Building the future energy markets in emerging Asia

With countries such as Indonesia and the Philippines trying to increase domestic energy capacity, Alex Davis examines how both emerging nations in the Asia-Pacific rim and international banks and energy firms can iron out nascent market risks

Alongside China, the emerging markets in the Asia-Pacific rim are all frontrunners to dominate the new world order for energy and commodity markets. The global economic meltdown in 2008, which hit the US and Europe hardest, may well be seen in future years as the changing of the guard, running as it did parallel to the breathtaking economic growth both in China and the rest of the Asia-Pacific region.

According to HSBC's grandiose report The world in 2050, released at the start of this year, by 2050, 19 of the 30 largest economies will be today's emerging markets, with Indonesia, Malaysia and Thailand all high up the scale. The massive potential contribution the region could make to global commodities markets and energy supply will hinge on overcoming factors such as capital risk and illiquidity risk that come with developing new markets.

A priority for emerging nations is guaranteeing themselves a secure supply of energy - without it, economic growth will be impeded. Each nation has its own notion of how it can achieve security of supply. The Philippines, for instance, set out in its Philippine Energy Plan for 2009-2030 plans to increase indigenous coal production by 250% from 2009 levels, while the targeted installed capacity for geothermal energy will increase from 1,972MW to more than 3,000MW by 2030.

On the other side, almost all US and European investment banks have been expanding their operations in the Asia-Pacific region and many have been expanding their physical commodity capabilities. While forays into the Far East have intermittently come and gone over the past 30 years, the banks believe that the latest wave, which arguably started in earnest in 2007, is permanent.

Added to this are the efforts of firms such as Gazprom, which opened a Singapore office for the first time in March 2010, trading liquefied natural gas, carbon emissions and oil, and Chevron, which stated in December last year it would be looking to expand geothermal energy capacity aggressively in Indonesia.

The lines have been clearly drawn. The Asia-Pacific region is full of countries bursting to expand their energy capabilities, while banks and international energy companies have been hovering in increasing numbers.

Turning the potential into a reality involves an arduous and tricky balance. Governments, banks and energy companies need to combine the process of investing in capacity and infrastructure and building up enough liquidity in domestic and international markets, while cushioning the whole enterprise from any number of risks that could deflate individual projects and skewer the region's future.

"As an overall view, you can say that, looking at incomes and fuel consumption in the longer term, the prospects [for the Asia-Pacific economies] are obviously bright. The question is how do you get from now to there? There's an awful lot of space sometimes. Often, we tend to interpret the world in the context of our own history," says Alan Troner, president of Asia-Pacific Energy Consulting (Apec). "Just because the general rules of economics determine that oil use [for a maturing economy] shifts from stationary to transport and the product barrel gets wider, which is true overall, doesn't mean that Asia-Pacific is going to follow the West lockstep."

Unequal burden

There are many things to consider when firms are putting together their feasibility studies on projects, including market potential, which often rides on the amount of deregulation a country has undertaken, and track record in terms of adhering to contract terms.

In terms of apportioning the risk and thus financial burden inherent in a project, be it stricter lending terms for untested nations or aggressive project bidding by international energy firms, the starting point for parties on either side is to ask who needs who more, as highlighted by Apec's Troner.

"What you're calculating is, 'can I make any money? Is the amount of money I can make sufficient for me to take a long-haul investment in the future? Is it a market that I have to be in regardless, if I'm going to be eating at the high table? Do they need us as much as we need them?'" says Troner.

A good example for inherent emerging market risk is Vietnam. The country is expected to release its seventh power development master plan (PDMP) later this year to set out how it will meet projected power demand between 2010 and 2020, with an overview extending to 2030. At the moment, the state-owned Electricity of Vietnam enterprise holds a monopoly on electricity transmission and distribution. Even before PDMP VII, to achieve the goals set out in PDMP VI, the government forecasts a requirement of $40 billion to build 95 power plants by 2015.

Plenty of foreign firms were interested but a major obstacle has been the lack of deregulation and the absence of a competitive electricity market. Although a law was passed in 2004 paving the way for a competitive power market, the three-phase scheme for deregulation is moving at a glacial pace, with the final phase not beginning until 2022.

This hesitancy was reflected in the poor performance of state-owned Petrovietnam Gas, which managed to raise only $97 million instead of the expected $152 million in its initial public offering in November last year.

"Vietnam has been moving towards a liberalised energy market. However, they don't want to let go of the controls on the price of power and therefore there's a lack of incentive to develop gas for that power," says Troner. "‘You're supposed to sell your gas [at prices] under international commercial levels to the domestic market, you can't export and we won't let you do anything until you've proven up to 50 years of reserves for production.' Who's going to put in a few billion dollars for that?"

In the absence of competitive domestic markets and export options to work through off-take agreements and spread around the capital risks from energy projects, banks in particular are able to fully dictate any lending terms in order to mitigate contractual risks.

"Ultimately, the financing package is linked to the contract and the term sheet, which will include various debt covenants, repayment schedules, definitions of what default is, and you make sure that you will own the asset in that jurisdiction in the event of a default," says a senior source at an investment bank based in Asia-Pacific. "What tends to happen is: if people want the money, they have to conform to the way you want to run it, going forward. So you have a level of guarantees and cross-guarantees – if people want to gear something substantially, then they have to agree to the term sheet that you're offering."

Yu-en Ong, a partner at law firm Norton Rose based in Singapore, thus sees the risks in Vietnam as currently too great for investment banks to jump in feet first.

"What I can say is that there are very few banks that are willing to go into Vietnam. It would be one or two deals, go in, get a good credit result on a company and then come out again as opposed to take on Vietnam as a country. One bank that has done that is Australia and New Zealand Banking Group (ANZ), which looks quite ambitious. I don't think any other bank has gone in full-scale," he says. "I don't think the floodgates are going to open until ANZ is making money. Right now it's very much a greenfield site - time will tell, I guess."

Equal burden

Although still not completely deregulated, countries such as Indonesia, Malaysia and Thailand are further down the road than Vietnam and this changes the dynamic between borrower and lender. With market conditions thus more attractive for lenders and the international energy companies, the Asia-Pacific investment banking source admits that competition among lenders means that negotiating becomes a little more even. Chevron's stated intent to aggressively bid for geothermal projects in Indonesia bears this out.

"Ultimately, it always comes down to competitive markets," says the source. "A few years ago, everybody wanted to be involved in financing packages in China or South Korea. If nobody wanted to finance, then the margins available to financiers would be much more substantial. That's how it is."

Once a firm has decided to involve itself, all the usual safeguards are available, as Norton Rose's Ong illustrates. "A lot of the banks are going in and lending to Asian companies and then what they do is sell down their deals, whether it's a bond issue or a syndicated loan, and they sell the bonds to third parties - possibly other banks, other loans. That's not very different from Europe," he says. "The documentation that we've got here is very similar to Europe – we've got the Asia Loan Markets Association (LMA) documentation. There's an Asia-Pacific LMA – some of the terms are slightly different but it's 99% the same. The market is used to take on risk on the primary deal. It's not as liquid as Europe, obviously."

Ong points out that although many Asia-Pacific energy markets are not fully deregulated, often state-owned enterprises provide peace of mind for lenders. "A lot of the lending is to state-owned enterprises and that is similar to what is happening in China, because it is perceived these companies have the backing of the government."

However, there have been precedents set in the region, from China especially, where state-owned companies have decided to break contract terms, leaving banks with little wriggle room. Famously, in August 2009 the Chinese government gave its support for legal attempts from state-owned companies such as Air China to default on huge loss-making commodity derivatives contracts with western banks.

In the present climate, if a country such as Vietnam tried something like that, the banks would never return. Yet, with China very much a market that one must be involved in, regardless, companies have very little choice. Norton Rose's Ong does believe, however, that on forming deals such as off-take arrangements, there are safeguards a firm can take.

"You look for external third-party security if you could. For example, if I were financing a Chinese coal producer to make coke, the off-taker would be a non-Chinese offshore entity so we always have someone backing them up either in terms of a security lend-type of arrangement or in terms of cashflow where an off-taker finances the deal as well," says Ong. "The problem that comes with having a third-party off-taker is that sometimes the company decides not to sell to the offshore company. You can get insurance over that kind of deal – an issue of financing would require some element related back to the country in question, to ensure the state-run insurers will step in. They won't necessarily jump in and save the transaction but you do at least spread the risk."

Deregulation

Although deregulation in the region is ponderous and piecemeal, it is seen as an inevitable part of a growing economy. For one, it offsets capital risk for all involved in energy projects. To refer again to Vietnam, although the deregulation timetable is lethargic, it is an eventuality. Also, as Apec's Troner points out, for a burgeoning nation, state-controlled subsidised energy is no longer affordable.

"The two-headed part of the problem of state control is, on one side you keep energy prices so low as to discourage expansion of supply. And by keeping them below their true worth, you encourage unnatural demand growth," says Apec's Troner. "You're creating a problem that you then have to spend more and more money to meet. Asia is slowly moving towards deregulation because as you saw in partially deregulated India, prime minister Manmohan Singh threw up his hands and said 'we simply can't afford this any more'."

So while emerging nations and foreign firms take stock of each other, looking to ensure they can adequately secure themselves on financing and building the many projects in the region, perhaps one aspect that is not so easily analysed in a bank's feasibility study on a country or project is that of simple face-to-face relationships.

Since opening last March, Gazprom Marketing & Trading Singapore has already traded around one million tonnes of LNG in the Asia-Pacific region. Arthur Tait, managing director, believes such relationship building is an element that has allowed the trading firm to expand rapidly in the region.

"As we're a new market participant, we've had to really get on our bikes and get to know the major players, just as anyone in our situation would have to," he says. "Behind the scenes, we've done a lot of introducing ourselves to new customers, signing master agreements, getting our foot through the door in the carbon markets so we've got deals in Vietnam, Thailand, India and China. We've very quickly spread ourselves around quite a bit and already feel nicely established."

Indeed, Gazprom has been quick to involve itself with Vietnam and Tait does not see a lack of liquidity as a major hindrance. He sees that those who are involved early stand to gain the most. "Again, it gets back to the relationships. A lot more of it is down to trust. You have to approach and deal with the right people. In Vietnam, it's been Petrovietnam that we've dealt with and had introductions through the government as well. It's maybe a bit slower but you get there in the end," he says. "I like that - it makes us work for a living. With anything that is volatile, there are opportunities in it and that's what we're priding ourselves on."