August 20, 2012 7:54 pm
Finance: The path to power
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©Corbis
A road to build: a dirt track in northern Vietnam leading to China illustrates the region’s need for infrastructure
In April 2010 the US power company AES signed an agreement to build a 1,200 megawatt power plant in the Vietnamese province of Quang Ninh. The $2bn project was three times larger than any previous power deal in the country.
At first glance, it would seem an alluring scheme. Vietnam is a dynamic emerging market of 88m people and is expected to double its electricity output between 2010 and 2015. But John Haberl, an executive at Virginia-based AES, admits it was a battle to entice the banks.
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“We really wondered if we could raise the financing,” he says. “A few months later, as the problems in Europe became more evident, it couldn’t have gotten done.”
Ultimately the funding came from sources not usually associated with big US-led projects. Much of the debt financing came from Export-Import Bank of Korea (Kexim) and the equity from a group that included the power unit of South Korean steelmaker Posco and the Chinese sovereign wealth fund China Investment Corp, which has a 15 per cent stake in AES.
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Increasingly, such institutions are set to take centre stage as companies seek a slice of a raft of infrastructure projects across south Asia.
There is little doubting the region’s allure. The Asian Development Bank estimates that investment in infrastructure will total at least $8tn over the next decade. Of more than $400bn-worth of global infrastructure projects last year, 47 per cent were in Asia.
Crucially, businessmen and bankers say most of the funding will not come from traditional commercial banks. The global financial crisis, compounded by fragility in the eurozone, means a new template is emerging. A leading role will be played by a group of state-run export credit agencies from east Asia whose fortunes have been boosted by the problems of private sector banks, particularly in Europe. Among the Americans, JPMorgan is active in Australian mining projects but otherwise, like Citigroup and Bank of America, largely absent from big Asia-Pacific projects.
Instead of the big western names, the driving forces of infrastructure funding look set to be Seoul’s Kexim, Japan Bank for International Cooperation and the two big policy banks of China: China Development Bank and China Export-Import Bank.
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While the lion’s share of capital will have to come from such institutions, there are still opportunities for the European banks in the region to add value through their knowhow. For example, HSBC co-ordinated the financing for AES’s Vietnamese project and is increasing such business. “Infrastructure finance is a market where HSBC is able to demonstrate its core strengths of advising global clients . . . at a time when other banks are pulling back,” Stuart Gulliver, the chief executive of HSBC, told the Financial Times.
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Standard Chartered is playing a similar role in co-ordinating South Korea’s landmark $20bn deal to build nuclear reactors in Abu Dhabi, although most of the capital is expected to come from Kexim.
Still, some feel western banks may only have five or so more years to enjoy such a privileged position as project leaders.
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“The export credit agencies will globalise and need the international banks less. And in a few years many of the deals will be renminbi deals,” says one project-finance banker in Hong Kong.
AES has access to its Korean financing in Vietnam because Doosan Heavy Industries is working as a contractor on the project.
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AES drew on a previous good rapport with Koreans. Not only were Chinese and South Korean bids more competitive than the Japanese but AES had also worked with both Posco and Kexim on a project in Chile and found them to be reliable.
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Moreover, thanks to the CIC connection, if the Korean funds proved inadequate, “we could always bring in the Chinese at a later date, if necessary”, says Chad Canfield of AES, who worked on the deal.
Their state credit agencies’ cheap, long-term capital is a powerful competitive advantage in winning contracts that run into the billions of dollars. But they bring another dimension too. Today, politics and the financing of infrastructure have become intimately intertwined.
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The competition for these multibillion dollar projects is becoming more fierce. Japan has run out of room to lay more roads and has already lined its rivers with concrete. China is completing its transport and high-speed rail networks. South Korea is seeking to expand its nuclear exports to emerging markets such as south Asia and Turkey.
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But gaining the right to build core infrastructure is hugely political. The shifting partnerships on projects lay bare the diplomatic alliances and faultlines in the region.
As China’s relations with its neighbours have become more fraught over matters such as tensions over energy reserves and fishing rights in the South China Sea, politics have become a bigger factor in commercial decisions. There is now a backlash against China in much of the region that the Japanese in particular are seeking to exploit.
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“The trust deficit is a real issue when it comes to China,” says the head of one major Asian bank based in Singapore. “Asians are wary of China, though that is where the money is.”
That is especially the case with Vietnam and the Philippines, whose sparring with China over the South China Sea has become more intense.
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It is easy to be tarnished. When one Japanese trading house teamed up with China Resources to bid for a power project in Vietnam, Vietnamese officials privately told them such an alliance was not a good idea, one trading company executive says. “We thought China has great power over Vietnam but actually, the Vietnamese don’t like the Chinese,” this person notes.
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There is also resentment of the Chinese in Indonesia, over a pattern of trade whereby China imports raw materials and then sells Indonesia the processed goods made from them. That discontent was openly expressed last year during the visit of Premier Wen Jiabao to Jakarta.
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Japanese companies seek to take advantage of the fact that they have no territorial disputes in south Asia. Japanese trading companies have a long history of operating in the region and, thanks to the financial support of JBIC, they can offer attractive long-term financing to match the Chinese.
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Meanwhile, in many cases the Koreans can benefit from the fact that both of their giant neighbours are regarded with some suspicion. In some places in Asia, Japan is still treated with suspicion for its imperial expansionism in the last century.
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China is often seen as suspect because of its perceived ambitions today. Vikram Chakravarty, an analyst at Kearney, says the “the Koreans have been the most visible and perhaps the most successful” in finding a compromise between the quality of the Japanese and the speed and low cost of the Chinese.
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Today the Koreans are often best placed for winning infrastructure mandates. Prices for Korean equipment are attractive, thanks partly to the appreciation of the Japanese yen against the won. The Koreans are also good at managing projects (a skill that rivals at Japanese trading companies attribute to universal military service in South Korea).
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Meanwhile, under its chief executive Hiroshi Watanabe, a former senior finance ministry official, JBIC has enjoyed a renaissance. To compensate for their high cost base and because of intense internal competition, executives at Japanese trading firms who put deals together say they are all reducing margins to win mandates. They have also sought to put pressure on their government to support their efforts in countries such as Indonesia, where competition is particularly intense.
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Perhaps the most formidable competitors today for all but the high-tech projects are the Chinese. China has natural economies of scale given the size of its own domestic infrastructure investment. With so much now in place, to keep its assembly lines operating Beijing has to seek international business. And its bids often reflect factors that are not purely commercial. For example, China now has a strong export order book for its train carriages, but “it is the ministry of railways that decides the price depending partly on demand in China itself”, says one senior planner at a Japanese trading company.
Such considerations serve partially to offset rising wage, material and transport costs, which are up as much as 60 per cent over recent years. Recently, even the Chinese financing for dollar-based projects has become more costly.
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In both India and Indonesia there are complaints about the quality of Chinese equipment in power plants, according to analyst Aashish Agarwal at CLSA in Hong Kong. Moreover, questions remain on the software and services side.
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On Philippine and Indonesian power projects, for example, rivals say the use of Chinese equipment and contractors caused drawbacks and delays. “China is often too hasty,” says another trading company executive in Tokyo. “Often they have sequence problems. You need to check everything. To control Chinese people is a mess.”
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However, rivals also concede that as the Chinese overcome quality concerns, they will “progress step by step”, this person adds.
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But one of the highest-profile infrastructure deals in Asia – a 2,000MW power project in central Java – shows why the Japanese still have some edge. A Japanese group consisting of J-Power, Itochu and Indonesian coal miner Adaro Energy with money from JBIC saw off heated competition from the Chinese. The $4bn project is the largest independent power project in Indonesia and uses so-called supercritical technology, which favours the Japanese. Bankers say the Japanese stepped up their official development assistance to the country before the award as part of a renewed courtship of south-east Asia.
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As long as private sector banks are constrained, the business of infrastructure is likely to remain hugely political. Today, the deep pockets of north Asia are the most visible. When the Europeans and the Americans recover their appetite, they may find they are no longer quite as essential as they once thought.
A relative minnow with a broad mandate
Last November, a little-known Chinese fund joined Baring Private Equity and Deutsche Bank in taking a stake in Asia Potash, a company that had obtained concessions from the Laotian government to develop mines in the country.
The China-Asean Investment Co-operation Fund trumpeted its investment as “of strategic importance to the region”, adding that the scheme would probably become the largest potash producer in Asia.
The project, intended as a source of cheap fertiliser, is important to Beijing – which is why China Development Bank is extending loans of $5bn to complement equity from CAF.
CAF’s mandate is to contribute to the prosperity of China while helping its neighbours to develop. It was established in 2010 to a more modest fanfare than the one that accompanied the birth of its big brother, China Investment Corporation, three years earlier.
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Today, with $1bn under management, it is a relative minnow among China’s sovereign investment arms – but ultimately it plans to raise $10bn to buy stakes in companies and projects throughout south-east Asia. That is serious money for any private equity fund dedicated to investing in the region.
Shareholders include the International Finance Corporation, the investment arm of the World Bank that provides the fund with further clout as it scours Asia for opportunities in transport, energy and natural resources. CAF’s biggest shareholder is Export-Import Bank of China, which makes loans to schemes across the region.
CAF itself seeks equity investments in both new and existing projects, a broad mandate that gives the fund considerable leverage. Even experienced counterparts such as the Canadian Pension Plan or Government of Singapore Investment Corporation prefer to steer clear of greenfield projects and put their money into schemes that already generate cash flow.
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In addition to the Laotian project, the fund has invested in Thailand’s largest port and a fibre-optic network in Cambodia. It also helped Negros Navigation, a Philippine shipping company, buy Aboitiz Transport Systems, the country’s largest shipping and logistics group.
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At a time when funding from other sources is increasingly scarce, the fund’s leverage can only grow.
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Copyright The Financial Times Limited 2012
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