in private participation in energy. Latin America Investment concentrated in middle- accounted for 42 percent of the investment in income countries private energy projects during the 1990s. Most of the region’s countries promoted private partici- Investment in energy projects with private par- pation in energy as part of broader sectoral ticipation has been concentrated in a few coun- reforms aimed at creating efficient, competitive tries, but it is beginning to spread. The top five energy markets. This approach has been countries accounted for 100 percent of invest- reflected in an emphasis on privatization. ment in 1990, but only 56 percent in 1997–99. Divestitures accounted for more than three- Although the top five vary from year to year, they fourths of the investment in energy projects with usually include Argentina, Brazil, China, and private participation in the region (figure 4). India, which also account for a major share of Greenfield projects, which accounted for the developing country income. other fourth, developed mainly in reformed mar- kets, driven by such market signals as energy By 1999 forty-eight middle-income countries had prices and demand growth. private energy projects (twenty upper middle income and twenty-eight lower middle income), East Asia accounted for a third of the investment but twenty-eight low-income countries also had in energy projects with private participation in opened their energy sectors to private activity 1990–99. Private activity in this region—as well (figure 5). Middle-income countries still attracted as in South Asia, the third-ranked region— most of the private activity in the sector, however focused on introducing independent power pro- (figure 6). Among low-income countries, China ducers in markets dominated by vertically and India accounted for most of the investment. integrated, state-owned enterprises. This strat- egy was aimed at expanding generating capac- Electricity projects predominate ity to keep pace with expected demand growth. Greenfield power projects accounted for 80 per- Electricity has led the growth of private activity cent of the investment in East Asia and 93 per- in energy. More than 600 private electricity pro- cent in South Asia. Other forms of private jects, representing investment of US$160 billion, participation were also designed to expand gen- reached financial closure in seventy developing erating capacity. Divestitures, involving the sale economies in 1990–99. Private electricity pro- of minority stakes through public offerings, were jects have been concentrated in generation, with aimed at raising funds for state-owned enter- projects involving generation assets capturing prises. And operations and management con- four-fifths of the investment. tracts centered on rehabilitating power plants. Natural gas projects—around 100 in thirty In the other regions private activity in energy was countries—accounted for more than US$27 bil- limited. In Europe and Central Asia it was lion in investment in 1990–99. This investment restricted to a few countries that mainly privatized has been concentrated in transmission assets, existing facilities through mass privatization or which accounted for almost three-fourths of total sales of controlling stakes to operators. Economic investment in natural gas projects in 1990–99. problems, low energy tariffs, and rudimentary The natural gas business has attracted so much legal frameworks limited additional investment in less investment than electricity mainly because these countries. In Sub-Saharan Africa and the of its early stage of development in most devel- Middle East and North Africa private participation oping countries. Except for countries in Europe was limited to some greenfield projects for capac- and Central Asia and a few in Asia and Latin 6 Private Participation in Energy BOX 2 PLANS FOR REFORM IN EAST ASIAN ELECTRICITY MARKETS The 1997 financial crisis made East Asian governments rec- electricity market to competition. But reforms have been ognize the potential problems of introducing private inde- put on hold until Congress approves the omnibus Electric pendent power producers—to sell power to state-owned Power Industry Code under discussion. The bill would enterprises—without reforming the sector. That strategy establish the legal framework for privatizing Napocor, cre- ignored the main problems in the sector, such as subsi- ating a competitive electricity market, and dealing with lia- dized tariffs, sector inefficiencies, and monopolistic mar- bilities under Napocor’s power purchase agreements. ket structures. And it forced governments to assume • Indonesia plans to establish a fully competitive power contingent liabilities, through take-or-pay power purchase market in phases. As a first step the state-owned utility PT agreements, that they have had to cover when least able to, Perusahaan Listrik Negara (PLN) will separate electricity as in the case of Indonesia. assets into two regions, Java and outside Java. In Java, The limitations of the strategy coupled with growing bud- which has a well-developed electricity system, PLN will get constraints made East Asian governments realize the divide its assets into several companies for generation, need to reform their electricity sectors. China, Indonesia, the transmission, and distribution to create a fully competitive Republic of Korea, the Philippines, and Thailand have power pool market by 2003. During the transition the trans- announced plans to introduce competition in their electricity mission company will purchase electricity from all genera- markets by establishing power pool markets. Power pools, tors connected to the grid on behalf of distribution open-bid processes in which the cheapest power is pur- companies and major consumers. This transitional single- chased first, have been introduced all over the world—in buyer model is designed to deal with short-term con- Argentina, Australia, Canada, Chile, South Africa, the United straints such as take-or-pay power purchase agreements, Kingdom, and the United States—to improve the management fuel contracts, underdeveloped transmission systems in of system capacity and reduce electricity prices. some areas, and lack of regulatory capacity. • Korea plans to liberalize its electricity market and create a Outside Java, where the electricity system is much less competitive power pool by 2003. As part of the plan, the developed, PLN will transfer its assets to a new state-owned government has allowed private power generators to sell company. This company will manage the system while con- electricity directly to industrial consumers since August tracting out new opportunities for generation, transmission, 1999. It plans to divide the generating assets of state-owned and distribution through competitive and transparent bidding. Korea Electric Power (Kepco) into six independent compa- The Indonesian government also plans to privatize state- nies, to be privatized by 2005. Korea is also revising the 50 owned assets, taking a phased approach until international percent equity cap on foreign investment in power to market conditions become more favorable. encourage greater private participation and competition. • China has launched a reform aimed at introducing compe- • Thailand plans to establish a wholesale electricity market tition in generation. Over the next decade State Power by 2005. The National Energy Policy Office plans to vertically Corporation (SPC), the monopoly power grid company, will separate the electricity business into basic units (genera- move electricity purchases from a contract system to a tion, transmission, and distribution) and privatize them. pooling program. Initially, SPC operating units will buy 15 Retail competition will be introduced initially for large cus- percent of their annual electricity needs from a pooling tomers, gradually expanding to a wider market. Regulated program and the other 85 percent under existing contracts. distribution companies will serve the remaining consumers. Purchases through open bidding will rise 3–4 percent The government may include a “competition transition annually until all electricity is bought and sold through charge” in tariffs to cover transitional costs of the reform, power pooling. Zhejiang and Shanghai Provinces and such as liabilities under power purchase agreements. Shanghai City will be the first to launch power pool reform. • The Philippines has plans for privatizing Napocor, the state- Three other provinces will introduce it by the end of 2000, owned generation and transmission utility, and opening the and the rest will follow. The World Bank Group 7 FIGURE 3 TOTAL INVESTMENT IN ENERGY PROJECTS WITH PRIVATE PARTICIPATION IN DEVELOPING COUNTRIES BY REGION, 1990 – 99 Billions of 1998 U.S. dollars 25 Latin America and the Caribbean 20 15 Europe and Central Asia East Asia and the Pacific South Asia 10 Sub-Saharan Africa Middle East and North Africa 5 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Source: World Bank, PPI Project Database. FIGURE 4 TOTAL INVESTMENT IN ENERGY PROJECTS WITH PRIVATE PARTICIPATION BY REGION AND TYPE, 1990 – 99 Billions of 1998 U.S. dollars 80 Greenfield projects 70 60 Operations and management contracts with major capital expenditure 50 40 30 Divestitures 20 10 0 Latin America East Asia South Asia Europe and Middle East Sub-Saharan and the Caribbean and the Pacific Central Asia and North Africa Africa Source: World Bank, PPI Project Database. 8 Private Participation in Energy FIGURE 5 NEW ENERGY PROJECTS WITH PRIVATE PARTICIPATION IN DEVELOPING COUNTRIES BY INCOME LEVEL, 1990 – 99 15 Upper-middle- income countries 12 Lower-middle- income countries 9 Low-income countries 6 3 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Source: World Bank, PPI Project Database. FIGURE 6 TOTAL INVESTMENT IN ENERGY PROJECTS WITH PRIVATE PARTICIPATION IN DEVELOPING COUNTRIES BY INCOME LEVEL, 1990 – 99 Billions of 1998 U.S. dollars 25 Upper-middle- income countries 20 15 10 Lower-middle- Low-income income countries countries 5 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Source: World Bank, PPI Project Database. The World Bank Group 9 FIGURE 7 ESTIMATED INFRASTRUCTURE INVESTMENT REQUIREMENTS IN EAST ASIA UNDER DIFFERENT SCENARIOS, 1996 – 2005 Billions of U.S. dollars 250 200 Baseline projections (precrisis) Revised projections (postcrisis) 150 Projections based on competition and privatization 100 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Asian Development Bank 1999. America, most developing countries have lim- environments as more governments recognize ited transport facilities and natural gas resources that competitive electricity markets can provide or none at all. cheaper and more reliable electricity service than monopolies. Looking ahead In East Asia private activity will focus on exist- Private energy activity should revive in devel- ing assets rather than capacity expansion if major oping countries as they recover from the eco- economies implement proposed sector reforms nomic crises of the late 1990s and as the (box 2). The 1997–98 financial crisis significantly fundamental reasons for long-term private reduced new investment requirements in the activity—increasing demand for energy, sector region for 2000–05 (figure 7). Those require- inefficiencies, and public budget constraints— ments may be further reduced if competition and continue. But private activity in the next decade private sector discipline are introduced in the will differ from the precrisis activity in two ways. sector (Asian Development Bank 1999). First, new capacity requirements will be smaller, reflecting the slower projected growth in devel- In Latin America private activity will revive as oping countries (excluding transition major economies recover, Brazil relaunches its economies) in 2002–08 compared with the pre- electricity privatization program, and Mexico crisis 1990s (World Bank 1999). Second, most accelerates its independent power producer private activity will take place in competitive program. 10 Private Participation in Energy In South Asia private energy activity will remain This Note originally appeared as a chapter in limited as countries continue to postpone sector Energy Sector Management Assistance reforms and rely on the private sector only for Programme (ESMAP), Energy and Development new generating capacity. Report 2000: Energy Services for the World’s Poor (Washington, D.C.: World Bank, 2000). In Europe and Central Asia private activity in For more information on energy will remain limited by slow economic ESMAP go to www.esmap.org. recovery and delays in sector reforms. But it may accelerate in countries applying for membership to the European Union, which face deadlines for energy sector reform. In Sub-Saharan Africa and the Middle East and North Africa private activity should increase as recent proposals for new generating facilities are implemented in the coming years. 1 For an overview of private participation in infrastructure see Roger 1999. For earlier reviews of private participation in electricity and in natural gas transmission and distribution see Izaguirre 1998 and 1999. 2 All dollar amounts are in 1998 U.S. dollars. Figures for project Viewpoint is an open forum intended to investments refer to total investment, not private investment alone. encourage dissemination of and debate on ideas, innovations, and best References practices for expanding Asian Development Bank. 1999. Private Sector Participation and the private sector. The Infrastructure Investment in Asia: The Impact of the Currency views published in this Crisis. Manila. series are those of the Gelinas, Nicole. 1999. “Taking Latam Chances.” In Rod Morisson, ed., authors and should not Project Finance International Yearbook 2000. London: Thomson be attributed to the Financial Ltd. World Bank or any of its Izaguirre, Ada Karina. 1998. “Private Participation in the Electricity affiliated organizations. Sector.” Viewpoint 154. World Bank, Finance, Private Sector, and Nor do any of the con- Infrastructure Network, Washington, D.C. clusions represent ———. 1999. “Private Participation in the Transmission and official policy of the Distribution of Natural Gas.” Viewpoint 176. World Bank, Finance, World Bank or of its Private Sector, and Infrastructure Network, Washington, D.C. Executive Directors or Lack, Howard. 1999. “Lessons Learned for Project Finance and the the countries they Emerging Markets.” In Adrian Hornbrook, ed., Project Finance represent. Yearbook 1999/2000. London: Euromoney Institutional Investor. Roger, Neil. 1999. “Recent Trends in Private Participation in To order additional Infrastructure.” Viewpoint 196. World Bank, Finance, Private copies please call Sector, and Infrastructure Network, Washington, D.C. 202 458 1111 or contact U.S. Department of Energy. 2000. “International Energy Outlook Suzanne Smith, editor, 1999.” www.eia.doe.gov/oiaf/ieo99/tbla9-16.html. January 17. Room F11K-208, The World Bank. 1999. Global Economic Prospects and the Developing World Bank, 1818 H Countries 2000. Washington, D.C. Street, NW, Washington, ———. 2000. Global Development Finance 2000. Washington, D.C. D.C. 20433, or Internet address ssmith7@ worldbank.org. The series is also available Ada Karina Izaguirre on-line (www.worldbank. (aizaguirre@worldbank.org), World Bank, org/html/fpd/notes/). Private Participation in Infrastructure Group Printed on recycled paper. The World Bank Group 11 BOX A.1 PPI PROJECT DATABASE: PROJECT CRITERIA AND DATABASE TERMINOLOGY Database coverage • Greenfield project. A private entity or a public-private joint • Projects that have reached financial closure and venture builds and operates a new facility. This category directly or indirectly serve the public. includes build-own-transfer and build-own-operate con- • Projects in energy, transport, water, and telecommu- tracts as well as merchant power plants. nications. The energy sector includes electricity • Divestiture. A private consortium buys an equity stake in a generation, transmission, and distribution and nat- state-owned enterprise. The private stake may or may not ural gas transmission and distribution. imply private management of the company. • The database excludes captive facilities, such as natural gas pipelines owned by private upstream Definition of financial closure. For greenfield projects, and gas producers, natural gas condensate operations, for operations and management contracts with major capi- incinerators, stand-alone solid waste projects, and tal expenditure, financial closure is defined as the exis- small projects such as windmills. tence of a legally binding commitment of equity holders or • Low- and middle-income developing countries, as debt financiers to provide or mobilize funding for the pro- defined and classified by the World Bank. ject. The funding must account for a significant part of the project cost, securing the construction of the facility. For Definition of private participation. The private company must operations and management contracts, a lease agreement assume operating risk during the operating period or assume or a contract authorizing the commencement of manage- development and operating risk during the contract period. A ment or lease service must exist. For divestitures, the equity foreign state-owned company is considered a private entity. holders must have a legally binding commitment to acquire the assets of the facility. Definition of a project unit. A corporate entity created to operate infrastructure facilities is considered a project. Recording of investments. Investments and privatization rev- When two or more physical facilities are operated by the cor- enues generally have been recorded on a commitment basis porate entity, all are considered as one project. in the year of financial closure (for which data typically are readily available). Actual disbursement has not been tracked. Definition of project types Where privatizations and new investments are phased and • Operations and management contract. A private entity data are available at financial closure, they are recorded in takes over the management of a state-owned enterprise for phases. a given period. This category includes management con- tracts and leases. Sources. World Wide Web, commercial databases, special- • Operations and management contract with major capital ized publications, developers, sponsors, and regulatory expenditure. A private entity takes over the management of agencies. a state-owned enterprise for a given period during which it also assumes significant investment risk. This category Contact. The database is maintained by the Private includes concession-type contracts such as build-transfer- Participation in Infrastructure Group of the World Bank. For operate, build-lease-operate, and build-rehabilitate- more information contact Shokraneh Minovi at 202-473-0012 operate-transfer contracts as applied to existing facilities. or sminovi@worldbank.org.