Financing power projects in Bangladesh
Monday, 19 April 2010
Mamun Rashid
THE current regime has highlighted development of power, and broadly infrastructure sectors, as one of its first and foremost objectives. This is an important area of the economy where investments remain below the potentials because investors, both local and foreign, were constrained by high level of corruption in the past. However the IPP (Independent Power Plant) story in Bangladesh has been so far very good for more than 10 years now without any dispute between the Government and the IPPs, giving us tremendous hope that we can do even better in the days to come.
Government and international agencies have put power sector high in their development agenda. Although the generation and distribution of electricity are currently dominated by public sector institutions, more private initiatives in the form of Independent Power Plants (IPPs), Small Power Plants (SPPs), and Rental Power Plants (RPPs) are catching up. Power system development plan till 2020 has been put in place by the government. Bangladesh has developed a robust IPP model, which has been proven successful.
There are various factors which are taken into account by financiers of power projects in Bangladesh.
Size: Size is an important determinant in attracting foreign lenders/investors. Banks and investors will be looking to participate in larger transactions in order to justify the time and effort required for due diligence and other tasks.
Off taker: Off taker or buyer is a primary concern for lender's credit committees. A project may have strategic and economic importance but financiers may not be comfortable with the off taker and remedies if the off taker fails to meet its obligations. Government guarantees may be required. Lenders will require any currency mismatch to be hedged, since large projects will require off shore financing. The off taker risk is the most important risk that the financiers need to justify after intense due diligence. This becomes even more important when the Government is trying to kick start the new generation activities in the country. For example, in Bangladesh, Bangladesh Power Development Board (BPDB) is the main off taker and they have been buying power from all the IPPs. To ensure that BPDB remain a credible off taker, the financials of BPDB need to be strengthened to give comfort that they will be able to pay for the electricity over a longer horizon of the Power Purchase Agreement (PPA) on a commercially sustainable basis. If required, raising tariff rates at end-consumption level has to be considered even if it is politically sensitive.
Fuel: Lenders will prefer to see long term supply agreements for the tenor of the debt from credit-worthy suppliers and may require hedging to reduce/eliminate price risk. The availability of gas and speed of exploration need to be looked at, apart from exploring other credible alternative fuel sources to ensure sustainable supply of fuel to the generation companies. Not much concrete progress has been made with coal and its associated policies. There are environmentally acceptable ways to extract and use coals which should be considered.
Transmission and distribution: The transmission and distribution capacity is an important element to be taken into consideration, as financiers view this as project-on-project risk; however Bangladesh seems to have made some progress on the distribution front already.
Sponsor: Strong sponsors with successful track record can mitigate a number of the risks, particularly completion risks if they provide such guarantee.
Construction: The experience and cost advantage of EPC firm in the related industry, the country and with specific assets is important as financiers will carefully analyse these aspects too.
Political risk: Lenders will look at the track record of government interference in the power sector, the ability of the government to affect pricing (including passing on increased fuel costs), and the ability of a government to enforce contracts in politically difficult situations. Most of these risks can be mitigated by ECA/multilateral involvement.
It is noteworthy that the existing IPPs in Bangladesh qualified the tough screening of investors and lenders, and are successfully operating. This should work as instance for successive implementation of future projects. Also, Bangladesh now has Sovereign Rating of BB-/B (long term/short term) with a Stable outlook from S&P's. This should improve Bangladesh's position in OECD ranking from six to at least five, thereby facilitating cheaper cost financing from Export Credit Agencies. The Government should push for this.
As for financing power projects, there are several alternatives and each of them has their own advantages and disadvantages:
Bank: Syndicated project finance bank facility to provide LIBOR based financing
Multilaterals/ Bilateral/ Export Credit Agency Financings: Provide cheaper financing option for development projects with well structured transactions.
Mezzanine Debt: Private investor market; no registration or public filing required.
Private Placement: Long-term unregistered fixed rate debt.
Secured Institutional Term Loan: Syndicated bank facility to provide fully drawn, longer term, LIBOR based financing with high yield-type tenor and amortisation.
Rule 144A Offering: Purchase of an issue of unregistered securities on firm commitment basis by an investment bank with subsequent resale to qualified institutional buyers.
Although larger power projects are primarily under focus, Bangladesh has shown success in implementing SPPs and RPPs. Given the type of contracts these projects have with off takers, it would be more appropriate to explore avenues such as - sponsors equity, preference shares, convertible bonds, syndicated term loan and non-convertible bond - all in local currency if there is no foreign currency risk hedging in the PPA. The Bangladesh Bank may be able to provide funding through commercial banks and offer refinancing to banks for lending to power projects.
Private equity firms also invest in power projects. Power sector in Asia continues to be a target for global and regional investors; however, equity investors are generally motivated by the GDP growth prospects, government stability, transparency of pricing regime, and credit quality of major off taker. In the present global financial scenario, Bangladesh should also look to the Middle East and Asia to tap Islamic liquidity pool for financing power/ infrastructure projects. Local capital markets can also channel domestic liquidity to an extent if the transaction is structured properly. Just to highlight, recently Citi raised US$102 million through privately placed Bonds for Orascom - a mobile telecom company in Bangladesh. Raising larger amounts should also be possible.
Power is an acute problem now and it creates obstruction in the whole growth generating process. In a country like Bangladesh, ensuring transparency, execution support capability and corporate governance can do miracle in terms of bringing back investors focus and successful implementation of power projects. To conclude, if we can synchronise the critical elements around a project, then funds are there to make it happen.
(The writer is the Citi Country Officer, Bangladesh. This article is an excerpt from of a keynote paper presented at a recent ICC Bangladesh seminar on `Energy for Growth'. The writer can be reached at e-mail: mamun.rashid@citi.com)
THE current regime has highlighted development of power, and broadly infrastructure sectors, as one of its first and foremost objectives. This is an important area of the economy where investments remain below the potentials because investors, both local and foreign, were constrained by high level of corruption in the past. However the IPP (Independent Power Plant) story in Bangladesh has been so far very good for more than 10 years now without any dispute between the Government and the IPPs, giving us tremendous hope that we can do even better in the days to come.
Government and international agencies have put power sector high in their development agenda. Although the generation and distribution of electricity are currently dominated by public sector institutions, more private initiatives in the form of Independent Power Plants (IPPs), Small Power Plants (SPPs), and Rental Power Plants (RPPs) are catching up. Power system development plan till 2020 has been put in place by the government. Bangladesh has developed a robust IPP model, which has been proven successful.
There are various factors which are taken into account by financiers of power projects in Bangladesh.
Size: Size is an important determinant in attracting foreign lenders/investors. Banks and investors will be looking to participate in larger transactions in order to justify the time and effort required for due diligence and other tasks.
Off taker: Off taker or buyer is a primary concern for lender's credit committees. A project may have strategic and economic importance but financiers may not be comfortable with the off taker and remedies if the off taker fails to meet its obligations. Government guarantees may be required. Lenders will require any currency mismatch to be hedged, since large projects will require off shore financing. The off taker risk is the most important risk that the financiers need to justify after intense due diligence. This becomes even more important when the Government is trying to kick start the new generation activities in the country. For example, in Bangladesh, Bangladesh Power Development Board (BPDB) is the main off taker and they have been buying power from all the IPPs. To ensure that BPDB remain a credible off taker, the financials of BPDB need to be strengthened to give comfort that they will be able to pay for the electricity over a longer horizon of the Power Purchase Agreement (PPA) on a commercially sustainable basis. If required, raising tariff rates at end-consumption level has to be considered even if it is politically sensitive.
Fuel: Lenders will prefer to see long term supply agreements for the tenor of the debt from credit-worthy suppliers and may require hedging to reduce/eliminate price risk. The availability of gas and speed of exploration need to be looked at, apart from exploring other credible alternative fuel sources to ensure sustainable supply of fuel to the generation companies. Not much concrete progress has been made with coal and its associated policies. There are environmentally acceptable ways to extract and use coals which should be considered.
Transmission and distribution: The transmission and distribution capacity is an important element to be taken into consideration, as financiers view this as project-on-project risk; however Bangladesh seems to have made some progress on the distribution front already.
Sponsor: Strong sponsors with successful track record can mitigate a number of the risks, particularly completion risks if they provide such guarantee.
Construction: The experience and cost advantage of EPC firm in the related industry, the country and with specific assets is important as financiers will carefully analyse these aspects too.
Political risk: Lenders will look at the track record of government interference in the power sector, the ability of the government to affect pricing (including passing on increased fuel costs), and the ability of a government to enforce contracts in politically difficult situations. Most of these risks can be mitigated by ECA/multilateral involvement.
It is noteworthy that the existing IPPs in Bangladesh qualified the tough screening of investors and lenders, and are successfully operating. This should work as instance for successive implementation of future projects. Also, Bangladesh now has Sovereign Rating of BB-/B (long term/short term) with a Stable outlook from S&P's. This should improve Bangladesh's position in OECD ranking from six to at least five, thereby facilitating cheaper cost financing from Export Credit Agencies. The Government should push for this.
As for financing power projects, there are several alternatives and each of them has their own advantages and disadvantages:
Bank: Syndicated project finance bank facility to provide LIBOR based financing
| Benefits | Challenges |
| = Can incorporate revolving feature= Least expensive form of construction financing via most efficient draws= Flexible amortisation= Private transactions - no rating required | = Limitations on senior secured leverage= Tighter maintenance covenants= Consolidation among lenders= Requires collateral= Depth of the market for Bangladesh risk |
| Benefits | Challenges |
| = Long tenors and very attractive pricing= No rating required= Strong appetite for well structured development transactions | = Require adherence to strict environmental guidelines= Risk appetite limit to small portion of overall debt= Due diligence is lengthily= Financing will depend on goods source from host country |
| Benefits | Challenges |
| = Likely to allow greatest financial flexibility= Maximizes debt capacity= Ability to significantly tailor structure | = Significantly more expensive than other debt financing alternatives= May require some form of equity participation |
Private Placement: Long-term unregistered fixed rate debt.
| Benefits | Challenges |
| = Tailored structure and covenants= Favourable tenor and amortisation= Moderate cost= Avoid rating process= Sensitive information not widely disseminated= Delayed draw down possible | = Tighter covenants than public style debt= Liquidity limited by regulation= Limited market for non-investment grade issuers |
| Benefits | Challenges |
| = Minimal annual amortisation, back-ended in last year= More investor appetite= Can be combined with a project finance revolver | = Pari passu with pro rata on ranking, security and covenants= Requires rating= Requires collateral |
Rule 144A Offering: Purchase of an issue of unregistered securities on firm commitment basis by an investment bank with subsequent resale to qualified institutional buyers.
| Benefits | Challenges |
| = Lower cost long term funding= Broader investor market and greater name recognition than traditional private deal= Can be fixed or floating rate interest = Subordinated debt possible | = Substantial disclosure requirements in Offering Circular= Less flexibility in covenants due to standardisation of terms= Public reporting requirements |
Although larger power projects are primarily under focus, Bangladesh has shown success in implementing SPPs and RPPs. Given the type of contracts these projects have with off takers, it would be more appropriate to explore avenues such as - sponsors equity, preference shares, convertible bonds, syndicated term loan and non-convertible bond - all in local currency if there is no foreign currency risk hedging in the PPA. The Bangladesh Bank may be able to provide funding through commercial banks and offer refinancing to banks for lending to power projects.
Private equity firms also invest in power projects. Power sector in Asia continues to be a target for global and regional investors; however, equity investors are generally motivated by the GDP growth prospects, government stability, transparency of pricing regime, and credit quality of major off taker. In the present global financial scenario, Bangladesh should also look to the Middle East and Asia to tap Islamic liquidity pool for financing power/ infrastructure projects. Local capital markets can also channel domestic liquidity to an extent if the transaction is structured properly. Just to highlight, recently Citi raised US$102 million through privately placed Bonds for Orascom - a mobile telecom company in Bangladesh. Raising larger amounts should also be possible.
Power is an acute problem now and it creates obstruction in the whole growth generating process. In a country like Bangladesh, ensuring transparency, execution support capability and corporate governance can do miracle in terms of bringing back investors focus and successful implementation of power projects. To conclude, if we can synchronise the critical elements around a project, then funds are there to make it happen.
(The writer is the Citi Country Officer, Bangladesh. This article is an excerpt from of a keynote paper presented at a recent ICC Bangladesh seminar on `Energy for Growth'. The writer can be reached at e-mail: mamun.rashid@citi.com)