Having favoured developed markets within recent years, power sector financiers are looking harder at emerging markets transactions, writes Kevin Godier.
Private money found its way into emerging markets in the 1990s. But it retreated after Asia’s currency devaluations of 1997-98, and Enron’s disastrous experiences at its flagship Dabhol project in India, followed by the dramatic 2001-02 collapse of the Enron business model – which dried up financing liquidity globally for the sector.
“Banks were nervous on power financings in emerging markets until around 2004, but there was a sense, from 2005 to 2007, that they were returning to the market,” says Darius Lilaoonwala, manager, power, in the International Finance Corporation’s (IFC) infrastructure department. “The new ‘demand’s hot spots are big economies such as India, China, Philippines, Turkey and Chile.”
Indeed, such is the turnaround that sponsors and developers globally are now operating in an environment where financing liquidity far exceeds deal flow, according to Mike Scholey, finance director at power developer Aldwych International, which has half a dozen active projects in Sub-Saharan Africa including Kenya, Uganda, Senegal, South Africa, and Tanzania amongst others. “There is no shortage of finance for the power sector, but lenders say there is a shortage of good projects,” he stresses.
Demand for finance is “sporadic”, argues Allan Baker, head of power project finance at Société Générale. “When demand for electricity surpasses supply in large markets such as Turkey, Morocco, Indonesia or the Philippines, the government tends to react by issuing tenders or supporting construction of several thousand megawatts of fresh generation capacity, the blackouts stop and any sectoral progress can often grind to a halt.”
Outside the Gulf region, which has all but left behind its former developing world categorisation, the formidable economic and population growth in the Asia Pacific region is leading the emerging market demand for power finance.
While India and China are the obvious growth potential markets, and Thailand and Malaysia are also looking to develop new power capacity, these markets are generally seen to have sufficient domestic financing liquidity – as well as a growing range of locally-based developers – for most of their project requirements.
“There are three markets where more foreign participation is especially needed – Indonesia, Philippines and Vietnam,” underlines Ashley Wilkins, head of capital raising and financing, Asia ex-Japan, at Société Générale Asia. “The major defining factor is that none of them have a very deep and active local banking sector able to provide long-term money. You can also source political risk cover from export credit agencies (ECAs) for all three on the back of equipment exports.”
In Indonesia, no significant new independent power projects (IPPs) have been developed since 1997, due principally to negative credit perceptions attached to the state power company PT Perusahaan Listrik Negara (PLN).
In June 2007, Standard Chartered put in place Indonesia’s first IPP financing for a decade, a US$298mn loan covering the refinancing and expansion of the existing 110MW Wayang Windu geothermal project in West Java.
Standard Chartered then advised and arranged a US$104mn loan in November 2007 for an expansion of the gas-fired Sengkang project, developed by Australia’s Energy World. “These two deals are syndicated in the domestic and international bank markets without export credits or multilaterals which is a small but significant milestone,” says Conor McCoole, head of project finance, Asia, at Standard Chartered Bank.
To add capacity quickly, the government is planning to generate an additional 10,000MW of power by 2010 under an emergency programme, for which it has signed up mainly Chinese contractors, backed by loans covered by Chinese ECA Sinosure, to provide some US$10bn-worth of equipment and services.
For this programme, PLN will be the direct borrower under the loan agreements backed by a full guarantee from the Indonesian Ministry of Finance (MoF). “The sovereign guarantee will cover the lenders against any governmental breach of contract,” says Wilkins, who predicts that “70% or more of the finance required for new Indonesian power projects will be foreign financing”.
For two major Indonesian IPPs that are due to tap long-term foreign money in 2008 – the US$1.135bn Paiton 3 expansion and the US$780mn greenfield Cirebon plants – a letter of comfort from the Indonesian government that it will stand behind PLN’s offtake agreement represents “a strong enough indication of support” to mobilise ECA-backed commercial finance, predicts Ian Mathews, ANZ Bank’s Singapore-based director, project and structure finance.
“Asian ECAs, such as JBIC and Korea Exim, have indicated they are comfortable with this level of support,” he notes.
ANZ is involved in both projects, and “has seen Asia start to take off again as an independent power project financing market over the last 18-24 months, with significant investments being seen in the Philippines, Laos and increasingly Indonesia,” Mathews says.
Looking ahead, fresh finance in the order of at least US$5bn will be required by 2010 for six large-scale hydros now being developed in Laos to provide around 6,000MW of capacity to Thailand. “Sponsors from Japan, Thailand, Korea and Malaysia are all actively developing projects that have attractive tariffs to the Thai offtaker and offer good returns for the sponsors.
“These projects are likely to need a combination of public and private sector insurance, Thai commercial banks and international commercial banks with the ability to understand and structure appropriate risk mitigants,” says Mathews.
He emphasises that rather than focusing excessively on state offtaker risk, banks have switched much of their credit analysis to ensuring that projects are economically and financially viable. “The Asian crisis brought the somewhat belated discovery that IPP tariffs in many countries were generally too high, which left offtakers holding all the risk. By ensuring that a power project’s tariffs are in the lowest quartile or at least below the average cost of the producers on a grid, and by stretching loan tenors out to 20 years or more, banks know that the offtakers are unlikely to seek renegotiation of an attractive tariff and that the chance of triggering a repayment default is significantly reduced.”
The Philippines’s power sector is also in the ascendant, having unbundled its distribution sector and then attracted the country’s largest single foreign investment, a US$3.424bn acquisition by Japan’s Marubeni and Tokyo Electric Power of the Pagbilao, Sula and Ilijan power stations under the Mirant Asia Pacific umbrella. This drew a huge US$2.7bn, limited recourse acquisition financing in mid 2007 from Japan Bank for International Cooperation (JBIC) and a group of banks comprising Sumitomo Mitsui Banking Corporation, Mizuho Corporate Bank, Calyon, ING Bank and ANZ.
“There has been a tremendous interest in the last six months, with AES, Suez and Norway’s SN Power making acquisitions, often with local partners, and each of the sponsors plan significant capacity expansions in future,” highlights McCoole. Financing for these deals has involved “a mixture of multinationals, international and local banks”.
And in Vietnam, where power demand is growing by some 15-20% annually, “there are two potential new private power generation schemes in 2008, in which we will be looking to get involved,” says Wilkins. “ECAs from China, Japan and Germany are focusing hardest on the sector, but whether there will be much need for ECA money depends on the equipment supply,” he adds, predicting that “more than 70% of the power financing in Vietnam could be foreign-sourced”.
Wilkins forecasts that the comforting presence of either, or both, the IFC and Asian Development Bank could be required in Vietnam. Lilaoonwala points out that the IFC is also taking a key role in India, where power investment needs are so large that the government has pursued three so-called ‘ultra-mega’s projects, each with 4,000MW generation capacity.
“We wanted to show the markets that this makes sense for India, so we are considering financing the Mundra Ultra Mega power project won by Tata Power with US$450mn in debt from our own account,” says Lilaoonwala. The scheme will require around US$1bn in equity and US$3bn in debt, in the shape of a “rupee financing that will keep the tariff down to the equivalent of about US$0.055 per kilowatt/hour, which is very competitive”, he explains.
“We hope to get to financial close by April 2008,” Lilaoonwala adds, stressing that Japan and Korea will be supplying the project with ‘super-critical’s technology, which cuts down carbon emissions.
Another IFC power sector initiative in India – as well as in China and the Philippines – has been to finance plants operating on a ‘merchant risk’s basis, where the sponsors sell their power on an open market rather than via the classic project finance structure of a long-term power purchase agreement (PPA) with a single offtaker.
Merchant power models were first laid down in Latin America, where markets such as Chile, Peru, El Salvador and Argentina have established generation companies selling power into a spot market.
When IFC put debt in place over two years ago for a hydro-power station in Himachal Pradesh in India, “the early worry was whether we could attract financiers”, recalls Lilaoonwala. “It was the first merchant plant in South Asia, and not even the Indian banks would provide debt. But commercial banks subsequently wanted in, the price of power in India has gone up by twice our base projection, and private equity funds are also offering to participate now.”
Cost-competitiveness is key to attracting banks that have endured painful experiences of merchant risk in the US and UK. “Merchant power in emerging markets can work, if the projects that you finance are among the least cost. In the context of India, if a state offtaker fails to pay for the power, the plant is likely to operate on a sufficiently competitive basis to find an alternative customer,” says Lilaoonwala.
The move by India and other countries to merchant power is being followed keenly by banks, says McCoole. “Banks are more pragmatic now, and are looking to understand market supply and demand whether there is a PPA in place or not. Lenders are dealing with a whole range of structures, risks and models as Asia transitions slowly to a more competitive electricity market.”
Elsewhere in the world’s developing markets, “things are relatively quiet – but new projects are in the pipeline,” says Société Générale’s Baker.
He comments: “Nigeria, to take one example, needs several billions of dollars invested in its power sector over the next few years, but it also needs strong political will to push this along. Most governments will say they need a long-term energy strategy, but the numbers are daunting, and many lack the expertise to run a process to implement that scale of development.”
In a number of markets, adds Baker, “the entire power industry needs restructuring to encourage outside investment”. He cites Serbia as an example, underlining that “the authorities are to pull in some US$20bn in fresh investment.”
Africa and Eastern Europe have already thrown up successful financing templates, emphasises Baker. “Morocco and Tunisia in North Africa put in place pathfinder financings in the mid-1990s, while Hungary started the private power financings in Central Europe in 1998, and was followed by the Maritza deal in Bulgaria, which opened up the possibilities in markets such as Romania, Montenegro and Slovakia.”
He continues: “Turkey is starting to get interesting. There has been limited international lending to the power sector since the BOOT (build-own-operate-transfer) projects some years ago but, with the prospect of distribution and generating companies being sold off, companies such as AES will be well positioned and external project financing will return to the market.”
In Latin America, “Chile is big, and right now, there are opportunities in Brazil, Peru and Central America,” notes Lilaoonwala. In Brazil, a US$430mn financing package was mobilised in early 2007 for an Eletrobrs power plant located at Candiota, at which a Chinese EPC contract won by Citic drew Sinosure support, in the form of a US$281mn buyer credit arranged by BNP Paribas.
BNP-Paribas’s Olivier Paul, global head of export finance, believes that there could be a greater role for export credits in the power market. “Over the last three-to-four years, export finance products have faced strong competition from other sources. However this situation may change if the sub-prime liquidity crisis reduces the appetite of banks in general for syndicated and structured loans,” he suggests.
In Africa, “things are gradually on the move across the continent, with lots of tenders and bids closing, not always publicly”, notes Jonathan Berman, principal at Fieldstone Capital, which is advising on the 190MW first phase of Nigeria’s first IPP, the Ibom Power scheme.
Aside from South Africa, where domestic liquidity will be ample for financing a series of badly-need new power projects, the biggest news has been the closure of financing for the US$800mn Bujagali power project in Uganda, marking Africa’s first privately financed hydro scheme.
This tapped a span of risk mitigation tools, including the presence of IFC and other multilaterals and the use of the World Bank’s political risk guarantee facility to bring in commercial lending worth over US$100mn from Absa Capital and Standard Chartered.
“Bujagali – and the late 2006 financing for the AES Sonel project in Cameroon – has shown that when you have a country committed to reforming its power sector, and ensuring that the distribution sector is privatised, the money will come,” says Lilaoonwala.
Ibom Power “is coming on nicely”, says Berman. “The sponsors will probably be looking to raise funding early next year, some of this in naira, as well as US dollar debt, for which we expect some political risk insurance cover to be taken out by the banks.
Elsewhere in West Africa, Ghana has a number of projects targeting its severe power crisis, while in East Africa, Tanzania and Kenya each have at least one power project for which financing is being progressed by the Emerging Africa Infrastructure Fund, according to the EAIF’s adviser, Frontier Markets Fund Managers.
“The EAIF is very active in the power sector in west and east Africa,” notes Orli Arav, senior investment adviser.
Further south, a Calyon-led acquisition financing for Mozambique’s Cahora Bassa hydro-power site, on which Fieldstone advised the Mozambique government, was reaching close as GTR went to press, and several Zambian hydro projects being advised by Fieldstone “are progressing steadily”, says Berman.
Given the continent’s range of risks, “most African power deals will access some form of covered project finance,” predicts Berman. “People are looking at ECAs more, but they won’t be the mainstay, aside from projects like the coal-to-power Mmamabula plant planned in Botswana, where the financing needs are so large that diversified funding sources are required.”
The 2,400MW Mmamabula project will require an estimated US$7bn in debt financing, and “will be at the forefront of all the coming baseload in the southern Africa region,” comments Anand Naidoo, director, Investment Banking Division, at Absa Capital, which has advised the sponsor, CIC Energy Corporation. “We envisage a closing next year, soon after the PPA finalisation,” says Naidoo, stressing that the transaction will be “a traditional project financing”.
Alternative financing sources are also “very strong”, says Berman. “Borrowers have most leverage on ECAs when the EPC contracts are awarded.” For countries such as Nigeria and Kenya, where credit yardsticks have been established, “lots of clean local and cross-border money is available, for maybe slightly shorter maturities”, he observes. “One trend to watch in Kenya could be five-to-seven-year loans from domestic banks, but with a bullet maturity, and backing by hedge funds.”
Naidoo reiterates that “huge, long-term liquidity is available for sponsors, but the very best advice is required to structure transactions correctly, which can be a problem for an unsophisticated developer with no access to capital.”