A View from East Asia

Dr. Piyasvasti Amranand
Secretary General, National Energy Policy Council
Royal Thai Government

from
Energy and Development Report 1999
"Energy After the Financial Crises"
The World Bank
1999

 

The Asian financial crisis has exposed inherent weaknesses in the institutional and financial structure of the energy sector in several East Asian countries – weaknesses which were not apparent while energy demand and the economy were expanding rapidly. Along with a number of other countries in the region, Thailand is seizing the opportunity for reform. Its plan is based on its experience that:

Reform must fairly balance the interests of producers with those of consumers: pressure from consumers will become a major factor in pushing forward the privatization and deregulation of the energy sector.

Sectoral context

Prior to the global financial crisis, the energy sectors of most East Asian countries were characterized by the following, common features:

High growth of energy demand, as shown in Box 1, is due to rapid economic growth, increasing industrialization and urbanization. Financial constraints and policies to promote competition have gradually increased the role of the private sector over the years. Very rarely, however, was the market completely open to investment without any control by the government on capacity expansion or through licensing.

Energy prices are only partially deregulated and in many countries prices are still tightly controlled by the government. There are exceptions, for instance, Thailand and the Philippines have deregulated oil prices. In the case of electricity, for which tariffs have to be regulated anyway even in developed economies, prices are controlled or regulated by the government rather than by independent regulatory bodies which tends to politicize pricing issues.

Exchange rates were fixed with few exceptions. Changes in the exchange rate or the introduction of floating exchange rate regimes were rarely contemplated. This provided stability for a while, but also sent the wrong signals for investment decisions. The risk of any change in the exchange rate was perceived to be negligible, and as a result bankers were prepared to finance projects in US dollars with income from electricity sales in Thai baht.

Deregulation and Privatization of the energy sector in most East Asian countries has only recently started. In the case of Thailand, when the global financial crisis occurred, most IPPs had not come to financial closure. Moreover, the deregulation process was just in its initial phase with many steps to be implemented before full competition could be achieved.

Local capital markets were relatively underdeveloped making project financing extremely difficult without relying on foreign funds; many financial instruments taken for granted in developed economies simply did not exist. Financing of private power projects, therefore, was only possible for projects whose incomes were fairly predictable – for example, projects with firm, long-term, offtake agreements; financing a merchant plant would have been extremely difficult.

 

Box 1
Before the crisis: high growth of energy demand

Thailand experienced an annual growth in primary energy demand of 8.9% during the period 1990-97 whereas the demand for electric power grew by 14.1% per year over the same period representing an average additional capacity requirement of 1,100MW per annum. South Korea also experienced similarly high growth rates: primary energy consumption grew by 9.8% per year on average during the period 1990-97. With the rapid growth in energy demand, the primary objective of energy policy was to procure a sufficient amount of energy to meet the increasing demand, and this was done mainly through investments on the supply side: power generation, transmission and distribution systems, oil refining and marketing as well as natural gas production and pipeline network.

 

The impact of the crisis

The global financial crisis has had a severe impact on the energy sectors of East Asian countries in the following ways:

Negative economic growth was recorded for the first time in decades with energy demand actually falling in many cases as shown in Box 2.

Devaluation of the exchange rate against the US dollar has pushed up the cost of energy in local currencies. The problem was particularly serious up until early 1998 as oil prices were relatively strong and the movement in the exchange rate was erratic. Although the problem has been alleviated by more stable and stronger exchange rates, together with the drop in US dollar oil prices, prices in local currencies in some cases are still higher than before the global financial crisis (Table 1).

Table 1
Prices of crude oil (per barrel)

  Pre-crisis During Crisis
June 1997 Jan 1998 June 1998 Jan 1999
US dollar 17.28 13.41 11.76 10.72
Thai baht 446 725 501 394
Indonesian Rupiah 41,788 121,486 150,928 86,178
Philippines Peso 453 569 473 407
Korean Won 15,337 22,801 16,410 12,579

Financial Difficulties. Deterioration in the financial markets not only disrupted the normal operations of the energy sector, but also had a substantial impact on the implementation of existing investment programs and lending for new investment projects. In Thailand, Indonesia, and South Korea, the local financial systems were on the verge of collapse with a large portion of domestic credit disappearing due to the insolvency of local financial institutions. Given the relatively fixed exchange rate regime before currencies to finance long term projects whose incomes were in the form of short term loans. When the financial crisis occurred, these energy related entities were suddenly faced with rapidly rising foreign debt and interest repayment in local currency and the disappearance of a portion of credit normally extended by financial institutions. Constraints in the financial markets also made it difficult for governments to raise long term borrowing to finance infrastructure projects. Before the global financial crisis, government-owned public utilities could borrow relatively easily on favorable terms; that is no longer the case. The financial solvency of government owned electric utilities has since become a major concern for institutions which are financing IPP projects.

 

Box 2
Impact of the crisis: energy demand collapses

Thailand’s primary commercial energy consumption fell by 7.0% in 1998, and power demand declined by 2.4%. South Korea and Indonesia had similar experiences. Primary energy consumption of South Korea is estimated to have fallen by 5% in 1998 with electricity consumption falling by 2%. In Indonesia the demand for oil declined by 5.3% while the demand for electricity grew by just over 4% in 1998. Prospects for 1999 and beyond are also not good: even the optimists are forecasting economic growth for the next 5 years well below the growth forecasts before the crisis. With rapid energy demand growth for energy in 1997 has suddenly turned into an enormous excess supply. For instance, the annual reserve margin of Thailand’s power system, which averaged 8.6% during the period 1990-97, is expected to rise to nearly 50% in 2000. The excess demand of natural gas which required the rapid the conclusion of various gas supply agreements during the period 1992-96 has developed into a surplus with the need to delay various natural gas schemes.

 

Viability of Investment Projects. The repercussions from the crisis have raised the cost of new investment capital to energy-related enterprises, as well as of the repayment of existing foreign and local debt. In certain cases, the problem is compounded by the deterioration in the business environment - for example, the decline in global energy demand. Moreover, electric utilities in a number of countries were not able to make sufficient tariff adjustments and this further weakened their financial positions. All IPP projects in Thailand, which had earlier signed power purchase agreements with EGAT with tariff income in Thai bah, found their projects to be no longer feasible.

Policy responses

What have been the responses to the impact of the global financial crisis? In all countries, the major policy prescriptions are very similar : reduction of investment on the supply side, price adjustments, acceleration of privatization and deregulation, and renegotiation of specific contracts.

Investment on the supply side has been sharply reduced wherever possible as described in Box 3.

 

Box 3
Rescheduling investment

In Thailand, all supply side negotiations which had not been committed before the crisis have been indefinitely or substantially delayed. These include an indefinite postponement of the LNG supply agreement with Oman, a substantial delay in the natural gas supply agreement from Natuna (Indonesia), a few years delay in the gas purchase from Thailand-Malaysia Joint Development Area and 3-5 years delay in about 2,700MW of power purchase from projects in the Laos PDR. Projects with commitments have also been "renegotiated", and the commercial operation dates for about 40 private power projects have been delays by between 3 months and 4 years. Investments by state-enterprises have also been delayed or cancelled. Projects in transmission and distribution have been delayed in line with lower demand, and EGAT has cancelled a number of generation projects: for example the 2,000MW Tab Sakae power plant and Thermal Units 3-4 at Ratchaburi. The natural gas pipeline network has also been scaled down, so that, for example, the third pipeline from the Gulf of Thailand had been postponed indefinitely.

The picture is similar in Indonesia and South Korea. In South Korea, the completion dates of 60 power plants under construction are being delayed by more than 3 months. The delayed capacity is around 17,435MW with an average of 15 months delay period. The natural gas industry has also revised its investment plan with a reduction of around 50% in investment expenditure.

 

Adjustments to Energy Prices. Both oil prices and electricity tariffs in local currencies have increased from the pre-crisis level. Where the energy price had already been deregulated, as in Thailand, the adjustment in prices has been generally easier. In Indonesia, where oil prices were controlled by the government, the political and social repercussions from the adjustment were much stronger. With economic recession a reality and unemployment rising rapidly, energy users have had little stomach for explanations from the government for energy price hikes; the fact that it is government which controls prices has tended to complicate the issue even further. Traditional price-setting mechanisms lead to a higher electricity tariff as demand falls and over-capacity is developed so that the financial performance of the electric utilities is maintained often to meet the requirements of the financial covenants agreed to with lenders like the World Bank. In a competitive commodity market, or a competitive electricity market, prices should fall as excess capacity is developed and not rise as we have seen. This downward price adjustment would lead to greater pressure for a more rapid reform of the energy sector and the introduction of measures to increase efficiency.

Privatization and deregulation of the energy sector are being accelerated. The crisis has increased the government's fiscal incentive to privatize, and has also put more pressure on deregulation and the creation of competition in order to provide consumers with lower prices and higher service quality (Box 4). Depressed capital markets, however, have also meant that privatization has had to rely much more on foreign strategic investors than on public offerings which makes resistance to privatization much stronger due to nationalist sentiment.

 

Box 4
Financial crisis - stimulus for reform?

Thailand, South Korea and Indonesia have all announced clear long term plans for the deregulation and privatization of the energy sectors. Moreover, there seems to be more political will to push through the necessary reform.

Thailand announced a transparent target for the deregulation of the power supply industry in September 1998, clearly indicating a desire to separate electricity generation from transmission so that a power pool and retail competition could be introduced in 2003. The government has also continued to move forward forcefully in the privatization of existing generation assets of EGAT's shareholding in EGCO to China Light and Power in 1998, and a plan to privatize the 3,200 MW Ratchaburi power plant in 1999. The natural gas deregulation plan was also recently announced which combines the separation of the Petroleum Authority of Thailand's gas transmission operation from its gas trading activity with the introduction of third party access by 2000, and private investment in new natural gas transmission projects.

South Korea announced a privatization initiative in July 1998, including the sale of 11 publicly-owned companies, KEPCO and KOGAS among them. Privatization will be accompanied by deregulation including removal of entry barriers at all levels, ensuring open access and import.

Indonesia also announced a policy to restructure the power sector in August 1998, with PLN being unbundled into independent units in generation, transmission and distribution.

 

Contract renegotiation and debt restructuring. Any project with foreign loans but income in local currency is unlikely to survive unless the contract is renegotiated and the debt restructured. Even government-owned enterprises found the terms and conditions for new borrowing worsen substantially in line with the rise in sovereign credit risk. New debt instruments had to be found e.g. US$ 300 million bond issue by EGAT with principle guaranteed by the World Bank and interest payments guaranteed by the government of Thailand. The bond was successfully issued in September 1998 with an interest rate of about 2.87% above US Treasury bills compared with the Thai government bond which at the time was trading in the international money market at around 7% above US Treasury bills.

Before the crisis, all PPAs between EGAT and private power producers were denominated in Thai baht, because the foreign exchange risk was perceived to be negligible. In order to make the projects viable after devaluation, the PPAs were renegotiated by indexing a portion of the capacity payment to the exchange risk, and various non-price terms in the PPAs were amended to bring the PPAs into line with best practice principles. This was negotiated together with the delays in the commercial operation dates. Since the shareholders had to absorb a portion of the impact and a number of Thai companies were also faced with financial problems, there has been considerable changes in shareholding structures of private power projects with foreign shareholding rising substantially.

Lessons of the crisis

In implementing the needed reform, social and political constraints as well as legal and institutional inertia, have made adjustment much slower than it should have been. The financial crisis has also brought out clearly a number of conflicting policy objectives which have to be carefully balanced. In the case of Thailand, the implementation of reform measures has had the following consequences:

The cancellation of energy supply projects by energy importing countries like Thailand, Korea and Japan have had repercussions for energy exporting countries in East Asia such as Indonesia and the Laos PDR, which have worsening economic problems. Thailand's cancellation of natural gas purchase from Indonesia has made the development of the Natuna gas project improbable. Postponement of 2,700MW out of a 3,00MW power purchase by Thailand from the Laos PDR plunged this country into even more severe economic problems as power sales to Thailand were expected to account for most of its foreign exchange earnings.

Contract renegotiations have to be carefully undertaken so as not to jeopardize investor confidence and the investment climate. Obviously, investors do not like contract renegotiatons which do not run in their favor, such as the reduction of prices in the gas supply agreements, or the delay of the commercial operation date of an IPP. Without renegotiations, however, the country and consumers could be left with an unmanageable financial burden.

Deregulation of energy prices is essential. In Thailand, the oil market was deregulated in 1991, thereby creating a more competitive and efficient market which was able to handle the crisis. Despite the weekly rise in the retail price of oil for about 25 consecutive weeks as the exchange rate fell from 25 baht/US$ in June 1997 to 55 baht/US$ in early 1998, consumers were very tolerant and understanding. However, social and political pressures are much stronger against increases in the price of electricity. Consumers are willing to pay higher prices in line with higher fuel costs but are less willing to pay for the inefficiencies of state-owned electric utilities. This issue is now being intensely debated. The deregulation of the power sector is also being discussed and pressure is clearly pointing in the direction of retail competition and a competitive electricity market.

The need to amend the various laws related to the energy sector, and to bring them up to the standards set by international best practice, has become even more apparent. Outdated laws and regulations are making much needed reform slower than it would otherwise be. In the case of Thailand, the enactment of an Electricity Act and the establishment of an independent energy regulatory body is now even more essential ion order to complete the process of deregulating the energy sector.

 

 

National Energy Policy Office
Posted 8 June 1999