Quezon Coal Plant Case

Study

Philippine Power Market Background

Frequent brown outs ranging from 2 to 12 hrs daily in early

1991.
Cancelled 625 MW Batam Nuclear plant when it was almost
complete.
Projected growth in electricity demand requires
commissioning of new plants and rehabilitation of old
plants.
State-owned Generating Company was NAPCOR; Approx.
72% of NAPCORs capacity is in Luzon.
Frequent closure of existing plants due to deterioration of
oil based plants.
Failure to undertake regular maintenance of certain plants
Postponed maintenance due to insufficient power reserve
The S&P bond rating for the Philippines was BB
The World Bank estimated that power outages in 1990
reduced economic output in Metro Manila alone by $2.4
billion.

Background on Existing State-Owned

Utility Company
Approx. 72% of NAPOCORs capacity is in Luzon.
Existing plant capacity exceeds peak demand (est. at
3,473 MW).
NAPOCOR unable to operate its plants at full capacity,
only 2,333 MW (50%) of 4,639 MW total Luzon
capacity.
Frequent closure of existing plants due to
deterioration of oil based plants.
Failure to undertake regular maintenance of certain
plants
Postponed maintenance due to insufficient power
reserve

Context of Power Crisis in Early

1990s
To understand the rush to welcome private investment
in the early 1990s, it helps to also see the cost of the
chronic blackouts of that time.
At the peak of the shortage, the blackouts averaged 1214 hours per day, 300 days per year.
A World Bank report in 1994 estimated that gross
economic cost of the outages was US$0.50/kWh.
Thus, even though IPP-generated electricity (average
cost US$0.0652/kWh) at the time was more expensive
that NPC-generated electricity (US$0.0637/kWh), the
inability of the government to finance rapid expansion
of the power sector made private investment extremely
attractive.

Legislation and the Power

Shortage
The Philippines entered the IPP market early, with a 1988
presidential decree authorizing private investment in the
generation sector. Major investment in IPPs occurred in response
to a 1991-93 electricity crisis.
The Electric Power Crisis Act passed in 1993 authorized
negotiating IPP contracts on a fast track basis.
In terms of addressing the power shortage, this law was a
successseveral thousand megawatts of generating capacity
was installed in the country in the first 18 months.
Most of the generating capacity built during this time was based
on combustion turbines or diesel systemsthe only generation
plants that could be brought to operation within a yearwhich
are characterized by low initial capital costs, but high operating
costs.
The fast track authority under this law expired in April 1994.

Growth in Electricity Generation

from EIA

Prediction was for

about 9% Growth

Fast Track Contracting

Because of the power crisis, the government had no
significant leverage in the negotiations. The unstable
political condition created a situation where economy
risks required a premium placed on project returns.
The entry of some IPPs had to be on a fast-track basis
and some were contracted through negotiations rather
than competitive bidding.
In contrast, Thailand bided out its first batch of IPP
capacity during the time when its economic performance
was the envy of all ASEAN. As a result, the offers were
very competitive (some offers took on the FOREX risk)
and represented about ten times more capacity than
what EGAT had asked for.

Three Rounds of
Development

The IPP sector in the Philippines developed in three main rounds.

First, the plants contracted in the early 1990s to address the power
crisis were largely oil-fired plants with 5-12 year PPAs. These tended
to be expensive because: (1) the rapid capital recovery period under
short PPAs, (2) the extreme pressure on government negotiators
stemming from the grave electricity crisis, and (3) the high fuel cost
oil plants were dispatched as baseload facilities during the crisis.
Second, a wave of large baseload coal plants most importantly
Pagbilao (700MW), Sual (1200MW), and Quezon (originally 440MW,
now rated at 460MW). These reached operation between 1996 and
2000 and had longer PPAs (up to 25 years).
Third, a round of big hydro/irrigation projects and natural gas plants
that reached aoperation from 1998 to 2002, including Casecnan
hydro (140MW), San Roque hydro (345MW), CBK hydro (640MW),
Ilijan natural gas (1200MW), Santa Rita natural gas (1000MW) and
San Lorenzo natural gas (500MW).

Philippines Contracts

Capacity was Added over Many

Years

Additions of Capacity by
Type

Diesel Added Early/Gas and Hydro

Added Later

Initial Contracts

The country had its first Build-Operate-Transfer contract in 1987,

with Hopewell Holdings Ltd. of Hong Kong tycoon Gordon Wu as
the proponent. Hopewell constructed two 100-megawatt gas
turbine plants in Luzon.
The venture was deemed so successful that the government was
encouraged to enter into more BOT power contracts and even
enact the BOT law (Republic Act 7718) that would allow Napocor
to tap the private sector more effectively. Past and present
government officials agree that the early Hopewell contracts
provided the model for all future power deals with the private
sector.
But Napocor soon found itself with more IPP contracts, and more
power, than it could handle, and what was once thought of as a
brilliant solution to the country's power needs have now become
problems themselves. At the time it was accumulating IPP
contracts, the government had also let the private Manila Electric
Co. (Meralco) to build its own power plants, which later
exacerbated an energy oversupply.

Summary of Capacity and

Costs
By 1998, foreign owned IPPs accounted for US$6 billion of
investment and 4800 MW of generating capacity. Over 90%
of new capacity installed during the 1990s came from
foreign owned IPPs.
Average capital cost of $1,250 per kW.
IPP capacity with PPAs is now 55% of the total capacity.
The first contract was signed in 1988 and more than forty
projects have been built in total. IPPs in the Philippines have
exhibited a wide variety of characteristics from fuel choice
to the composition of project sponsors and the identity of
the offtaker. IPPs in the Philippines have largely earned
healthy returns, even in the wake of economic crises and a
highly visible renegotiation of most of the PPAs in the sector.
From the country perspective, returns have been mixed.
Political instability and poor sector planning have led to
expensive electricity.

Cost of New Plants

Comparative Plant Costs

Cost of Plants per kW

Philippines PPA Features

Capacity-based formula with take or pay and capacity

nominated by the IPP.
Energy-based formula, a percentage is applied on a
contracted or guaranteed annual energy.
Availability fee formula carries both the capacity recovery
and the fixed O&M fees. These fees are payable as long as
the facility is available even if not dispatched.
NPC is responsible for the supply of fuel, with delivery at site.
Storage, usage and management of the fuel are within the
control of the IPP. This was because NPC has tax-exempt
privileges with respect to fuel oil purchases and governmentto-government arrangements for coal; making fuel pass
through charges to consumers cheaper.
Fee payments by NPC to the IPPs have large dollar
denominated components. NPC thus bears the currency risk
to the extent of the dollar payments.

Philippines PPA Provisions Continued

Payments in IPP contracts have both Capacities cost recovery
and O&M component. In turn, the O&M portion is subject to
escalation. In some of the geothermal contracts, fees are
bundled into a single energy charge and escalation is pegged
thereon to as high as 75%.
Escalation is based on varying factors depending on the
project such as salary adjustment of personnel, movement of
local and foreign consumer price indices, and the peso-dollar
exchange rate.
A number of NPCs obligations are fully backed up by a
government guarantee or performance undertaking. Very few
contracts have only partial government performance
undertaking depending on stipulations regarding payments
of fees, privatization, and foreign exchange convertibility.

BOT and Sovereign

Guarantee
Ownership structure for IPPs in the Philippines is
dominated by the BOT form. The prevalence of
BOT contracts as opposed to other forms results
from the fact that the transfer element of the
project makes the project eligible for a sovereign
guarantee. Formally, only solicited projects are
eligible for this guarantee a rule that invited
substantial controversy in the case of the CBK
hydro project, which although unsolicited,
received a performance undertaking from the
Department of Finance.

List of
Projects and
PPA Terms

Latest Photograph of Plant Under Construction

May 18,
Subic
Group
2001

22

Case 1: Enron Subic

Summary
Financial Close:
1993 (First Round)
Commercial Operation: 1994
PPA Agreement:
15 Years; Guarantee by
Government
Bonds:
$105 Million

Maturity
15 Years
Repayment
Level
Interest Rate
9.5% (3.68% spread to
Treasury)
Minimum DSCR 1.37
Completion Guarantee/Liquidated Damages
Capacity Charge
$21.6/kW/Month

BOT/PPA Contract
15 year BOT and toll process
NAPOCOR (government owned generation company)
to supply fuel & take electricity - no fuel availability
risk
Capacity fee $21.6/kW/month on available capacity
Capacity fee is dollar denominated no direct foreign
exchange risk, overseas a/c
O&M fixed fee and energy fee is in Peso $4.56/kW/Month
heat rate penalty & bonuses
buy out rights @ NPV capacity fees- late payment,
change of BOT law, war, etc

Case Study - Funding

Enron - Subic Bay, Philippines

Philippines
Government
Performance
Undertaking

Napocor
Buyout
Rights
Capacity Charge
O&M Charge
Energy Charge

PPA

Equipt Cos.

Warranties

Fluor Daniel
15-year
BOT
Concession
Supply
Fuel Free
Ground
Lease

EPC

Enron Power
Operating Co.

Enron Power
Turnkey
Phils. Opg Co.
Construction
Contract
Enron Subic
O&M
Power Corp
Agreement

113MW
Subic
Power
Corp.

65%

35%
Insurances

US$105 million, 15-year Notes

Completion
Guarantee

Enron
Corp.

Enron Power
Philippines Corp
Philippine
Investors

113 MW Diesel Generator Power

Station
Subic Bay, Philippines
Sources of Funds:
Notes
$ 105 M
Subordinated Note
7
Contr. Of Shareholders
Working Capital
2
TOTAL
$ 142
Uses of Funds:
Turnkey Contractor
$ 112 M
Bonus to Turnkey Contractor
Development and other related costs and Fees
Pre operating, Start-up and Commissioning Costs
IDC
4
Working Capital
2
TOTAL
$ 142

28

14

7
3

Subic Covenants

Financial Covenants
Debt Service Cover Ratio 1.10
Debt Service Reserve Account: 6mos debt service deposit
Debt Payment Account: monthly retention
Restrictions on

additional indebtedness other than

financing acquisition of Additional Facilities @
max 75%
financing scheduled payments to EPOC
subordinated debt < US$ 25mln
working capital loan

May 18, 2001

shareholder payments / repayments

payments of sub-debt
investments other than permitted
investments

27

Conclusion from Investor

Perspective
In Conclusion:
Attractive Return
Well Structured Deal
Solid Sponsors (Enron, NAPOCOR and the
Philippine Government)
Manageable Risks
Minimum Take:

US$ 20 Million

Bond issue under rule 144 A

BORROWER
Amount
Maturity

- Subic Power Corporation

- USD 105 million
- 15 years

Payments of Principal & Interest are fully guaranteed by

Enron Corporation until the Facility Completion Date.

- equal semi-annual Jun 28/Dec 28.

Repayment
Interest is accrued - 9 1/2 % p.a payable semi annual.
Interest base and Margin - US Treasuries 15 Y + 385 bp
fixed rate

Key Defaults

Failure to pay principal/ interest within 15 days after due

dates
Fails to perform following covenants
maintain DSRA, DPA & Revenue account & payments
therein
amendment of project contracts or merge/ sell assets
outside indenture
default on other indebtedness over $1 mn. - right of
acceleration not waived
Ceasure of BOT/ Performance undertaking and/ or
reduction under BOT by over 2% and modification of
Performance utkg. for the same
Enrons completion guarantee held invalid/
unenforceable
NAPOCORs bankruptcy and Govt.s non-confirmation
of performance utkg.

Completion Guarantee

Completion Guarantee
All principal and interest payments on the Notes are
guaranteed fully by Enron Corporation, and severally, in
proportion to their ownership interest in the Company, by
House of Investment (HI) and Rizal Commercial Banking
Corporation (RCBC).
Security:
Mortgage on all real property and security interest on all
substantial tangible property.
Security interest in Companys cash and investment.
Collateral assignment of:

BOT Agreement
Turnkey Construction contract
Performance Undertaking
Other project contracts

EPC Contract
EPOC wrap- Fluor Daniels assistance &
local contracts
$112m fixed price
LDs $6m capacity, $10m heat rate
$2m scope discrepancy
bonus payments for $3.6m capacity and
$3m heat rate
12-19 month warranty with liquidated
damages per day

Sensitivity Cases
What If
Base Case
Availability = 81%
Operating expenses
are 50% higher/yr
Interest Rate is 12%

Min
DSCR
1.39
1.25
1.19

Min
Interest
Cover
2.01
1.80
1.72

PV Loan
Cover
Ratio
1.53
1.36
1.23

Equity
IRR
(Post Tax)
19%
14%
9%

1.37

1.77

1.40

17%

Adjusted Results

Other Assumptions

Quezon Coal Plant Case

Quezon Case Study

Capacity 440 MW
CostUSD 808.9 Million
Transmission 230 kV 31 km
PPA
25 Years
covered costs as long as as-contracted
performance met

Offtaker: Meralco (First PPA with Private

Utility)
BOO without government guarantee

Sources and Uses of Funds

Construction Period

Development Risks

Approval and Construction

Financing Risks
Contractual and Operating
Currency/Country

Public Support During

Contruction

Quezon EPC Contract

Pulverized Coal -- Proven Construction since
1950s
Bechtel EPC Contractor
LSTK
Liquidated Damage Caps
Meralco Leased Property
Contingency USD 35 Million
Cost Over-run Facility
Debt
30 Million
Contingent Equity
20 Million

Sponsors
Contribution
Ownership
Intergen

72.5%

71.875%

Bechtel and Shell Joint Venture

Ogden Enterprises
Local Developer

27.5%

26.125%
2.000%

Fuel Supply
Fuel Supply from Indonesia
Potential and Desire to Use Local

PPA Provisions
Four Part Tariff
Capacity Payment for Fixed Charges
Fixed O&M Charges
Variable O&M Charges
Energy Charges

Off-taker

Meralco is Private Distribution Utility

Currency Risk
Franchise Renewal
Electricity Prices
Bond Rating BB+

O&M Contract
Ogden was O&M contractor
Received USD 160,000 per year
above costs
Bonuses
Achieving high capacity factor
Costs under budget

Intergen Management Fee USD

400,000

Project Debt
Political Risk Insurance
Generally not for bonds
Exim takes insurance, but includes upfront fee

Treatment of Exim Up-front Fee

S&P Initial Comments on

Project

S&P Comments on Quezon

Continued

Moodys Comments

Downgrade of Bonds

Problems with Quezon

Moodys Comments

S&P Comments on Meralco

Comments on Meralco

Cost Comparison in Case

Recent Comparison of Cost of

Project

PAGBILAO, Quezon ,Philippines Team Energy, a joint

undertaking of Japanese firms Marubeni Corp. and Tokyo
Electric and Power Corp., will start the $700-million
expansion of the Pagbilao coal-fired power plant in this
province next year.
Federico Puno, Team Energy president and chief executive
officer, said the company would finalize the details of the
project that would generate another 400 megawatts of
power.
Puno said talks with another Japanese firm, Mitsubishi, for
the engineering, procurement and construction (EPC)
contract of the project are ongoing.
If there is no agreement firmed up within the first half of
the year, Team Energy will bid out the EPC contract to
enable them to set up everything they need in time for the
planned groundbreaking in the first quarter of next year,
he said.
He said Team Energy is optimistic commercial operations

Valuation of Plant

Covanta Holding Corporation (NYSE:CVA) (Covanta), announced that it

has agreed to sell all of its interests in the Quezon coal-fired electric
generation facility located in the Philippines to Electricity Generating
PCL (EGCO) for a price of approximately $215 million in cash. EGCO is
a current partner in the Quezon project and we expect the transaction
to close in the first quarter of 2011, subject to customary approvals
and closing conditions.
Quezon is a world-class asset and the valuation reflects its strong
potential going forward."
The Quezon assets being sold consist of the Company's entire interest
in Covanta Philippines Operating, Inc., which provides operation and
maintenance services to the facility, as well as its approximately 27%
ownership interest in the project company, Quezon Power, Inc. (QPI).
The sale is expected to generate a one-time after tax book gain of
approximately $140 million at closing. For the twelve months ended
September 30, 2010, Quezon's contribution to Covanta's consolidated
results was: $2.8 million of revenue, $19.5 million of Adjusted EBITDA,
$15.9 million in Free Cash Flow and $0.12 of diluted earnings per
share.
Covanta Completes Sale of its Interest in Quezon Project
March 28, 2011 Covanta Holding Corporation today
announced that it has completed the sale of its interests in
the Quezon coal-fired electric generation facility located in the
Philippines to Electricity Generating PCL (EGCO). The

Quezon Transactions
14 May 2012 (Reuters) - Thailand's secondlargest private power producer, Electricity
Generating Pcl (EGCO), said on Monday it would
spend $375 million to buy an additional 45.875
percent stake in Quezon power plant in the
Philippines.
The transaction, expected to be completed in the
second quarter, will raise EGCO's holding in
Quezon Power to 98 percent. Quezon owns and
operates a 503 MW coal-fired power plan.
The deal would also include a 100 percent stake
in InterGen Management Services (Philippines)
Ltd, which provides project management and
administrative services to Quezon Power,

Philippines Case - Results

Results Power Outages

Measured by their ability to reduce power outages, the BOT
programs were undoubtedly a success. Notably, this
increased provision of power came without increased
government debt as most projects were financed on global
capital markets. The BOT and related programs also
significantly increased the scope of private sector
involvement. At the beginning of 1996, 21% of the
countrys installed capacity for power generation was
contracted with the IPPs. Because the IPP schemes also
encouraged private sector operation of government-owned
plants, fully 42% of Philippine generation capacity was
operated by the private sector. 21 The World Bank praised
the BOT programs, calling them a potential model for other
developing economies.

Capacity and Demand

By 1998, peak capacity was 11,988 MW while peak demand was 6,421 MW.
Demand projections in the early- and mid-1990s forecast demand growth
ranging from 9.5-12% per year.
A 1994 report by the World Bank already warned implicitly against the risk
of over-commitment through the uncoordinated signing of PPAs, which
essentially passed demand risk to the consumer through take-or-pay
provisions.
The costs of IPPs were often high because the new capacity was not
consistent with the least-cost expansion path and the private sector
required high rates of return.
The focus on production rather than efficient distribution put the public
sector in the position of retaining that activity in which it was least
effective and restricting the private sector from performing the customer
focused activities (distribution and supply) where it had real expertise. At
the same time, it isolated the private sector from the market through a
combination of regulated pricing and guarantees against commercial risks.

Philippines IPP Contracts

Reserve Margin is
about 155%

Estimated
Growth 9.2%

Actual
Growth 3%

PPA Provisions
The take-or-pay provisions ensure that the IPP
proponents are paid up to the level of the minimum
energy off-take (MEOT) whether the government
utility was able to sell the power or not.
IPP liabilities estimates up to the remaining terms
of the contracts is in-between $6 - $ 8B in net
present value. The buy-out figure of $11.8 B is
gross since the Government can turn around and
sell the capacity to another party.
In 1992, the GDP was US$52 billion. PPA buyout in
total would be 21% of GDP.

Effects of PPA Program

The effects of the PPA capacity charges were
exacerbated by the structure and implementation of
the IPP program. The rapid build-out of IPPs during the
1990s meant that with the impact of the Asian
financial crisis in 1998, the cost of electricity began to
explode dramatically due to a combination of:
the high fixed cost of the IPPs (capacity payments or
minimum offtake) and
the escalating foreign exchange liability stemming from
deep reliance on foreign capital.

The controversial PPA pass-through mechanism

began climbing rapidly with the crisis, eventually
becoming larger than the base rate itself.

Exchange Rates
Depreciation in exchange rates
of about 70% caused increases
in capacity charges

Risk Mitigation and Purchasing

Power Parity
Purchasing Power Parity
Change in exchange rate (versus USD)
Current exchange rate x (1+local inflation)/(1+US$ inflation)

How purchasing power parity mitigates risk

In theory people in the country are willing to pay higher
nominal prices because of inflation and the net cash flow for
the project should be the same
For example, if the inflation rate increases to 20%, the
exchange rate should reflect depreciation in the currency of
20%.

Problems with purchasing power parity assumption

Large devaluations can occur without inflation rate changes
For example, the East Asian Crisis of 1997

Example of Purchasing Power Parity

and Inflation
Philippines Exchange Rate and Inflation Rate
60.00%

60.00

50.00%

50.00

40.00%

40.00

30.00%

30.00

20.00%

20.00

10.00%

10.00

0.00%

0.00

Infllation Rate
Exchange Rate

Index of Exchange Rate and Purchasing

Power

Result High Power Rates

Exceptionally high power rates were cited as one reason why Intel
Philippines, one of the country's biggest foreign investors and largest
employers, with over 5,000 workers, plans to close down its Philippine
operations and divert the company's investments to lower-cost Vietnam and
Malaysia. A recent government survey showed that the high cost of
electricity is one of the main reasons why foreign investors are reluctant to
locate their businesses in the Philippines.
According to the Heads of ASEAN Power Utilities/Authorities, a consultative
group attached to the 10-member Association of Southeast Asian Nations,
the average cost of electricity in the Philippines last year was 17.5 US cents
per kilowatt-hour (kWh). That is more than three times the 5.38 per kWh
cost in Vietnam, and is markedly higher then the 6.77 per kWh cost in
Indonesia, 7.67 per kWh in Malaysia and 8.50 per kWh in Thailand. Even
high-cost Singapore recorded cheaper power rates at 13.07 per kWh.

High Power Rates (Excluding Europe)

Price Comparison from Wikipedia
35.00

C
e
n
t
s

30.00

p
e
r

20.00

k
W
h

28.80

25.00

15.00
10.00

i
n

5.00

U
S
D

0.00

15.31
12.30

11.80

11.61

10.44

10.15

9.28
7.42

7.11

6.95

6.18

Philippines Contract Review

The process began with a 2001 electricity sector reform law
(EPIRA) that required the appointment of an inter-agency
commission (IAC) to review the IPP contracts, which by
2001 had become politically and economically vulnerable.
The law also mandated the unbundling of electricity rates in
consumer bills. This seemingly innocuous measure allowed
Filipino citizens to see for the first time the precise origins of
the costs that created some of the highest electricity rates in
Asia.
What they saw was that the power purchase adjustment that
financed the state utilitys IPP obligations was almost equal to the
cost of the actual electricity consumed.

Philippines Review of
Contracts

The IAC Review covered a total of 35 projectsall of Napocors operating contracts

with IPPs. Of these, six were cleared, and the other 29 contracts were found to have
issues of various kinds and were targeted for renegotiation.
Upon completing the review, the IAC handed responsibility for implementing its
findings to the Power Sector Assets and Liabilities Management Corporation
(PSALM).
First, IPPs would bear cost or fee reductions that were not contrary to the terms
of the original contractmost commonly the project companies made a
collateral agreement not to nominate the full 105% or 110% that the contract
allowed, or clarified ambiguous terms in a manner advantageous to the
government.
Second, PSALM also considered a negotiated buy-out when the sponsor firms
were interested in exiting the project.