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IEEFA update: Southeast Asian fossil fuel risk is underpriced

August 08, 2018
Melissa Brown

HONG KONG — We’ve just published a memo describing how July was an exceptionally telling month for Southeast Asia power-generation markets.

Our memo argues that fossil fuel risk is underpriced in the region, and it makes four specific points along these lines.

First, that there is too little transparency around certain deals in Indonesia.

News in July around purported corruption involving approvals for the proposed coal-fired 600 MW Riau 1 IPP (independent power producer) project was prominent, in no small part because of the individual caught up in scandal: Eni Maulani Saragih, a Golkar legislator who is deputy chairwoman of House Commission VII has been named as a suspect. Separately, Sofyan Basir, the president director of the state-owned monopoly electricity company PLN, has been named as a witness in the case.

Big lenders to coal projects are seeking to offload their exposure onto others.

The circumstances surrounding the Riau 1 IPP are emblematic of Indonesia’s strategic challenges that have arisen from its over-reliance on coal IPPs backed by a revolving cast of coal producers who are highly motivated to push speculative projects that will benefit narrow interests.

Many mine-mouth IPP deals like Riau 1 were not included in the planning process that started at the beginning of President Joko Widodo’s initiative to expand Indonesia’s power generation capacity by 35,000 megawatts, and this one appears to have been suddenly added into the official Electricity Supply Business Plan of PLN, the state-owned utility.

Second, we point out that the Malaysian government’s announcement that it is cancelling four new coal IPP contracts is a clear indication that Indonesia is not alone in needing to re-assess its risk-laden IPP process. That’s why Malaysia’s new government is making a commitment to transparent market structures that will support the transition to more cost-effective energy options.

A prominent part of the policy shift under way in Malaysia will be a move toward open tenders, and Energy Minister Yeo Bee Yin has advised developers to concentrate on cost competitiveness rather than relationship building with government officials.

Third, we note a trend among investors and regulators toward re-assessing the way that risk ratings are attached to project loans as coal power assets begin to be stranded across a range of markets that include Australia, Indonesia, and Vietnam.

This process is relatively advanced in developed markets, but in Southeast Asia, it remains comparatively subdued even with the speed of the transition taking place in India and China—and despite the clear evidence of growing stranded-asset risk.

SO IT’S IMPORTANT TO DIG DEEPER PERHAPS THAN USUAL WHEN NEW STRUCTURED PRODUCTS are brought to market that give the big coal project lenders a chance to reduce their coal risk. In a US$458 collateralized loan issue in July, the market had a chance to see that Temasek, DBS Bank, HSBC, Mitsubishi UFJ Financial Group (MUFG), Sumitomo Mitsui Banking Corp (SMBC), and Standard Chartered Bank—each of which has teams of bankers and lawyers that are adept at assessing the underlying risks—are all sellers. This suggests that some of the region’s biggest financial sponsors of project financed infrastructure projects may see the balance of risks differently than portfolio investors who are more distant from the projects and markets.

Clearly, they are looking to offload risky project debt.

Fourth, we ask why U.S. investment bank Evercore thinks it’s smart to dabble in Indonesian coal deals by acting as the financial advisor to sponsors of the controversial coal-fired 1,320MW Tanjung Jati A IPP.

It’s surprising that Evercore is involved given that leading banks are increasingly reluctant to be involved in these projects. And it’s surprising as well that Evercore lacks awareness of the controversy attached to large project financings for coal IPPs built to supply the over-crowded Java-Bali grid, which has a current reserve margins in excess of 30%.

In recent years, all of the traditional leaders in Asian power-sector advisory work have spent time devising coal policies and re-assessing their commitments to the coal IPP market. Evercore does not appear to have any similar formal policies and appears to lack board capacity with deep Asian expertise. This raises obvious questions about whether the bank understands that this particular advisory role may not result in a financing that investors or the Indonesia public will thank them for.

Melissa Brown is a Hong Kong-based IEEFA energy finance consultant.

Full brief here: A Bad Month for the Southeast Asian Coal Power Juggernaut: Warning Lights Flashing for IPPs in Indonesia and Malaysia While Global Bankers Play Poker with Coal Risk


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Melissa Brown

Former Director, Energy Finance Studies, Asia, Melissa Brown, a former securities analyst at JP Morgan and Citigroup, has played a leading role in various Asian investment organizations focused on mainstream and sustainable investment strategies for public and private equity investors over the past 25 years.

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