Quezon Power

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October 2008
Quezon Power Ltd Co. Project Finance

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The impact of risk management on the cost of funding

Order reference F245945
Veronica Bonetti
Stefano Gatti
Copyright © 2008 SDA Bocconi, Milan, Italy

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109-041-1
SDA Bocconi Quezon Power Ltd Co. Project Finance
Veronica Bonetti, Stefano Gatti
Quezon Power Ltd Co. Project Finance.The impact of risk

management on the cost of funding 1
1. The Project
In the early ‘90s, the Philippines were hit by a major energy crisis. The Quezon Power Project was undertaken in

an attempt to find a solution to this critical macroeconomic problem. By means of this initiative, in fact, the
Philippine government would improve national energy planning by diversifying the mix of sources utilized to
generate electric power in the country. In addition, the project would make it possible to extend power supply to
developing parts of the country, and to stabilize the electrical energy distribution system.
The project consisted of building and running an electric power plant. The plant would be designed, constructed,
and operated by the SPV Quezon Power, a Limited Company with legal headquarters in the Philippines. The
facility in question, which was to generate 440 megawatts of electricity, would be built on the island of Luzon
and fired by pulverized coal. (Figure A1).
1
Veronica Bonetti is Strategic Equity Derivatives Analyst at Barclays Capital in London. Stefano Gatti is associate professor
of Banking and Finance and Director of the BSc. in Economics and Finance at Bocconi University in Milan. The case study
was prepared by the authors with the sole purpose of case discussion of a real project finance transaction. The case is not
intended to show better managerial practices and is based on public available information. The authors would like to thank
Emilia Garcia-Appendini, Bill Megginson and Davide Ravasi for helpful suggestions on an earlier version. The responsibility
of the contents is of the authors’ only.
2
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Figure A1: Geographic location of the Quezon Power

Plant
Source: Kennedy (2000)
The low-sulphur coal used as feedstock for the plant would be imported from Kalimantan, Indonesia, and a sea
water desalination facility located within the plant itself would supply the necessary water. In addition to the
power generation plant, Quezon was to operate a 31 kilometer, 230 Kilovolt transmission line.
The electricity produced by Quezon Power would be subject to a take-or-pay Power Purchase Agreement (PPA)
which obliged Manila Electric Company (Meralco) (the Philippine power distribution company) to pay both fixed
and variable costs of the plant in question. These costs would be established on the basis of parameters linked to
the progress of the construction work and the performance of the plant as set down in the relative legal
agreements.
1.1 . Project Sponsors, Ownership Structure and basic terms of financing

The Quezon Power Project was born out of the close relations between Meralco and PMR Power Ltd (“PMR”), a
Philippine de jure company. The consulting company Pacific Manufacturing Resources controlled 50% of PMR,
while the other 50% was in the hands of a group of Filipino power sector executives to whom PMR turned to
develop the Quezon Project. Meralco had worked with PMR in the past on a total quality management project.
Following the intensification of the Philippine energy crisis, PMR considered the possibility of developing a
power generation project with Meralco by founding an ad hoc SPV. PMR made an initial proposal to its partner
in August of 1992 which Meralco rejected because talks were already underway with another power developer
that the company had contacted. Only after these negotiations failed in mid-1993 did Meralco and PMR sign a
Memorandum of Agreement (MoA). Subsequent to this, PMR convened several Filipino managers who worked in
the power sector and founded PMR Power Ltd, the first sponsor of the Quezon Power Project, in early 1994.
In the meantime, the newly established company started the search for a US partner who would collaborate on
project development and become co-owner of the plant. Covanta Energy Corporation (Covanta) was chosen
among the various possible candidates who had expressed an interest in joining the project. Covanta was an
3
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American leader in the sector of designing and developing privately-owned power plants. Originally called
Ogden Energy Corp, the company changed its name to Covanta Energy Corp following a reorganization aimed at
refocusing its core business in March of 2001. Negotiations between Covanta, PMR, and Meralco led to the
signing of the take-or-pay Power Purchase Agreement (PPA) in August of 1994 by the Philippine power
distribution company.
Finally, in September of 1994 Covanta signed a co-development agreement with Bechtel, the third project
sponsor, who granted PMR Power Ltd voting interests of 2% in Quezon Power, without requiring any equity
contribution. After InterGen was founded in 1995, Bechtel transferred its interest in the Quezon project to its
affiliate; InterGen was controlled through subsidiaries by Bechtel Enterprises (Bechtel) and Royal Dutch/Shell
Group (Shell).
InterGen was founded in early 1995 following the acquisition by Bechtel and PG&E Enterprises (“PG&E” –
subsidiary of Pacific Gas and Electric Company) of J. Makowski Corporation (“JMC” – a US company, founded
in 1972 as developer of small hydroelectric power plants). JMC handled co-generation and development of
private projects for power production.

InterGen was created with an eye to tapping JMC’s experience in private projects involving the construction of
power plants. This would be combined with Bechtel’s competencies in terms of developing, financing and
building, and PG&E’s expertise in fuel negotiations; the aim was to realize projects that served to satisfy the
growing demand of private players in the power production sector in emerging countries. In late 1996, PG&E
sold its participation in InterGen to Bechtel, which later set up a partnership with Shell to run the project.
The final ownership structure of the Quezon Project was as follows (Figure A2):
Figure A2: Ownership structure of Quezon Power
InterGen Covanta Energy

N.V. Group
100%
Quezon Power QGC 72.5% Quezon Equity

Investments LP Holdings Ltd. Funding Ltd. 100%
(indirect)
63.3% Redeemable 27.5%
36.2% shares
Quezon Generating Covanta Power

Co. Ltd. Development Cayman Inc.
72.5% 27.5%
voting
Quezon Power interests PMR
Inc. Ltd. Co.
71.875% 26.125%
2%
Quezon Power
(Philippines)
Ltd. Co.
4
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Source: Standard and Poor’s
The initial financial structure called for a debt equity ratio of 75/25. Equity amounted to US dollars (USD)
202.2m, wholly paid up by the American sponsors. In fact, the Philippine sponsor PMR was granted voting
interests in the SPV without having to contribute equity to the project company (Table A1).
Table A1: Voting interests and equity contribution
Voting interests Equity Contribution
InterGen 71.875% 72.5% USD 146.6m
Covanta 26.125% 27.5% USD 55.6m
PMR Power 2% - -
Source: Kennedy (2000)

The debt portion in the plant construction phase, totalling 578.2m USD, consisted of 5-year syndicated loans, the
most important being:
- USD 405m – loan underwritten by the Union Bank of Switzerland with a guarantee against political risk
provided by the Export-Import Bank of the United States2 (“Ex-Im Bank”);
- USD 100m – loan granted by the Overseas Private Investment Corporation (“OPIC” – US).
- Close to the termination of the construction phase (scheduled for December 1999), Quezon would be
refinanced by:
- USD 215m –a 20-year, fixed coupon (8.86% per annum paid quarterly) project bond (2017 maturity) issued
on the US market in USD on 3 July 1997, with Salomon Brothers in the role of lead manager of the deal;
- USD 392m – loan directly issued by Ex-Im Bank.
1.2. The contractual structure of Quezon Power Project

The Quezon project involved several contracts which served to allocate project risks and responsibilities to
participants in such a way as to minimize the possibility that negative events might jeopardize the cash flows
generated by the project (Figure A3).
2
Ex-Im Bank is the independent US governmental agency that promotes and finances various kinds of projects the world
over, primarily in emerging countries. Its aim is to encourage export of US goods and services on international markets.
5
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Figure A3 –Contract structure of Quezon Power
Contractual document
Bechtel
Enterprises Participant
Contract agreement
Ownership
Bechtel Bechtel InterGen
Corp. Power N.V. Affiliation
Bechtel
Indonesia Australia Overseas InterGen Covanta Energy
Mission
Energy Overseas
Firm Firm Energy Bechtel Mgmt. Co. Group
Corp.
Const. Mgmt. Covanta Power
EPC
Mgmt. Service
Development
PT Adaro Cayman Inc.

Quezon Power ( Philippines )
Covanta
Coal Ltd. Co. O&M Philippines
Supply
Operating Inc.
(Borrower )
BP
PLC
PT Kaltim Coal
Supply
CRA Transmission Substation

RTZ PPA Leases
Line Agmt. Interconnection
Ltd. LOC
Deutsche Wheeling National

Meralco
Bank Agmt. Power Corp.
1.2.1 Power Purchase Agreement (PPA)

In August 1994, Quezon drew up a 25-year contract with Meralco agreeing to sell the power produced by the
plant to this counterparty. The PPA was structured as a take-or-pay, which ensured Quezon a stable and
predictable flow of revenues, and was based on a minimum availability factor between 82% and 88%, on average
85% over the 25-year contract period. No force majeure event or unanticipated occurrence in the Meralco system
would exonerate the offtaker from making the monthly payments stipulated in the contract, which were set on the
basis of the fixed and variable costs the plant would incur.
In addition, payments were indexed to the USD exchange rate, thereby reducing the risk of a devaluation of the
local currency affecting the SPV’s cash flows. (The bond earmarked for refinancing would be issued in 1997 and
stated in USD.) For the entire duration of the contract, Quezon was obliged to deliver, and Meralco to receive and
pay for, at least the minimum guaranteed quantity of electricity every month (Table A2), as established in the
PPA.
6
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Table A2 – Guaranteed minimum quantity of electricity
Years Annual guaranteed minimum quantity of electricity (MWh)

Year 1 3,149,267
Year 2 3,268,858
Years 3-15 3,388,452
Years 16-25 3,288,791
If the plant could not supply the stipulated quantity of power, Quezon would be required to pay Meralco
liquidated damages, which were relatively low as compared to the plant’s tariffs. The total amount of liquidated
damages would depend on Meralco’s power needs and the possibility of finding alternative energy suppliers.
More specifically, Quezon would pay Meralco 0.26 Philippine pesos (PHP) for every kilowatt hour (kWh) that it

could not supply; this amount would escalate to PHP 0.52 per kWh if the offtaker could not procure the power it
needed from an alternative supplier.
According to the PPA, Meralco was to pay the following:

– Capacity fees – USD 0.029546 per kWh, which would be gauged as a function of variations in the US
consumer price index from the date that the PPA was finalized (August 1994). Monthly payments would
equal the capacity fee multiplied by 1/12 of the relative annual minimum guaranteed quantity of power.
– Operating fees – One portion of these fees was stated in local currency and another in US dollars. The fixed
operating fee was set at USD 0.0104 per kWh and PHP 0.0323 per kWh; the variable operating fee instead
was USD 0.0015 per kWh and PHP 0.0937 per kWh. These per unit amounts were to be adjusted to
variations in the US and Philippine consumer price indices respectively, as measured from the date the PPA
was signed. The monthly fixed cost payment was computed as the fixed operating fee multiplied by 1/12 of
the respective annual minimum guaranteed quantity of electricity, while the monthly variable cost payment
was equal to the variable operating fee multiplied by the plant’s output.
– Energy payments – These payments were 1.06575 times the costs incurred for procuring fuel per every
million British Thermal Unit (BTU), multiplied by the product of the net output in kWh and 0.00975 million
BTUs per kWh.
The PPA allowed Quezon to deliver power in excess of the minimum quantity set in the contract priced at 70% of
the capacity fee and 100% of the fixed and variable operating fees.
If Meralco was not able to buy all or part of the plant’s output, Quezon would have the right to sell this energy to
an alternative buyer. In this case, Quezon would have the option to deduct the payments received from third party
buyers from Meralco’s payment obligations.
1.2.2. Leases
Meralco leased its property rights to the site where the power plant and transmission plants were built to Quezon
for as long as the duration of the PPA. In fact, Philippine law allows only citizens or companies controlled by
Filipinos to own land or hold property rights on land within national borders. This being the case, the project was
structured so that Meralco was listed as holding property rights and relative easements on the land where the
power plant and transmission plant were built.
7
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1.2.3. Transmission Line Agreement

This established the remuneration that Meralco would make for the use of Quezon’s power transmission network.
Payment, which was to be absolute and unconditional, was set at approximately USD 13.8m per year. In other
words, the offtaker was obliged to pay even if a force majeure event or a defect in the Meralco system made
reception of the power transmitted by the plant impossible. 3
Furthermore, the Transmission Line Agreement named Quezon as the party responsible for obtaining the
necessary permits, and for building, financing and running the transmission line. This accord also granted a
building lease to Quezon for the land where the transmission plant was built; Meralco was recorded as owner of
this land, in accordance with the Philippine law cited above.
Monthly payments to be made by Meralco can be broken down into two components:
Capital Cost Recovery Payments – Relative amounts were earmarked to compensate Quezon for costs
–
incurred for building the transmission plant. Such monthly payment were calculated on the basis of an initial
estimated total cost of construction (equal to approximately $ 500,000 per month), to be adjusted to reflect

the actual capital cost of the line incurred by Quezon.
– Transmission Line Operating Payments – Monthly payments based on operating and maintenance (O&M)
expenses and a portion of some financing fees. 4
1.2.4 Engineering, Procurement Contract (EPC) and Construction Management

These are agreements signed between Quezon and Bechtel subsidiaries Overseas Bechtel and Bechtel Overseas
Corp. (see Figure A3). These accords assigned the latter two the task of carrying out all actions and underwriting
all contracts needed to set up preliminary projects, to obtain permits and to build the plant.
1.2.5 Management Service

It is a 25-year agreement between Quezon and InterGen pertaining to project administration in the post-
construction phase. It stipulated that Quezon would make monthly payments to InterGen equal to costs incurred,
plus a fixed commission of USD 400,000 which was subject to periodic increases over the term of validity of the
contract.
1.2.6 Operation and Maintenance (O&M)

It is an agreement between Quezon and Covanta pertaining to operating and maintaining the power generation
plant in accordance with sector standards. The accord stipulated that Quezon would reimburse all plant-related
costs, in addition to a monthly commission of USD 160,000. Further, the O&M provided for the payment of
bonuses based on the electric energy output, and on the attainment of pre-set budget targets.
3
The agreement was modified in April 2003 when Quezon assented to relinquish 54% of transmission costs upon request by
Meralco, a figure which amounted to USD 646,000 monthly. This came after the Energy Regulatory Commission (“ECR”)
(the authority responsible for power distribution tariffs in the Philippines) determined that Meralco was not authorized to
charge its customers for transmission costs. Later, in October 2004, following an investigation conducted to ascertain the
transmission costs incurred by Quezon, the ECR allowed Meralco to charge its customers 70% of transmission costs. Since
that time, the offtaker began to pay Quezon the sums set down in the Transmission Line Agreement, equal to the amounts
established in the 2003 amendment. Quezon assumed it could cover the lower takings with a boost in sales of USD 40m in the
six years following the agreement, sales which would be made to Meralco within the framework of the PPA. In so doing, the
impact of the changes to the Transmission Line Agreement on the SPV’s cash flows would become nearly negligible.
4
Meralco therefore bore both the risk of the possibility that actual costs for the maintenance of the transmission line might be
higher than estimated costs and the risk of any potential additional capital spending.
8
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1.2.7 Coal Supply Agreement

It is a long-term agreement signed between Quezon and two Indonesian companies, PT Adaro and PT Kaltim, for
the supply of coal needed to run the plant. The former was to provide 67% of the required feedstock, and the
latter to cover the remaining 33%. In any case, if the two suppliers were not able to respect their contractual
obligations, the geographical location of the plant was ideal for receiving fuel from alternative coal suppliers.
1.2.8 Wheeling Agreement

It is an agreement between Meralco, Quezon, and the National Power Corporation (NPC) for the transmission of
electric power from the production plant to Meralco upon payment of a commission.
9
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2. The problem
Suppose to be a bank invited by UBS to participate to the 5 years syndicated loan discussed in Section 1.1.
Would you feel comfortable with the contractual structure envisaged for the project? In particular, are there any
risks in the PPA agreement signed by Meralco that could create some problems to Quezon Power once the
financial close is reached? How could we measure the impact of possible troubles faced by Meralco on the
soundness of Quezon Power?
10

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109-041-1

Quezon Power Ltd Co. Project Finance

The impact of risk management on the cost of funding

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

Veronica Bonetti, Stefano Gatti

Quezon Power Ltd Co. Project Finance.The impact of risk

Purchased for use by Philippe Wind on 06-Mar-2015. Order ref F245945.

and fired by pulverized coal. (Figure A1).

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

Figure A1: Geographic location of the Quezon Power

Source: Kennedy (2000)

1.1 . Project Sponsors, Ownership Structure and basic terms of financing

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

Purchased for use by Philippe Wind on 06-Mar-2015. Order ref F245945.

Figure A2: Ownership structure of Quezon Power

InterGen Covanta Energy

Quezon Power QGC 72.5% Quezon Equity

Quezon Generating Covanta Power

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

Source: Standard and Poor’s

Table A1: Voting interests and equity contribution

Voting interests Equity Contribution

InterGen 71.875% 72.5% USD 146.6m

Purchased for use by Philippe Wind on 06-Mar-2015. Order ref F245945.

1.2. The contractual structure of Quezon Power Project

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

Figure A3 –Contract structure of Quezon Power

Purchased for use by Philippe Wind on 06-Mar-2015. Order ref F245945.

CRA Transmission Substation

Deutsche Wheeling National

Source: Standard and Poor’s

1.2.1 Power Purchase Agreement (PPA)

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

Table A2 – Guaranteed minimum quantity of electricity

Years Annual guaranteed minimum quantity of electricity (MWh)

Purchased for use by Philippe Wind on 06-Mar-2015. Order ref F245945.

According to the PPA, Meralco was to pay the following:

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

1.2.3. Transmission Line Agreement

Purchased for use by Philippe Wind on 06-Mar-2015. Order ref F245945.

1.2.4 Engineering, Procurement Contract (EPC) and Construction Management

1.2.5 Management Service

1.2.6 Operation and Maintenance (O&M)

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

1.2.7 Coal Supply Agreement

1.2.8 Wheeling Agreement

Copyright © 2008 SDA Bocconi, Milan, Italy

SDA Bocconi Quezon Power Ltd Co. Project Finance

Copyright © 2008 SDA Bocconi, Milan, Italy

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