Case Studies Electric Power

Case Studies in Electric Power
Contents
• Argentina and Chile – State versus Private

• California Power Crisis – Problems with De-regulated Market
• Philippines – Benefits and Problems with Single Buyer Model
• Drax in the UK -- Merchant Power
• Enron Dahbol in India – PPA Contracts
Electricity Case Studies March 25, 20242

Significant Emerging Country Defaults (S&P 2007)

Other Problem Loans (S&P 2007)

Argentina and ChileCase Study
History – Argentina and Chile
• The reform of the electricity sector in Argentina that began in

the early 1990s was widely seen as an example for the
developing world. Argentina quickly established a stable
institutional design to govern electricity provision, considerably
improved the financial and technical performance of the sector,
and had one of the most advanced electricity systems in the
developing world – with open access to the grid and
competitive wholesale markets.
• During the 1980s Chile became the first country in the world to
break up power monopolies, progressively withdraw the state
from management - but not regulation - of the electricity supply
industry, and divest state ownership in most of them to private
investors.

Argentina Privatization
• The principal goals of the electricity restructuring in Argentina

were:
 (i) to improve the economic and technical efficiency of the
electricity market, and
(ii) to ensure adequate long-term investment levels in electricity.
• In the process of unbundling, the major electric utilities were
commercialized – in the case of SEGBA, this process has
begun as early as 1989. The original round of privatization
was very competitive.
• Roughly 10,000 MW of Argentina’s total installed capacity of
18,300 MW has been sold, leaving about ten power generators
under the ownership of federal or provincial governments.

Capacity Ownership in Argentina
• The restrictions placed in IPPs were largely to protect the competitive

composition of the wholesale market. First, no single generation
company was allowed to provide for more than 10% of national
generation capacity.
• Additionally, IPPs were prohibited from owning majority shares in
electricity transmission facilities.

Efficiency In Argentina Market – Heat Rates
• A couple of simple statistics illustrate significant improvements in the productivity of

generating plants. The above chart shows the amount of fuel used relative to
electricity output has declined significantly

Plant Availability
• Plant Availability has dramatically improved from about 60% in 1993-

1994 to 75-80%

New Argentinean Plants in Database
• Argentina demonstrates that a developing country can attract capacity with

reasonable financing terms

New Capacity in Argentina
• The current reserve margin in Argentina is 89% due to merchant capacity

additions

Prices in Argentinean Market

Un-served Energy in Argentina and Losses

Chile Privatization
• Privatization in Chile increased the productivity of utilities by:

cutting energy losses by more than half to 8.3 percent in 1997,
by doubling labor productivity in distribution, and
by tripling energy generation by worker in the largest generating
company.
• Although privatized companies became substantially more efficient, however,
these gains were only transferred to customers in areas characterized by
competition.
• In the main market, the regulated wholesale price of electrical energy fell by 37
percent. In contrast, the final price to customers did not fall to reflect the huge
productivity gains that were achieved after privatization. Between 1987 and
1998 the regulated price to consumers fell by only 17 percent. This situation
led to spectacular increases in the profit rates of distribution companies: the
rate of return of the largest distributor rose from 10.4 percent to 35 percent in
this period. These profit rates are striking considering the low market risks
carried by distribution monopolies (Fischer and Serra 2000).

Argentina Market Pre-Requisites
• Investment Climate
 Country Bond Rating: S&P BBB-
 Billions of USD in Foreign Investment
• Physical
 Economics of Natural Gas Combined Cycle
 Natural Gas Availability
 Transmission System
• Rates/Regulatory
 Industrial Customer Rates
• Separation into Multiple Companies
 Unbundled System
 Cost-based Energy Bids
 Capacity Price Up-lifts

Capacity Up-Lift in Argentina

Market Structure - Capacity Pricing Using Up-Lifts
• Generators whose plants are scheduled for dispatched one day in advance or
who are actually dispatched receive a pre-determined capacity payment for hours
falling outside low periods.

Financing of AES Panara
• Combined Cycle Plant (830 MW)

 Sponsors: AES and CEA; Plant Cost $448 Million
 Financing
 Equity $154 Million: 34%
 IDB – A Loan $ 66 Million: 15%; 14.5 Year
 IDB – B Loan $ 66 Million: 15%: 12.5 Year
 JEXM Direct $ 81 Million: 19%
 JEXM Comml $ 81 Million: 19%
 No long-term Contracts
 Plant Operation - 1999

AES Panara – Financing Structure
• Analysis Model Driven

 Current and projected capacity
 Analyse
 Hydro conditions, planned capacity, interest rates, fuel dynamics, capacity payments
 High DSCR’s – 2.31 in first 5 years

 Trapped Cash
 Cash Sweep Mechanisms
 Forward Looking Financial Ratios
 12 Month Debt Service Reserve

La Plata Cogeneration Plant
• 128 MW Combined Cycle

 Cost $110 Million or $859/kW
 Debt Financing $75 Million (68%)
 OPIC Guaranteed
 Term: 12 Years
 Electricity Sales
 73 MW to Refinery
 55 MW to Grid

Implications of Argentina Case Study
• Divest generation into many companies at outset

 Generation was split into multiple companies and vertical integration was
not allowed at the outset
 Markets work well when efficiencies are available
 Natural gas was available and could new combined cycle plants could
compete with existing capacity; hydro fluctuations caused problems for
merchant plants
 Financing MPP’s in developing country requires multilateral support, but
can be accomplished
 Plant costs are competitive with developing countries
 Capacity prices can be stable, but can promote excess capacity
 Markets can work with cost based energy pricing and administrative
capacity prices

Argentina – Postscript
• After having been a model for developing countries, Argentina

economy collapsed during a four year period from 1999-2003. The
seeds of this collapse had been apparent for some time – for example
in the ballooning external-debt-to-GDP ratio, which rose from 28% to
51% during the 1990s, while total debt service as a percentage of
exports rose to 97% by 1999.
• Internal consumption plummeted, fiscal policy contracted, and private
investment has all but disappeared. In 2001, Argentina abandoned the
currency peg that had maintained 1:1 parity between the dollar and
peso throughout the 1990s, and watched its currency lose 200% of its
value in a matter of months.

Argentina Financial Crisis
• During the period 1992-2000, from the initial privatization until

the recent national crisis, IPPs for the most part thrived in a
strong market overseen by a stable regulatory regime.
• Since the crisis, IPPs (and all private infrastructure sectors)
have been locked in ongoing disputes with the government
regarding aggressive policies in the aftermath of the
devaluation. These measures included freezing of tariffs and
limits on expatriation of profits.

California Power Crisis
California Crisis Introduction
• During the period of May 2000 – May 2001 prices of electricity

skyrocketed, there were numerous power outages and one of the largest
and oldest utility companies in the country was forced to declare
bankruptcy.
• The crisis led to fierce debates between people who advocate free
markets in electricity and people who argue that market liberalization is
bad policy and commentaries on the crisis continue to be influenced by
the source of party making the commentary.
It is clear that the situation in California put a stop to the deregulation movement
around the whole world.
It is also clear that very sophisticated analysts who developed the California
market had not predicted the possibility of the price spikes in their risk analysis even
though the fundamental factors that supposedly caused the crisis including demand
growth, low water flow, plant outages and fuel price volatility were predictable.
•Those who developed pricing models could not predict the
possibility of extreme scenarios outside of relatively narrow ranges.

De-regulation
• A few year before the California crisis virtually nobody questioned the
benefits of de-regulation. Utility companies, competitive suppliers,
environmental groups, consumer representatives and government
regulators all groups supported de-regulation. Legislation that de-
regulated the industry was often passed by unanimous margins and
competition was replacing government oversight all over the world.
That has all changed with the California crisis and the financial demise
of Enron.
• According to the Wall Street Journal:
“It was one of the great fantasies of American Business: a deregulated
market that would send cheaper and more reliable supplies of electricity
coursing into homers and offices across the nation…Now with the power
industry hovering uneasily between regulation and deregulation, it faces the
prospect of a market that combines the worst features of both: a return to
government restrictions, mixed with volatility and price spikes as companies
struggle to meet the nation’s energy needs.”
Understanding pricing and valuation in competitive markets is not less of
an issue because of questions related to the efficacy of regulation. Indeed,
the problems with Enron and California demonstrate the immense
complexity of risk assessment, pricing and valuation issues in the industry.

California Crisis Issues
• What was the cause – was it changes in demand and supply,

problems with the design of the market or was it a fundamental
problem with deregulating markets?
• Can mechanisms be designed to avoid similar problems in
other markets or is the problem fundamental to markets?
• Economic and Financial Issues
Use of history in making forecasts of the value of electricity
Dramatic changes in value with different hydro conditions
Differences between upside potential and downside risk
Non-linear movement of value in electricity

Belief that Problems were or were not Inherent with
Market Systems
• Argument that the problem was just the manner in which

California set up the structure of the market:
The California power crisis of 2001 gave reform an unjustified
bad image. The spectacular collapse of the Californian power
market in 2001 -- due mainly to design faults -- has created the
impression that liberalization of power markets is too risky for
developing countries.
• Argument that the problem is inherent in de-regulated markets
Difficulties in implementing competition in power markets so by
now well known, as illustrated by California.s experience. Full
competition in the wholesale power market should therefore not be
attempted for the foreseeable future in most developing countries.

Outages Caused by the California Crisis

Other Crisis Impacts
• Rolling Blackouts
• PG&E Bankruptcy
• Edison Electric Near Bankruptcy
• State Budgetary Surplus Eliminated
• Governor Arnold

Opinion about the California Crisis Depend on
Perspective
• Advocates of Competition
Problems were in the structure of the market
 Consumers did not see prices
 Long-term contracts not allowed
 Capacity pricing not structured
 Transmission not structured correctly
 Obstacles to building new plant
• Critiques of Competition
Problems inherent in competitive markets
 Exercise of Market power will occur
 Market did not encourage building
 Market cannot work in hydro systems

Initial Effects
• At the end of May--in fact, on May 22, 2000 --there was an

unseasonably hot day. Power use went up some in California,
but the price of power skyrocketed--much more than the
demand for that day.

Poor Analysis of Price Risk
• High wholesale prices turned out to be a very large risk. But

the risk may have been severely underestimated or completely
unrecognized by many participants in the process. The utilities
could have protected themselves against high wholesale price
by entering contracts for financial hedges, designed to cover
risks of buying power from a volatile spot market while selling it
at a frozen retail rate. However, although such hedge contracts
were offered to utilities, they rejected these offers, apparently
believing that the hedges included overestimates of the risks
and thus that the prices of the hedges were too high.

Long-term Contracts and Reduced Reliance on Spot
Prices
• The utilities tried as early as 1999 to gain the right to procure electricity on a longer term
basis. But the block forward market allowed contracts for no more than one year. More
significantly, such markets, by necessity, offered a standardized contract and did not allow
the wide range of contractual agreements that would be desirable for a utility to cover its
purchases.
• But it was a step, albeit a small step, toward allowing the utilities to move away from
exclusive reliance on spot markets to acquire electricity. However, until August 2000 the
utilities had no right to enter bilateral contracts.
• Entering such contracts could have substantially reduced the risk of large changes – up
or down – in the acquisition cost of electricity. Utilities with such contracts thereby could
have guarded against or at least limited the high risk of large fluctuations in the wholesale
price of electricity. But that was not to be the case and thus the system was characterized
by unnecessarily large risks.
• Divestiture had greatly increased the risk facing investor-owned utilities, although it did
not change the inherent system risk. If the utilities had continued to own their generating
capacity, they would have faced cost variations that changed with the average generation
cost; but because they had divested the assets, they would face cost variations that
changed with the marginal cost of electricity. Since the marginal cost is much more
volatile than the average cost, divestiture led to far more cost volatility for the investor-
owned utilities.
• Problem with contracts: options to leave the utility or to come back to the utility.

Economic Variables are Non-Linear and Difficult to
Evaluate with Statistical Analysis of Historic Data
• It is apparent that investors did not
California Market Prices
appropriately quantify the upside
potential relative
Prices beforeto the
the downside
California risk.
electricity crisis were relatively low. But most of
The problem
the is that
forces that investors
lead focus on high prices such as high electricity demand,
to the extremely
expected
no newreturns
capacity without
and low paying
levelsenough
of water in damns could have been predicted.
attention to the skweness of the upside
and downside returns. The upside
return on underlying loans was a credit
and a higher margin when the loans
were re-financed.
Sub-Prime versus Other Spreads

2000
California Orgeon Border Prices
1800
160 140.8 139.0
1600 140
1400 120
1200 $/MWH 100
Basis Spreads
80
• .
A-rated
1000
BBB-rated
800 BB-rated 60
Sub-Prime 28.0 31.6
26.1
600
40 18.5 19.3
400
20
-
• . 200
1996 1997 1998 1999 2000 2001 2002

0
1/3/2006
2/3/2006
3/3/2006
4/3/2006
5/3/2006
6/3/2006
7/3/2006
8/3/2006
9/3/2006
1/3/2007
2/3/2007
3/3/2007
4/3/2007
5/3/2007
6/3/2007
7/3/2007
8/3/2007
9/3/2007
1/3/2008
2/3/2008
3/3/2008
4/3/2008
5/3/2008
6/3/2008
10/3/2006
11/3/2006
12/3/2006
10/3/2007
11/3/2007
12/3/2007

Oil Price Errors from EIA
Actual Annual Oil Prices and Prices Forecast by EIA

160.00
N Actual
o 1998 Forecast
140.00
m 1999 Forecast
i 2000 Forecast
n p 120.00 2001 Forecast
a e 2002 Forecast
l r 100.00 2003 Forecast
2004 Forecast
O B
80.00 2005 Forecast
i a 2006 Forecast
l r
2007 Forecast
r 60.00
2008 Forecast
P e
2009 Forecast
r l 40.00
2010 Forecast
i
c
20.00
e
s
0.00

Case Study - California Meltdown
• Results of Market
 Market Power
 Bankruptcy of Distributors
 Price Volatility
 Little Merchant Construction
• Regulatory/Market Structure Problems
 Stranded Investment Charges
 No Retail Price Signals
 No Bilateral Contracts
 No Capacity Pricing
• Characteristics of Physical System
 Transmission Bottlenecks
 Reliance on Imports
 Hydro Volatility
 Natural Gas Market Power

Supply and Demand
 Demand for Electricity Increased a Bit More than Expected

Healthy California Economy
Growth of Electricity-intensive Products
Decline in the Retail Price of Electricity
 Supply of Electricity Did Not Increase

Until Recently No New Generating Plants on Line
 But Many in pipeline
 Slow Regulatory Approval Process
Hydro Supplies from Pacific Northwest and Southwest Decreased
 Costs of Electricity Generation Increased

Prices of Natural Gas increased
Prices of NOx Prices skyrocketed under RECLAIM project

Figure 2
Western Generation Mix Options
(% of Installed MW Capacity)
100%
90%
80% Nuclear/Other
70% Geothermal
60%
50% Wind
40% Coal
30% Gas
20%
10% Hydro
0%
Source: Western Governors’ Association,

Conceptual Plans for Electricity Transmission

Volatility in Demand Growth
• During the period from 1997 through 2000, the consumption of

electricity in California continued to grow slowly as it had for the last
ten years.
• The California economy was remaining healthy and population was
continuing to grow steadily. Per capita electricity use grew modestly
during that time.
• From 1990 to 2000, use of electricity increased from 26,000 MW
average consumption rate to just above 30,000 MW, a growth of 16%
over ten years, or 1.4% per year.
• Growth in energy consumption, however, was somewhat faster from
the 1997 through 2000 period, increasing by almost 2,000 MW during
the three years, or an average growth rate of 2.3% per year average.
• From 1999 to 2000, average consumption increased slightly more
than 1,000 MW, almost 4%.
• Peak loads were growing at roughly the same rates.

2001 ESTIMATED PEAK DAY RESOURCE
SUMMARY
52,000
50,000
48,000
46,000
44,000
42,000 Peaker
40,000
Hydro
38,000
36,000
Wind
34,000
Im port
32,000
30,000
Resource [MW]
28,000
26,000
24,000
22,000 Therm al
20,000
18,000
16,000
14,000
12,000
10,000
8,000 QF
6,000
4,000
2,000 Nuclear
0
1
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Time [Hours]
Nuclear QF Thermal Import Wind Hydro Peaker

Supply and Demand During a Typical Day

Trends in Electricity Demand

Supply and Peak Demand
Projected Monthly Peak Load, 2001

(MW)
60,000
50,000
Load+
40,000 Op. Res.
Load
30,000
20,000
10,000
0
APR MAY JUN JUL AUG SEP
Gen Cap Dynamics Imports

Electricity Usage in California

Forecast of Electricity Prices Before the California Crisis
The published analyses, including those done by the California
Energy Commission and those published through
the academic community all forecast relatively low wholesale
prices.
12
10
8
¢/kwh
6
4.2
3.6
4 2.9 3.1 2.7 2.9 3.1 3.1 3.3
2.6 2.5
2
0
00
01
02
03
04
05
06
07
08
09
10
20
20
20
20
20
20
20
20
20
20
20
California Energy Commission “Market Clearing Prices… 2000-2010”, Feb. 2000, p. 6
Cautious Development Scenario, nominal dollars

Actual Costs of Wholesale Power
11.5
30
12
27.1 26.8 10.7
25 10
Total Cost $/Billion
Average Cost ¢/Billions

20 8
15 6
10 7.4 3.1
4 2.9
5
2
0
1999 2000 2001 0
1998 1999 2000 2001
ISO Control Area,

$40 BILLION MORE !! ISO Department of Market Analysis

Price History

Electricity Prices Relative to Natural Gas Prices

Similar Problems in New Zealand

Factors that Cause Volatility in Electricity Prices and
Electricity Costs
• Volatility in Electricity Prices

Demand Volatility (Higher or Lower Economic Growth)
Hydro and Renewable Volatility
Fuel Price Volatility
Outage Volatility
• Effect of Risks
On Prices
On Costs

Western U.S. Supply Curve
250
200
Average Load Peak Load
Incremental Cost ($/MW)
150
100
50
0
85200 95200 105200 115200 125200 135200 145200 155200 165200
Load (MW)

Prices and Loads Before the Crisis

General Conditions in California that Made Markets Difficult
• Hydro System
• Reliant on Imports of NWPP Hydro Generation 2000 Relative
Energy to 1999 -- May-June
• Difficult to Build
NGCC 2000
• Hydro was 23% 0
below previous Week Week Week Week Week Week Week Week Week
levels -2000 1 2 3 4 5 6 7 8 9
aMW -4000
-6000
-8000
NWPP total NWPP US Systems

Mountain Snowpack 2001 v.s. 2002

California Case Study demonstrates what is not a Success
• One problem often cited was that the

market framework did not encourage
development of new capacity
• Lack of Capacity was Related to
Market Power Exercise
• Was it prudent to consider California
in Developing Market Framework

In-State Generation After Considering Reduced Imports
from Hydro Resources

Why was Capacity not developed in California Framework
• Market Prices Did Not Justify Additions

• Environmental Constraints All Daily COB Prices $/MWH
700.00
• No Bilateral Contracts 600.00
500.00
• No Capacity Prices 400.00
• No Market Monitoring to Build Capacity 300.00

200.00
Supporting Hydro (as in New Zealand)
100.00
• IPP Contracts Made Problem Worse 0.00

Demand Response Argument
March 25, 2024 www.edbodmer.com 60

Lack of Demand Reduction

San Diego Gas & Electric
Southern California Edison
Pacific Gas & Electric
Power Contract Issues
• Variability in spot price versus total generation

• Use of contracts to limit dependence on spot prices
 the state initiated requirement for California's investor-owned utilities to sell
all of their generation into, and buy all of their energy needs from, the PX
should be eliminated. The buy/sell requirement led to over-reliance on spot
markets and over-exposure to short-term price fluctuations.

Market Power
• FERC: “there is clear evidence that the California market

structure and rules provide the opportunity for sellers to
exercise market power when supply is tight and can result in
unjust and unreasonable rates.”

Price Caps Established

Market Power and Game Playing
• But a detailed examination of recently released internal memos by Enron Corp. lawyers,
transcripts of trader conversations gathered by investigators, and scores of interviews
with market participants and regulators yields a comprehensive look at how the U.S.
energy industry cashed in on and contributed to California's energy crisis. Among the
findings:
Energy companies seized on loopholes and local shortages to charge prices hundreds of times
higher than normal.
Suppliers withheld power from the state's primary market, and sometimes idled power plants to
induce shortages and boost prices.
Gas companies manipulated supplies and prices, driving up the cost of a main ingredient of
electricity.
Enron played a much bigger role than previously believed in California's energy market. Its trading
strategies overwhelmed regulators and drove up prices.
• Almost from the start, participants on all sides probed for weaknesses. One way the ISO seeks to ensure reliability
is to pay plant operators to keep generators on standby to meet last-minute surges in demand. In the market's first
weeks, payments for this service, set by auction, were typically less than $10 a megawatt-hour. (A megawatt-hour
is roughly the amount of power needed to supply 1,000 homes for an hour.)
• Then on July 13, 1998 -- 3-1/2 months after deregulation started -- a unit of Houston-based Dynegy Corp. offered
to supply standby power at $9,999 a megawatt-hour. Dynegy was exploiting the fact that the market had been set
up with few rules on what suppliers could charge. The ISO had to accept the bid because it expected high power
demand and there were few other offers of standby power. Thus, Dynegy and three other suppliers wound up
splitting $8 million for keeping plants on call for five hours, according to state and federal records. Dynegy declines
to comment on the incident.

Manipulation of Natural Gas Prices
• Charge that El Paso, a Texas Natural Gas company was

manipulating the price, and manipulating behavior on the main
pipeline into California. He showed me his evidence. I thought
it was a dead-bang, absolute case of price manipulation.
• The CPUC claimed El Paso had increased natural gas prices in
California, by withholding capacity on its pipeline. The FERC found
that El Paso had the ability to exercise market power. El Paso and the
CPUC settled the case in late-2003 for $1.6 billion.

Enron Market Manipulation
• On December 2, 2001, Enron filed for bankruptcy.

Subsequently, allegations were made that Enron, through its
affiliates, used its market position to distort electric and natural
gas markets in the West. These allegations included the claim
that Enron’s filing for bankruptcy had caused a substantial
decline in spot prices and, thus, demonstrated that Enron had
been manipulating prices.
• Strategies engaged in by Enron traders, including “Ricochet,”
“Get Shorty,” “Death Star,” and “Fat-Boy.”
• Enron’s trading strategies used false information in an attempt to manipulate
prices also found that the published natural gas prices at the California border
could not be independently verified and may have been manipulated.
• Enron owned a number of qualifying facilities.

FERC Report on Market Manipulation
• The Report found evidence of significant market manipulation

in Western energy markets during 2000 and 2001.
• According to the Final Report, increases in spot gas prices
contributed to the price increases in the electricity markets.
Dysfunctions in the natural gas market appeared to stem, in
part, from efforts to manipulate price indices compiled by trade
publications, including reporting of false data and wash trading.

Comments on Market Power
• I believe that they are engaging in cartel behavior--or cartel-

like behavior. They can--through manipulating whether their
power plant runs on a particular day, and through manipulating
the old system of biding--dramatically increase the price of
power, or dramatically reduce the supply on any given day,
which creates an artificial shortage, and then drives up the
price power.
• Yes, in order to create a shortage in the winter, because California has plenty
of power capacity in the winter. To put a number to it, we only use about
roughly 30,000 megawatts a day at peak of power in California in a winter day.
We have 41,000 megawatts available in California--power plants ready to run.
So we've got a big cushion on any given day.
• But what happened starting in December, and continuing through January and
February, is the folks who could run, didn't run--dropping the available amount
of power down to--imagine this--just below what our power needs were,
creating an artificial shortage and driving prices up.

Enron Strategies in California
• No company devised more ways to take advantage of the system than Enron, which remade itself in the
1990s from a pipeline company to an energy trader. The Houston energy giant bought Portland General
Electric Co., a regional utility located in Portland, Ore., in 1997, and set up a trading desk later run by
Tim Belden. A former researcher at a federal energy lab who typically rode his bike to work, Mr. Belden
spent 15-hour days combing through regulatory filings trying to crack the code of California's new
market, according to former employees in the office.
• He wasn't afraid to take chances. A former co-worker recalls Mr. Belden losing $100,000 of Enron's
money on an "experiment" to see how prices would react if Enron simultaneously exported power from
California at several locations.
• Mr. Belden quickly focused on wringing profits from the state's aging and inadequate transmission
network. Enron bid aggressively at the ISO's 1999 auction for transmission rights on heavily used lines,
which gave Enron priority for moving electricity on these lines, and a share of the ISO's fees for
allocating capacity.
• Enron devised multiple strategies for overloading transmission lines and reaping payments for relieving
the congestion it had created, according to the memo by Enron's lawyers and interviews with former
traders. The congestion fees could be so lucrative -- as much as $600 a megawatt-hour -- that Enron
regularly transferred power across the state and sold it at a loss, with the fees more than making up the
difference, according to a former Enron trader.
• By the summer of 2000, Enron traders had a portfolio of such tactics, with colorful nicknames such as
"Death Star" and "Red Congo." Both involved scheduling power to flow in one direction on the ISO
system, and in the opposite direction on another system outside the ISO's control, such as a
transmission line operated by California cities. In that way, Enron could be paid for "relieving" congestion
on the ISO system without actually putting power on or taking it off the grid. To execute these strategies,
Enron created complicated chains of transactions using out-of-state partners.

Prices versus Marginal Cost

Outages Increased
• Outages: Year 2000 Planned and Unplanned Outages increased by 53% in

June, 57% in July and 23.5% in August compared to 1999.
• Average megawatts out of service increased by 77% in June, 121% in July and
461% in August above the same period in 1999.
• California's power plants started getting sick. By mid-November, 2000, nearly
one-fourth of the state's generating capacity sat idle for planned maintenance
or emergency repairs, more than three times the outage rate in November
1999. But it was difficult to determine, even after state officials began surprise
plant inspections, whether the outages were a deliberate attempt to make
money by shrinking supply or the predictable result of running 30-year-old
plants hard all summer.
• "There's something broken in every power plant all the time," says S. David
Freeman, director of California's public-power authority, who formerly ran
municipal utilities in Sacramento and Los Angeles. Under the old system, Mr.
Freeman says, utilities tried to keep plants running. But under the new system,
he says, generators had incentives not to.

Units Off-Line During California Crisis

Physical Withholding
Statewide Average Daily Forced or Scheduled Megawatts Off Line
16,000
• Price volatility was
affected by plant 14,000
outages that were

in part driven by 12,000
problems with IPP 10,000

contracts
MW
8,000
6,000
4,000
2,000
• suppliers began offering less power to the daily auctions at the Power Exchange and at
higher prices. On the afternoon of June 28, for example, prices climbed to $750 a
megawatt-hour, four to five times as high as on similarly hot days in the summer of 1999.
Power Exchange investigators later concluded that all of the power-plant operators --
Dynegy, Williams, Duke Energy Corp., Reliant Energy Inc. and Mirant Corp. -- as well as
marketers such as Enron had at times withheld electricity from its daily auctions. The
suppliers may have tried to sell the power to the ISO or out-of-state buyers, hoping to
fetch a higher price. Or, they may have idled the plants, hoping to induce a scarcity that
would drive prices even higher.

Were Maintenance Outages Expected of Manipulated
• Maintenance occurred at generating plants that were 30 to 40 years old. These

generating facilities were operated at a significantly higher rate in 2000 than in
previous years. Most of the generating facilities were out-of-service because of
tube leaks and casing problems, turbine seal leaks and turbine blade wear,
valve failure, pump, and pump motor failures.
• Staff did not discover any evidence suggesting that the audited companies
were scheduling maintenance or incurring outages in an effort to influence
prices. Rather, the companies appeared to have taken whatever steps were
necessary to bring the generating facilities back on- line as soon as possible
by accelerating maintenance and incurring additional expenses. Also, the
outages did not necessarily correlate to the movement of prices on a given
day.
• However, it is practically impossible to accurately determine whether such
outages are orchestrated or not because plants frequently run with physical
problems and the timing of repairs and maintenance is often a judgment call on
the part of plant owners or operators.

Gas Price Discussion
• Contributing to the increase in electricity prices during the crisis were even more dramatic
increases in the natural gas price than had occurred earlier in 2000. In December, the
California natural gas price jumped to about $50 per million Btu, a factor of 10 higher than
it had been.
• Although this price peak lasted for only two weeks, the spot natural gas prices in
California remained above $10 per million BTU until June of 2001 (see Figure 25, based
on data from Enerfax.com). These high prices did not result from limitations in the
availability of natural gas at the wellhead or at market centers, as shown by the prices of
natural gas at Henry Hub, Louisiana, the major market center. Rather the price spike
resulted directly from the large demand for natural gas to fuel electric generators during
the winter when the demand for natural gas naturally peaks, coupled by limitations in the
pipeline capacity to transport natural gas within the State and the absence of natural gas
held in storage from previous months.
• The sharp increase in natural gas prices, coming just when investor-owned utilities were
not paying generators for electricity they sold, provided strong incentives for generators
either to stop producing electricity or to bid very high prices to sell the electricity they did
generate. Thus, these natural gas prices probably contributed substantially to the
wholesale electricity price increases during the crisis, particularly to the December
electricity price spikes.

Manipulation of Natural Gas Prices
• Suppliers again showed their ability to adapt to

new rules, this time by possibly manipulating
natural-gas prices. Gas prices were a key
ingredient in FERC's formula for determining
justifiable electricity prices during that period.
FERC investigators believe Enron and others
may have manipulated gas prices to boost
allowable electricity prices. On Jan. 31 alone,
investigators say, Enron did 174 natural-gas
trades with one other unidentified company,
helping to send gas prices in California up 33%
in a single day. Investigators proposed changes
to the electricity-price formula that would reduce
justifiable power prices on some days by two-
thirds.

Exercise of Market Power in California Meltdown
• Market Power resulted in significant increases in prices

Prices did not Reflect Competitive Outcomes

Average California PX price and MC
PX price Competitive Price
180.00
160.00
140.00
120.00
($/MWh)
100.00
80.00
60.00
40.00
20.00
0.00
Apr-98 Jul-98 Nov-98 Feb-99 May-99 Aug-99 Dec-99 Mar-00 Jun-00 Oct-00 Jan-01
Month

Kernel Regression of
Lerner Index vs. Capacity Ratio
May - December 1999
Cal NE PJM
0.9
0.8
0.7
0.6
(p-MC)/p
0.5
0.4
0.3
0.2
0.1
0
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Residual Demand/ Capacity

Monopoly Rents Due to Market Power

Market Share and Market Power
• Current standard of 20 percent market share gives no

assurance of whether a seller can inflate the market price
• As low as 5 percent market share can create a problem when
the demand is more than 95 percent of the total available
capacity.
• In this case, a supplier with 5 percent of market share
becomes pivotal.

End of the Crisis
• Suddenly, in June, 2001, it was over. The long-term contracts

were in place. Gas prices began to fall. More hydro-power was
available. Users, reeling from a slowing economy and higher
rates, embraced calls for conservation. And finally, FERC
imposed price caps across the West, eliminating some
loopholes and signaling a new, tougher stand against power
suppliers. With peak power demand down 14% from a year
earlier, wholesale power prices fell by almost half in June and
declined further each month for the rest of 2001.
• A year later, an uneasy calm has settled over California's
electricity grid. The last rolling blackout was in May 2001. The
state survived near-record demand for power during a July
heat wave.

Lessons Learned – California ISO
• The premise that “The Market will Provide” is too simple for a critical
infrastructure such as the electric energy system - can have both over &
under supply
• Some one has to have the responsibility for ensuring adequate generation
supply
• Construction of power plants is very capital intensive so builders want some
guarantees of revenue for several years to lower their risks
• The time delay from when it is obvious new plants are needed to when they
can be sited, built and on-line is 2 to 4 years.
• Single Price Auction structure breaks down when there is a scarcity of
supply
• Bi-lateral deals and forward contracting for blocks of energy is essential to
reduce risks and guarantee adequate energy supplies

California Lessons
• The California power crisis produced the following useful

lessons:
A mandated, deregulated, wholesale bid-based spot market is
too complex to operate and too difficult to monitor for abuse of
market power for all but the most advanced developing countries.
Long-term contracts should be allowed as a form of insurance for
distributors purchasing from a new spot market. A vesting contract
that fixes the sale price for trade between existing or new
generators and distributors for five or more years should be
established before the market goes into operation. They also
provide at least initial protection against market power.

California Lessons Continued
• Retail tariffs should be aligned with the costs of wholesale

power. Regulators should avoid rate freezes that expose
distributors to the possibility of an unsustainable squeeze on
their cash flow occurring when rising wholesale power costs
approach or even exceed fixed retail rates.
• A poorly designed power market will not operate properly, and
inadequate attempts or delays in correcting market distortions
will spill over into a serious financial crisis.
• One or more commercially viable entities must have a legal
obligation to provide adequate supplies for Small retail power
users who prefer to deal with a default supplier rather than
shop around in the market for a supplier and face volatile spot
market prices.

Implications of California Meltdown
• What really could have been done differently in California

 Don’t create markets when there is:
 Reliance on significant hydro
 A tight reserve margin
 Restrictions on natural gas supply
 Transmission constraints that limit competition
 The market should not
 Explicitly limit bilateral contracts because all of the prices will
be at the marginal cost
 Begin when prices do not equal long-run marginal cost --
stranded investment problem
 Involve a single-buyer model where there is limited retail
access

Implications for Market Analysis
• Should Bilateral Contracts be Encouraged?

• Should Retail Customer Choice be Limited to Create More Creditworthy Off-
takers?
• Should Industrial Customer Choice without Fixed Tariff Rates be
Demanded?
• Should Capacity Markets be Implemented?
• Should Price Caps be Implemented and if so, at what Level?
• How can Forward Markets be Developed?
• What Market Monitoring Systems should be Established to Limit Market
Power?

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 NAPCOR’s
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 NAPOCOR’s 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 1990’s
• 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 12-14
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 success—
several 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 systems—the only generation plants that
could be brought to operation within a year—which 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 operation 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 government-to-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 NPC’s 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.

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.

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
2001 Group 113
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 Equip’t Cos. Warranties Enron Power Completion

Operating Co. Guarantee
Government Fluor Daniel EPC
15-year Turnkey
Enron Power Enron
Phils. Op’g Co.
Performance BOT Construction Corp.
Undertaking Concession Contract
O&M Enron Subic
Supply Agreement Power Corp
Napocor Fuel Free
113MW
Ground Subic
Lease
Buyout Power Enron Power
Rights
Corp. Philippines Corp
• Capacity Charge
• O&M Charge Insurances
• Energy Charge
PPA US$105 million, 15-year Notes
113 MW Diesel Generator Power Station
Subic Bay, Philippines
Sources of Funds:
Notes $ 105 M
Subordinated Note 7
Contr. Of Shareholders 28
Working Capital 2
TOTAL $ 142
Uses of Funds:
Turnkey Contractor $ 112 M
Bonus to Turnkey Contractor 7
Development and other related costs and Fees 14
Pre operating, Start-up and Commissioning Costs 3
IDC 4
Working Capital 2
TOTAL $ 142

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
 shareholder payments / repayments
 payments of sub-debt
 investments other than permitted investments
May 18, 2001 118

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 - Subic Power Corporation

• Amount - USD 105 million
• Maturity - 15 years
• Payments of Principal & Interest are fully guaranteed by Enron Corporation until the
Facility Completion Date.
• Repayment - equal semi-annual Jun 28/Dec 28.

• 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 u’tkg. for the same
Enron’s completion guarantee held invalid/ unenforceable
NAPOCOR’s bankruptcy and Govt.’s non-confirmation of performance
u’tkg.

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 Company’s 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
Min Min PV Loan Equity

What If DSCR Interest Cover IRR
Cover Ratio (Post Tax)
Base Case 1.39 2.01 1.53 19%
Availability = 81% 1.25 1.80 1.36 14%
Operating expenses 1.19 1.72 1.23 9%
are 50% higher/yr
Interest Rate is 12% 1.37 1.77 1.40 17%

Adjusted Results

Other Assumptions

Quezon Coal Plant Case

Quezon Case Study
• Capacity 440 MW
• Cost USD 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
Capacity 440,000 MW
Construction Operation USD/kW Percent

Sources of Funds
Eximbank-Supported (Political Risk) Loan Facility 358,894,000
Eximbank Direct Term Loan Facility 391,733,000 890.30 48%
Senior-secured bonds, due 2017 215.000.000 215,000,000 488.64 27%
Total Credit Facilities 573,894,000 606,733,000 1,378.94 75%
Total Equity Contributions 202,244,000 202,244,000 459.65 25%
Total Sources 776,138,000 808,977,000 1,838.58 100%
Uses of Funds
Generation Facility 419,560,000 419,560,000 953.55 52%
Transmission Line 23,306,000 23,306,000 52.97 3%
VAT, Insurance, Escalation 21,878,000 21,878,000 49.72 3%
Total EPCM Costs 464,744,000 464,744,000 1,056.24 57%
Start-up and Other Owner Costs 50,487,000 50,487,000 114.74 6%

Development Costs 37,885,000 37,885,000 86.10 5%
Development Fee 8,000,000 8,000,000 18.18 1%
Eximbank Exposure Fee 32,839,000 74.63 4%
Interest During Construction 75,038,000 75,038,000 170.54 9%
Other Financing Fees 68,425,000 68,425,000 155.51 8%
Contingency, budgeted 35,000,000 35,000,000 79.55 4%
Other 36,559,000 36,559,000 83.09 5%
Total Uses 776,138,000 808,977,000 1,838.58 100%
Contingent Commitments
Cost-Overrun Loan Facility (Unsupported) 30,000,000 30,000,000

Contingent Equity Contributions 20.000.000 20.000.000
TotatContingent Commitments 50,000,000 50,000,000

Construction Period
1996 1997 1998 1999

USES DURING CONSTRUCTION
Environmental, Procurement, Contracting 11,408 170,178 210,784 54,123
Start-up Costs 559 4,968 13,370 8,973
Development Costs & Fees 30,098 13,000
IDC 16,487 32,515 44,648
Financing Costs
Upfront Fees 9,250 2,930 45,128
Commitment Fees 245 5,580 4,689 3,978
Development Capital & Project Equity 3,250 0
Debt Placement Advisory 3,750 7,498 5,473
Other Financing Costs 7,300 6,552
Contingency 11,667 11,667 11,667
Working Capital 8,865
Other 8,711 6,596 9,474 10,463
TOTAL USES 74,571 224,958 289,997 206,318
SOURCES DURING CONSTRUCTION

Debt
Working Capital
Eximbank 44,601 192,848 144,435
Capital Markets Debt 215,000

OPIC Loan 74,573 -74,573
Net Bonds 74,573 140,427 0 0
Local Bank Loan
International Banks
Total Debt 74,573 185,028 192,848 144,435
Equity
InterGen 28,950 70,433 44,864
Ogden 10,981 26,716 17,017
Total Equity 39,931 97,149 61,882
TOTAL SOURCES 74,573 224,959 289,997 206,317

Development Risks
• Approval and Construction

• Financing Risks
• Contractual and Operating
• Currency/Country

Public Support During Contruction

Quezon EPC Contract
• Pulverized Coal -- Proven Construction since 1950’s

• 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 27.5%
26.125%
• Local Developer
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 up-front fee
• Treatment of Exim Up-front Fee

S&P Initial Comments on Project

S&P Comments on Quezon Continued

Moody’s Comments

Downgrade of Bonds

Problems with Quezon

Moody’s Comments

S&P Comments on Meralco

Comments on Meralco

Cost Comparison in Case
Project Location Capacity Total Cost Cost per kW Operational Date Major Owners
InterGen 71.5% Ogden

Quezon Philippines 440 MW, Coal-fired $812 million $ 1845.45 per kW Dec. 1999
26.5% PMR 2%
United 770 MW, Combined
Rocksavage $600 million $ 779.22 per kW Jan. 1998 InterGen 100%
Kingdom cycle
700 MW, Combined InterGen 20%; GE40% El
Samalayuca Mexico $630 million $ 818.18 per kW Nov. 1998
cycle Paso 30% ICA 10%
United 770 MW, Combined
Spalding $577rnillion $ 749.35 per kW March 2000 InterGen 100%
Kingdom cycle
235 MW, Natural gas- InterGen 54% Emcali 43%
TermoEmcali Colombia $212 million $ 902.13 per kW Jan. 1999
fired CFP 3%
360 MW, Pulverized
Jacui Brazil $370 million $ 1027.78 per kW June 2000 InterGen 100%
coal fired
InterGen 50% Shell 40%
Sao Paulo 1 and II Brazil 900 MW $510 million $ 566.67 per kW June 2001
VBC 10%
United
Coryton 750 MW $660 million $ 880.00 per kW March 2001 InterGen 100%
Kingdom
2 x 360 MW, Coal- InterGen 40.5% Lippo
Meizhou Wan China $751 million $ 1043.06 per kW Aug. 2000
fired Group 49.5% Others 10%
InterGen 32.5%
700 km natural gas
Mayakan Mexico $260 million Sept. 1999 TransCanada 62.5% Gutsa
pipeline
Const. 5%
Average $ 956.87 per kW

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 could start
in 2015.

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
purchase price of $215 million was paid in cash.

Quezon Transactions
• 14 May 2012 (Reuters) - Thailand's second-largest 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 country’s 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
Infllation Rate
30.00% 30.00 Exchange Rate
20.00% 20.00
10.00% 10.00
0.00% 0.00
61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20

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
30.00 28.80
C
e
n 25.00
t
s
20.00
p
e 15.31
r 15.00
12.30 11.80 11.61
k 10.44 10.15
10.00 9.28
W
h 7.42 7.11 6.95 6.18
i 5.00
n
U 0.00
Philippines
Singapore
HK - Kolowoon
Iceland
South Africa
Australia
Finland
HK - Island
Perú
USA
Malaysia
Canada
S
D

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 utility’s 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 projects—all of Napocor’s 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 contract—most 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.

Operation Phase – Revenue Risks and Price Volatility and the
Case of AES Drax
Convincing Yourself That Unrealistic Optimistic
Forecasts Will Occur – Firehouse Effect
• It seems obvious that the base case should represent likely comments
rather than optimistic or best case estimates. However, models often
represent optimistic rather than likely outcomes. The Firehouse
effect – Fireman with too much time agree on many things that
an outside, impartial observer would find ludicrous.
• Examples:
LBO’s: Some transactions were based on assumptions that companies
could achieve levels of performance – revenue growth, operating margins,
capital utilization – never before achieved. Buyers had no concrete plans.
Yet as the number of participants in the hot market increased, discipline
declined. The swelling ranks of LBO firms bid up prices for takeover
prospects encouraged by investment bankers, who stood to reap large
advisory fees, as well as with the help of commercial bankers, who were
willing to support aggressive financing plans.
S&P
Financial projections …are probably inherently skewed toward
successful results...hiding the true technical and operating risks
inherent in many projects..."

Don’t Ignore Basic Supply and Demand
• Investors and bankers did not account Merchant Power in U.S.

for the obvious prospective oversupply
• In many project finance cases where
of homes in their analyses. This
surplus of residential homes could be the same mistake has been made.
verified by a simple drive around For example, there was a massive
sprawling suburban areas of American increase in supply in the
cities where it was apparent that supply Telecommunications industry and the
was increasing much faster than the merchant power industry that resulted
overall population. in a very high default rate.
• Estimated $100 Billion Loss in
Merchant Markets
• .

Debt to Income versus Debt to Capital
• Part of the problem was relying on Household Debt/GDP
debt to the value of assets rather 1.00
than on debt to income. The chart 0.80
below shows that the level of debt 0.60
relative to aggregate income was 0.40
dramatically increasing. 0.20
• The same mistake has been made 0.00
Jan 53
Jan 55
Jan 57
Jan 59
Jan 61
Jan 63
Jan 65
Jan 67
Jan 69
Jan 71
Jan 73
Jan 75
Jan 77
Jan 79
Jan 81
Jan 83
Jan 85
Jan 87
Jan 89
Jan 91
Jan 93
Jan 95
Jan 97
Jan 99
Jan 01
Jan 03
Jan 05
Jan 07
in project finance where a 20%-
30% equity buffer gives a bank
Index of Housing Growth and Population Growth
comfort that equity investment 1.6
comes after debt investment. 1.5

Population Index
1.4
• The second chart shows that the 1.3

Housing Index
housing as measured by cumulative 1.2
starts has increased by about 40%

1.1
more than population. 0.9
0.8
92 Jan
99 Jan
06 Jan
93 Oct
00 Oct
07 Oct
97 Apr
04 Apr
94 May
01 May
08 May
91 Jun
94 Dec
98 Jun
01 Dec
05 Jun
95 Jul
96 Feb
02 Jul
03 Feb
93 Mar
00 Mar
07 Mar
90 Nov
96 Sep
97 Nov
03 Sep
04 Nov
92 Aug
99 Aug
06 Aug
Ignoring Economics and Long-Run Marginal Cost when
Evaluating Prices
• Loans were granted on the presumption
AES Drax thatand housing
UK Merchants
prices would follow historic trends and
continue to increase. The most fundamental of economic principles dictate that prices
Declines in prices
eventually movewere not predicted
to long-run marginalin cost,
merchant electricity
or the marketsaafter
cost of building new increases
home. Asin a supply.
Losses wereeconomics
corollary, estimated suggests
to be $100 billion.
that pricesIncan
themove
U.K. changes in the
to short-run marketwhen
marginal structure and
surplus
increased
capacitysupply
exists.pushed prices
The graph to marginal
of median cost.prices in the U.S. shown below illustrates how
housing
the basic economic principles were ignored.
• .
UK Annual Electricity Prices

30
29.0
28
27.0
• . 26 26.0
25.0
24 24.0 24.0
23.0
GBP/MWH 22 22.0
21.0
20 20.0
19.0
18
17.0
16 15.5
14
12
10
1990 1991 1992 1993 1994 1995 1996 1997 1999 2000 2001 2002 2003

The U.K. Market
• The deregulation process started in 1990, after the UK Electricity Act signed in
1988.
• Central Electricity Generating Board was, until 1990, responsible for the
generation and transmission of electricity. After market opening, generation is
carried over by
National Power, and PowerGen (fossil fuel generators)
British Energy and Magnox (nuclear)
Eastern group, and a good number of independent generators recently created.
Scottish generation companies and Electricite de France are in charge of imports
into England and Wales.
• Total generation capacity is 70GwH.
• Low voltage transmission is done through 12 companies (Regional Electricity
Companies, or RECs). High voltage transmission is done by the National Grid
Company.
• Any approved generator can generate into the grid and contract through the
transmission companies delivery to retailers.

UK Electricity (2)
• Prices are fixed through an auction mechanism, where each

generator can submit offers for prices for different leads, with
additional information such as operational restrictions, for each
half-hour period for the day-after. The market operator performs
a demand forecast as a function of bids, and uses a process
matching bids and offers, which results in a System Marginal
Price, and the schedule for the next day. The final price is
revised one month later, and gives rise to additio0nal charges
or rebates.
• System Marginal Price (SMP) is the largest price reached in the
auction process.

Contract versus Commodity Price
• Risk analysis has similarities in contract versus non-contract

transactions
Similarities
 Need to assess economic viability in either case because of
incentives to abrogate contract if the plant is uneconomic
 Some suggest that contracts are not a good idea because of long-
term problems.
Differences
 Must assess the credit quality of the off-taker
 Small risks become large in transaction with many contracts
 Heat rate degradation
 Plant availability
 Contract penalties
 Interest rate changes

Merchant Plant Activity
• “…in the US, private companies that own merchant plants have lost of more than $100
billion in market capitalization.”
• Banks are “now highly reluctant to take merchant risk of any kind… and they are skeptical
about long-term purchase or tolling contracts that in any way are considered to be out of
the money.”
New Merchant Capacity in Database
• “Merchants will have to redesign their business 35,000.00
models. Those players that have 80-90
percent of their capital in the form of debt won't survive. The ratings agencies have said 2 9 ,513
30,000.00
that such debt-to-capital ratios must be in the 50-50 range to earn investment grade
status so that the cost of borrowing is reasonable.”
25,000.00 2 3 ,9 4 2
• The merchant plant activity has been very high.

20,000.00
MW
15,000.00 13 ,9 2 4
9 ,78 3
10,000.00
4 ,8 6 9 5,13 6
5,000.00 3 ,58 0
2 ,0 75 2 ,4 9 4
1,3 3 5 1,2 2 9
-
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Merchant Power Return Assumptions

Capacity Additions in US

Background on UK Market
• The United Kingdom de-regulated its power system before any

country in Continental Europe, North America or Asia in the late
1980’s after parliament passed the Electricity Act of 1989. In the initial
years after deregulation, prices to consumers fell by about 30% and
electric industries in other countries began to follow the lead of Britain.
• Virtually all of the formerly government owned generating capacity
was divided into three companies, two of which – National Power and
PowerGen – owned power plants that were privatized, while the third
was a government owned company that controlled nuclear stations.
• Prices were set through a bidding process along with an
administrative uplift that was intended to compensate for capacity that
was available but not used. Since there were only two firms in the
market, some argued that prices did not reflect marginal cost but
rather were set in an ologopolistic manner
•

Market Based Prices in the UK – Not too Much Volatility
£/MWh
(99/00)
40 Transport Uplift
Uplift
35
Capacity Payment
30 SMP
25
20
15
10
0
1990/1 1992/3 1994/5 1996/7 1998/9 2000/1

Capacity and Demand in UK

Case of AES Drax
• Drax, a 3,960 MW station commissioned in two parts in 1974 and 1986,

is the largest coal plant in Europe.
• In mid 1999, the plant was purchased by AES from National Power
(renamed Innogy) for £1,963 million. This amounted to $758/kW –
higher than NGCC plants which dispatched ahead of the coal plant.
(the plant sale was driven by the government ordered divestitures
associated with reducing market concentration.)
• To finance the acquisition, AES injected £224 million of its own equity,
resulting in a debt to capital ratio of about 90%. The debt consisted of
bonds which initially carried an investment grade rating of Baa2 by
Moody’s. The debt term was 15 years with a spread of 165 basis points
and 90 basis points fee.
GBP Millions Percent

AES DRAX Holdings Limited Bonds 400.00 18.2%
AES DRAX Energy Senior Notes 267.00 12.1%
In Power Bank Facility 1,308.00 59.5%
Equity 224.00 10.2%
Total Capitalization 2,199.00 100.0%

Drax Outage

Moody’s Comments on Drax

Hedging Agreement to Mitigate Risk

AES Drax Continued
• Drax Debt was Investment Grade:

S&P highlighted uncertainty surrounding generation prices
as a concern, but stated that one of the deal’s strengths was
its 15 year hedging agreement:
“The hedging agreement underpins a large portion of the
debt service during the first seven years of the contract
thereby reducing merchant risk.”
• Other Transactions were more aggressive than Drax
Often 80% Debt Financing
Long Tenors
AES Debt Matured in 2025

Analysis of Market Prices by Experts and Rating
Agencies
• For example, according to a Moody’s pre-sale report issued in

May 2000 on the AES Drax plant, “We do not expect … a
sudden and marked fall in wholesale electricity prices in
England and Wales.”

AES Time Line
• “The initial assumptions on which the

AES Drax companies relied when
making the original investment
assumed that it would have the
protection of its long-term Hedging
Contract with TXU Europe and that
electricity prices would remain at a
certain level. Since we acquired the
Drax Power Station electricity prices
have declined on average by
approximately 40% and in November
2002 our Hedging Contract with TXU
Europe was terminated and the TXU
group entered into administration.”
Drax Annual Report

Political Pressure over Market Concentration
• The precept that the market would

remain ologopolistic was also not
sustainable.
• Moody’s: “the dissatisfaction with the 120
Pool relates essentially to the scope 100
SM P, marginal cost
for manipulation that generators with 80
60
significant market power enjoy under 40
the Pool’s complex rules.” 20
0
• The ability to exercise market power 0 10000 20000 30000 40000
D emand, capacity
50000 60000 70000
is demonstrated on the graph below M arginal cost (Frontier estimates) Sample Pool price outcomes
which shows that market clearing

prices were generally higher than the
marginal cost of running plants before
markets were reformed in 2000.

Break-up of Coal Fired Generation

Reforms and Market Concentration in UK 1990 and 2000
• The problems for banks exposed the sector boil down to one thing:
overcapacity. There is calculated to be roughly 22% overcapacity and it is
therefore not surprising that prices have slumped so spectacularly. Prices are
now around 17 to 18 per MWH, down 40% from levels prior to NETA’s
introduction.
• The atomization of the generation sector was a function of new entrants and
forced sales and pricing power was lost before NETA was introduced.
After Reforms Before Reforms

70000 Own capacity 70000 70000 70000
Own capacity
Generation capacity (assuming 95% availability)
Generation capacity (assuming 95% availability)

Cumulative
Cumulative
60000 Max demand 60000 60000 60000
Max demand
Min demand
50000 50000 Min demand
50000 50000
40000 40000
40000 40000
30000 30000
30000 30000
20000 20000
20000 20000
10000 10000
0
• . 0
10000 10000
National
AES
Scottish &
British Energy
Scottish Power
Other
Bnfl Magnox
Powergen
Mission
EDF
TXU
NRG
0 0
Edison
Southern
Power
National
Scottish Power
Nuclear
Scottish Hydro
PowerG en
NG C
EDF
Electric
Power
Electric

Financing of Merchant Plants
• If the structure of the

market remained static
and demand grew at a
similar rate to new
capacity additions, the
historic stable prices and
low volatility would imply
that investments could
support a relatively high
level of debt and implicitly
have a low cost of
capital.
• Many of the new plants
that were built were able
to achieve high levels of
debt financing.

Economics of Combined Cycle Under Existing Prices
• Because of the innovations in the technical efficiency of

combined cycle gas plants, profit could be realized from selling
power at the ologopolistic prices. The table below shows that
power plants could be constructed profitably at historic prices
realized in the past of ₤22.5/MWH to ₤26.5/MWH and achieve
more than a 15% return as long as debt financing was
available.
Equity Price 26.50 Equity Price 24.50 Equity Price 22.50
D ebt Pct Equity IRR Debt Pct Equity IRR Debt Pct Equity IRR
0.0% 11.6% 0.0% 10.3% 0.0% 9.0%
19.2% 12.6% 19.2% 11.2% 19.2% 9.7%
37.3% 14.1% 37.3% 12.4% 37.3% 10.6%
54.5% 16.4% 54.5% 14.3% 54.5% 12.1%
62.8% 18.1% 62.8% 15.7% 62.8% 13.1%
70.8% 20.7% 70.8% 17.8% 70.8% 14.7%
78.7% 24.9% 78.7% 21.2% 78.7% 17.2%
86.4% 33.5% 86.4% 28.1% 86.4% 22.3%
93.9% 69.6% 93.9% 56.8% 93.9% 42.6%

Surplus Capacity from New Construction
• The underlying assumption of stable prices

depended on limited surplus capacity and
continuation of the ologopolistic market
structure. Neither of these assumptions
were reasonable.
First, capacity was being added much faster
than demand as demonstrated by the following UK Demand and Supply GW
table. The increase in capacity was due to the Natural Gas and Conventional 18.5
Nuclear 1.2
fact that natural gas combined cycle facilities Total 19.7
could operate profitability at pricing levels that
historically existed in the market. Demand Growth 2.7
The private power plants that were

developed increased the U.K. reserve margin
(the amount of capacity divided by the peak
load) to more than 25%, far above the typical
reserve margin criteria used in the industry of
15%.

Profits of Participants

Electricity Prices
UK Annual Electricity Prices

30
29.0
28
27.0 Prices can move to
26 26.0
25.0 short-run marginal cost
24 24.0 24.0
23.0
GBP/MWH
22 22.0
21.0
20 20.0
19.0 Although NETA
18
17.0 has impacted
16 15.5 electricity prices,
14
NETA has not
12
generally been
10
1990 1991 1992 1993 1994 1995 1996 1997 1999 2000 2001 2002 2003
considered to be
the principal
underlying cause
behind the
decline in UK
power prices; this
is more likely due
to the over-
capacity in the
UK generation
market,
increased
competition and
fragmentation of
the market.
AES Drax Annual
Report

Drax Financials

Funding from Debt Service Reserve Account

AES Walks Away
• Paul Hanrahan, said, “For the past 12 months, AES has worked
diligently to navigate the interests of Drax stakeholders through all of
thisturmoil, beginning with the onset of TXU Europe’s demise, through
their bankruptcy and beyond. We have operated the plant extremely
well,we have committed top management resources, we have
preserved the claims of Drax in the TXU Europe administrative
proceeding and we have led the process of restructuring and
reorganizing the very complex and oft-times conflicting set of creditor
concerns. We have done all of this in good faith towards preserving as
much value for all Drax stakeholders, and most importantly, we have
done this without any compensation to AES. In fact, we have offered
to put more money in to Drax as part of the restructuring. AES looked
at its participation as it would any new investment, applying rigorous
investment criteria to its commitment.At this time, we feel it
appropriate that the creditors of Drax exhibit a commitment to AES

Value of UK Power Transactions

AES Drax Bond Rating Time Line
• Rating Action 25 JUL 2000 MOODY'S • Rating Action 21 AUG 2002 MOODY'S
ASSIGNS (P)Baa3 RATING TO AES DOWNGRADES DEBT RATINGS OF AES
DRAX HOLDINGS LIMITED AND (P) Ba2 DRAX HOLDINGS LtD, INPOWER LtD,
TO AES DRAX ENERGY LIMITED AND AES DRAX ENERGY LtD
PROJECT FINANCE BONDS
• Rating Action 14 OCT 2002 MOODY’S
• Rating Action 20 APR 2001 MOODY'S DOWNGRADES DEBT RATINGS OF
CONFIRMS AES DRAX'S DEBT INPOWER LTD AND AES DRAX
RATINGS; CHANGES OUTLOOK TO HOLDINGS LTD TO Caa1, AND DEBT
NEGATIVE RATINGS OF AES DRAX ENERGY LTD
TO Ca. ALL RATINGS ARE LEFT ON
• Rating Action 7 DEC 2001 MOODY'S REVIEW FOR FURTHER DOWNGRADE
DOWNGRADES AES DRAX HOLDINGS
Ltd BONDS AND INPOWER Ltd BANK • Rating Action 7 NOV 2002 MOODY'S
LOAN FROM Baa3 TO Ba1, AND AES DOWNGRADES DEBT RATINGS OF
DRAX ENERGY Ltd NOTES FROM Ba2 INPOWER LTD AND AES DRAX
TO B1 HOLDINGS LTD TO Caa2, AND DEBT
RATINGS OF AES DRAX ENERGY LTD
• Rating Action 1 MAR 2002 MOODY'S TO C
PUTS AES DRAX ENERGY LTD HIGH
YIELD NOTES RATED B1 ON REVIEW • Rating Action 19 JAN 2004 MOODY’S
FOR DOWNGRADE WITHDRAWS RATINGS ON DRAX
POWER PROJECT
• Rating Action 13 AUG 2002 MOODY'S
PLACES Ba1 DEBT RATINGS OF AES
DRAX HOLDINGS LTD AND INPOWER
LTD, AND B1 RATINGS OF AES DRAX
ENERGY LTD ON REVIEW FOR
DOWNGRADE

10
15
20
25
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Electricity Case Studies

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AES Stock Price
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S&P Index
Drax Case

Contract Viability
• Project finance is a long-term business and long-term

contracts that give advantage to one side are vulnerable
It is impossible to provide in advance for every event that may
affect a project contract in the future.
An aggrieved party will take advantage of any flaw to get out of
an onerous obligation.
• The underlying contract must make economic sense to both
parties.

Commodity Prices Merchant Electricity Plant Financing
in UK
• Before Financial Meltdown

Leverage -- 75-80%
Debt tenor -- 20 years
Credit spread -- 150-200 basis points
Equity IRR – 13%-15%
• After Meltdown
Leverage 50%
Debt tenor 10 Years
Credit spread 250 basis points
Equity IRR – 16%

Crash of Merchant Power

Case Study of Unsustainable Contacts or Inappropriate
Political Interference – Dabol
Introduction from Harvard Case Study
• This project is new-it's definitely a pioneer and as a result the policies

and approvals are still evolving. But precisely because of its pioneer
status and government interest at the top, many in India feel that this
project has moved quite rapidly.
• Judging from our Philippines experience, the first project through
certainly paves the way. The first one is like a "baptism" for the
country-after that you can use boilerplate documents; people are
educated about the process .... The fact is that we've already invested
$13.2 million with Bechtel and GE on this project, so we're very
committed .... If we didn't believe in this project and the importance of
it to India, we wouldn't be doing it. We believe in the goal of cheap
power in abundance for India ....
• The stakes are high for India too. By having three large American
companies involved, issues of national pride and the sincerity of
economic reform naturally arise .... This project is really important for
India. It symbolizes that real change has occurred, that they can get it
done. Foreign investment will follow as will greater economic growth.
This is a bellwether project. Other projects are being held up to see
what happens here. If it can't happen here-with the most respectable
sponsors, with independent fuel supply, and the most financially stable
state-can it happen anywhere in India?
Contract Risk and Dahbol
• Investment in a $3 billion, 10-year liquefied natural gas power plant

development project, was the largest development project and the
single largest direct foreign investment in India’s history.
• Begun in 1992, the Dabhol power plant near India’s financial capital of
Bombay in Maharashtra state was to have gone online by 1997. It was
supposed to supply energy-hungry India with more than 2,000
megawatts of electricity, about one-fifth the new energy needed by
India each year.
• In a joint venture with U.S. companies General Electric and Bechtel,
Enron created an Indian subsidiary, Dabhol Power Co. DPC, which
was 65 percent owned by Enron, was to build the power plant. Enron
was to develop and operate the plant. Bechtel was to design and
construct it, with GE supplying the equipment.
• Enron brokered a deal with Qatar to provide the Dabhol plant 2.5
million tons of liquefied natural gas per year for 25 years, starting in
1997.

Dabhol Structure
Reserve Government Domestic

Government
Bank of of Maharashtra (Indian)
of India
India Financial
Full Institutions
Guarantee
(Banks)
Ministry Maharashtra Limited
of Power State guarantee
State
Support Electricity US Exim
Agreement Board Political Risk
Comfort
Guarantee
Letter
PPA Lending Banks
FX Availability
Dabhol Loan
Power Agreement
Corp

Dabhol Plant
• Project Included
Largest Independent Power
Producer – 695 MW + 1,320 MW or
2,015 MW. 22.4% of Capacity of
Maharashtra
LNG Re-gasification Plant
LNG Tanker to access supplies in
Qatar
85% Debt and 15% Equity
Equity
 Enron 65%
 Bechtel
 GE
Enron Net Income $465 Million

Enron Assets (1993): $12 Billion
Enron Equity (1993): $3.5 Billion

Dabhol Plant Cost
• First phase
Second phase
• 695 MW
1,320 MW
plant
capacity
• Cost of
LNG re-gasification
$920 M plant, storage, and harbor facilities to be built.
• Construction to
began
begin
1995,
afterproject
phase to
1 completed
come on-line in 1997
• Cost of
$1323/kW
$1.88 B
• Comparable
Cost per $1,466/kW
costs $650/kw

Cost of New Plants

Comparative Plants

Dabhol Timeline
• May-June, 1992: India invites Enron Corp to explore the • June-Oct 2000: Maharashtra government allies
possibility of building a large power plant in Maharashtra. demand scrapping the project because of the cost
of the power it produces.
• June 20, 1992: Initial memorandum of understanding
signed between Enron and Maharashtra government for • Oct, 2000: MSEB defaults on its October payment
a plant with capacity of 2000-2,400 MW. The to DPC.
Maharashtra State Electricity Board is expected to pick
up a 10 per cent stake. • Dec, 2000: Maharashtra state announces plan to
review the project, stating that the tariff is too
• Jan 2, 1993: The Foreign Investment Promotion Board high.
clears proposal for a 1,920 MW plant, expandable to
2,550 MW. • Feb, 2001: The Credit Rating Information Services
of India Ltd cuts ratings on bonds issued by
• Dec 8, 1993: The power purchase agreement signed Maharashtra government due to defaults on
between Dabhol Power Company and MSEB for a 2,015 payments owed to Dabhol. Enron invokes the
MW project to be implemented in two phases. Union government guarantee.
• March-June, 1995: Following state elections, a new • April, 2001: Enron issues a notice of arbitration to
Maharashtra government, headed by the Shiv Sena, the Indian government to collect on the December
scraps the project, alleging corruption and high costs. bill of Rs 1.02 billion.
• Nov 1995: Project re-negotiated with a final capacity of • April, 2001: Enron invokes the political force
2,184 MW. MSEB's stake is upped to 30 per cent -- 15 majeure clause in its contract with MSEB, stating
per cent in the first phase, and a further 15 per cent upon that unfavorable political conditions have prevented
completion of the project. it from fulfilling contractual obligations.
• May, 1996: India extends counter-guarantee to the • April 23, 2001: DPC and its lenders meet in
project, under which the federal government promises to London to discuss the payments issue. Enron
cover any defaults by the state utility. seeks lenders' permission to issue a notice of
termination.
• May, 1999: Phase one of the project with a capacity of
740 MW begins operating. • April 25 2001: The board of Dabhol Power
Company authorizes management to terminate the
contract any time it chooses.

Structure of Dabhol PPA Contract
• PPA Contracts can transfer all demand and fuel cost risk. The
Dabhol PPA contract is illustrated below

Dahbol PPA Tariffs
• The Tariffs were about 7

U.S. cents per kWh
increasing to 11 cents over
20 years.
• Comparable plants in the
US were selling power at
3-4 cents per kWh.
• Initially IRR was 26.52%
• Officially the ROE allowed
was up to 16%
• The contract was indexed
to USD

Comparative Plant Costs for Natural Gas

Enron’s Economic Rational Underlying the Transaction

Transparency

Ways to Get Around the Contract
• A common (though unverified) account of one episode in the

Dabhol controversy has Maharashtra officials reducing
dispatch gradually until the plant shut down, then requesting
full dispatch in three hours from a cold start. The PPA required
a three hour horizon for full availability; project management
protested that this provision did not contemplate ramping up
from a cold start (a requirement almost any power plant would
have trouble with).
• Despite protests to the contrary (and the fact that a court would
likely find such a failure immaterial), the inability to comply with
the requirement eroded the leverage of the Dabhol sponsors in
the dispute.

Dabhol Issues
• Enron made the headlines over its stance on a massive power

blackout that threw more than 200 million people into darkness
in northern India. Enron demanded three times the normal rate
for supplying power from its Dabhol plant to re-start the stalled
electricity stations. Electricity was finally sourced from the
government's own units.
• Indian economists calculated that the after-tax rate of return
would actually be 32 percent, about three times the average
rate in the US;
• Enron paid $20 million as "educational gifts". Critics consider
these payments to be bribes to clear the project;

Contract Off-taker Risk and Dahbol
• Endless disputes over prices and terms of the deal turned the venture
into a symbol of what can go wrong in large-scale development
projects when cultures collide.
• In April 1993, a World Bank analysis questioned the project's
economic viability, citing the high cost of importing and using liquefied
natural gas relative to other domestic sources of fuels. Because of
those findings, the World Bank refused to provide funds for the
project.
• "Price is becoming a sticky issue," the Financial Times reported.
"Indian officials see the price as very high compared to domestic gas
and imported and indigenous alternative fuels."
• Protesters took to the streets to support demands for changes in the
plant's design and -- more broadly -- to oppose the Indian
government’s economic liberalization policies. Social activists,
lawyers, villagers and farmers banded together in groups opposed to
the Enron project.
• The devaluation meant that Dabhol's energy prices would soar to
between two and five times the average price in the area.

Problems with PPA’s in Asia
• Some PPA’s featured high prices for a variety of reasons and

became very unpopular (Pakistan, India, Indonesia,
Philippines)
Exchange rate de-valuation
High capacity prices
Over-capacity
High capital costs
• IPP’s with long term PPA’s have added a substantial stock of
generators to developing countries (Pakistan, the Philippines,
India, Malaysia, Thailand, Indonesia)
Current Problems
 No access to gas from Iran
 Nuclear not feasible

Vemagiri Power Project
Capacity of 388.5 MW
 15 year PPA for 370 MW
• Natural gas fired (1x1) GE 9FA CCGT
 1.64 mmscmd of gas allocated
on firm basis
• Project cost US$ 238 mn, project cost is
the lowest for any gas based plant
VPGL -
Vemagiri constructed in India
• Estimated first year tariff of Rs. 1.94/
kWh (approx 4 cents)
 Fixed Charge - Rs. 1.01/kWh
 Variable Charge - Rs. 0.93/kWh

Dabhol Postscript
• The power plant Phase I which was re-named Ratnagiri Gas

and Power Pvt Ltd (RGPL) started operation in May 2006, after
a hiatus of over 5 years.
• The plant runs on naphtha supply and LNG.
• GE and Bechtel were fully compensated for their investment
• Reduced Enron interest.

Other Countries
Indonesia
• Indonesia, where almost all twenty-seven IPPs had as a

partner a member or associate of the Suharto family. These
partners were often “allocated” by the ruling family as a kind of
prerequisite to securing a project, but also offered political
cover and access in a country where such assets came at a
premium.
• With the end of the Suharto regime shortly after the financial
crisis had shocked the country’s economy (and created stress
for IPPs), the new government faced decisions about private
infrastructure contracts that were becoming increasingly
expensive as the local currency plummeted.

Malaysia
• It also appears that these practices have resulted in prices that

are high and profits that are large for the initial lPPs. Prices
have not been officially disclosed, but have been reported to
be as high as 15-16 cents per kWh (the IPP price may include
required transmission and other non-generation items),
compared to a wholesale generation cost of about eight cents
per kWh from TNB. In response, the government has not tried
to renegotiate the pricing in the IPP contracts (these costs are
still passed through to TNB and to customers). However, it has
recently required all IPPs and TNB to contribute one percent of
their revenues to an Electricity Trust Fund that is used for
electrification, power sector research and development,
training and education, and consulting studies in renewable
energy.

Foreign Exchange Rate Risk
• Recent experiences in the power sector in emerging markets

have dramatically illustrated how foreign exchange
devaluations can undermine a project's competitive position.
Many cross-border projects, particularly infrastructure projects,
have revenues denominated in local currencies but have debt
obligations in a different currency. The mismatch creates two
potential risks.
If the currency exposure is un-hedged, a project could likely
experience a cash shortfall sufficient to cause a default if a sudden
and severe devaluation occurs.
The second risk occurs when project revenues are contractually
indexed so as to pass on the exchange rate risk to off-takers. In this
second instance, lenders run the risk that a massive devaluation will
make the project's off-take so expensive in the local currency that
off-takers cannot afford to purchase the output. Hence, the risk of
contract abrogation may soar.

Evaluating Foreign Exchange Rate Risk
• The limitations of indexing, however, can do little to offset the threat

posed by sudden and severe depreciation.
• Standard & Poor's will look to severe scenarios to test a project's
robustness in speculative-grade sovereigns or in any other sovereign
where the exchange rate regime may be unsustainable. The question
is how much devaluation be assumed in the scenarios.

Example of Catastrophic Devaluation – PT Pation
• An offtaker or contractor authority who is taking exchange rate risk by

indexing the tariff against a foreign currency probably cannot pass on
the this indexation after a major devaluation to the local end-users of
the product.
• The effect was seen in the Asian crisis of 1997 and in Turkey in 2001,
where power purchase contracts under long-term PPA’s had linked
tariffs to the foreign currencies. When the power purchasers home
currencies suffered huge devaluations, they had obligations under the
PPA to increase the tariff and make increased payments.
• These adjustments were not economically or politically realistic.
• Indexation did not work; must evaluate macro-economic data.
• OPIC has debt facility to deal with the problem in Brazil. Comes into
play with devaluation and intended to pay back from purchasing
power parity notion and the eventual increase in prices.

Catastrophic Foreign Exchange Risk (S&P 2001)

Brazil – Power Crisis of 2001-2002
• In the 1980’s, the monopolistic, state-owned organization of

the power market faltered; many power companies were
unable to meet investment needs even with state support and
concessionary finance. The financial situation of power
companies deteriorated as a result of increasing capital costs,
low tariffs and over-capacity, as demand growth was lower
than anticipated
• From May 2001-March 2002 blackouts were avoided only with
a strict rationing regime consisting of a set of penalties and
incentives that reduced consumption by 20%. The effect was
to essentially cut disco revenues by 20%. In this way, the crisis
furthered troubles for private distribution companies, many of
which were already fragile after the 1999 devaluation of the
Real. Even after the rationing ended the habit of conservation
persisted and consumption remained low. Only five years later,
is consumption recovering to 2000 levels, in 2005.
Brazil
• All the energy transactions in the Regulated Market are carried out through
auctions that are conducted by Aneel in accordance with MME rules. EPE
aggregates and reviews the future electricity consumption estimated by the
distribution companies. Assuming its estimated future power consumption,
EPE provides a list of power plants that can eventually balance supply and
demand in the regulated market. Aneel then auctions that list, having in mind
its obligation to keep tariffs at the lowest possible prices.
• In auctions for new capacity, investors will bid on a concession to provide a
certain amount of “assured energy” to the regulated market. Assured energy is
a number determined by government planners that reflects expected
hydrological conditions. For a hydro plant, assured energy is the amount of
energy that can be produced by the plant in the worst hydrological conditions,
given the integrated management of reservoirs. For a thermal plant, assured
energy is the amount of electricity expected to be dispatched, given
hydrological forecasts. For both types of plants, assured energy is the energy
that can be sold under long term contract—whether to the free or regulated
market

Midwest Peaking Plants
Standard and Poors and Housing Price Assumptions –
Comparison with Iriduim Assumptions
According to one story an

investor called the rating
agency Standard & Poor’s
and asked what would
happen to default rates if real Projected and Actual Revenues for Iridium
estate prices fell. 9,000,000
Actual
8,000,000 Salomon Smith

Barney
“The man at S&P couldn’t 7,000,000

Credit Suisse/First
Boston
Lehman Brothers
say; its model for home 6,000,000 Merrill Lynch
prices had no ability to accept CIBC Oppenheimer

5,000,000
a negative number. ‘They

were just assuming home 4,000,000
prices would keep going 3,000,000
up…’” 2,000,000
1,000,000
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

The summer of 98
• Electricity prices hover around the $50 MWh.

• In the summer of 98, during an unusually hot week, a generator broke down in
the Northwest US
• The power shortage that resulted increased prices to a historical high of $7,000
MWh, with rumors that in peripheral markets prices rose to $10,000 MWh.
• In money markets, this would be comparable to the DJI rising to 2,000,000, or
dropping to 50 pts, in a matter of a few days. While this is an absurd financial
analogy, its mathematical implications cannot be ignored.

Resources and Contacts
• My contacts
Ed Bodmer
Phone: +001-630-886-2754
E-mail: edbodmer@aol.com
• Other Sources
Financial Library – project finance case studies including
Eurotunnel and Dabhol
Financial Library – Monte Carlo simulation analysis

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