Proposals for the financing of Phu My 2.2, a 715MW gas fired power station sponsored by Electricite de France (EDF), Tokyo Electric Power Company (Tepco) and Sumitomo Corp, estimated to cost between $400 and $450 million, were due to be submitted on 23 October. Close on Phu My 2.2's heels, banker's expect another power project deal for Phu My 3, a 720MW facility sponsored by BP Amoco, SembCorp and Kyushu Electric. The two ventures are part of the overall 3,600MW Phu My power and Nitrogen complex, one of the key infrastructure schemes in Vietnam's national power development master plan.

The two projects are being planned around what bankers describe as fairly standard IPP formats. But given the nature of the government in Vietnam and the fact that there is no track record of project finance in the country, the financings will be about as speculative as any in the project finance universe. As one banker in Hong Kong puts it: ?Vietnam's right out there at the end of the spectrum in terms of project finance risk.?

One aspect of the Vietnamese power industry that hasn't worried the banking industry so far is deregulation. In broad terms EVN aims to develop a national electricity grid by 2020 that will include power stations driven by a range of energy sources. By 2005, EVN plans to build a series of hydropower plants in the country's central highland regions. Three hydroelectric dams, with capacities of between 285 MW and 370 MW will be built with the construction of the first at Dai Ninh set to begin in 2001. Construction of Vietnam's first nuclear power plant is included in the plan, to be completed by 2020. These projects are being financed with assistance from multi-lateral agencies including the World Bank.

?If deregulation is going to happen its not going to make much progress for at least 10 years, possibly 20,? believes the same Hong Kong source. However, Oliver Massmann, a lawyer with Baker & McKenzie in Hanoi, disagrees. ?The power purchase agreements that both Phu My 2.2 and Phu My 3 have signed with Electricity Vietnam (EVN) might not last beyond 2006 when the country has to meet its WTO obligations because of the changing face of the power industry,? he says.

The government has set out a five year restructuring and equitization plan for EVN between 2001 and 2005 which will see the monopoly's generation, transmission and distributions businesses split off from each other. The equitization plan has not yet been published and until recently it was expected that the government would continue to hold a 70% majority stake in EVN and its subsidiaries.

The bilateral trade agreement signed between the US and Vietnam is changing the rules about ownership. The agreement gives US companies the right to buy majority interests in the deregulating power industry after a six-year grace period starting from when Vietnam officially ratifies the treaty (ratification is expected to happen this month). The central government has actually stated that foreign companies from all the developed nations, not just US firms, will be able to buy majority stakes in Vietnamese power companies.

No one is willing to predict how the restructuring of the power industry in Vietnam will unfold. Bankers involved in financing Phu My 2.2 and 3 will take comfort in the termination and price stabilization clauses attached to the PPA contracts. They also know that, in a competitive pooling system, were one to be established, the two new Phu My power facilities are amongst the cheapest cost producers in the country.

The tariffs that the two power stations will get from EVN are also competitive, even by international standards. According to one source close to Phu My 3, the plant will get 4.09 cents per Kilowatt-hour (Kwhr) for its electricity. By comparison, the state electricity monopolies in Indonesia and the Philippines (PLN and Napocor) had to pay 6 to 7 cents per Kwhr to some independent power producers. It is therefore highly unlikely that renegotiations of PPAs will occur, as happened in the Philippines, in which tariffs paid to the IPPs are substantially cut back.

Bankers are relatively comfortable with Vietnam's IPP risks. Vietnam's legal system, on the other hand, is uncharted territory, even for lawyers. Phu My 2.2 was delayed more than a year due to legal concerns. ANZ bid for the finance advisory mandate for the project as far back as 1998 and was awarded the role in 1999. But the financing made little progress in 2000 because most of the necessary legal framework still had to be drawn up and enacted. While lawyers say that much more still needs to be done, the good news is that the government is moving extremely quickly to establish a legal framework for all sorts of financing transactions including project finance. ?Forms of security are still very limited but it is now possible, for instance, to arrange mortgages,? says Massmann.

Massmann admits that procedures to enforce mortgage claims are still absolutely untested. However, the Vietnamese authorities have been particularly efficient in processing most of the necessary documentation for the power projects which indicates a clear commitment to seeing these sorts of ventures succeed. It is now taking only a week for some energy projects to get operating licenses when sponsors had previously to wait two to three months.

But in order to deal with this legal landscape, sponsors have naturally sought extensive undertaking guarantees from the government. The precedents are good. In recent years energy and power projects have been favoured by the Vietnamese authorities ahead of other types of ventures which also have foreign backing.

Sponsors and financiers will also seek state guarantees to avoid potential problems over the convertibility of the Vietnamese Dong and a shortage of US dollars. The Dong is not freely convertible nor is hard currency a readily available commodity in the country. In the recent, $154 million Thu Duc water treatment plant financing, the arranging banks tried to tackle the foreign exchange problem by seeking an availability guarantee from the State Bank of Vietnam. When it became apparent that wasn't feasible, the arrangers went for a more practical approach, seeking and getting priority of access to US dollars at the state bank level, ahead of the majority of other foreign lenders to the country. Banks lining up to finance Phu My 2.2 expect the power station to be at the head of the queue (and ahead of Thu Duc) for US dollars.

Since Vietnam's exports are small, the global economic slowdown raises justified concerns about the availability of hard currency and the stability of the Dong. Vietnam's central bank recently considered revising downward its GDP growth projection from 7.5% to 7.1%. While that looks very strong in the current global economic context, the export sector is weaker than the domestic economy. Nevertheless, export growth is forecast to remain above six percent this year, compared to last year's 25%.

The gas supplies to fuel the Phu My power stations are to be delivered using infrastructure built at the same time as the power plants. Sources involved in Phu My 2.2 say that BP Amoco will have the main responsibility for constructing the offshore infrastructure while PetroVietnam will build the onshore facilities. Bankers say BP is financing its gas supply commitments on a corporate basis.

The Vietnamese government approved the $580-million gas pipeline project between BP and PetroVietnam in November last year. The pipeline is part of a total $1.5-billion integrated project involving the use of gas from Lan Tay and Lan Do fields off the southern coast, an undertaking in which PetroVietnam has a 51% stake. Survey figures show Nam Con Son has reserves of 59 billion cubic meters of gas, which would be commercially viable for 20 to 25 years. The peak pumping rate envisaged is 2.7 billion cubic meters a year. Other new gas finds have combined reserves of about 30 billion cubic meters.

Market observers say that the response to Phu My 2.2's request for financing proposals has been mixed. It is expected that the major French banks, including Societe Generale, BNP Paribas, Credit Lyonnais and Credit Agricole Indosuez as well as Japanese finance houses including Sumitomo-Mitsui will be submitting proposals given the sponsor profile. ANZ Investment Bank, which is acting as adviser to the consortium, is putting in a financing bid. Fortis Bank, one of the key arrangers of the first BOT project financing in Vietnam is also expected to be amongst the bidders. However, US banks, with the possible exception of Citibank, are not expected to be involved.

Interestingly, banks were asked to submit proposals individually and not in conjunction with other finance houses at this stage, an indication says one banker that sponsors did not expect a large number of bidders. The beauty parade of bidders was held in Hong Kong on October 29.

A second source in Singapore says that multilateral support for the project could be accessed from six sources: ADB, JBIC and Proparco, who are all expected to provide direct loans, and from the World Bank, the EIB and Coface. The project sponsors are still negotiating with the multi-laterals for extended political risk insurance. The banker says that equity will account for 25% of the total project financing amount ($400 million plus additional contingent financing). EDF will inject the majority of the equity into the project (56.25%). Sumitomo will put in 28.125% and Tepco 15.625%.

The three sponsors have set up a project company called the Mekong Company (Meco). It is in Meco's name that the financing will be arranged. Mekong is also responsible for building the 715MW gas-powered station and managing it for a period of 20 years. Work on the station should begin in the middle of next year, with the plant opening scheduled for September 2004. The Vietnamese government has given the sponsors a 12-month window to reach financial close.

Phu My 3, was originally to be financed in a quite different way to Phu My 2.2. The sponsors of the deal when the project was first conceived were BP Amoco and Statoil. The two planned to finance the entire cost of the venture with their own equity. When Statoil pulled out of the project and new partners had to be found, BP had to revise its funding strategy and consider bringing in bank debt. BP was originally advised by Citibank on the funding of Phu My 3. Since the change in equity partners, no new adviser has been appointed.

BP and its new co-sponsors SembCorp and Kyushu Electric are now talking to banks about financing options. Rather than arranging financing prior to construction as Phu My 2.2's sponsors have done, the sponsors have had to start construction to avoid breaching agreements signed with the Vietnamese government and pull the financing together at a later stage. ?This puts Phu My 3 in a slightly more difficult position but I don't expect the debt pricing to be substantially different to Phu My 2.2 unless BP and its partners decide to opt just for post-construction financing,? says another Hong Kong-based banker.

To price the two deals bankers will look to the Thu Duc pricing for some guidance, (pricing on the Coface and OND export credit loan tranches of the water transaction were 200bp over Libor and 80bp respectively) but the Phu My financings are fundamentally different deals with different risks. ?We expect pricing to be a little above the Thu Duc levels,? says the Hong Kong source, ?if only because a slightly larger volume of funds is needed.? n