Asia Looks for Power Industry Revival

Issue 8 and Volume 107.

By Brian K. Schimmoller, Managing Editor

Through the early 1990s, power purchase agreements were being written across Asia, in places as high as 8-9 cents/kWh. All well and good, particularly for the IPPs that flocked to the region to capitalize on the liberalization of the power sectors in various countries. Problem was, the situation was inherently unsustainable, as end-user prices averaged only 4-5 cents/kWh in a number of these countries. The ‘boundless optimism’ that characterized much of Asia – spearheaded by strong economic growth – came crashing back to Earth when the Asian economic crisis hit in 1997. As recession took hold, power demand fell sharply, power projects were cancelled, and state utilities struggled to cope with changing realities.

U.S. Fallout

As the Asian economy slowly crawled out of its depression in 1999 and through 2000 and 2001, the power sector rebounded slightly, but the past year-and-a-half has reintroduced considerable uncertainty, primarily due to the collapse of the U.S. power bubble and its impact on U.S. developers and their interests in Asia. “In the world of private power, if the U.S. market is struggling, then the reality is that other regions, no matter how rosy they are, are going to feel the pinch,” said Gavin Thompson, Senior Consultant for Asian Pacific Energy with Wood Mackenzie. The simple truth is that for most U.S. and European power companies, Asian business development is no longer a priority, as they struggle to deal with more pressing problems in their home markets and elsewhere.

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The evolution of the Asian market over the past decade has been remarkable (see table). However, the economic boom and optimism of the early 1990s, which attracted foreign developers en masse to state-guaranteed power purchase agreements, had been replaced by the late 1990s with a far more guarded approach characterized by increasing risk aversion, awkward efforts at liberalization, and the emergence of the Asian IPPs. Looking forward to 2010, the region is poised for a revival, but in a more sustainable, integrated fashion. For example, market players will likely pursue a more balanced portfolio, with diversity in project size, fuel input, market focus, financing options (some balance sheet, some debt), and contract type (some PPAs, some competitive dispatch).

The road to competitive dispatch, of course, remains rocky and, in some cases, blatantly blocked. “The progress to privatize power utilities is languishing in several key markets, partly due to political inertia in domestic markets and partly due to unfavorable foreign investment capacity,” said Robert Montgomery, Director, Infrastructure & Utilities, PricewaterhouseCoopers. “The privatization processes in the Philippines, Singapore and Korea, for example, have stumbled and been postponed – indefinitely, in practical terms – due to the difficult market conditions. Political inertia towards real privatization continues to be evident in Thailand.”

Wood Mackenzie’s Thompson agrees. “Progress in deregulation and liberalization in most of Asia is basically one step forward and two steps back. While forward steps have been taken, the politically entrenched government-owned utilities still wield considerable clout and can delay activity.” The California debacle provides additional political cover, as utilities are able to point to the Golden State’s deregulation troubles as a valid reason for delaying previously announced liberalization programs.

Upcoming proposals for the privatization of a number of state-owned generation companies in markets such as Singapore and the Philippines is set to create a glut of acquisition opportunities. In addition, in response to weakening liquidity, the bulk of assets in Asia with U.S. or European equity are now on the block. With most U.S. and European firms retrenching, however, there is a distinct lack of bidders for either state-owned assets or existing IPP projects. Asian IPP developers such as China Light & Power and Singapore Power International have emerged to fill the void, but the pace of deals is measurably slower than that of the early 1990s. “Until there’s an overall improvement in liquidity of potential buyers for assets, the pace of market liberalization will remain pretty depressed,” said Thompson. “Who wants to go to the market now when there are few players with any significant money available?”

Natural Gas Wakes Up

Natural gas is gaining significant traction in Asia as a power generation fuel, particularly in the Southeast Asian countries. In Thailand, for example, 70 percent of the generation capacity is now gas-based; in Malaysia, the figure is nearly 80 percent; and in Singapore, essentially the entire generation fleet is switching from fuel oil to gas. Even heavily coal-dependent China is dipping its toe into the gas pool, with development of the massive West-East Gas Transmission Project,

To an extent, the growing importance of natural gas is re-defining regional market dynamics in South East Asia. “Malaysia is setting itself up as a regional gas hub, taking gas from other sources,” said Thompson. “If they could effectively regulate and organize their energy sector, they could become the key supplier, not only of LNG, but of pipe gas into Southeast Asia.”

Despite their relative self-sufficiency in natural gas, there are some growing concerns about an over-reliance on gas in the electricity generation sector. “In Thailand, a number of coal-fired power plant development projects have been scuttled because of local opposition on environmental grounds, leading some to question the wisdom of the country’s gas-centric generation fleet,” said Montgomery. “And the 20,000 MW Salawin hydro project on the Thailand-Myanmar border is being promoted largely premised on concern for the growing dependence on natural gas.” Malaysia also has a high dependence on natural gas for electricity generation and has been promoting the development of new large coal-fired plants that will come on-stream over the next five years.

Where to Go?

Amid the worldwide economic slowdown, however, there are some Asian opportunities. The Java-Bali region in Indonesia is facing a major supply crisis within the next 12 months because of the lack of IPP development and the fact that state utility PLN is cash-strapped. “Indonesia badly needs new generation capacity, but foreign investors are wary of making new development commitments given the bad experience of the PLN default and subsequent enforced renegotiations of power purchase agreements during and following the Asian crisis,” said Montgomery.

“We’re expecting a potential supply shortfall in Java of as much as 2.7 GW by 2008,” said Thompson. “PLN is seeking to raise bonds at the moment, but PLN remains seriously cash-strapped and no major IPP capacity is currently under construction. We may end up seeing a repeat of the Philippines situation, with a lot of fairly expensive short-term IPP facilities, possibly even barge-mounted plants.”

China’s giant market gets people excited about foreign development opportunities, but there are many mixed messages. “The government’s plan to split into five generation companies seems to be having some success,” said Thompson. Starting next year, China plans to allow about 15 percent of the power in several northeastern and eastern provinces to be sold through bidding. While the break-up is moving rather quickly from a regulatory point of view, however, whether it fundamentally impacts prices remains to be seen. With Chinese electricity demand expected to increase by 15,000 MW/yr for at least the next three years, the central government is bound to retain a strong presence, and permit only baby steps toward liberalization.

Finally, Japan provides a fascinating case study, primarily because of the nuclear crisis. The incumbent utility companies — historically strong and unchallenged — may be ripe for re-shaping. “Because of the utility companies’ involvement in the nuclear crisis, the Japanese government may take the view that it needs to shake the sector up some more,” said Thompson. “The fallout, literally and figuratively, is that it may become easier to gain access to retail customers.” If a number of nuclear plants are shut down, the question then becomes how to replace the lost generation. Coal is cheapest, but is constrained by environmental regulations. The next option is gas, but Japan’s LNG costs are significant, according to Thompson.

Primed for Growth

Fundamentally, the Asian economic engine is primed to drive electricity demand higher. With a population increasingly able to pay the full economic cost of power generation, sustained growth in the medium to long term is likely. The Energy Information Administration’s International Energy Outlook 2003, in fact, projects the strongest world economic growth to be in Asia, where energy demand is expected to double from 2001-2025.

Asian markets have demonstrated that they are especially vulnerable to system upsets, world events, and bureaucratic malaise. Inefficiencies with state utilities, for example, can only be improved by injecting private capital. While the days of ‘boundless optimism’ are over, however, the days of growth are not.