Renegotiating Power Projects in Developing Countries

1
Renegotiating Power Projects in Developing
Countries
Erik J. Woodhouse Program on Energy Sustainable
Development General Counsels Roundtable Stanford
University, February 10, 2006
2
The IPP ExperiencePresentation Overview

• PESD IPP Study Structure and Methodology
• Core Observations
• Renegotiation Experiences
• The Road Ahead

3
The PESD Study of the IPP ExperienceScope
4
The IPP Experience Core Observations

• Mismatch between risks and responses
• Investors loaded country risk into contracts
• Unfocused risk allocated en masse rather than
  adopting tailored response
• Limited contracts alone cannot carry weight of
  developing country risk
• Stress is inevitable
• 60 (20/33) of projects in PESD study altered key
  contractual terms
• Of these projects, 65 (13/20) at least
  moderately successful
• Who breaks, and who bends?

5
Why do renegotiations happen?

• At first glance, key variables appear
  country-specific
• An accurate, though incomplete explanation.
• E.g. Macroeconomic shock affected projects in 9
  of 12 countries but does not fully explain
  variation in outcomes across countries.
• E.g. The regulatory framework is geared to reduce
  risk, but often reform creates new risks that
  affect projects in different and unpredictable
  ways.
• On second glance, key variables are
  project-specific
• Contracts alone cannot cleanly allocate undiluted
  risks
• E.g. Brazilian thermal projects.
• Projects vary in capacity to dilute risks
• E.g. Turkeys BOTs and BOOs.
• Sometimes stakeholders need to self-correct
• E.g. Philippines geothermal

6
Who Breaks and Who Bends?Characteristics of
Successful Renegotiations

• Collective Action
• Successful Thailand, The Philippines (Napocor
  IPPs)
• Not so successful China, The Philippines (other
  IPPs)
• Factors Counterparty selection, Project
  governance
• Adapting to Change
• Successful Gujarat, Shandong
• Not so successful Tamil Nadus IPPs, Brazilian
  merchant plants
• Factors Local partners
• Identifying Mutual Gains
• Successful Mirant (Philippines), IberAfrica
• Not so successful Westmont
• Factors Investor commitment, expectations

7
What about constraining or deterring
opportunistic behavior?

• Contracts Necessary, but not sufficient
• Poor contracts invite poor outcomes.
• However, the opposite is not equally true.
• Commercial Banks A silent barrier
• Every government official identified debt service
  to international commercial banks as the outer
  limit of renegotiation.
• Multi- or Bilateral Partners Effective in worst
  conditions
• Significantly related to successful
  renegotiations, but the machinery of this
  phenomenon remains opaque.

8
The Next Wave

• Key lessons
• Reduce risk, do not allocate it.
• Identify and respond to risk before deciding who
  bears it.
• Structure projects for effective response to
  change.
• Structure incentives to withstand inevitable
  instability.
• Key Questions
• Contracts or Governance?
• Get good contracts, but act like you have none.
• New mechanisms?
• Can these lessons be formalized?

9
Background Slides
10
Local Partners
11
Prominent International Partners
12
Macroeconomic Shock

• Macroeconomic shock dominant fact driving
  outcomes across the IPP experience.
• Acute shock in six countries and gradual
  devaluation in two more played dominant role in
  outcomes, particularly for governments.
• But, projects beat the curve in several cases.
• In some cases, structural variables explain some
  of the outcomes (Thailand, Malaysia, Egypt).
• Success.
• Renegotiations in Thailand, Philippines
• Stability of projects in India and Kenya

13
The Legal and Regulatory Framework

• IPP Strategy.
• Raw legal framework, detailed regulation in
  contracts.
• General success contracts filter out small
  stress.
• Two Failings.
• Complete risk allocation impossible.
• China, Turkey
• Uncertain/political reform opens new
  vulnerability.
• Brazil, India, Philippines, China, Thailand.
• Success.
• Shandong Zhonghua, Shajiao C.
• Quezon, Mirant Philippines.
• Brazil self-dealing.

14
Fuel Markets

• Consistent outcome across IPP experience.
• Sixteen out of thirty-three projects faced some
  real fuel risk.
• Only seven successfully weathered that risk.
• Why?
• Non-transparent fuel markets stress.
• Country Success centralization.
• Project Success unique arrangements (no general
  rule)
• Gujarat IPPs, Shandong Zhonghua, Quezon, Brazil
  hydro

15
Elements of a New Model

• Where do private IPPs fit into the picture?
• Electricity sector reform is difficult.
• The investment climate will be unstable.
• What areas can be improved?
• Improve information, clarify expectations, tailor
  solution to risk
• Keep the IPP program small, use camouflage
• Governance options?
• New Players.
• Positive local capital and flexibility or
• The only firms able to operate in uncertain,
  political markets?
• The classic IPP model is limited.
• Success often implies enormous risk assumption
  by hosts.
• Tension between successful IPPs and long-term
  reform.
• Even the best cases look dubious for the future.

16
The Two Dimensions of IPP Outcomes
17
Electricity Market Context for IPPs

18
The IPP Experience South East Asia

• The Philippines
• Success in the short term
• Long term challenges social sustainability,
  sector management
• Thailand
• Very competitive plants effective management of
  IPP commitments
• But still maybe facing an unfriendly market?
• Malaysia
• Insulated from shock by reliance on domestic
  capital
• Insider management

19
The IPP Experience Latin America

• Mexico (single-buyer model)
• Largely unreformed system performing well
• Payment regime increasingly unstable
• Brazil (partially private multi-buyer model)
• Flaws in original thermal IPP arrangements
  showing
• Argentina (fully private, competitive markets)
• Success derailed by economic crisis and political
  instability

20
The IPP Experience India and China

• China
• Dramatic growth followed by equally dramatic
  decline.
• Classic unenforceable contracts the
  obsolescing bargain?
• India
• Dramatic goals, but high project mortality,
  persistent shortages.
• Controversy has obscured relative successes.
• Continuing investment from domestic sources
  appears robust.

21
The IPP Experience Europe and Central Asia

• Turkey
• Several failed attempts to attract IPPs lead to
  vulnerable arrangements
• Problems in sector following 2001 economic crisis
• Poland
• IPPs entered as part of broad reform under the
  1997 Energy Law
• Stranded costs problems as Poland tries to join EU

22
The IPP Experience Africa

• Egypt
• Competitive projects have performed well.
• Economic downturn and devaluation has inflated
  IPP payments.
• Kenya
• Total installed capacity 1.2 GW, only 15 of
  population w/ electricity.
• Two classic IPPs 20 year PPAs, single buyer,
  but no guarantee.
• Two stop gap IPPs 7 year PPAs, BOT framework.
• Both government and investors (some) wary of new
  investment.