CANADA MAY CLAIM ONLY A SMALL SHARE OF THE world's high-profile power developers, but that hasn't stopped its financial institutions from becoming big players. These public and private lenders have made available billions of dollars to nearly any project willing to use Canadian consultants or equipment.
Furthermore, the government is willing to back its country's products with political risk insurance as part of the package. In a world where power projects are becoming expensive and pose greater market and political risk, Canadian involvement is welcomed.
The linchpin of Canada's policy starts with its Export Development Corp., which boasts an asset base of about $8 billion (all denominations in U.S. dollars). Its capital and surplus base (including allowances) totals about $2.4 billion. EDC is part of the Export Credit Agency of Canada, which is controlled by a 15-member board of directors drawn predominantly from the private sector. That makeup gives the ECA an appetite for taking on risk.
Other countries also have similar agencies, but Canada's is different. The U.S. Export-Import Bank, for example, operates as a lender of last resort, using funds appropriated annually by Congress. If the bank runs out of money midyear, it shuts down.
Canada's EDC, though government owned, is financially self-sustaining, operating on a user-pay basis. In fact, during its 53 years, the agency has never lost money, according to Eric Siegel, EDC executive vice president. Last year, its volume increased 30 percent, reaching $18.6 billion. Siegel reports the EDC continues to evolve. About 70 percent of its business last year came from commercial transactions, up from 25 percent and 50 percent of its loan portfolio as recently as 1994 and 1997.
"EDC is also incredibly flexible," according to one banker who has worked with both agencies. "Instead of bureaucrats telling you what they can't do, the EDC people roll up their sleeves to figure out ways to make it happen."
In 1995, EDC created a dedicated unit to deal with limited-recourse financing. Since then, the agency has concluded more than 40 transactions with a financing volume topping $2.2 billion.
"We also have presently an active pipeline of some 50 projects, with EDC direct financing potential participation in excess of $3 billion," says Siegel. He adds that EDC has provided about $2.5 billion in the power sector since 1990 in about 80 transactions.
That support has had a significant impact on Canadian business, which exports almost $2 billion a year in power generating equipment. For example, more than half the hydro generators provided worldwide by General Electric, including those for the Three Gorges project in China, are supported by EDC. On the thermal side, Babcock & Wilcox - provider of about 20 percent of worldwide utility boilers - also has received major EDC support, including a $220-million loan in 1993 for the 1,800-megawatt project in Suralaya, Indonesia.
The EDC: Three Defining Deals
What the EDC is looking for in a project is a payback to Canada, either in goods and services, dividends to Canadian companies or promise of future work. It extends loans to foreign buyers to purchase Canadian goods and services, and it pays the exporter directly as it performs under the contract, collecting repayment from the foreign borrower over the life of the loan. It is interested in making loans on projects in the U.S. and other developed nations, as well as places like Southeast Asia.
What do U.S. companies think about turning to Canada for project assistance?
Southern Energy Inc., for one, sees no reason not to look north. Southern, launched six years ago as a subsidiary of The Southern Company (which owns utilities Alabama Power, Georgia Power, Gulf Power, Mississippi Power and Savannah Electric & Power), is one of the largest power producers in the world, operating worldwide plants generating more than 10,000 MW, with another 8,000 MW under development. It sees itself as the largest independent power producer in Asia, and the largest foreign investor in the Philippines.
"We're like every other developer out there," says Thomas Boren, Southern's president and CEO. "We'd like to use equipment from whatever country we're from, but we're going to win, first and foremost." And if winning means buying equipment from Canada, then that's what Southern Energy will do. "[We] like to think of Canada as part of our family because it's so close," he adds.
The EDC can act as owner/lessor in cases where normal lease arrangements aren't practical, or where the buyer prefers a lease option. The company can make financing available directly to a Canadian company to cover pre-shipment costs, become the senior lender in structured project financing or take a minority equity position in a foreign project (25 percent or less of total equity). The EDC's financing participation is in line with the Canadian benefits expected to flow from the project.
Jonathan Robinson describes the growth at his EDC project finance team: In 1995, five deals closed worth $244.2 million. In 1996, 13 deals closed worth $626.5 million. In 1997, another 13 deals closed, worth more than $1.368 billion.
Although none of last year's deals involved the power sector, EDC is reviewing generation projects. In the deals it did close, (most in telecommunications) EDC took commercial and political risk. Adds Robinson: "There are very few ECAs out there who will do that in a developing market."
His group usually starts with a preliminary due diligence, which might take a week. Then EDC requires formalizing a transaction team of two senior staffers who may call on 10 more professionals to conduct intensive due diligence. The full due diligence process can take from a few weeks to a year before the deal closes.
"We start with the host country and the regulatory issues there, then look through power purchase agreements and other documents," Robinson says.
An added benefit comes with the EDC seal of approval: it often acts as an incentive for other lending institutions to provide more support. Either EDC introduces new lenders, or it is introduced by another financial institution. Either way, "we are strong advocates of sharing counsel, engineers and advisers," says Robinson. He points to three "defining deals."
The first was the Fauki Kabirwala gas-fired combined-cycle facility (151 MW) in Pakistan, developed by Westinghouse Electric Corp., El Paso Electric Co., and the Bounty Foundation. The project cost $170 million and saw the EDC working with the Asian Development Bank for the first time. "This was a situation in which EDC was able to come to the table fairly early to commit $35 million," Robinson says. "Often a commitment that is also a hold position is critical in some markets, like Pakistan."
The second defining deal was a $450 million Pangue hydro project in Chile (450 MW) owned by GE Hydro, in which the International Finance Corp., affiliated with the World Bank, participated as lead lender.
"It was a limited recourse hydro deal, which makes it unique in itself," says Robinson. But there was no purchase power agreement, making it more of a merchant-type deal with pricing and commodity risk. "We also demonstrated that we can work with the IFC," says Robinson, "which is one of the most active lenders on the international scene."
The third defining deal was an MTBE/methanol project in Qatar sponsored by China Petroleum WGPC, Methane Octane Ltd., and Lee Chang Yung Chemical. The project is worth about $670 million. "Early on, we were able to give an indication of the level of support we could offer before Canadian benefits were nailed down," Robinson says. "This is important for Canadian suppliers because EDC can have a material impact on Canadian procurement. That's particularly relevant in the tougher market deals." EDC also provided political risk insurance for the project, and coauthored the information memorandum as technical consultant.
"We're used to looking at demand-side risk," Robinson says. "This holds true for some of the commodity deals on the telecom side as well as power deals.
"It's not like a private power project. We don't flick on a switch and know exactly what the capacity payment will be within six months. There's additional capital expenditure, even as cash flows are being generated."
Other Lenders: Ready for Privatization
The EDC isn't the only source of money in Canada. The country's 59 domestic and international chartered banks boast assets of $816 billion. Six banks have been active in major Canadian project finance and structured finance deals, all rated "Schedule I" widely held banks: Canadian Imperial Bank of Commerce, Bank of Montreal, Royal Bank of Canada, Scotiabank, Toronto Dominion Bank and National Bank of Canada.
David Clee, managing director of CIBC World Markets, says his group reviews proposals for power plants of more than $1 billion. "When we're looking at a project, our goal is risk mitigation. We also look at the framework of the deal, knowing what our rights and remedies are, should something go wrong with the economics of the project."
Today, developers are hiring financial advisers and turning toward auction financing, bidding out loans to the lowest-cost money. "There may not be a conflict," says Clee. "We have found ways to work with developers. We will offer advice to provide a structure that we can finance, and then bid it to the market to provide a floor price. If it's beaten by some competitor, the developer gets a lower cost of capital."
There are other ways to gain access to Canadian capital, including nonbank lending institutions.
The recently formed Borealis Infrastructure Fund, for example, boasts that its sponsor, the Municipal Employees Retirement Fund in Ontario, raised $350 million this year for independent power or other infrastructure projects.
Another nonbank lender, Newcourt Capital, recently established a project finance fund with $500 million from large institutional investors, which included Canadian investors like Sun Life, Mutual Life, Caisse de Depot et Placements and the Ontario Teachers Pension.
According to managing director Daniel Morash, the company has assets of $4.5 billion, with $18.3 billion in owned and managed loans operating in 24 countries. Newcourt's first transaction was a 32-year leveraged lease agreement for a natural gas storage facility in Michigan developed by MCN Investment Corp., a subsidiary of MCN Energy Group Inc., which owns Michigan Consolidated Gas Co., a local distribution company. Projects don't have to be on Canadian soil, or use Canadian-manufactured equipment to qualify for Newcourt's business. But its ongoing relationship with Canadian agencies helps those projects that do.
Morash favors leveraged leasing arrangements, which can provide up to 97 percent of the capital needed to complete a project with fewer lending costs. In this scenario, Newcourt Credit is established as a passive funding partner to a sponsor corporation, a limited liability company, which serves as a vehicle for the financing and operation of generating capacity. During construction, the financing typically would be 3 percent equity, 97 percent debt, where the debt would be provided by the Newcourt fund or in consortia with other funding institutions.
An Expanded Role
As the sixth-largest generator of electric power (116,000 MW) and the largest producer of hydroelectric power, Canada stands third in the world in per capita consumption of electricity. Its equipment manufacturers appear only too willing to join hands with financiers on overseas projects.
H. William Pearson, president of Agra Development Inc., believes that Canada is positioned to be a player in the 60 gigawatts of worldwide privatization projected by 2000.
"The end result is that we produced world-class utility operators, manufacturers, engineers and contractors to build those plants," Pearson says. "We have tremendous strengths in our own land in doing those things. Canada is an export-oriented country. We survive by exports. It's built into the culture of our industry, our manufacturers, our engineering and construction contractors."
Paul Koenderman, president of Babcock & Wilcox Canada, believes there are other reasons to buy from his country: an attractive exchange rate, proven international savvy and strong affiliations with major U.S. parents.
On the hydro side, Canada is the world leader, having built 40 percent of the world market, more than 46,000 MW, according to Haresh Ramchandani, marketing director in India, Nepal and Sri Lanka for GE Hydro. Some key projects under way are Sanxia (Three Gorges) in China (4,260 MW when complete), the Pangue hydro project in Chile (450 MW when complete) and Chamera in India (600 MW when complete). Worldwide, hydro represents about 20 percent of electricity production.
"The bulk of the new market will be in Asia," says Ramchandani. "With more and more projects on the horizon, equipment suppliers are changing from just being suppliers of turbines and generators ... to full developers."
Pearson of Agra Development agrees. "Engineering contractors are willing to take a design-and-build contract today for a power plant plus dam, plus facilities, that 10 or 15 years ago they just wouldn't have considered because of the risk." He adds, "Our fundamental understanding of those risks has gotten better."
"We see a supplier convergence," adds John Balint, vice president of project finance for the EDC. "Suppliers are now trying to be developers. Sometimes they're prepared to do investments. Perhaps they're in the development phase, or into the project. We're also seeing vertical integration, with the fuel suppliers and power generators becoming one and the same."
Newcourt's Morash describes this as shared risk, in the absence of a long-term purchased power agreement. "Everyone brings something that reflects the risk that they are able to control," he says. "Basically you have a structure that survives by virtue of limited levels of financial support from each of the participants."
Surviving the "Asian Flu"
The EDC's political risk insurance program was established in 1969 and has grown more important to clients over the last five years. Derek Baas, who represents the program, says the policy covers risks associated with transfer and inconvertibility, expropriation and political violence.
"Once the benefits to Canada are established, and once the risk acceptability of the project and country are established, there's no nationality test to be able to qualify for coverage," Baas says.
This approach differs from other insurers, which have more stringent ownership requirements in terms of the banks they will cover. "It gives us the ability to work with foreign banks and developers," Baas adds. "We have a limit of [about] $200 million per project, but for very large projects with good risk-sharing arrangements, we might be able to look a little bit higher."
Project specifics matter: Whether the company receives insurance, will depend on due diligence that will concentrate on agreements, relationships and responsibilities of the governments involved.
Another important distinction is that EDC's insurance is "priced to the risk, not to the capacity in the market," Baas adds. "Unlike in the private market, as more coverage builds up, the price of each additional dollar of coverage also goes up. In our policy, given equal projects in the same country, the first dollar of coverage should cost the same as the $500 millionth."
The EDC also is unique because its corporate goals include an appetite for high-risk markets. It's covering markets that private political insurers aren't entering, or aren't interested in now. These markets include the former Soviet Union, South Africa, Papua New Guinea and Guyana.
Canada can play an advocacy role in support of investors, even on a diplomatic front.
The currency crisis in Asia is in the spotlight now, according to Boren. "Three or four years ago we thought those companies in Indonesia got good contracts at a fine price, typically dollar-indexed in the range of 7 to 8 cents per kilowatt-hour." Three years later, with the devaluation of the Indonesian rupia, the price is between 25 and 30 cents/KWh.
But third-world countries aren't the only risky markets in the world. Boren would put the United Kingdom on his list of trouble spots. Southern Energy was one of the first U.S. companies to invest in U.K. distribution companies.
Says Boren: "Think about it: not a difficult country to get approval from; AAA credit rating; one of the most civilized, industrialized nations, with a strong legal system - everything you could possibly want."
Three years later, and a change in government, Boren's company faced a windfall profits tax of $119 million. "Now we see the threat of potential additional reviews in the future," he says. "The United Kingdom seems less safe to us now than it did three years ago." Boren's advice to other investors: "Similar does not always mean safe." Another new maxim: "No government is as stable as it appears."
Profit Outlook: A Caution
China and India promise to continue as the largest markets for power generation, with about $20 billion a year in investments, according to John Balint of the EDC. In China, sovereign power deals will predominate, with a few private projects occurring.
Coal and natural gas will be the preferred fuel, more favored than hydro or nuclear. In fact, for the next 10 years coal and natural gas are predicted to run neck-and-neck worldwide, even though people keep talking more about gas, says Balint.
Newcourt's Morash adds that the Asian financial crisis renewed attention on power project development in North America. "For the lender, this is a passive investment with a good sponsor, good equipment, a strong package of covenants, rights and remedies," he says. But he also cautions: "The historic performance of monopoly industries that become competitive show that prices only go in one direction. And that's down. In the power market, capacity is built for peak demand, which means that you're generally looking at system marginal cost pricing.
"We've experienced declining real energy costs as the costs of finding energy has declined, and there's no reason to believe it won't continue to decline in the future on a real basis," Morash adds. "The technological improvement to new generating assets means that you may be a low-cost producer when you go into service today, but down the road you may be displaced by future low-cost producers who have a technological advantage."
Meanwhile, there's money out there for power producers. As one Canadian official quipped to U.S. independent power producers in Washington, D.C., recently: "We have baskets of money for you on the way out."
Sarah McKinley is a freelance writer based in Arlington, Va.
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