Tuesday, October 28, 2008

Ani Arope, TNB and IPPs

It is always a good time to re-visit some recent history to obtain some perspective on things. First, read the interview that Tan Sri Ani Arope, ex-TNB boss, gave in The Star published on Tuesday, June 6, 2006. I am relying on the database of Jeff Ooi (I'm sure he doesn't mind).

The interview sheds some light on the circumstances under which the Independent Power Producers (IPPs) came into being. That is the historical context.

This post is pertinent because the Malaysian government is in the midst of preparing a National Energy Policy. The Malaysian public deserves to be involved. When the first draft of the Policy is ready, it should be made public for input. But, will the government do it? Or, will they just ram-rod it through as "business as usual"?

As for the politico-economic context of IPPs, like all important things in Malaysia, I had to dig up an excellent paper written by Jeff Rector of Stanford University, California entitled, The IPP Investment Experience in Malaysia. I implore you to read this paper if you wish to have a good idea of what the IPP issue is all about.

But, to lend you a quickie on the paper, I have extracted below the summation pages of Rector's paper:

ANALYSIS OF THE MALAYSIAN IPP EXPERIENCE

A. Was the IPP Program a Success or a Failure?

Given what we know about the Malaysian IPP experience, we must assess that the experience from the investors’ perspective was very positive.We don’t know exactly how much money the sponsors made,but all accounts indicate that the first wave of investment was very profitable.

One analyst said, “The first batch of IPPs, namely YTL Power, Malakoff, Genting Sanyen, Powertek and PD Power Bhd derived between eighteen and twenty-five percent internal rate of return (IRR). Other observers said that the first five IPPs had been “‘laughing all the way to the bank’ as they had been enjoying favourable terms ‘not found anywhere else in the world.’”

Additionally, all of the original players are still in the business and willingly entering new contracts at rates lower than agreed in the first round of investment. As to the second wave of investment, an analyst said that “the market expectation is that any new PPAs signed with [Tenaga] will give an IRR of only about twelve per cent.”

That Tenaga was willing to threaten unilateral revision of the contracts and withhold payment for two months may have hung a cloud over the sector, but during the crisis period, IPPs were perceived by at least one analyst to be one of the best sectors in which to invest. Publicly listed IPPs have provided a better return than both the Kuala Lumpur Stock Exchange index and Tenaga during the relevant period. Separately, it seems that bondholders and lenders to the project companies were paid according to originally contracted schedules without difficulty.

B. Why did the Contracts Hold?

It is notable that the PPAs were not altered during the economic crisis—a period when there must have been tremendous pressure on Tenaga to unilaterally change the terms of its expensive obligations to the IPPs. The national off-taker was forced to manage a debt crisis while it was hemorrhaging due to the expensive IPP contracts coupled with low power demand.
Nor were they altered in 2001 as some reports have indicated.

This conclusion would be hardly a surprise to those close to the deals but others have somehow been given a different impression. In 1998, IPPs constituted about thirty-five percent of Tenaga’s capacity (and even more of production) and were more expensive than Tenaga’s own generating capacity. Power demand was low and Tenaga was contractually bound to purchase power that it could not sell. The drop in electricity demand brought on by the Asian financial crisis exacerbated these problems, but the fact that fuel for the IPPs was produced domestically and the projects were financed exclusively in local currency significantly mitigated the stress of the crisis.

In light of the breaches of contract and forcible renegotiations seen in the IPP sectors of Pakistan and Indonesia, we might not have been surprised if in a country like Malaysia, with a weak rule of law, the state-controlled power company under serious duress decided to change the rules on investors after the investment was in place and the balance of leverage shifted. But this did not happen.

How was it that the IPPs could withstand Tenaga’s pressure to renegotiate in a time of national crisis? Was it because of the strength of their legal protections, or was it something else?

We offer the following hypothesis, which has two distinct parts.

First, the outcome of the 1998 renegotiation attempt was not the result of a two-party negotiation. Nor was it influenced by the expected value of the legal claims that either party may have brought. While the public position of the government at the time was that the dispute was not a government affair and that it should be resolved by Tenaga and the IPPs themselves, behind the scenes, the exact opposite was true. The outcome of the 1998 renegotiation attempt was determined and orchestrated by one actor, the Malaysian government.

Second, we identify a handful of considerations that might have influenced the government’s decision not to allow a renegotiation of the PPAs. The Malaysian government was the final decision maker and orchestrator of an agreement not to re-open the PPAs. Because the government had connections or control over each major stakeholder, there was no need to resort to the courts. It may very well be that because the courts were not believed to be reliable, an organizational structure that was held together with personal and ownership relationships was deliberately chosen so as to have a mechanism for commitment enforcement and dispute resolution without the courts.

In the aftermath of the crisis, the Malaysian government was involved in each of the key stakeholders in the IPP sector:

1. The government was a controlling shareholder in Tenaga. It appointed the Tenaga board and had final authority over any significant corporate decisions.

2. The government was an indirect shareholder in the IPPs. The government's super majority shareholdership in Tenaga flowed through Tenaga’s ten to twenty percent stake in all but one of the IPPs at the time of renegotiation.

3. The principle lenders to the IPPs were state-controlled. Most of the banks lending to theprojects were state banks. The state pension fund was by far the largest bondholder lending funds to the IPPs. In some cases it was the only bondholder. Needless to say, the government had influence and control over the decisions of state controlled banks and the state pension fund.

4. Finally, the promoters and principal investors in the IPPs reportedly had close personal ties to the prime minister and his close associates. The government was also the regulator of the IPPs and therefore capable of imposing future costs on the IPPs.

Given these extensive relationships, the fallout from the crisis for the IPPs in Malaysia was constrained by a number of factors. These include, concern over the reputation effects of instigating a dispute in the IPP sector, particularly given the troubles that were facing foreign investment throughout Asia at the time, and Malaysia’s successful incorporation of FDI in its own manufacturing sector as a driver of economic growth. Because of the broad reliance on domestic capital markets to finance the IPPs in Malaysia, decisions regarding the IPP sector here affected a distinct constituency than in many other IPP sectors. At the time, foreign equity investment in Malaysia was broadly spread in the power sector—including substantial investment in both IPP sponsors (e.g. National Power’s 15% stake in Malakoff), and in Tenaga itself.

Policy decisions on this front were made in an environment characterized by two factors unique to Malaysia.

First, Tenaga’s obligations (and the project companies’ financial structure) were comparatively less vulnerable to currency risk, due to reliance on local capital and fuel inputs.

Second, the network of relationships that connected equity holders and sponsors to debt holders and other lenders to government policy makers (and to Tenaga itself) likely opened avenues of communication and accommodation that were not available elsewhere in the IPP universe. IPP arrangements in Malaysia thus faced less pressure than in other countries that faced macroeconomic troubles, and were manageable through a range of relationships that also were not common in other countries.

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