Mong Duong Power Project, the Largest Project Finance Deal in Vietnam - Lessons Learnt and Key Takeaways 1. Introduction Mong Duong Power Project is the Vietnam s biggest IPP now under construction. The project is a lesson in the ability of a carefully structured project financing to withstand some severe external shocks. The project faced all sorts of difficulties one can conceive of in the region including devaluation of local currency, high inflation, and negative outlook for the country by the international rating agencies. Moreover, in 2010, state-owned shipbuilder Vinashin's default on a $600 million loan created another crisis challenging Vietnam's ability to get its economy under control. To make things worse, from sub-prime mortgages in 2007 to the downgraded US debt status, global financial crisis came to a head in 2008. Credit flows to the private sector were choked off as business confidence collapsed and LIBOR lost its credibility fuelling financial market instability. Despite the project development taking severe beating from all odds both at global and local level, the non-recourse project financing was closed on time (fifteen months after PPA signing per contractual obligations) in 2011 with an oversubscription from commercial lenders. The project boasts of a solid contractual structure that was developed using the Vietnamese BOT framework. The 1240 MW power plant in Quang Ninh is the country s first privately owned power plant now being built since the early 2000s. The US $ 1.5 billion debt facility, meanwhile, is the largest in the country s power sector and at 18 years, the longest ever tenor for the power project financing in Vietnam. The author of this paper was previously the manager in AES to develop this project from start to financial close and commencement of construction. In this paper the author summarizes lessons learnt, and some key take away from this project that are relevant not only in Vietnam but also in other developing countries in the region. The opinions expressed within this article are the personal opinions of the author and do not reflect the views of AES or his present company. 2. Lessons Learnt 2.1. Agreement on Principles of the Deal by Key Stakeholders The developers, EVN, Government had a prolonged negotiation for the project. There were a number of times the commercial terms that were being negotiated and renegotiated over five years since 2007, but all parties made sure that the main heads Paper for POWER-GEN Asia 2014, Kuala Lumpur by Prabaljit Sarkar Page 1 of 8
of terms that were signed back in 2006 under a Project Principles Agreement (PrPA) were kept intact. The PrPA contained the common principles that can be applied to the main project contracts including PPA, Coal Supply Agreement, and BOT Contract. The PrPA included key features with respect to risk sharing amongst the various parties including the BOT Company, EVN, VinaComin, and the Ministry of Industry and Trade (MOIT). PrPA covered the provisions related to force majeure, termination and compensation for buyout, fuel supply risk sharing, lenders step-in-right and other salient contractual terms that are very essential for project finance. PrPA was negotiated between the Investors and the negotiation committee led by MOIT. The negotiation committee included representatives from VinaComin, EVN, State Bank of Vietnam (SBV), Ministry of Finance (MOF), Ministry of Justice (MOJ) and Ministry of Planning and Investment (MPI). Therefore PrPA had an endorsement from all decision makers and key stakeholders from the Vietnamese side. Whenever there was any disagreement while negotiation of detailed commercial terms, the PrPA acted as guiding principles that all parties abided by. This is an important success factor for the project that could be followed across the region. PrPA which is signed much in advance of executing project agreement and deciding on tariff, set the expectations of overall deal upfront as regards contractual terms and risk sharing are concerned, and also generated lenders confidence in the deal. 2.2. Credit Enhancement as a Catalyst Credit enhancement was instrumental in providing access to capital for the Mong Duong project under reasonable terms. Mong Duong project was covered under a sovereign guarantee from the Government of Vietnam. The project is the first Vietnamese transaction for the South Korean entities. It saw the first participation of Korea Trade Insurance Corporation (K-Sure) and Korea Exim Bank (KEXIM) on the back of Posco Power s equity stake and an EPC Contract from Doosan. The total project cost is US$ 1.95 billion, and portion debt is US$ 1.46 billion, that were divided into three tranches. Tranche 1 is KEXIM direct loan of US$ 342 million; Tranche 2 is 80% K-Sure covered facility of US$ 839 million Tranche 3 is a 100% Kexim-covered US$ 280 million Banks signed up to Tranche 2 and 3 on pro-rata basis with coverage from the Korean ECA, which is a key factor in the appeal of the loan and ended up winning support of twelve commercial banks- seven of which under wrote one-seventh of the loan Paper for POWER-GEN Asia 2014, Kuala Lumpur by Prabaljit Sarkar Page 2 of 8
amount. B Paribas (facility agent), Credit Agricole (document bank, inter creditor agent), HSBC (account bank and collateral agent), ING (model bank), Natixis, Socete Generale and SMBC (insurance bank) were book runners. They were joined as MLA s by Mizuho Corporation Bank, Stanchart and Unicredit while CIC and DZ Bank signed up as lead arranger. The project company has to maintain a DSCR 1 of 1.4 x 1.5 x and DSRA 2 is six months equivalent of repayment. Figure 1: Mong Duong Financing Scheme BOT Contract GGU Investors MOIT AES POSCO CIC GGU Vinacomin EVN EPC Contractor CSA PPA EPC BOT Company (BORROWER) Debt Equity Facility Agent KEXIM Commercial Banks PRI KEXIM & KSURE ( ) Collateral Agent Lenders BOT Contract: Build-Own-Operate-Transfer Contract, CSA: Coal Supply Agreement, GGU: Government Guarantee and Undertaking, PPA: Power Purchase Agreement In developing economies all project financed power projects will need credit enhancement in some form or other. Particularly, in countries where State utility is not rated by international rating agencies and their bottom line is heavily influenced by Government decisions or budgetary support (e.g. Indonesia, Vietnam), sovereign guarantee and political risk insurance from multilateral development banks (MDB) or bilateral are the key requirements for successful power project finance. 1 Debt Service Coverage Ratio 2 Debt Service Reserve Account Paper for POWER-GEN Asia 2014, Kuala Lumpur by Prabaljit Sarkar Page 3 of 8
2.3. Risk Assumption by Government In Mong Duong project, Government accepted suitable level of project risk that is conducive for project finance. Other government entities such as Vinacomin, the national coal company which is coal supplier for this project, EVN, the national utility which will purchase power from the project, local governments such as Quang Ninh Provincial Peoples Committee that made land available for the project free of all encumbrances, Quang Ninh Water Works and Water Supply Company, water supplier for the project- all took equitable project risks. This shows that as governments increasingly come to accept suitable level of project risks, they are more likely to embrace private power as an equitable way of meeting long term needs. 2.4. Risk Allocation Matrix for State Infrastructure Availability One of the major obstinate bottlenecks of project development in developing countries is issues related to resettlement and compensation for land acquisition, and providing access to infrastructure such as access road, national grid and jetty wherever applicable. Mong Duong project was no exception. In Mong Duong project, Government and developer showed adeptness at sharing the risk of infrastructure availability in a very unique as well as aggressive way. The project achieved financial close and started construction before the entire piece of land was available to the project company! The project took the possession of land in three phases as the construction progressed. The turn-key EPC Contractor and international lenders were comfortable to this arrangement because of a watertight contractual terms and a fair and equitable risk sharing among EVN, MOIT and the project company. A special chapter in PPA on Vietnam-side Infrastructure Facilities (VISF) was dedicated to the threadbare concepts of risk sharing arrangement of land clearance and construction of infrastructure facilities among the parties. The parties showed extraordinary dexterity in closing the negotiation although it was dragged over a prolonged period due to hierarchical decision making process on the Vietnamese side. Under the VISF, although EVN s construction arm which was responsible for completing the infrastructure, MOIT backstopped the performance of EVN under the BOT Contract that went a long way to give confidence to project owners and lenders alike. Under the BOT Contract which was executed by MOIT, the project company got the protection under deemed commissioning, in the event that the BOT Company is unable to commission the plant due to the unavailability of the Vietnam Side Infrastructure Facilities. The agreement on VISF was a landmark achievement for the project developer and Government given that there was no such precedence in Vietnam and even in the region. Without VISF, the construction for the project would have to be pushed Paper for POWER-GEN Asia 2014, Kuala Lumpur by Prabaljit Sarkar Page 4 of 8
further by almost two years, which would have made the EPC price as well as tariff of the project invalid. Figure 2: Summary of Contractual Terms of Mong Duong Power 2.5. A New Concept of IRSIM to Tackle the Time Lag in Financial Close As stated in the introduction, Mong Duong project development and negotiation took place during a time when there was severe turmoil in the financial market. Though PPAs were executed finally in 2010 when financing market showed sign of recovery, raising debt finance of US$ 1.46 billion was still challenge- more so in Vietnam due to country s falling economic health for other domestic reasons including inflation, devaluation of Dong, and default of State-owned Vinashin to international banks. It was estimated that the financial close will take time more than a year even after execution of PPA, given that the financing would involve a club deal of several commercial banks which have individual limits for taking exposure to Vietnam- not to mention close to eight hundred Condition Precedents that were needed to be fulfilled for the first draw down. Developer, therefore, proposed an Interest Rate Swap Mechanism (IRSM) in the PPA to address the change of base interest rate between date of PPA signing and the date of financial close (first draw down). Under the IRSM, the PPA provides for adjustment of the Fixed Capacity Charge by way of Supplementary Interest Charge (SIC) to account for the variation in the base interest rate on the financial closing date and the base interest rate on the PPA signing date. The SIC formula as derived from the projects financial model is fixed positive or negative adjustment, and designed to keep the project s equity IRR constant. Paper for POWER-GEN Asia 2014, Kuala Lumpur by Prabaljit Sarkar Page 5 of 8
The concept of IRSM was first time ever used in Vietnam. Had there been no such provision in the PPA, the BOT Company needed to hedge interest rate exposure to buy a swap and included in the tariff. This might have increased the tariff unnecessarily. Since SIC under IRSIM is determined upfront while signing PPA, it avoids potential opening up the PPA and renegotiating tariff should there be any material adverse change in the financial market during the time between the tariff negotiations were concluded and the time of financial close. 3. Future Takeaways for the Power Project Finance in the Region The Mong Duong project finance experience should give a favorable base for future BOT power projects in Vietnam. However, the future holds many challenges, including the specter of a decrease in sovereign guarantee, fewer market participants and also uncertainties of long-term PPA in future power market as Vietnam pursues power market reform. The following takeaway from the project is not only applicable to Vietnam but also other developing economies in the region having similar settings. 3.1. Finding Substitutes of Sovereign Guarantees Though precedent Phu My BOT projects in Vietnam got project guarantee for entire duration of PPA, guarantee period for Mong Duong project offered was reduced to eighteen years from commercial operation date whereas the PPA term is for twenty five years. This did not impact bankability of the project significantly- as loan tenor for projects is also 18 years door to door. However, for future projects, Vietnamese Government may further curtail coverage of tenor and amount under the guarantee. It is not known how much curtailment on guarantee coverage will be accepted by the investors. Political risk (including Breach of Contract/ Arbitration Award Default, Currency Transfer & Convertibility, Expropriation, Political Violence) still remains the salient constraint to investment not only in Vietnam but in many developing countries. Governments that are unwilling to offer comprehensive guarantees can offer partial ones, such as only debt repayment in the event of termination for breach of contract or adverse regulatory changes. MIGA EIU Political risk survey showed that the political risk due to breach of contract and adverse regulatory changes, were the two risks for which investors are most concerned of and they claimed most frequently the losses on account of these two risks in previous years. 3 If Governments offer partial guarantees, they need to also consider other additional forms of financial security such as escrow account, letter of credit from the power purchaser for short-term credit support. Governments may also consider co-finance 3 MIGA WIPR report of 2011 and 2012 Paper for POWER-GEN Asia 2014, Kuala Lumpur by Prabaljit Sarkar Page 6 of 8
from local development banks to reduce the quantum of international loan that will require cover from guarantee. Governments need to recognise that until off-takers become commercially viable and recognized by an international rating authority, they need to continue offering substantial amount of security in one form or other. Government guarantee for political risk help investors to access finance in better terms in terms of tenor and size of loan and price electricity economically. Therefore, it is important that Governments, if unwilling to provide comprehensive guarantee will have to explore viable alternatives. 3.2. Role of Debt Capital As the need for private investment in power projects grow, and more and more projects coming to pipeline of development, ability of Government, multilaterals and ECAs to continue to take risk may become limited. Private debt capital may need to assume a larger role such as providing larger percentage of the total debt as uncovered finances- at least in low risk countries to begin with. 3.3. Maintain sanctity of negotiated contracts Investors, project developers, lenders and government, all should bear responsibility for avoiding reopening of contracts. It is important that Government and political leaders communicate and take consensual decisions on salient terms of contracts and the deal in advance with the state utilities and other government entities that are party tot the project contracts. The agreement like PrPA followed in Mong Duong project may be executed in advance to fix the boundary line within which the project contracts will be structured. If state utilities or local government authorities perceive that the project is being thrust upon them by the Government or Ministries, utilities may take many u turns while signing the project contract. 3.4. Keeping Alive Investor Confidence Private players will shun away from those countries having cumbersome development process. Solicitation and bidding process therefore must be clear and transparent. Government decisions need to be fair and provide a level-playing field to the investors and keep alive investors confidence in the country s business environment. 3.5. Increased Standardization of Risk Allocation Like Vietnam, many of the developing countries have already experienced more than one successful project finance, and they already know what structure of contracts and risk sharing works in the international financial market and what does not. Therefore, governments should not tamper with the general approach to risk allocation in project contracts and reinvent the wheel. Governments may take advice from ECAs and MDBs Paper for POWER-GEN Asia 2014, Kuala Lumpur by Prabaljit Sarkar Page 7 of 8
who are well positioned to advise Governments structuring projects that are financeable. 4. Tailpiece In general, all governments, private investors, bankers and multilaterals, ECA and EPC Contractors have strong interest in maintaining private power market. Therefore, all market participants must play their respective role to enhance private power market. Governments need to execute fair policies, and provide adequate security to attract private investment. Private investors need to maintain long-term business commitment with the countries. Private banks can take more exposure to low-risk countries by way of increasing percentage of uncovered loan, and also find ways to invest safely in high-risk countries. Multilaterals, ECAs and bilateral needed to continue to provide credit enhancements, and play strong roles in markets. Achieving private power s potential to meet the power demand of the developing nations need contribution from all market participants. ********** Paper for POWER-GEN Asia 2014, Kuala Lumpur by Prabaljit Sarkar Page 8 of 8