Fast on the heels of the recently completed restructuring for Meizhou Wan, banks are working to restructure two more refinancings for foreign owned IPPs in China. One sponsor suggests investors in a large number of other IPPs are also overhauling original funding deals. Although the reasons for the restructurings are not identical, tariff revision is a common theme for the projects.

Meizhou opens the pipeline

The new refinancings for both French Investment Guangxi Laibin Electric Power (FIGLEC), the owner of Laibin B, and Shandong Zhonghua Power Corporation will involve refinancing dollar debt with Renminbi debt provided by local banks. Meizhou Wan's $566 million debt, including ADB, Coface, CESCE, and commercial bank portions was replaced by a RMB4.3 billion ($535 million) 15-year term loan and RMB130 million three-year revolver.

SG advised the sponsors in Meizhou Wan's refinancing. Another French bank, Credit Agricole Indosuez (now Calyon) has been mandated to arrange the new financing package for Shandong Zhonghua. According to Grace Chen, responsible for the power sector in Calyon's Hong Kong project finance department, the bulk of the new loan package for the project company is also likely to be provided as a RMB loan of about 15 years.

Exact details of the Shandong Zhonghua deal, including the Chinese banks involved, were not available, as Project Finance went to press, although the deal is expected to close in a matter of weeks. In terms of generating capacity, the 3,000MW project is the largest independent power producer project with foreign investment in the Chinese mainland, costing $2.2 billion. The original limited recourse financing was jointly arranged by Greenwich NatWest, IBJ Asia and SG and involved an offshore commercial loan of $350 million, a $312 million, 18-year term loan, underwritten by ECGD, and $822 million in RMB loans.

BNP Paribas is rumoured to be advising on the refinancing for Laibin B, but would not comment on the mandate. That deal, which replaces a financing originally comprised of a $303 million Coface loan, a $159 commercial loan and a $40 million standby facility arranged by Barclays, Banque Indosuez and HSBC, will not close for at least several months and possibly not before the end of this year.

Refinancing was an absolute necessity for Meizhou Wan but not for Laibin B or Shandong Zhonghua. "For Meizhou Wan, the problem wasn't just the tariff, but many other key elements. In fact, Meizhou Wan provides a great lesson in how not to go about power projects in China," says a PRC-based source. He explains: "The project company is handicapped for being a wholly-foreign owned venture and is unable to benefit from the local clout that a joint venture scheme can draw on through its Chinese partner. Its fuel supply and financing, at least until recently, were drawn entirely from foreign sources. It was built with a very high cost EPC contract. And because of the nature of the financing, fuel supply and EPC contract, it produces power at a cost far above that of other generators in the province."

These problems, plus poor customer management, led, according to a local banker, to a fundamental breakdown in relations between Fujian Provincial Electric Power Bureau and the project company and its sponsors. "The power bureau (believing it was being ripped off) made every excuse not to provide a declaration of completion, despite the fact that the plant had been operational for several years," the banker says. In doing so, the bureau was able to buy power from Meizhou Wan at rates well below what the original PPA specified for the plant had it been declared complete.

Saddled with high financing and operating costs and a much lower than expected revenue, Fujian Pacific Electric Company, the Meizhou Wan project company, either refinanced or went bankrupt. "The original lenders themselves were very lucky to get out of the project without taking a hit on their original commitments," says the banker.

But in the end, the sponsors, InterGen, El Paso, Lippo China Resources and the ADB, suffered alone, taking a substantial hit on their returns. Giving some indication of how much returns have been slashed, another banker indicates that Meizhou Wan's tariff fell from RMB0.45 per kwh to RMB0.39 per kwh. This is unconfirmed, however, by sources involved in the deal. A second report suggests the tariff was originally higher, and fell by over 20%, from RMB0.56 per kwh down to RMB0.44 per kwh.

Forced though the refinancing was, there was still a strong financial rationale for refinancing Meizhou Wan, notwithstanding the tariff situation, says a sponsor in the project. "The offtaker wanted this done because there is an adjustment mechanism in the tariff structure if FX rates do change."

The healthier pretenders

According to the local banker, the situation for Laibin B and Shandong Zhonghua is quite different to that faced by Meizhou Wan. The source says: "Neither are distressed projects. Shandong Zhonghua, for instance, is robustly structured and is actually meeting its projected return on equity rate. Approximately 55% of its debt is already provided in RMB (via China Construction bank and Shandong International Trust and Investment Corporation)." Also and very importantly, the offtaker, Shandong Electric Power Corporation, has a 36.6% stake in the project company. The authorities therefore have a considerable incentive to avoid a major tariff reduction.

Grace Chen confirms that Shandong Zhonghua has not been compelled to refinance. "The local currency refinancing does allow the financing to better match the tariff and local currency revenue stream. But even without a new financing arrangement, the project company could quite comfortably meet debt service and its other commitments," she says.

Richard McIndoe, Managing Director, CLP Power Asia, says that, from the start, an eventual refinancing was envisaged for the Shandong project. "As is the case with a lot of greenfield projects, we always look for opportunities to refinance once the construction risk has been removed," says the official.

Because of the strength of the domestic bank market in China, McIndoe adds: "we have been able to take advantage of that strength to lower the interest cost on both the RMB and US Dollar tranches and to extend the loan maturities to better match the life of the assets."

McIndoe reveals that economic benefit from the refinancing will be passed on to the offtaker in the form of a lower tariff. "It is the nature of the PPA contract that reduced costs will be passed on," he says.

McIndoe suggests that the prime advantage for Shandong Zhonghua in the refinancing is in becoming a lower cost and therefore lower risk producer. "We are still able to maintain our target return with the lower tariff," confirms McIndoe.

Shandong and its offtaker are still in negotiations regarding lower fuel and OEM costs.

Jean-Christophe Delvallet, CEO China for EDF, says that tapping cheaper and long tenor bank debt are also the prime drivers for the Laibin B refinancing. "We would also enjoy a simpler, more sponsor-friendly security package with the new financing," says the official.

Significantly, Delvallet indicates that a few foreign banks could be participants in the refinancing. "International banks clearly want to keep tabs on the China market, and the only way to do that in-depth is to be involved in deals," explains Delvallet. Certain foreign banks are considering a small participation in the refinancing, under the same terms and conditions that the PRC banks will accept.

Unlike Shandong Zhonghua, no other aspects of the Laibin B project, apart from the original financing, are subject to review, in order to further reduce the tariff.

Delvallet also reveals that Laibin B's previous tariff revision applies only to excess electricity purchased above and beyond what was originally specified in the PPA. The tariff for the take-or-pay minimum, specified in the PPA, has not been changed.

"What we have negotiated is a win-win situation for both the offtaker and Laibin B," says Delvallet. "Because the cost per unit of additional electricity supply will be lower than the cost per unit of the take-or-pay volume, there is an incentive for Guangxi to take more electricity from Laibin B." And this is exactly what the offtaker has done. Before the tariff revision, Guangxi never took volume beyond the contractual minimum. Now, according to Delvallet, the offtaker is taking much more than the minimum.

Tariff reform to answer shortages?

Banking sources interviewed are not aware of any other upcoming refinancings for foreign-owned power projects in China. The tariff revision issue is affecting power generating companies the length and breadth of the country, including both Chinese and foreign owned plant, says Mary Tang, in HSBC's corporate finance and advisory team. All three of the big listed Chinese IPPs, Huaneng Power International, Beijing Datang and Shandong International Power Development have reported reduced tariffs.

Hinting at the scale of the problem for foreign IPPs, the US embassy in China has claimed some $2 billion of IPP revenue has been under arbitration. And underscoring how severe tariff revisions could be, it is understood that the Fujian provincial government forced the Houshi power facility to sell at just 78% of its previously agreed rate.

A key reason for the drive to lower tariffs, says Scott Roberts, director in Cambridge Energy Research Associates (CERA)'s Beijing office, has been to increase margins for the transmission and distribution sector. "Much of the transmission and distribution business in China is in the red. Clearly the growth of China's power market is threatened if transmission and distribution companies don't have enough money to invest in the grid. So, to correct the situation the central government wants to lower the price per kilowatt hour paid to generating companies, to raise the average rates for consumers, and to pass the difference on to transmission and distribution." Delvallet's information on the rationale for the tariff revisions is slightly different. "Electricity prices will rise for industrial users alone," he says.

The government has also pursued tariff reform to try and bring some structure to what is currently a very uneven tariff system. "There are wide variations in tariffs at the national level, the provincial level, and between two plants of similar age and type," says Tang. There are even instances where two units in the same power plant have different tariffs.

According to Edward Turner, a partner at Shearman & Sterling, which has acted on both original IPP project financings in China and the Meizhou Wan restructuring, China's provincial price commissions have, for the most part, taken a logical, bottom-up approach to tariff reviews. "If a plant is supplying electricity at rates above those of other plants in the region, the commission involved will look at the various inputs into the tariff formula. It will try to have the high cost elements revised, allowing the overall tariff to be brought down."

Although Turner would not comment on the specifics of the Meizhou Wan case, he says tariff reviews have examined the cost of operational aspects, fuel supply, financing and expected returns. "The tariff review isn't necessarily going to focus on the initial construction cost because that cannot be altered, but a review of a foreign-operated IPP may examine whether reoccurring operating costs can be brought down by localizing many of the operational aspects."

While the recent spate of refinancings for foreign-owned IPPs might suggest otherwise, Roberts at CERA says the Chinese government has actually decelerated its program of tariff reform in the last year, in light of the current situation of supply shortage and rising fuel costs. 23 provinces out of a total of 31 are reporting that there is insufficient generating capacity to meet demand for electricity, and for China as a whole, Roberts expects a net shortage to exist until 2006. "To provide more incentive for generating companies to run and to offset the rising fuel costs (including a sharp rise in the spot price for coal), the authorities are clearly being less aggressive in pursuing tariff revisions at the moment," he adds.

Because of the supply demand imbalance, this is, in fact, a good time to be an IPP in China. "Offtakers want all the electricity they can get, so utilization rates amongst offtakers is now very high," Roberts points out. "Today's market is a benign environment, many foreign players are attaining the sorts of rates of return they originally envisaged," he adds.

The Chinese government is very aware that foreign investment into the power industry has slumped, says CERA, another reason to move more slowly on tariff reform. At the general policy level, CERA's Roberts says the Chinese government has reaffirmed its commitment to honour contractual agreements with generating companies.

Observers will note, however, that such commitments have been made before. Zeng Peiyan, the State Planning and Development minister made a similar pledge in 2002, when the 'Plan for the Reform of the Electric Power System' (primarily focused on breaking the monopoly of the State Power Corporation) was approved. No specific new proposals have been proposed to support existing PPAs.

New plants shun the internationals

Banks do not believe that EdF, a key sponsor in both FIGLEC and Shandong Zhonghua and the largest foreign investor in the PRC electricity market, has any firm new investment plans in China. Delvallet confirms this. Asian power companies, which are the most active cross-border players in the global power market (Singapore Power, for example, has just purchased TXU's Australian energy assets), are not making large-scale investments in the Chinese power business.

Delvallet says EdF has no immediate plans to invest in new greenfield IPPs because its core strategy lies mainly in participating in markets outside of Europe as an industrial operator and service provider (design, engineering services etc) rather than investor. "The question is not: do we want to invest, but how are we best able to bring our industrial know-how to the market? Indeed, the reason we invested money in Shandong Zhonghua and Laibin B was so that we could exert the full scope of our industrial know-how," he says.

Even if EdF does not currently have plans to build new greenfield power projects, the company is exploring long-term strategic partnerships with prominent Chinese generating companies. Delvallet says, for the most part these partnerships will be industrial and technical partnerships (for example EdF providing consultancy services), and not necessarily investment related ventures.

Delvallet does add, however, that his company's concerns regarding China investments centre on the absence of new PPA agreements, even more than the tariff issue. "10 years ago new power plants could secure PPAs wherein guaranteed levels of offtake were specified. This is no longer the case and new power plants are being built - in many respects on merchant power terms. This reinforces our willingness to enter into long-term partnerships with major Chinese players, rather than looking at project-by-project opportunities."

Given this business focus, EdF's position as a foreign electricity company in China is somewhat unique, CLP's principal approach to the market may be more instructive. "The risk of tariff revision has encouraged us to pay even more attention to average tariff rates in the areas where we are considering a new power project," says McIndoe. CLP would continue to pay greatest heed to these local averages even if it got assurances and specific local and central government approval for a higher tariff rate, unless there was a powerful rationale for a higher tariff, such as the project being a more environmentally-friendly power producer.

McIndoe says that CLP is currently looking at three greenfield power projects in mainland China. The three are: a 1200MW coal-fired facility in Guangxi Province, another 1200MW coal-fired power station, this time in Anhui Province, and a 1000MW hydroelectric project in Sichuan Province. "The three projects are currently going through the feasibility study stage," says McIndoe.

Apart from the tariff issue, the prospect of oversupply from 2006 is no doubt a major deterrence. Roberts says that the central government now expects 430GW of new capacity (in the form of both greenfield power stations and expansions of existing facilities) to be on line by the end of 2005. "There will be additional capacity expansions above that number," says the analyst, "as small-scale plants will be built with local approvals and local finance."

These plants are being built under the assumption that there is no significant fall in projected electricity demand growth. "But the risk that demand growth will fall is high," says Roberts. "We estimate that about a third of the growth in demand over the last few years has come from four industrial sectors, cement, steel, aluminum and chemicals, all of which are very sensitive to a slowdown in the economy at large."

Foreign investors are also concerned about the government's medium-term plan to introduce a power pooling system into the China market. "These concerns are likely to be there for some time," says McIndoe. "I don't think we will be seeing comprehensive details of new pool rules for some time." Uncertainty over the new pool rules serves to underline the importance of CLP's strategy of concentrating on low cost projects with are competitive with other local power plant. "This gives us good comfort that the projects will survive long term," McIndoe comments.

HSBC's Tang indicates that a pool market will be introduced into Guangdong province as early as 2005 or 2006 and notes that the gas-fired power stations being built in Shenzhen (and backed by local sponsors) have only been able to secure short-term, interim PPAs of between 3 and 5 years.

Tang advocates a different approach to investing in the market to that traditionally adopted by foreign power companies. If international players want to be in the market, they need to adopt an approach very similar to Chinese investors or CLP Power China. That is to say a very commercial view, paying very close attention to average tariffs across the grid and average utilization rates. Foreign investors also have to accept that the returns in the high teens, which they once took for granted, are probably a thing of the past.?