In the latest Behind The Deal interview series, Hong Kong reporter Wai Yee Tsang speaks with Bill McCormack, Scott Baggett and Anna Chung from Shearman & Sterling about the Tabalong 200MW Coal Power Project in Indonesia
McCormack: Kalsel was originally tendered back in 2011. It was awarded to Adaro and Korea East-West Power [the sponsors] in 2012. We were appointed by K-Sure in 2012 after an RFP [request for proposal] process. We were working on the Central Java deal [a greenfield coal-fired power project in Central Java] and have a strong reputation for acting on similar projects in Indonesia.
McCormack: It is not easy to get a project in Indonesia to financial close. Even though there have been multiple projects that have closed, every project is different and there always seems to be one challenge or another. In our case, there were a number of issues along the way, including the elections in Indonesia, changes to the regulatory framework dealing with the BVGL (business viability guarantee letter) which is the government support provided in relation to PLN obligations. Kalsel was not the first project with the BVGL, but it was a relatively new product that required a bit of digestion and this was the first project in Indonesia led by K-Sure.
The environmental process in Indonesia whereby you get environmental approval and public consultations are simply time consuming. Central Java was delayed due to challenges in completing the land acquisition process, but this was not the issue in Kalsel. It was more the regulatory framework that was changing. The process could be more streamlined, however we were not surprised by the time it took, as this is broadly typical in Indonesia.
Chung: In theory it could be more streamlined. One of the challenges for developing and financing projects in Indonesia is that the regulatory regime and/or the documentation is subject to changes from one project to another. In the current case, we were aware of the coming regulatory changes that would affect the Kalsel project as we were also working on other Indonesian projects, but these changes required analysis with the lender group.
McCormack: Banks like certainty and following precedent, so if there are new regulations then it will take more time to digest the differences.
McCormack: The big issue in Indonesia, historically, has been the government’s support for PLN’s obligations. In this case we had the BVGL, which made the deal quite attractive. In addition, there were financing documents which took time to negotiate and finalise, such as the hedging arrangements, the insurance provided by K-Sure, and inter-creditor arrangements. Then you have the project documents, the PPA was being negotiated and finalised, and the due diligence in addition to the technical issues, environmental issues and the regulatory framework [to take into account]. You also have to register the security and satisfy hundreds of conditions precedent before reaching financial close.
Chung: It was mainly the regulatory regime which changed a number of times and we had to respond to that.
McCormack: The project was on the list that made it eligible for it to receive the BVGL. So when it was tendered, it was on the basis that there will be government support. Some projects were tendered on the basis that there won’t be government support. We advised on another project that started around the same time called Banten, which was the first major coal-fired [power plant] IPP in Indonesia to be financed without government support.
The format of the BVGL had not been fully drafted when we started to work on Kalsel. The draft was produced at the same time that the ministry of finance was finalising the format on other projects—a BVGL was provided on the Wampu hydroelectric project and also on the Sarulla geothermal project. So the format was being developed on various projects at the same time. Therefore it was not that the letter was difficult to obtain, but there was a process of finalising the terms and format and then, as mentioned, there were subsequent regulations that impacted the format. That meant we needed to go through the exercise again, reviewing the BVGL based on the regulatory developments.
McCormack: It is typical for lenders to take security over everything, from share pledges over shares in the company to security over the physical assets—the land, as well as an assignment of the material contracts. And each element has its own issues. For example, there was a lot of discussion on the share-pledge structure. There were lots of formalities involved in taking security over land. With regard to the assignment, you generally also require direct agreements with the counterparties.
On top of that K-Sure is providing commercial and political cover to the commercial banks, which means K-Sure is really taking most of the risk involved in relation to the covered lenders, and the inter-creditor arrangement that arose out of the relationship between K-Sure and the banks is also quite involved.
McCormack: The commercial banks involved in the Kalsel deal are all very experienced project finance banks.
Baggett: Korean Development Bank (KDB) as well has done deals in Indonesia and therefore is familiar with the market.
McCormack: While there are some banks that are still financing coal-fired power projects, we understand that some banks are pulling back from those types of project for policy reasons, including a number of multilateral institutions and ECAs.
McCormack: There is a major initiative to develop some gas-fired projects. For example we are advising on Jawa-1, which is an LNG-to-power project; and there is also Riau under negotiation, and Jawa Bali 3 which is expected to be re-tendered.
That is probably the most notable trend in Indonesia in the last 12– 24 months. There are also a number of wind, solar, geo-thermal and small hydro projects in development.
McCormack: Singapore continues to be a regional hub for energy work and project finance. From Singapore, we cover the South East Asia market—we look north to Thailand and Malaysia, south to Indonesia, and east to Philippines.
It makes sense for Singapore to be the hub for that type of work. A lot of our key competitors are here—Milbank, Latham, White & Case, A&O, and Clifford Chance. It continues to be a fairly buoyant market for infrastructure and energy [transactions].
I don’t think we were that impacted by the day-to-day volatility of the market or the election in the US in 2016. These projects spend a long time in development and there is a longer term approach. We are affected by the oil price environment which has affected the viability of some projects. Nonetheless we have seen a lot of work in the mid-stream—for example LNG receiving terminals, and floating LNG.
As for infrastructure and transportation projects in the region, we also advised on a LRT-1 railway project in the Philippines last year. The Philippines is particularly active in the infrastructure space, but we are also seeing similar types of opportunities in Indonesia and elsewhere. Indonesia continues to be the major jurisdiction that everyone focuses on. We are also working on projects in Malaysia and Vietnam. Last year was a very busy year and we closed a number of deals that we worked on for a while. This year will be another strong year, we hope.
This deal record is from the new IFLR1000 Deal Data project.