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Are consumers being short-circuited by private power producers?
Are the Ceylon Electricity Board’s (CEB) agreements with private power companies structured to earn independent power producers (IPPs) towering profits? And are we, the electricity consumers, footing the bill?
ACE Power Embilipitiya Ltd, a 100 megawatt thermal power station running on heavy fuel oil, recently invoiced the CEB Rs 840mn for generating a month’s worth of emergency power. Of this, Rs 140 million was capital recovery cost. But here’s the hitch: the plant was retired in 2015, ten years after its commissioning.
ACE Embilipitiya was only recently recommissioned on a Cabinet approval, along with two other plants with expired licences. Capital recovery is the earning back of the initial funds of an investment. It must happen before a company can earn a profit. In the ten years that it was in operation, did ACE Embilipitiya not recover its start-up capital with a margin?
For critics of certain power purchase agreements (PPAs) signed between the CEB and IPPs, it is inconceivable that full capital recovery was not factored into the initial deal. Why, then, is the company continuing to bill the utility for this component?
Questions such as—but not only—these are keeping the regulator, Public Utilities Commission of Sri Lanka (PUCSL), from approving a licence for the recommissioned plant. So ACE Embilipitiya merely ran without it and billed the CEB.
But the CEB’s Deputy General Manager (DGM) Energy Purchases refused to pass the payment citing legal impediments. While Cabinet may have approved a new three-year contract with ACE Embilipitiya, the Electricity Act mandates that the Public Utilities Commission of Sri Lanka (PUCSL) must also sanction it, he pointed out. The law requires, too, that the selection of a power producer is on the basis of “technically acceptable tenders”. PUCSL permission has not been granted and no tenders were called.
The Kerawalapitiya power plant run by West Coast Power
The CEB interdicted the DGM on a separate matter. Power and Energy Ministry Secretary B M S Batagoda then authorised the settlement of dues even while accepting in writing that the “Sri Lanka Electricity Act does not provide provisions for extension of existing IPPs”.
Electricity from IPPs is typically expensive. While it should be relied upon only in emergencies, prolonged delays in introducing new low-cost, long-term power plants has led to dependence on IPPs to bridge the gap.
Worse, there is a complete avoidance now of the competitive bidding process. The interdicted DGM had also flagged that power procurement through extensions to the terms of PPAs of retired IPPs was “unsolicited in nature” and that it cannot be determined whether the tariffs were competitive.
Granted, even where tenders are called, the processes are blighted by strong allegations of bid-rigging. The latest to be hit in the power sector is the proposed 300mw Kerawalapitiya liquefied natural gas (LNG) power plant, delayed for 18 months by haggling among politically backed interest groups.
The only technically qualified bidder that conformed to the minimum functional specifications—a consortium comprising Samsung C&T, Korea Midland Power and GS Energy—was knocked off. And the contest has narrowed down to two parties: the CEB-affiliated LTL Holdings (Pvt Ltd); and China’s Golden Concord Holdings (GCL) with its local partners WindForce & RenewGen. The first is reported to be favoured by one Minister while the other is allegedly championed by the Secretary to a Ministry.
Still, even a flawed process is better than none because agreements that are worked out behind closed doors—such as the PPA between the CEB and West Coast Power (Pvt) Ltd—can remain under a cloud for years. There is now renewed scrutiny of this deal, particularly because LTL is a frontrunner for the Kerawalapitiya LNG plant.
West Coast Power (WCP) was set up in 2006 to own and operate a 300mw combined cycle (gas and steam turbines) power plant at Kerawalapitiya. The PPA was a negotiated agreement and, even at the time, energy experts like Tilak Siyambalapitiya expressed concern that the numbers were too high.
“The cost of a plant of this nature at the time would have been around US$ 900 per kilowatt which works out to around US$ 270mn,” he said. “That was my estimate but the overnight cost of the project was US$ 330mn and it needs to be explained how this came about.”
Overnight cost is the cost of a construction project if no interest is incurred during construction, as if the project is completed “overnight”. The term is frequently used when describing power plants.
The lack of a competitive procurement process is most noticeable in the case of West Coast Power (WCP), “whose costs appear extremely high relative to other generators and which was directly negotiated”, states a 2014 report commissioned by PUCSL from Pathfinder Foundation (Sri Lanka) in association with Britain’s Economic Consulting Associates Ltd and KPMG Sri Lanka. “A competitive procurement process would have been expected to deliver the least-cost outcome and would have provided comfort to PUCSL and electricity customers that WCP’s costs are reasonable and efficient.”
What has caught the interest of some analysts, however, is the capital recovery cost component of the PPA. The initial investment came by way of a loan of 152.2mn euros (US$ 230mn) arranged by HSBC from US and European export credit agencies, with a 100 percent unconditional guarantee from the Sri Lanka Government. The rates were not disclosed. A further US$ 294mn came by way of equity from LECO, the Employees’ Provident Fund and rupee loans.
The Pathfinder report compared the capital cost recovery rate for WCP with another combined cycle plant called AES Kelanitissa. The implied capital cost for West Coast PowWCP, it said, was more than three times that for AES Kelanitissa. It is almost double after allowing for cost increases since the date of the signing of the AES PPA. “This looks very high, both relative to that project and when compared with external cost estimates,” the report stated.
Meanwhile, the capacity charges (made up of a fixed charge and capital repayment cost) for AES drop sharply after year ten when, it is assumed, debt service ends. By contrast, those for WCP rise over time, even after the end of the debt service component. “This implies that much of the apparent ‘excess’ capital cost is accruing to equity investors,” the report says.
If the total cost was US$ 300mn, capital recovery must also be US$ 300mn, contended a power sector analyst who requested anonymity. But according to the schedule in the West Coast PPA, the company will take out US$ 607mn–double that amount–at the end of the 25-year contract.
“The West Coast PPA is recovering two times the value of the investment from the Government and public!” he exclaimed. “The excess payment from this project is US$ 307mn or Rs 40bn. In theory, they can build the new LNG project for free.”
“Secondly, when you look at the contract, after the end of the contract the capital repayment cost jumps and keeps increasing,” he continued, a detail also flagged in the Pathfinder study. “Whereas if you look at the AES contract repayment schedule, after ten years is over it falls to zero. That’s how a proper repayment should be.”
Analysts in this school of thought feel power plant operators should be making their money (profits) through operations and not through capital recovery. But Dr Siyambalapitiya, who has years of domestic and international experience in the industry, said this was incorrect.
“A power plant that makes profits through operations is known as a ‘merchant plant’,” he explained. “In PPAs, the operating costs–fuel plus variable operations and maintenance (O&M)–are pass-through costs, calculated at the guaranteed heat rate.”
Pass-through costs are fees paid to other companies who operate and maintain the electricity network. Heat rate is the amount of energy used by an electrical generator or power plant to generate one kilowatt hour (kWh) of electricity.
“Operators may incur losses or gain profits through operations (which are relatively small) if the power plant runs at lower or higher efficiency, respectively, when compared with the guaranteed efficiency,” Dr Siyambalapitiya said, adding that the return on equity is never just restricted to capital recovery.
The problem with this transaction, one analyst said, however, is that all the profits were being made out of a capital recovery component. “That should only cover the capital repayment and should end at that point,” he said. “It is as if your mortgage company keeps asking you to pay installments till you die as opposed to stopping after they recover your debt.”
But Dr Siyambalapitiya said such an assumption could not be made without seeing the detailed financial model and commitments to equity investors. “It is hard to say whether the rupee component of the capacity charge equals committed return on investment to investors, including self-investment and, as claimed by certain parties, a profit.”
Are WCP’s margins excessive? And where do the dividends go?
A separate study on West Coast Power dated last month by Verite Research was leaked this week. It analyses the share breakdown and returns from the West Coast project and concludes that the Government has taken on high risks for no returns.
Fifty percent of WCP shares are held by the Ministry of Finance through loans from the National Savings Bank and Employees’ Trust Fund; 27.05 percent by the Employees’ Provident Fund (EPF); 18.18 percent by LECO; and 4.77 percent by Lakdhanavi, of which the majority shareholder is LTL.
The Government/Treasury has guaranteed at least 80 percent of the direct and indirect debt financing of WCP, Verite observes. “In contrast, Lakdhanavi only carries the risk of forgoing equity investment from its own funds.”
Although the GoSL has not contributed directly initial equity investment of the power plant, the entity still carries a high risk particularly in meeting the repayment obligations for both foreign and domestic debt for no return, the study states. “It must be noted that in the event that WCP fails to obtain an adequate return for these obligations, the GoSL has no choice but to make the necessary payments on the debt,” it warns.
Verite adds that neither the Government nor Treasury gains any financial returns on their stake or risk “since the dividend income after settling debt taken to purchase the shares is siphoned back to Lakdhanavi”. “As such, in the period 2008-2016, Lakdhanavi has received 24 percent of the total dividend income, though at the time their equity stake in WCP has been less than 5%,” it states.
The nominal annual return on investment for Lakdhanavi was almost 40 percent, whereas both LECO and EPF, which have larger direct equity investment into WCP, had only about 20 percent annual nominal return on investment, Verite found.
| Statement by West Coast Power West Coast Power (Pvt) Ltd said the investment into WCP was made by way of equity and debt in 2007. The project development cost of the build, own, and transfer (BOOT) project was 152.2mn euros and Rs 12.425bn (then equivalent to US$ 294.88mn). The Cabinet-approved construction contract was for a design, build and transfer (DBT) costing U$ 222.5mn. The difference in the final price was owing to financing and development costs borne by WCP due to the change from DBT to BOOT. They include loan interest during three-year construction period, cost of opening letters of credit, exposure fees, loan insurance, legal fees, cost of environmental impact assessment and other project permits, etc. “When project development structure was changed from DBT to BOOT, all of the additional costs which were to be borne by CEB were transferred to the power plant developer,” WCP said, in a statement. Initially, the Ministry of Finance’s (MoF) investment was split into preference shares and ordinary shares. On the former, high interest was paid to MoF during construction so it could pay interest on loans taken from NSB and ETF. After the full 300mw was built in May 2010, all preference shares were converted to ordinary shares. The return is 22.6%. “As you are aware this investment was made in 2007-2010 period when interest rates were high and equity investors, consisting of all GoSL owned institutions, demanded an equity return of above 20% consumer ate with the risk they took and alternative investment opportunities they had,” WCP said. “One should also consider the situation that prevailed in Sri Lanka, especially with terrorist threats to economic targets.” “You should also bear in mind that this power plant has to be handed over at a condition acceptable to CEB in 2035,” the statement elaborated. “There is a significant restoration cost that will have to be done before the handover in consultation with CEB. There are no other funding sources for this other than this same capital recovery rate income which will have to be utilized.” Equity investors still are getting less than their expected return of 20% in first ten years. This is expected to improve after the loans are repaid, provided power plant is able to deliver contractual capacity (without any major t breakdowns) in the next 15 years, to 22.6%. “We do not think this rate of return is ‘high’ given the risks taken by these institutions,” WCP said. “After all these returns are also for GoSL.” WCP is still paying the loans taken from HSBC. It will be completed only in 2022. In addition to the euro component, owners of the power plant have invested LKR 12,425 million as equity investment. “Return for equity is always expected by investors until the end of the business, i.e., 25 years period,” WCP said. “Therefore, in our PPA with CEB, euro capital recovery charge stops in 2022 but rupee capital recovery continues until end of the PPA in 2035.” In nominal terms, for the entire 25 year period, WCP will receive Rs 264bn by way of capital recovery charge (if it meets all contractual obligations to CEB). “There is a principle called time value of money in finance,” the company said. “That is, the value of Rs. 100 you have now is more than the value of Rs. 100 you may have in 2035. It is the same for investors of WCPL. What do you expect a loaf of bread to cost in 2035?” “Therefore, you unfortunately cannot do a simple addition of annual income when money is paid in different periods to calculate returns,” WCP said. “If you bring this annual cash flow which totals Rs 264bn to today’s money value, it is a different figure. In this case, Rs 264bn is only worth Rs 12.4bn if the annual value of money is assumed 22.6%. That is the same amount they invested in 2007-2010 period. | |