The future of African and Asian economies depends on creating a reliable and long-term source of power for their ever-growing populations and industries. However, the power sectors within these emerging markets are rife with problems, ranging from delays sourcing equipment to persuading a population struggling with inflation, and subsequent rising food prices, that they might now have to pay far more for their electricity supply.
Factor in cash-strapped banks, over-stretched export credit agencies (ECAs) and under-committed governments, and for many countries it is hard to see when black-outs and power rationing will end.
Such a desperate dependence on new power capacity creates potential for quick-fire deal flow which is good news for advisers, arrangers and those lucky banks that still have capacity. In an inflation-riddled world, the question now is whether utilities will be able to increase power tariffs to pay for new plant, and who will emerge as tomorrow’s project sponsors and financiers.
South African demand
Stronger economies, a growing middle class and the development of service industries not dependent on tourism are driving power demand growth across swathes of Africa, says Mike Scholey, finance director at Aldwych International in London.
“Sub Saharan Africa is booming,” he says. But how long this lasts will depend on how hard the global slowdown bites, and its effect on commodity prices in particular.
According to Jonathan Berman, managing director at Fieldstone in Johannesburg, investment in African power falls far short of demand, and governments – which continue to control the vast majority of the continent’s capacity – are largely to blame. “What is needed is more private capital to go in. It’s about money, it’s about management skills.”
The day before we spoke, Fieldstone’s Johannesburg office in the heart of the city’s central business district suffered a two-hour power cut. “And that’s in South Africa, which is historically one of the best supplied in the region,” Berman notes.
Indeed, most of Africa’s current power deal flow is focused in and around South Africa, says Gerrit Kruyswijk, head of energy project finance, at Nedbank Capital in Johannesburg. “South Africa produces the most power in Sub Saharan Africa and is currently facing shortages for the first time in history.”
South Africa’s state-owned power company Eskom plans to spend $65bn to $70bn on new generation over the next three years, “just to get the South African power system up the curb,” says Will Rathvon, chief executive – project and export finance at HSBC in London. “So we’re working very closely with companies like Eskom, to help them do that.”
Progress has not been smooth though, with the country struggling with power shortages, rationing and stagnant power tariffs. “Officially South Africa is scrambling to put in place new capacity,” adds Scholey. “But it’s moving at it slowly and in a reasonably confused manner.”
Admittedly, it is hard to increase supply in the short term, as building power generation is capital intensive and involves a long lead time. Therefore in the short term, governments face a difficult choice of either disconnecting people to ration demand, or increasing the price of electricity to reduce consumption.
Ensuring long-term supplies
One issue hampering the creation of new power capacity in Africa is the high cost of construction.
“Equipment supply, particularly for large generators, is very tight,” observes Berman, and African projects are struggling to compete for contracts.
With China installing 80,000MW a year of capacity, compared with the 40,000MW that comprises South Africa’s entire current capacity, “you can see where the power suppliers are going to be spending their time.”
“It has become a serious constraint,” Berman says. “You make the decision to invest, you get the money and then the guy who’s going to sell you the equipment says he can’t deliver it for three years, and that the price has just doubled.”
And even with China and India starting to develop their own equipment manufacturers, the problem, “won’t ease up quickly, because it’s not about quick decisions.”
“One of the prime beneficiaries is companies like Aggreko,” says Scholey. “They’re doing an important job of keeping the lights on in many countries.”
Aggreko is a provider of rental power generation, used in emergency outages, planned project, or surge in demand. In fact, the company was responsible for the supply of power to the national stadium and international broadcast centre during the opening ceremony of the Beijing Olympics.
However, the technology and white fuels used by small generators make them very expensive. Scholey comments: “Countries need to break out and get the big base-load long-term generation solutions in. But they’re struggling right now.”
A reliance on small generators is however helping some countries push through power tariff increases. In Nigeria for example, where a large proportion of supply comes from small diesel generators rather than the grid, it is easier to justify building new power plants – and to persuade end-users to pay for the tariff hikes needed to finance them.
“You don’t go to your customer saying ‘I’m putting your tariff up by 60%. You say ‘the notional tariff of the utility is going up by 60%, but in fact I’m going to give you electricity from the power station that’s far cheaper than from your diesel generator,” explains Berman. “It’s a far easier sell in the Nigerias of the world.”
For many African nations however, the need for tariff hikes is mired in politics.
Creating new capacity incurs borrowing costs as well as capital, and to help pay for it South Africa’s Eskom is calling for a 60% tariff hike, something that an inflation-beleaguered government is loathe to introduce.
Some African governments are backing their utilities better. In Namibia for example, which neighbours South Africa and is connected to its grid, a more pragmatic government has proved more willing to increase tariffs.
Appetite stronger for Asian power
Over in Asia, a similar story of power shortages unfolds, but here better bank appetite and stronger government support mean the problem is being fixed faster.
Economic growth is driving deal flow across Asia, with China and India rolling out massive plant-building programmes, says Dung Ho, head of power (Asia), project and export finance at Standard Chartered Bank in Singapore.
Thailand has concluded a new round of IPP bidding, with over 4,000MW awarded to the private sector. The first 700MW of this is now approaching financial close with several IPPs approaching debt markets for funding.
Indonesia has brought forward its pending IPPs, accelerated its programme to build 10,000MW of PLN-sponsored capacity, and has won support from Beijing for various landmark power projects. Vietnam and Bangladesh are in the process of tendering bids for international BOT power projects.
Demand growth and a current lack of power penetration in Vietnam is driving deal flow in that country, while “Laos is slightly more difficult but equally exciting in terms of demand growth,” says Allan Baker, global head of power project finance at Société Générale in London.
“Indonesia is once again suffering power shortages, and asset sales in the Philippines and Singapore are attracting interest,” he adds.
Quotas introduced on Chinese banks’ lending have meanwhile pushed Chinese projects back into the international market – and this should mean the next deals to come to market will be structured more in line with international practice.
While local banks could lend aggressively to Chinese projects, structures were more in accordance with local practice. Now however, “it has to be assumed that if the projects need to look further afield for financing, more conventional terms will be negotiated to bring in international banks,” explains Baker.
Key Asian deals completed over the past year include Wayang Windu, a 2 x 110MW geothermal power project in Indonesia’s West Java. As the first new IPP in Indonesia since the Asian financial crisis of 1997/98, the US$298mn project financing,
“marked a crucial milestone in developing Indonesia’s potential for renewable energy,” remarks Standard Chartered’s Ho.
Standard Chartered is now lead arranging the Gheco-One project, a 700MW coal-fired power plant in Thailand, selling electricity to EGAT under a 25-year power purchase agreement. It is the first among a new round of IPP solicitations to approach the market for finance, raising around US$820mn in both US dollars and Thai baht.
Turkish power sector
With power demand growing at around 5% per year, Turkey is also under pressure to build capacity. Here though healthy bank appetite, strong government backing and a robust privatisation process make it more likely that the necessary capacity will be created.
“It’s just an incredible domestic market,” says Susana Vivares, co-head of EMEA energy markets at WestLB in London.
WestLB has already closed two power project financings in Turkey, most recently an €865mn debt package it arranged for EnerjiSA power generation portfolio. The deal, which was later increased to €1bn, will fund the construction of ten hydropower plants and a gas-fired thermal plant.
Some issues of course affect all markets, not least the credit crunch and a new breed of power investor that it has helped create.
Capacity overflows in Middle East
The Middle East, one region that has a phenomenal surplus of capital, is producing a number of new power investors, says Terry Newendorp, chairman and CEO at Taylor DeJongh in Washington DC. Many of these are already familiar with Asia, but are now looking at Africa for the first time as capital there starts to generate better returns.
However, although new Middle Eastern sponsors are “are eager and have a lot of capital,” Newendorp comments that many don’t have much experience in investing and developing properly structured projects in places like Sub Saharan Africa.
“It will take a few years for such new groups to make a meaningful impact on investment requirements,” he predicts.
An increasing number of power sponsors in Africa are in fact local, as they can keep costs low, and know their way round the local market. Yet, again these players do not as yet have a strong track record.
“It’s learning on the job, which can lead to projects that aren’t properly structured,” remarks Scholey.
Local independent power producers are also playing a bigger role in a number of Asian countries such as India, says Société Générale’s Baker. “A lot of the Asian players are going across borders into other neighbouring markets. They understand these markets, they feel that they are a natural extension of their business. So they are real competitors when assets come up for sale.”
In Singapore, the first two asset packages to have been offered for privatisation have attracted mainly Asian bidders, he notes.
Some 75-80% of power projects in Turkey involve a local player, either acting alone or as part of a joint venture with an international energy company, notes WestLB’s Vivares.
“This is completely different if you compare with other markets,” she says. In Latin America for example, “the international sponsors went into those markets and developed strategies by themselves, because they didn’t have strong local partners to develop joint ventures.”
Power plant deals at crunch point
The credit crunch’s biggest impact on power has concerned bank capacity, especially for countries considered non-core. Although European banks still have capacity for big petrochemical and infrastructure deals in the GCC, for Sub Saharan Africa, Central Asia and India, Newendorp has noted a “definite constraint”.
“There are a lot of transactions going on, a lot of transactions still being worked on, but finding banks now to finance those is a lot more challenging,” adds Baker. “It’s not a risk issue – it’s an availability of capital and pricing issue.”
Liquidity is particularly tight for dollar-funded deals, notes Nedbank’s Kruyswijk, adding to difficulties in South Africa’s power sector.
Limited bank capacity then, “flows downhill to the folks who are structuring, who are negotiating covenants, who are trying to manage a much more difficult syndication process,” adds Newendorp.
Club deals between five or six banks are increasingly being negotiated to avoid the pricing uncertainty typically seen in syndications.
Furthermore, as seen across all sectors, deal structures are beginning to get tighter, but some commentators believe power deals in certain regions never became that loose in pre-credit crunch times.
This is particularly the case in Africa. In Nigeria for example, Fieldstone is working on a power plant project with 60% debt, compared with the 80-90% typical for projects in Western countries. “Nigeria was the first to go and do it with 60% on a long-term loan anyway. Had we got to the 80-90% stage, we might now be moving back,” comments Berman.
However, in other markets a return to fundamentals is clearly resulting in tighter structures. “We’re seeing a fair amount of tinkering – not just with price but with the fundamental credit structures that are being reinforced now,” comments Newendorp.
“There are quite a number of transactions that thought they were fully structured and thought that they were done where the banks have come back in and said sorry, times have changed materially, and we’re going to have to decrease the amount of debt leverage, we’re going to have to increase the covenants, we’re going to have to improve the waterfall in terms of when equity gets returns,” he notes.
Something that everyone agrees is changing is funding costs, with step-up pricing and even cash-sweep or lock-up periods often introduced, says Rathvon. “Flex on pricing is now part of every deal, and this gives comfort to the syndication.”
Pricing on Asian power deals rose an average 75 basis points between Q4 2007 and Q1 2008, while some deals in Europe and elsewhere have been flexed by 100 to 150bp, says Baker. In Africa, pricing has increased 50 to 100bp, says Kruyswijk.
One power project that Aldwych International is presently financing in Kenya is experiencing some pricing pressure, “but whether that’s due to the credit crunch, or to Kenya-specific problems, I’m not sure,” Scholey says. “There’s not enough deal flow to draw significant conclusions.”
In Turkey, although local banks have ample liquidity and willingness to lend post-crunch, most are financed via lines from international investment banks, increasing their funding costs, notes Vivares. A transaction that was previously priced at 250 to 300bp would probably now be 50 to 75bp more expensive, she estimates.
One effect of higher bank pricing is the revival of ECAs, notes Rathvon. ECA pricing has almost doubled post-crunch, at the very time that banks have expanded their margins by 25-50%, he says.
Even so, “some of the ECAs find themselves back in a competitive mode from a pricing perspective,” he says. “I think previously the bank financing was so attractive for borrowers that it disintermediated the ECAs. But now they’re definitely coming back.”
Agency financing is certainly in high demand in Asia. While this is partly a direct result of tight liquidity brought on by US sub-prime issues, there is also an increasing need for political risk insurance amid today’s uncertain credit climate, inflationary pressures and sharply rising oil and coal prices.
Even agencies however are struggling to supply the demand for funding in some markets. In Southern Africa especially, “the capital required far exceeds the availability of the country limits or the balance sheet limits at the export credit agencies,” reports Newendorp.
“And that’s the part that concerns me. We may have a billion dollars-worth of well-structured transactions that could and should be financed. But capacity may be a third of that.”
Carving out roles for global banks
Over-stretched as they may be, ECAs are mopping up more of the global power market. So is the role of investment banks in global power shrinking along with their balance sheets, and if so how hard could this hit the sector?
In Africa, the role of investment banks is already fairly small, says Scholey. “They’ll come in for small tranches on the debt. But the heavy lifting is largely done by the development banks.”
In many markets though, domestic banks don’t have enough capacity to support mega deals, says Rathvon. “Local financing can handle certain volumes of transactions. But when you’re talking about billions of dollars of capital, then there’s scope for international tranches.”
In South Africa however, the ability of sponsors to raise money in rand has made the market relatively competitive for international banks.
But, there is also a continuing role for investment banks as financial advisers on larger power transactions, especially where international companies are involved.
In Turkey, WestLB’s Vivares observes that the partnership between international and local banks works well. Investment banks are, if anything, increasingly keen to finance the sector, and competition in this sphere should help push down debt pricing and introduce more sophisticated structures, she remarks.
While the global power market is certainly moving, the challenges it faces won’t go away soon.
Rising engineering, procurement and construction (EPC) costs could endanger projects, as will stringent environmental measures and limited liquidity.
“But there are going to be plenty of deals out there,” adds HSBC’s Rathvon. “The question will be how swiftly you can get them closed.”
And as for power crises in countries like South Africa, this ultimately depends on good governance, concludes Berman. “We know deals can be done. The deals that have happened have worked, the deals that are happening are working, despite the credit crunch,” he says. “Now we need to see more urgency.”