developing the power sector through private investment in mongolia

Edgar Saravia

Program Manager

October 2008

Developing the

Power Sector

through Private

Investment in

Mongolia

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 Public Private Partnerships (“PPPs”)

Best Practices in IPP Bidding

Introduction to Independent Power Projects (“IPPs”)

Project Agreements

Introduction to the International Finance Corporation

(“IFC”)

Wo

rld

Ban

k

Gro

up

Multilateral Investment Guarantee Agency

The World Bank (IBRD & IDA)

International Centre for Settlement of

Investment Disputes

International Finance CorporationPrivate sector arm of the World Bank Group

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

International Finance CorporationInfrastructure Advisory Services

Agenda




Project Agreements


(“IFC”)

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”

Public Private

Engagement Anywhere Along the Spectrum

Ultimate Goal: Ensuring Access to Reliable and Affordable

Basic Services

Divestiture

Technical

Assistance

Service

Contract

Management

Contract

Lease

Contract

PPP

Concessions

3-5 yrs

8-15 yrs

1-3 yrs

25-30 yrs

State Risk

Private Sector

Risk

Options for Private Sector Participation

MOST EFFECTIVE

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.

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.Source: PWC

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

Private

Sector

Financial

Equilibrium

1

Appropriate

Framework

2Allocation

of Risks

4

Transparency

of Process

3

Agenda




Project Agreements


(“IFC”)

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

Agenda




Project Agreements


(“IFC”)


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

Agenda




Project Agreements


(“IFC”)

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:

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

ECA

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-or-

pay 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 “pre-

negotiated” 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

State: Operator:

Technical

Assistance

Market Risk

O & M

Invest. Renewal

New Assets

Financing: Access

Debt Service

Full

DivestitureConcessionManagement

& Services

Lease/

Affermage

Cost covering tariff-

Actual tariff

Time

User Contribution

Trans. Subsidy

Time

User Contribution

Trans.

Subsidy

Subsidies

Time

Example: A Possible PPP Setup

Type of Subsidies

Capital Subsidies

Transition

Subsidies

Ongoing

Subsidies

(targeted poor

population)

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 industry-

specific issues.

• Resource mobilization: IFC helps companies to tap into

international capital markets via syndicated loans.

IFC Products and Services

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 state-

enterprise 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 non-

arbitrary 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

developing the power sector through private investment in mongolia

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