Working through a crisis

Christopher Brown,

Managing Director,

Singapore Power International Pte Ltd.

As a leading utility group in the region, Singapore Power welcomes the opportunity to be involved in PowerGen Asia `98. This year`s show comes at a time when the economies of Asia are in the midst of a severe financial crisis. Many countries face recession and currencies and stock markets are a fraction of their level just a year ago. Despite this, there remain many opportunities in the Asian electric power market in view of privatizations and the need for new capacity and networks. Hence, this may prove to be a strategic time for aggressive investors to gain a competitive edge over the long term.

There are many theories on the causes of the financial crisis. Neither of the two most popular explanations is by itself fully satisfactory. The conventional macro-economic diagnosis blames exchange rates, that were effectively pegged to the US dollar, becoming overvalued and pricing exports out of world markets while allowing local consumers to buy imports at increasingly attractive prices. The resulting large current account deficits had to be financed by overseas borrowings, much of it in short-term maturities. Many of the countries most affected by the crisis had current account deficits larger than the country`s hard currency reserves.

Another popular explanation is that the crisis was brought about by the collapse of the banking system in the region. This was a result of the intricate links between Southeast Asian banks, their major borrowers and the region`s governments which had significant influence on where the loans went and therefore implicitly guaranteed them. A huge influx of foreign capital in search of high returns helped finance this situation leading to uneconomical loans. Asset prices spiraled until the market eventually burst as holders of domestic currencies lost confidence and ran to the dollar and foreign capital disappeared.

Knock-on effects

The financial crisis has had a severe effect on the power industry. It has changed the way in which foreign developers look at expanding into Asia. Historically, strong interest was shown in taking advantage of the apparently huge demand for energy in Asia. Asian governments, encouraged by rapid and sustained economic growth, as well as eager foreign developers, laid out ambitious long term power development plans and IPP programmes. Indonesia, Philippines and Thailand put aggressive IPP programmes in place and initiated studies on privatizating their electricity industries.

But the crisis has dealt several blows to the development efforts of greenfield projects by foreign developers.

Firstly, the economic downturn has led to a sharp decrease in electricity demand and growth forecasts as industries decrease production and adopt intensive cost cutting measures. The regional utilities were slow to appreciate the seriousness of the crisis and were unable to slow the increase in capacity growth. To add to the problem, cash rich foreign developers under pressure to invest continued to propose new projects. A medium term oversupply situation has resulted and regional utilities have had to act to reduce capacity growth.

There is also an imbalance between the rates utilities can charge their customers and the rates they have to pay the IPPs. The issue arises as foreign developers have typically required US dollar based returns in the PPAs whereas tariff payment to the local utility is in local currency. When the currency depreciates, the result is bankruptcy of the regional utility, government support or renegotiation of PPAs.

In other countries such as India and China, which have been relatively untouched by the crisis, other development problems have lead to slow progress in the IPP programmes. In India, lack of tariff reform has caused weak creditworthiness of the state electricity boards as offtaker and state government as guarantor. In China, concerns exist over power demand growth, tariff approvals and currency depreciation.

The increasing difficulties in greenfield development have led foreign developers to shift their focus to acquiring operating assets or those in an advanced stage of development. Opportunities also arise from the sale of assets by financially distressed local developers who need to raise cash. Although these operating assets do not suffer from many of the inherent risks in greenfield development, they do share common risks such as offtaker, dispatch and foreign exchange risks which have been significantly increased as a result of the financial crisis.

Combating the crisis

But it is not all bad news. A fundamental change in the perception of risks is taking place in the minds of the foreign developer as well as lender. This should benefit both parties resulting in a healthier risk reward ratio. Some developers under pressure to invest spare cash see the crisis as a bargain hunting opportunity. Others see the risks as too high and are leaving Asia. Confidence in the region remains vulnerable as currencies continue to fall. A reasonable period of stability and signs of successful economic reform are required before significant confidence returns.

In the meantime, the question is how the industry is going to combat the effects of the crisis. The primary aim of developers is to ensure their investment produces an adequate forecast return which rewards the risks taken. Equally important is to ensure the forecast return materialises. To minimise key risks such as political risks and dispatch risk, there should be a fundamental need for the project`s product – be it generation, transmission or distribution. The tariff should also be made as competitive as possible.

Another major risk is that of local currency depreciation. This can be mitigated by matching the currency of funding expenditure with sources of funding during the construction period and indexing the tariff to cover any foreign exchange exposure.

The crisis could be an opportunity to correct the major stumbling blocks which have plagued foreign power project development in the past. To a large extent it is in the hands of each government to promote the necessary reforms to encourage foreign investment and kick-start their economies.

It is difficult to say how fast each country will recover, but typically a country which has a lower reliance on trade and a higher level of self-sufficiency and budget surplus would be quicker to surface from the crisis. But what could help ultimately, is the willingness of each country to adopt the necessary economic reforms and restructuring.