Power Projects Under Stress: What Happened and How to Work It ...

Power Projects Under Stress: What Happened and How to Work It ...

Power Projects Under Stress: What Happened and What Risks call for Mitigating Measures Ananda Covindassamy Introduction Participants in the March 2004 Power Investors Roundtable stressed that one of the reason for the decrease of investment in power PPI was that a number of projects had gone sour They indicated that the settlement of the disputes related to these projects would contribute to restoring their confidence in the energy sector of emerging markets Outline This presentation comprises four parts An overview of private participation in the electric power sector

An analysis and classification of the stress situations. An analysis of the causes of stress An analysis of the consequences of stress Financing Gap for the Energy Sector in Emerging Markets, 19902020 Investment in Power Projects with Private Participation in Developing Countries by Type of PPI, 19842003 Management and lease contracts 0% Total: US$256.3 billion Greenf ield projects 55%

Concessions 5% Divestitures 40% Annual FDI Inflows in Developing Countries by Region, 19842003 300 EAP ECA LAC MENA SA SSA Total 200 150 100 50

2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992

1991 1990 1989 1988 1987 1986 1985 0 1984 US$ Billion 250 Overview: Private

Participation in the Electric FDI in electricity has been more volatile than total FDI in Power Sector developing countries and has been more affected by the post2000 decline. Investment concentration in generation (70 percent) and much less in distribution (14 percent), suggest an aversion toward taking market and commercial risk. FDI in electricity was concentrated geographically, with 15 percent of the countries accounting for 86 percent of investment. EAP: Greenfield IPPs in East Asia and the Pacific, with little sector reforms; LAC: More investment in distribution though with significant investment in generation, as wellwith major sector reforms. Outline This presentation comprises four

parts An overview of private participation in the electric power sector An analysis and classification of the stress situations. An analysis of the causes of stress An analysis of the consequences of stress Electricity Projects Under Stress Stress situation in the electricity sector is a rare event: 4 percent of power projects in number and 10 percent in value. Workouts played an important role: 21 percent of the projects that incurred stress were ultimately worked out.

Stress occurrence is linked to overall country performance: There is a positive correlation between sovereign credit rating and the percentage of power projects under stress. There is a country risk level beyond which no investment occurs. When a country credit rating falls below CCC, according to S&P ratings, private sector investment in the power sector falls to zero. Electricity Projects Under Stress Electricity Projects under Stress Geographical Allocation of by Subsector Projects under Stress 18% Sub-Saharan Africa 12%

East Asia and Pacific 7% Europe and Central Asia 14% South Asia 12% Middle East and North Africa 0% 16% 14% By number of projects By value of projects 12% 10% 8% 6% 4%

2% Latin America and Caribbean 55% 0% Generation Distribution Utility Electricity Projects Under Stress by Region South Asia had the highest risk of stress. Sub-Saharan Africa becomes appears as high risk, with a percentage of 11 percent. LAC region had a relatively low risk levels at 6 percent. Eastern Europe and Central Asia and the East Asia and the Pacific regions have low risk levels, 3 percent and 1 percent, respectively.

Electricity Projects Under Stress by type of project Divestirures are more risky: More than half of the electricity projects under stress, due to the more complex nature of divestiture. Greenfield projects, which are mainly IPPs for power generation based on long-term power purchase agreements (PPAs), are less prone to stress. Outline This presentation comprises four parts

An overview of private participation in the electric power sector An analysis and classification of the stress situations. An analysis of the causes of stress An analysis of the consequences of stress Frequency of Causes of Stress 100% 90% Sociopolitical causes 80% Macroeconomic causes Regulation and price issues Project structural problems

Investors performance issues 70% 60% 50% 40% 30% 20% 10% 0% % of projects % of projects % of projects % of projects % of projects under stress under stress under stress under stress under stress in AFR in EAP in ECA in LAC in SA Causes of Stress Stress Risk for Investors and Lenders

Risk management instruments do not prevent stress under extreme circumstances; the possibility of renegotiation of contracts under severe macroeconomic conditions should be included to ensure that the balance between the interests of the parties is maintained, even under extreme situations. PPI needs to be accompanied by an effective consensus-building process with the public. The closing of a deal with the government is not sufficient for a successful PPI. There is a clear regional differentiation in causes of stress East Asia and the Pacific IPPs problems were mainly macrto-economic LAC faced also some socio-political problems in distribution Africa was affected by an uncertain national adherence to adopted sector reforms ECA suffered from socio-political uncertainties Causes of Stress

Regarding the Formulation of Workout Strategies The importance of contractual- and regulation-related issues indicates that many stress issues can potentially be addressed through a workout process. Financing- and exchange raterelated issues are the second priority to be addressed in project workout, through the deployment of specific financial engineering instruments. Communication should be included in workout strategies for the transaction to receive political and social support. The workout process should also include the formulation of a management strategy, because the performance of investors was perfectible on occasions in the area of commercial management and quality of services.

Workout strategies should be differentiated by type of project. Outline This presentation comprises four parts An overview of private participation in the electric power sector An analysis and classification of the stress situations. An analysis of the causes of stress An analysis of the consequences of stress Consequences of Stress by Region 100% Risk of default on debt

90% 80% Nonpayments to gov. 70% 60% Inadequate return on equity 50% Inadequate selffinancing 40% 30% License cancellation 20% 10% License nonrenewal

0% AFR EAP ECA LAC SA Consequences of Stress In all regions, the consequences were primarily financial and subsidiarily administrative. Interregional variations seem to reflect the level of political support for sector reforms and for PPIs. The most frequent occurrence of administrative

threat to PPIs because of a stress situation is in Africa and in Eastern Europe and Central Asia; In East Asia and the Pacific, where the reforms may be less structural, the administrative threat to PPIs is much less. The financial consequences in each region are related to the type of PPI projects in the region: regions with a high number of IPPs under stress showed a high risk of default to lenders (East Asia and the Pacific and Latin America and the Caribbean). Regions where PPIs were developed mainly in utilities or in the distribution sector (Africa and Eastern Europe and Central Asia) show less risks Conclusions

Reforms without strong consensus generate stress and consensus building should be part of the workout Workouts imply a willingness to renegotiate and to depart prudently from the principle of sanctity of contracts The Bank may have an important role to play for consensus (re)building and financial engineering

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