Asia’s emerging economies continue to grow, in spite of the continued economic and political uncertainties in Europe. But finding stable and reliable sources of power remains a priority and a necessary condition for sustained growth in the region. The power sector in Asia continues to grapple with the legacy of underinvestment in previous decades and increasing economic activity highlights shortages in generation capacity even more acutely.

Fortunately, the region’s governments are continuously addressing this legacy and this is reflected in strong levels of new strategic investments in power infrastructure in the region. As a result, the power project finance sector in Asia displayed healthy levels of activity in 2011.

New power investment in Asia-Pacific in 2011 was in excess of $80 billion, with roughly 70GW added in China (about $44 billion) and India (roughly 12GW) but also in markets such as Indonesia and Vietnam. Most of those investments have been financed through state-owned entities rather than the private sector.

Project finance loans to the power sector amounted to about $30 billion in 2011, 37% of global project finance loans to the sector and the most of any region around the globe. Strictly speaking, IPP financing through the use of limited-recourse debt financing has been confined to power projects under governments’ independent power plant programmes, or pool markets in the case of the Philippines, Singapore or Australia. In terms of numbers, actual pure-play project financing business in the power sector in 2011 was between $10 billion and $15 billion.

The key regional power markets for project finance bankers featured impressive levels of activity as well as notable developments. Thailand witnessed a financing with a longest-ever debt tenor in the region for a power asset. Vietnam’s largest deal ever, with the longest tenor, closed in 2011. Indonesia, having regained its investment grade credit rating, is now bringing projects to the market with no government guarantees of any sort. Malaysia has emerged as one of the most attractive markets regionally, as it opens up to international sponsors and financiers. Overall, there are plenty of opportunities for international project finance lenders and sponsors, underpinned by evolving, and vastly different, market dynamics in regional markets. A brief review of select transactions and markets follows.

The competitive landscape in India, say, is vastly different to that of Australia or Vietnam, and countries’ sovereign ratings range from BB- to AAA, but a number of very diverse power transactions closed in 2011 in the region. Plants with both merchant and contracted structures successfully raised local currency and US dollar debt, because each country has a different currency to which power purchase agreements are indexed, as well as foreign exchange swap markets of varying degrees of depth. Some markets were characterised by fully amortising long tenors, while markets such as Australia were dominated by shorter tenors with refinancing risk.

Mong Duong 2 – Vietnam

One of the largest and highest-profile power project financings of 2011 was the Mong Duong 2 1,200MW domestic coal-fired IPP in northern Vietnam, sponsored by AES (51%), Posco Power (30%) and China Investment Corporation (19%). The project was developed under Vietnam’s well-established build-operate-transfer regulatory framework: 25-year capacity-based (take-or-pay) and cost pass- through PPA with state-owned EVN; a 25-year coal supply agreement with Vinacomin; the BOT contract with Vietnam’s Ministry of Industry and Trade and a government guarantee from the government of Vietnam, which guarantees the financial performance of the main Vietnam state-owned counterparties.

HSBC advised on the $1.5 billion project financing, which represented a significant evolution in Vietnam project finance transactions, pushing the limits of the market in a number of ways. This was the first large scale involvement of the Korean export credit agencies K-Sure and KEXIM in the country, by far the largest ever limited-recourse debt financing in Vietnam, the longest tenor ever achieved in the country (18 years door-to-door), the first IPP financing in the country since 2003, and the country’s first coal IPP.

Closed despite choppy market conditions in Vietnam, it demonstrated investors’ confidence in Vietnam’s economic outlook and its ability to maintain strong growth momentum amid challenging economic times. Mong Duong 2 sets a precedent in the country and hopefully opens the door for a second wave of IPPs that will monetise Vietnam’s domestic coal and gas reserves.

Tanjung Bin Energy – Malaysia

The Malaysian power market has traditionally been dominated by domestic investors and domestic sources of financing, but 2011 also saw the market opening up to international capital. The pathfinder project for the use of international bank financing is Malakoff Corporation’s R6.7 billion ($2.2 billion) Tanjung Bin Energy 1,000MW supercritical coal-fired power plant, located at the southern tip of Johor, Malaysia.

HSBC was financial adviser and sole coordinating bank and spearheaded the development and structuring of the transaction, which combined a US dollar loan and Malaysian ringgit sukuk financing for the first time in the country’s IPP sector in the country. The project represents the first foray by international lenders into the IPP market in Malaysia, as the levels seen in the basis swap market and the swap liquidity provided by large players such as HSBC allow sponsors to arbitrage between the cost of local and international financing to reduce the all-in cost of debt funding.

The project was awarded to Malakoff in June 2011 following a competitive tender organised by the Malaysian Energy Commission (EC) and it was the first time a competitive process was used in the country to procure generation capacity. The 25-year availability-based PPA with national utility Tenaga Nasional Bhd and the 25-year coal supply and transportation agreement with TNB Fuel Services were signed in December 2011 and financing documentation was signed in February 2012.

The transaction is noteworthy in the context of the development of the local financing market, as competitive bidding puts pressure on tariff levels and necessitates the use of innovative structural features in the funding mix to reduce the all-in cost of financing, and hence allows the sponsor to bid a more competitive tariff.

As Malaysia moves to competitive bidding as its preferred method to procure additional generation capacity, it is inevitable that the structures displayed in this transaction will continue to be adopted in the Malaysian market. The transaction generated strong interest from a range of international financial institutions and the structure set a new benchmark for AA3-rated Malaysian project bonds, testimony to the strong level of comfort that bond investors have with greenfield risk in the Malaysian IPP market, and paving the way for future IPP financings using non-vanilla structures in the country. We look forward to the next round of IPP tenders, where a large presence of international sponsors is expected.

Sasan UMPP – India

The Sasan Ultra-Mega Power Project (UMPP) is a 4,000MW coal-fired power plant in Madhya Pradesh, India, sponsored by Reliance Power, which reached financial close on a largely rupee-denominated project financing in 2009. In 2011, Reliance Power executed a debt substitution, taking-out some of the rupee-denominated debt with US dollar lending, taking advantage of the Reserve Bank of India external commercial borrowing (ECB) guidelines for offshore loans. The purpose of the substitution was to reduce the all-in funding costs, as US dollar-denominated debt swapped back into rupees through the use of cross-currency swaps benefits from a sizeable cost advantage compared to local rupee debt, given the relatively deep foreign exchange swap market that allows sponsors to use arbitrage to find the cheapest source of financing.

As Malaysia moves to competitive bidding as its preferred method to procure additional generation capacity, it is inevitable that the structures displayed in this transaction will continue to be adopted in the Malaysian market.

The $2.2 billion ECB debt financing was an achievement, given the backdrop of global economic uncertainty. A large portion of the debt came from Chinese banks (a 13-year $1.1 billion tranche), which benefited from 50% commercial and 95% political risk cover from Sinosure. US Ex-Im contributed a 15-year $917 million tranche, on the back of a broader agreement between Reliance Power and General Electric covering Indian projects. The remaining $150 million was provided by three international commercial banks on an uncovered basis and is the second uncovered international bank financing of an IPP in India, following CLP’s Jhajjar transaction, which closed in 2010.

The Sasan UMPP, which uses supercritical technology, is a captive coal-fired power plant and will sell capacity and electricity under a 25-year PPA with offtakers supplying seven states – Madhya Pradesh, Punjab, Uttar Pradesh, Delhi, Haryana, Rajasthan and Uttarakhand. As is now customary for Indian power project financings, lenders are looking beyond the immediate creditworthiness of the offtakers and towards a broader Indian growth story, taking comfort from the project’s competitive tariff and the acute need for power generation capacity throughout the country, providing continued and sustained long-term demand for competitively-priced baseload power. They do so despite coal supply risks related to India’s national system of coal logistics.

Nong Saeng IPP – Thailand

Nong Saeng is a 1,600MW combined cycle gas turbine (CCGT) undertaken by Gulf JP NS Company, in Nong Saeng, Thailand. Electric Power Development Co (J-Power), together with Gulf Holding Company, won the concessions to build two CCGT power plants of 1,600MW each under Thailand’s second IPP solicitation in 2007, an open and transparent bidding process that awarded concessions to build four new power plants to supply an additional 4,400MW to the country.

The $1.2 billion project financing signed in November 2011 on the back of a standard IPP contractual structure: 25-year capacity- based PPA with Electricity Generating Authority of Thailand (EGAT) featuring fuel and operating costs pass-through to EGAT and a satisfactory PPA gas supply agreement framework.

Much as the Mong Duong 2 IPP did in Vietnam, Nong Saeng achieved several firsts, such as the longest power project finance loan tenor (23 years) in Thailand. The project financing was raised from both international and local commercial banks on an uncovered basis, as is the norm in Thailand, and benefited from the strong commitment of JBIC and ADB, which together provided direct funding of $440 million. Given that the Thai PPA only features US dollar indexation on 50% of its capacity payments – the rest being THB-denominated – half the financing needed to be raised from Thai banks, which also provided a 23-year project loan in Baht, with the inter-creditor discussions this entails.

The success of this transaction is expected to generate appetite for J-Power’s second IPP financing, U-Thai, which will have a similar structure. A successful IPP solicitation process in Thailand, together with sponsors and lenders able and willing to push tenors, should lead to lower electricity tariffs, and consequent benefits to the Thai economy, and will be an encouraging backdrop to the third Thai IPP solicitation, which is currently in preparation.

Common trends and outlook

The Asia-Pacific region saw a wide range of financing structures used in IPP financings, depending on local power markets’ idiosyncrasies: merchant and regulated markets; PPAs with or without government guarantees; PPA tariffs in US dollars or local currencies, or even a mix of US dollars and local currency; balloon structures and fully amortising tenors in excess of 20 years; uncovered US dollar commercial loans in sub-investment grade countries like India or strong support from export credit agencies in Vietnam; greenfield Islamic bonds (sukuk) in Malaysia; deep FX markets allowing sponsors to arbitrage between domestic currency and US dollar debt swapped into local currencies. Regional markets remain fragmented, and different markets display different levels of maturity and unique characteristics. Nevertheless, a number of common themes can be traced.

Coal continues to dominate power generation in Asia-Pacific. The existence of ample coal reserves in India, Indonesia, and Australia has translated into an increasing share of the fuel in most countries’ generation mix. The low cost of the fuel ensures that electricity tariffs for end-users remain low, an important political consideration in developing markets. On the other hand, renewables (wind and solar) have so far failed to take off on a large scale, outside China and India.

The use of Chinese engineering, procurement and construction (EPC) contracts has been somewhat popular, driven by their low per-MW price and the increased convergence of Chinese EPC contractual terms with international standards. The availability of Chinese bank funding tied to the equipment supply makes a Chinese construction package attractive, in an era of tight liquidity at international, and particularly European banks, another common theme globally. Nevertheless, the relatively high cost of US dollar debt from Chinese financial institutions requires that sponsors consider the attractiveness of a Chinese EPC solution against the cost of funding that may be obtained from Chinese banks.

Almost everywhere throughout the region, competition from local banks is putting pressure on international lenders. Whilst international banks can usually provide US dollar debt at longer tenors, local banks are proving to be strong competitors, especially in markets such as Thailand and the Philippines. In addition, local banks’ closer familiarity with the local sponsors and legal and regulatory framework undoubtedly provide them with an advantage compared to their international counterparts.

Almost everywhere throughout the region, competition from local banks is putting pressure on international lenders. Whilst international banks can usually provide US dollar debt at longer tenors, local banks are proving to be strong competitors, especially in markets such as Thailand and the Philippines. In addition, local banks’ closer familiarity with the local sponsors and legal and regulatory framework undoubtedly provide them with an advantage compared to their international counterparts. Nevertheless, international banks continue to counter the imbalance with long-standing and global relationships with foreign investors, structuring skills, experience from projects in other jurisdictions and an understanding of the international financing landscape, which allows them to tap into many pockets of liquidity. It also helps that in certain markets, US dollar debt swapped into local currency is cheaper than domestic bank loans.

These themes will continue to be relevant throughout 2012 and 2013 and drive the dynamics of the project finance market in the sector. Activity is expected in India, as usual; but also Malaysia, where the next round of IPP tenders will be held through the year; Mongolia, where the country’s government is tendering its first IPP; Indonesia, where geothermal projects are moving ahead; the Philippines, where a number of players are planning capacity expansions in Luzon; Laos where a number of hydropower projects are currently raising financing; and possibly Thailand, if a new IPP solicitation is called, or Vietnam, if negotiations are concluded on a number of BOT projects. In each of these markets, the continuing competition in the power sector – amongst sponsors, contractors as well as lenders – means that the era of off- the-shelf solutions is over and those wishing to play successfully in the sector must continue to innovate to deliver strong returns to their shareholders and competitive tariffs to end-users.

Authors: Gilles Pascual is head of power & renewables, and Simon Gaudin and Marat Zapparov are associate directors, in HSBC’s project finance Asia-Pacific group.