Download Phu My 2.2

Case Study: PHU MY 2.2
Located in the Phu My Power Generation Centre, Vietnam, Phu My 2.2 is a 715 MW combined cycle gasfired power plant which will cost approximately US$400 million. Phu My 2.2 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 stateowned utility Electricity of Vietnam (EVN).
Despite the difficulties and rather bad track record of BOT development in Vietnam, Phu My 2.2 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 and the legal and financial achievements
of the project.
The coming of age of the Vietnamese power market
Vietnam is rich in natural resources, yet its energy production is among the lowest in the Asia. In April
2003, the Vietnamese government and EVN listed 62 new power projects as part of Vietnam’s policy to
tackle demand growth, expected to be some 10 and 12 per cent per year over the next decade.
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 the government is
looking to reduce dependence on seasonal hydropower generation. Consequently 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 is looking 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.
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 by establishing its own bank, issuing bonds
and 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 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 viable rate. 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, Phu My 2.2 and Phu My 3 at the Phu My complex near Ho
Chi Minh City.
The success of foreign-funded power projects such as the Phu My 2.2 plant has provided an important
endorsement for other potential investors, but it remains to be seen whether the EVN's ambitious growth
targets can be met.
Teething Troubles
Already 12 months behind schedule in November 1997, Vietnam invited bids from foreign power
companies for a 450-600 MW, US$500 million project for a gas-fired power station to be built on a BOT
basis 50 kilometres southeast of Ho Chi Minh City.
Bidding documents were issued to over ten foreign consortia. The size of the deal, as well as the pressure
the World Bank would put into its reaching closure made it the first real test of Hanoi's willingness to
provide pricing and currency convertibility guarantees to foreign investors. Convertibility, or currency risk
is always an issue in Vietnam where utility revenues are collected in the non-convertible national currency,
the Dong. Investors thus needed to seek guarantees from the host government that these can be exchanged
into hard currency for repatriation overseas. The guarantees are not always easy to find considering Hanoi
only has US$2 billion in foreign exchange reserves.
Bidders for Phu My 2.2 included a consortium involving Mitsubishi, Petronas, Unocal and Illinova, another
comprising Tractebel, British Petroleum, Statoil, Mobil and Asea Brown Boveri and a third made up of
Electricite de France, Alsthom and Tokyo Electric.
US energy consultancy K&M Engineering was involved advising the Vietnamese government on the
project.
The Wartsila precedent
Wartsila of Finland also won approval for the 120 MW diesel-powered thermal plant in Ba Ria-Vung Tau
in 1997. The project was to be on a BOT basis but Wartsilla tried to go ahead before obtaining the allimportant government guarantees on pricing and foreign exchange. This was the only other BOT-based
power project in Vietnam at the time.
The project was licensed without securing commitments on risk guarantees from the government and
received £84.5 million in support from the IFC (£28 million in concessional lending, and £56.5 million as a
syndicated loan). EVN then agreed to buy electricity generated by the builder at 7.59 cents per kWh for the
first three years and 4.59 cents for the subsequent 17 years.
In 1998, Wartsila asked EVN to share risks that might be caused by natural disasters and technical
problems. The Finnish company and EVN began talks on prices, but no consensus was reached. As
negotiations dragged on, the Industry Ministry sent a notice to Wartsila to terminate the project, saying that
the power price sought was unrealistic and rendered the project unfeasible. By this stage Wartsila had
already spent US$10 million on the site.
Some analysts believe that Wartsila's willingness to be flexible on guarantees in initial negotiations has
made things harder for other companies who were trying to get commitments from Vietnam on guarantees
against non-performance by EVN, or foreign exchange convertibility. In any case, it certainly was a
warning shot for those working on Phu My 2.2 at the time.
World Bank’s involvement
The Government of Vietnam and EVN’s executives were failing to provide clear pledges on the extent of
government guarantees to support the project. With no export revenues incorporated into the scheme,
questions of currency risk over the Dong's convertibility were severely limiting enthusiasm among the ten
foreign groups to whom bidding documents had been released, despite heavy involvement on the part of the
World Bank.
The World Bank's country strategy for Vietnam includes a commitment to provide more services that will
facilitate enhanced private participation in the energy sector, including putting in place a transparent and
independent regulatory framework. The World Bank saw Phu My 2.2 as a test case for power BOTs in
Vietnam as it made funding of a related project conditional on Hanoi committing to embracing the BOT
concept.
But while it pressed for greater private involvement in the sector, its own attempts to promote a showcase
BOT project remain bogged down. The Bank had been actively assisting Vietnam in the development and
assessment of bidding documents for Phu My 2.2, providing its first ever £75 million Partial Risk
Guarantee, which would eventually contribute to low initial electricity prices of around 3 cents/kWh
offered by the Phu My bidders.
Bids for the project were submitted in April 1998, already some 18 months behind original schedule, but by
December they had not yet elicited a response from EVN. Four international consortia were still in the
running, led by EDF, Mitsubishi, AES and Tractabel.
Furthermore, in 1998, negotiations on power BOTs were taking place against continued ODA funding of
power projects, particularly from Japan's donor agency, the OECF. It had already committed to finance a
600MW thermal power plant at O Mon, near Can Tho in the lower Mekong Delta. The OECF was also to
propose funding a new 300MW hydro-power plant at Dai Ninh in the Dong Nai river basin during fiscal
1999-2000.
Given the choice between a low-cost ODA funded project, and a high-cost BOT project, Vietnam’s
willingness to go down the road signalled by the World Bank was limited.
EDF wins the deal
In January 1999, the consortium consisting of EDF, Sumitomo, Alstom and TEPCO was selected to
develop the 20 year BOT. Following the Wartsila failure, it would be the first private infrastructure BOT to
be launched under an international competitive bid in Vietnam, and its largest limited recourse financing to
date.
In July, EDF started negotiating final terms with EVN and the Government and it was hoped were that this
round of talks would secure an investment licence for the project by the end of the year.
After the award to build the plant had been made in January 2002, the next steps were to negotiate various
other aspects of the provisional contract, such as the fuel supply agreement and various regulatory
approvals. A subsequent round of talks would focus on government guarantees and on ways to convert
Vietnamese Dong revenues into hard currency.
In April that year, BP Amoco, Statoil and ONGC Videsh had signed MOUs with Hanoi that covered a
broad investment framework for a £1.5 billion offshore gas project in the Nam Con Son Basin which would
feed Phu My 2.2.
EVN rebellion
In July 2000, Vietnamese authorities started putting extra pressure on international power developers and
issued a deadline to EVN to seek alternatives to BOTs passed without any formal statement from potential
foreign investors.
Authorities kept saying to EDF that there was no reason to doubt that the Phu My 2.2 project would go
ahead.
Initially, it was hoped the BOT schemes would account for around 20 per cent of Vietnamese capacity. But
negotiations regularly hit stumbling blocks regarding wholesale prices, and the Government’s edict was
meant to devise other ways of meeting the country's spiralling power demand, set to increase to 170-200
million MWh by 2020.
The length of negotiations, and the presence of so many foreign power professionals in Vietnam in one
capacity or another was starting to undermine the development of Vietnamese BOTs. Authorities had too
many cards to play, and it was started to be feared that the amount of technology transfer was been such
that Vietnamese would soon start thinking of proceeding on their own.
Negotiating the contract
In June 2000, Phu My 2.2 had not yet been licensed, and the parties were in the midst of negotiating the
BOT contract and related gas purchase and power purchase agreements. Negotiations were being watched
with great interest as the project was believed to be the litmus test of BOT development in Vietnam. The
absence of foreign exchange as well as the electricity price were at the heart of the talks.
The issues, as BOT projects proceeded from the proposal phase, through licensing toward implementation,
were always the same. The negotiation process necessitated obtaining government interpretations and
clarifications, and was sometime subject to changes in policies. Because the Authorized State Body (see
box 1 on Vietnamese BOT negotiations) has inadequate authority to resolve issues related to the BOT
contracts, too many other bodies had to be consulted, making an already complicated process even more
complicated and slow.
Parties to BOT negotiations also complained that other involved bodies were unsure of their role in the
decision-making process and, were therefore reluctant to sign off on projects. These problems existed in
every phase of the process.
Administrative layers
Vietnam first introduced the concept of BOT investment projects when it amended its Foreign Investment
Law in 1992.
Many reasons have been advanced to explain the slow pace of development. The Asian financial crisis has
had some impact. Slower growth within Vietnam had dampened demand for power and thus slowed
negotiations on power plant BOT projects. ODA from international organizations such as The World Bank,
the ADB and bilateral donors has allowed Vietnam to pursue large infrastructure projects without the help
of foreign investors. Where foreign investors have participated, they have encountered difficulty in
arranging financing because, among other reasons, the bank regulatory regime interferes with a
fundamental element of project finance: cash flow financing.
Foreign investors had to address obstacles in taking security over land-use rights, the guarantee of income
streams, the impact of Vietnam's limited foreign exchange reserves, and the difficulty for the Vietnamese to
pay a price that would ensure commercial viability.
The clearly-defined negotiation process set forth in the BOT Decree masked the fact that the authorized
Vietnamese government negotiator has limited authority to settle substantive issues that arise during BOT
contract negotiation. For example, the right to foreign currency may be provided in the Decree, but another
organization, the State Bank of Vietnam, with a different agenda, must provide the guarantees. The right to
mortgage assets may be set forth, but the procedure to implement and enforce mortgages does not exist.
Existence of a framework to resolve disputes obscures the fact that enforceability, as a general matter, is
also a problem in Vietnam.
Furthermore, the detailed formulation for dispute resolution is based on a distinction between foreign and
local companies. As a result, some contracts related to a BOT project may have to be resolved in Vietnam
while others may be resolved overseas, opening up the possibility of related disputes being heard before
different jurisdictions. Therefore, although steps in the negotiation process are clearly set forth, the
problems which have arisen relate to the realities of the decision-making process and business practices in
Vietnam.
While layers of opaque bureaucracy naturally tend to persist the Vietnamese authorities have made vast
steps to address regulatory problems discouraging investment. However, with or without regulatory
improvements, foreign investors interested in BOT projects had to find more direct routes to financial
closure.
Achieving 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.
The recipe of success
Phu My 2.2 has reinforced the on-going trends of other successful large scale infrastructure financings in
emerging markets such as AES Meghnaghat and AES Haripur in Bangladesh, and AES Kelantissa in Sri
Lanka. A number of common elements contributed to the successful financial close of these projects,
starting with the commitment of the sponsors. In addition to their financial investments, they have to
remain committed to the Project during the long development phase in order to build the level of consensus
required amongst the various stakeholders.
All parties had to realise that underlying commercial rationale has to be the driver of the project financing,
rather than contractual mitigants. At the same time, contractual arrangements were made to allocate risks
and rewards fairly to enable stakeholders with conflicting interests to achieve a ‘win-win’ outcome
acceptable to all.
It is important that the host government is comfortable that the sponsors and financiers take a long-term
view of their investment in the country. This contributes to the government’s willingness to participate in
‘good faith’ discussions towards a mutually acceptable outcome, and facilitates the project development
process.
Multilateral and bilateral institutions, including ADB and IDA, have not only played significant roles in the
project financing, either as a provider of direct loans, or political insurance, but have also contributed in
other ways. Their involvement ensured transparency in the selection of sponsors and other parties, and
helped to lay the foundation for a ‘fair deal’ at an early stage. They were also key in mobilising private
capital, acting as the catalyst between the government and the private sectors, and playing the role of an
‘honest broker’ in facilitating negotiations, especially in cases of disputes. Additionally, their assistance to
host governments in implementing key sectoral reforms in their countries helped secure the foreign direct
investment required.
Conclusion
In May 2003, EVN announced it is planning to restructure itself into a consortium and shift its operations to
the model of parent companies and affiliates. The affiliates would be either totally foreign-invested,
liability limited or joint-stock companies, which would operate independently in terms of finance.
Even though a new Electricity Bill and a proper power market are still necessary for Vietnam to enter
electric modernity, it is starting to look like the new power generation in Vietnam is embracing
international private finance.
EVN has been carrying out sales contracts signed by the Vietnamese government with the sub-Mekong
regional governments of Laos, Thailand, Myanmar and China. Separate energy cooperation agreements
with Laos and Cambodia have enabled EVN to sell electricity to the two countries through medium-voltage
power transmission grids. EVN is also installing a 220-kv power grid for, the Cambodian capital, which is
expected to be complete by 2005.
EVN is also now in negotiations with Laos about the purchase of electricity from the latter's Nammo
electric power plant. It is to cooperate with a number of domestic companies to build an electric power
plant at Sekaman, Laos, with electricity being transmitted to Vietnam. EVN is also considering buying
electricity from China.
The development of Phu My 2.2 has eased the way for other BOT projects in the country. The Phu My 3
BOT Power Company, jointly owned by BP Holdings BV, SembCorp Utilities Pte, and the consortium of
Kyuden International Corporation and Nissho Iwai Corporation is embarking on the construction of a 717
MW power plant at Phu My called Phu My 3. Both projects have received loans from the ABD but the two
projects are implemented by different sponsors and do not have links other than the location and that the
contractual arrangements in terms of power offtake, gas supply, and the government support are
substantially the same.
The project has established precedents in managing political and country risks and established mechanisms
in Vietnam to meet international legal requirements. Furthermore, Phu My 2.2 in Vietnam is part of a
continuing trend for project finance in emerging markets with the following ingredients for success: (i)
strong commitment from all parties to the Project; (ii) solid underlying commercial/strategic rationale; (iii)
fair risk allocation; (iv) significant role of multilaterals and bilaterals; (v) finance plan with country risk
largely mitigated. Its success paves the way for attracting private capital investment flows for future
infrastructure development, and offers guidance to prospective lenders and investors in emerging markets.
The developers and negotiators who worked on the Phu My 2.2 also demonstrated that it is more efficient
to negotiate the project as a whole, including final prices and guarantees, before looking for financing, than
getting a looser agreement which looks initially very attractive to the Host Government, and then blame the
lenders for demanding stricter conditions. Wartsila paid the price for this second approach. IJ
BOX 1: The Legal Framework for Vietnamese BOT Projects
The Foreign Investment Law of Vietnam encourages investment in infrastructure projects. BOT projects are encouraged in the areas
of transportation and communications, power production and trading, water supply, drainage and waste treatment. Investment in other
sectors, such as airports, seaports, railways and telecommunications, is restricted.
Decree 62 and a subsequent amending decree, define and establish the basic parameters of BOT contracts involving foreign
investment in Vietnam. Foreign organisations or individuals may be investors in a BOT contract, but the local party has to be
designated by the Prime Minister, and may be a ministry, governmental body, or centrally-governed provincial or municipal People's
Committee. The BOT project itself is implemented through a ‘BOT Enterprise’, which may be either a joint venture or a 100 per cent
foreign-invested enterprise.
The BOT Decrees establish preferential tax treatment for BOT Enterprises, including import and technology transfer tax exemptions;
specify the BOT Enterprise's right to convert profits into hard currencies; and address issues which relate to the mortgage of assets and
dispute resolution. They allow Vietnamese enterprises to take part in BOT projects when permitted by the responsible State authority
(Authorized State Body). They also provide that the Authorized State Body may "sponsor the implementation of commitments
involving a Vietnamese enterprise's financial obligations."
Anyone, including a foreign investor or a State-owned enterprise, may propose a project to the Prime Minister for BOT treatment.
Even so, Decree 62 authorises the Ministry of Planning and Industry (MPI) to submit to the Prime Minister a list of proposed projects,
showing necessity, location, designed capacity, estimated investment capital needed and suggested modes to choose foreign investors.
The Prime Minister designates which projects will go forward and nominates the Authorized State Body which will be responsible for
negotiating the relevant contracts, coordinating with ministries, and assisting the foreign investors to set up and implement each
project.
Once the Prime Minister approves a project and designates the Authorized State Body, that Body gives instructions for the preparation
of feasibility studies, which are used as a basis for choosing the foreign investor. The Authorized State Body must recommend a
foreign investor based on Vietnam's bidding regulations and must forward its recommendation to the Prime Minister for final
approval.
After the designated foreign investor prepares a more detailed feasibility study, the Authorized State Body coordinates with various
ministries, branches and central government People's Committees to consider and approve the feasibility study. In the event that
matters arise which the Authorized State Body is not authorized to address, such matters are referred to the Prime Minister for
resolution. Upon approval of the feasibility study, the Authorized State Body and foreign investor negotiate the relevant contracts,
until an agreement in principle is reached. The contracts are then submitted to MPI for assessment before being sent to the Prime
Minister for approval. Following Prime Ministerial approval, the agreements are signed and MPI issues the investment license to the
BOT Enterprise. Next, the BOT Enterprise submits the technical design to the Authorized State Body, which then consults with the
Ministry of Construction and other relevant ministries and People's Committees to assess the technical details. Once approval is
obtained, the BOT Enterprise may begin the project.
Potential risks:
- Availability of foreign currency
The BOT Decrees state that BOT Enterprises may exchange Vietnamese dong earned from implementing BOT projects for hard
currency in order to pay for imported materials, equipment, etc., to repay loans and make interest payments, and to transfer profits and
capital overseas. The two main issues in this respect are: Will the currency be available and approved for transfer when it is needed?
When may the money be transferred overseas (is it earned before or after taxes are paid)?
- Security for Loans
Foreign investors have been frustrated by regulations that restrict the securitization of available collateral. These restrictions include
requirements that collateral have been financed by the proceeds of the foreign loan and prohibitions on the mortgage or pledge of
after-acquired assets and the mortgage of land to overseas lenders or to foreign branch banks. Recently, after much prodding by
foreign investors and banks, the government took significant steps to clarify this area. However, foreign investors await implementing
regulations to see whether the changes are meaningful.
- Dispute Resolution
Parties to a BOT contract may stipulate in the contract that foreign law will apply; however, that foreign law must not be contrary to
the laws of Vietnam. This stipulation must be approved by the Ministry of Justice, which is issued in the form of an opinion letter.
The BOT regulations support negotiation and conciliation in the event of a dispute, with arbitration being an acceptable means of
resolution in the event that negotiation and conciliation fail. However, for some contracts, and depending upon the parties to the
contract, arbitration must be undertaken before a Vietnamese arbitration tribunal. For others, the parties may arbitrate abroad.
BOX 2: Project Information
Sponsors:
Lead Arrangers:
Borrower:
Advisers:
EDFI, Sumitomo Corporation, Tokyo Electric Power Company International BV
ANZ Banking Group Ltd, SG Asia Ltd, Sumitomo Mitsui Ban Corp
Mekong Energy Corp
Clifford Chance (to lenders) with local Vietnamese LF VILAF, Allen & Overy (Sponsors), Vietbid LF/ Gide
D/E:
Loyrette Nouel (Vietnamese counsel)
75/25 (US$340 m/ US$140 m)