Located in the Phu My Power Generation Centre, Vietnam, Phu My 2.2 is a 715 MW combined cycle gas-fired power plant, which will take natural gas from the Nam Con Son gas fields contracted to state-owned Oil & Gas Corporation of Vietnam (PVN), under a 20 year take-or-pay Gas Supply Agreement, whereby fuel risks are passed through to PVN. All its electricity capacity and energy output is contracted under a 20 year Power Purchase Agreement signed with state-owned utility Electricity of Vietnam (EVN). Total cost for the project is approximately US$400 million.

Despite the difficulties and rather bad track record of BOT development in Vietnam, Phu My achieved financial closure in October 2002. This article looks into the intricacies of the Vietnamese power market, highlights the different phases of BOT development in the country since the end of the 1990s, and looks at the legal and financial achievements Phu My 2.2 represents in such a context.

The coming of age of the Vietnamese power market

In April 2003, the Vietnamese government and EVN listed 62 new power projects as part of Vietnam’s policy to tackle demand growth over the next decade. Vietnam's power demand is expected to grow at between 10 and 12 per cent per year over the next decade, necessitating rapid development of new power generation facilities.

In total the listed projects, which are either at the proposal stage or already under development, would provide 9,800MW of new generating capacity by 2011, pushing the country's total capacity to over 15,000MW. Forty two are hydroelectric projects, accounting for 5,150MW of output, but many of the largest individual projects are thermal-fired, including gas-fired plants supplied from offshore projects in the South China Sea.

For this ambitious program, Vietnam has tried to avoid embarking on too many high-profile pet projects, and to look at the development of several dozen small-scale projects, many of which have generating capacities of less than 100MW. EVN is developing several thermal plants in partnership with local companies, whilst the Vietnam Coal Corporation (Vinacoal) is also involved in the development of three plants that are due for completion within the next three years.

Whilst developing the new capacity will require US$22.5 billion of investment over the next ten years, EVN believes that it is capable of raising 50 per cent of that money via: a) establishing its own bank, b) issuing bonds c) privatising and selling shares in existing plants. EVN says that it will welcome investment in existing plants and would not rule out different joint-venture or joint-stock structures. Current rules may allow private domestic investors to buy up as much of a privatised enterprise as they wish but foreign ownership is limited to 30 per cent.

Key projects however, require foreign capital, and a major challenge for the government is to demonstrate enough flexibility in its approach to foreign investment in order to attract the necessary capital funding, while working within the framework of Vietnamese legislation and business practices.

When IPPs first appeared in Vietnam at the end of the 1990s, the immediate response from EVN and Vietnam’s administration was rather ambiguous. After opening offices in Hanoi in 1997 to develop a 300MW coal-fired power station in the Quang Ninh province, Oxbow International Power Group had to withdraw from the US$300 million project, reportedly because the government was unwilling to set the electricity tariff at a rate that will permit the project sponsors to receive a reasonable rate of return. Oxbow left the negotiating table having failed to reach an agreement on coal prices, and over Vinacoal’s insistence that coal supply should be paid in US dollars.

At present foreign investment in new plants is permitted in the form of BOT or BOO contracts, and so far only two foreign-funded projects are operating, at the Phu My complex near Ho Chi Minh City (Phu My 2.2 and Phu My 3).

Achieving Phu My 2.2. closure

From 1997 to the end of 2001, ANZ acted as Financial Adviser to the consortium in the development of a bankable project financing structure. The transaction was launched in the international bank market in September 2001, when ANZ, SG and SMBC were appointed Coordinating Lead Arrangers for the commercial debt facilities. Financial closure was reached October.

The risk that had to be mitigated for the project included:

• securing a government guarantee of Vietnamese party obligations, foreign currency availability, conversion and remittance
• taking all security available over Vietnamese assets (tangible and intangible)
• taking back up security under English and Singapore law, including assignment of rights which may not currently be recognised by Vietnamese law
• taking English law security over offshore assets
• maximising re-insurance offshore, with assignment of re-insurance and retrocession contract (given Vietnamese requirements for domestic retention of insurance and reinsurance)
• ensuring pre-approval of financing documents by the state bank of Vietnam
• restricting sponsors’ transfer of share capital
• having direct agreements with Vietnamese counterparties and the ministry of industry, including step-in rights

The result is a complex financing structure, first of its kind in Vietnam, with participation by international banks and supranational and bilateral institutions.

The structure also involves one hundred per cent extended political risk insurance for commercial bank funded facilities.

Preparation of the project facilitated the development of a legal framework and clarification of a number of policies that could enable further progress of private provision of infrastructure service in Vietnam. Project debt is provided by supranational and multinational agencies and international commercial banks and consisted of five different facilities of various structures and tenors to accommodate funding requirements and mitigate project risks. The commercial facilities are supported by extended political risk insurance.

As part of the downstream component of the Nam Con Son Gas project, the Project benefits from a Government Guarantee, which not only guarantees the convertibility, availability, and transferability of foreign exchange, but also guarantees the obligations of each Vietnamese counter-party.

It is also the first project in Vietnam to benefit from the ADB’s and IDA’s political risk guarantee program. The political risk cover provided by IDA and ADB mitigates the sovereign and political risks for commercial lenders, by guaranteeing the contractual obligations of the Government of Vietnam and its agencies for this Project.

The risk transfer achieved through political risk guarantees was key in attracting long-term financing from the international commercial bank market. Under its guarantor-of-record program, ADB transfers its risks under its political risk guarantee to a private sector insurer via a risk participation agreement, while providing the commercial banks and the private insurer with the benefits of its ‘preferred creditor status’. This structure galvanised the private political insurance market, which might not have been previously available to the commercial lenders.

In order to protect the project tariff revenues against interest rate fluctuations, the sponsors had to explore various interest rate hedging mechanisms. This presented both regulatory and commercial challenges, as there was no precedent for long tenor US$ swaps in Vietnam. Lead arrangers worked closely with the sponsors and received approval from the State Bank of Vietnam to implement the tailored swaps.

As a result, PHU MY 2.2 represents the first Vietnamese BOT, the largest PF in Vietnam, the first time hedging arrangement are approved in Vietnam, the first time the ADB issues political risk guarantees backed by a commercial insurer (Sovereign Insurance ltd) and the first assignment of reinsurance approved in Vietnam.IJ

(A full version of this article will be published in Infrastructure Journal next month)