Viewpoint Note No. 146 August 1998 The East Asian Financial Crisis-Fallout for Private Power Projects R. David Gray Countries around the world have increasingly country's single buyer. The single buyer enters andJohn turned to the private sector to finance and build into long-term power purchase agreements Schuster new power projects. This trend has been es- (PPAs) in which the buyer agrees to take power pecially pronounced in Asia, which accounts at specified rates from private power produc- for nearly 60 percent of all new private gen- ers for periods ranging from ten to thirty years. eration capacity financed in the developing wsvorld. But the East Asian financial crisis that While the full extent of the crisis and its fallout in began in mid-1997, triggering dramatic stock these four countries is not yet known, information market and currency slides and stalling eco- available to date shows that the effects vary widely nomic growth in the region, has already had a among the countries. To varying degrees their profound effect on investment in infrastructure. private power programs have been affected by: This Note discusses the impact of the crisis in * Increased cost of power. the power sectors of four of the most severely - Threats of contract defaults and renegotiations. affected economies-Indonesia, Malaysia, the * Contraction of the market for private power. Philippines, and Thailand. All have major pri- vate investments in power generation, but their As the following analysis will show, the diver- power sectors are still dominated by vertically gences in the management and impact of the integrated public utilities that act as the crisis suggest a number of important lessons for TABLE 1 CRISIS-RELATED FACTORS AFFECTING THE IMPACT OF IPP COSTS ON RETAIL TARIFFS Denomination Overall Country _V of payments impact Indonesia Q O 0 0 Malaysia c 0 0 0 0 0 ° Philippines 0 * C c C/o Thailand d*0 C C C0/ C Little impact C Some impact *Severe impact The World Bank Group . Finance, Private Sector, and infrastructure Network 2 The East Asian Financial Crisis-Fallout for Private Power Projects power reform and the role of independent tricity rates will need to increase only slightly power producers (IPPs) in that process. in Malaysia and Thailand to cover increased IPP costs-though rates may have to increase Increased cost of power further for other reasons. A currency depreciation of the magnitude of Dimensions of the economic crisis those in East Asia increases the cost of most goods and services, including electric power. All four countries have suffered severe economic The extent of the rise in power costs attribut- setbacks since mid-1997, and the International able to private power has varied among the Monetary Fund has forecast a significant slow- countries, depending on such factors as: down in economic growth in 1998.1 By early * The dimensions of the economic crisis. June 1998 Malaysia, the Philippines, and Thai- * The origin of the fuel supply. land had experienced currency depreciations of * The currency denomination of the wholesale around 35 percent, and interest rates in Malay- tariffs. sia and the Philippines had risen 50 percent from * The extent of domestic financing for projects. a year earlier. Interest rates in Thailand are nearly * The amount and timing of private power twice the previous year's level. The drop in the purchases. value of currencies was accompanied by de- * Wholesale and retail tariffs. clines in regional stock markets. The Malaysian market index fell by more than 50 percent in Each of these factors is examined below, and local currency terms between early June 1997 table 1 sums the aggregate implications for tar- and 1998, while the Philippines and Thailand iffs. This analysis suggests that the crisis will suffered slides of 30 and 40 percent. Indonesia have the most severe impact in the Indonesian has been hit hardest-the rupiah has dropped power sector, where retail tariffs may need to 80 percent in value in the past year, increasing rise by up to 70 percent to pay for the increased the local cost of imports by a factor of five. In- cost of private power. In contrast, retail elec- terest rates are more than three times higher FIGURE 1 PRIVATE POWER CAPACITY, MARCH 1998 Megawatts In construction 6,000 In operation 5,000 4,000 3,000 2,000 1,000 0 Indonesia Malaysia Philippines Thailand Source: Hagler Bailly IIP Knowledge Base. The World Bank Group 3 than before the crisis, the stock market has fallen Democratic Republic, payments to private power by more than 40 percent, and growth is pro- projects are denominated in baht. Nonetheless, jected to turn sharply negative this year. the depreciation of the baht made planned projects unfinanceable under the existing power Many regional utilities have high levels of for- purchase agreements. EGAT reopened negotia- eign debt, and the depreciation has led to heavy tions with sponsors to ensure the financial vi- foreign exchange losses in servicing that debt, ability of projects needed to reduce the country's eroding their financial positions. The cost of capi- power shortages. The utility pegged part of the tal for new projects is likely to rise sharply as private power tariff to the U.S. dollar and as- investors assess additional premiums to com- sumed some currency risk by agreeing to pay pensate for higher perceived risk. The skyrock- IPPs at an exchange rate of 27 baht per dollar, eting domestic interest rates also make financing close to the precrisis rate of about 25 baht per new projects costlier. dollar. In early June the baht traded at 40 to 42 per dollar. Origin of fuel supply Extent of domestic financing for projects Fuel costs, a pass-through for power off-takers under most private power contracts in Asia and Projects attracting high levels of domestic finance throughout the developing world, can repre- are less susceptible to exchange rate volatility sent about a third of the life-cycle cost of a (although they may be vulnerable to interest coal project and about three-quarters of the rate hikes). Malaysia and Thailand both have life-cycle cost of oil and gas projects.2 If fuel is high levels of local debt financing for IPPs (90 imported, a depreciation of the size of those in percent and 75 percent), which help to mitigate East Asia significantly increases the local cur- the impact of the currency depreciation. Do- rency costs of both public and private power. mestic financing is negligible in the other two In the Philippines and Thailand most private countries-14 percent in Indonesia and just 3 projects import fuel-at prices about 50 per- percent in the Philippines-leaving them more cent higher in 1998 than in 1997. exposed to the mismatch between project rev- enues denominated in local currency, and hard Currency of wholesale tariffs currency obligations to project lenders. The currency denomination of payments for Amount and timing of private power purchases private power is one of the most important dif- ferentiating factors in the impact of the crisis Indonesia, Malaysia, and the Philippines are on those payments. In Indonesia and the Phil- among the developing world's largest markets ippines, where wholesale electricity tariffs for for private power with limited recourse financ- IPPs have been denominated in hard curren- ing.3 Each has nearly 5 gigawatts (GW) of pri- cies, the local currency cost of utilities' off-take vate power capacity in operation or under obligations has ballooned. In Malaysia, where construction (figure 1). Private power now ac- power purchase payments are denominated in counts for more than half of all generation in local currency and interest rates have risen com- Malaysia and the Philippines. It has played a paratively less, the cost of private power has smaller role in Thailand. But once all the nearly risen by less than 10 percent. 2 GW of private generating capacity now under construction in Thailand becomes commercial- Thailand's national utility, the Electricity Gener- ized, private power will account for about 10 to ating Authority of Thailand (EGAT), has been 15 percent of the country's electricity. partly insulated from currency exchange risks because, with the exception of purchases from The four countries differ in the timing of their a private power project in the Lao People's private purchases. Malaysia and the Philippines 4 The East Asian Financial Crisis-Fallout for Private Power Projects began their private power programs early and Wholesale and retail tariffs now account for about 80 percent of the com- mercial private power capacity in operation in A rational system of wholesale IPP tariffs and the four countries. The financial crisis is likely retail consumer tariffs is a prerequisite for a to have a large impact on electricity costs in successful private power program. Wholesale the Philippines, which must make dollar pay- power costs should on average be about two- ments to several operating IPPs. But in both thirds of retail rates, which must also cover Malaysia and the Philippines relatively little new nongeneration costs (suchi as transmission, private power is expected to be commercial distribution, administration, and customer ser- by 2001. The fact that relatively little new pri- vice). Wholesale IPP tariffs in Malaysia and vate capacity is coming on line, along with the Thailand range from 3¢ to 4¢ per kilowatt-hour substantial payments for private power made (kWh), while retail tariffs are substantially before the crisis, will help mitigate the short- greater, suggesting that utilities in these coun- term impact of the crisis in these two countries. tries have adequate margins to pay nongener- The longer-term impact of the crisis will de- ation expenses. pend on the cost and timing of development after 2001. Currently, the Philippines plans to The relationship between retail and wholesale commercialize substantial gas and hydroelectric power tariffs in Indonesia and the Philippines capacity starting in about 2002. implies a less stable financial situation. Whole- sale power tariffs in the Philippines are rela- The crisis will have the largest impact in Indo- tively high, and retail rates may not be sufficient nesia, which accounts for nearly half the new to cover the cost of operations by the national IPP capacity due to begin operation in these power utility, Napocor. The increase in inter- countries in 1998-2001. In all, more than 9,000 est costs on foreign debt and in fuel and other megawatts (MW) of capacity is under construc- costs in the wake of the crisis has further eroded tion or at an advanced stage of development Napocor's financial position. Rates should rise in Indonesia (figure 2). substantially as a result of automatic tariff ad- FIGURE 2 CUMULATIVE DEVELOPMENT OF PRIVATE POWER CAPACITY, 1991-2001 Megawatts 12,000 10,000 Indonesia 8,000 Philipies/ 6,000 4,000 Malaysia 2,000 Thaad 0 1991 1992 1993 1994 1995 1996 1997 1998' 1999' 2000' 2001' a. Projected. Source: Hagler Bailly IIP Knowledge Base. The World Bank Group 5 justments and will need to rise even more if Napocor is to cover its costs. TABLE 2 EFFECT OF THE CRISIS ON EXPECTED NEW In Indonesia Perusahaan Listrik Negara's (PLN) GREENFIELD PROJECT DEVELOPMENT, 1998-2001 financial situation appears even more critical. Gigawatts Even before the crisis retail tariffs appeared inadequate relative to costs. While wholesale N E_ tariffs for private power ranged from 5.4c to _ 85f per kWh, retail tariffs were just over 7c Precrisis Highngrow per kWh, implying that margins were inad- projections C : scenario equate to pay for nongeneration expenses. When the rupiah fell from roughly 2,500 per Indonesia 7.3 3.8 4.0 U.S. dollar to more than 10,000, PLN's position Malaysia 1.4 0.1 0.5 deteriorated. Even with price hikes in March Philippines 3.6 2.8 3.3 and May 1998 totaling more than 30 percent, Thailand 3.8 0.2 2.0 retail tariffs remained below 3¢ per kWh. Total 16.1 6.9 9.8 Some of the region's utilities will need massive Source:Hagler Bailly UP Knowledge Base. cash infusions from either government trans- fers or privatization to meet their debt obliga- tions. As a result, their ratings by international credit agencies have been downgraded, and an interest in reviewing agreements that may some are now considered technically bankrupt. lead to an unsustainable situation. Many factors affect the sustainability of IPP programs, includ- Threats of contract defaults and ing (as outlined below) the appropriateness of renegotiations government support for private projects, the use of competitive procurement procedures for The public utilities' worsening situation has in- projects, and the need for power. Analysis of creased pressures to renegotiate contracts. Sev- such factors in the four countries predicts sus- eral planned projects with signed PPAs have been tained government commitment to private reviewed or postponed. Governments have also projects in most countries. But it also points to sought to modify contracts for projects already a high risk of breach of contract by the govern- in operation. Indonesia, the most heavily exposed ment or public utilities in some cases. country, has called on project sponsors to lower power prices and has tried to negotiate lower Government risk sharing purchase obligations. In February 1998 PLNT issued letters to three IPPs unilaterally setting an ex- Governments have assumed some risk for change rate for its payments to the private projects private power projects in all four countries. of 2,450 rupiah per dollar (the rupiah was then Such support may take the form of govern- trading below- 8,450), in violation of the existing inent guarantees backstopping the obligations PPAs. PLN later backed away from this position, of the power purchasing utilities or financial promising eventual full payment in dollars. But participation in the projects. While direct sup- international rating agencies have assessed an port to projects can serve as an indicator of increased risk of default for several projects. government commitment, excessive liabilities that are likely to come due when governments Renegotiating or defaulting on contracts can be can least afford them (such as during a finan- costly to governments as well as to sponsors cial crisis) can undermine the sustainability of and investors. Countries that have breached con- private investment programs, leading to default tracts will deter investors. But all parties have and renegotiation. 6 The East Asian Financial Crisis-Fallout for Private Power Projects In Malaysia and Thailand the central govern- agreed to support the discharge of PLN's respon- ments have assumed some risk, but have sibilities. These letters do not amount to a guar- granted no guarantees or other direct official antee, however. Project sponsors assumed some forms of support. They have provided no spe- fuel supply and other risks. cial foreign exchange protections for private power projects beyond those granted to all Competitive bidding foreign investors. Government fuel suppliers have provided similar levels of security to Recent experiences such as Enron's Dabhol projects as would be provided under commer- project in India have shown that governments cial fuel supply contracts. In many projects may face pressure to renegotiate projects that governments have assumed risks mainly by pro- have not had to undergo the scrutiny of a for- viding loans through government pension mal competitive bidding process. Both Malaysia funds, state banks, or other public sources of and Thailand procured new generation using funds, thus assuming similar commercial risk competitive bidding-one reason for the lower as other lenders. wholesale tariffs in these two countries-while most IPP projects in Indonesia and many of In contrast, the government of the Philippines the early projects in the Philippines were con- assumed fairly substantial risks through sover- cluded through direct negotiation with project eign guarantees, including all fuel supply, infla- sponsors. The Philippines has since adopted tion, and foreign exchange risks.4 Its willingness international competitive bidding to increase to assume these risks was important to the suc- transparency and lower costs. cessful financing of several early projects. Now that the market is fairly mature, the Philippines Need for power has recently reduced the guarantees offered to new projects, and some are being financed with The primary motivation in seeking private power no sovereign guarantees. The Indonesian gov- was the dire need for more generation capac- ernment assumed fewer risks for projects, but it ity. Widespread power shortages and blackouts granted projects "letters of comfort" in which it are a costly drag on private investment and eco- T AABLE 3 FFFAC S A Indoinesi Q MalaysiaQ Philippines Thailand Lw The World Bank Group 7 nomic growth. As long as this need persists, it Implications for private power policy creates powerful incentives for governments to remain committed to private power projects. While no one could easily have predicted the dimensions of the crisis or have designed a There is a long-term need for power in all four power policy to protect projects from the eco- countries. While there is currently excess capa- nomic shocks, analysis of the effects offers les- city in the Philippines and Thailand, future de- sons for Asia and the rest of the developing mand growth should eliminate these surpluses world. Countries such as Malaysia and Thailand and create a need for new projects. The future have adopted power policies that appear to have balance of supply and demand depends on the left them less exposed than other countries (table pace of new capacity additions. Excess capac- 3). Price reform, domestic financing, competi- ity is expected to materialize in parts of the In- tive bidding, and appropriate government sup- donesian power system as large plants now port mechanisms mitigate the effects of the crisis under construction become operational. Exces- on the cost of power and the sustainability of sive surpluses could lead to pressures to break investment programs. The timing of project de- agreements on new projects. Thailand has taken velopment also appears to be a major factor in steps to avoid surpluses by delaying power the severity with which the crisis has affected projects for two years. regional power programs. A shrinking market for private power The Philippines and Thailand are pushing ahead with plans to privatize their national utility com- The economic slowdown and the higher prices panies, despite the more difficult environment for many basic goods have reduced demand for privatization in the wake of the crisis. But for electricity, restricting future private power unlike many countries in Latin America, no Asian opportunities. It is estimated that total new countries have yet undertaken fundamental private power development in the region could restructuring and privatization of their power fall from around 16 GW to less than 7 over the sectors to reduce the burden of public sector period 1998-2001 (table 2). In Indonesia alone liabilities and put the whole power industry on new private power development could decline a more sustainable footing. by 3.5 GW, and near-term markets for new projects in Malaysia and Thailand could all but The market for private power in Asia appears disappear. In the Philippines the crisis is ex- both smaller and more fraught with uncertainty pected to have a modest impact on new project than before the crisis. In this new environment commercialization through 2001. investors will scrutinize projects more closely, and governments will need to manage power The financial crisis has stalled many new con- programs judiciously to continue to attract struction projects, both public and private, as investment. They need to strike a balance in the construction costs have soared in local cur- providing support to the industry, shoring up rency terms. PLN has canceled sixteen IPP private projects in the near term while avoid- projects, many of which had signed contracts. ing burdensome, open-ended commitments Plans for a 1,000-MW private power project in that could hamper the longer-term prospects Malaysia have reportedly been shelved because for reform. the drop in the exchange rate increased the project's prospective costs by more than 1 billion ringgits (about US$260 million). Depreciation Intetra fnea und odEconomcOutlook(Wasington poses a greater challenge to countries still in D.C , May 1998). the early phases of IPP development, when con- 2 Power off-takers accept fuel risks in most projects with power pur- most equip- chase agreements. Banks generally believe that power off-takers struction risks are important, since most equip- are better able to take these risks than other project participants ment and construction costs are in hard currency. because of their ability to pass fuel price increases along to 8 The East Asian Financial Crisis-Fallout for Private Power Projects consumers. See Suman Babbar and John Schuster, 'Power Project Finance: Experience in Developing Countries" (R\MC Discussion Paper 119, World Bank, Resource Mobilization and Cofinancing Vice Presidency, Washington, D.C., 1998). See Suman Babbar and John Schuster, "Power Project Finance: Ex- perience in Developing Countries" (RMC Discussion Paper 119, World Bank, Resource Mobilization and Cofinancing Vice Presi- dency, Washington, D.C., 1998). See David Baughman and Matthew Buresch, "Mobilizing Prihate Capital for the Power Sector: Experience in Asia and Latin America" (U.S. Agency for International Development and World Bank, Wash- ington, D.C., 1994). R. David Gray (rgray@wvorldbank.org), consult- ant, Private Sector Development Department, and John Schuster (jschuste@haglerbailly.com), manager, HaglerBailly Consulting Viewpoint is an open forum intended to encourage dissemina- tion of and debate on ideas, innovations, and best practices for ex- panding the private sector. The views pub- lished are those of the authors and should not be attributed to the World Bank or any of its affiliated organiza- tions. Nor do any of the conclusions represent official policy of the World Bank or of its Executive Directors or the countries they represent. 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