3URMHFW )LQDQFH DQG *XDUDQWHHV June1995 CofinancingandFinancialAdvisoryServicesVicePresidency ProjectFinanceGroup q World Bank Guarantee Sparks Private Power Investment in Pakistan The Hub Power Project The Hub Power Project marks the first use of a Project sponsors are expected to mobilize 20- World Bank guarantee for a private sector 25% equity and raise the remaining 45-50% of What is Project Finance? project and is a major step forward in the Bank's the funding in domestic and international effort to increase private sector investment in financial markets. Project finance, sometimes referred to infrastructure. In addition, the project sets A special-purpose project company, several milestones for the Bank: as limited-recourse finance, refers to · Hub Power Company (HubCo), was first use of a partial risk guarantee; financing structures under which · established by private developers in Pakistan to largest private sector infrastructure project lenders look to project cash flows for own and operate the power station. The supported by the Bank to date; debt repayment and to project assets for · sponsors, which led the development and first Bank-financed infrastructure fund to collateral. In deciding whether or not negotiation process, were Xenel Industries of support private sector projects; and to lend to a project, a lender bases its Saudi Arabia and National Power of the U.K. · first co-guarantee with another financial decision on an evaluation of a HubCo will build, own and operate the institution, the Japan Export-Import Bank. project's--not the sponsors-- conventional, oil-fired steam plant. The transmission interconnection between the plant creditworthiness. In the event of Financial closure occurred in January and the national power grid is being handled by default, the liability of project sponsors 1995, putting into place nearly US$1.8 billion in the Water and Power Development Authority is limited to their investment in a equity and long-term debt financing required to (WAPDA), partially financed by a Bank loan. project. refinance construction bridge loans and complete the project. Construction of the 1,292 Hub is important to Pakistan for megawatt power plant began in early 1993 and several reasons. In addition to being the is expected to be completed by 1997. The largest private sector project in the country, it project is located about 40 km outside Karachi. demonstrates investor confidence in the expansion of the private sector's role in The Bank's guarantee, which protects infrastructure development. The project also commercial lenders against sovereign risks played a significant role in the formulation of associated with the project, establishes a new the Government's long-tem strategy to attract method of supporting build, own, operate (BOO) private investment to the power sector and the projects which are normally financed on a development of model independent power project finance or limited-recourse basis. Prior contracts. As a result, several follow-on to Hub, Bank guarantees were utilized as projects are expected to be completed relatively cofinancing instruments designed to help quickly. Finally, the project will expand mobilize commercial funding for Bank-supported Pakistan's generating capacity by public sector projects. It is expected that the approximately 20% and ease power shortages Bank guarantee for the Hub project will serve as that currently constrain economic growth. a model for future guarantees in support of other BOO projects. Financing Structure Project Overview The total financing of US$1.8 billion includes Bank involvement in the project dates back to US$1.7 billion equivalent in foreign exchange the late 1980s, when Pakistan initiated an and about US$100 million equivalent in local energy sector adjustment program with Bank costs. The capital structure is 20% equity and assistance. A key element of the program was 80% debt--the debt is mobilized on a project the opening of the power sector to private finance basis. Included in the financing plan investment To this end, the Bank, along with are costs associated with the turnkey several bilateral donors, established the Private construction contract, development costs, Sector Energy Development Fund (PSEDF). interest during construction and other finance- PSEDF, a Government-owned facility, provides related costs, as well as a reserve contingency debt financing of up to 30% of the financing fund. needs of private sector energy projects. 3URMHFW)LQDQFH The Sponsors contributed a · Fuel Supply Agreement (FSA) significant portion of the project's total equity. Fuel supply is secured through this 30- DQG*XDUDQWHHV Other equity sources include Commonwealth year agreement between the Government- Development Corporation (CDC) of the U.K., owned fuel supplier, Pakistan State Oil June 1995 Entergy, Xenergy and other offshore and local Company, and HubCo. investors. An innovative feature of the project's · Operation & Maintenance Agreement financial structure is the US$102 million global (OMA) depositary receipt (GDR) issue underwritten by The OMA between HubCo and National Morgan Grenfell, U.K., the first GDR issue for Power International (a subsidiary of an independent power project. National Power, UK) has an initial term of 12 years and provides for operation and The amount of debt financing required for the maintenance of the plant according to project (US$1.4 billion) necessitated that it be agreed terms and technical criteria. raised from a variety of sources, including · Construction Contract PSEDF, foreign commercial banks supported A fixed-price, date-certain turnkey by partial risk guarantees from the World Bank construction contract between HubCo and and J-Exim, and political risk insurance from a consortium led by Mitsui 7 Company of export credit agencies of France, Italy and Japan was signed in 1991. In addition to Japan, local commercial banks, and CDC. Mitsui, the consortium includes Accelerability and Other large private sector infrastructure Ishikawajima-Harima Heavy Industries Guarantees projects will likewise be obliged to obtain debt Co., Ltd. of Japan, Ansaldo GIE, S.R.I. of financing from many different sources, given Italy and Campenon Bernard SGE-SNC of If a loan is accelerable, lenders the exposure limitations of lenders, insurers France. can demand payment of the and guarantors. · Other Agreements unpaid balance if specified Several other agreements/provisions are events of default occur. Under integral components of the contractual an accelerable guarantee, the Contractual Framework arrangements of the project. These unpaid balance of guaranteed include: (i) escrow agreements for local exposure (which could be A key element of project finance is the and offshore escrow accounts; (ii) foreign different than the unpaid apportioning and allocation of risks, a difficult exchange risk insurance provided by the balance) would be payable by and complex process even in developed State Bank of Pakistan for a fee included countries. In a developing country such as the Bank upon call of the in the project cost; and (iii) a shareholders' Pakistan, the process is substantially more guarantee. Prior to call of the agreement and related corporate difficult. There is often a lack of precedents to documentation guarantee, however, all build on, and the process is further hampered remedies specified in project by and undeveloped legal regulatory agreements must exhausted. Bank Guarantee environment. In contrast, under a To match project revenues with debt service, nonaccelerable guarantee, Under Hub's commercial long-term financing is critical to the viability of each individual payment is, in arrangements, project-specific risks power (and other infrastructure) projects. effect, guaranteed, and the (completion, performance operation and However, due to its poor credit standing, such guarantee would be called each underwriting risks) are assumed by equity long-term financing was inaccessible to time a payment default occurs. investors and lenders, while sovereign-or Pakistan. Commercial lenders needed a political-risks are assumed by the Government creditworthy third party to back commitments (GOP) and its agencies. These risks are made to the project by the Government of identified and allocated via the project's Pakistan to enable them to make long-term contractual framework, which comprises the loans--hence the need for the World Bank following main agreements: Guarantee. The Bank is providing a partial risk guarantee to a syndicate of international · Implementation Agreement (IA) commercial banks. The guarantee covers, on Overall project implementation is being an accelerable basis, principal repayments for undertaken within the provisions of this 30- up to US$240 million in loans. It would be year agreement between HubCo and triggered if GOP noncompliance with one or GOP. The IA grants HubCo the sole right more of its obligations, as outlined in project to develop the project and defines each contracts, resulted in a default in the repayment party's responsibilities during the of the loans. Specifically, these obligations are construction and operation phases of the delineated in the project agreements (IA, PPA, project. FSA--see above). The US$120 million J-Exim co-guarantee is of an identical structure. The 12 year maturity of the project's commercial · loan financing is a major achievement, Power Purchase Agreement (PPA) considering that prior to Hub, Pakistan's access The PPA, which secures the project's to international credit markets was limited to revenue streams, is the most important short-term trade credit and medium-term commercial agreement. The 30-year aircraft financing. agreement also defines the interface There are three main categories of between HubCo and WAPDA. risk covered by the Bank and J-Exim 3URMHFW)LQDQFH guarantees: (i) GOP guarantees of obligations government contractual obligation to a project. DQG*XDUDQWHHV (payment and supply) of state-owned entities, Therefore, and risks covered by a Bank including WAPDA and PSO; (II) GOP guarantee need to be clearly defined in the June 1995 payment obligations specified in the commercial contracts which set out the risk Implementation Agreement, including payments sharing allocation for a build, own, operate resulting from occurrence of certain force project. To allow the Bank's guarantee to majeure events (force majeure events can be voucher these risks, they must be translated political events, such as war of civil strife, or into government payment obligations. In the natural events, such as lightning outside plant case of government guarantees of payment boundaries); and (iii) provision and transfer of obligations of state-owned entities, this is foreign exchange through the Foreign relatively easy to quantify since payments are Exchange Risk Insurance Scheme provided by related to the provision of a service at a the State Bank of Pakistan. specified price. For other government Risks guaranteed by the Bank were obligations which could jeopardize project cash translated in GOP payment obligations so that flows, such as the granting of permits, or the exact cause of a debt service default can be political force majeure, this quantification determined, and hence what constitutes a becomes more difficult, This may be handled, legitimate call of the guarantee is well defined. as in Hub, by linking government defaults The Bank entered into Guarantee Agreement related to these events to the payment of fixed with the commercial banks which outlines the amount (defined in the Power Purchase coverage and mechanics of the Bank's Agreement as the capacity purchase price) guarantee. In parallel, the Bank entered into an which covers fixed costs, including debt service Indemnity Agreement with GOP counter- In summary, the Bank's guarantee guarantees the Bank for any disbursement can act as an important catalyst for mobilizing made under the terms of the Guarantee private sector financing for private sector Agreement. (A counter-guarantee is a infrastructure projects. As exemplified by the requirement of the Bank's Articles of Hub Power Project, not only does the Bank Agreement; it takes the form of an indemnity guarantee provide coverage for a part of the agreement.) The Bank's US$240 million debt financing, but the presence of the Bank in commitment under the guarantee was counted the project enhances the project's at 100% in the lending program, i.e., as if the attractiveness to other providers of capital, both Bank had made a loan, because the Bank is debt and equity. Providing coverage on the whole loan amount. For more information on the Hub (against certain risks). Power Project and the Bank's partial risk The commercial banks, despite the guarantee, please contact Suman Babbar, breadth of the Bank's guarantee, are assuming CFSPF (ext. 32029) or Per Ljung, SA1EF (ext. substantial risks, including those associated 81933) with construction and completion of the project within budget within budget and on time and efficient plant operation. Construction cost overruns and delays, depending on their severity, would first erode returns to equity and could also jeopardize debt service. Although the debt-equity ratio grants debt providers a cushion of 20% (standby facilities are also available), lenders are still at risk in the event of a shortfall in project revenue. Cost overruns and/or inefficient management of the project during operation also could lead to debt service default. Bank Guarantees and Private Sector Projects In order to streamline its appraisal of private sector projects involving Bank guarantees and shorten project development time, the Bank intends to capitalize on project reviews by other project participants. To this end, the Bank can incorporate third-party project assessments into its own appraisal. For instance, since commercial lenders will assume construction and performance risks of a project, they will closely scrutinize the project's technical and financial characteristics. If it finds them satisfactory, the Bank could incorporate the results of the analysis into its own appraisal. The Bank's partial guarantee covers debt service default caused by nonfulfillment of 3URMHFW)LQDQFH DQG*XDUDQWHHV )XQGLQJ 6WUXFWXUH June 1995 World Bank/ Export Credit J-Exim Guarantee Agency Insurance $360 $335 Commercial Banks $695 Hub Power PSEDF* $602 $372 Equity Company Subordinated Loan Investors (Project Cost: US$1.8bn) $163 Other Local and Offshore Lenders * World Bank, J-Exim, France, Italy, Others. 6HFXULW\ 6WUXFWXUH World Bank Pakistan State National Oil Company Power Plc Counter- Fuel Supply guarantee Agreement O&M Agreement Government Implementation Hub Power Agreement Guarantee of Pakistan Project Agreement Power Purchase Construction Agreement FX & Contract State Bank Transfer WAPDA Construction of Pakistan Consortium Cash Flows Offshore Domestic Commercial Escrow Account Escrow Account Lenders To obtain a copy of the brochure, The World Bank Guarantee: Catalyst for Private Capital Flows, please contact Andres Londono at (202) 473-2326, or by email at alondono1@worldbank.org