KDC11- Anand Rohatgi, Synergy Consulting


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Kuwait District Cooling Summit 2011

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KDC11- Anand Rohatgi, Synergy Consulting

  1. 1. Why District Cooling Under BOT/BOO Structure May Not Be For Private Sector Off-takers: Learnings from Dhahran District Cooling Project<br />For Kuwait District Cooling Conference<br />26th January, 2011<br />Presented by<br />Anand K Rohatgi<br />anand.rohatgi@synergyconsultingifa.com<br />
  2. 2. 2<br />Outline of the Presentation<br />Philosophy of a District Cooling Plant<br />Key Participants in District Cooling Project<br />Key Revenue Sources – The Tariff<br />Requirements for a Bankable Transaction<br />Profiling of Private Developer / Offtaker vs. Public Offtaker<br />Key Challenges for a Private Development <br />Dhahran Area DCP – A Case Study<br />Conclusion<br />Solution for Making Such Transactions Viable <br />
  3. 3. 3<br />Philosophy of District Cooling<br />Motivational Factors<br />Hygiene Factors<br />Highly Profitable From National Economy Prospective<br />Lower Initial And Recurrent Operating Costs For DCP Operator<br />Smart Energy Technology And Economically Efficient Utility Service<br />Reliability In Excess Of 99.7%<br />Philosophy of District Cooling<br />Improvement In Carbon Footprints For The Economy<br />Smooth Load Distribution – Lower Cumulative Capacity Requirements <br />Presents Attractive Value Propositions To Building Owners In Terms Of Space<br />Lower Cooling Costs To End Users<br />
  4. 4. 4<br />Key Participants in a District Cooling Project<br />Shareholder 2<br />Shareholder 1<br />Shareholders Support/Agreement<br /> Lenders<br />Utilities<br />Financing Agreement<br />Project Company<br />Offtake Agreement<br />Offtaker<br />Utility Guarantees<br />Concession Agreement<br /> Concessionaire<br />EPC Contract<br />O&M Contract<br />EPC Contractor<br />O&M Contractor<br />
  5. 5. 5<br />Revenue Sources : For Recovery of Costs <br />Tariff Components<br />Connection Charge<br />Capacity Charge<br />Fixed O&M Charge<br />Variable O&M / Consumption Charge<br /><ul><li>Payable to compensate Project Company for Capital Expenditure incurred.
  6. 6. May include coverage for costs like:
  7. 7. Service Line Costs
  8. 8. Distribution System Extension Costs
  9. 9. Some Portion of Other Capex
  10. 10. One time Upfront fee payable on connection date
  11. 11. No Offtaker or End User = no Connection Charge
  12. 12. Payable by Offtaker to Project Company to compensate for Capital costs.
  13. 13. Is a function of Contracted Capacity
  14. 14. Includes coverage for:
  15. 15. Debt Service i.e. Interest + Principal
  16. 16. Equity returns for investors i.e. ROE
  17. 17. Paid From Date of Connection of Load
  18. 18. No End User / load = no Capacity Charge
  19. 19. Payable to compensate Project Company for Fixed O&M cost
  20. 20. Includes coverage for costs like:
  21. 21. Plant O& M
  22. 22. Overhaul & Replacement
  23. 23. Plant G&A
  24. 24. Other Fixed Expenses
  25. 25. Paid from Date of Connection of Load
  26. 26. No End User / load = no Fixed O&M Charge
  27. 27. Payable to compensate PC for Variable O&M cost
  28. 28. Is a function of Actual Cooling provided, EFLH
  29. 29. Includes coverage for costs like:
  30. 30. Water
  31. 31. Electricity
  32. 32. Sewage
  33. 33. Chemicals
  34. 34. Variable O&M
  35. 35. No Impact on Economics if Pass -Through </li></li></ul><li>6<br />Requirements for a Bankable Transaction<br />Key Success Factors<br />A Bankable Transaction<br />Interpretation <br /><ul><li>Provides comfort to Lenders that Debt Service shall be met within schedule
  36. 36. Ensures balanced recovery of all project costs
  37. 37. Ensures appropriate equity returns
  38. 38. Ensures proper risk allocation</li></ul>Credit Worthy Offtaker<br />Take or Pay<br />Risk Allocation<br />Tariff Structure<br /><ul><li>A credit worthy Offtaker ensures lower payment risk
  39. 39. Thus enables access to competitive, long term and high level debt funding
  40. 40. Capacity planning should be such that complete capacity is utilized at commissioning
  41. 41. In case of under-utilization, proper debt repayment should be ensured thru fixed revenues
  42. 42. Contractual framework should be such that proper risk allocation is made to the entity who is best positioned of handling the risk
  43. 43. Tariff structure should be designed so as to cover 100% of underlying costs (Fixed & Variable)
  44. 44. Should be properly indexed to inflation</li></ul>Impact<br /><ul><li>Ensures availability of economical debt
  45. 45. Ensures rationale equity return requirements
  46. 46. Financial viability over the concession term
  47. 47. Successful DC services
  48. 48. Rationale tariff levels for the End Users </li></li></ul><li>7<br />Profiling of Private Developer / Offtaker vs. Public Offtaker<br />
  49. 49. 8<br />Challenge: Capacity Planning and Utilization…1/2<br /><ul><li>Not Guaranteed Capacity Requirement Forecast
  50. 50. No Fixed Schedule + level for such capacity utilization</li></ul>Capacity Planning / Forecast<br />Public Sector Offtaker<br />Private Sector Offtaker<br /><ul><li>In a better position to project the demand figures as planning based on Captive requirements
  51. 51. Lower probability of demand-supply mismatch due to planned requirements
  52. 52. Can take the financial onus of inconsistent projections due to strong balance sheets
  53. 53. Higher probability of demand-supply mismatch as basic infrastructure for medium-term demand to be created upfront
  54. 54. Demand linked to ability to sell (real estate risk)
  55. 55. Further offtake subject to start of utilization.
  56. 56. May have to infuse extra equity impacting overall Project IRR</li></ul>Impact on Stakeholders<br />Impact on Stakeholders<br />Developer <br /><ul><li>Takes the financial onus of unachievable projections</li></ul>Developer <br /><ul><li>Nil as generally may not take any obligation </li></ul>Project Company<br /><ul><li>Undesired increase in costs absorbed by Public Offtaker
  57. 57. Thus no impact </li></ul>Project Company<br /><ul><li>Bears increase in costs due to incorrect projections
  58. 58. Thus Higher contingency requirements or failure to meet obligations </li></ul>Lenders<br /><ul><li>Strong Balance Sheet ensures timely debt repayment, thus provides required comfort </li></ul>End User<br /><ul><li>Financial onus of wrong projections on Offtaker
  59. 59. Tariff not prone to changes</li></ul>Lenders<br /><ul><li>May face a risk of delay in debt repayments
  60. 60. Thus Project may not be bankability</li></ul>End User<br /><ul><li>Increase in tariff due to, if borne by end users may lead to increased Tariff
  61. 61. Or failure to receive DC services</li></ul>?<br />
  62. 62. 9<br />Challenge: Capacity Planning and Utilization…2/2<br />Case Study *<br />* Only Elaborative in Nature<br />
  63. 63. 10<br />Challenge: Not Very Strong Contractual Framework<br />Weak Contractual Framework<br /><ul><li>Un-clear / un-balanced risk allocation
  64. 64. Generally offtaker sided contracts</li></ul>Public Sector Offtaker<br />Private Sector Offtaker<br /><ul><li>Ensure tight contractual framework with adequate penalties and remittances for appropriate events
  65. 65. Can favorably influence regulatory aspects
  66. 66. May not ensure a water tight contractual framework leading to increased project risk
  67. 67. Has little influence on the laws of regulations
  68. 68. May tend to execute not very strong contracts </li></ul>Impact on Stakeholders<br />Impact on Stakeholders<br />Developer <br /><ul><li>Water tight framework ensures lower but defined / balanced risk</li></ul>Developer <br /><ul><li>Mostly nil, as offtaker takes no obligations</li></ul>Project Company<br /><ul><li>Well defined rights and obligations
  69. 69. Lower risk thus lower debt and equity costs </li></ul>Project Company<br /><ul><li>Exposed to risks as rights and obligations not clear and balanced
  70. 70. May fail to be viable in long term </li></ul>Lenders<br /><ul><li>Well defined contractual obligations
  71. 71. Acceptable protection for client risks events
  72. 72. Acceptable project risk</li></ul>End User<br /><ul><li>Well defined rights and obligations
  73. 73. Lower tariff due to lower overall project risk</li></ul>Lenders<br /><ul><li>Exposed to substantial project risk
  74. 74. Thus project not financeable </li></ul>End User<br /><ul><li>Unfavorable clauses may lead to higher obligation or higher tariff or failure to receive district cooling</li></ul>?<br />
  75. 75. 11<br />Challenge: Utilities - Minimal Control and Full Risk<br />Utility Guarantees<br /><ul><li>Utilities may not guarantee </li></ul> adequate and timely supply<br />Public Sector Offtaker<br />Private Sector Offtaker<br /><ul><li>Public Offtaker has better control over the public utilities
  76. 76. Can support adequate and timely supply of utilities to keep the plant operational (utilities a part of overall development)
  77. 77. Can support payments even if plant is un-operational
  78. 78. Generally do not take any obligations related to utilities
  79. 79. Cannot guarantee adequate and timely utility supply
  80. 80. Poses high risk to the viability of the project</li></ul>Impact on Stakeholders<br />Impact on Stakeholders<br />Developer <br /><ul><li>Nil</li></ul>Developer <br /><ul><li>Nil </li></ul>Project Company<br /><ul><li>Adequate utility supply thus plant operational
  81. 81. No cash flow risks </li></ul>Project Company<br /><ul><li>May not be able operate due to unavailability
  82. 82. Loss of revenue for such periods</li></ul>Lenders<br /><ul><li>No Impact as defined revenues to the Project for debt service </li></ul>End User<br /><ul><li>Lower tariff due lower risk on Project, Lenders and Shareholders </li></ul>Lenders<br /><ul><li>May impact ability for timely debt service
  83. 83. Thus project not bankable </li></ul>End User<br /><ul><li>No district cooling service for periods when plant does not receive utilities
  84. 84. May result in higher overall costs </li></ul>?<br />
  85. 85. 12<br />Challenge: High Payment / Credit Risk <br />Non Payment by End Users<br /><ul><li>Risk of delay or non payment by end users</li></ul>Public Sector Offtaker<br />Private Sector Offtaker<br /><ul><li>Generally payments guaranteed by the Public Sector entity
  86. 86. Public Sector entities tend and have the ability to fulfill their financial obligations
  87. 87. Onus of tariff collections from End Users on Project Company
  88. 88. Developers tend to back-end payments to ensure lower upfront to encourage sales. Thus higher risk
  89. 89. Exposing Project to credit risk from non-payments later </li></ul>Impact on Stakeholders<br />Impact on Stakeholders<br />Developer <br /><ul><li>Minimal impact as Public Offtaker have the financial strength to make such payments </li></ul>Developer <br /><ul><li>Nil </li></ul>Project Company<br /><ul><li>No impact as payments are received in full</li></ul>Project Company<br /><ul><li>Reduction in anticipated revenues
  90. 90. Eventual failure to provide service if cost unrecovered </li></ul>Lenders<br /><ul><li>No Impact as defined revenues to the Project for debt service </li></ul>End User<br /><ul><li>May face disconnection (if End User not same as Developer)</li></ul>Lenders<br /><ul><li>May put debt service at risk
  91. 91. Thus project not bankable </li></ul>End User<br /><ul><li>If recovered from existing users - increase cost of services
  92. 92. Or, no district cooling services</li></ul>?<br />
  93. 93. 13<br />Result: High & Un-Competitive Capital – Debt & Equity<br />Un-Competitive Debt Financing <br />High Returns for Equity<br /><ul><li>Due to higher and sometimes unbalanced risks, lenders may not provide Long Term Debt but will only provide Short Term Corporate Finance
  94. 94. In order to make the project viable, the revenues may need to be able to meet debt service i.e. meet DSCR requirements
  95. 95. Thus for higher revenue levels, higher tariffs should be required (as compared to Long Term debt transaction)
  96. 96. Due to higher and sometimes unbalanced risks, equity investors may need higher return
  97. 97. Lender’s requirements of Corporate Guarantees for debt may result in increased equity risk (and thus pricing)
  98. 98. In order to meet such return requirements, the revenues may need to be higher and thus higher tariffs</li></li></ul><li>14<br />Result: High Cost of Capital – Debt + Equity<br />To Make Tariff Attractive for End Users<br />For Public Off-taker / Developer<br />For Private Off-taker / Developer<br />Assumptions:<br /><ul><li>In house cooling capex of SR 13,400 per TR of cooling with SR 2200 / TR as O&M each year
  99. 99. Debt interest rate is assumed to be 10% for the computations
  100. 100. Leverage of 70% and tariff is set while ensuring that the debt is serviced in the required tenor
  101. 101. EFLH of 4,000 Hrs
  102. 102. A typical in-house cooling consumption charge of SR 0.481/TR-HR whereas for DCP of SR 0.187/TR-HR</li></ul>Inferences:<br /><ul><li>DC is viable in the long run due to better efficiency which can be observed by comparing the consumption charges
  103. 103. The viability increases with the availability of longer term debt
  104. 104. In the above, DCP becomes viable if debt tenor is >9 years</li></ul>Assumptions:<br /><ul><li>Leverage of 70%.
  105. 105. Various combinations of IRRs are used and the increase in tariff required to meet the IRR is normalized and displayed</li></ul>Inferences:<br /><ul><li>To double the IRR from 8% to 16% a 33% increase in tariff is required in this particular example</li></li></ul><li>15<br />Dhahran Area DCP – A Case Study<br />
  106. 106. 16<br />About Project<br />Showcasing the first scheme of its kind in the MENA region<br /><ul><li>Saudi Tabreed as Project Developer is required to develop, own & operate a district cooling system to provide cooling services for offices at Dhahran.
  107. 107. Cooling Capacity of 27,000 TR expandable to 32,000 TR
  108. 108. Developed under Offtaker’s initiative towards energy conservation & environment protection since District Cooling consumes half the electrical energy as compared to traditional cooling.
  109. 109. First District Cooling Project to be financed under long term non-recourse project financing structure.
  110. 110. Project under “Take or Pay” Structure to ensure commercial viability of the Project</li></li></ul><li>17<br />Advantage All – With Public Offtaker<br />PublicOfftaker<br />Public Offtaker Support<br /><ul><li>Credibility and strong balance sheet of Public Offtaker lead to Long Term Non-Recourse debt funding
  111. 111. Tariff components covered all underlying costs and thus assured returns on equity.
  112. 112. Lower IRR requirements by equity as assured of repayment thus leading to lower tariff</li></ul>Adequate Utility Supply<br /><ul><li>Offtaker agreed to pay capacity payments to Project Company in case of failure of availability of utilities
  113. 113. Cost of utility supply accepted as a pass-through cost
  114. 114. Lead to lower risk of increase in tariff due to non availability of essential utilities </li></ul>Take or Pay Tariff Structure<br /><ul><li>The Public Offtaker understood the consequences of demand supply mismatch and agreed on a Take-or-Pay structure to ensure commercial viability of the project
  115. 115. Essential so that Project Company can meet its debt obligations on time</li></ul>Water Tight Contractual Framework<br /><ul><li>Ensured water tight contractual framework assuring appropriate risk sharing mechanism
  116. 116. Ensured low project risk with other supporting aspects for project financing such as termination payments, force majeure coverage, etc </li></ul>Lower Tariff for End Users<br />
  117. 117. 18<br />The Conclusion<br />Projects with Private Off-takers May Not Be Viable <br />
  118. 118. 19<br />The Solution: Support from All Stakeholders <br />From Developers<br />From Lenders<br />From Shareholders <br />From End Users<br /><ul><li>Consider DC as any other Utility
  119. 119. Should not be treated as a Construction Contract and consider importance over Concession Term (15-20 Yrs)
  120. 120. Important to balance between lower tariff & viability
  121. 121. Work with the Project Company in defining the Project configuration (capacity, schedule, tariff , payments etc)
  122. 122. Hold partial stake in Project to ensure balanced approach by Project Company
  123. 123. Treat District Cooling like any other utility concession thus lower risk
  124. 124. The risk of non-payment is lower as DC alike any other utility is a minimum requirement. Thus disconnection of DC services to End Users is not a likely option
  125. 125. Maintain balance between the profitability and viability of the project as this is a utility
  126. 126. Should budget temporary plants to avoid phasing risk
  127. 127. Should implement a granular design to avoid phasing risk, the additional cost is a reflection of reduced risk
  128. 128. Should maintain transparency by involving all stakeholders in sharing both, the appropriate risks and the benefits
  129. 129. Realize the benefit of District Cooling over In-house Cooling
  130. 130. Should accept a level of “Take or Pay” as may exist in any other utility (similar to power or water)
  131. 131. Should accept that DC service in the initial period might cost more due to the presence of temporary chillers (ramp-up period) but should be beneficial over long term .</li></li></ul><li>20<br />Thank You<br />
  132. 132. 21<br />Abbreviations<br />
  133. 133. 22<br />About Synergy…1/2<br />
  134. 134. 23<br />About Synergy…2/2<br />An International Financial Advisory Services Company with experience in projects across 36 countries spanning across most of the continents<br />Across All Infrastructure Sectors<br />Boutique of Services Offered<br />
  135. 135. 24<br />Disclaimer<br />