Prai and Tanjung offer outsiders hope in Malaysian power

In recognition of its looming power shortage, Malaysia is looking at more innovative ways to finance the sector’s investment requirements. Local bond issues, frequently placed with government-linked pension funds, funded investment by government-linked developers, off the back of power purchase agreements with government-controlled state power company Tenaga Nasional Berhad.

As competition heats up, falling margins on power purchase agreements, and in turn rates of return, are forcing developers to hunt for more creative funding, lower margins and longer tenors. A newly-formed state-owned bond insurer is giving lower-rated credits a boost and allowing them to reach longer maturities. For the first time a handful of foreign banks have started lending to power projects.

Prai points forward

Market attention in the sector is focused on the 1,000-1,400MW combined-cycle gas-fired plant project at Prai. The Malaysian Energy Commission has short-listed nine bidders on Prai. These bidders are set to submit proposals by mid-July and the preferred bidder will be named at the end of October. The Prai deal offers the chance for a handful of foreign sponsors to muscle in on a sector that has been dominated by indigenous players like Genting, Ranhill, YTL, Powertek, Malakoff, and Tenaga, still 35% state-owned, and both an offtaker and, in a twist typical of Malaysia’s power sector, an independent power project sponsor.

Foreign participants can bid to own up to 49% of the project, in a process that has prompted a rush to partner with local operators. The nine short-listed bids include indigenous heavyweights YTL, Malakoff and 1Malaysia Development (1MDB). But these developers have formed consortiums with Japanese and Korean operators for the first time on home soil. In another development, five first generation IPPs are poised to competitively bid to renew 21-year old PPAs, which signed back in the early 90s but are set to expire in the next four years.

It all amounts to a rash of competition in the sector that to date has facilitated high rates of return for generators, rates that the Energy Commission has been struggling to reduce. The recently-closed Tanjung Bin Energy coal-fired power project was the first to emerge under a new, formalised bidding process. Market observers describe it as open and transparent, with much greater emphasis on bidders’ commercial and technical prowess, rather than just the deal’s tariff.

Research from regional banking group OSK argues that because the five IPPs renewing their PPAs will have to compete against both the new Prai power plant, as well as each other, the PPAs that result from the renegotiations won’t be nearly as lucrative as the existing contracts. “IRRs may be in the high single-digits, or just over 10%. As such, we do not expect the 10-year extension on PPAs to be particularly value enhancing for the IPPs,” the bank says. The renewals process will also offer a window for foreign groups to enter the market, although bankers say the owners of these projects will most likely invite foreign partners to join them after the PPAs are successfully extended.

Banks take on sukuks

A small $400 million international commercial bank tranche of Malakoff’s recently closed RM6.7 billion ($2.19 billion) Tanjung Bin financing points to a home for debt beyond the domestic capital markets for the first time. To date, most of Malaysia’s power projects have been funded with Islamic-compliant sukuk bonds. Local bondholders are comfortable with accepting construction risk and the market is liquid, margins low and competition fierce.

However foreign debt is starting to gain ground. Dollar-denominated debt offers longer tenors than borrowing from local banks in local currency and allows sponsors to pay equipment and construction costs without dabbling in Malaysia’s costly swap market. “Sponsors want to get the lowest tariff without impacting their internal rates of return,” notes one lender. “They have to balance paying costs in dollars versus the cost of the swap market – on balance it’s cheaper to borrow in dollars.” But Malaysia’s flush local market still makes it tough for foreign lenders to compete, and any international lender to Prai, not to mention the other projects, will have to get comfortable with the risk allocation on Malaysian IPPs. Neither government nor Tenaga offer any foreign exchange risk protection on plants’ ringgit-denominated PPAs.

The offtake credit, while strong, is not sovereign. “The government doesn’t stand behind the PPA – there is no visibility here,” said one banker. Malaysia’s government owns 35% of offtaker Tenaga, while Malaysia’s sovereign wealth fund has majority control. The government feels that Tenaga is a robust enough credit without additional government guarantees. Malaysia does not have the same country risk as its more unstable neighbours and the ringgit-denominated PPA “is not insurmountable”, suggests one lender. However the cost-effectiveness of the cross-currency swap market and swap tenors change daily.

It’s a factor that ECAs stepping into Malaysia – which prefer government guarantees of emerging market PPA obligations and are most comfortable lending in dollars – will have to negotiate. Japanese and Korean ECAs are expected to feature in the Prai deal, in support of their domestic construction contractors and equipment suppliers. But the advantages of ECAs’ low-cost, long-tenor debt may be smaller when swap costs are taken into account. Critics also point out that, despite growing opportunity in Malaysia’s power sector for international lenders, there may, thanks to general market conditions, not be that many takers. The Tanjung Bin deal drew in those banks most aggressive in pursuing regional project finance business – namely Mizuho, HSBC, BTMU, SMBC, and OCBC. “There are fewer and fewer banks left in this space; more are retreating. Japanese banks are the strongest, with most liquidity,” said one observer.

A home-grown monoline

In another example of the new options available to Malaysian power developers – and a reflection of how cheaper financing is an increasingly important part of developers’ bidding strategy – Malaysia’s new financial guarantee provider Danajamin is starting to issue guarantees on domestic capital markets financings.

The Malaysian finance ministry set Danajamin up in 2009, in the aftermath of the last financial crisis, to help companies raise long-term debt by wrapping domestic bond and sukuk issues. Danajamin has guaranteed three power projects to date.

In its most notable financing it backed a RM350 million portion of the RM710 million Ranhill Powertron 11 development. The shorter maturities of one to eleven years, of RM360 million in total, were issued on a standalone AA-basis without any cover, but Danajamin stepped in at the longer end. “Via our AAA-credit wrap facility we assisted Ranhill Powertron in tapping the longer end of the capital market. 12-18 years is much less liquid for bonds issued on a standalone AA-basis,” said Danajamin’s chief executive officer, Ahmad Zulqarnain Onn.

More recently, Danajamin guaranteed RM500 million in bonds with maturities of between eight and 15 year son NUR Power’s RM650 million 15-year sukuk mudharabah facility. However some critics suggest Danajamin is less focused on power, compared to other infrastructure. Power projects only account for a fraction of the 17 bond or sukuk programmes amounting to RM4.9 billion ($1.63 billion) that Danajamin has backed since inception. The size and experience of the sponsors and offtaker Tenaga  mean “these kinds of government guarantees aren’t really required,” suggests one lender.

Overseas champions

As the domestic market becomes more competitive, Malaysia’s IPPs have become increasingly active overseas. Malakoff recently bought a 40% stake in Bahrain’s largest independent power generation and water desalination plant, Hidd Power, which is responsible for 35% of the country’s power production. Malakoff financed its acquisition with a $90 million five-year loan from Exim Bank of Malaysia and Japan’s Mizuho.

Expanding into Indonesia, where the power shortage threatens to put the brakes on economic growth, is another trend. Bajradaya Sentranusa obtained a $330.6 million syndicated term facility from Maybank to refinance the 180MW Asahan 1 hydroelectric power plant in North Sumatra. Tenaga recently signed a memorandum of understanding with Indonesian state-owned utility Perusahaan Listrik Negara (PLN) and coal miner Bukit Asam to build a 1,200MW coal-fired power plant in Sumatra, with the aim of the plant exporting some of its output to Malaysia. Elsewhere,1MDB Energy is buying Tanjong Energy which owns 3,981MW of generating capacity in Malaysia, Egypt, Bangladesh, Pakistan, Sri Lanka and the United Arab Emirates for RM8.5 billion ($2.7 billion). Its financing for the acquisition included a $1.75 billion bond issue that Goldman Sachs placed privately, and which benefited from a wrap from Abu Dhabi’s International Petroleum Investment Company, plus RM6.17 billion ($1.95 billion) in bank debt from local lenders Maybank and RHB.

But the progress of the Prai deal will more effectively test the government’s ability to internationalise the market. Tenaga is among the bidders on Prai, but is also the project’s potential offtaker. It will, therefore, be in a position to offer the most competitive pricing. “If Tenaga wins it’ll send the wrong signal to foreign investors looking at Malaysia’s power sector,” said one critic.