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| China-Japan-Koreas |
| Ertan dam's market failure |
| 2006-02-16 |
| From Threegorgesprobe.org website. The financial implications are huge, and the World Bank is in the middle of it. The World Bank has given China's second-largest hydropower project a satisfactory rating on its financial performance, despite its failure to meet the Bank's financial targets and its near-bankruptcy in the first five years of operation. Maybe we can get the US govt to do the same....oops, already have, sigh. Unable to service its debts, the US$2.2-billion Ertan project,1 which received more than US$1 billion from the World Bank,2 was bailed out by the Bank of China in 2003. With a US$396-million loan from the central bank, Ertan Hydropower Development Corporation repaid its commercial financiers and a portion of its World Bank debts. The whole Chicom financing thing is a shaky deck of cards. Since then, EHDC's finances have improved somewhat due to increased electricity sales and lower interest charges on its outstanding debts, according to last year's performance assessment by the World Bank's operations evaluation department.3 However, the company's earnings are still nowhere near the Bank's target of 15-per-cent return on assets. By selling power below cost to its industrial customers, EHDC is losing more than US$15 million a year. Its debt-to-equity ratio is "still unsatisfactory and will limit its future borrowing capacity." Its shareholders4 have not yet paid in their full 20 per cent of the initial project investment equity. The company is not generating enough cash flow to mobilize capital for expansion nor does the Bank expect progress any time soon in raising rates to cover EHDC's actual costs. In other words, the project is failing on its business plan. Despite these fundamental weaknesses, the Bank gives EHDC a satisfactory rating because it "acquired the technology and project management skills for the design and implementation of very large, world-class hydroelectric schemes." Having built the 240-metre high Ertan dam, EHDC now has "the capabilities to undertake further major hydroelectric developments on the Yalong River such as the much larger Jinping hydro project." There ya go, build some more monster dams that will no pay for themselves. Sounds like Communist central planning, with help from the World Bank. What matters, in other words, is EHDC's capacity to keep on building large dams regardless of their high cost and risk of financial failure. Shortly after this endorsement from the World Bank, China Construction Bank announced a US$3.7-billion loan for EHDC's next project in Sichuan province.5 Digging a bigger financial hole with more money. Ertan with its six General Electric (Canada) turbines was designed to generate 17 billion kilowatt-hours of electricity per year - equivalent to about one-third of Sichuan province's annual power supply. The dam's output was to be delivered via high-voltage transmission lines (also partly financed by the World Bank) to Chengdu, the capital of Sichuan province, and Chongqing, a municipality of 30 million people at the upper end of the Three Gorges dam reservoir. But when Ertan began generating power in 1998, there wasn't enough demand for its output. Many state-owned factories were shutting down at that time, which caused electricity demand to drop sharply. More importantly, Ertan's two biggest prospective customers had become its competitors. Wonder if that was part of the business plan.....In the decade it took to build the giant dam, Sichuan province and Chongqing had financed and built their own sizable coal-fired plants (ranging from 50 to 700 MWs) that produce power for less than Ertan. As a result, Ertan Hydropower Development Corporation "suffered serious financial losses in terms of forgone revenues at a time when its debt service burden was very high." Bad financial combo... The Bank's disclaimer for EHDC's failure is found on Page 3 of its assessment: "No safeguards or mitigating measures could have been incorporated at [World Bank loan] appraisal to have prevented the project from suffering the financial difficulties it encountered in its first five years of operation." This is Bank-speak for "don't blame us." Heh heh. Rather than accept some responsibility as the lead financier, the Bank praises EHDC's bailout as a "foreign debt adjustment" that demonstrates its client's "financial management capabilities." It blames Ertan's lack of customers on local protectionism, depicting local governments' preference for cheaper power as a "perverse outcome." From the Bank's perspective, the market failed its client, not the other way round. The Bank goes on to warn that other state generating companies are at risk of bankruptcy in the coming power glut. State generating companies currently have about 300,000 MW of new capacity under construction, "which is a massive amount, even by Chinese standards." In 2004 alone, an estimated 50,000 MW of new capacity was added to the power system, and at least that much was expected to be added last year. By 2007-08, the Bank predicts: "A significant portion of this new capacity. . . is likely to be surplus to requirements . . . even if rapid economic growth continues. . . . many [new power] projects may run at low levels of capacity utilization and their promoters may have difficulty generating sufficient cash flows to service their loans." Build like hell, then look around and say, "Oh, Sh*t! The market is saturated. The expected surplus generating capacity has "serious implications for the Chinese banking system," the Bank adds. "Since the major portion of the loans are from state owned banks to state owned generating companies, formal defaults are unlikely, but loan rescheduling on a large scale would be needed to avoid adding to the stock of the [state] banks' non-performing assets." Which means that the Chicom banking system is full of shaky deals like the above. The Bank criticizes the central government's response to the last oversupply crisis. When Ertan couldn't sell its output, the government stopped issuing permits for construction of new power plants. The two-year ban (2000-01) resulted in a capacity shortfall that contributed to severe power shortages in 2003 and 2004. According to the Bank, the ban was motivated by concern that the country's largest hydro project, the Three Gorges dam, would run into the same difficulty as Ertan when it started generating power in 2003. Note the Bank doesn't disagree with the central government's ban on building new plants, only that it was too long. It calls for better planning and blames decentralization for the current overbuilding of generation plants. "Indicative power system planning at the national level is essential in order to avoid boom-bust investment cycles such as the one currently building up in the Chinese power sector." Nowhere do the Bank evaluators consider that huge-scale power projects like Ertan are ill-suited to China's newly decentralized power market. With the decentralization of investment authority, and more entities involved in power generation since the 2002 breakup of the state power monopoly, competition for customers and demand uncertainty is on the rise. With decentralization, big state-backed power projects can no longer be assured of a market for their power. And should not be assured of financing, in a normal market system, being bad risks and all. To protect Ertan and other state power companies, the Bank recommends a market by government fiat: rate increases to cover uncompetitive investments made by state companies, closure of local power plants that offer cheaper power, and more high-cost long-distance transmission lines so that oversized power plants can export power beyond local markets. Heavy handed socialism at its finest. The Bank fails to consider the effect of this no-fail environment for state power companies: more overexpansion of risky projects that invite financial ruin. Nor does the Bank consider itself part of the problem. But when the Bank provides loan guarantees to protect commercial lenders from market risk, when it subsidizes transmission costs, and when it glosses over the dismal financial performance of state companies, as it does with EHDC, the Bank helps create companies unhinged from market reality. Understatement of the week. By shielding commercial lenders from market risks, the World Bank, like the Chinese government, sends the wrong signal, encouraging high-risk expansion that leads to higher-than-necessary electricity costs or more state bailouts. And where, pray tell, does the World Bank get its funding? Without World Bank and central government protection, power companies would adjust their perception of market risk and abandon megaprojects in favour of smaller scale investments better suited to a decentralized market and consumer demands. By providing less not more financial protection for generation and transmission companies, the central government could better concentrate on becoming an effective regulator - to protect the interests of power consumers, including the 30 million rural Chinese who currently lack access to basic electricity service. Footnotes: 1 The US$2.2-billion cost excludes US$1 billion for high-voltage transmission lines. 2 The World Bank provided US$780 million for the dam project, a US$150-million loan guarantee for Ertan's commercial financiers, and US$270 million to Sichuan Electric Power Corporation for the transmission lines linking the dam to Chengdu and Chongqing. 3 The full project performance assessment report by the World Bank's operations evaluation department (Report No. 32664), dated June 27, 2005, is available at www.worldbank.org 4 EHDC is a limited liability company with share capital divided between the State Development Investment Company and the Sichuan Provincial Investment Group with 48 per cent each, and the remaining 4 per cent held by China Huadian Corporation. 5 "Bank offers loans for infrastructure, power projects in Sichuan," Xinhua news agency, Sept. 15, 2005. |
| Posted by:Alaska Paul |
| #6 welllllll in the NEXT 5-year plan, they plan to... |
| Posted by: Frank G 2006-02-16 22:26 |
| #5 Who's overextending themselves, the Chinese or the World Bank? |
| Posted by: Phil 2006-02-16 21:37 |
| #4 Of course, having Paul Wolfowitz as head of the World Bank would have nothing to do with encouraging the Chinese to horribly overextend themselves, now would it? |
| Posted by: Anonymoose 2006-02-16 21:28 |
| #3 I agree, when you build something as hugely expensive as a dam and generating station you MUST make the project many times larger than the current need, or ten years down the road you're out of power. A good idea would be to build the dam and powerhouse, but only 2 turbines. With plenty of room and design features allowing more turbines as need increases, say ten pentstocks leading to turbine wells, with huge shutoff valves, or welded closed pipe ends for future turbines to be installed. Ther's no such thing as obsolescence here, the turbines are custom built for each given head, flow, and generator requirements. So build them as needed. (Dad was a Civil Enginer, Army Corps of Engineers, a lot soaked through) |
| Posted by: Redneck Jim 2006-02-16 21:16 |
| #2 I'm going to have to disagree here. I'm not in favour of governments doing most things, but there some things that governments are particularly well suited to do, and one of them is carry the financial risks of large infrastructure projects. Large scale hydro is far and away the cheapest means of generating electricity and over time will be hugely profitable. The problems of oversupply and market distortions are strictly short term. |
| Posted by: phil_b 2006-02-16 20:54 |
| #1 Ah, I love the smell of socialism in the morning! |
| Posted by: Bobby 2006-02-16 19:49 |