Connecting Thailand, Laos and Japan
The Nam Ngiep 1 hydropower project (the Project) is the first cross-border project between Laos and Thailand to have reached financial close with a combination of multilateral, ECA and commercial bank investment since the refinancing and expansion financing of Theun-Hinboun (THPC) in 2008. By Laurent Margoloff, director, project debt advisory and finance APAC,Shinichi Yashiro, deputy head, export finance Japan, BNP Paribas, and Stephen Jaggs, managing partner, Bangkok office, and Sarah Wilson, senior associate, Bangkok office, Allen & Overy.
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The financing for Nam Ngiep 1 represents a landmark in relations between Japan, Laos and Thailand, being the first participation by Japan Bank for International Cooperation (JBIC) in a Lao project financing and the first significant investment by a Japanese sponsor in the Lao power sector.
The project involves many other “firsts” from a financing perspective. The door-to-door maximum loan tenor of 22.5 years is the longest ever for a Lao cross-border power project and involved the first Thai baht loan provided by Asian Development Bank (ADB) to a Lao project and also the longest fixed-rate Thai baht loan ever provided. The project also had to achieve bankable arrangements on a limited recourse basis for a multiple construction contract structure and interconnection through a substation and transmission line owned by another existing operating project and for the upgrade of that substation to 500kV.
The project will provide dependable, renewable and low-cost energy to the Thai and Lao power grids, as well as important benefits to Laos in the form of royalties, income tax, and various community livelihood improvement programs, all funded by the project. Under the off-take arrangements, 94% (approximately 272MW) of the generating capacity of the project will be distributed to the Electricity Generating Authority of Thailand (EGAT) under a 27-year take-or-pay power purchase agreement from a main dam, while the remainder (approximately 18MW) will be generated by a powerhouse at a re-regulation dam and sold to Electricité du Laos (EdL) on the same basis.
Allen & Overy, international legal adviser to Nam Ngiep 1 Power Company Ltd (NNP1) and its sponsors, and BNP Paribas, sole financial adviser to NNP1 and its sponsors, have collaborated to provide some insights into what marks the Project out for special mention and the hurdles overcome to reach financial close.
The project has a long history, being identified as a potential hydropower site in the early 1990s. Over the subsequent decade, it received interest from a number of investors, including French, American, Japanese and Thai developers. However, it was not until a feasibility study, carried out by Nippon Koei with funding from Japan International Cooperation Agency and submitted to the Government of Laos (the GOL) in November 2002, that the feasibility of the Project was confirmed and it was earmarked for development.
The Kansai Electric Power Co Inc (Kansai Electric), a Japanese company, executed a Project Development Agreement with the GOL in 2006 and subsequently took various initiatives to promote the project, including an additional technical survey to further confirm the project’s feasibility while minimising construction costs in order to ensure the financial viability of the project.
The current foreign sponsors, Kansai Electric and EGAT (which subsequently novated its rights to its subsidiary, EGAT International Company Ltd (EGATi), a Thai company), signed a consortium MoU in April 2007 with a third developer that withdrew its investment later that year. Kansai Electric and EGATi have jointly pursued the Project since its inception and NNP1 is currently co-owned by Kansai Electric (through a Dutch holding company), EGATi and Lao Holding State Enterprise (LHSE).
An original tariff MoU was concluded with EGAT in June 2007. This terminated in December 2008 largely due to the global economic uncertainty induced by the financial crisis. Following additional field surveys in respect of the environmental and social and technical aspects of the Project (including assessments to determine how to minimise risks during construction, particularly associated with the construction of the dam) and the restructuring of the EPC configuration/scheme to determine an appropriate risk allocation between the contractors and NNP1 for the Project, a new tariff MoU was concluded with EGAT in July 2011.
Kansai Electric also undertook the selection of construction contractors together with EGATi and LHSE, the negotiation of the power purchase agreements with EGAT and EDL and the concession agreement with the GOL. Numerous hurdles (the most difficult and interesting of which are detailed below) had to be overcome by Kansai Electric, together with its partners in the Project, EGAT PPA and EdL PPA in order to sign the Concession Agreement in August 2013, and move forward to realise the Project by achieving financial close.
* Debt financing – The financing for the project is a blend of US dollar and Thai baht debt. The US dollar loan tranches are being provided by JBIC (under its Overseas Investment Loan programme) and the ADB. The three Japanese lenders (which also acted as US dollar mandated lead arrangers), Mizuho Bank Ltd, Sumitomo Mitsui Banking Corporation and Bank of Tokyo-Mitsubishi UFJ Ltd Bangkok Branch, all entered into a separate B Loan risk participation with ADB.
Notably for a deal of this type, a significant portion of the Thai baht loan tranches are being provided by ADB, with the remaining Thai baht debt being provided by Bangkok Bank Public Company Ltd (BBL), Export-Import Bank of Thailand (Thai-Exim), Kasikornbank Public Company Ltd and Siam Commercial Bank Public Company Ltd. As there were restrictions for ADB to provide baht loans to non-Thai companies, the baht loan from ADB required additional Bank of Thailand approvals as compared with other cross-border financings.
The four Thai lenders (which acted as Thai baht mandated lead arrangers) are also providing a commercial securities facility to enable NNP1 to satisfy its obligations under the EGAT PPA. Under this facility, the initial development security provided by Kansai Electric and EGATi to EGAT prior to financial close has been replaced by four bank guarantees, provided pro rata by the four Thai lenders.
* Equity funding – The shareholders have provided equity commitments to the project on a pro rata basis in accordance with their shareholding in NNP1, being Kansai Electric (45%), EGATi (30%) and LHSE (25%). These contributions are backed by a mixture of parent company guarantees and SBLCs. The shareholders are required to inject their equity on a pro rata basis with the financing, so as to maintain a 71:29 ratio between debt and equity.
One of the key aspects of past hydropower project financings in Laos has been the substantial equity stake taken by a GOL shareholder in the project companies. This has assisted with addressing the political risk involved in carrying out projects in Laos (for both the foreign shareholders and lenders), by ensuring that the GOL shareholder (in this case, LHSE) is a full partner in the Project and shares in the risks and benefits associated with its successes and failures.
On this project, the equity requirement of the GOL shareholder, LHSE, could not be wholly met from LHSE’s own resources. Accordingly, it was necessary to raise funds on sufficiently attractive terms (pricing and tenor) to make it worthwhile for LHSE to invest in the project. Working together with this goal in mind, NNP1, Kansai Electric, LHSE and the GOL (represented by the Ministry of Finance (MOF)) were able to successfully raise equity funding from JBIC, Thai-Exim and BBL.
This was the first equity funding loan provided by JBIC to the GOL, reflecting the significant Japanese investment in this transaction. As in past projects, the equity loan was provided to MOF with the majority of the funding then being on-lent by MOF to LHSE. However, unlike many past projects that could attract concessional and donor funding for the MOF/LHSE equity funding, the loans were made on commercial terms and the pricing and tenors offered to the GOL reflected this. While secondary security in relation to the Project was taken by the three equity lenders, the loans were made on the basis of the GOL’s (rather than the Project’s) credit.
LHSE was not (unlike previous Thai/Lao hydro power projects) required to inject all equity commitments to the Project prior to financial close. Over time and given increased experience on the Lao side, the GOL has looked to ensure that its shareholder in hydropower projects invests on substantially the same terms as the foreign shareholders in the relevant project.
This has meant a move away from the practice of LHSE immediately drawing on the full amount of its equity loan. On this financing, LHSE instead put in place SBLCs for its equity commitment on the same terms as the other shareholders, thus strengthening its projected equity IRR. Ultimately, given the increased complexity required to put in place SBLCs, the structuring of the equity loan financing so that it dovetailed with the senior lending proved to be one of the most difficult issues to be addressed by NNP1 and its shareholders.
* Foreign exchange and interest rate – NNP1 has formulated a very coherent plan for mitigating foreign exchange and interest rate risks for both the construction and operation phases of the project.
As customary for recent IPPs in Thailand and cross-border between Thailand and Laos, the project financing was raised half in Thai baht and half in US dollars to create a natural currency hedge with currency denomination of the EGAT PPA tariff. Equity contributions were fully denominated in US dollars, mainly to increase the US dollar denomination of the committed capital (debt and equity in aggregate) and more closely match the currency denomination of the construction costs, a large portion of which is denominated in US dollars, particularly with respect to offshore construction contracts.
Further, NNP1 devised a foreign exchange hedging strategy throughout the construction period to fully cover the remaining currency mismatch and to allow some degree of flexibility in future fixed settlements in case of delay.
NNP1 also aimed to minimise interest rate risk during the construction and operation phases and take advantage of the low interest rate environment. While the US dollar-denominated loans could be hedged for a large portion of the loan tenors, there were no Thai baht interest rate hedging instruments available for non-Thai borrowers/counterparties for such a long tenor. Instead, NNP1 was able to agree an innovative structure with the lenders, whereby ADB provided a baht-denominated fixed-rate direct loan for the full tenor, which was combined with fixed-rate arrangements for shorter tenors that were put in place with the Thai lenders.
* Construction risks – Multiple construction contracts– The project construction is undertaken under four separate and interdependent construction contracts as follows:
i) Civil work contract with Obayashi Corporation for the construction of the Project’s civil works structures, including the river diversion, main and re-regulation dams, power houses and ancillary infrastructure facilities such as access roads and buildings;
ii) Electric and mechanical work contract with Hitachi Mitsubishi Hydro Corporation for the design, procurement and installation of electromechanical equipment including two vertical shaft Francis hydraulic turbines at the main dam, one Bulb hydraulic turbine at the re-regulation dam and associated generators, transformers and switchyards;
iii) Hydraulic metal work contract with IHI Infrastructure Systems Company Ltd for the design, procurement and installation of hydraulic metal equipment such as spillway gates, steel penstock, intake gates and draft gates; and
iv) Transmission work contract with Loxley PLC/Sri consortium for the procurement and installation of 125km 230kV transmission line from the main dam switchyard to the Nabong substation.
While such construction arrangements are not unusual for a hydroelectric power project given the large component of civil work that power equipment manufacturers are not able to undertake, they raised a number of construction risk issues in the context of a limited recourse financing where a single turnkey, fixed-price, date-certain engineering, procurement and construction contract is generally the norm. In particular, the split of responsibilities and therefore liabilities between contractors means that underperformance of one contractor could affect the overall construction schedule and cost, while the project would be unable to fully recover resulting cost overrun and liabilities from the liquidated damages of the underperforming contractor.
Various risk mitigation measures were implemented in consultation with the lenders and their legal and technical advisers to overcome construction risk while maintaining the limited recourse nature of the project financing:
i) The employment of reputable international and financially solid contractors with relevant experience in each specific field of work and in most cases previous successful engagements with Kansai Electric and/or EGAT;
ii) Construction co-ordination support from Kansai Electric and EGATi under Project Management Agreements availing to the project the extensive expertise of Kansai Electric (including among others through its Kurobe dam in Japan) and EGAT in hydropower development and experience in managing and co-ordinating civil work, electromechanical work and other activities for hydroelectric power plant construction; and
iii) Ample contingency in the base Project finance plan in addition to capped contingent equity support provided by the sponsors.
*Interconnection issues – The Nabong substation– By far the greatest challenge faced by NNP1 was how to deliver its power across the Thai-Lao border to EGAT in Thailand. This is because NNP1 was required by EGAT under its power purchase agreement to make arrangements to interconnect to the Nabong substation (which is currently owned and operated by Nam Ngum 2 Power Company Limited (NN2)). The Nabong substation transmits power along a 27km 500kV transmission line that crosses the Thai-Lao border and delivers power to EGAT at Pakxan.
The development plans surrounding the Nabong substation have had a long history. The original intention of EGAT and the GOL was for four separate projects (NNP1, NN2, Nam Ngum 3 and Nam Theun 1) to interconnect through the Nabong substation and deliver power from Laos across the border to EGAT in Thailand, thereby sharing the construction and operation costs associated with the transmission line and substation. Of those four projects, only one (NN2) proceeded to complete its financing and move on to its construction phase on the original timeline, with the three other projects being delayed due to the global financial crisis.
As a result, NN2 took on full responsibility for the construction of the Nabong substation and transmission line (both of which continue to be owned by NN2) rather than the substation being developed on a joint basis between the four projects as originally planned. The NN2 project agreements made minimal provision for future interconnection by other projects and did not contain clear mechanisms for the handover of the substation and transmission line to the GOL or for the sharing of this infrastructure with other projects.
Other projects (together with the GOL and EdL) have tried and failed to reach an agreement with NN2 to provide for interconnection to the Nabong substation and transmission line and, partly as result, these projects have all ultimately been delayed, at least in their originally intended form as cross-border project financings.
The structure that was finally reached on this project will involve the GOL owning the Nabong substation and providing all rights for NNP1 to interconnect. While the upgrade works are contracted to NN2 (to provide an additional incentive for the transfer of the infrastructure from NN2 to the GOL), the GOL is ultimately responsible for completing the necessary upgrades to the Nabong substation and for providing access to NNP1.
Significantly, this makes NNP1 the first project in Laos to have successfully negotiated an interconnection to a substation constructed and owned by another power project (made even more challenging as this was an already operational project). All such arrangements were agreed on a bilateral basis between NNP1 and the GOL, with the GOL agreeing to bear the risk for NNP1’s interconnection and negotiating its own bilateral back-to-back arrangements with NN2.
Given the delays caused to project development by the Nabong substation issue, the GOL was keen to ensure that other substations that were intended to provide shared infrastructure for delivery of electricity to Thailand did not face similar problems. Accordingly, in negotiating the Xe-Pian Xe-Namnoy (XPXN) concession agreement – another cross-border hydropower project delivering electricity to Thailand in the southern part of Laos that was closed at the beginning of the year – a detailed process for the interconnection of future projects to the Pakse substation was drafted and structured by Allen & Overy, as adviser to the XPXN project company and sponsors, together with the financial adviser and the GOL and included as a separate annex to the concession agreement.
The Pakse substation will be constructed and owned by XPXN with upgrades to allow for the connection of other projects also being undertaken by XPXN but partially funded by other projects that will interconnect on the basis of infrastructure-sharing arrangements that are detailed in the annex to the Concession Agreement. As such, the project company will retain a large degree of control over its interconnection infrastructure whilst still assuring access on reasonable terms to other projects.
From a financing perspective, the work associated with the Nabong transmission infrastructure did not end upon the signing of agreements with the GOL. It took more than a year for NNP1 and its advisers to ensure the lenders were comfortable with the terms agreed for interconnection and to structure a financing solution with the lenders for this key portion of the project’s infrastructure requirements. Achieving this successful conclusion required an intelligent and pragmatic approach on behalf of the lenders and their adviser together with a well-structured contractual package.
* Environmental and social issues– One of the most important and difficult areas for a hydropower developer to negotiate is the environmental and social impact of its project. From a financing perspective, a key element of this challenge is to demonstrate compliance with Lender requirements – both in terms of institutional guidelines and the requirements of commercial lenders that are signatories to the Equator Principles. In putting in place the financing for NNP1, the developers co-ordinated closely with the lenders (in particular, with assistance from ADB) to improve studies and project company capacity, all with a view to ensuring high environmental and social standards for the project.
The GOL has also developed a much more rigorous approach to its involvement in the environmental and social aspects of projects. On recent projects, it has incorporated a detailed environmental and social annex into the concession agreement that also includes fixed penalties for failure to achieve certain criteria.
For the management and advisers of NNP1, environmental and social issues have been a key area of focus for many years. It has taken significant effort on the part of all involved to develop and document an E&S framework that caters for all stakeholders, to ensure that the obligations placed on the project are consistent within such documentation, and to obtain corresponding assurances and co-operation from the GOL.
Development of the project has required detailed analyses of various ecological zones, in order to identify sensitive sites for further investigation to ensure no critical habitats will be affected by the project. Many of these studies required close co-operation between NNP1 and ADB to ensure all studies reflected international environmental standards and that relevant specialists were involved at appropriate stages, for example, to conduct on-the-ground surveys.
Resulting from these studies, plans have been developed to ensure the project’s continued adherence to such standards, including, by way of example, the development of a comprehensive resettlement action plan for the reservoir area. Ensuring compliance with legal as well as Lender E&S requirements has been one of the key determining factors in achieving completion of the financing of the Project.
The successful financing of the project demonstrates that there remains a viable market in Laos for multi-sourced financing from multilaterals, ECAs, and international and Thai commercial lenders for well-structured projects. The challenges faced and innovative solutions found in the course of the financing provide an illustration of the changing legal, administrative and operational landscape for hydropower in Laos.
As the first hydropower project to agree contractual terms for interconnection through another project’s substation and infrastructure, and achieve financing on the basis of those contractual terms, we expect this Project to be an important milestone for the expansion of the Lao national grid and a stepping stone toward the goal of wider interconnection within Laos, across the Lao-Thai border and throughout the Greater Mekong sub-region.