Power Projects Under Stress: Power Projects Under Stress: What Happened and What What Happened and What Risks call for Mitigating Risks call for Mitigating MeasuresMeasures

Ananda CovindassamyAnanda Covindassamy

• 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

IntroductionIntroduction

OutlineOutline

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 Financing Gap for the Energy Sector in Emerging Markets, Sector in Emerging Markets,

1990–20201990–2020

Divestitures40%Greenfield

projects55%

Management and lease contracts

0%

Concessions5%

Total: US$256.3 billion

Investment in Power Projects with Investment in Power Projects with Private Participation in Developing Private Participation in Developing

Countries by Type of PPI, 1984–2003Countries by Type of PPI, 1984–2003

Annual FDI Inflows in Annual FDI Inflows in

Developing Countries by Developing Countries by Region, 1984—2003Region, 1984—2003

0

50

100

150

200

250

300

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

US

$ B

illio

n

EAP

ECA

LAC

MENA

SA

SSA

Total

•FDI in electricity has been more volatile than total FDI in developing countries and has been more affected by the post-2000 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 well—with major sector reforms.

Overview: Private Overview: Private Participation in the Electric Participation in the Electric

Power Sector Power Sector

OutlineOutline

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

• 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 Electricity Projects Under Stress Stress

Electricity Projects Under Electricity Projects Under Stress Stress

Geographical Allocation of Projects under Stress

East Asia and Pacif ic

7%

Europe and Central Asia

14%

Latin America and Caribbean

55%

Middle East and North Africa

0%

South Asia12%

Sub-Saharan Africa12%

Electricity Projects under Stress by Subsector

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Generation Distribution Utility

By number of projects

By value of projects

• 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 Electricity Projects Under Stress Stress

by Regionby Region

Electricity Projects Under Electricity Projects Under Stress Stress

by type of projectby 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.

OutlineOutline

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 Frequency of Causes of Stressof Stress

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

% of projectsunder stress

in AFR

% of projectsunder stress

in EAP

% of projectsunder stress

in ECA

% of projectsunder stress

in LAC

% of projectsunder stress

in SA

Sociopolitical causes

MacroeconomiccausesRegulation and priceissuesProject structuralproblemsInvestors’ performanceissues

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 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 rate–related 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.

Causes of Stress Causes of Stress

OutlineOutline

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 Consequences of Stress by RegionRegion

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

AFR EAP ECA LAC SA

Risk of default on debt

Nonpayments to gov.

Inadequate return onequity

Inadequate self-financing

License cancellation

License nonrenewal

• 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 for the lenders.

Consequences of StressConsequences of Stress

ConclusionsConclusions

Reforms without strong consensus Reforms without strong consensus generate stress and consensus generate stress and consensus building should be part of the workout building should be part of the workout

Workouts imply a willingness to Workouts imply a willingness to renegotiate and to depart prudently renegotiate and to depart prudently from the principle of sanctity of from the principle of sanctity of contractscontracts

The Bank may have an important role The Bank may have an important role to play for consensus (re)building and to play for consensus (re)building and financial engineeringfinancial engineering