Open for Business Under New Owners – Asian Electricity Ten Years On

Martin Daniel, Editor, Platts Power in Asia

The Asian financial crisis of 1997 hit few sectors harder than the electricity supply industry, with few countries in the region left unscathed. Ten years on, how much has changed and how is the sector faring?

AT FIRST GLANCE, THERE APPEAR TO BE striking similarities between the Asian electricity market today and the sector ten years ago. The market is characterized by strong and accelerating demand across most of the region, it is dominated by projects developed using the independent power producer (IPP) model, it is witnessing an influx of new investors, and the predominant characteristic of market players is one of optimism.

But appearances can be deceptive. To start with, the optimism today is blended with a caution born of hindsight. And that is because ten years ago, in the course of a few short weeks in the third quarter of 1997, the Asian electricity sector saw a complete reversal in sentiment. Heady optimism based on the belief in ever-expanding electricity demand was replaced by an increasingly somber mood, as the implications of the unfolding Asian financial crisis became clearer by the day.

By September 1997 many of the region's governments and electricity utilities were furiously calculating the cost of a swathe of power purchase agreements they had entered into with IPP developers. And the figures just did not add up.

Although almost invariably denominated in US dollars, the power sales tariffs agreed with IPP projects in the mid-1990s were to be paid by state-owned utilities from revenues collected in local currencies. These were more often than not below or barely covered the tariffs, even at the time of signing. But with power demand growing relentlessly during the early and mid-1990s the utilities had argued that their overall revenue pool would increase. And even if it didn't, governments said they were prepared to guarantee their utilities' power offtake commitments, and accept some level of subsidy, to ensure the lights stayed on.

Then came the triple whammy of the July 1997 Asian financial crisis. The collapse in exchange rates resulted in a vast inflation in the cost of IPP power purchases. The crisis halted economic growth in its tracks, with an even more abrupt end to the growth in electricity demand. This meant there would be no growth in utility revenues but no let up in the commissioning of IPP capacity whose output was contracted on a take-or-pay basis regardless of need for the output. Meanwhile governments were left looking at ballooning financial commitments to electricity at a time when treasuries were depleting fast and every other economic and social sector was seeking funds. Something had to give.

So September 1997 saw governments, utilities and private investors throughout the region revise policies and initiate actions that were to dominate the Asian power sector for years to come. Many utilities refused to lift power from IPPs, or only at a hefty discount to the contracted rates. A host of projects were cancelled, some unilaterally.

The sector thus became overshadowed by protracted and increasingly bitter and politicized disputes over contract breaches, countered by allegations of corruption in the award of the projects. And high-profile projects such as India's Dabhol Power, which at one time had been acclaimed as role models by multilateral agencies and international investors, were transformed into cautionary tales about the risks of doing business in the Asian electricity sector.

Nowhere, perhaps, was this truer than in Indonesia where a large number of planned IPP projects were suspended by the government in September 1997. Arbitration proceedings over one such project, the Karaha Bodas Company's geothermal development in West Java province, only ended earlier this year. And Indonesia has remained one of the most challenging destinations in Asia for power sector investmentsince 1997 the sector has seen virtually no foreign direct investment.

Well, that is until recently. Back in September 1997 a gas-fired IPP project integrated with a gas field development at Sengkang on the island of Sulawesi started electricity generation for the first time. Fast forward ten years to May 2007 and the project owner, Australia's Energy World Corporation, announced the start of construction on an expansion project at the plant.

That announcement came shortly after another Indonesian IPP project, the 110-megawatt (MW) Wayang Windu geothermal plant in West Java province, agreed to a $298.2 million refinancing and expansion package with Standard Chartered Bank. By a neat coincidence of timing, the first phase of the project had begun construction in June 1997, just days before the onset of the Asian crisis.

That is not to say that the Sengkang and Wayang Windu projects went problem free in the intervening decade. Far from it. Sengkang lost one of its international investors, the US's El Paso Energy International, while it had to accept the renegotiation of its power purchase agreement, with a lower power sales tariff being partly offset by a longer payment period and the right, just exercised, to expand the project. Meanwhile Wayang Windu also lost its main investorstwo New Zealand companies who wrote off their investment in 2000and experienced uncertain ownership until the local Star Energy acquired the project company in November 2004.

The bank behind the May 2007 Wayang Windu financing, Standard Chartered, makes no bones about the fact that it is breaking new ground. Wayang Windu is a "landmark transaction," according to William Rathvon, the bank's global head of project and export finance. This is the "first new integrated power plant in Indonesia to be financed since the Asian financial crisis in 1997," he says.

And Indonesia is no different from other Asian countries. Indeed, the country has been a laggard in being accepted as open for business by international lenders and investors.

A laggard, because the Asian electricity market once again appears to be a magnet for investment and players. In a manner reminiscent of the mid-1990s, developers and investors are scouring the region for bankable projects, both new build and acquisitions. But before looking at these investors in more detail, it is worth putting developments in the ownership and structure of the Asian electricity market in a wider context.

1. Asian Power Generation Prospects, TWh. Source: International Energy Agency, World Energy Outlook 2006 (Reference case)

Asian Power Demand Projections

Asian electricity output is growing fast and projected to carry on growing for decades to come. The Paris-based International Energy Agency (IEA) projects that Asian power generation will almost triple from 5,500 TWh in 2004 to more than 14,500 TWh in 2030. The projections, carried in the reference case of the IEA's World Energy Outlook 2006, mean that Asian electricity demand is forecast to easily outstrip the growth both in overall Asian energy consumption and global electricity demand.

The IEA projects that the Asian electricity sector, which accounted for 25% of all Asian energy use in 1990, will account for 44% of the region's total energy consumption by 2030. And while the IEA says that Asia accounted for only 20% of world electricity production in 1990, it projects that it will account for almost 44% of total global output in 2030.

One other set of figures from the IEA's long-range forecast are worth noting. Worldwide, coal currently accounts for about 47% of total electricity generation, with the fuel's share expected to show little change to 2030 by the IEA. But in Asia the percentage, already above the global average at 56%, is projected to rise to 63% in 2030. Meanwhile Asian renewable energy generation is projected to surge ahead, albeit from a very low base, while the percentage shares of natural gas, hydroelectric and nuclear power are all projected to decline in the face of coal's continuing regional dominance.

These projections are, of course, subject to the usual caveats attached to any long-range forecasts. But set against a much shorter time horizon, Platts' own analysis of the power generation projects currently under development in the region chimes with the IEA projections. It also underlines the rapid acceleration in Asian power sector activity since the early 2000s.

Platts' annual survey of activity in the Asian power generation sector indicates that there was a substantial increase in the amount of capacity under development in the region in 2006. To put this in context, it should be noted that the survey is based on a bottom-up aggregation of identified individual projectsit is not a country-level compilation of government statistics and wish lists.

The upsurge in 2006 activity followed on from the already marked increase in activity recorded each year since 2003. It was evident throughout the project pipeline from the initial announcement of plants to their entry into operation.

The upward and accelerating trend in activity is most marked at the beginning of the project development process. In 2006 at least 140,000 MW of new generation capacity was announced across the region. This was an increase of about a third compared with 2005 and is almost three times higher than the position in 2003, when less than 50,500 MW was announced.

On top of this more than 70,000 MW of capacity received formal government or company approval in 2006, while a further 70,000 MW and more of capacity either signed engineering, procurement and construction (EPC) contracts or started construction. Together, this means that more than 280,000 MW of capacity is currently moving through the project pipeline for entry into operation over the next few years.

Moreover, these figures exclude the Middle East where activity is also rapidly growing. If activity in this region is included, it would push the amount of capacity in the project pipeline that could enter operation in the next few years to well in excess of 300,000 MW.

Apart from reinforcing the thrust of the IEA projections in terms of the scale of activity, the survey also underlines the dependence of the Asian electricity sector on coal. Indeed, one of the key developments identified by the Platts' survey was the clear indication of reduced interest in natural gas-fired power projects in Asia in 2006. Announced gas-fired capacity plummeted from about 24,000 MW in both 2004 and 2005 to less than 5,000 MW in 2006, as concerns over the future availability and price of natural gas dampened investor interest. There was also a fall in the amount of gas-fired capacity starting construction or signing EPC contracts during 2006. The trends were apparent in many jurisdictions, including the key regional markets of China, India and Indonesia.

2. Power Project Activity by Year in Asia and Australasia, MW. Source: Platts

The beneficiaries of the decline in gas-fired generating projects, and of the overall growth in project activity, varied by country. For example India, which had looked to strong growth in gas use in previous years, saw a marked reversion to coal-fired projects. Some 52,800 MW of the 75,050 MW of coal-fired projects announced in Asia in 2006 were announced in India.

Indonesia showed a similar preference for coal among new projects. But the amount of Chinese coal-fired capacity announced in 2006 was much lower than in recent years. Instead, much of the new capacity announced in China comprises large hydroelectric and nuclear complexes, with nuclear reactors also being the subject of considerable interest in countries throughout the region.

One factor behind the reduction in project announcements in China, both for coal and capacity overall, is that the power shortages that have affected the country since 2002 are now at an end in most parts of the mainland. Indeed, a significant overhang of capacity is developing in some areas.

Over the past few months the emphasis of project activity among the country's leading generators has thus shifted from announcing new-build projects to a renewed interest in the acquisition of existing plants as the companies seek to consolidate their plant portfolios and position themselves in the wider generation market.

Asian Acquisitions Bounce Back

Nor is the renewed interest in acquisitions limited to China. There has been an upsurge in merger and acquisition activity across the Asian power sectora sector that for almost a decade until late 2005 saw little activity.

In particular the privatization of state-owned assets, whether power generation plants or transmission and distribution networks, was almost non-existent until 2006. Against a background where the most frequently heard phrase was "weak market sentiment," many auctions were cancelled before they were held and others that did proceed fell through as bids failed to meet the minimum price.

There was more activity in the sale of privately-owned assets but more often than not these were effectively fire sales. Many of the sales were prompted by the withdrawal of North American or European investors from the Asian power market because of unhappiness with returns from the investments or because of the need to refocus effort and resources on their home markets. With the departure of these players coming at a time when there were few new entrants in the market, and few existing players interested in new purchases, many of the departing investors sold assets at a fraction of the price they had bought them for in the mid-1990s.

The position has, however, changed markedly over the last year or so. Assets that were withdrawn from the market a decade ago because of poor market sentiment are back on the block. Prominent among the assets is the 10,000 MW or so of capacity owned by Singapore's three state-owned generation companies, PowerSeraya, Senoko Power and Tuas Power, all three of which were put up for sale in June 2007.

Not only is the amount of capacity entering the sale pipeline increasing but the prices achieved by some of the assets are also forging ahead. In this respect some spectacular deals were recorded in the latter part of 2006 and the first half of 2007.

Take the Philippines, for instance. The privatization of hydroelectric facilities with a strong market position as peaking plants has seen high and escalating prices. This included the sale of the 360-MW Magat plant to the SN-Aboitiz consortium for the equivalent of $1,472/kW.

But even this very respectable unit price was trumped in June 2007 with the completion of the sale of 2,203 MW of capacity at three coal and gas-fired IPP plants in the Philippines. The portfolio was sold for the equivalent of more than $1,550/kW to a consortium comprising Japan's Tokyo Electric Power and Marubeni. And at the end of July the U.S.-based AES offered a similar unit price for Masinloc, a 600-MW coal-fired plant for which the first privatization auction in 2004 had been a failure.

The upward trend is apparent elsewhere in the region. One example may suffice. In late 2005 the state-owned Electricity of Vietnam sold a 22% stake in the 1,040-MW Pha Lai coal-fired plant for the equivalent of $205/kW under the country's equitization program, which involves the partial privatization of the utility's unbundled assets. But in April 2007, following an upsurge of local and foreign interest in the Vietnamese power sector, the utility sold a second 13.6% tranche of Pha Lai shares for the equivalent of $1,276/kW.

While there may have been an upsurge in project activity across the new-build and acquisitions sectors, the structure and design of the electricity sector across much of Asia has changed little since the mid-1990s. Indeed, in some jurisdictions the market is less liberal than it was a decade ago.

Asian Power Market Structure

Most national electricity markets still comprise state-controlled utilities complemented by private generators selling their output on an IPP basis. There are variations of the model with, for instance, the generation and wires activities of formerly monolithic power utilities having been unbundled into separate cost centers in many countries, accompanied in cases by the creation of a separate body to buy the power from IPP plants. Regulatory models also vary widely across the region. But for the most part the Asian electricity sector remains firmly under state control.

State control has had one important drawback in large parts of the region. The price paid for electricity by many consumers does not reflect the cost of supply. Regulated rather than market-based retail tariffs means that electricity is used inefficiently and its supply, let alone new investment in the sector, requires state subventions. And with the short-term political pursuit of votes outweighing the longer term exigencies of reform, the situation appears set to change only slowly in these jurisdictions.

The embrace of competition has also for the most part been slow and cautious. In many cases competition has been limited to no more than the award of IPP projects on the basis of the lowest tariff offered following an open tender, rather than on a cost-plus basis through direct negotiation.

Few markets have embraced competition between generators and even fewer have allowed even large electricity consumers to choose their own supplier. Indeed, several countries that had at one stage planned to take the competition route, such as Indonesia, Malaysia and Thailand, have reverted to the state control model for political or legal-constitutional reasons. And among those that have introduced competition, including Australia, Japan, New Zealand, and Singapore, the tendency has been for incumbent generators to become dominant by buying customers to physically hedge their production risks.

Geography has been one of the reasons behind this cautious approach to power sector liberalization. The electricity grids of most Asian countries are either not interconnected at all or not to the extent needed to create the regional electricity markets that could kick-start competition. Nor do the institutions necessary to administer and regulate regional markets exist, with bodies such as the Association of Southeast Nations currently having no charter or prescriptive powers.

Another influence urging a cautious approach to market reform on the part of Asian lawmakers is the continued fast growth in electricity demand in many countries. With the California power debacle still fresh in the minds of many Asian legislators, their argument for the status quo goes along the lines that a combination of robust demand growth, slim generation reserve margins, and market-based prices is a disaster waiting to happen.

Such arguments can of course be self serving and have been discounted by a small number of Asian countries, such as the Philippines, which have taken the competitive market route. This is in the belief that past examples of poor market design and governance are there to be learned from, rather than shied away from.

But even so, caution still characterizes market design in much of Asia. Cases in point are Singapore's high level of vesting contracts and New Zealand's reversion to the provision of reserve capacity by state mandate rather than market signals. Meanwhile China's very gradual approach to competitive generation through a succession of pilot trials and India's stuttering implementation of electricity reform legislation are further indicators that the development of competitive electricity markets in most of Asia has a long way to goand with little evidence of any acceleration in the process.

With bustling activity in state-controlled markets still characterized by the IPP model one might ask what differences an observer of the power sector would notice if transported from mid-1997 to September 2007. One answer would be the origin and background of many of the power developers and investors in the sector.

In one respect ownership of the sector is little different. It is not only predominantly state controlled but also to a great extent state owned.

Asian Power Sector Ownership

The level of state ownership across the Asian electricity market has certainly changed little in the course of the past decade, at least until the last year or so. Few state-owned assets have been privatized and some that were planned for sale, either on a trade basis or through initial public offerings, have been withdrawn from the market. The Electricity Generating Authority of Thailand and the five fossil-fueled generating subsidiaries of the Korea Electric Power Corporation are just two examples of assets for which planned sales fell through for political or legal reasons.

On the positive side, though, there has been an upswing in activity in the past year or so. As earlier noted, Manila has auctioned several power sector assets in the Philippines, while minority equity stakes have been sold in several subsidiaries of the Vietnamese power company. Elsewhere, the Australian state of Queensland has sold two state electricity retailers; India has sold minor interests in some central government-owned power enterprises, and is planning more; the tender of Singapore's three state-owned generators and suppliers has been announced; and a string of Chinese state generators are planning to list subsidiaries either on the mainland or overseas bourses.

State ownership of the Asian electricity sector is thus declining, although it still remains dominant. But our time-traveling power observer would see a much more radical transformation in the ownership of IPP and other private generation plants.

Back in the mid-1990s the Asian private power sector was dominated by North American and European companies. A jostling pack of deep-pocketed players seeking fast-track deals, many of the companies were from an electric utility background. They also included a broad spread of oil, gas and general energy companies and a fair smattering of equipment manufacturers, construction companies, and infrastructure and financial investors, together with a penumbra of other businesses.

Some of these North American and European enterprises remain in the Asian market today. But most have gone, returning to focus on home country businesses or markets with a more familiar terrain.

As earlier noted, there were initially few takers for the assets of the departing investors, with many being sold at knockdown prices. The buyers included well-established regional power utilities, including Japanese, Korean and Hong Kong companies.

Most of these regional companies have been active in the Asian power market for years, both in the acquisition and new build businesses, but tended to shy away from high-priced assets and took only minority stakes in overseas projects during the feeding frenzy of the mid-1990s. More recently, though, they have become both more assertive in the Asian market and more global in their investment strategies.

There has also been a new wave of local players from a wide range of backgrounds including industrial conglomerates and energy companies. Often starting from a small base of generation capacity, located in one or two markets, many are now expanding aggressively in the regional market and beyond.

One notable group in this respect is Malaysian investors who started in the local IPP market in the mid-1990s. Many are now expanding into overseas IPP markets such as the Middle East, assisted in large part by their familiarity with and access to sources of Islamic finance.

The Asian electricity market has also seen an influx of new entrants into niche markets such as the renewable energy sector. And, increasingly, the market has attracted a range of financial investors. While regionally-based and Middle Eastern funds led the way, the tide has turned with U.S. investors once again entering the market in the form of private equity funds and others.

The Asian electricity market in fact appears awash with finance, with developers bemoaning the fact that too much money and too many investors are chasing too few bankable projects and acquisitions. And this is a parallel with the mid-1990s that does not sit entirely comfortably with the efficient and trouble-free development of the industry, one might think.

Well to some extent yes, but mainly no. There have been recent deals at prices that appear to lack commercial rationale, with the sale of the Australian electricity retailer Powerdirect being one of the most frequently quoted. But these deals mainly involve incumbent investors consolidating or hedging their position in a market rather than, as so often in the mid-1990s, new entrants desperate to get a foothold in a market at any price.

And we should also remember our starting point. The Asian electricity market may carry an aura of optimism, but too many of its participants were active in the mid-1990s for confidence to outbid caution. With more realistic goals, an ownership structure based more squarely in the region, and a much stronger financing base than in the mid-1990s, derailment of the market seems much less likely than a decade ago.

At the same time it would be difficult to deny that the Asian electricity market faces enormous challenges, not least in the need to construct a vast amount of new generation, transmission and distribution capacity. The absence of market-based pricing and the competitive structures that could facilitate future waves of investment are also issues across much of the region. But it would be equally hard to deny that, in overall terms, the market is in much better shape than for well over a decade.