The Geneva summit between Ronald Reagan and Mikhail Gorbachev signaled the beginning of the end of the Cold War. With a diminished threat of East-West confrontation, countries throughout the world gradually reoriented their priorities (em away from politico-military security and toward economic development. To paraphrase Woodrow Wilson, the end of the Cold War had made the world "safe for capitalism."Now, 10 years later, with a few notable exceptions in the Balkans and elsewhere, evidence abounds to support that appraisal, from Argentina to Prague to Manila. And in no industrial sector is this new "liberation theology" more evident than in infrastructure development (em especially power generation.
In Asia for example, more power has been generated and consumed in the past five years than in the previous 15. Still, as power developers from Bombay to Budapest to Beijing will attest, the introduction of free-market principles in the power sectors of the world remains more a goal than a reality. The learning curve is steep (em both for governments and independent power (IPP) developers (em and success by no means assured. In this article I will try (em as one who entered this fray as a developer seven years ago (em to assess the future of the global IPP market, comment on the factors that account for the success of a few IPP developers and the failure of others, and identify countries with sensible policies that equitably share risks and rewards with investors, and thus present the most attractive climate for independent power projects in the years ahead.
Good Corporate CitizenshipIn a perfect world, governments would liberalize their energy sectors on purely intellectual grounds (em because it makes sense to establish a private, competitive power sector that will produce least-cost power in the shortest period of time. Unfortunately, governments are run by politicians who do not always see the situation that way.
The following questions were posed to me four or five years ago by the prime minister of a large country in South Asia: "Why should I privatize a government power plant that is one of the few assets that actually brings money into the treasury? Why should I incur the public criticism that I am selling the 'patrimony of the country' to some foreign cartel that will reap all the profit and do nothing to improve the plant's output or performance? Why should I (em through privatization (em stimulate massive personnel layoffs and labor unrest? In short, this sounds like political suicide; what's in this for me?" Of course, there are obvious answers to these questions. If a country faces power blackouts for several hours each day (em as most emerging markets do (em and has no money in the treasury to build new capacity, the president's political half-life will be short anyway. So why shouldn't he try to make matters better? A properly executed project will provide more power, at a lower price, faster than the state-owned company can produce it, and if the government holds on to shares in the privatized company, it can use the shares for capital formation when the company goes public in New York a few years later (em … la Telefonos de Mexico. My point is not that there are no good answers, but that teaching forms an important part of successful project development.
Over the past seven years, I have devoted probably half my time as pro bono counsel to cabinet-level and subordinate officials in emerging markets, explaining what has worked best (em among the half-dozen models of privatization (em in terms of protecting government interests and providing a solid return to investors. It was time well spent. If you can show political figures how sensible policies can yield them the political benefits of providing additional generating capacity to consumers (voters) faster and at lower cost, while also improving the country's fiscal and balance of payments situation, you are well on your way toward a successful project. You will have created the most important ingredient for any successful project (em trust between the developer and the government. Such a relationship must be developed not only with the political leadership at the top but also with the career establishment down to the third and fourth level; otherwise a project, once begun, may suffer prolonged delays when elections occur.
Once a relationship of trust is established with the host government, project development involves varying amounts of engineering, finance, and management. While the engineering component (em especially assuring a predictable fuel supply (em is never easy, there are a number of very competent American utilities, oil and gas companies, and EPC (engineering, procurement, and construction) contractors available. Indeed, one of the happy outcomes of the downsizing of the 1980s is that it left American companies as leaders not only in EPC work, but in equipment supply, management, and most importantly, price competitiveness.
The finance dimension has also become less problematic. Raising equity has been made easier by the conscription of a number of international equity funds, underwritten by investors attracted by returns in excess of 25 percent. The AIG-Asian Infrastructure Fund (just over $1 billion) is almost fully invested, and its manager is well along in subscribing an equivalent fund. A third fund is also planned. Near-equivalent funds have been raised by the Beacon Group, the Energy Investors Fund in the Bay area, and several others. The debt side has become more difficult, but here too a solid relationship between the project sponsors and the host government will go far toward shortening the due-diligence period for lenders. If there is a single lesson that stands out regarding debt finance, it is "the simpler the better." Here and there, developers shopping for a lower cost of capital for a given project have enlisted a dozen sources who end up so complicating and extending the due-diligence phase and generating exorbitant development costs that any hoped-for savings are lost. Worse, the project participants lose considerable goodwill with the government of the host country.
Where's the Action?As concerns the relative attractiveness of their power sectors, the seven most promising countries vary considerably in their understanding of, and therefore commitment to, private participation in power projects. These differences are reflected in the degree to which state-owned power companies and labor unions accept the concept, how streamlined their decisionmaking has become, the uneven quality of their draft power-purchase agreements, and their acceptance of how the market assesses the risk of investment in their country. On this latter point China, after considerable reflection, has found ways to shape the terms of its power contracts to provide an acceptable return to investors.
Measured purely by the sophistication of its power contracts and the timeliness of official decisionmaking, Pakistan would have to be at the top of the list of attractive places to develop a private power project. Unfortunately, the persistent violence and instability in Sindh province has curbed the willingness of some lenders to commit funds.
As already mentioned, China has become quite realistic as to what represents a fair sharing of risks and rewards, and will present a huge demand for new IPPs for as far as the eye can see. In my judgment, China will experience considerable turmoil, even violence, in the next two to five years as a consequence of growing tensions between the haves and the have-nots and, separately, the transition to a successor political leadership. But that should not be seen as an impediment to investment in the power sector. It is true that some U.S. companies may face a measure of discrimination by Chinese authorities owing to strained Sino-U.S. relations, but with proper organization and representation within the consortium, these problems can be overcome.
With the election of President Fidel V. Ramos three years ago, the Philippines has become one of the most attractive sites for independent power production in Asia. President Ramos is supported by highly professional officials in the Department of Energy and the National Power Corp. who have put in place a sound energy policy. This policy has been expressed in straightforward template agreements that expedite the development process considerably.
Thailand's power sector has always been dominated by the Electrical Generating Authority of Thailand (EGAT), perhaps the most efficient state-owned power company in the world. Starting last year, however, the government began moving in earnest to open the energy sector to private participation. While Thailand will be able to meet its short-term needs through IPPs now being awarded, its real problem is fuel. Faced with diminishing gas supplies of its own and the prospect of higher prices from neighboring Myanmar (with whom they have begun to contract for gas), Thailand should ultimately come to an agreement with Malaysia (em the most secure and economic source to meet its long-term fuel requirements. IPPs that take this into account could face a very bright future in Thailand.
Indonesia decided to open its power sector to private participation several years ago, and has recently reached financial close for the first phase of the giant Paiton project. In the years ahead, it promises to present extremely attractive prospects for the privatization of several existing plants that are suitable for repowering and/or expansion.
Apart from these Asian countries, both Peru and Brazil promise the most appealing targets for privatization in South America.
My prognosis for the future of independent power in the next 10 years is extremely positive. Competent project development involves a huge amount of very hard work (em especially in government relations (em but the rewards are there. The next 10 years will see a bankable demand for more than $500 billion in new generating capacity. Most of that ought to go to U.S. companies. Whether it does will depend on the wisdom with which U.S. power consortia organize and conduct themselves and the extent to which President Clinton's national security policies toward Asia become more realistic. I am optimistic about the former, less so about the latter. t
Robert C. McFarlane was President Reagan's national security advisor from 1983-85. He is currently founder and chairman of The Asian Energy Corp., which has four independent power projects under development.
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