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Financing agreements were recently signed for the US$1.582bn 1,070MW Nam Theun 2 hydroelectric power project in Laos, the largest cross-border power scheme in Asia and the largest privately financed hydropower scheme in the world.
This article, divided into two parts, provides some insight into development of the project, describes the role of the supporting institutions and outlines the structure on which the financing was banked. Part 1 is co-authored by Stv©phane Lebeau of EDF, Ian Mathews of ANZ Investment Bank (financial adviser), and Sam Bonifant and Russell Wells of Clifford Chance (legal adviser to NTPC). It covers project inception and the beginning of the financing phase, and addresses some key challenges and issues faced by the developers. Part 2 is co-authored by Christopher Thieme of BNP Paribas (documentation bank and intercreditor agent) and Thomas Brown and Roger Lui of Allen & Overy (legal counsel to the lenders). It describes the financing structure and some challenges faced in the financing phase, and how resolution was reached.
The Nam Theun 2 (NT2) hydroelectric power project is a major milestone in the economic development of Laos, as the total cost of the project is equivalent to more than 85% of the country's annual gross domestic product. It will be the largest economic asset and the largest foreign exchange earner in the country, as well as the largest single contributor to the government's budget.
Under the terms of a revenue-management programme to be implemented by the Laos government and under the supervision of the World Bank and the Asian Development Bank (ADB), the US$2bn of revenues expected over the operating period will be used to reduce poverty and assist development in Laos. A robust environmental and social impact safeguards programme has also been designed in conjunction with several of the participating financial institutions and will be fully funded as part of the project's budget.
The project comprises the development by project company Nam Theun 2 Power Co (NTPC) of a 1,070MW trans-basin hydroelectric power plant. Of this, 995MW of generating capacity and electrical energy will be sold to the Electricity Generating Authority of Thailand (EGAT) under a take-or-pay power purchase agreement. A further 75MW will be sold to Electricitv© du Laos (EdL) on the same basis.
NTPC is a limited liability company owned 35% by EDF International (a wholly owned subsidiary of Electricitv© de France), 25% by Electricity Generating Public Company (EGCO), 15% by Italian-Thai Development PCL (ITD), and 25% by Lao Holding State Enterprise (LHSE), a special purpose company wholly owned by the Lao Ministry of Finance.
Part 1 - From inception to financing
The potential for a hydroelectric power project on the Nam Theun river was first identified in the mid-1970s and was the subject of detailed feasibility studies during the following decades. However, it was not until 1994, with the introduction of sponsors EDF and ITD and the invitation to the World Bank to participate in the project, that it moved from a concept to the development phase.
The project's development since the mid-1990s has mirrored, in many aspects, the changes in structuring project-financed deals. Today's project financiers would view as anachronistic an information memorandum summarising agreements with no detailed political risk mitigation, depicting the currency risk as limited to the historical value of exchange rates or including a limited environmental assessment and management plan, yet this was the case pre-Asian crisis.
A temporary delay caused by the Asian crisis allowed the sponsors (which by 2000 also included EGCO) to revisit a number of aspects of the project to reduce risks and to develop a structure more suited to the prevailing reduced risk appetite of commercial lenders to projects in emerging markets.
Structuring the project. In order to ensure the successful financing of the project, it was necessary to address several critical aspects of the structure in parallel. A number of these overlapped to lay the foundations for the financial structure.
Political risk mitigation, overcoming the challenges of a cross-border deal and an undeveloped regulatory framework. Several factors, including the need to raise a large sum of limited recourse debt financing in a country eligible for debt relief under the HIPC Initiative, the significant size of NT2 when compared with the overall Lao economy, the low level of Lao's foreign exchange reserves, and the cross-border nature of the transaction, all meant that comprehensive political risk mitigation was critical for the successful financing of the project.
The contractual structure was developed to ensure that Thai political risks were satisfactorily addressed under the EGAT PPA in accordance with the framework established by the Thai IPP financings, and the Lao political risks were allocated to the Government of Laos (GOL) under the Concession Agreement (CA) consistent with precedents developed in the past for other projects in emerging markets.
Notwithstanding this, the risk allocation could not be structured in this cross-border deal in the same way as conventional IPP practice as neither the GOL nor EGAT was ready to bear risks across the Mekong River. In particular, EGAT would not assume the consequences of force majeure occurring in Laos, nor would the GOL provide cover in respect of Thai force majeure. Also, there remained potential competing claims between EGAT and the GOL (such as with acquisition rights/obligations arising post-termination), which needed to be resolved through a direct agreement between those two parties.
Similarly, at the start of the CA negotiations, NTPC and its advisers concluded that the legal framework in Laos was not sufficiently developed in a number of areas. A comprehensive strategy was implemented to compensate for the uncertainties of Lao law, with NTPC gaining clarifications under the CA from some contradictory existing laws, the CA being approved by the Lao National Assembly (the highest law-making body in Laos), and the GOL addressing and implementing new laws and agreeing to provide specific approvals where needed.
A third mitigation was the inclusion of the World Bank, ADB, EIB, Nordic Investment Bank, European Development Finance Institutions and Export Credit Agencies in the financing structure. The involvement of these institutions, which provided a combination of both debt and equity-related financing, was viewed as a key risk mitigation factor as these ongoing relationships are essential to the GOL's ambitions for continued economic development and future inflows of assistance from these donors.
In addition, these institutions would ensure, through on-going monitoring, that the revenue-management programme, a condition to the involvement of international financial institutions, would be properly implemented, and that the royalty, tax and dividend revenues to be received by the GOL would be channelled to fund social and economic development. Comfort was further derived from the GOL being a 25% shareholder within the project, as this significant ownership interest would ensure a fair and equitable participation by the GOL in this key national development project.
In respect of potential Thai political risks, the highly attractive 2009 tariff of approximately US$0.04/kWh meant that EGAT would enjoy sustained economic advantages from the PPA, thus reducing the risks of breach of contract. Comfort was also drawn from the unbroken 30-year history of cross-border sales between Laos and Thailand, and the memorandum of understanding on electricity exchanges between the two countries. The involvement of all the major Thai commercial banks and Thai-Exim added a further level of reassurance to the non-Thai parties.
As such, it became increasingly evident during the project's development that the single greatest risk mitigant was the project itself, as it was not in the interests of any party to do anything to prejudice a project that was both a supplier of cheap electricity to EGAT and a significant source of revenues for the GOL.
Limiting foreign exchange risk, a lesson from the Asian crisis. Structuring the currency profile of the funding to match that of the project costs (pre-completion) and revenues (post-completion) mitigated currency risk and provided a natural hedge against the tariff structure. This required that the underlying long-term debt structure be denominated half in baht and meant that financing of approximately Bt20bn would need to be raised from Thai commercial lenders, a level significantly higher than for any other Lao project, and one that raised a number of key challenges.
Environmental and social impact mitigation, harmonising the requirements of the multiple private and public sector participants. From the earliest stage of development, the sponsors were keenly aware of the requirement to establish the highest standards for the mitigation of environmental and social impacts while conforming to the requirements of a project-financed deal and the accessible skills of developers in the energy sector. The involvement of the World Bank (since 1994), the ADB and the EIB since 2002, the European DFIs, ECAs and the commercial banks meant that the project was required to meet an unparalleled number of institutional requirements and international guidelines.
The environmental and social mitigation obligations of both NTPC and the GOL were developed in conjunction with the IFIs, transparent public consultation, and domestic and international stakeholder workshops through the three main safeguard documents, the Environmental Assessment and Management Plan, the Social Development Plan, and the Social and Environmental Management Framework and First Operation Plan.
These are enshrined within the CA, which also provides for the financial backing of NTPC's environmental and social obligations through the provision of letters of credit. These obligations are significant as the project is contractually committed to spend in excess of US$100m in mitigating environmental and social impacts during the construction period (including US$60m on technical design modifications developed from discussions with affected parties), and is committed to spend a further US$60m on livelihood improvement, watershed management protection and related costs during the remainder of the concession.
GOL equity funding, raising in excess of US$100m for a government with no history of commercial indebtedness. As the US$112.5m equity requirement of the GOL was substantially in excess of its own resources, the raising of these funds had to be addressed in a manner that would dovetail with the proposed senior debt financing while meeting various eligibility constraints and disbursement requirements of the funding providers.
NTPC and the GOL were successful in identifying and raising a combination of loans and grants from the ADB, AFD, EIB and the World Bank. This involved providing comfort to the equity funders that the GOL would not later seek to exercise its rights to debt relief under the HIPC Initiative, providing comfort to the GOL that the costs of its loans could be capitalised within its available funding commitments on a stand-alone basis, and providing comfort to the senior lenders that the funds would be made available when required by structuring the equity facilities to ensure that the disbursement by the IFIs was either directly to NTPC or to bank accounts under the control of NTPC.
Construction contractual structure. Unlike a conventional project financing, the construction activities are spread over an area of more than 450 sq km and involve a diverse range of activities, including significant civil and underground works. While EDF as the head contractor has overall single-point responsibility for the works, the construction was packaged into five principal sub-contracts, each structured as a mini EPC contract and each focused on a discrete area of activity.
This structure allowed NTPC much greater control over the appointment of the key sub-contractors and also permitted it to ensure the required alignment of the currencies of project costs and funding. Three civil works sub-contracts were largely denominated in baht and the two electro-mechanical sub-contracts were largely denominated in US dollars. The selection of a consortium led by GE Norway for the main electro-mechanical sub-contract brought Nordic Investment Bank and three ECAs (including Coface, which was also supporting the project management role of EDF) into the transaction.
Hydroelectricity, taking lenders through the learning curve. While lenders are familiar with the risks associated with thermal IPPs, one challenge was to make many financing institutions comfortable with the technical features of a hydroelectric project, including substantial civil works and underground structures, as well as understanding hydrological patterns from rainfall assessment to reservoir storage, conversion to kWh and ultimately revenue generation.
This involved the lenders understanding that the EGAT PPA was structured on the basis of an appropriate mitigation of the hydrological risk, including a mechanism in the PPA that both separated EGAT's energy purchase obligations from its energy payment obligations and incorporated a split tariff structure. This unique and complex structure, together with the large storage capability of the reservoir, gives NTPC the maximum opportunity to stabilise its revenues and significantly reduce its (and the lenders') exposure to any variations in hydrological conditions.
Multilateral involvement. As the project developed, it became increasingly evident that the multilateral agencies (MLAs) would be of critical importance in successfully financing the project, as:
- Their involvement would mean that both NTPC and the GOL would be required to adhere to the environmental and social standards required by these institutions;
- Their involvement would support the funding of the GOL's equity requirement;
- Their involvement would provide significant political support for the project;
- The provision of political risk guarantees for Laos (and, in the case of the ADB and MIGA, Thailand and Laos) would provide strong political risk mitigation for international commercial lenders;
- The provision of direct lending would assist in obtaining tenors from the commercial banks beyond those historically seen in comparable markets; and
- The overall provision of a significant funding obligation across both debt and equity would mobilise other sources of finance.
The US$305m aggregate participation of the MLAs was critical, since without the MLAs, the European DFIs and ECAs would not have participated; without the MLAs and the ECAs, the international commercial lenders would not have been able to accept the Lao political risks; and without the international lenders, the Thai commercial banks would not have been willing to provide debt finance.
Therefore, there was the need to incorporate the requirements of the MLAs within the overall project framework such that NTPC was not burdened with the wider obligations that the MLAs required of the GOL. The key was for NTPC to manage the expectations and requirements of the MLAs such that its obligations were limited to those activities it was responsible for. By doing this, it was possible to implement a commercially viable transaction within both a comprehensive environmental and social structure and a long-term development framework.
This structure, with the MLAs, ECAs and European DFIs underpinning the financing plan, was the basis upon which NTPC and the sponsors invited commercial banks to bid in November 2003. While the financing plan did evolve over the intervening period to financial close (as outlined below), the final debt package bore a very strong resemblance to that proposed to the commercial lenders in 2003, clearly evidencing that the MLA-led option was the most appropriate and, quite possibly, the only viable structure for the financing of the project.
Part 2 - Financing phase
The financing was complex, innovative and ambitious, and most of the many solutions pioneered in this financing are expected to establish NT2 as a valued model of project finance for public-private partnerships. It is one of the most complex limited recourse financings closed in Asia in many years.
It included senior debt facilities of US$1.132bn equivalent, denominated in Thai baht and US dollars, and shareholder equity commitments of US$450m. Twenty-seven financial institutions participated in the financing, including the World Bank, Asian Development Bank (ADB), European Investment Bank (EIB), MIGA, Nordic Investment Bank, Coface, EKN, GIEK, Agence Franvßaise de Dv©veloppement (AFD), Proparco, Thai-Exim and sixteen Thai and international commercial banks.
Lenders' response to the IM. The project, as presented in the information memorandum provided to the lenders selected for the financing, benefited from several salient features that underlie its economic and structural soundness.
- History of commercial financing in Laos - NT2 is the fourth hydropower project located in Laos that sells substantially all of its availability to EGAT in Thailand. The earlier developments were more modest in scale - with about 500MW in combined capacity - but had established the viability of such hydropower developments in Laos.
- Importance of the project to Laos - The project is of immense importance to the economic development plans of Laos and will be a milestone in the economic history of the country. Laos has a predominately impoverished rural population with few natural resources other than the hydropower potential of its rivers.
- Financial benefits to Laos - The financial benefits for Laos are substantial and well distributed over the project life. The GOL will collect up to US$2bn in taxes, royalties and dividend income from the project over the 25-year concession period. The project assets will then be transferred to the GOL at no cost and with an estimated working life of at least a further 25 years.
- High value project for Thailand - NT2 is positioned at the top of the merit order within the Thai electricity system, delivering the lowest cost per kilowatt based on a high quality hydropower site and the absence of direct fuel costs.
- Alignment of interests of parties as a risk mitigant - A substantial source of overall risk mitigation is the basic alignment of interests of the parties involved, with the undisturbed continuity of NTPC and its contractual framework the ultimate source of protection that Lao sovereign events will not arise as an issue for the project.
- Technical/construction - Detailed financial and technical analysis was performed, aimed at a robust mitigation package for cost overrun risks. A large number of scenarios were modelled, with a sizeable number of constraints on debt financing needing to be factored, such as eligibility issues in relation to ECA and multilateral facilities; intercreditor issues in relation to equitable sharing of funding commitments; and general commercial constraints such as availability end-dates and an end-date for the first principal repayment.
- Nature risk - For a hydropower plant, risks include hydrology, geological conditions, seismic conditions, sedimentation in the reservoir and flooding. Lenders relied on historical and technical data, which evidenced that the site was excellent for hydropower development.
- Force majeure treatment, contractual tensions - The existing concession agreement and the EGAT PPA were evidence of a project in which participants have spent years analysing and providing remedies or mitigants for potential risks. The due diligence led to a positive conclusion that, to a very large extent, risks had been allocated equitably between the various parties to the project. There were, however, some tensions between the concession agreement and the EGAT PPA, resulting in NTPC bearing exposure to some force majeure events of a political nature that would ordinarily be mitigated by political risk cover. Protracted negotiations were conducted on all fronts, with interfaces among the competing interests of the GOL, EGAT, the political risk cover providers and the delay liquidated damages bonding providers (which, in turn, gave rise to complex intercreditor issues), and were satisfactorily resolved.
Key features of the financial package - The financial package presented by the sponsors at the inception of the financing phase evidenced a mature and well-considered structure that bore a remarkable resemblance to finance documents signed less than 15 months after the release of the initial term sheet. This section highlights some of the key features of the financing.
- Currency risks - The sponsors had structured the financing programme so as to provide for a natural hedge during construction and operation, thus mitigating foreign exchange risk during operation, with the higher level of US dollars required during construction being funded by equity in US dollars. This structure was embraced by the lenders as a well-considered solution.
- Back-ended equity and rebalancing - One of the touchstones of the financing structure is the back-ending of equity. Through the use of stand-by letters of credit to support equity commitment; the accounting recognition of the substantial development costs incurred by the sponsors as equity; the front-ended provisions of equity by LHSE; strict contractual obligations to inject equity commitment prior to project completion; and the application of back-ended equity towards rebalancing debt drawn up-front, the lenders and sponsors have been able to settle on a back-ended equity structure that provides for attractive economics for the sponsors without exposing the lenders to equity risk, while at the same time addressing the limitations given rise by the eligibility constraints under several of the term loan facilities.
- Eligibility constraints - Several of the multilateral institutions and the export credit agencies impose eligibility constraints on the application of the loans provided or supported by them, as is customary in transactions of this nature. As a result, the application of sources of funding towards specific uses has an element of prescription, but which is aided by structures whereby untied sources of funding such as equity, insurance proceeds and liquidated damages may be applied when ineligibility arises. This tool is valuable, in particular, in the application of contingency funding, where the uses (and hence the eligibility of funding towards such uses) cannot be predicted.
- PRGs and ECAs - The cross-border nature of the transaction required political risk mitigation for both Thailand and Laos and saw the pioneering use of dual-country PRGs within Asia by both the ADB and MIGA. The three ECAs were packaged under a reinsurance scheme, with Coface acting as the lead ECA to front the insurance and EKN and GIEK providing reinsurance to Coface. The pragmatism and flexibility of the ECAs towards the risk mitigation structure of the project played a sizeable role in ensuring a timely financial close.
- Environmental and social aspects. As mentioned in Part I, the international community has been observing the development of NT2 with keen interest from an environmental and social point of view. The alignment of the various stakeholders' interests featured prominently in the financing process. The World Bank conducted a series of stakeholders' workshops around the world in the earlier part of 2004, after which the interested finance parties began discussions with NTPC and the GOL to incorporate their particular requirements. These requirements range from institutional guidelines of the multilaterals, bilaterals and export credit agencies, to requirements of the commercial lenders including those that are signatories to the Equator Principles, to views solicited from the other stakeholders.
The resulting environmental and social regime, derived primarily from the EAMP, SDP and SEMFOP referred to in Part 1, incorporates the views of the interested finance parties. From the CA, a project implementation plan was also developed to provide operational guidance on how NTPC is to implement its obligations. Annual implementation plans will be derived from this for each year of construction and operation. Central to the regime is an independent and private monitor in the form of the lenders' technical adviser, PB Power, in addition to the independent experts and monitors put in place under the CA. The lenders' technical adviser, whose scope of work has been meticulously discussed and agreed, will report periodically to the interested finance parties.
Intercreditor solutions. Although intercreditor issues arising from mixed-currency financings, co-financings between multilaterals, export credit agencies and commercial lenders and mixed long-term/short-term financings have all been dealt with by the seasoned financiers, the resolution of such complexities owes much to the professionalism of the institutions involved.
With total capital commitments of US$1.58bn, NTPC is the largest internationally financed IPP in South-East Asia since 1997, the largest ever private-sector hydropower project financing, the largest ever private-sector cross-border power project, and the most diverse project financing - when measured by the number of institutions and the range of participants - closed in Asia for many years. Due to the unique nature of the project, the financing was challenging, complex and ambitious yet was completed within 15 months of the release of the initial term sheet. There is little doubt that many of the solutions pioneered in this unique financing will establish NT2 as a valued model of project finance for years to come.