Construction of Nam Theun 2 in Lao PDR is a major challenge but so, too, was developing the project finance arrangements
The Nam Theun 2 hydropower project is pivotal to the economic fortunes of Lao PDR. With a total cost of almost US$1.6B, equivalent to more than 85% of the annual GDP, the 1,070MW plant will be country’s largest economic asset as the leading foreign exchange earner and top single contributor to the national budget.
Under the terms of a revenue-management programme to be implemented by the Laos Government and under the supervision of the World Bank and the Asian Development Bank (ADB), the US$2B of revenues expected over the operating period will be used to reduce poverty and assist development in Laos. A robust environmental and social impact safeguards programme has also been designed with several of the participating financial institutions, and will be fully funded as part of the project’s budget.
Nam Theun 2 is a 1,070MW trans-basin hydroelectric power plant, and impoundment of the reservoir has been approved to begin in June. Of the total installed capacity, 995MW and electrical energy will be sold to the Electricity Generating Authority of Thailand (EGAT) under a take-or-pay power purchase agreement (PPA). A further 75MW will be sold to Electricite du Laos (EDL) on the same basis.
The scheme is being developed by Nam Theun 2 Power Co (NTPC), which is a limited liability company, owned: 35% by edf International (a wholly-owned subsidiary of Elecricite de France); 25% by Electricity Generating Public Company (EGCO); 15% by Italian-Thai Development (PCL (ITD); and, 25% by Lao Holding State Enterprise (LHSE), a special purpose company wholly owned by Lao PDR’s Ministry of Finance.
Inception to Financing
The hydropower potential of the Nam Theun river was formally identified in the 1970s and a number of detailed feasibility studies were undertaken over the following decades. In 1994, the introduction of EDF and ITD as sponsors, and the invitation to the World Bank to participate, took the project to the development phase. Since then, its development has mirrored, in many aspects, changes in structuring project-financed deals, such as detailing political risk mitigation, currency risk beyond historical exchange rates, and greater environmental assessment work. Such was not the case at the outset and only were introduced following the clampdown on risk following the 1998 Asian financial crisis.
Several critical aspects of the project financing structure had to be addressed in parallel: political risk; currency risk; socio-environmental impact mitigation; equity funding; contract structures; technical briefing for lenders; and, multilateral agency involvement.
Political risk mitigation
The key challenges for political risk mitigation were to overcome the challenges of a cross-border deal and an undeveloped regulatory framework.
Factors to be addressed included the need to raise a large sum of limited recourse debt finance in a country that was eligible for debt relief under the World Bank/IMF’s initiative for heavily indebted poor countries (HIPC); the project being comparatively large in the overall economy in Lao PDR; the country’s low level of foreign exchange reserves; and, the cross-border nature of the transaction.
The contractual structure was developed under two aspects: first, to ensure that Thai political risks were satisfactorily addressed under the PPA with EGAT, in accordance with the framework established by Thai independent power project (IPP) financings; and, second, that the Lao PDR political risks were allocated to the Government under the concession agreement consistent with precedents for emerging market projects.
But the risk allocation faced a problem as neither the Government nor EGAT was prepared to bear risks across the Mekong river boundary. Further, the backers would not assume the consequences of force majeure in the other’s country of the other partner. And, should the project not get that far in development there was a need to have clarity, and agreement, on any potential competing claims if Nam Theun 2 had to be shelved. Clearly, there were many barriers to overcome and have the parties amicably work together.
Further challenges, at the start of the concession negotiations, for NTPC and its advisers resulted from their view that the legal framework in Lao PDR was not sufficiently developed in a number of areas. A strategy was implemented to compensate for the uncertainties and NTPC gained clarifications on contradictory existing laws as concession arrangements moved through the legal approval process.
A key major risk mitigation factor was involvement of the major finance organisations, including the World Bank, Asian Development Bank (ADB), European Investment Bank (EIB), Nordic Investment Bank (NIB), European development finance institutions and export credit agencies. They were to provide a combination of both debt and equity-related financing. In addition, the institutions would ensure, through ongoing monitoring, that the revenue management programme would be properly implemented, and that royalty, tax and dividend revenues would be channelled as appropriate to fund social and economic development.
In respect of potential Thai political risks, the highly attractive 2009 tariff of approximately US$0.04/kWh meant that EGAT would enjoy sustained economic advantages from the PPA, thus reducing the risks of breach of contract. Comfort was also drawn from the unbroken 30 year history of cross-border sales between Lao PDR and Thailand, and the memorandum of understanding (MoU) on electricity exchanges between the countries. The involvement of all the major Thai commercial banks and Thai-Exim added a further level of reassurance to the non-Thai parties.
As such, it became increasingly evident during the project’s development that the single greatest risk mitigant was the project itself, as it was not in the interests of any party to do anything to prejudice a project that was both a supplier of cheap electricity to EGAT and a significant source of revenues for Lao PDR.
Limiting foreign exchange risk
Structuring the currency profile of the funding to match that of the upfront project costs and later revenues mitigated currency risk and provided a natural hedge against the tariff structure. This required that the underlying long-term debt structure be dominated half in Thai baht, raised from Thai commercial lenders, but the volume was significantly higher than for any other Lao PDR project.
Environmental and social impact mitigation
From the earliest stage of development, the sponsors were keenly aware of the requirement to establish the highest standards for the mitigation of environmental and social impacts, while conforming to the requirements of a project-financed deal and the accessible skills of developers in the energy sector.
The involvement of the World Bank, ADB and EIB and other organisations and commercial banks meant that the project was required to meet an unparalleled number of institutional requirements and international guidelines. The environmental and social mitigation obligations of the sponsors were developed in liaison with a number of agencies, public consultation, and workshops guided by safeguard planning documents, enshrined within the concession agreement.
With the project is contractually committed to spend more than US$100M in mitigating environmental and social impacts during the construction period, the obligations are significant. The sum includes US$60M on technical design modifications following discussions with affected parties. On top, a further US$60M is to be spent on livelihood improvement, watershed management protection and related costs during the concession period.
Raising US$112.5M for Lao PDR, specifically for a government with no history of commercial indebtedness, was a challenge, not least as the sum was well beyond its own resources. Also, the money would have to be raised in a way that complemented the senior debt financing while meeting eligibility constraints and disbursement requirements.
NTPC and the Government of Lao PDR were successful in identifying and raising a combination of loans and grants from the ADB, Agence Francaise de Developpement (AFD), EIB and the World Bank. The effort involved providing assurances to all sides n matters such as not debt relief under the HIPC Initiative, that the costs of Lao PDR’s loans could be capitalised within existing commitments, and to the senior lenders that the funds would be structured for availability as required.
Construction contractual structure
Unlike conventional project financing, the construction activities are spread over a wide area and involve a diverse range of activities, including significant civil and underground works. While EDF, as head contractor, has overall single-point responsibility for the works, the construction was packaged into five principal sub-contracts, each structured as a mini-engineering, procurement and construction (EPC) contract.
The framework of contracts allowed NTPC much greater control over the appointment of the key sub-contractors, and also permitted it to ensure the required alignment of the currencies of project costs and funding. Three civil works sub-contracts were largely denominated in baht and the two electro-mechanical sub-contracts were largely denominated in US dollars. The selection of a consortium led by GE Norway for the main electro-mechanical sub-contract brought in NIB and three export credit agencies, including Coface which was also supporting the project management role of EDF.
Lenders’ learning curve
Lenders are relatively more familiar with the risks associated with thermal IPPs, so one challenge was to help them be comfortable not only with the technical features of a hydroelectric project but one involving substantial civil works and underground structures. They also needed to gain sufficient understanding of hydrology, and its conversion to energy output and revenues.
The funding organisations were briefed on EGAT’s PPA structure, which mitigated hydrological risk, and includes separation of its energy purchase and payment obligations. It also incorporated a split tariff structure. This unique and complex structure, together with the large storage capability of the reservoir, gives NTPC the maximum opportunity to stabilise its revenues and significantly reduce its (and the lenders’) exposure to any variations in hydrological conditions.
As the project developed, it became more evident that the multilateral agencies would be of critical importance to successfully financing the project. The US$305M aggregate participation of the agencies was critical, since without them there would be no participation of the European development and export agencies, international commercial lenders would not have been able to accept the Lao PDR political risks, and then without the latter the Thai commercial banks would not provide debt finance.
Therefore, there was the need to incorporate the requirements of the agencies within the overall project framework, such that NTPC was not burdened with the wider obligations that they required of the Government of Lao PDR. The key was for NTPC to manage the expectations and requirements of the agencies and, in doing so, ensure its obligations were limited to the activities it was responsible for. In doing so, it was possible to implement a commercially viable transaction within both a comprehensive environmental and social structure and a long-term development framework.
This structure, with the agencies and export and development organisations from Europe underpinning the financing plan, was the basis upon which commercial banks were invited to bid in November 2003. While the financing plan did evolve further in the period to financial close, the final debt package bore a strong resemblance to that proposed to the commercial lenders in 2003, showing that option of having the agencies lead was not only the most appropriate but, quite possibly, the only viable structure for the financing of the project.
The financing was complex, innovative and ambitious, and most of the many solutions pioneered in this financing are expected to establish NT2 as a valued model of project finance for public-private partnerships. It is one of the most complex limited recourse financing closed in Asia in many years.
The financing included senior debt facilities of US$1.132B equivalent, denominated in Thai baht and US dollars, and shareholder equity commitments of US$450m. A total of 27 financial institutions participated in the financing.
The project, as presented in the information memorandum provided to the lenders, benefited from salient features that underlie its economic and structural soundness, such as the:
• History of commercial financing in Lao PDR – the project is the fourth hydropower project in the country to sell most of its availability to EGAT. The earlier developments were more modest in scale (about 500MW of total installed capacity) but established the viability of such a development;
• Importance of the project to Lao PDR, being a milestone in the economic development of the country. Hydropower is a key natural resource;
• Substantial financial benefits to Lao PDR, which are distributed over the 25-year project life and total up to US$2B in taxes, royalties and dividends. Thereafter, the state receives the asset, which should have another 25 years of life, at no cost;
• Value of the scheme to Thailand for the project would deliver the lowest cost energy to the national grid;
• Alignment of the interests of parties involved, and there being no issue of sovereignty arising for Lao PDR.
Among the key concerns on the project were matters of technical/construction concern, general environmental/natural resource risks, and how contractual tensions/force majeure would be handled.
The financial package resembled well the documents signed less than 15 months after the release of the initial term sheet. Key features included:
• Currency risks – the sponsors structured the financing to provide for a natural hedge during construction and operation to mitigate foreign exchange risk, with the significant volume of US dollars required being funded by equity in US dollars;
• Back-end equity and rebalancing – stand-by letters of credit supported equity commitment; there was accounting of the sponsors’ development costs as equity; there was a contractual need for equity injection prior to project completion; and, use of rebalancing of such back-end equity against early drawn debt. The arrangement provided attractive economics without exposing lenders to equity risk, and it help deal with eligibility constraints;
• The cross-border nature of the transaction required political risk mitigation for both Thailand and Lao PDR, and the pragmatism and flexibility of the export credit agencies played a sizeable role in ensuring a timely financial close.
Although intercreditor issues arising from mixed-currency financings, co-financings between multilaterials, export agencies and commercial lenders and mixed long-term/short-term financings have all been dealt with by the seasoned financiers, the resolution of such complexities owes much to the professionalism of the institutions involved.
Despite the total capital commitments of US$1.58bn and the risk mitigation challenges for such a high-level call for funding of a hydropower project, the complex financing that was required was completed within 15 months of the release of the initial term sheet.
Many of the solutions pioneered for Nam Theun 2 will establish the project as a valued model.
This article is based on the longer, hydropower feature in the “Financing Renewable Energy” report from PFI, and the authors were Stephane Lebeau, EDF; Ian Mathews, ANZ Investment Bank; Sam Bonifant and Russell Wells, Clifford Chance; Christopher Thieme, BNP Paribas; and, Thomas Brown and Roger Lui, Allen & Overy.
PFI is making the report, which covers the full range of renewables, available to IWP&DC readers at a 50% discount on the full price of £796. Contact Adrian Gilbert, by email, at email@example.com