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Unformatted text preview: 3 ASIA’S ELECTRICITY CRUNCH,
POLICY-MAKING AND THE IPP SOLUTION
Iustin Auld A lack of electric power continues to constrain the economic
growth ofAsia’s developing countries. Traditionally, the state—
run power sector tends to be manipulated by domestic politics
in regard to the size, cost, output pricing, financing, and
location of new plants. As a result, when recession hits,
generator construction and planning literally grind to a halt,
exacerbating economic conditions and slowing recovery. In
this paper, an alternative to the cyclical frustration of unwieldy
state projects is explored. Privately-owned Independent Power
Producers (IPPs) can provide developingAsian countries with
power plants and related infrastructure specifically tailored to
local demand, fuel sources, and financing capacity. Addition—
ally, IPPs can assume risks in project management, construc—
tion, technology, and financing that developing world govern—
ments and their state power sectors are ill—equipped to handle.
Current power sector policy—making in Asia’s developing
countries tends to overlook the benefits of international IPPs
in favor of political and security interests that, in fact, impede
economic growth. Furthermore, governments need to install a
credible and transparent regulatory and policy mechanism for
the power sector that encourages private participation and ' investment. justin Auld is a Master of Arts candidate at the Graduate School of International
Relations and Pacific Studies, University of California, San Diego 34 Justin Auld INTRODUCTION Governments throughout developingAsia face a vicious circle ofdevelop-
men‘t needs requiring power, and the power sector lacks the investment,
technology, and market know—how that development brings. Unfortu-
nately, traditional power sector planning has not been able to resolve this
conundrum, leaving an expansive gap between power needs and supply.
A solution, however, is at hand: Independent Power Producers (IPPs) and
their engineering, procurement, and construction (EPC) partners repre-
sent a flexible growth option to the governments of developing markets in
energy hungry EastAsia by providing smaller scale plants tailored for local
conditions, world-class equipment, and international financing connec-
tions. The practice of adjusting power policy for recessions, national
security issues, local interests, and even international politics undermines
foreign participation and investment in the sector. Independent power
project construction is a feasible solution to traditional public sector
efforts, and, therefore, developingAsia’s policy makers should smooth the
Way for IPP participation. THE POWER CRUNCH IN DEVELOPING ASIA Demand is escalating across Asia in primary energy consumption and
electricity generation, jumping 160 percent and 1 89 percent respectively
between 1986 and 1996. By way of comparison, North America con—
sumed 1.26 times its 1986 primary energy level in 1996 and produced
1.42 times more electricity; the Middle East (186 percent) and Central/
South America (1 52 percent) recorded the second and third greatest
generation gains, consuming about 50 percent more primary energy in the
process (EIAa). While no region comes close to touching the energy or
economic growth levels of Asia in the past few decades, developing Asia’s
supply of electricity remains insufficient to support efficient growth, even
in the go—slow period of the present financial crisis. Annual GNP growth rates have slowed in Asia recently, reducing power
sector development but not significantly impacting the demand for
electricity. The increasing gap between power demand and supply—the
electric energy crunch—is a consequence of feeble power sector architec—
ture, slow policy reform, and the traditional practice of squeezing utility
profits for economic development. Traditionally, electric power has been
a resource prone to political manipulation. In addition to granting official
appointments, plant contracts, and employment opportunities to friends
and associates, politicians in many developing countries have pursued
cheap energy policies for big business interests. In this scenario, electric Aria’: Electricigl Crunch, Poligy—Ma/einggnd the IPP Solution 35 utilities’ profits are squeezed by mandated price ceilings to promote
economic growth. The implicit costs of this activity, including the
opportunity costs of capital and chronic under—investment in existing
infrastructure, and the explicit costs of lower debt ratings and higher
interest payments drive the overall costs of generation up. Certainly
foreign investors, as potentially significant players in many new projects,
will not be convinced to enter into the market under these conditions.
In the last decade, authorities in developing Asia have approached
industry reform in different ways to match power growth to economic
development. Two policy camps seem to be taking root in developing
Asia’s power sectors: opening reformers and self-sufficiency advocates. Two POWER POLICY SCHOOLS OF THOUGHT Opening reformers have to some extent eliminated barriers to foreign
competition in domestic power production and construction and actively
support regulations that encourage foreign investment in the sector. At the
other end Of the spectrum, self-sufficiency advocates promote internal
solutions to power sector problems. Governments in these countries Often
find it expedient to keep competition to a minimum for political or
economic purposes. Opening and reform efforts have been most actively pursued in
Thailand, Malaysia, and the Philippines. Indonesia, Bangladesh, China,
and India have also begun to alter the traditional paradigm of power sector
management, choosing some degree of power sector opening and market-
Orientation as a formula for success. Policies have usually focused on
government re—prioritization of energy needs in the competition for fiscal
resources, efforts to attract foreign investment and foreign partner partici—
pation, increased local partner participation, a transparent regulatory
regime, fuel source diversification, and, in some cases, market—oriented
approaches to power sector management. The implementation of these reforms has produced mixed results, and
in general terms even those countries previously committed to economic
liberalization have wavered since the crisis appeared. Even Malaysia,
Thailand, and the Philippines have since stalled the process ofrestructur—
ing, deregulating, and sometimes privatizing their power generating
systems. The crisis has forced policy makers to re—evaluate, and in some
cases retreat from, opening and market reforms. I Malaysia and Thailand have led‘ their peers in generating capacity
increases in the last decade (EIAb). With the onset of the Asian financial
crisis, however, Malaysia has resorted to traditional power sector manage- 36 [ustin Auld ment techniques, putting pressure on utilities, including foreign IPPs, to
lower rates for the sake of business. In Thailand, the state generating
authority has suffered a 53 percent decline in annual profits from 1997 to
1998‘as a result of government orders to cut tariff rates, although some of
the Thai authority’s prior international loan commitments strictly pre—
clude it (Luce 1999). China, long an adherent of zz'ji zim self-sufficiency strategies in
development, seemed to be switching camps until electricity consumption
and output declined in late 1 998 (Milwaukeefoumal 1 998) . In December,
the government mandated that power sector restructuring now be done
with local equipment in order to trim imports and stimulate domestic
industry (Bangsberg 1998). The current five year plan indicates that
electric generation needs will jump from 200,000 megawatts (MW) to
300,000Mw by 2000, at a cost of $100 billion. Twenty to twenty five
billion dollars of this is expected to come from foreign sources (Halasz et
al 1996), which the central government is vigorously trying to attract
through two 1 997 initiatives: the Build Operate Transfer program and the
Measures on the Administration of International Project Finance. China’s impressive gains in power generation have significantly outper—
formed the Indian model in the last ten years. Despite Delhi’s 1992 “fast-
track” approval and opening programs, the Indian sector has added about
five percent a year in kilowatt hours (kWh) as compared to eleven percent
annually in China. Indeed, a 1997 Indian power ministry report noted
that “power shortages are likely to accentuate in the next three years,”
because only 11,000 of the needed 40,000Mw will come on line in this
period (Nicholson 1997, 6) in the face of provincial opposition. Similarly,
Bangladesh announced a major power reform in 1995 to encourage
foreign participation in funding and construction of 2,300Mw capacity by
2000 (Independent Power Report 1995) and has not yet reaped significant
capital inflows or power development. On the other side of the fence are countries like Vietnam, Mongolia,
and to a lesser extent, Pakistan, which have pursued self-sufficient devel—
opment. These countries’ power sectors are typified by limited foreign
capital and construction, cumbersome state power ministries, and politi—
cally-oriented project planning. Vietnam, which currently lacks raw and
refined fuels (although its South China Sea share has been valued at 600
billion barrels of proven reserves and 6 trillion cubic feet of gas) has
recently ignored two foreign consortia recommendations on a new refin—
ery location in favor of the regime’s vastly more expensive Dung Quat site
(Birchall 1998). Plans to increase generation by 17.5 percent a year to 50 Asia’s Electricity Cram/7, Polity-Making and the [PP Solution 37 billion kWh by 2012 (from 15 billion kilowatt hours in 1996) seem almost
unattainable without a consistent supply of fuel and investment. In Pakistan, where foreign participation in any sector inspires emotional
demonstrations, planners estimate the countrywill need about fourteen to
eighteen thousand megawatts of capacity by 2010, but the state sector is
not equipped to provide the growth. Sadly, the government lacks the
political support and policy direction to open the power sector to more
than minimal foreign participation. Although Karachi promulgated a
limited set of reform measures recently to appease the World Bank, it is not
clear how committed the government is to these new regulations, nor how
committed it is to the independence of the power sector in the face of the
Asian crisis. Six IPPs in Pakistan have been threatened with intent of
termination notices, and several other projects under construction have
been suspended (Gray 1998) because their dollar denominated power
purchase agreements (PPAs) have become 25 percent more expensive in
terms of the rupee paid by domestic customers. Mongolia, which returned the communist party to government in
1 997 after a tumultuous encounter with market reforms, has also sidelined
reforms. The previous government’s efforts to establish a market-oriented
power sector were thwarted by the incoming communists, an action that
lost the country some substantial Asian Development Bank loans. Not
surprisingly, the Mongolian power system has actually seen a yearly
reduction in generation capacity since 1989 (EIAC), an inescapable
indictment of state sector management. In conclusion, some countries have been more successful than others in
escaping the vicious circle of economic growth and power development.
From the evidence, it appears that the ability of countries to free them-
selves of this problem in the future rests heavily on a consistent and
effective opening and market reform policy today. THE ASIAN FINANCIAL CRISIS:
THROWING A WRENCH IN THE WORKS The crisis has barely reduced long-term demand forecasts for electricity
while diminishing the Asian state sector’s ability to invest in new power
projects. Bureaucrats battling with depreciated currencies and capital
flight have not inspired investor confidence by meddling in power sector
affairs. Adding to this mess, capital markets, wary of developingworld IPP
ventures since late 1997, were scarred again recently by the Russian debt
moratorium. 38 [ustin Auld Many developing Asian states have seen current accounts go into deficit
as their national currencies erode, making it difficult to finance fuel
imp'orts or power projects. Borrowing in dollars has become an impossibly
risky venture, and few developing Asian governments, aside from Malay—
sia, have been able to finance in local currency (Gray 1998). Furthermore,
recent increases in interest rates to limit capital flight have also stymied
planned power project construction. In short, the Asian power industry is in turmoil. Besides encouraging
under-investment within the power sector, the Asian crisis has also spurred
capital exit. Contract re—negotiations have become common between
utilities and those plants with IPP operators or owners throughout Asia,
because original price forecasts embedded in PPAs were built on higher
barrel prices. In Pakistan, Malaysia, and Indonesia, governments have
simply bullied the IPPs into taking lower prices for their electricity
production. In Thailand, the state utility racked up record losses and froze
all dealings with IPPs (Power Technology 1998). The Pakistani govern—
ment ordered nine IPPs to cut rates (Petroleum Times 1998) and called
in the army to run its loss—stricken national utility corporation in Decem—
ber 1998 (Nicholson 1998). Manhandling the industry, however, simply
reinforces financial market fears of investing in these countries’ power
sectors and causes an exodus of capital from the power industry when it
needs to be growing. Additionally, the depressive influence of the crisis on oil prices has
discouraged fuel source diversification plans in Asia. Cheaper oil creates a
reluctance to develop new fuel sources, a sentiment reinforced by weak
Asian currencies. Coal-dependent countries like India and China will be
less likely to reduce emissions by substituting natural gas for low—quality
brown coal, and energy efficiency will take longer to improve as a result.
Net investment in hydro, nuclear, liquid natural gas, and natural gas
projects will naturally fall off as oil—fired investments prove more profit—
able at ten to twelve dollars a barrel. Economic theory dictates that newly
formulated environmental policies and energy—efficient gas plant pro—
grams will both suffer under—investment. This predisposition for oil
consumption ultimately leads to long-term distortions in fuel source
diversity, and could even present policy—makers with major fuel security
issues, such as the defense of sea-lanes connectingAsia to the Middle East. Whether or not the crisis will endure is still a matter of dispute, but it
is possible to imagine a worst case scenario in which foreign IPPs and their
Asian clients may no longer be able to raise equity for projects due to lack Asia’s ElectricilCmnc/a, Policy—Making and the IPP Solution 39 of investor confidence. In similar circumstances during the Tequila crisis
of 1 994, many IPPs spent periods varying from several months to a couple
of years trying to re—establish capital financing for developing world
projects (International Trade Finance 1995). IPPs AND EPCs: WHAT THE INTERNATIONAL
PRIVATE SECTOR CAN OFFER ASIA Independent power producers engage in the building of electrical genera—
tion facilities for industrial, commercial, and residential use. Many IPPs
are based in the United States, where stateside power deregulation in the
Reagan era has led to a spot market for electricity. Big U.S. players in Asia
include Edison Mission of Southern California, Southern Energy, Duke
Power (now owned by EPC F luor Daniel), CalEnergy, Oxbow Power, and
Enron. European firms also have a stake in this competition, including the
Belgian Tractabel, UK National Power, and French—owned Sithe and
EDF. Large—scale Japanese manufacturers like Mitsubishi have also been
active in the IPP market, while Korean companies such as Lucky Goldstar
have participated as suppliers in power plant consortia for at least a decade.
It is likely that Korean, Japanese, and Hong Kong—based companies like
Hopewell will take larger shares of the Asian IPP market in the future.
Many other firms, including turbine producers Siemens/Westinghouse,
ABB, and G.E., and EPC interests (e.g., Bechtel or Fluor Daniel), play a
significant role in construction, as do financial institutions, government
ministries, resource suppliers, and host utilities. These firms can construct
economically feasible plants for a variety of fuel sources, recommend or
obtain financing, and perform maintenance in the post—construction
phase. In a nutshell, the foreign IPPs’ or EPCs’ expertise lies not only in
technology but also in business operations and financial connections.
While cumbersome state power bureaucracies tend to think big and
finance on the run, if at all, IPPs will build smaller, more efficient plants
that economize the use of resources and capital while tailoring plants to
demand. V
Examples of public sector resource misallocation abound in the global
power industry: Brazilian hydro plants working far from capacity in the
remote interior, Paraguayan generators being abandoned for lack of funds
(Hines 1998), and Vietnamese plans to construct multiple nuclear reac-
tors in the near future despite a lack of capital and grid infrastructure
(EIAd) . IPPs are often more capable ofhandling fuel supply arrangements,
analyzing demand issues, and constructing the plants than government
ministries. Additionally, they can provide financing avenues in global 40 [ustin Auld capital markets and vital “operation and maintenance” knowledge to cash-
strapped, technology—poor host governments. IPP FINANCING ADVANTAGES The positive experience generated globally by IPPs over the past decade
has permitted a broader array of ownership options, such as “build own
and operate” (BOO) , “build lease and transfer” (BLT) as well as the more
popular “build operate and transfer” (BOT), among other models. These
models provide the IPP, its customer, and the financing entities with a new
way of sharing risk and rewards. At the same time, these ownership
formulas can overcome host country regulatory aversion to foreign
involvement in the power sector. I Funding can be derived from traditional project finance sources, such
as commercial banks, public sector bond issues, and multilateral agencies,
or from newer sources such as international capital markets, where
governments may not be welcome for political risk or creditworthiness
issues. Certainly, borrowing on international capital markets does de-
crease the borrower’s flexibility, as tenors tend to be too long (from 15 to
25 years) for IPP planners to adequately forecast future income streams
and repayment probabilities, and transaction costs of changing payment
terms are high. However, securitization concepts in capital markets have
also created flexibility by encouraging new forms of financing to replace
company equity, so that an IPP can, in effect, issue subordinated debt
based on its corporate cash flows instead of raising funds specific to a risky
project (Meyers 1998). Enron’s work in Dabhol, India, for example,
managed to survive unilateral U.S. sanctions in the aftermath of the
nuclear testing imbroglio by substituting this company—side financing for
U.S. Exim bank funds. As an IPP with global credentials, Enron International was able to
borrow capital market subordinated debt on its name, at rates derived
from the holding company’s credit rating. In these circumstances, an
Indian state—owned utility would have been forced to accept marginally
higher rates associated with international evaluations of the nation’s
sovereign and political risk. Creative financing by IPPs therefore dimin-
ishes some of the financial burden of project risk by reducing the cost of funds. The U.S. Securities a...
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