From BOT to BOO-m
In Turkey, few topics are taboo anymore ? even the authorities'
past disdain for human rights talk, one of the biggest blocks in
the way of Turkey's EU membership, has matured into a more liberal
minded debate. As momentous, though, is the country's power sector
reform.
So far, progress on the ground has failed to match the fervent pace of planning and revision. But with the mechanics now mostly in place, this will change.
Broadly, the plan is to privatize power generation and distribution and to encourage more foreign investment. Indeed, power privatization has been twitching on various government agendas since Ozal's administration introduced the Build Operate Transfer (BOT) scheme in 1984. But only now is private sector power generation and project finance-coloured foreign investment inching towards a sizeable, and palpable, reality, with a few conspicuous energy projects reaching financial close and several dozen projects in tender or awaiting approval.
The depth of Turkish power demand is far from trivial. The government plans to add an ambitious 40,000MW of new generating capacity by 2010, requiring, by World Bank estimates, roughly $2 billion a year.
The backdrop to all this is encouraging. The economy, though stuttering, has grown fast. The centrally-planned system nourished by decades of Kemalism, is gladly yielding to the market and privatization. As Christopher Wilkinson, Intergen's vice-president and country executive puts it: ?Ozal's reforms have taken off. People have digested them and Turkey has finally come of age as a people.?
There are many reasons for optimism. In December the government disclosed an IMF crafted three-year reform program. If all goes according to plan, Turkey will be down to single digit inflation by 2003 ? a vast drop from the last decade's average of 80%. The debt to GNP ratio is falling, interest rates have declined rapidly and output growth is resuming. In sum, this has generated the much needed credibility in international financial markets.
Politically, Turkey is enjoying its most robust government in years, Prime Minister Bulent Ecevit's three party coalition, which is eager to see to completion the reforms it has helped initiate.
With its optimal geopolitical poise and a long-term commitment to the EU in the works, Turkey is open to an ever-increasing surge of foreign investment. Moody's is expected to upgrade Turkey's sovereign rating from B1, four steps to investment grade, to Baa3 soon. Standard & Poor's, on a the more conservative ? though still confident ? side expects to notch the rating up from its current B+ to BB- later this year.
Legal-ease
Over the last year constitutional upheaval has been the catchphrase of, among other things, power market reform, as Turkey's leaders scramble to hoist the country inexorably westwards. And it shows.The government, as part of its reform program, recently made room for international arbitration for disputes on contracts to which the state is a party. For project financiers, the complaint has typically been the lack of such a clause and the inability to sign private law contracts. Permitting international arbitration eases investor's fears of potential injury by local courts.
?On the legal side, we're now closer than ever to target,? suggests Asli Basgöz, partner, at the international law firm White & Case, who specializes in international finance. On a broader scale, she continues, ?the passage of the recent constitutional amendment demonstrates that the government is committed to these project and can organize a bloc of votes to pass one ? an important step indeed.?
The constitutional amendment allowing private law contracts for the energy sector was enacted in August 1999, with subsequent enabling legislation in October 1999 and most recently in January 2000. But although seven months have elapsed, the progress remains painfully slow.
?As the process of approving and signing continues, we haven't yet seen the vast majority of the projects reach financial close,? says Citibank's head of project finance, Eren Güra.
Moreover, of the dozens of projects permitted to either apply for international arbitration or convert existing administrative law contracts to private law contracts, any sponsors failed to act at all. Explains Ümit Herguner, partner at local firm Hergüner, Bilgen & Özeke, ?for decades they used international arbitration as an excuse, but when the gates were opened for prospective applicants to make the necessary adjustments, they didn't even apply. This tells me the concern was more country-risk oriented than an issue of legal sensitivity.?
Another expert adds: ?International arbitration has been a proxy for a whole slew of international standards that typically apply to project financing, from a lawyer's and lender's perspective.? These issues include allowance for government default, buy-out, and lender step-in or assignment rights.
The launch of international arbitration, then, though perhaps not strictly necessary, has in theory streamlined matters, according to one government adviser, making proceedings less costly in terms of bureaucratic wrangling.
Project Prognosis
Yet to date, a handful of private power projects, all based on the BOT scheme, a concession-financing and risk-sharing model, have successfully circumvented these supposed legal concerns, ?slipping through the cracks,? and casting further doubt on the necessity of the constitutional amendment.
The author of the BOT model, a former adviser to then President Ozal, argues that the success of the early BOTs hinged on their following procedure, without hubris. ?There is no inherent problem in doing project finance in Turkey. There has been a sort of deep-rooted arrogance on the part of many foreign developers. They need to understand that they're not coming into a gold-plated situation. We understood this and we succeeded.?
The BOT program has seen only four power projects reach financial close since its 1984 inception: the 672MW hydro-electric project at Birecik in 1995; two Enron-sponsored 478MW gas-fired projects in Marmara, in 1996; and the gas-fired 180MW Esenyurt project in 1997.
Says Mehmed Çavusoglu, manager at GE Power Systems, ?after this first round of projects, the Turkish mistake was to try to reinvent the wheel. They had four examples of IPP's which passed through the hurdles, secured financing and started production. With that sort of track record, the process was intact. It didn't need to be tinkered with.?
But it was tinkered with. And, just as new legislation cleared the field for a financeable BOT power model, the Turkish Constitutional Court decided, somewhat ironically, that the generation, transmission and distribution of energy constituted a public service. The rules changed again, with private power projects redefined as ?concessions,? requiring considerable revision to the terms of contracts between developers and the state. Outcome ? the delays.
To provide a partial solution to this problem, the build-own-operate (BOO) model was proposed in 1996. Despite its initial shroud of legal uncertainty, the scheme seduced hordes of developers and bankers eager to skirt perceived contractual quandaries. Nonetheless, it defeated the argument that it was a concession contract. A foreign developer, lamenting the legal cramps of late, argues that ?the government went down this traumatic route of changing the constitution when in fact it wasn't necessary. They would have been better off spending their energy highlighting the hallmarks of the BOO program, which is an open, clear, international, pre-qualified tender process, and which achieves benchmark prices.?
Since then, four of five viable BOO projects have reached the financing stage. The first deal, Siemens/Steag 1210MW coal-fired Iskenderun plant, reached successful syndication at the end of June, 2000. The $1.37 billion deal is being financed under a 75/25 debt/equity split, with equity sourced from Siemens and Steag. The $1 billion of 51¼2 year loans will be guaranteed by Hermes, $372 million, OeKB, $136 million, GKA, $356 million, and CGIC, $131 million. Lead-arranging the deal are Dresdner Kleinwort Benson, KfW, WestLB and ABSA bank.
An Intergen-Enka consortium is developing three gas-fired BOO projects. The first two plants, Adapazari and Gebze, are slated to reach financial close within the next few weeks. The third plant, the 1,555MW Izmir, is still in preliminary financing stages. The $660 million Gebze deal is for a 1,555 MW plant, the bulk of financing for which is rumored to come from US Exim, OPIC, Hermes and OND. The 780MW Adapazari plant, at $660 million, will feature a similar financing structure.
The final BOO project fluttering on a hopeful horizon is National Power/Bayinder's 700MW natural-gas fired Ankara plant. The project is still far from securing financing, though it is also likely to pluck its cash from ECA and commercial bank loans. Nonetheless, the entire BOO scheme, which envisages more than 40 billion KWh electricity to be produced annually from its total power capacity of 5,740MW, seems the most flourishing of Turkey's power schemes.
Of over forty proposed power projects, roughly half are BOT projects. The balance consists of projects that transfer operation rights (TOR), where a private company, for a fee, finances and operates a facility for a specified term, before transferring it to the original owner.
Ali Alpacar, vice-president of Chase Manhattan bank in Istanbul, says that after the recent legal amendments, ?the expectation at the beginning of the year was that the BOT's would take off. But, contrary to expectation, this did not happen. The government has cold feet for BOT projects.? Citibank's Güra adds that ?its unlikely we'll see many BOT's come to fruition. Besides, if the core idea is to privatize state owned industries, then transferring the assets to the government after a certain period doesn't make sense. Accordingly, BOO's are preferable.?
The BOT's are still lingering at bottom of the pile. In fact, only one thermal BOT was presented to the cabinet for international arbitration approval ? the Ak-El Yalova 306MW, $242 scheme. Three others, Yilsan/GVA 199MW Eskisehir, PSEG 425MW Konya and Artam Eletrik 206MW Deniz Ereglisi were not put forth.
The three are believed not to have accepted new contract terms in return for obtaining international arbitration. These terms include better tariffs for TEAS, the sate electricity company, compliance with forthcoming Electricity Market Law, no escalation articles and completion of the deal by year-end.
Only one of the large hydro BOT's went forward, Erg Insaat's 250MW scheme, but not the larger Dogus 500MW scheme.
That leaves the TOR projects ? all of them were submitted to the cabinet. ?The immediate need of the country is to advance on these projects,? contends a local developer. ?They lack sufficient maintenance, and they desperately need investment and rehabilitation. Moreover, they will provide a fresh new source of funding for the government, and hence should be a priority.?
Be that as it may, there are too many projects in the pipeline and not all of them will move forward, cautions Ahmet Tüzün, general manager of the local company Marketing, Aviation and Power.
But until the government states its priorities, most agree that it is not easy to speculate with any accuracy which projects will get done.
Such a priority list will likely be encouraged by the following key factors, says Tüzün. Projects with earlier realization dates will be favored. With Turkey's energy supply expected to shift heavily towards natural gas, those projects in line with new fuel supply requirements will be singled out. Projects that can get done more simply with commercial loans and private equity will have an easier time moving forward. Equally important are the demographics of the project: if the project meets an urgent demand in a specific area, it will be prioritized. Finally, projects which don't require treasury guarantees will become increasingly more attractive.
Projects fitting at least these criteria are more likely to attract foreign investment. First priority has since been given to the already agile BOO plants. And with a clear project schedule, it should be much easier to raise finance for the relevant projects.
With deals like last year's Afsin Elbistan B and this year's Iskenderun coming to the market, its hard not to be upbeat about the future of Turkish power project financing. Afsin Elbistan B, at $1.6 billion, marked the largest power financing ever done in Turkey, adding 1,400MW to the country's 21,000MW capacity, now up to 24,500MW. Financing consisted of several loans backed by government and export credit agencies and commercial bank loans, lead arranged by Citibank. Although a full-recourse deal, it is a rousing example for those interested in the future of limited and non-recourse financing in the country.
Beating bureaucracy
With the resolution of most alleged legal qualms, the gradual bolstering of government and economy, and ensuing credit rating upturns, the maddening question is why, aside from the advancing BOO scheme, the momentum for further power project finance still dithers.
?This is essentially a Turkish domestic problem,? explains a local developer. ?What we've been seeing over the last several months is the state bureaucrats trying to seek coverage, trying to search for a responsibility sharing mechanism for the new contracts, and this is delaying the process. We, as developers, are still lumbering down the lane, while the bureaucracy is trying in its drawn-out way to diffuse its responsibilities.?
Also, with each swig of IMF stabilization, inflation drops further. This aggravates somewhat the problem in the short run: within a swiftly mutating business community, many private companies have not fully restructured themselves to play according to the new rules of low inflation.
Commenting on why several international developers have failed so far to advance their projects or have retreated entirely from the Turkish market, a foreign adviser to the government appeals to psychology: ?the problem is a question of misguided attitudes. Many developers approach Turkey the way they approach the US, neglecting the fact of a different motivational structure, legal framework and economic climate.? His appraisal, then: ?its like trying to bang a square peg into a round hole.?
Part of this understanding means grasping the fact that power is fundamentally a public policy issue in Turkey. In fact, domestic power pricing is the largest single policy issue facing the government. And the single biggest risk to the government is no power. So, argues the adviser, when the government vacillates or cuts back developers' options, it is simply playing safe.
?If progress is to be made,? concludes Yüksel Güler, general manager of local company Zorlu Enerji, ?one or two new examples need to be set, to pave the way for new projects?.
The current friction, it seems, is primarily procedural in nature. But, nonetheless, it needs to be addressed before non-recourse money comes to bear. ?If there had been a true non-recourse example set in another industry, that would have helped. But there aren't any,? shrugs another developer.
The only projects so far to slither along unimpeded are the auto-generation facilities. ?They have been a quiet success,? describes Güler. The scheme allows local manufacturers to generate their own power, primarily for the producer's use ? but it can also be sold on to the national grid. These projects are typically small enough to be financed by capital-limited local banks.
But suspicion lingers around the vast number of projects actually awarded tender. ?No one can say that the initial number of projects was truly realistic,? admits a local developer, ?the bureaucracy was inclined to create more projects than necessary in the hope realizing at least some of them earlier. But the number of projects piled up, in part because, despite the legal system being ill-equipped for true non-recourse project finance, the hope for a remedy persisted. As that remedy, constitutional amendment, was slow to arrive, many projects were created to simply bypass this obstacle using other financing techniques, such as commercial loans.?
Treasury guarantees
To boot, the question of treasury guarantees cuts directly to the core of the energy debate. The IMF standby agreement and World Bank reform package limit the issuance of treasury guarantees, in an attempt to restrict contingent liabilities. But all project finance deals to date have been fully guaranteed by the treasury.
Citibank's Güra clarifies: ?in line with the restructuring towards a free energy market, it's logical to reduce guarantees.? Referring to the projects already underway, he adds, ?those that have an earlier impact on Turkish energy shortage will still enjoy treasury guarantees. The others still to come on line will have limited guarantees.?
But the offtaker, TEAS, suffers from a limp balance sheet, and, accordingly, is having a hard time meeting its take or pay obligations. And the guarantees are on the utility company's payments. Many bankers argue that TEAS lacks credibility and thus needs treasury guarantees: ?there's no way a project involving TEAS will get done without treasury guarantees.?
The only thing that would ensure a treasury guarantee non-requirement, then, is the strength of TEAS' balance sheet. And until it perks up, through impending market reforms, the requirement, albeit curbed, will persist.
?I personally don't see a way out of this without raising tariffs,? concludes Tüzün. ?If subsidies are discontinued, the only way to correct the balance sheet is to raise the tariffs. And the net effect will be a net increase in tariffs to the public and to businesses.?
Criteria for treasury guarantee provision are being worked out currently. For BOT's, guarantees are likely to be issued to cover payment obligations of public institutions or local authorities to project companies. Additionally, they will cover the repayment of subordinated loans obtained by companies from international credit institutions. And finally, they will include the repayment of senior loans obtained by project companies from international credit institutions in case of early termination of implementation contracts.
These guarantees provide the basis for take or pay obligations under certain energy sales agreements as well as debt assumption mechanisms under implementation contracts relating to power projects.
Regulatory Framework?
With this wide wave of reforms, Turkey is set to move much more aggressively towards real market energy models. It has reached a comprehensive agreement with the World Bank to fortify the legal framework, establish an energy regulatory body, and drain out costly ?take or pay? deals, all spearheaded by a $750 million World Bank loan.
In a letter to the World Bank, Recep Onal, Minister of State for Economic Affairs, insists that the government is addressing the frail regulatory environment for energy by moving to a competitive market, through privatization: ?The cornerstone of this new approach will be the electricity market law currently under preparation.? He continues, ?The law will meet applicable EU standards. It will establish an independent regulatory body with full authority over tariff policy, establish the framework for a competitive market and set a clear timetable for moving to the market model of 1.5 years following enactment of the electricity market law.? The government expects the law to be enacted, on a liberal estimate, by the end of the year, with technical assistance being provided by the World Bank Group.
The Draft law supposedly submits several innovations. For instance, it allegedly authorizes project companies the retail and wholesale of electricity, also allowing wholesale electricity trading companies to import and export electricity.
Further, under the new proposals, licensed private legal entities, other than the authorized project companies, may enter into option and future transactions regarding the sale for electrical energy.
The law will introduce certain restrictions on project companies operating in the sector. For instance, a distribution company will not be allowed to generate electricity. Also, companies' total market share thresholds will be limited. and, in the case, of generation, will not be allowed to exceed 20%.
Transition provisions will be enacted to protect companies that have already executed contracts.
But an informed local developer is not so satisfied: ?having looked at the latest draft of the electricity market law, I'm not satisfied with the state it's currently in. Such a law can only be properly drafted when supply exceeds demand. But we're currently in a deficit situation in which it's not so easy to talk of a market place as such.? And there's more: ?The latest draft also lacks what's at the heart of the matter, namely, a priority list of projects, generators and their prices, from the purchasers' perspective, instead of an outline of how the committee intends to oversee procedures.?
As a preliminary step toward a real market model, the government has split TEAS into distinct generation, transmission and energy trading companies. A state monopoly will be reserved for transmission. Authorized private legal entities will undertake all other electrical energy related activities. Describing the anticipated market model, Sankaran Balasubramanian, the IFC's country head, points out that ?the regulatory authority won't be a free electricity on tap model, which some Latin American countries have adopted. There will be some kind of price-fixing. We're essentially looking at an intermediate market model where there will obviously be different producers whose pricings will be set by the authority, based in part on fuel supply.?
The World Bank Group wants to see a complete overhaul of the energy environment to avoid, as one expert puts it, ?a sector regulated by a bunch of ad hoc contracts between the developers and government.?
Hergüner and his legal team expect many existing arrangements at the decree level to be advanced to the rule of law to create a much more consistently regulated energy environment. ?Of course, certain markets in the world are moving towards deregulation,? Hergüner reflects, ?but lets first regulate before we can deregulate.?
Fresh Financing
With the liberalizing of the market, an assortment of fresh financing instruments should begin to surface.
A mixed mood prevails around the immediate future for project bond financing. ?It will take a while for project bonds to be used,? claims Chase's Alpacar. ?It will take a number of deals for people to affiliate themselves with project financing coming out of Turkey, not only because people will want to see how potential problems are dealt with but also to see and realize that there are obvious opportunities in Turkey,? he adds.
But given the impending credit rating upswing, there is hope yet. ?The turning point will be Turkey hitting investment grade,? insists Garanti Bank's project finance vice president, Ugur Turkmen.
The IFC's Balasubramanian agrees: ?with some firms already having proved themselves, they should have easier access to international bond markets. And with interest rates declining on government bonds, there's a good chance of setting off the domestic bond market.?
Securitization is also an efficient tool for creating ample headroom for companies by packaging and pooling the risks of their different assets. The problem, says Balasubramanian, is that ?it's a nightmare in terms of the current legal framework. The Central Bank has asked for our assistance in streamlining the securitization rules.? To date, the IFC has done the only existing asset securitization in Turkey, last year's Garanti leasing securitization, which picked up Euromoney's Deal of the Year Award. With the structure of asset ownership being reworked legally, securitization is set to become a more frequently applied tool.
Regardless, insists the IFC, ?the dollars will be pooled for infrastructure project finance. That's what this country needs.?
So far, progress on the ground has failed to match the fervent pace of planning and revision. But with the mechanics now mostly in place, this will change.
Broadly, the plan is to privatize power generation and distribution and to encourage more foreign investment. Indeed, power privatization has been twitching on various government agendas since Ozal's administration introduced the Build Operate Transfer (BOT) scheme in 1984. But only now is private sector power generation and project finance-coloured foreign investment inching towards a sizeable, and palpable, reality, with a few conspicuous energy projects reaching financial close and several dozen projects in tender or awaiting approval.
The depth of Turkish power demand is far from trivial. The government plans to add an ambitious 40,000MW of new generating capacity by 2010, requiring, by World Bank estimates, roughly $2 billion a year.
The backdrop to all this is encouraging. The economy, though stuttering, has grown fast. The centrally-planned system nourished by decades of Kemalism, is gladly yielding to the market and privatization. As Christopher Wilkinson, Intergen's vice-president and country executive puts it: ?Ozal's reforms have taken off. People have digested them and Turkey has finally come of age as a people.?
There are many reasons for optimism. In December the government disclosed an IMF crafted three-year reform program. If all goes according to plan, Turkey will be down to single digit inflation by 2003 ? a vast drop from the last decade's average of 80%. The debt to GNP ratio is falling, interest rates have declined rapidly and output growth is resuming. In sum, this has generated the much needed credibility in international financial markets.
Politically, Turkey is enjoying its most robust government in years, Prime Minister Bulent Ecevit's three party coalition, which is eager to see to completion the reforms it has helped initiate.
With its optimal geopolitical poise and a long-term commitment to the EU in the works, Turkey is open to an ever-increasing surge of foreign investment. Moody's is expected to upgrade Turkey's sovereign rating from B1, four steps to investment grade, to Baa3 soon. Standard & Poor's, on a the more conservative ? though still confident ? side expects to notch the rating up from its current B+ to BB- later this year.
Legal-ease
Over the last year constitutional upheaval has been the catchphrase of, among other things, power market reform, as Turkey's leaders scramble to hoist the country inexorably westwards. And it shows.The government, as part of its reform program, recently made room for international arbitration for disputes on contracts to which the state is a party. For project financiers, the complaint has typically been the lack of such a clause and the inability to sign private law contracts. Permitting international arbitration eases investor's fears of potential injury by local courts.
?On the legal side, we're now closer than ever to target,? suggests Asli Basgöz, partner, at the international law firm White & Case, who specializes in international finance. On a broader scale, she continues, ?the passage of the recent constitutional amendment demonstrates that the government is committed to these project and can organize a bloc of votes to pass one ? an important step indeed.?
The constitutional amendment allowing private law contracts for the energy sector was enacted in August 1999, with subsequent enabling legislation in October 1999 and most recently in January 2000. But although seven months have elapsed, the progress remains painfully slow.
?As the process of approving and signing continues, we haven't yet seen the vast majority of the projects reach financial close,? says Citibank's head of project finance, Eren Güra.
Moreover, of the dozens of projects permitted to either apply for international arbitration or convert existing administrative law contracts to private law contracts, any sponsors failed to act at all. Explains Ümit Herguner, partner at local firm Hergüner, Bilgen & Özeke, ?for decades they used international arbitration as an excuse, but when the gates were opened for prospective applicants to make the necessary adjustments, they didn't even apply. This tells me the concern was more country-risk oriented than an issue of legal sensitivity.?
Another expert adds: ?International arbitration has been a proxy for a whole slew of international standards that typically apply to project financing, from a lawyer's and lender's perspective.? These issues include allowance for government default, buy-out, and lender step-in or assignment rights.
The launch of international arbitration, then, though perhaps not strictly necessary, has in theory streamlined matters, according to one government adviser, making proceedings less costly in terms of bureaucratic wrangling.
Project Prognosis
Yet to date, a handful of private power projects, all based on the BOT scheme, a concession-financing and risk-sharing model, have successfully circumvented these supposed legal concerns, ?slipping through the cracks,? and casting further doubt on the necessity of the constitutional amendment.
The author of the BOT model, a former adviser to then President Ozal, argues that the success of the early BOTs hinged on their following procedure, without hubris. ?There is no inherent problem in doing project finance in Turkey. There has been a sort of deep-rooted arrogance on the part of many foreign developers. They need to understand that they're not coming into a gold-plated situation. We understood this and we succeeded.?
The BOT program has seen only four power projects reach financial close since its 1984 inception: the 672MW hydro-electric project at Birecik in 1995; two Enron-sponsored 478MW gas-fired projects in Marmara, in 1996; and the gas-fired 180MW Esenyurt project in 1997.
Says Mehmed Çavusoglu, manager at GE Power Systems, ?after this first round of projects, the Turkish mistake was to try to reinvent the wheel. They had four examples of IPP's which passed through the hurdles, secured financing and started production. With that sort of track record, the process was intact. It didn't need to be tinkered with.?
But it was tinkered with. And, just as new legislation cleared the field for a financeable BOT power model, the Turkish Constitutional Court decided, somewhat ironically, that the generation, transmission and distribution of energy constituted a public service. The rules changed again, with private power projects redefined as ?concessions,? requiring considerable revision to the terms of contracts between developers and the state. Outcome ? the delays.
To provide a partial solution to this problem, the build-own-operate (BOO) model was proposed in 1996. Despite its initial shroud of legal uncertainty, the scheme seduced hordes of developers and bankers eager to skirt perceived contractual quandaries. Nonetheless, it defeated the argument that it was a concession contract. A foreign developer, lamenting the legal cramps of late, argues that ?the government went down this traumatic route of changing the constitution when in fact it wasn't necessary. They would have been better off spending their energy highlighting the hallmarks of the BOO program, which is an open, clear, international, pre-qualified tender process, and which achieves benchmark prices.?
Since then, four of five viable BOO projects have reached the financing stage. The first deal, Siemens/Steag 1210MW coal-fired Iskenderun plant, reached successful syndication at the end of June, 2000. The $1.37 billion deal is being financed under a 75/25 debt/equity split, with equity sourced from Siemens and Steag. The $1 billion of 51¼2 year loans will be guaranteed by Hermes, $372 million, OeKB, $136 million, GKA, $356 million, and CGIC, $131 million. Lead-arranging the deal are Dresdner Kleinwort Benson, KfW, WestLB and ABSA bank.
An Intergen-Enka consortium is developing three gas-fired BOO projects. The first two plants, Adapazari and Gebze, are slated to reach financial close within the next few weeks. The third plant, the 1,555MW Izmir, is still in preliminary financing stages. The $660 million Gebze deal is for a 1,555 MW plant, the bulk of financing for which is rumored to come from US Exim, OPIC, Hermes and OND. The 780MW Adapazari plant, at $660 million, will feature a similar financing structure.
The final BOO project fluttering on a hopeful horizon is National Power/Bayinder's 700MW natural-gas fired Ankara plant. The project is still far from securing financing, though it is also likely to pluck its cash from ECA and commercial bank loans. Nonetheless, the entire BOO scheme, which envisages more than 40 billion KWh electricity to be produced annually from its total power capacity of 5,740MW, seems the most flourishing of Turkey's power schemes.
Of over forty proposed power projects, roughly half are BOT projects. The balance consists of projects that transfer operation rights (TOR), where a private company, for a fee, finances and operates a facility for a specified term, before transferring it to the original owner.
Ali Alpacar, vice-president of Chase Manhattan bank in Istanbul, says that after the recent legal amendments, ?the expectation at the beginning of the year was that the BOT's would take off. But, contrary to expectation, this did not happen. The government has cold feet for BOT projects.? Citibank's Güra adds that ?its unlikely we'll see many BOT's come to fruition. Besides, if the core idea is to privatize state owned industries, then transferring the assets to the government after a certain period doesn't make sense. Accordingly, BOO's are preferable.?
The BOT's are still lingering at bottom of the pile. In fact, only one thermal BOT was presented to the cabinet for international arbitration approval ? the Ak-El Yalova 306MW, $242 scheme. Three others, Yilsan/GVA 199MW Eskisehir, PSEG 425MW Konya and Artam Eletrik 206MW Deniz Ereglisi were not put forth.
The three are believed not to have accepted new contract terms in return for obtaining international arbitration. These terms include better tariffs for TEAS, the sate electricity company, compliance with forthcoming Electricity Market Law, no escalation articles and completion of the deal by year-end.
Only one of the large hydro BOT's went forward, Erg Insaat's 250MW scheme, but not the larger Dogus 500MW scheme.
That leaves the TOR projects ? all of them were submitted to the cabinet. ?The immediate need of the country is to advance on these projects,? contends a local developer. ?They lack sufficient maintenance, and they desperately need investment and rehabilitation. Moreover, they will provide a fresh new source of funding for the government, and hence should be a priority.?
Be that as it may, there are too many projects in the pipeline and not all of them will move forward, cautions Ahmet Tüzün, general manager of the local company Marketing, Aviation and Power.
But until the government states its priorities, most agree that it is not easy to speculate with any accuracy which projects will get done.
Such a priority list will likely be encouraged by the following key factors, says Tüzün. Projects with earlier realization dates will be favored. With Turkey's energy supply expected to shift heavily towards natural gas, those projects in line with new fuel supply requirements will be singled out. Projects that can get done more simply with commercial loans and private equity will have an easier time moving forward. Equally important are the demographics of the project: if the project meets an urgent demand in a specific area, it will be prioritized. Finally, projects which don't require treasury guarantees will become increasingly more attractive.
Projects fitting at least these criteria are more likely to attract foreign investment. First priority has since been given to the already agile BOO plants. And with a clear project schedule, it should be much easier to raise finance for the relevant projects.
With deals like last year's Afsin Elbistan B and this year's Iskenderun coming to the market, its hard not to be upbeat about the future of Turkish power project financing. Afsin Elbistan B, at $1.6 billion, marked the largest power financing ever done in Turkey, adding 1,400MW to the country's 21,000MW capacity, now up to 24,500MW. Financing consisted of several loans backed by government and export credit agencies and commercial bank loans, lead arranged by Citibank. Although a full-recourse deal, it is a rousing example for those interested in the future of limited and non-recourse financing in the country.
Beating bureaucracy
With the resolution of most alleged legal qualms, the gradual bolstering of government and economy, and ensuing credit rating upturns, the maddening question is why, aside from the advancing BOO scheme, the momentum for further power project finance still dithers.
?This is essentially a Turkish domestic problem,? explains a local developer. ?What we've been seeing over the last several months is the state bureaucrats trying to seek coverage, trying to search for a responsibility sharing mechanism for the new contracts, and this is delaying the process. We, as developers, are still lumbering down the lane, while the bureaucracy is trying in its drawn-out way to diffuse its responsibilities.?
Also, with each swig of IMF stabilization, inflation drops further. This aggravates somewhat the problem in the short run: within a swiftly mutating business community, many private companies have not fully restructured themselves to play according to the new rules of low inflation.
Commenting on why several international developers have failed so far to advance their projects or have retreated entirely from the Turkish market, a foreign adviser to the government appeals to psychology: ?the problem is a question of misguided attitudes. Many developers approach Turkey the way they approach the US, neglecting the fact of a different motivational structure, legal framework and economic climate.? His appraisal, then: ?its like trying to bang a square peg into a round hole.?
Part of this understanding means grasping the fact that power is fundamentally a public policy issue in Turkey. In fact, domestic power pricing is the largest single policy issue facing the government. And the single biggest risk to the government is no power. So, argues the adviser, when the government vacillates or cuts back developers' options, it is simply playing safe.
?If progress is to be made,? concludes Yüksel Güler, general manager of local company Zorlu Enerji, ?one or two new examples need to be set, to pave the way for new projects?.
The current friction, it seems, is primarily procedural in nature. But, nonetheless, it needs to be addressed before non-recourse money comes to bear. ?If there had been a true non-recourse example set in another industry, that would have helped. But there aren't any,? shrugs another developer.
The only projects so far to slither along unimpeded are the auto-generation facilities. ?They have been a quiet success,? describes Güler. The scheme allows local manufacturers to generate their own power, primarily for the producer's use ? but it can also be sold on to the national grid. These projects are typically small enough to be financed by capital-limited local banks.
But suspicion lingers around the vast number of projects actually awarded tender. ?No one can say that the initial number of projects was truly realistic,? admits a local developer, ?the bureaucracy was inclined to create more projects than necessary in the hope realizing at least some of them earlier. But the number of projects piled up, in part because, despite the legal system being ill-equipped for true non-recourse project finance, the hope for a remedy persisted. As that remedy, constitutional amendment, was slow to arrive, many projects were created to simply bypass this obstacle using other financing techniques, such as commercial loans.?
Treasury guarantees
To boot, the question of treasury guarantees cuts directly to the core of the energy debate. The IMF standby agreement and World Bank reform package limit the issuance of treasury guarantees, in an attempt to restrict contingent liabilities. But all project finance deals to date have been fully guaranteed by the treasury.
Citibank's Güra clarifies: ?in line with the restructuring towards a free energy market, it's logical to reduce guarantees.? Referring to the projects already underway, he adds, ?those that have an earlier impact on Turkish energy shortage will still enjoy treasury guarantees. The others still to come on line will have limited guarantees.?
But the offtaker, TEAS, suffers from a limp balance sheet, and, accordingly, is having a hard time meeting its take or pay obligations. And the guarantees are on the utility company's payments. Many bankers argue that TEAS lacks credibility and thus needs treasury guarantees: ?there's no way a project involving TEAS will get done without treasury guarantees.?
The only thing that would ensure a treasury guarantee non-requirement, then, is the strength of TEAS' balance sheet. And until it perks up, through impending market reforms, the requirement, albeit curbed, will persist.
?I personally don't see a way out of this without raising tariffs,? concludes Tüzün. ?If subsidies are discontinued, the only way to correct the balance sheet is to raise the tariffs. And the net effect will be a net increase in tariffs to the public and to businesses.?
Criteria for treasury guarantee provision are being worked out currently. For BOT's, guarantees are likely to be issued to cover payment obligations of public institutions or local authorities to project companies. Additionally, they will cover the repayment of subordinated loans obtained by companies from international credit institutions. And finally, they will include the repayment of senior loans obtained by project companies from international credit institutions in case of early termination of implementation contracts.
These guarantees provide the basis for take or pay obligations under certain energy sales agreements as well as debt assumption mechanisms under implementation contracts relating to power projects.
Regulatory Framework?
With this wide wave of reforms, Turkey is set to move much more aggressively towards real market energy models. It has reached a comprehensive agreement with the World Bank to fortify the legal framework, establish an energy regulatory body, and drain out costly ?take or pay? deals, all spearheaded by a $750 million World Bank loan.
In a letter to the World Bank, Recep Onal, Minister of State for Economic Affairs, insists that the government is addressing the frail regulatory environment for energy by moving to a competitive market, through privatization: ?The cornerstone of this new approach will be the electricity market law currently under preparation.? He continues, ?The law will meet applicable EU standards. It will establish an independent regulatory body with full authority over tariff policy, establish the framework for a competitive market and set a clear timetable for moving to the market model of 1.5 years following enactment of the electricity market law.? The government expects the law to be enacted, on a liberal estimate, by the end of the year, with technical assistance being provided by the World Bank Group.
The Draft law supposedly submits several innovations. For instance, it allegedly authorizes project companies the retail and wholesale of electricity, also allowing wholesale electricity trading companies to import and export electricity.
Further, under the new proposals, licensed private legal entities, other than the authorized project companies, may enter into option and future transactions regarding the sale for electrical energy.
The law will introduce certain restrictions on project companies operating in the sector. For instance, a distribution company will not be allowed to generate electricity. Also, companies' total market share thresholds will be limited. and, in the case, of generation, will not be allowed to exceed 20%.
Transition provisions will be enacted to protect companies that have already executed contracts.
But an informed local developer is not so satisfied: ?having looked at the latest draft of the electricity market law, I'm not satisfied with the state it's currently in. Such a law can only be properly drafted when supply exceeds demand. But we're currently in a deficit situation in which it's not so easy to talk of a market place as such.? And there's more: ?The latest draft also lacks what's at the heart of the matter, namely, a priority list of projects, generators and their prices, from the purchasers' perspective, instead of an outline of how the committee intends to oversee procedures.?
As a preliminary step toward a real market model, the government has split TEAS into distinct generation, transmission and energy trading companies. A state monopoly will be reserved for transmission. Authorized private legal entities will undertake all other electrical energy related activities. Describing the anticipated market model, Sankaran Balasubramanian, the IFC's country head, points out that ?the regulatory authority won't be a free electricity on tap model, which some Latin American countries have adopted. There will be some kind of price-fixing. We're essentially looking at an intermediate market model where there will obviously be different producers whose pricings will be set by the authority, based in part on fuel supply.?
The World Bank Group wants to see a complete overhaul of the energy environment to avoid, as one expert puts it, ?a sector regulated by a bunch of ad hoc contracts between the developers and government.?
Hergüner and his legal team expect many existing arrangements at the decree level to be advanced to the rule of law to create a much more consistently regulated energy environment. ?Of course, certain markets in the world are moving towards deregulation,? Hergüner reflects, ?but lets first regulate before we can deregulate.?
Fresh Financing
With the liberalizing of the market, an assortment of fresh financing instruments should begin to surface.
A mixed mood prevails around the immediate future for project bond financing. ?It will take a while for project bonds to be used,? claims Chase's Alpacar. ?It will take a number of deals for people to affiliate themselves with project financing coming out of Turkey, not only because people will want to see how potential problems are dealt with but also to see and realize that there are obvious opportunities in Turkey,? he adds.
But given the impending credit rating upswing, there is hope yet. ?The turning point will be Turkey hitting investment grade,? insists Garanti Bank's project finance vice president, Ugur Turkmen.
The IFC's Balasubramanian agrees: ?with some firms already having proved themselves, they should have easier access to international bond markets. And with interest rates declining on government bonds, there's a good chance of setting off the domestic bond market.?
Securitization is also an efficient tool for creating ample headroom for companies by packaging and pooling the risks of their different assets. The problem, says Balasubramanian, is that ?it's a nightmare in terms of the current legal framework. The Central Bank has asked for our assistance in streamlining the securitization rules.? To date, the IFC has done the only existing asset securitization in Turkey, last year's Garanti leasing securitization, which picked up Euromoney's Deal of the Year Award. With the structure of asset ownership being reworked legally, securitization is set to become a more frequently applied tool.
Regardless, insists the IFC, ?the dollars will be pooled for infrastructure project finance. That's what this country needs.?
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