Will infrastructure finance return to East Asia?

Transcription

1 East Asia 2004 Will infrastructure finance return to East Asia? Frédéric Blanc-Brude Introduction In 1997, a World Bank publication about the Asian power sector stated: Demonstration effects arising from the success of privatisation and unbundling efforts (for example in the United Kingdom) and the possibility of using regulation to protect the public interest are making new approaches to upgrading infrastructure [in Asia] viable. 1 Such comments would, no doubt, make most project financiers wince nowadays. The 1997 economic crisis left East Asian project finance and infrastructure finance in the doldrums. As stability and growth return to the region, along with the prospect of everincreasing demands for essential services, it is appropriate to assess the lessons that have been learned in the latest boom and bust cycle. The Asian financial crisis had a mixed impact on the East Asian economies. For instance, Indonesia and the Philippines were severely affected in the power sector, mainly because foreign currency obligations of various privately financed projects, as a result of foreign borrowing and foreign currencydenominated power purchase obligations, were much higher than in Malaysia and Thailand, where local funds were mobilized to finance long-term projects and power purchase obligations were denominated in local currency. In the Philippines, the ripples of the shock can still be felt today. Earlier this year, the Suez-led consortium, which ran one of the two water concessions in Manila, East Asia requires a minimum of US$300 billion in infrastructure investment. But private capital inflows for infrastructure have been consistently decreasing since 1997 and, as risks on sovereigns have been down-graded, investors require everhigher returns on their capital terminated the concession contract and is now in arbitration. Growing East Asian countries still have a fundamental and ever-increasing need for infrastructure investment to keep pace with economic development. Historically, for each percentage point of growth in a country s per capita GDP, the infrastructure stock has grown by the same amount 2. Whilst the need for capital is not in question, the form and the mix between public and private remains a debate which neither host governments, international institutions nor other key stakeholders have been able to resolve to everyone s satisfaction. According to the World Bank s projections in June 2003, East Asia requires a minimum of US$300 billion in infrastructure investment. But private capital inflows for infrastructure have been consistently decreasing since 1997 and, as risks on sovereigns have been down-graded, investors require ever-higher returns on their capital. As project costs rise, so the cost of providing the services needs to be inflated to keep pace, which puts pressure on the economic sustainability of projects which, by their very nature, need to be viable over several decades. Whilst sustained economic growth could theoretically make such costly projects viable, infrastructure development is itself a key factor in such growth, which leaves observers with a chicken and egg dilemma. This article examines the 30

2 state of the East Asian infrastructure by key markets: China Vietnam Indonesia The Philippines Malaysia Thailand and evaluates the key success factors necessary to ensure a sustainable flow of infrastructure projects. 2003: An Energetic Market The fundamental drivers of East Asian growth appear not to have been in place this year. As a consequence, most deals that were in the pipeline have remained there. A quick look at any project financier s agenda for 2003 provides an insight into the potential for the region. The PRC led the way in the list of mega deals with the mother of all deals the US$22 Electricity of Viet Nam announced in April that it would build 62 new power plants to push the country s capacity to 15GW by 2011 billion Three Gorges Dam successfully undertaking an IPO in late October Other major project finance deals included the Nanhai project a US2.7 billion joint venture between the Chinese state oil company CNOOC and Shell and US$1 billion Kihu Gas project with CNOOC partnering up with Sinopec. Preferred bidders were announced for the US$850 million Guangdong LNG (CNOOC and BP), and CNOOC agreed to finance the first Asian pipeline to Kazakhstan in October this year for an estimated cost of US$800 million. The Shenyang subway in northern China will be built by the Korean corporate, Daewoo at a cost of US$1 billion. There will be a second international airport near Beijing (Hebei province). The Shandong Province water diversion project will cost something like US$2.8 billion, about as much as the projected Beijing Olympic Stadium. Other projects on the radar screen include the US$10 billion East- West gas pipeline and US120 million Beijing Water n 10 transaction. In Viet Nam, Electricity of Viet Nam (EVN) announced in April that it would build 62 new power plants to push the country s capacity to 15GW by For this ambitious programme, Vietnam has avoided the pitfalls that Indonesia encountered in developing too many large and high-profile power projects, by developing a portfolio of smaller-scale projects, many of which number in the hundreds of megawatts of capacity. EVN as an integrated utility has adopted a mixed procurement strategy in terms of meeting its high power demand forecasts. The success can be seen in two IPPs that have reached financial close over the past 12 months, Phu My 2.2 at the end of 2002 and Phu My 3 in the first quarter of 2003, totalling US$800 million of investment. It has also financed the construction of its own power According to Infrastructure Journal s mid-year 2003 League Tables, more than 80 per cent of projects that reached financial close or are still under discussion, are in the power or Oil & Gas sectors plants by tapping the local debt markets: Central Quang Tri provincial project with a US$32 million loan from the Commerce and Industry Bank of Vietnam; a US$109 million loan from the Investment and development Bank of Vietnam to develop the A Vuong power project; and US$135 million from the Vietnamese Bank for Agriculture and Rural Development to fund the Buong Kuop power project. EVN also borrowed US$100 million during 2003 from Citigroup for the Ban La power project, US$120 million from BNP Paribas for the Tuyan Quang 31

3 project and US$100 million from ABN Amro for the Buong Kuop project. The Vietnamese Government also approved a US$500 million Can equity investors and project financiers return to the region with the belief that sustained economic growth will make new projects bankable? Or is the development of such projects a necessary condition for sustained economic growth to happen in the first place? loan for the 600MW Ha Khanh project, and is currently assessing water and sanitation projects for Ho Chi Minh City. Moving south, the US$280 million Blue Sky pipeline project reached financial close in Indonesia this year. Jawa Power was refinanced at US$1.7 billion, along with Paiton Power I (US$2.6 billion) or West Seno I (US$1 billion). Other Indonesian deals in the pipeline include the Tuban Petrochemical deal (US$1.5 billion), Paiton Energy refinancing (US$3.3 million) and PT Mobile for US$350 million. In Malaysia, the US820 million financing of Malaysia International Shipping Corporation s Berhad LNG Tanker deal reached financial close, while in Thailand, the US$1.1 billion Map Ta Phut power project reached financial close this year, as did smaller projects such as Bangkok Cogeneration (US$53 million). Several more projects are in the pipeline, such as Tg Bin Power (US$1.5 billion) in Malaysia and a 1.44GW IPP could be developed in Thailand costing US$1.3 billion. Finally, while the Philippines have seen little deal closure this year (Long Distance Telephone Company was one of the few), there are plenty of projects coming up, including the Malampaya Deepwater Gas-to- Power project, valued at US$5 billion and the Mindanao power project estimated to cost US$310 million. Some investors are showing renewed interest. For instance, having first pulled out of the market in the early summer, EdF chose to commit to the US$1.5 billion Nam Theum Hydro project in Laos. According to Infrastructure Journal s mid-year 2003 League Tables, more than 80 per cent of projects that reached financial close or are still under discussion, are in the power or Oil & Gas sectors. Some of these needs will be met by intra-regional transportation projects. However, some of the more mature South East Asian sources of energy are facing declining production and there is a need to invest in the exploitation of marginal fields and the development of frontier areas. This has now been made possible by technological advances such as deepwater drilling and floating production facilities. Regional energy supplies will not, however, be sufficient to satisfy demand and to guarantee security of supply. Imports of crude and gas will have to increase. The Middle East, Central Asia and Russia will become increasingly strategic sources of energy supply. In this respect, 2003 deals are announcing only longer-term trends: pipelines, East Asian states are increasingly cooperating and coordinating their activities, starting utility trading blocks and institutions with specific mandates for regional energy development LNG terminals and tanker deals should stay on the East Asian financing agenda for several decades. Also of note is the relatively new phenomenon of state companies investing outside their national markets. East Asian states are increasingly 32

4 cooperating and coordinating their activities, starting utility trading blocks and institutions with specific mandates for regional energy development. Cross-border pipeline projects and LNG projects (e.g. liquefaction in Malaysia regasification in China) spring from this rising regional interdependence. Long-term projects such as the Trans-ASEAN gas pipeline, which could link 80 per cent of the total of ASEAN gas reserves, or the idea of an ASEAN power grid, also reflect this trend. Chicken and Egg The fundamental economic drivers of the region have not changed. But apart from the well ring-fenced, sovereign-guaranteed oil and gas deals, legal and regulatory uncertainties make it difficult to evaluate the long term business potential of projects in the region. The fundamental dynamics are: Economic growth and infrastructure investments may have been hampered by the crisis but the underlying factors that drove the Asian miracle are unchanged: increased urban migration, industrialisation, a growing middle class and higher disposable incomes. Investment requirements still exceed the capacities of national utilities and governments, with the total infrastructure investment requirements for the region estimated at between US$300 and US$1,500 3 billion by the World Bank; State-owned infrastructure assets do not meet international standards of efficiency; Management and technical expertise is inadequate. As a consequence, the limited coverage and quality of Asian countries infrastructures are limiting their capacity to achieve international competitiveness and When Thailand abrogated its commitment to increase tolls in the Bangkok Second Stage Expressway, a project with large Japanese involvement, the Japanese government chose not to step in given the other major Japanese interests in Thailand eventually boost economic growth. Thus, it remains difficult to know exactly what will provide the impetus. Can equity investors and project financiers return to the region with the belief that sustained economic growth will make new projects bankable? Or is the development of such projects a necessary condition for sustained economic growth to happen in the first place? As the length of the current pipeline deal indicates, there is massive interest from international equity investors. For instance, 30 investors participated to the Phu My 2.2 pre-bidding competition to build the first Vietnamese IPP. In this perspective, governments will have to continue reforms to establish the legal and regulatory regimes to allow private sector participation in finance, technology and management. For this process to be successful and to facilitate economic growth, these reforms must guarantee that there is a sound economic rationale for deregulation, that a model for reform exists that best fits each country s requirements and that there is a solid legal and regulatory framework for investment. Uncertainty in this respect will impede the development of the region s infrastructure assets. Indeed, such expressions of interest do not necessarily mean that investors see East Asian projects the way they used to. The net amount of private capital invested in the region s infrastructure has decreased steadily since 1997, as Infrastructure Journal League Tables and World Bank Statistics released last June show. International equity investors and the banks that shoulder their projects do not take for granted that the current model of doing business in East Asia actually is good business. Confidence Lost Numerous comments from the market confirm that confidence in 33

5 the idea that private finance could somehow provide public goods on a sustainable basis in developing countries of East Asia has been destroyed. Currency risk, political instability, leadership changes, corruption, and excess capacity due to over-estimated demand have all made developers and financiers wary of investing in these countries. The bulk of the blame still lies with governments, who proved unwilling or unable to respect their obligations to the international private investors who had been pouring cash into their power, water or transport infrastructure. But if equity investors have to be convinced that investing in developing Asian countries can generate sufficient upside,. this, in turn, brings up the question of acceptable prices and acceptable equity returns. The costs of project finance tend to increase the price of the kwh, for example. Furthermore, with each sector being developed on a project-byproject basis, it is not self-evident that there can be a set of equilibrium prices. To some, especially IFIs, developers are asking for too much return on equity given the actual risks, especially as they insist on sovereign guarantees before going ahead with a project. Political risk, however, has proven to be a more elusive form of risk than project developers initially believed. The expected political risk coverage built into many projects often proved insufficient. Political risk mitigation provided by multilateral agencies and ECAs (Export Credit Agencies) did not prove systematic because of conflicting national or supranational interests. When Thailand abrogated its commitment to increase tolls in the Bangkok Second Stage Expressway, a project with large Japanese involvement, the Japanese government chose not to step in given the other major Japanese interests in Thailand. The United States similarly felt it had broader national interests in Projects should be part of a well-structured, regulatory approach at the relevant level (municipal or national), with a focus on grids and distribution systems, instead of creating islands of profitability within an unpredictable system Indonesia in the late 1990s, than to insist on payment to power projects undertaken by American companies and funded in significant part by US agencies. Arbitration processes can also be a liability, as not all aspects of a deal will always fall under the same jurisdiction (national or international) and under the same rules (as is the case for Vietnamese BOTs for instance). A new model is needed to bring the region s infrastructure beyond the threshold where positive externalities and reduced transaction costs for national economies will guarantee the profitability of these projects. BOT and BOO contracts and the ring-fencing of projects from the rest of the economy have demonstrated their limitations when the nature of infrastructure assets, as public goods, is to be integrated in the economy and to enhance its capacity to develop. A New Model The task is to create financing structures that mitigate noncommercial risk to a level such that international investors, more cautious than in years past, can tolerate. This will involve full implementation of the financial and legal reforms that have been on the World Bank s agenda for a decade. In countries such as Thailand and the Philippines that have a developing local bank network, risk might be mitigated by combining local and offshore borrowing, while simultaneously utilizing currency, interest rate and other derivative instruments. This kind of strategy would reduce risks to more manageable levels, especially in projects where cash revenue is denominated in local currency. Firstly, governments need to commit to private participation in infrastructure. The liberalisation process must be crystal clear, as the acknowledgment that the rule of law will be observed. For instance, the suspension or reopening of contracts, as experienced in the power 34

6 industries of Indonesia and China and as is expressly provided by the Philippines Electric Power Industry Reform Act, creates investment risks and uncertainties that can only limit future investment flows. Serious moves towards fully competitive bidding processes still have to be made even though the region s record is varied (from a formalized competitive procurement for IPPs in Indonesia since 1997 to the complete absence of such procedures in Macau). Investors confidence in governments will be a function of this greater transparency and a better flow of information. Setting up specific policies and government bodies to encourage private sector entry, as well as a fully transparent system of evaluating bids and awarding contracts will help achieve an appropriate allocation of risks between public and private sector. One of the keys to the success of infrastructure projects in the region will be the autonomy and accountability of regulators when addressing the factor of investment risk. Governments must look at the current fiscal and other investment incentives offered to project developers to ensure that adequate investments are made throughout the whole of their national infrastructure. Encouraging investment in areas which would otherwise not be commercially viable, can strengthen the country s economy as a whole and help reach the economic threshold past which economic development and infrastructure development become mutually re-enforcing and beneficial. Changing legal and fiscal regimes can also allow for mergers and acquisitions and divestments between local and international Finally, international financial institutions should play a greater role in helping private projects survive in times of crisis. Preserving key infrastructure projects from collapse in difficult times is key to the development of the region s infrastructure in the long run, given the enormous associated costs of restarting/ redeveloping projects, not to mention the disruption of service to the economy and associated negative externalities investors. This creates the kind of long-term shared vested interests that make projects participants work together. But on top of the implementation of these reforms, a new model for the development of public goods with the support of private capital, technology and management seems necessary to give true momentum to the deal flow which crowds the ongoing deal section of Infrastructure Journal League Tables and has yet to make it to the closed deals section. New partnership models are needed between the public and private sectors in the developing world to provide greater assurance of project viability and greater incentives for performance by governmental parties. Standard project financing is limited by creditworthiness. A more resilient model could take a PPP approach or combine state aid and privately managed projects. Projects should be part of a well-structured, regulatory approach at the relevant level (municipal or national), with a focus on grids and distribution systems, instead of creating islands of profitability within an unpredictable system. The BOT and BOO approaches do not suffice to develop national infrastructures. Ring-fencing islands of profitability within a non-viable country system is simply not good enough to guarantee sustainable projects. Corporate interests have to approach projects with a longterm view involving all stakeholders and favouring coinvestment with Governments. The increase of private interest might in fact come increasingly from regional companies with different business practices from their international counterparts. 35

7 Private companies must behave responsibly and avoid entering into deals where the underlying economics are not sound and cannot support the long-term life of the agreement. Project size is also an issue. Big projects cost a lot to put together in the first place and generate their own risks. The more expensive the project, the more difficult it is to finance locally. This tends to create projects with massive currency risk exposure. At the opposite end of the spectrum (and of the globe), EBRD has been pioneering the development of small utilities projects financed in local currencies. New technology also makes a smaller project approach more economically viable and environmentally friendly. Other initiatives could reduce project costs through improved management, using domestic energy supplies where possible, reducing complexity, having a portfolio approach to projects or integrating projects value chains forward and backward. The development of targeted political risk insurance involving both private insurance and government bodies is also a necessity. Finally, international financial institutions should play a greater role in helping private projects survive in times of crisis. Preserving key infrastructure projects from collapse in difficult times (currency crises, for instance) is key to the development of the region s infrastructure in the long run, given the enormous associated costs of restarting/redeveloping projects, not to mention the disruption of service to the economy and associated negative externalities. Conversely, a way to avoid such crises for projects is to promote local currency financing each time it is feasible. Conclusion This year s activity demonstrates that East Asia has the needs and the economic drivers for massive The recipe for success in the region will depend on the capacity to strike a balance between the interests of all stakeholders in an infrastructure project, including investors, governments, as well as the existing consumers infrastructure investments in the coming decades. It is not always the case, however, that it has the right legal and regulatory frameworks to make these projects bankable. But the region s development does not solely depend on national governments capacity to acknowledge the rules proposed by the World Bank. Countries could face difficulties in areas such as implementation, or could face opposition from national legislators: yet reforms could fail to influence private investors confidence if they are not perceived as permanent. What can make a difference in the development of such a framework is the interaction of all stake-holders, public, private, institutional, local or international to make these rules come alive and fit each country s requirements. In this perspective, project finance will continue to play a key role in the region s future. Involving private management in aid-funded projects, for instance, could be a new form of private-public partnership to develop East Asia s infrastructure. Infrastructure sectors bear most of the characteristics of public goods and could be approached as projects in their own right. In the power sector, this would mean looking at the whole valuechain, from generation through to distribution. Power asset development could then become sub-projects for private capital to develop within an overall coordinated development plan involving the Government, multilaterals and the private sector. The recipe for success in the region will depend on the capacity to strike a balance between the interests of all stakeholders in an infrastructure project, including investors, governments, as well as the existing consumers. i J Frédéric Blanc-Brude 1 (Private participation in Infrastructure: Lessons learned from Asia s Power Sector, Finance and Development, 1997, World Bank) 2 World Bank Data 3 The latter was advocated by the Bank in the more optimistic days of the mid-nineties 36