With Bank Austria and local affiliate BPH PBK officially mandated last month to arrange the Eu215 million Warsaw Airport second terminal 15-year EIB loan commercial banking guarantees, Poland is again showing signs of being the accession country most likely to project finance ? albeit on Polish government terms, which are rarely straightforward.

And the Warsaw deal does look good for the government. The structure is technically corporate to afford more lender comfort but is backed by project-type revenue streams from the existing terminal and forecast revenues for the second terminal. And although sponsored by state airport operator PPL, the deal comes with no Polish sovereign guarantees.

The deal ? if and when it goes ahead ? should boost project banking interest in the country, which has wained over the past couple of years after an initially promising burst of power privatisation sales and associated debt financings in the late 1990s.

But if the Polish infrastructure market is showing signs of growth ? the deal potential in the Polish power market remains a long way off while the government struggles with EU environmental and liberalsiation benchmarks and an outdated but overproducing power sector

Since the initial deals privatisations have been few and far between and there has also been slow progress made by the government in liberalising the electricity market, and putting in place a new tariff system that bankers can work with when doing their cashflow predictions.

The situation is made worse by the fact that in the Polish power sector has excess capacity at present, which, coupled with efforts at market based pricing, put downward pressure on investment returns. There are a few greenfield projects on the drawing board, but most of the activity centres on replacing or upgrading large numbers of environmentally unsound coal-burning power plants that were built during a period of rapid expansion in the 1970s. The latest Polish power plant to be privatized ? the coal-fired Zespa Elektrowni Dolna Odra ? only attracted one bid, from Electrabel.

EU incompatible with power reality

?Investment banks are trying to get deals underway, but the regulators and the government have not sorted out what they are going to do with long term Power Purchase Agreements [PPAs],? comments one French banker. ?So until people know where they stand with that it is very difficult to get any investment. They are under pressure to cancel them in order to comply with the EU Electricity Directive, but obviously you can't finance a power station on the back of a market situation that nobody understands, so over the last two or three years have been no new deals, and I don't think there will be any closed in the near future.?

?Around two-thirds of the electricity sold in Poland is currently being sold under long term Power Purchase Agreements between the generators and the grid at above market prices, and there are various plans from the government to try and restructure those PPAs, and create a more competitive marketplace? explains Michael Davies, partner at Allen & Overy in Warsaw. ?However the banks who have financed power stations, and have security over these long term PPAs, do not want to give up their security.

One example often cited by bankers is the Elektrownia Turow project, which is a giant 2000MW lignite fired complex. The first two stages of modernisation involved $570 million worth of bank debt, and stage three involved $650 million, including the first ever project bond on the international capital markets out of Poland. The availability of security over the PPA receivables was a key factor for lenders in all three stages, and the project bonds were rated BB by Standard & Poor's.

Other high profile foreign investments backed by bank debt include EDF at the Krakow-Leg heat and power plant; MEAG at the Bedzin combined heat and power plant; Vattenfall at Elektrocieplownie Warszawskie, Tractabel at the Polaniec Power Plant; and EDF and EnBW of Germany at the Kogeneracja plant in Wroclaw.

If PPAs involving these plants are now cancelled because they are considered anti competitive, it will severely impact an entire group of international banks and institutional investors, the same people who are needed to finance future projects in the power sector.

?One possible solution is the new scheme to try and raise funds by securitising part of the electricity tariffs, and use that money to compensate the generators and the bank lenders,? says Davies at Allen & Overy.

According to rating agency Fitch Polska, the power grid operator Polskie Sieci Elektronenergetyczne (PSE) has already begun preparations to raise $1.5 billion in the international bond markets by securitising a new tax paid by electricity consumers, but some legal changes are still required before the deal can move forward.

So, with bankers waiting for clarification of the PPA problem, new project lending activity has ground to a halt. In the meantime, the government has been dragging its feet on the privatisation front.

There are plans afoot to merge various state-owned power companies, such as PKE with Stalowa Wola Power Plant, to ready them for privatisation. But process is very slow, and government is now saying that privatisation of energy plants is scheduled to start in 2004 at the earliest. And investors are sceptical about this timeline.

The current government is now on its third Privatisation Minister, after less than two years in office, and the privatisation programme seems directionless. Foreign power companies interested in acquiring existing power plants are having to wait.

In March there were some encouraging signs, when the State Treasury said that it was once again holding talks about the sale of its 50% stake in Patnow-Adamow-Konin (PAK), which is the country's second largest generator.

This three plant PAK complex in the west of Poland, which burns lignite fuel, is badly in need of new investment. But the Polish power and telecoms conglomerate Elektrim, which acquired a 39% stake in PAK in the late 1990s as part of the privatisation process, has had its own well-publicised financial difficulties, including missing payments on a convertible bond back in 2001.

Elektrim had committed to invest $1 billion in PAK over a ten-year period, but lacks the resources. Last year there were attempts to raise $500 million worth of fresh financing for a new generating unit at PAK, using a mixture of European Bank for Reconstruction and Development (EBRD) funding and commercial bank debt.

But one of the key contracts at PAK relied upon a guarantee from Elektrim, and banks were unable to get comfortable with the credit risk associated with Elektrim.

Thus what was to have been the single bright spot in power sector financing in 2002 also fell through.

The shape of energy markets to come

Meanwhile bankers are watching to see the new shape of the electricity market emerge. The main legislation covering the sector is the 1997 Energy Act, which is amended from time to time. It created the basic framework for the private energy sector, and established the independent regulatory body Urzqd Regulacji Energetyki (URE) to oversee the sector and issue licences.

The latest update to the Energy Act, from last August, are related to compliance with the EU Internal Market Directives on electricity and gas, and some important steps will have already been taken prior to joining the EU next summer.

Part of the new market structure could involve limiting PSE to the transmission sector, and will allow distribution companies and big industrial users to negotiate their own wholesale prices. This will begin with the very largest companies which consume in excess of 10GWh per year, gradually being extended to include customers with lower annual consumption.

But this still involves addressing the existence of the many long term PPAs and setting up mechanisms to create a market and an efficient pricing system. The Power Exchange is however already up and running, and wholesale electricity is being bought and sold on the Exchange, whose members are the main generation and distribution companies.

While various plans are being discussed, bankers say that they do not expect to see any sizeable power sector financings close in 2003, and are just hoping that 2004, when Poland is expected to join the EU, will show more signs of life.

?We are currently talking to people about projects, but they are not really at the stage of being live deals,? says a financier with a German bank. ?We certainly have an appetite for stuff in sectors such as power, waste and environment, but there is a lot of EU money sloshing around, and many projects are just getting done with EU funds, and so never reach the market. But there is a massive need, and Poland has got to be an important market in the future.?

In the meantime there is some syndicated loan activity alongside players such as the EBRD and EIB. Soon to come up for board approval at the EBRD is part financing for the Polyolefins Project located in Plock in Cenral Poland. The project, which will be located adjacent to PKN Orlen's refinery complex, will produce polypropylene and polyethylene, and will primarily supply the rapidly growing market for plastics in Poland and Central Europe.

There has been very little modernisation in the chemicals sector, mainly because of the slow pace of privatisation. The sponsors are PKN Orlen and a unit of Netherlands-based petrochemicals company Basell NV. Total project costs are estimated at Eu435 million, with Eu320 million of this comprising bank debt, and the EBRD expects to provide an Eu85 million portion of the bank debt.

Waste-to-energy beginnings

Taking a more long term view, players such as the US Trade Development Agency (USTDA) are making small grants to help American companies get the inside track in areas such as Waste-To-Energy (WTE), as EU accession will necessitate much stricter targets for environmental standards.

The USTDA believes that projects in the WTE and renewable energy sectors are foremost among commercially viable environmental investments in Europe. The USTDA has already made a small feasibility study grant towards a WTE facility in Konin, and an offshore wind farm project in Poland.

Last December the USTDA awarded a $418,000 grant to Heat and Power Associates Polska (HPA) for a feasibility study on the modernisation of a combined heat and power plant in Torun.

But bankers have been here before on WTE deals which have never closed. For example, in 2000 the Bydgoszcz WTE project was being pushed forward with Credit Agricole Indosuez as financial advisor, but this Eu130 million 200,000 t/y waste to energy plant never got off the ground.

In the meantime bankers are having to look at other sectors, such as PFI. One encouraging sign was the selection in January by the EBRD of a consultant to help the municipality of Warsaw prepare the expansion of the Warsaw Metro.

There was fierce competition, and the winner was the Dutch based research and consultancy firm ECORYS. The Eu1.5 billion project involves an extension of an existing line running North-South and the building of a new line running East-West.

It will be implemented via public private partnership, and should be ready for tendering by the end of this year. In addition, the ECORYS-led consortium will support the Polish Ministry of Infrastructure to set up a PPP Task Force to further extend the concept of PPP in Poland. The other members of the consortium are law firm Allen & Overy, the German based rail engineering firm TransTec, and the UK-based engineering firm MottMcDonald.