El Faro Project: Valuing an LNG Plant in Honduras

1
El Faro ProjectValuing an LNG Plant in Honduras

• Stan Brunson
• Rachel Fefer
• Andrew Frankel
• Carlos Sanchez

Emerging Markets Corporate Finance Prof. Campbell
Harvey Fuqua School of Business, Duke
University Term 3, 2002
2
Case Issue

• Senior investment advisors Carlos Garcia and Stan
  Johnson must decide
• Should United Energy invest 25 million for an
  equity stake in a Central American power plant
  project?

3
Agenda

• Background
• Key Parties
• Project Overview
• Financials
• Case Discussion
• Project Valuation and Decision
• Update

4
Background

• Honduras
• Pro-market Stanford-educated President
• Central American electricity market currently
  fragmented
• Puebla-Panamá Plan for regional wholesale
  electricity market
• 240 million IDB financing support

5
Key Parties

• AES
• U.S. power company
• International experience
• Equity holder offering 12.5 stake
• IFC
• A-loans
• B-loans
• Export Credit Agencies

6
Project Overview

• 650M largest project ever in Central America
• Construction of LNG power plant in El Faro,
  Honduras
• Capacity to grow in stages
• Upgrade to existing transmission line
• Electricity to be sold below existing market
  rates to Honduras, El Salvador, Nicaragua,
  Guatemala, Costa Rica

7
Project Integration
El Faro Project 650M investment
Puebla-Panamá Plan 240M investment
El Faro Site
Power Transmission Upgrade
8
El Faro Site
Artists Rendition
1-Steam Turbine 3-LNG Turbines Storage
Facility Terminal
El Faro
9
Financials
10
Case Discussion

• Should United Energy invest in this project?
• How should Carlos and Stan value this investment
  opportunity?

11
Major Risks
Risk Mitigation
Operational Completion AES experience
Operational Natural gas price volatility Some hedging in tariff structure
Sovereign Currency USD denominated
Sovereign Expropriation IFC involvement
Financial Cost of debt IFC involvement
12
Natural Gas Spot Price
13
Cost of Capital Calculation

• Use ICCRC to calculate a blended country risk to
  reflect exposure to multiple countries
• Adjust for idiosyncratic risks
• Composite risk 29.91
• Currency risk -5.75
• Operational risk -1.50
• Financial risk -3.00
• El Faro cost of capital 19.66

14
Project Valuation and Decision

• IRR
• Project valuation Monte Carlo analysis
• Real options
• Sensitivity analysis
• United Energy recommendation

15
IRR, Static Results

• IRR, Year 10 18.6
• IRR, Year 15 25.3
• IRR, Year 20 26.7
• IRR, Year 25 27.1

Cost of Capital 19.66
16
Monte Carlo Results
LNG price modeled in 10-50-90 distribution
Abnormal Earnings Model NPV positive project
17
Real Options
Static Model
Best Outcome Build LNG 2 and LNG 3 on time
18
Sensitivity Analysis
Terminal Growth Rate Not sensitive
19
Recommendation

• We recommend investment in this project
• NPV positive given electricity pricing fluctuates
  with LNG spot price.
• Static IRRs higher than cost of capital, except
  for IRR at year 10.
• Even with construction delays or change to
  capacity built, project NPV positive.

20
Update

• February 19, 2002
• AES announces major divestitures of Latin
  American interests
• What will happen to the El Faro Project?