Energy Private Equity Funds in Current Unstable Market Conditions

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Phat Nguyen spoke at VietPower 2009, an IBC Asia-organized energy conference, in September 2009 at HCMC, Vietnam

Phat Nguyen spoke at VietPower 2009, an IBC Asia-organized energy conference, in September 2009 at HCMC, Vietnam

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  • 1. VIETPOWER Vietnam, September 2009 Private Equity Funds in Current Unstable Market Conditions
  • 2. Agenda 1 Trends in equity financing for power projects in Asia 2 Sources of capital and structuring strategies 3 Mitigating risks in equity financing 2
  • 3. What’s up lately? Dramatic fluctuations in crude oil prices The year 2008 was the first year that global investment in new power generation capacity from renewable energy projects ($140 billion) was more than investment in fossil-fuelled projects ($110 billion). A number of funds have turned their investment radars to clean energy 1 The rise in infrastructure funds also gives private equity investors a way to participate in the energy industry 2 Private equity firms are on the defensive. While firms once spent much of their time on deal generation, the emphasis now is on operations In the boom years from 2005 to 2007, private equity deals were completed with as little as 15% equity. Since the economic meltdown that began in late 2007, 35% to 40% equity has been required. Emergence of supplier credits and Shariah-compliant PE funds in equity financing (India, Indonesia…) It was very rare, to the point of never happening, that generalist private equity firms would dip their toe in the water of the hard-core energy space 3 4 5 6 3 Turbulences in the global financial arena The politico-environmental concerns about conventional energy use
  • 4. Renewable power* Generation and Capacity (% of global power) 4
  • 5. Sustainable energy in Asia Source: Renewable Energy in China, Knowledge@Wharton Over half IFC-financed power sector projects fall to renewable energy "Despite the difficult financing environment, FY09 proved to be the year of renewables," said Dana Younger of IFC's Infrastructure Department 4 First Asia-Pacific Renewable Energy Trust formed by Conergy Subsidiary and GE with US$250 Million target The Renewable Energy Trust Asia is an investment vehicle focused on the US$7 billion annual renewable energy markets of India, the ASEAN countries and South Korea Exploring alternative energy sources is not a luxury based on environmental concerns, but an absolute necessity to simply provide enough energy for China. One provision in the Renewable Energy Law of 2006 requires 15% of all energy consumed in China to be renewable by the year 2020
  • 6. VC/PE new investment in sustainable energy by stage, $billion 5
  • 7. Financing new build in sustainable energy by region,$ billion 6
  • 8. Agenda 1 Trends in equity financing for power projects in Asia 2 Sources of capital and structuring strategies 3 Mitigating risks in equity financing 7
  • 9. Sources of capital Source: Various sources from news, reports, real projects 8 Sources of capital
    • Senior debts: loans from commercial banks are limited, whereas those from multilateral/bilateral agencies, ECAs, vendors play a much larger role
    • Quasi-equity: still limited
    • Equity from investors: investors become more prudent
    • Risk capital (developers/VC)
    Structuring Strategies
    • Optimize debt/equity ratio
    • The simpler capital structure the better
    • Non-recourse debt at asset level
    • Debt maturity profile extends over considerable period (debt term matches PPA length)
    • Currency match between revenues and debt payment; otherwise, financial instruments to be used
    • Drawdown of debt and equity: a way to have higher IRR
    • Strategy for refinancing is to be considered even before an original loan is signed
    • Quasi-equity investments are considered to minimize dividend distribution risks
  • 10. Recent highlights on sustainable energy in Vietnam Source: Vietnamnews, Decision 18 8
    • “ Decision of applying avoided energy costs to the tariff” effective since Jan 2009
    • PPA term: 20 years
    • Tariff is based on the costs of thermal power plants that EVN can avoid by purchasing renewable energy and is defined as avoided cost tariff (“ACT”)
    • ACT is to be announced every year by an energy agency (part of the Ministry of Industry and Commerce)
    • ACT includes 2 components, namely capacity charge and energy charge
    • An option to fix the tariff range over a maximum period of 12 years
    • EVN buys all output
    • “ The World Bank provides US$202-million credit to support renewables-based projects in Vietnam”, April 2009
    • Not exceeding 30MW, developed by private sponsors
    • Three Vietnamese banks on-lend to private developers
    • “ The European Investment Bank is providing a EUR100-million loan for Viet Nam to finance investments that will contribute to the mitigation of climate change”, May 2009
    • Renewable energy and energy efficiency
    • Four Vietnamese banks on-lend to developers
  • 11. Agenda 1 Trends in equity financing for power projects in Asia 2 Sources of capital and structuring strategies 3 Mitigating risks in equity financing 9
  • 12. A general framework 10 Risk Assessment Risk Structuring & Allocation Risk Mitigation
      • Commercial Risks
      • Macro-economic Risks
      • Political Risks
      • Due diligence process to identify risks
      • Appropriate financial leverage and project cash flow
      • Proper risk sharing between private and public participants
      • Allocation of risks to appropriate parties through provisions in project-related contracts. Pass through to third parties as necessary
      • Diversifying project portfolio
      • Contractual arrangements, contingency funds and reserves, line of credits, insurance, cash traps
      • Interest rate swaps, fixed-rate lenders, forward contracts
      • Bank and government guarantees
      • Involvement of bi-lateral/multi-lateral agencies
    Risk Management System Financial instruments Portfolio Diversification Due Diligence Team Continuous Assessment of Internal Controls Liquidity Management External Risk Consultants Legal Advisors Macro Research and Forecasting Source: Indochina Capital, 2008
  • 13. Elaborating on other risk mitigants 11 Be minimalistic upfront and ramp up gradually Avoid straight equity stakes where conflicts of interest may arise or the sector has yielded poor returns. Quasi-equity investments allow for upside participation DEVELOPERS TECHNOLOGY SHIFT SAFETY INVESTMENT APPROACH PUBLIC SUPPORT Only work with capable and trust-worthy developers Convince the public with a compelling economic case Heavy emphasis on public relations Acquire credible capabilities in safety and operations; maintain good safety and operating records Conduct thorough due diligence on developers’ backgrounds Hedge against technology risk by double betting i.e. invest in two or more versions of technology simultaneously RISK MITIGANTS Improve safety culture through communication, education / training, positive reinforcement Adopt advanced operation process & systems; optimize business design for cost efficiency
  • 14. Phat Nguyen Indochina Infrastructure Management Floor 10, Capital Place, 6 Thai Van Lung, District 1, HCMC, Vietnam [email_address] www.indochinacapital.com This presents the author’s view and does not necessarily reflect Indochina Capital’s