First Gen taps into unique market
First Gen Corp is one of the Philippines’ leading power generating companies and focuses on clean and renewable energy. The company, the power generation arm of the Lopez Group, operates in what is one of South-East Asia’s most deregulated power markets. First Gen’s president and chief operating officer, Francis Giles Puno, speaks to Jonathan Rogers.
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There is 3,000MW of power capacity in the Philippines and this is insufficient to meet demand as the economy continues to grow, outpacing its Asian neighbours in 2012 and 2013 with GDP growth of 6.8% and 7.2% respectively, in the latter case registering the highest growth in the region, with China and Indonesia in second and third place. This stellar growth facilitated the Philippines obtaining an investment-grade credit rating from Fitch in 2012, with Moody’s and S&P following suit the following year.
With economic growth comes rising power demand and it is expected that installed power capacity will rise to 25,800MW by 2030, according to the Philippine Energy Plan drafted by the Department of Energy (DOE) in 2012. But in the meantime, while not in a state of crisis, the demand-supply situation for power in the country remains very tight.
This tight supply situation and the deregulated nature of the market has created a situation of aggressive competition among the country’s independent power suppliers (IPPs).
“The Philippines is unique in Asia given the deregulated nature of the energy market and the fact that there is no state utility dominating that market. The government has divested and privatised so many power assets over the past 25 years with the result that its role in the power market is very small,” said First Gen’s president and chief operating officer, Francis Giles Puno.
There are numerous vocal critics of the Philippines’ energy privatisation programme that emerged from the experience of the summer of 1993 when there were power outages – known colloquially in the Philippines as brown-outs – lasting for up to 10 hours a day in Metro Manila.
Newly elected president Fidel Ramos pledged to end the brown-outs and the privatisation strategy was put in place, with a 1994 World Bank study that advocated radical reforms in the power industry anchoring the policies put in place by the Ramos administration.
The Electric Power Reform Act was passed in 2001 and created the Power Sector Assets and Liabilities Management Corporation (PSALM), which had the mandate of reforming and restructuring the Philippines power sector. Since its formation, PSALM has privatised 26 generating plants, and liquidated the financial obligations of the National Power Corporation (NAPOCOR) and the Philippines National Grid Corporation.
It has been estimated by KPMG that the Philippines’ energy sector requires aggregate investment of US$25bn up until 2030 and a significant increase in available capacity.
“Given the need to increase capacity, and the likelihood that the government will increase the required reserve margin, we focused in 2014 on growing our portfolio of assets. We are somewhat unique in the Philippines’ energy sector in that we focus on renewable and clean energy. Half of our capacity is in natural gas and the other half in a mix of geothermal, hydro and wind,” said Puno.
Geothermal was very much the focus for First Gen in 2014. The company holds a 50.06% interest in Energy Development Corporation of the Philippines (EDC), which is the world’s largest vertically integrated geothermal company with 1,150MW of installed capacity.
“We have been able to complete our Bacon-Manito facility, which is about 130MW and which has come on line this year. And we have added an extra 20MW from assets that we transferred from another area where there was more steam available. So in 2014, we have increased our geothermal capacity from our steam fields,” said Puno.
In addition to geothermal power, First Gen has made significant investments in wind capacity. In 2014, the company completed a 150MW wind farm, the Burgos Wind Project, which was completed at a cost of US$450m.
“As far as the wind project was concerned there was something of a race as far as being eligible for tariffs and there was only a 200MW allocation for wind power to be able to get the tariff available. We will have additional capacity coming on stream through geothermal, with an additional 100MW to be added by April next year and 414MW by March 2016.”
According to Puno, the Philippine government may seek to increase the 200MW availability, although the key question is at what tariff rate. “We are likely to bid in the second round for the additional wind power capability, but it will depend on the tariff rate and how we see the competition at that time,” he said.
Puno observed that First Gen in 2014 had to revise its approach to developing power projects, and in certain cases eschewed typical project financings but chose instead to visit the bond market. First Gen also utilised its own balance sheet in order to build up its asset portfolio of power projects and on occasion went ahead with project execution before off-take agreements had been secured.
“We had to revisit our approach to developing projects in 2014. It wasn’t the ‘old world’ of power purchase agreements and sequential development,” said Puno. “There is more risk in the market and we had to ask ‘is this project bankable?’ and in turn take on more risk ourselves. As around 65% of the Philippines’ generating capacity is over 15 years old there is something of an urgent need to increase capacity and therefore the risk appetite for a company like First Gen rises. Nevertheless given the prominence of oil-fired power production in the Luzon Visayas grid and the relative costliness of that power, we go ahead with our projects because they produce more cost-effective power.”
The Philippines national grid requires an extensive overhaul, with the Luzon-Visayas grid not connected to the Mindanao grid, and with the combining of the two grids requiring significant investment and sensitive policy implementation from the Philippines’ Department of Energy (DOE) and the Energy Regulatory Commission (ERC).
“If you take the Luzon-Visayas area, there’s not much left for the government to divest apart from some oil-fired plants and some storage facilities under contract. In Mindanao the government is still the dominant player via hydro electric plants and these will eventually be privatized. At the moment, Mindanao is very much an independent market,” said Puno.
First Gen reached some milestones in the gas segment of its business in 2014. The company currently has 1,500MW of capacity, with some of that represented by a joint venture with British Gas that First Gen bought out in 2012.
“We thought in 2014 that the gas market in the Philippines might hit overcapacity, but in fact the two significant project announcements this year were in coal-fired plants,” said Puno. “Despite these announcements, the projects have been delayed. That encouraged us to proceed with the San Gabriel project. This was a very ambitious move on our part, given the hefty 414MW capacity of the project plus the target to get the plant up and running by March 2016.”
The initial capex for the project has been funded to the tune of US$300m through an offshore public bond issue and a US$265m loan provided by Germany’s KfW and guaranteed by Hermes, Germany’s export credit agency.
“This was a major milestone for First Gen in that it’s a non-recourse financing that essentially uses First Gen’s balance sheet. Taking on board more risk than was once the norm is certainly a trend in the Philippines power market, a pure merchant financing rather than project financing appears increasingly to be normal practice,” said Puno.
First Gen, in November 2013, sold US$250m of 10-year non-call five Reg S bonds through Deutsche Bank, HSBC and JP Morgan, managing to achieve the optimal distribution result by selling down 60% of the paper onshore.
The halo effect of the company’s ownership by the Lopez Group, a family-owned Philippines conglomerate with high name recognition helped in this regard. The issue was sufficiently well-placed that the leads were able to tap it for a further US$50m just over a fortnight later.
“Once a project has a proven track record, then you will get rewarded for having taken the risk of using balance sheet because you will be able to refinance it on conventional project finance terms. So while I’m not enamoured of using balance sheet, if you do a prudent risk reward calculation, eventually once the refinancing comes up, it will work in your favour,” said Puno.
First Gen enjoys a smooth working relationship with local government around its plants and Puno observed that the permitting process for San Gabriel went smoothly and, given that the land was adjacent to the existing facility, none of the usual land acquisition bugbears that are frequently a feature of power projects were a critical factor.
“We are using indigenous natural gas, which is cleaner than coal and therefore we got a lot of support for this new capacity to come in. This is in direct contrast to what other developers aiming to build coal-fired power plants are experiencing, where approval bottlenecks are the norm and the challenge is much higher,” he said.
Despite the regulatory challenge, Puno noted that First Gen’s competitors were looking to fill the Philippines’ power capacity gap by building smaller coal-fired plants, at around the 100MW range.
“Trans-Asia and Ayala are building a two-by 135MW plant near out San Gabriel facility. Local developer DMCI is also building a coal-fired plant at Calacan. It’s notable that these plants are being developed by local players. When you look at foreign participation there is much less willingness to take on merchant risk. There is a decent availability of getting power purchase agreements in other parts of Asia and foreign players might feel more comfortable in those markets rather than seeking off-takes in the Philippines,” said Puno.
He said that while there was a drive to reduce greenhouse gas emissions in Asia, the Philippines was running behind in terms of formal government policy to push for a greener country.
“We are investing in the most technologically up to-date gas turbines and by definition we will be producing less CO2 emissions from our plants. But it is not factored in in terms of any greenhouse gas allowances. The coal-fired plants in the country are using sub-critical technology but remaining within the current rules. But I’m sure that going forward those rules will change and the regulatory backdrop will become much more environmentally friendly,” said Puno.
Although the current regulations allow for the construction of coal-fired power plants, these regulations will need to change if the Philippines is to achieve its target of being 100% reliant on renewable energy by 2024.