An industry on fast forward

Global Finance, Dec 1997/Jan 1998 by McGoldrick, Beth

Economic growth, exuberant equity markets, and privatizations in key regions throughout the world have switched on the global power industry. Its new players, increasingly sophisticated investors, and new financings are surging ahead, despite recent market setbacks.

The global power industry is finally coming into its own. After years of struggling to develop a paradigm for limited recourse and nonrecourse power projects around the world, developers and bankers are beginning to see the fruits of their labors. Economic growth, the boom in worldwide equity markets, and continuing privatization efforts in Asia, Latin America, and Europe are drivers for strong, sustained activity in the power sector. Many analysts expect the pace to continue for several years, despite events such as Southeast Asia's recent currency crisis.

Several themes mark the industry right now. True independent power projects-selling power into a grid at market prices-are now beginning to be seen outside of developing countries. Investors' sophistication is growing. Banks are increasingly willing to take on political risk in projects, for example, and the project bond business has strengthened. As power producers seek the right competitive mix of generation, transmission, and distribution assets, mergers and acquisitions are expected to continue apace. The deregulation of the US power market will spawn even more consolidation among US utilities, while crossborder mergers are a strong trend as well. "Clearly, the globalization of the power industry will continue to be a dominant theme," says Robert Gillham, managing director, Chase Securities. "We may see interruptions from time to time, but they will be due to market forces, not the economics of the power business."

The pace will not be slow and deliberate. "If anything, power is stuck on fast-forward," says John Hushon, president of El Paso Energy International. "One thing we're seeing is that the total number of projects being made available through privatization or greenfield development is so great, and the time period available to develop bids is so compressed, that we are unable to line up partners and finance in advance," he says. As a result, his company has placed bids on massive deals-even relying on its own balance sheet to back them up-and has gone out to find equity partners only after winning a mandate. El Paso was able to line up the arrangements in advance for the 1996 Samalayuca power plant deal in northern Mexico.

Attempts to quantify demand for global power inevitably produce numbers so huge that their precision may not actually matter. "After you get to $3 trillion," asks Hushon rhetorically, "does it really matter if it's really $3.5 trillion?" The International Monetary Fund has estimated that Asia alone, excluding Japan, has a $3 trillion demand for new infrastructureincluding power projects-over the next decade. For power, specifically, the World Bank suggests that between 1994 and 2005, requirements for China, Indonesia, Malaysia, the Philippines, Korea, Taiwan, and Thailand stand between $531.3 billion and $708.1 billion. For the years 2006 through 2010, the need will be an additional $392.5-$537.3 billion.

Fortunately, investors are willing to step up, as the rapid growth of the project bond business attests. The volume of rated deals for power projects this year will exceed that of 1996. "We believe this will be a continuing and growing financial source for projects," says Christopher Beale, global head of project finance at Citibank. Deals will go straight to the bond market for financing rather than relying on the capital markets to take out bank debt. Quezon in the Philippines, for example, is the first SEC-registered bond for an emerging market project, and its 20-year maturity is the longest. Quezon's sponsors are Intergen and Ogden, both USbased.

In the syndi- cated loan arena, "Until the Asian financial crisis, we saw extraordinary liquidity in the marketplace for projects," says Beale. "Indeed, there have been large numbers of banks chasing projects, resulting in some banks making large underwriting commitments at tighter corporate spreads rather than at project spreads." The result he explains is that some banks got stuck with overly aggressive bids which have been difficult to syndicate. Beale says he is seeing perhaps one in 10 deals where the syndication has gone slowly and the underwriting was not sold down. The reason, he says, is the pricing and terms. "Sponsors have been taking the lowest offer, and then the lead arranger can't get the banks in," he says.

Banks are also increasingly willing to take on political risk in power projects as well. Adebayo Ogunlesi, managing director with Credit Suisse First Boston, notes that six months ago in Venezuela, for example, political risk insurance was a project requirement. Yet last summer the Petrozuata project went out 14 years on the $450 million bank portion of its $1.45 billion project financing, uncovered by political risk insurance, largely due to its export receivables. Citibank's Beale also notes there have been uncovered financings in Argentina as well. "In other countries, such as Turkey, the involvement of export credit agencies remains necessary," he says.