Gulf Power 2010: Part 3

Gulf Power Roundtable 2010
30 min read

Ravi Suri: Absolutely correct and that’s where partnerships will emerge and that’s where you’ll find the Japanese and the Koreans co-ordinating and working in a consortium. And you’ll find the Japanese and the Chinese working on a consortium. And you’re right, the yen is where it is today, so it’s not going to be a Japanese-dominated EPC contracting market like it was five years or six years ago. But the Japanese will still be there and in partnership. China has probably an important role also in this contracting capacity.

Rod Morrison: On the Sinosure product, do they have to have a construction guarantee? Do the Chinese banks need Sinosure cover to lend overseas? Is that a limiting factor at the moment?

Ravi Suri: Well you see every deal is different, every sponsor is different and yes, there are issues where you need Sinosure cover but you can work around it and you can get Sinosure cover. We have been working on quite a few deals where Sinosure cover has come in. Salalah was a classic example and then others have been implemented. I think it’s a learning curve also for the Chinese banks and it’s a learning curve for Sinosure, and when there’s Chinese contracting involved Chinese banks will be there.

Sachin Karia: I agree with the comments made, that the Chinese will undoubtedly play a bigger role. I find it quite interesting to argue their corner and say, why isn’t every project being run by a Chinese contractor? And I think people don’t yet factor that actually the Chinese tied funding solution is not as competitive as other Chinese funding solutions.

And the ease of doing business with a Chinese ECA is not the same as with JBIC and Kexim. There is not yet in terms of the level of understanding, an acceptance of risks, it’s not the same dealing with the Chinese as it is with the Japanese. And I think the choice of fuel is, certainly from where I’m sitting in the market, a key driver of whether you go with a Chinese contractor or not.

I think if it’s a HFO plant, I think Chinese contractors are much more competitive than others, whereas if it’s gas then I think you’ve got a less compelling story. In any case you’ll see more Chinese sourcing, which doesn’t necessarily mean Chinese contracting because a lot of the Western contractors

I think will increasingly be moving their shops to China and manufacturing an increasing number of their components
in China.

So China’s most certainly going to become the electrical workshop of the world, whether it’s the Chinese contractor, the Chinese funding solution leading that I think is, you know, it’s going to take some time before we get there. I think ultimately on the EPC side, you pay enough money you will get the contractors to take part.

I think the perfect storm was a combination of every market in which these contractors are participating, oil and gas, petchem, you know, everything was booming and the fabrication shops were full. I think it’s less so now, with some of the oil and gas and petchem markets not being quite as active as the infrastructure side.

Charlie Seymour: Is there sufficient capacity in the contracting market? I think yes. Although I think a word of caution about IWPPs with the water components to projects, I think there’s a less deep market for water contractors. Why is there sufficient capacity? I think the contractors like the IPP model in the Middle East. I think they like repeat business. They like the risk template of an IPP; they like the quality counterparties, and they like getting paid, primarily.

So I think definitely the European, the American, the Asian contractors are hungry; prices are coming down. Chinese, I don’t disagree with what’s been said. I think Sachin raised some interesting issues. I think from a procurer perspective, ADWEA, where our technology use and our projects have been gas-fired combined cycle gas turbine plants, no big conventional plants, IPP yet, but with a Chinese contractor, I think the procurer is looking, number one for credentials that Chinese contractors can deliver, failing in a tender is just not acceptable. We need power that can tender a project, we need to be very confident that the package can be delivered on time.

And I think linked to that point, procurers are very much looking for developers who can manage the Chinese contractor, I think there’s a degree of uncertainty and the unknown and I think some developers who have worked with the Chinese contractors, certainly I don’t mean prime position.

It’ll be interesting to get a perspective of Acwa on the whole Chinese contracting market. Security of supply, quality control are absolutely fundamental to a procurer. We in Abu Dhabi want world best technology and a very high quality control.

So I think looking at Chinese, I think maybe there is a difference between CCGT projects and conventional projects - on the conventional projects the Chinese have been commissioning 17GW of conventional each fortnight for the past ’x’ many years, so those guys can deliver, there’s no question about that. They’re competitive, they’re also getting to know the IPP market, and the IPP market in the Middle East has been an attractive jurisdiction. I think Sachin’s absolutely right, the last issue procurers are looking at is competition as well in the projects.

We’re very mindful of the fact that we do go to conventional projects because of fuel; fuel choice pushes us that way. We still want a competition, we don’t want just a one bidder or two bidders, we want some more competition and Sachin, I think you’re right, I think the next stage of development will be joint venturing in China, not necessarily just pure Chinese contractors, you know, the likes of a Siemens for example bidding into a project in the GCC where they compete against the Chinese contractors on a conventional technology plants.

Those guys, to be able to bid, have to make some pretty fundamental economic decisions to bid, which involves hiring a lot of people for a period of time, sourcing equipment and sourcing materials. They’re not going to make those economic decisions if they feel that they’re not going to win the project or they haven’t got a good chance of winning a project. So I see companies like Siemens, they’ve already started the process of looking to JV in China and participating that way.

Duncan Allison: Well Charlie I think has just espoused a fairly typical view of the procurer in the region. I mean, as an adviser, I suppose I long for the day that we Salalah and Rabigh complete so we put to bed some of the concerns that do run around the market about the ability and risk.

There’s no doubting on the coal side, the Chinese run them off every day. But with the gas here, their experience of international contracting, we hope it’s there and a number of sponsors internationally, have put a lot of support in to see us there. So I think the Chinese contractors are here to stay.

But it would be wrong to say the argument is entirely one way. We have just heard a very powerful argument just why some procurers are nervous, it still also applies to a number of the banks and in a limited pool of banks. Advantages of the Chinese, I mean we’re talking Chinese contractors but you could also talk Chinese developers because this is going to be the next stage and very, very soon I suspect, not necessarily leading but certainly as an investor. There have very little competitors and they’re certainly going to open up the market, and they’re very aggressive and they’re very keen to win business really, so it is a prime target area.

Rod Morrison: Are their financial products difficult to deal with?

Duncan Allison: Well I think the answer is, I think they’re perfectly manageable and I think there’s just an educational process, so I think it is - they are supportive, they understand the market, they’ve got immense liquidity. And a number of the international banks are comfortable with Sinosure and lending of this nature.

Ravi Suri: It’s not as cumbersome as you’re speaking of it to be. I think it’s a process you have to follow, every region has a process and we found them very responsible.

Rod Morrison: Regarding the Koreans, obviously they are at the top at the moment - do you see there’s plenty of bank appetite for Kexim risk?

Duncan Allison: The discussion on the concerns on concentration of Kexim risk has gone on for about the last 12 months, I mean again it comes down to the size of the debate. I mean we’ve not seen any project constraint to date by a lack of appetite for Kexim paper. I am aware of it, people are aware of it but as long as people are sensible I can’t see that being a significant problem. And the Kexim direct product of course is becoming much more frequently seen and very aggressively used, and very effectively in fact, in support of Korea Inc.

Gijs Olbrechts: If you look at the infrastructure market, the main growth areas are the Middle East and Latin America. In regions like Europe, UK and US, there will not be a lot of growth. Even in Asian countries such as South Korea the growth slowed down. So the GCC market is one of the key markets for EPC contractors.

For the South Korean EPC contractors, their domestic market is declining and they are looking at the overseas market to capture growth and re-allocate the overcapacity. We currently not only see the traditional EPC contractors like HHI, Doosan, Samsung, etc, but there are a number of new entrants in the GCC market that previously focused on the domestic market. Hence. We believe they will be able to cope with the demand.

With regard to the Chinese contractors, they have a huge capacity to add power plants and this capacity is mainly used for the domestic market. We are currently already seeing Chinese contractors entering the GCC market and believe that, once the growth in the domestic market starts declining, we will see more and more Chinese contractors. Chinese contractors not only have the capacity to build large power plants, but they can also do it on a very competitive basis.

We look at Chinese contractors and/or equipment suppliers on a case-by-case basis. The acceptability criteria for the sponsor, offtaker and lender are important to select a Chinese contractor and/or equipment suppliers. In the case of a coal plant or a fuel plant, the choice of technology (for example sub vs super vs hyper critical) will be an important criterion, where the Chinese have more experience with sub-critical technology. Also, for CCGT gas fired plant, the competitive advantage of Chinese contractors and/or equipment suppliers diminishes as these CCGT are manufactured under the licence of traditional manufacturers. Also, the Chinese contractors and/or equipment suppliers need to be acceptable for the lenders and off-takers.

Harold Fairfull: There’s been a lot of discussion about Chinese contractors, but certainly if we’re looking at the short to medium term in the next 18 months to two years, I think the last majority of new contracts that have been awarded for power plants in this region will have a Korean component. And so I think we should certainly look at the Chinese but I think we’re going to have to look at them as being a little bit further than in the next coming years.

In terms of the viewpoints of lenders on the Chinese, both equipment and in contracting, we jointly with Ashursts have been doing a number of power projects surveys over the last 18/24 months. And it’s actually been very instructive to see how the views of lenders have changed quite dramatically within that period.

If we go back to the first survey at the beginning of 2009, there was quite a reluctance then at the majority of banks to accept any form of Chinese equipment and certainly no appetite at all for Chinese EPC contracting. The latest one done this summer showed that the majority of banks would have no issue using Chinese steam turbines, Chinese boilers, and not a majority but a very increased number of banks would also accept a Chinese EPC contractor.

There was one area where there was a very clear consensus among those, on gas turbines, and they simply wouldn’t accept at this stage a Chinese gas turbine. So I think, given the dramatic shift over the last 18-24 months of banks’ views, we can expect over the next two years that to continue and that there will be a general acceptance within the market of Chinese EPC contracting.

Pascal Martese: We are looking very carefully at Chinese contracts. No doubt, the Chinese can do engineering procurement and construction. I think there’s the right consensus that it’s not going to be in the short term that gas turbine manufacture in China will be accepted by lenders or sponsors and procurers. So I mean we are doing our sets through the motion because we are part of the project of Rabigh in Saudi Arabia. So we were aware of certain challenges in terms of managing the EPC contractor and being sure that the process and the co-ordination is in place.

Rod Morrison: One final question, procurement models. As the current model has become more successful, and the more the region gets tied up in these long-term contracts, is there the need for a different model?

Ravi Suri: Well I think Charlie mentioned a very interesting point about how this model will be tweaked not to have full underwritings. I think that’s a modification, but this model has worked very successful in this region, its privatised very well, so I think a bit more they’re here to stay.

Regarding a merchant market, you know there has been no merchant risk on the some of these projects. And you really don’t need more than that here because you don’t have different fuels. You need a merchant market when you have different fuels and you have different fuels in the margin, you need different dispatch instructions. The beauty of this market here is that you have nearly one and there are two fuels in the grid. So I don’t think really a merchant market is very necessary, but this procurement model has worked well and with a few tweaks probably it will serve the need for the next few more years.

David Warren: If you look across the region then more and more of the countries here are developing an IPP programme, so you know Kuwait, Dubai, Syria are all moving towards an IPP model. But that’s not the whole picture, of course. I mean in Saudi Arabia we’ve seen WEC step back from modelling the Ras al Zour project, went from an IWPP, unfortunately for some of us around the table, into a more traditional procurement model.

But I think the overall trend is towards doing IPPs, I think the emphasis really is going to be on tweaking that model to make sure that it works in terms of the market. And I think the procurement process is an interesting one.

I think ADWEA is taking a very interesting step in terms of doing the partial underwrites because underwriting it at five or six times over in the current market, it makes no sense. The Qataris have taken another approach, which is an approach dominated and informed by QP, which is to say we know the project finance market therefore bidders please go out and do your EPC and O&M and we will fit the finance on to that.

Developers don’t always like it because it removes another variable for them to play with and in terms of competitiveness. So I think the emphasis is going to be on tweaking the IPP model rather than reinventing it. Also, I think in terms of merchant, I think for the Middle East I think it is a long way off. IPPs mostly out of these here are not very far into some very long-term contracts, so moving to a merchant model would raise significant issues in terms of dealing with stranded cost type issues.

I think also one comes back then to the question of regulation. I know Oman has taken significant steps towards unbundling its power sector but really you’ve got to have a fully unbundled sector if you’re going to make a merchant scenario work.

I think the other important aspect to bear in mind is the subsidy element. If you move to a merchant market, you deal with subsidies. At the moment, I think the Abu Dhabi tariff for Emirate consumers is five fills per kilowatt hour, even for its ex-patriots it’s 15 fills per kilowatt hour and a half, so there are issues that they would have to wrestle with, difficult political issues on subsidy if one is really going to look at the merchant market.

Sachin Karia: Having cut my teeth on Europe and the UK power market, it became increasingly obvious that for the mature markets a merchant power model with trading gives you the best price provided it’s structured correctly, the price to the consumer is the lowest and if that is your objective then at some point in time you want to move to it.

I think in order to move to it there are a number of characteristics that the market itself has to have, which I’m not sure we’re there or I’m not sure we will get there in the near future. These types of trading and merchant power markets are much more suitable to mature power markets, although demand is not growing as quickly or as unpredictably as it can in much smaller markets.

So you put a huge petrochemical project in a city even like Abu Dhabi, it’s going to require an enormous amount of power and then suddenly it just changes the entire market dynamic. If it’s a merchant power market, you can’t control that because relative to the overall demand an enormous thing like that would just suck up a lot of power. So I think 10, 15, 20 years down the line with a GCC grid and a much more stable, in terms of demand of its market perhaps, we will move to a merchant power station, I just do not see it happening in the immediate term.

Charlie Seymour: Speaking from an Abu Dhabi perspective, probably similar with other jurisdictions, the privatisation was not purely about money, this region has money to procure for other structures, but I think discipline and transparency was a key issue, developing local markets, debt markets and equity markets are important and developing the local economy by involvement of local players, international best practice.

It’s the best way of bringing international best practice and also, even though there’s a leverage component, IPPs do produce keen prices, so it’s been successful and I don’t see it changing, the model. Merchant, for the reasons Sachin mentioned, I think for a merchant market to work successfully there has to be a true economic merit order and the merit order in this region is skewed by a whole heap of factors - subsidies, gas, fuel subsidies, seasonality, you’ve got water production as well, and that makes it more complicated.

I think with the grid being integrated we could see some power flows going into different directions. But fundamentally, people need power in the summer months here and there are nuclear projects that produce power all the year round, in the winter they’ll find that it’s not needed in other countries. It would be interesting if it somehow flows and travels as far as Europe, where there’s an inverse demand for a suitable profile but that’s a long way to come.

Duncan Allison: I think that the point is that the IWPP programme was a programme that was built up based on narrowing multiple objectives, some of which were monetary, some which were non-monetary. And therefore it actually meets what everybody wants and that hasn’t changed. And there’s absolutely no interest or incentive on anyone actually to change that model and no one’s driving for it and no one’s asking for it.

And there are a number of significant difficulties with trying to do a merchant programme that have already been identified. There are the technical difficulties in the fact that your despatch in this country isn’t totally governed by monetary concerns, you’ve got to run water, you’ve got a very difficult balancing act with how we’re going to deal with the base load economics with nuclear and all this means that you just simply aren’t going to be able to dispatch according to a merit order.

The other issue that has also been touched on is that you need clear visibility as to what your modelling is to your end-consumer. And that is something people are quite happy with what the arrangements are at the moment, whatever they may be. And that is not going to change. And so I think there’s absolutely no interest or momentum at the moment.

There was a consultant’s report issued not very long ago that was bemoaning the fact that the IPP market was tying up effectively the whole of the electricity market and it wouldn’t even be feasible until an interesting bit of analysis on the grounds of how much procurers would have to pay to buy back the projects in order to launch a merchant scheme, well I’m not going to be the adviser who goes in and recommends to my clients that they should consider buying back projects on a project that is running perfectly successfully. So I don’t see the model changing in the near future.

Gijs Olbrechts: If you compare the merits of the EPC model with the IPP model for GCC governments: they don’t need our equity, debt raising or management capability. Their most important concern is to add the required capacity on time, because power and water are so essential for the population and the GCC countries are experiencing sizeable growth in demand for power and water.

IPP models have a better track record than EPC models regarding the timely delivery of the capacity. In addition, international players will also bring best practice standards regarding the availability, environmental awareness, reliability and efficiency. We see nowadays more governments stepping over to the IPP model, with Kuwait and Dubai tendering their first IPPs.

Harold Fairfull: I think the track record of procurement in the GCC region over the last decade has been highly successful. It’s certainly met the requirements of the procurers and it’s generated substantial interest from a wide range of bidders and institutions.
And I think the events of 2008/2009 when a number of projects were successfully financially closed in the midst of the finance crisis was a very big vindication of the fact that there is a loss of encouragement about the entire procurement process in the market.

I think going forward each of the procurers needs to think very carefully about its financial requirements for bids in the future projects.Clearly, if you’re asking for the same project to be underwritten seven times over, you’re taking a huge amount of the market and if, as Duncan has said, he gets approached by seven bidders for each deal, the likely requirement, the likely outcome of that is simply that every bidder is going to have substantially the same finance terms. If we get into that sort of circumstance the procurers would need to ask themselves is that a sensible way to go because effectively they could do the portfolio exercise.

Duncan Allison: Just to support briefly what Harold says, it is a major resourcing issue, one of our strategies could be to support no one. It’s also a relationship issue.

Pascal Martese: I think everyone will agree that the long-term procurement model has largely been successful and the reason is what eventually the procurers are outsourcing, they haven’t go many components - construction contracts, operational maintenance of the assets, liquidity funding and debt funding.

I think there’s no doubt that setting the minimum function of specification is to develop free and to the sponsors to optimise the technical design of the projects and deliver what is going to generate the lowest economic cost and also being obviously responsible and liable for the long-term operation and maintenance of the assets.

These two components, I think, are priced competitively and so is equity. Now there is a debate as to whether or not you are happy with the cost of debt financing, which is coming because of the lack of liquidity, and Qatar has taken a decision to take that risk and that execution on themselves.

There may be middle grounds and the way procurers are setting the bank exclusivity rules is one of them. And I’m sure there’s going to be more evolution on that front. But the global framework of procuring equity, construction and O&M through private sponsors, you’ll probably get public partnership, because again in all these jurisdictions, the government takes the majority of the equity, is here to stay.