Financing Energy Projects in Developing & Transition Economies APEC EGNRET Workshop on Financing New and Renewable Projects   12-13 May 2004, Hawaii Yonghun JUNG, Ph.D Vice President Asia Pacific Energy Research Centre

(Source) APERC (2002), “Energy Demand and Supply Outlook 2002” Total Primary Energy Demand in APEC (1980-2020) TPED is expected to grow at an annual rate of 2.1 percent (1999-2020) and it is translated into $3.3 trillion to $4.4 trillion of new investment requirement. NRE 1.1 % p.a. Nuclear 1.7 % p.a. Hydro 2.7 % p.a. Natural Gas 2.6 % p.a. Coal 2.1% p.a. Oil 2.1% p.a. This is the history and outlook of total primary energy demand in APEC up to 2020. As you can see, we will not see much change in terms of fuel composition. Oil will maintain dominant share, growing at an annual rate of 2.1 percent, coal is expected to be still important source of fuel maintaining the second largest position, and natural gas will be the fastest growing fuel among fossil fuels. Based on this outlook, we conducted estimation of energy sector investment. It suggests some trillion dollars of new investment will be required, which is not a small number to be neglected. (Source) APERC (2002), “Energy Demand and Supply Outlook 2002”

Energy Growth by Region (1999-2020): Oil, Coal and Natural Gas Significant proportion of new investment will be required in developing economies. This is to show you incremental growth of oil, coal and natural gas by region. As you see, Oil – due to gasoline demand, substantial growth is expected in North America, and China. Coal – China will account for major portion of increment at 42 percent due to the power sector demand growth. Gas – power sector demand contributes to the significant portion. This energy demand growth indicates investment requirements for upstream, midstream and downstream. In the economies at an early stage of energy market development, such as China, there will be considerable investment requirements. For instance, introduction of LNG to Guangdong and Fujian is hotly debated and attracting attention. China will make investment on upstream, liquefaction, regasification, storage and domestic pipeline to transport gas. As this case suggests, significant proportion of new investment will be required in the economies of early stage of market development. Growth in oil, coal, gas demand is projected in both developed markets and in new markets (China and Russia in particular). In the economies where the markets are already well developed, investment will be on how to replace the existing obsolete technologies. We will look at this issue later. (Source) APERC (2002), “Energy Demand and Supply Outlook 2002”

Total Investment Requirements 2000 – 2020, by Infrastructure Total = Trillion 1999 US$ 3.4 to US$ 4.4 This is the result of total investment requirements to build new infrastructure. The time frame is between 2000 and 2020. Total APEC energy investment requirements amount to between US$ 3.4 trillion to US$ 4.4 trillion. Largest share is taken up by electricity sector at 49 percent, followed by oil and gas production (23 percent), oil and gas pipelines (16 percent), oil and gas international trade (9 percent) and coal 3 percent. (Source) APERC (2003)

Total Investment Requirements 2000 – 2020, by Economy 1,307 762 689 288 243 195 162 137 103 95 91 69 68 59 48 41 This is the total investment requirements shown by economy. As you can see, China represents the largest investment requirements at around 1.3 trillion USD, followed by USA and Russia. Upper limit case China, North America, including USA and Canada and Russia represents around 65 percent of total investment requirements in the APEC region. 25 10 7 4 4 (Source) APERC (2003) 1999 Billions US$

Energy Investment Requirements by Region (2000-2020) China takes the largest share (29%), followed by North America (24%) and Russia (16%). This is the investment requirements by region. China – largest at 29 percent, followed by North America at 24 percent and Russia at 16 percent. (Source) APERC (2003)

Share of Energy Investments Relative to the Size of Economy (2000-2020) Developing economies of APEC will require larger size of energy investment relative to GDP. This is to show you the relative size of energy investment requirements into the future. Developing economies of APEC require larger size of energy investment when we compare it against each GDP. (Source) APERC (2003) Percentage

Historical Trend of Energy Investments for Utilities in Selected Member Economies The relative size of energy investments greatly vary depending on the level of economic development, industry structure and living standards. This figure compares the share of gross domestic product that is taken up by energy investment with gross domestic product per capita in several APEC economies for the period from 1980 through 2001. The comparison clearly shows that the share of investment relative to GDP declines as GDP percapita increases. The most developed economies with highest GDP per capita, have relatively low investment requirements relative to GDP, as shown by Canada, Japan and United States. The least developed economies with lowest GDP per capita have relatively high investment requirements as shown by China and Viet Nam. So, energy investment is a key component of industrialisation. At the early stage of development, the requirements tend to be larger relative to the size of GDP. As economies become industrialised, less energy intensive services sector will fuel energy sector. As a result, their energy investment need relative to economic output tend to decrease. [Korea, shows interesting trend. The share of energy utilities investment in GDP declined roughly from 3 percent in 1980 to 1 percent in 1988 but grew again to around 2 percent during the 1990s. Increased investment for the last decade was driven by natural gas infrastructure development and power sector growth.] (Source) APERC (2003)

Risks for Energy Sector Investment Economic Risks Completion Risk Discount Rate Risk Currency Risk Environmental Risk Raw Material Supply Risk Infrastructure Risk Political Risks/ Institutional Risks Political Violence Expropriation Risk Force Majeure Energy projects are not necessarily the most attractive among competing investment opportunities internationally. The life time of energy projects are long, from 20 to 30 years. This means decision today will affect such a long period of time. At the same time, rate of return for energy projects are lower when we compared with the other types of investment. There are huge barriers. Economic risks include Completion risk suggesting cost of delay poses huge burden on project developer. Discount rate risk Political risk Force majeure.

Lessons Learned from the IPP Projects in Asia To understand better about the risks in energy projects, we studied some cases of failed projects to learn lessons out of them. I do not go into detail, but, for example, in Indonesia – For example, Chinese Taipei. It comes down to the coordination of upstream, midstream and downstream as the case for Chinese Taipei suggests. Also, coordination between central and local government is quite important. (Source) APERC (2003)

Share of Energy Investments Relative to the Size of Economy (2000-2020) Developing economies of APEC will require larger size of energy investment relative to income level. To remind you of the size of investment requirements, I would like to show you the figure. The size of investment requirements for energy, large for developing economies. (Source) APERC (2003)

Sizes of Savings Relative to GDP (Group A, B and C) Proxy for domestic capital availability Less than enough capital availability for developing economies of APEC. Despite the large energy investment requirements, capital availability in developing economies are limited. This compares saving ratio in 3 income groups of APEC. Share of savings to GDP is used as a proxy for capital availability. (Source) World Bank (2002), “World Development Indicators”

Development of Bond Markets in Asia Development of capital market is needed to efficiently channel the available financial sources. (Source) APERC (2003), “Energy Investment Outlook for the APEC Region”

Project development comes down to financing Lack of domestic funding sources for some developing economies Underdeveloped equity market and bond market Risk should be appropriately reflected on rate of return Reconsideration of Pricing - issue of subsidy Question on affordability remains. International lending organisations, regional development banks and export credit agencies are and will be playing important role to add credibility to the project off-take. In short, financing will be the key for energy projects. In the case of developing economies, source of finance is in short as we have seen in the share of savings. Not only that, but also they do not have equity and bond market. When the country risk is real, there should be mechanism to reflect the risks appropriately to the rate of return. Third it is important to reconsider pricing. Finally, role of international lending organisation is quite important to add credibility to the project off takes.

Role of Multilateral Development Institutions Multilateral Development Institutions (MDI) include: World Bank, IFC and IMF. Their contribution to investment in and financing of energy project plays minor role. MDI’s contribution does not exceed $10 billion/year, while annual world investment requirements is more than $150 billion. Despite small contribution, MDI’s participation is quite important. Improve creditworthiness of projects, Assurance of transparent legal, administrative and regulatory procedures. E.g., the Philippines’ National Power Corporation The World Bank’s guarantee helped NPC to obtain a 15-year maturity in issuing bond.

(Source) Nevitt and Fabozzi (2000) Importance of Government Role: A Case of Laibin B, BOT Project in China Guangxi Industry Power Bureau Laibin B 2*350 MW Coal - fired Power plant Construction & Fuel Co. Coface /Commercial Banks Loans US$ 502 m EdF 40% Alstom 60% Equity US$ 154 m Provincial Government Site Lease 18 Year BOOT agreement Performance Guarantee Fuel Supply Agreement 350 * 2 MW Coal Power Purchase Off take This is a case of Laibin B, China’s first BOT power project, which is fully owned by foreign operators. This project is considered as a model case for the other BOT project to follow. Operator is EDF and Alstom GE And French export credit agency – COFACE provide loan along with the syndicate of commercial banks. Tenor is relatively long at 10 years. Guangsi province is not the most advanced area compared with eastern coast area such as Guandong. The Guangxi province is not the most advanced provinces in China, with the per capita income representing xxx in 1998 while that of Chinese average was xxx at the same time period. In order to minimise market risk and give comfort to the lenders, the Guangxi provincial government issued letter of comfort that underwrites the power purchase agreement between the Laibin B and the Guangxi industrial power bureaux. The power purchase agreement included that the Guangxi power bureau would purchase about 63 percent of plant output, thereby guaranteeing cash flow to service their debt. Not only the support by provincial government, central government through Ministry of Power Industry offered help to the provincial government in preparing feasibility study, reviewing letters of intent from the potential foreign investors and communicating with State Development and Planning Commission for the several different approval processes[1]. Those efforts made by central and provincial governments resulted in successfully inviting loans from COFACE, French export credit agency, and syndicated loans from commercial banks, totalling US$ 502 million. Loan maturities are relatively long with 15 years maturity for COFACE and 10 years for commercial bank loans. (Source) Nevitt and Fabozzi (2000)

Implications Energy investments in the APEC region will be needed between US$ 3.4 trillion and US$ 4.4 trillion for the next twenty years. Requirements of energy investment vary greatly depending on the level of economic development, industry structure and living standards. For some developing APEC economies, capital may not be readily available. Demand prospect Pricing, including subsidy issue Lack of domestic capital market Project developers need to appropriately asses the demand prospect, availability of infrastructure and affordability. Lessons have been learned that project off take depends on the structure of security package including government guarantee. Governments need to take into account economic and social benefits besides financial viability of energy projects. Policy objectives Environment