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PPPs offer new promise to Philippines power

07 Sep 2011

Electricity generation in the Philippines has been mired in inefficiencies and poor service, but the administration of president Benigno Aquino III is set on improving this area, in part via public-private partnerships. ASIAMONEY spoke to leading government officials and energy executives on August 4 about the potential and challenges facing these bold plans.

Opening speech by Jose Rene D. Almendras, secretary, Department of Energy (JRA): We are here to talk about power. The government is no longer in a position to influence supply or the pricing of power but we can control quality because of the standards and policies we put in.

But when there is a brownout, the bad guy is the energy secretary. This is the same when the price of fuel goes up. Fortunately this week it went down. The popularity of the Department of Energy (DOE) inversely reacts to such news.

We are in the middle of an initiative to make sure the country has the much-needed energy it requires. The world is shifting towards electricity, even transport is moving in that direction – all energy ratios reflect that cars should run on electricity. The future of fossil fuel is very limited.

The growth of the economy is a function of faith and the offering of an even playing field. I want to be here today to offer that assurance. The mandate of the DOE is to promote energy resources – mostly indigenous – and ensure the supply of the future.

The law doesn’t allow us to be a direct participant in the energy market. I believe this was a good law, but the problems lie in the implementation and the hurdles that came about. That’s the reason why the price of electricity so high.

People in this room are relatively happy about that – it makes your investments more profitable. But that’s part of my problem when the profits of the oil companies and the energy companies are growing at 30% and above year-on-year.

We need to make sure the infrastructure and policy in place to make sure the investment of the private sector are protected, within constitutional bounds.

The last two years have witnessed a series of controversial decisions. Last year as required by law we finally cancelled the DWS – default wholesale supplier. When a distribution utility had nowhere else to get power the National Power Corp. [Napocor] automatically had to provide them with prices at Napocor rates. The DWS was supposed to be transitory. It was to be taken away as soon as there was enough supply elsewhere.

It was not too much a controversy in Metro Manila because Meralco was no longer dependent on Napocor but throughout the rest of Luzon and Visayas and some of Mindanao, we had a little revolt. It was not San Miguel or Aboitiz Power who required me to do it.

A few months later we issued a disconnection policy – after 10 years the DOE finally put its foot down and said ‘if you don’t pay you will get cut off’. Controversies arose – you had several provinces who weren’t paying, and several distribution electric cooperatives who having written off PHP184 billion (US$4.32 billion) of payables in 2001, accumulated about PHP6.7 billion of payables again. There was never any reason for them to abide by the rules of the game. Yet despite [widespread] resistance, the DOE implemented the spot market in Visayas. We immediately stopped the brownouts when this was done.

The truth is we need more energy regeneration, more power. By the end of 2013, we will have a new power plant and looking forward to come on-stream thereafter. The only reason we can do these things is if the private sector/investors are there and the project proponents are there to support the projects.

Much has been criticised of the Philippines’ situation. We have the most expensive residential rates in Asia. Commercial rates in Singapore and Japan are still higher than us.

The infrastructure and market policies in place are already quite advanced. We look forward to greater efficiencies that will eventually result in better pricing for the consuming public as well as industries that need electricity and therefore better pricing for the consumer.

I’ve been accused of being a coal boy. It’s not because I really love coal but if you can find me a cheaper source of energy which can be implemented quicker to cover the needs we now have, I’d gladly go in that direction. We are pushing geothermal in a big way; hydro and whatever other source we can develop.

Asiamoney [AM]: The Philippine President made no mention of Public-Private Partnerships in his most recent State of the Nation address. Is this reason for concern, considering the delays in announcing any contracts?

Josefina Patricia M. Asirit, Department of Energy [JA]: This is a private sector issue but government remains a policy making and regulatory body for risk. In the power sector we have recently launched a program wherein several projects in renewable energy are being processed in terms of service contacts. These projects that require the assistance of government in terms of facilitating permits, making sure other government agencies are in compliance. The DOE is drawing up an Energy Investment Guide book which will serve as a road map and easy reference for energy investors.

Manuel N. Tordesillas, ATR Kim Eng Capital Partners [MT]: I believe the government is trying to do this the right way. We want to avoid some of the pitfalls seen before. For example, the airport situation [in 2002 when the construction of terminal three of Ninoy Aquino International Airport was delayed amid allegations of corruption] – we went into it and then at the end there were unanswered questions and controversies.

If you compare that to the [more recent] bidding of the power plants – in the beginning it took some years before they started bidding the large projects, starting off with the smaller ones. There was initial hesitation about how long it was taking but it all got implemented and most of the investors in the power sector are quite happy.

So my response to the question of duration: We have to be patient. They are studying and making sure the process is well understood, the bidders are properly informed and so forth. My sense is that when this does start it will snowball and there will be a lot more interest. The way they will handle it will be more transparent and on a level playing field.

Hans B. Sicat, The Philippine Stock Exchange [HS]:
I agree. Unfortunately what you see in the popular press about the speed is predicated on the expectation levels set by the government originally. They said there would be 10 projects that would come up. However, they are doing the right thing today to talk about process and evaluation. I would suggest instead of focusing on 10-15 projects, to really focus on one or two and get them announced. The funding is going to be there.

Ferdinand K. Constantino, San Miguel Corp. [FC]: We agree. The government is now clarifying a lot of things, making sure all issues are addressed, that there is transparency and clarity on the role expected by the private sector from the government on specific projects. We got very involved in the privatisation of the Independent Power Producer Administration (IPPA) programme of the government and I agree with Mr. Tordesillas – there was a lot of clarity in the contracts and they were successful. We should give the government more time to clarify and promote transparency.

Erramon I. Aboitiz , CEO, Aboitiz Power Corp. [EA]: I hope my friends in government are not about to get upset at what I will say.

I’d like to talk about PPP in general. To my mind the government should get involved in this process in the least way possible. Take, for example, power plants. It used to be you couldn’t build a plant and get it financed without a government guarantee. That has changed. The government doesn’t have to do that anymore. The power industry is such that it has been deregulated, privatised, and competitive. The private sector is competing and anticipating needs.

The golden contracts of take-or-pay are not necessary anymore. The private sector is willing to take market risk so where do we need government? Clearly at a policy level but I think it should be an enabler of these projects and not a taker of risk. A few years ago if you asked a banker if he could finance a power plant the answer that there was no way they would. Why? Because they were used to the government backstop. Once you have it you don’t want to give it up.

JRA: I chair some PPP meetings personally. Everyone in the panel is correct. Yes, there was an initial expectation. Admittedly, we inherited some feasibility studies of a few projects which were supposed to be significantly matured. In the process of converting those into projects we realised they were not as developed as they should have been.

Rather than push something that could create problems it was opted to take a step back. When in discussions with the private sector we realised things were not as clear as they should have been in the original studies. We have sped up projects down from three months to a six-week cycle but you can only move a project that fast through the bureaucratic process if you have a very strong feasibility study that can stand up to the critique.

Mr. Aboitiz is correct. Yes we are an enabler, we will take some risk but there are many opportunities [for the private sector]. Let’s have clarity here: A lot of people believe all the PPPs will be concessionary, where the government will guarantee a certain return. It does not have to be this type. In fact, there will be PPPs not of this type but with direct government investment. For example, if we are in need of building a new airport we know the runway is the most expensive aspect of it. The government is going to use budget to build a runway and let private sector come in to build the terminal, for example. If we don’t do it that way the project is not viable financially.

We have stumbled across some, of what I like to call, time bombs and landmines. One year into government there are still these to be handled as far as projects are concerned. There will definitely be two more PPP projects by the end of this year and many more going forward going into the list.

Cristino L. Panlilio, Department of Trade and Board of Investments [CP]:
Due diligence is the longest stage. Documentation is another long process. Those who have gone through negotiations like this know it takes time. I’d like to assure you this is going to be transparently bid out, negotiated and that there are serious bidders/parties involved. There are at least a dozen per project in the first 10 that have been rolled out.

AM: Let’s discuss transparency further. Is there enough trust in the contracts?

JA: I will speak for the power sector. We are looking at ways to improve the system in terms of service contracts the energy could be engaged in. There is a levelling of the playing field: everything is bid out, there is transparency of information for the public, and there is accountability and responsibility on the people involved in the processing of application of renewable energy service contract applications.

HS: I’d like to comment on a broader scale. The President has put into place an environment of transparency and good governance. As to how investors look at the Philippines as a place to do business, I think comfort levels have increased – with anecdotal evidence from dormant investors – from both the West and East Asia. This is driven by the desire to have a level playing field and important and timely information.

FC: Based on our experience from our three infrastructure projects, there was already some good room in terms of clarifying our position with the government. We are getting support. The contracts are there, although we need to clarify certain aspects and make necessary changes. The secretary of energy’s point is important: to look at the contacts of the past because there are the areas that can be improved more forcefully.

We’ve been involved in a lot of the bidding of the power plants in the last few years and many of them were with our foreign partner SN Power, who is involved in many other bids and acquisitions globally. Their comment to us was that they were very impressed by the level of transparency and professionalism the government agencies displayed during the bidding process.

CP: I believe that what president Aquino did in coming out with a wish list of 73 projects and publishing them in a handbook was an historic event. In past the juicy projects were kept close to the chest of cronies, political facilitators, and shady characters and they dealt things behind closed doors so to speak. What Aquino did in July last year was the launching of a transparent manner of bidding out the PPP project to the world.

AM: Mr. Aboitiz said that government should play a part in underwriting these contracts. Is this a fair comment?

JA: Mr. Aboitiz is right there is no need for the government to come back in because we have established an energy market that can sufficiently progress on its own.

The biggest challenge is transparency. In a country where certain pre-conceived processes are embedded and endemic in the bureaucracy that is a big challenge for all agencies. You want reform, it starts with bureaucracy. You want change so that there is sufficient investor confidence you start with bureaucracy. With the president’s thrust – and even without government coming in and providing guarantees – the projects can fly.

MT: We’ve come a long way. In the eighties when we did the first public-private deal with the Navotas power plant, we required operating guarantees from the government. For the MRT-3 light rail transit, a letter of credit from a Philippine bank was also needed. Going forward the successes of the past will translate into a better environment for raising finance for these projects.

But for the bidders themselves, I think the two areas they will need some form of assurance is in the area of dealing with local stakeholders such as the local governments where they might want ways for them to be signatories to the agreements. In terms of financing itself, I don’t think they need to rely on government.

I think the capital markets have moved a long way in the last 20 years – be it project financing or exchange listing of a fund. It’s not so much about the financial guarantee of a particular instrument or return.

The concern of financiers and investors is that there needs to be a constancy of application of government rules, of tariffs and understanding how these rules play out in the future. I think the biggest problem is to explain why you should come to this country.

Just recently, the Supreme Court, when trying to answer a particular question on a specific firm has, by the stroke of a pen, potentially changed economic policy in this country. Ownership levels are being recalculated differently to the way our own SEC has practiced it for many years. This to me is a big risk that needs to be addressed by all branches of government. It goes to a much larger question of whether Philippines Inc. is a viable destination.

FC: I think we have progressed a lot in terms of consistency of policy and regulations but still there is room for improvement. One would be project proponents should be conscious in dealing with local governments. Some of them feel they are left out – complaining they haven’t been informed or consulted.

We, as project proponents, have to ensure that local communities are also well informed and involved. The national government can help by encouraging the local governments to welcome these investments. In the end it’s the local communities who will also benefit from all of these.

EA: I might say something a little controversial here. Everyone says the Philippines has a reputation of changing the rules of the game in mid-stream. I think it’s exaggerated. If you look at the financial crisis of 1997, almost every country in Asia renegotiated their IPPAs. Indonesia did not allow the currency to be adjusted in their IPPAs; many other countries did not honour some of their contracts. The Philippines honoured every single contract, every last centavos was paid.

In relation to the building of a controversial nuclear plant: I had a heated discussion with a banker. I’m a financial man by background but as a Filipino I believe we should repudiate the debt of that power plant. He couldn’t understand how I could say it. There was a lot of corruption, so why should we pay for something we are not going to use? Yet, we paid everything.

Fedinand mentioned about local governments. We have our issues too but the reality is that they have been taken for granted for many years. When you go to somebody’s community where he has resources and you are going to extract that and give the local government nothing, it’s ridiculous. I think the reason they are reacting the way they are is that they have been taken for granted for all this time.

Back to balance. If we want local government to support us there has to be something in it for them.

CP: Don’t expect the government to give you all of your favourable investment requirements on a silver platter. We can only do so much. We are not shirking on giving you all the best service we can give but look at these two gentlemen from San Miguel and Aboitiz. All of these people endured all kinds of bureaucratic difficulties and yet look at where they are now. If you are a serious investor you will not let the infirmities of government, regulation, threats, and weaknesses destabilise your plans to move forward.

Don’t expect a perfect situation. You’ve heard the phrase: when there’s blood on the street, invest. We are far from that situation. These conglomerates have made use of the situation to build their business empires to where they are now. The message is there: there’ll be threats and risks but this is where those who have the guts for succeeding and moving forward will benefit.

JA: I’d like to respond to how we tackle the local government issues. I am happy to engage in debate but I take exception to the statement local government has been neglected. The fact is the local government law that was passed in 1992 gave a lot of powers to LGUs [local government units].

Where government has failed perhaps is in assisting LGU CEOs /legislators to understand just what their responsibilities are and what the privileges are under the code. Speaking of energy projects, this is where we have to make sure investor confidence is consistent and therefore sustainable.

There are discussions in making energy projects of national significance so that they enjoy a premium without leaving the LGU with an empty balance sheet. Mr. Aboitiz is right that the LGU as host should be able to get something. Perhaps it’s not enough that it gets one centavos for each kilowatt of energy sold but we also have to be guided on how to utilise whatever benefits the communities we have. It’s a matter of balancing the needs of the municipality and the importance of the project at a national level.

CP: We have to review the latitude of discretion given to local government officials. For example for real estate [tax] assessment – if an asset is appraised, there’s an assessment level: it is the basis for you being taxed 2%. We noticed the assessment authority of LGU’s range from a low of 10% to a high of 80%. A LGU council can assess from 10%-80%. In the case of one power plant it was assessed at a high of 80% – and this is a power plant appraised at PHP17 billion.

Immediately there is a disconnect between a project so highly valued and of national interest being charged the maximum tax. These issues we are reviewing: to unbundle and unravel all of the local government authority that we could perhaps temper their latitude of discretion. It’s a long term project which would require legislative amendment.

AM: What do capital markets investors want to see in the contracts?

MT: We don’t want to see contracts overturned or reversed in the future, and no contracts dishonoured.

The other point is in terms of what the PPP might require in terms of financing. Sometime projects have a long cooperation period and sometimes there’s a mismatch in between the length of the cooperation period and what’s financing terms are available in the market. From the point of view of the project proponents and from the investors themselves, they want to have the sense they can raise future financing at the tail end of a project.

That’s not something you can put in a contract but you have to consider what is available in terms of financing and matching what’s needed by the project, especially as they have long gestation periods.

JP: We at the DOE have been making progress in terms of what investors and proponents want for the investor’s handbooks. First they want to know what is available. Once they know what is available how do they go about investing and what are the procedures, they want consistency in that. If we make that clear we would already be able to answer 90% of the investors’ questions.

AM: Do you agree?

HS: Transparency is a challenge. If you look at what investors and proponents want it’s about understanding and accepting the risks and understanding your target rate of return. Can I get a decent return for what I’m getting into? In doing so you have to factor in red tape, incomplete information, risks that may not clearly be identified and the potential that contracts may change in the future.

Look at the financing side today: one has various funding routes. The stock exchange provides the ability to issue a follow on for already listed firms; the banks offer a lot of advice on structured finance arrangements; there are also some private placement situations where specific companies want to get into specific partnerships with a particular project proponent and provide the funding.

AM: The DOE and PSE are apparently relaxing listing rules for renewable energy companies. Is this a sound decision?

JA: I’m sure developers would welcome this route and form of assistance.

MT: In terms of renewable energy – in some cases the technology and market are not proven and so therefore it involves more risk. I think the financing available might not be through a listing necessarily but perhaps through private equity. In other countries it’s more prevalent: companies raise their equity finance through PE [private equity] and funds that invest in these situations. I think a listing of a renewable energy entity might not be the appropriate financing.

HS: I agree. However it is early days with the where we are with the DOE. The idea is to stave off a situation, which we had a few years back, where the listing requirements for the PSE focused on proven track record companies in term of performance/profitability.

As a result, one energy company with its own contracts/uptake remits wanted a listing on the PSE. It wanted to augment the capital it had raised from the various partners but could not find the appropriate reason to do it and ended up listing in the Australian Stock Exchange. This is a sad situation where the assets are in the Philippines, exploration is in the Philippines but there’s a small office in Australia. It’s an irony.

There have been a lot of renewable and energy companies coming up to us and asking if there’s a way to augment their capital base. It would require a higher risk type of listing. We are trying to figure out with the DOE whether we can certify a company which has a contract to explore and is looking at an area where there is proven or highly probable likelihood of reserves. We could then offer a listing segment to allow some of these companies to come to the market – understanding of course that there will be a high reliance on the current equity partners and the technology to make sure it comes to full fruition. It is a high risk listing. Disclosure requirements would be high. We may end up in that situation. We hope that collaboration comes to fruition with the DOE.

FC: If I were a banker I would want to look for a very clear outlook in terms of the specific project. The bankers are also the risk takers and they would be willing to finance these projects if they understand the risk.

As a project proponent we would prefer longer-term financing, especially for infrastructure financing. It takes time before you can get more revenues in excess of costs.

In the last project we were able to get seven-year financing, which is quite good, but for other projects that might take longer to break even it’s a little harder. Ten-year plus would be most desirable. There are more financial institutions which are willing to take a longer-term view. Hopefully they will be interested in putting in as long they understand what the project is about.

EA: With respect to the financing of infrastructure projects, the challenge is accessing long term financing. Over the past few years, the banks have moved to offering new flexible terms such as longer tenors, like 10-15 years, with balloon maturities which gives you a similar effect of a 20-year loan. I think the market is developing quite well in terms of providing longer term financing.

CP: I’d like to congratulate our bankers. I was reading some stats yesterday: total loan portfolio of the commercial banking system has grown 15% to PHP2.4 trillion. The NPL [non-performing loans] is down to 3%. I was a banker for 20 years and I don’t think I’ve seen the banking industry beat that level ever before.

The banking sector is healthy. One of the healthiest in the world. I believe they are more bullish on lending money right now. I can see the banks are all over the place trying to cut a deal on loans. I believe the wishes of San Miguel and Aboitiz will be a reality soon.

On a macro level we are rated almost investment grade but it’s amusing to observe that although we are not quite yet IG [investment grade] but we see how much premium banks charge on Philippines sovereign debt, particularly the ROP [Republic of the Philippines] bonds. This is the market reaction atmosphere for our debt and banking sector. The banking sector is well taken care of and government is best leaving this alone.

Filipinos are putting money where their mouths are. Appetite for Philippines projects is the top priority. The country’s GDP grew 7.8% last year. We will try to obtain 7% growth rate next year. This is already good but not yet excellent.

We need to see more growth coming through larger FDIs [foreign direct investments] and domestic investments. Our poverty level is still high at 30%. This is the challenge of the present administration. The mandate: to bring poverty levels down to a single digit by 2016. We can’t rest on our laurels.

AM: There are brownouts in the country and many anxieties that the cost of electricity is too high. Who will take responsibility and who will take the risks to resolve these issues?

JA: I don’t want to say indefinitely it should be the consumer but we are trying to find ways to ensure otherwise, that there is enough capacity that will give the distribution utilities the cheapest form of power available. There are tax issues – property tax issued embedded into operational costs. Moving forward, rates are regulated but policy-wise the DOE is seeking to bring in more investors so there’s more competition in the energy sector.

MT: I think the private sector is obviously gearing up. A lot of them have raised capital, prepared for the PPP and from that standpoint are prepared to take the risks. It’s best the government pushes that so that targets of efficiency/low prices are finally achieved. From our standpoint in the capital markets we are looking forward to more activity generated by the PPP because the projects will need capital and finance – both debt and equity.

HS: Project proponents are finding a lot of the opportunities around the PPPs, including the energy projects. It is interesting because they will be the first drivers in terms of getting investors to come in. There are enough complementary funding sources.

FC: With enough investments and efficiency on the part of the private sector putting up the plants, the market will take care of the price of the power service provided. We have to make sure the new projects are very efficient and have good support from local and national government. We agree with the government there should be no more subsidies.

EA: Everyone comments on the Philippines for being too expensive for power.

We are expensive, no question about it. The unfortunate circumstance for the Philippines is that we don’t have the resources. We import our fuel; we are an archipelago with three grids and are forced to build smaller plants. What about the rest of Asia?

Look at power prices – we probably are more expensive but if you look at residential pricing in Singapore I don’t think we are that far away. Industrial [sector prices] maybe, but not residential. Countries like Thailand, India and Indonesia subsidise inputs to power plants whereas we do not. The comparison is not quite correct. Moreover, Metro Manila power rates are not representative of the entire country. Rates in Mindanao are lower, for example.

CP: The market-driven sector will usher us to more reasonable rates in the next five years. [In terms of] market share: San Miguel: 20%, Aboitiz: 17%. I’m sure Mr. Aboitiz won’t take that sitting down as he has many power plants already to break ground. So there’s healthy competition to help bring down prices. The energy sector is well taken care off.

When people talk of us as the second-most expensive [market for electricity] in Asia it is a disincentive to attract foreign investment, especially in the field of manufacturing and electronics. There are nuances but we can solve them during the Aquino administration.

07 Sep 2011