2000-11-E-IPPs (1)

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Public Services International Research Unit (PSIRU)

Independent Power Producers: A Review of the Issues

by

Kate Bayliss, Research Fellow, PSIRU, University of Greenwich

and

David Hall, Senior Research Fellow PSIRU, University of Greenwich

November 2000

This report was commissioned by Public Services International

Public Services International Research Unit (PSIRU)

School of Computing and Mathematical Sciences, University of Greenwich30 Park ow !ondon S"#0 $!S U%&%

Email: psiru'psiru%orgTel( )**+0-.0/+33#+$$33 Fax( )** 0-.0/+33#+/# www%psiru%org

1irector( 1avid 2all esearchers( &ate ayliss, Steve 1avies, "manuele !o4ina, Sam 5einstein

6he PS7U was set up in #$$/ to carry out empirical research into privatisation, pu4lic services,and glo4alisation% 7t is part of the School of Computing and Mathematics in the University of

Greenwich, !ondon% PS7U8s research is centered around the maintenance of an e9tensive andregularly updated data4ase of information on the economic, political, :nancial, social and

technical e9perience with privatisation and restructuring of pu4lic services worldwide%

6his core data4ase is :nananced 4y Pu4lic Services 7nternational PS7-, the worldwideconfederation of pu4lic service trade unions% www%world+psi%org
mailto:[email protected]://www.psiru.org/http://www.world-psi.org/mailto:[email protected]://www.psiru.org/http://www.world-psi.org/

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Independent Power prodcers ! a review of the isses ""#$%#&'

! Introduction!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"

! The problems with IPPs!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!"

1.1 IPPs - not a source of funds.......................................................................................................................................3

1.1 IPPs are uncompetitive and inflexible.......................................................................................................................51.2 High prices and generous concessions......................................................................................................................61.3 is! exposure for governments is a!in to debt........................................................................................................."1.# $orruption % undue influence.....................................................................................................................................&1.5 'xcess capacit(..........................................................................................................................................................&1.6 egulation and legalit(..............................................................................................................................................)

2! #rac$s are emer%in%!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!0

2.1 *o+n+ard renegotiation of PP,s...........................................................................................................................12.2 $ontracts are being declared illegal or not rene+ed...............................................................................................1

"! #onclusions!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!0

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! Introduction

Increasingl( governments are turning to the private sector for po+er generation. /ome developing countriesstarted allo+ing private firms to enter electricit( generation at the beginning of the 1))s. Investment b(Independent Po+er Producers 0IPPs gre+ rapidl( particularl( in ,sia. hile expansion faltered follo+ingthe financial crisis in the region4 IPPs have been gaining ground in other parts of the +orld. ,frica4 /outhand $entral ,merica as +ell as 'astern 'urope have all opened the door to IPPs in some +a( or another.

IPPs are presented as an attractive option because the( are supposed to facilitate investment +here aban!rupt public sector can barel( afford to ma!e ends meet and because the( allo+ the private sector tooperate +ithout the need for length( regulations to be in place beforehand4 as the conditions of operatingcan be specified in the terms of the IPP contract. IPPs are heralded as the start of further liberalisation andsubseuent privatisation of electricit(.

Ho+ever4 more and more governments are running into difficulties +ith IPPs. In the countries +here the(have been established for some time4 such as Pa!istan and Indonesia4 IPPs have been the sub7ect of

protracted legal4 political and economic battles. 8ther countries have seen electricit( utilities crippled b(pa(ments due to IPPs4 for example4 the Philippines and *ominican epublic. 8thers have uestioned thegenerous terms offered to po+er producers b( previous governments and have attempted to limit the damagesuch arrangements might cause for example4 $roatia and Hungar(. *espite these difficulties4 more IPPs arestill being planned in various countries.

9his paper aims to set out the main categories of problems that have arisen +ith IPPs4 based on experiencein a range of countries.

2! The problems with IPPs

2! IPPs & not a source of funds

IPPs are sometimes presented as ne+ sources of finance for investment in electricit( generation. :orexample4 the 'xecutive ;ice President of the orld ipevu in >en(a4 said that the private sector financingof the plant +ould

?enable the @overnment of >en(a to conserve limited public resources for other priorities4 such aseducation and healthcare.A1

9his is misleading. Investors in an IPP +ill not construct 0or bu( a po+er plant unless the( are sure the(+ill be repaid 0+ith a profit margin4 and so usuall( reuire that a po+er purchase agreement 0PP, is in

place. Bnder the terms of a PP,4 the electricit( utilit( underta!es to bu( 0usuall( all the po+er produced b(a po+er plant. 9he price of the po+er 0usuall( in foreign currenc( and the amount to be sold are specified.

9his is considered essential to induce investments in potentiall( ris!( pro7ects. :or example +hen the

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8ften the IPP +ill reuire that an 'scro+ account is established to ensure pa(ment. 9his means that someagreed amount of government revenue 0+hich ma( or ma( not be revenue from electricit( charges issiphoned to a foreign exchange account. 9hese funds are earmar!ed for the IPP and government cannottouch this mone(. 9o provide Dcomfort= for investors4 escro+ pa(ments ma( actuall( exceed those reuired

b( the PP, 0see India and >en(a belo+.

9his arrangement means that governments do not have more funds but the( do have less control over fiscalarrangements.

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2!2 IPPs are uncompetitive and infle(ible

9he terms of po+er purchase agreements can be fixed for decades4 in some cases for up to 35 (ears.$ircumstances can change dramaticall( over such a timeframe. Jet4 the terms b( +hich governments have to

purchase po+er from IPPs remain inflexible. @overnments are tied into bu(ing the same amount of po+er4regardless of fluctuations in demand or alternative sources of suppl(. Prices are fixed in foreign exchange4regardless of ho+ this might relate to domestic prices or to +hat utilities are able to charge customers. 8ncePP,s have been signed4 it can be difficult to change the terms4 not least because of the fear that futureinvestors +ill be put off b( a government that is seen to renege on agreements.&

IPPs are supposed to speed up the pro7ect process compared +ith government contracts but this has not beenthe case. 9ransaction costs have tended to be high and elapsed time to financial close4 according to oneorld

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In India4 the @u7arat /tate 'lectricit(

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In the Philippines4 the average generating cost for IPPs in 1))6 +as "6 per Ch compared +ith

5" per Ch for the state-o+ned utilit(. Po+er contracts entered into b( the former amosadministration +ith independent po+er producers 0IPPs are bleeding the ational Po+er $orp. todeath. apocor chief operating officer ,sisclo @onKaga told senators that the( paid a total of P51

billion to various IPPs during 1))) and the amount +as euivalent to 6 percent of apocorFs total

operating expenses. @onKaga said apocor had to obtain foreign loans to pa( up P12 billion to theIPPs. apocorFs revenue +ere simpl( not enough4 he said.1"

In Indonesiastate electricit( compan( P9 Perusahaan Listri! egara 0PL announced a t+elve

fold increase in losses of in the first half of the (ear 2. 9hese losses +ere made despite a 3percent increase in revenue over the period. , stronger B/ dollar caused a big increase in the cost ofpo+er from IPPs. PL bu(s po+er from IPPs at an average price of 5.5 B./. cents or about p #53per !ilo+att hour 0>+H but resells it to the public at an average of p 25. PL calculates that it+ill o+e almost 1bn a (ear 7ust to Paiton I and II4 t+o IPPs that have started production.

9he rigidities of IPPs can increase prices as in Philippines+here apocor is alread( collecting a

DPP, ad7ustment charge= from customers to reflect the cost of IPP obligations. ,s of Ca( 24 this

component represented 2G of the total tariff. hile onl( #G of generated po+er is actuall( usedb( the public4 consumers are allegedl( charged bet+een P.2 and P.# per !ilo+att-hour for theunused po+er produced under the contracts.1&

2!, Ris$ e(posure for %overnments is a$in to debt

8ne of the supposed advantages of foreign investment is that it allo+s the burden of ris! to be shared4 thusreducing ris! exposure for investment partners 0in this case4 electricit( utilities and governments. Bndernormal euit( arrangements4 an investor4 producing for the local mar!et +ould sell goods in local currenc(.Profits +ould be remitted to the parent compan( in the form of dividends. If the value of the currenc( falls4the investor=s profit +ould have less value and the international value of dividends falls.

ith IPPs ho+ever4 even +ith euit( investment4 the investor is insulated from currenc( ris!. Cost IPPsnegotiate ta!e-or-pa( contracts +here the utilit( is committed to bu(ing all the po+er generated +hether ornot it is needed and the pa(ments to be made are specified in B/ dollars.

9his then is far more li!e international debt than euit( investment. ,s +ith debt4 a fall in the currenc( value+ould ma!e it ver( difficult to meet foreign pa(ment obligations. 9his situation has faced man( privatefirms in ,sia follo+ing the crisis of the 1))s +here their outgoings or loan pa(ments are in dollars andtheir income is in domestic currenc(.

here an organisation cannot meet debtrepa(ments4 there are mechanisms to deal +ith this. *ebt can berescheduled or even ban!ruptc( might be an option. In Indonesiafor example4 there are vehicles to help

businesses reschedule their dollar-denominated debts. ith IPPs there is no such mechanism. 9heIndonesian electricit( utilit(4 the PL4 faces mounting obligations on its IPP and no +a( of pa(ing them.$onventional legal mechanisms are failing. In Indonesia4 even +hen investors +on a court ruling in theirfavour4 the PL still cannot raise the revenue to meets its obligations.

Privatisation has been promoted in part because of the vie+ that private investors can bring in finance thatgovernments +ould not be able to access because of their lo+ credit status - particularl( no+ thatmultilateral institutions are less +illing to lend to governments in their efforts to promote the private sector.Ho+ever4 if creditors might hesitate to lend directl( to a government then the( should be even morecautious about the government=s abilit( to provide finance for the more restrictive terms of a PP,.

9o evaluate the ris!s associated +ith IPPs the( need to be compared +ith the government-financed

alternative. It is not unli!el( that some form of loan in foreign exchange +ould have been underta!en and sonot all foreign exchange exposure can be attributed to the IPP. Ho+ever4 IPP pro7ects do tend to be more

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highl( leveraged than state-o+ned investment +hich t(picall( uses more internall( generated revenue. /o ingeneral foreign exchange exposure has increased +ith IPPs.

,ccording to the < stud(4 the electricit( sector=s exposure to foreign exchange ris!s has ?sta(ed the sameor increased +ith IPPs.

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In Indonesiaunder IPP contracts signed +ith the former government under the /uharto regime4

PL has 5G more capacit( than it needs on the main grid of

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"! #rac$s are emer%in%

"! +ownward rene%otiation of PPAs

*espite rigidities4 investors are having to face the fact that the( need to restructure terms because utilities7ust cannot meet pa(ments. 'conomic realit( is forcing investors to face up to changing circumstances4 and

accept more reasonable charges4 regardless of the legalities of the PP,s.

In the Philippines4 apocor is discussing terms of restructuring pa(ments +ith 32 IPPs. 8ne possibilit(

is an arrangement b( +hich some of the pa(ments due from apocor are dela(ed until the end of the IPPcontract period. 9he negotiations are over the appropriate interest rate and the relative costs ofalternative financing sources open to apocor 0although these are limited due to its commitments and

poor record +ith IPPs.2#

In Indonesia4 PL is re-negotiating its po+er purchase contracts +ith the IPPs that have come on

stream in an attempt to lo+er the price of their po+er. In one case4 PL effectivel( negotiated thenationalisation of a po+er plant at a price +hich made the station=s output attractive as +ell as

allo+ing PL the flexibilit( that comes +ith o+nership.

"!2 #ontracts are bein% declared ille%al or are not renewed!

In other countries4 there are intiatives +hich have declared PP,s inherentl( illegal and so unenforceable.

In #osta Rica4 0mentioned above the countr(Fs $omptroller @eneral has declared that clauses relating

to rates levels in 15 private sector po+er generator contracts lac! legal status because rates levels andad7ustments sought to guarantee profits of the private sector4 and not to ensure economic benefits to thecountr( or consumers4 as the 1)) la+ on electric po+er cogeneration reuired them to do.25

9he )un%ariangovernment and state utilit( C;C have decided not to sign an( more PP,s as the( are

inherentl( anti-competitive. 9he government sa(s it needs to ma!e the electricit( sector competitive andthis +ill not happen +ith PP,s +hich inherentl( restrict competition4 are incompatible +ith the spirit ofthe 'B electricit( directive4 and carr( the ris! of state-guaranteed Ostranded costsO - the compensation

paid if4 in a free mar!et4 ne+ po+er providers undercut the previousl( contracted generators. 9hisbrought it into sharp conflict +ith multinationals ,'/ and 9ractebel.26 In Nul( 1))) the Hungarianparliament had alread( declared that a PP, signed +ith multinational ' +as unconstitutional andvoid ' stated that it +ould bring a la+suit to demand the return of its 26m.2"

In ,ugust 2 the #roatiangovernment insisted on tearing up a PP, contract signed b( 'nron +ith a

previous government. 9he contract +as considered to be unaffordable4 had been signed in politicall(dubious circumstances4 and despite pressure from the B/ ambassador4 $roatia successfull( forced 'nronto abandon the original agreement. e+ agreements +ere signed4 but it is not clear that these +ill ever

be implemented.2&

In the Philippines4 in /eptember 24 to avert the financial burden caused b( the IPP deals4 'nerg(

/ecretar( Cario 9iaoui said the government +ill not rene+ these contracts.2)

,! #onclusions9he benefits of IPPs have been greatl( exaggerated. IPPs are 7ust one means of financing expansion of

po+er generation but +e have sho+n this is fraught +ith difficulties.9he financial burden imposed b( IPPs is no+ being recognised. Ho+ever4 the solution commonl( proposed

is to privatise the rest of the electricit( sector4 +hich simpl( extends the dangers of a financiall(

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unsustainable solution. ,s +e have seen in the *ominican epublic4 service provision has deteriorated badl(after both generation and distribution services +ere privatised.

Jet there appears to be a reluctance to learn lessons of experience. *espite blac!outs of up to 2# hoursfollo+ing privatisation of electricit( generation and distribution4 in ,pril 2 it +as reported that the*ominican epublic +ill privatise electricit( trans/issionin order to compl( +ith orld

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15 Ca( 2 I:$ invests #1 million in private po+er pro7ect in >en(aE ,frica e+s /ervice orld eporter25 :eb 1))) o *am In ,9, P8/9E P9 PL :I/9 H,L: L8//'/ /B@' 12-:8L* 9he Na!arta Post - Indonesia 1-/ep-22#.S and 5ractebel clash with Hn)arian )overn/ent over PP>s Sorces 9 BUSI?.SS @IR. Reter5e0tline, "2*$"*%% 9 Financial 5i/es, $"*$7*$$2"PSIRU datbase news Ite/ +2'1 Hn)ary and R@. in lawsit over spply a)ree/ent SorceE Reters "3#$3#%%

2&P/IB database e+s item #&2. /ourcesE euters4 &-&- E :inancial 9imes 'urope Intelligence ire4 22-6-.

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2000-11-E-IPPs (1)