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p. 11 of 21 BACK | NEXT Introduction: Looking ahead Past policies and operations Changing context of the policy review Poverty reduction Private sector participation and sector restructuring Regional and global environmental impacts Regional cooperation Impact of the financial crisis Future assistance in the changing context Conclusions

Energy 2000: Review of the Energy Policy of the Asian Development Bank : Changing context of the policy review

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Impact of the financial crisis

69. Governments are introducing structural reforms, mostly in the financial and enterprise sectors, to avoid repetition of the contagion effect that damaged many Asian economies in 1997–1998. While it is unlikely that the same causal weaknesses will result in another crisis of similar magnitude, the sudden change in economic activities and exchange rate has valuable lessons for the sustainable development of the energy sector.

Impact on energy demand and investment

70. The sudden large drop in the value of domestic currencies and the sharp increase in public debt needed for stabilizing the economies affected by the financial crisis had considerable impact on the energy sector. While capital flows from the more developed countries had helped meet the vast energy investment needs of the DMCs, the crisis highlighted the major exchange risk involved as revenues in the energy sector were generally in local currencies. This is likely to increase the pressure on energy sector companies to generate surplus for new investments and to use more domestic capital and equipment for new projects. The financial crisis has also demonstrated that long-term planning based on optimistic economic growth projections can result in large errors in the short and medium term. Implementation of new projects targeted at providing adequate capacity can lead to significant overcapacities, if the deteriorating macroeconomic situation is neglected or, in general, inadequate attention is given by developers to the macroeconomic context of their investments²¹. The financial impact on companies with administrative price regimes is even more serious; while costs increase substantially, particularly for servicing foreign debt, an increase in administrative prices is controversial during such a crisis as it would drastically reduce the consumer welfare and could make it more difficult to come out of the crisis. In the case of private sector companies, the loss of investor confidence and capital flight reduce the size of the debt market, making it difficult to borrow adequate working capital for sustaining the level of turnover. Under such circumstances, governments are left with no choice but to provide budgetary support, either directly or by restructuring public debt obligations. The business outlook becomes even more bleak as manufacturing units close down and energy demand drops, and insolvent corporations seek means to avoid paying the energy bills.

71. From the viewpoint of new investments, the financial crisis in Asia has bottomed out and some DMCs such as the Republic of Korea, Malaysia, and Thailand are recovering more rapidly than anticipated. In most cases, the deceleration in economic and energy demand growth led to postponement of the commissioning dates of major energy projects, rather than to their outright cancellation. Capital requirements in the power subsector in 16 DMCs²² in the period 2000–2005 have been recently estimated (rather conservatively, tempered by the recent crisis experience) at $178 billion ($112 billion for generation and $66 billion for transmission and distribution), or at $30 billion per year. In the hydrocarbon subsector (oil and natural gas), capital requirements for the same period in seven large DMCs²³ are estimated at $101 billion ($48 billion for upstream investments and $53 billion for downstream investments), or at $17 billion per year²⁴. Total investment in energy sector projects with private participation in DMCs reached a peak in 1996 ($17.2 billion) and dropped dramatically in 1998 ($5.7 billion)²⁵. However, world capital markets still have considerable liquidity and can meet a large portion of Asia’s capital needs for energy by adjusting their portfolios by not more than 1 percent. As observed in the Fourth Asia-Pacific Economic Cooperation Finance Ministers Meeting in the Philippines in April 1997 and further elaborated in the documents prepared for the sixth meeting held in Malaysia in May 1999, it is up to the DMC governments to win back the confidence of international investors by focusing on six key responsibilities: (i) sound macroeconomic management by pursuing prudent monetary, fiscal, and exchange rate policies; (ii) stable and transparent legal framework and regulatory systems; (iii) sound sector policies promoting competition and change in the role of government from that of owner and operator of energy facilities to that of provider of independent regulation; (iv) development and deepening of domestic capital and long-term debt markets; (v) adoption of sound risk-sharing practices without eroding market discipline, when resorting to BOT transactions; and (vi) ensuring good governance by, inter alia, using transparent international competitive bidding (ICB) procedures for the selection of independent power producers or strategic partners for the privatization of energy facilities, as well as by making decisions on such matters strictly in accordance with the law.

Role of BOT projects

72. The BOT approach has played a significant role in attracting private sector investment into the energy sector in the region. In using this approach, however, DMCs have not always adopted competitive and transparent processes. This tendency has given rise to questions on governance and the adequacy of regulatory and institutional frameworks to be able to make the best use of the BOT approach. For example, a large number of projects were finalized by DMCs on the basis of unsolicited proposals without transparent ICB, and the prices for electricity agreed in many cases were higher than the avoided generation costs of the utility and sometimes even exceeded the average end-user tariffs. In many private power projects, a state-owned electricity utility acted as the single buyer on the basis of a long-term take-or-pay contract for the full output in terms of capacity (MW) and energy (gigawatt-hours), and the transaction was covered by some form of government assurance of the utility’s payment obligations. DMC governments or their agencies provided guarantees to projects to cover various risks such as dispatch risk, market risk, payment risk, and exchange rate risk. Also, projects were provided with assured returns. While the need for clear, long-term contracts was understandable to attract private sector investors in the face of various risks faced in the DMCs, in hindsight, the contracts could have been made less rigid and allowed for flexibility to adapt to rapidly changing circumstances such as those experienced recently in the region. A net outcome of this rigidity of higher-priced contracts has been that many of the DMCs need to substantially increase consumer tariffs to maintain the financial viability of their power utilities. In some DMCs, such tariff increases have not been possible and utilities are compelled to provide services below cost, which results in huge financial losses.

73. The financial crisis has highlighted some of the dangers arising from the PPAs and other contracts due to foreign exchange, maturity, and capacity mismatches. Since these contracts did not usually provide for invoking force majeure and relaxing the fulfillment of obligations, the DMCs are looking for ways to deal with the situation. It has been relatively easier to address the contractual issues when (i) the sponsors were selected through a transparent and competitive process; (ii) a major portion of the power sale price was not linked to the exchange rate; (iii) capacities under BOT contracts constituted a small part of the country’s capacity; and (iv) parties were prepared to renegotiate some of the terms, like commercial operation date, in view of the lower demand growth. Considering that a number of DMCs are expected to move toward a competitive market in power generation, it is preferable to provide for such a possibility in BOT contracts and renegotiate the terms of participation in the market when competition is introduced.

74. On the other hand, there have been some BOT projects where the selection of independent power producers has been through ICB and it resulted in very competitive prices of electricity. An example of this is the ADB-supported Meghnaghat gas-based combined cycle power plant in Bangladesh. Bids to develop the project using the BOT approach were invited and evaluated on the basis of quoted wholesale tariffs, which allowed bidders to be innovative with project design, risk mitigation measures, and financing plans to make the tariffs competitive. The lesson herein is that the success of BOT projects depends on the existence of supportive frameworks and the approach adopted in applying the model.

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