Developing the Power Sector through Private Investment in Mongolia. Edgar Saravia Program Manager

Developing the Power Sector through Private Investment in Mongolia Edgar Saravia Program Manager October 2008

Setting the Context Government of Mongolia ( GoM ) wishes to introduce PSP in power generation Benefits of PSP: Introduce competition Increase efficiencies Improve reliability of electricity supply Major form of PSP in power generation = design, construction and capital financing for one or more new power generation facilities under private initiative ( IPPs ) Rationale: Alleviate existing and future electricity supply constraints outside of state budget

Agenda Introduction to the International Finance Corporation ( IFC ) Introduction to Public Private Partnerships ( PPPs ) Introduction to Independent Power Projects ( IPPs ) Best Practices in IPP Bidding Project Agreements

World Bank International Finance Corporation Private sector arm of the World Bank Group Group The World Bank (IBRD & IDA) Multilateral Investment Guarantee Agency International Centre for Settlement of Investment Disputes

International Finance Corporation Infrastructure Advisory Services Lead advisor mostly to governments Due diligence and structuring of infrastructure projects Strategy definition for PSP-PPP Marketing of business opportunities to selected investors Transparent international competitive bidding Acting as advisor to various governments to implement IPPs through competitive bidding: Current mandates include Vietnam, Indonesia, Philippines, Bangladesh, Lebanon, Albania, Zambia

What Are PPPs and How Are They Different From Privatizations? PPP is a generic term for the relationships formed between public bodies and the private sector with the aim of introducing private sector resources and/or expertise to provide and deliver public sector assets and services Engagement Anywhere Along the Spectrum Public Private Ultimate Goal: Ensuring Access to Reliable and Affordable Basic Services

Options for Private Sector Participation State Risk MOST EFFECTIVE Divestiture Technical Assistance Service Contract 1-3 yrs PPP Concessions Lease 25-30 yrs Contract Management 8-15 yrs Contract 3-5 yrs Private Sector Risk

Contrasting Public Sector Payment Profiles of Traditional and PPP Procurement Models Capital and operating costs are paid for by the public sector, who take the risk of cost overruns and late delivery. Source: PWC The public sector only pays over the long term as services are delivered. The private sector funds itself using a large portion of debt plus shareholder equity. The returns on their equity will depend on the quality of services.

NAO Report UK s National Audit Office report on PPP (2003) Improved Project Delivery Non PPP Procurement (1999 Survey) PPP Procurement (2002 Survey) Price Overruns 73% 22% (mostly client changes) Time Overruns 70% 24% (only 8% > 2 months)

Key Benefits of PPPs For the public sector: Injection of private capital Skills / know-how from the private sector result in higher quality of service Optimized allocation of risks Better management of public finance: Government pays only when services are delivered Budget certainty More efficient use of public funds Delivers value for money For the private sector: Attractive framework to enter or develop new markets Attractive returns Legal and financial guarantees from the Government

Structuring PPPs - A Balancing Game 1 Financial Equilibrium 2 Appropriate Framework Private Sector 4 Allocation of Risks 3 Transparency of Process

What Are IPPs? IPPs are PPPs in the power generation sector Private investors build and operate independent power plants and supply electricity according to long-term power purchase agreements (PPAs) typically 15 to 30 years Under the terms of a PPA, the project company typically agrees on an exclusive basis to make available to the offtaker the plant s entire generating capacity and, to the extent dispatched by the offtaker or the relevant transmission authority, supply electricity up to the plant capacity VERY DIFFERENT FROM A CONSTRUCTION CONTRACT WITH GOVERNMENT AS OWNER

Sustainable IPP Investments Simple hypothesis Sustainable IPP investments depend on a balance between investment and development outcomes Investment outcome: Adequate return on investment Prospects for expanded investments Development outcomes Reliable power Competitively priced power Timely power

Best Practices in IPP Bidding Two stage tender Stage 1: Pre-qualification Pre-qualification (PQ): to narrow down (ideally) 5-6 qualified sponsor / consortium of sponsors PQ on pass-fail basis based on objective and quantifiable criteria Criteria to test financial strength, IPP development experience, construction experience, O&M experience Stage 2: Tender Technical proposal on pass-fail basis Includes legal statement, bid bond, technical proposal, accepted final project agreements (PPA, etc.) Only those proposals that pass have their financial proposals opened Financial proposal single number, usually lowest levelized tariff wins Occasionally PQ is merged with Tender by including qualification criteria in the Technical Proposal

Best Practices in IPP Bidding (cont.) Advantages of this approach Transparency and Objectivity PQ criteria based on objective, quantifiable criteria no room for dispute Pass-fail system in PQ ensures that all bidders have level playing field and are equally qualified Pass-fail system in Tender (technical proposal) ensures that there are no deviations to the bid (difficult to evaluate) Single number for evaluation of financial proposals easy to evaluate, no room for dispute If project agreements/terms vary between bidders, not comparing apples to apples Most multilateral financial institutions look for transparent competitive procurement when providing financing

Best Practices in IPP Bidding (cont.) Advantages of this approach (cont.) Speed Project agreements pre-negotiated with pre-qualified bidders prior to bid Bidders must accept final project agreements in tender with no material deviations minimizes post-bid negotiations and time to PPA signing Assurance Bid security ensures that winning bidder has a high stake in ensuring financial close

Best Practices in Project Agreements Sponsors and lenders invest/lend to a project after close scrutiny of project agreements Power Purchase Agreement Between winning bidder s project company and offtaker Sets out the rights and responsibilities of each party and allocation of project risks Risk allocation should be based on which party is best able to manage the relevant risk and on market precedent Eg. project company usually takes construction risk, financing risk, operating risk and risk of natural force majeure. May also take market risk and fuel supply and price risk depending on type of contract Eg. offtaker or Government usually takes political risk, FX risk. May take market and fuel supply and price risk depending on type of contract Specifies default, termination events and consequence of termination

Best Practices in Project Agreements Power Purchase Agreement PPA must specify tariff structure typically two-part tariff Capacity payment covering fixed costs of financing (debt and equity) and fixed O&M costs Energy payment covering fuel cost and variable O&M If plant is not dispatched due to fault of offtaker/government, capacity payments must be made Other agreements may include Implementation Agreement between Gov and project company where Gov assures an enabling environment Gov guarantee of the offtaker s payment obligations The above are standard requirements for IPPs in IDA countries May include a Land Lease Agreement, fuel supply agreement

Energy Conversion Agreement Two possible structures: ECA Energy Conversion Agreement ( ECA ) Power purchaser or off-taker (Gov entity) bears responsibility for fuel supply to the power producer (including quantities, costs, delivery and quality) Power producers agrees to convert fuel into electricity and deliver power to purchaser Power Purchase Agreement ( PPA ) Power producer responsible for fuel supply Power producer recovers fuels costs through tariff paid by power of taker Provides needed certainty to investors Better financing/bankability perspective for lenders

Market Reforms We understand that GoM is planning to transition from Single Buyer Model to Competitive Markets Bidders/lenders will be concerned about weakening of take-orpay provision typical in PPAs To satisfy bidder/lender concerns, typically Retain take-or-pay levels in PPA i.e., grandfather the PPA since it would have been signed before the reforms and priced on that basis (in un-tested markets) Provide in the PPA that any restructuring would preserve equity returns and debt service capability (still voluntary on part of investor) AND provide that any successor offtaker obligations be guaranteed Provide for gradual lowering of take-or-pay provision (unlikely to be accepted except in mature markets)

Providing Credit Enhancement Improve credit worthiness of offtaker For IDA countries, state guarantee from Gov may not be sufficient How to provide comfort to investors and lenders: Escrow account arrangements to cover payment risk Capital subsidies to the Project by using the grants and subsidized loans available to GoM Partial financing by ECAs and multilaterals World Bank Partial Risk Guarantee ( PRG ) or similar guarantee to cover residual termination risks MIGA Political Risk Insurance ( PRI ) to cover residual risks Once track record is established (one or two successful IPPs with a stable payment record), investors/lenders will become more comfortable and need for guarantees may reduce for future projects Guarantee and all other credit enhancements must also be prenegotiated with bidders

The End THANK YOU

Key Challenges of PPPs For the public sector: Select the right partner (expertise, capacity, commitment etc) Select the right structure (PPPs = wide variety of models) Potential high procurement costs Define the optimal risk allocation Risks should be borne by the party that controls them Project contracts are used as a means to mitigate these risks Residual risks, such as political force majeure and regulatory risks, are mitigated through guarantees and insurance Long term commitment For the private sector: Define the optimal risk allocation Lack of protections to guarantee sufficient return on investment Long term commitment

Typical Risk Allocation Risks Technical Assistance Management Lease/ & Services Affermage Concession Full Divestiture Market Risk O & M Invest. Renewal New Assets Financing: Access Debt Service State: Operator:

Subsidies Example: A Possible PPP Setup Type of Subsidies Capital Subsidies Transition Subsidies Trans. Subsidy Trans. Subsidy - Cost covering tariff Actual tariff Ongoing Subsidies (targeted poor population) Contribution User Contribution Time Time

IFC Products and Services IFC deals only in private sector projects IFC operates on a commercial basis. It invests exclusively in for-profit projects, fully shares risks with its partners, and charges market rates for its products and services. Products cover three broad areas: Financial products: IFC provides loans, equity finance, quasi-equity and financial risk management products. Advisory services: IFC is the only multilateral which provides advice and technical assistance to private businesses and governments. Areas include privatization, business-related public policy, and industryspecific issues. Resource mobilization: IFC helps companies to tap into international capital markets via syndicated loans.

IPP Investments Best Practices Investment process and support 1. Economic and political sustainability of the investment enhanced by a competitive selection process 2. Government responsive to needs and time frames of investors 3. Presence of government guarantee of stateenterprise performance and revenue sufficiency 4. Availability of limited recourse financing Revenue factors 1. Cash flow sustainability: retail tariff levels and collection discipline adequate to meet cash flow needs of sector 2. Demand growth was in line with projects, no oversupply or capacity utilization problems

IPP Investments Best Practices (continued) Operational factors 1. Public-private partnerships facilitated success of investment 2. Ability to exercise effective management and operational control of the investment Regulatory factors 1. Regulatory commitment sustained through long-term contract 2. Regulatory process allowed for satisfactory and nonarbitrary adjudication of tariff adjustments and dispute resolutions Government support and performance 1. Government met all commitments of state-enterprise performance and exchange conversion 2. Laws and contracts were enforced