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Quezon Power Ltd. Co.
CASE STUDY 3
Quezon Power Ltd. Co. Veronica Bonetti and Stefano Gatti
C3.1 THE PROJECT In the early 1990s, the Philippines were hit by a major energy crisis. The Quezon Power Project was undertaken in an attempt to find a solution to this critical macroeconomic problem. By means of this initiative, in fact, the Philippine government would improve national energy planning by diversifying the mix of sources utilized to generate electric power in the country. In addition, the project would make it possible to extend the power supply to developing parts of the country and to stabilize the electrical energy distribution system. The project consisted of building and running an electric power plant. The plant would be designed, constructed, and operated by the SPV Quezon Power, a Limited Company with legal headquarters in the Philippines. The facility in question, which was to generate 440 megawatts of electricity, would be built on the island of Luzon and fired by pulverized coal (Figure C3.1). The low-sulfur coal used as feedstock for the plant would be imported from Kalimantan, Indonesia, and a sea water desalination facility located within the plant itself would supply the necessary water. In addition to the power generation plant, Quezon was to operate a 31-kilometer, 230-kilovolt transmission line. The electricity produced by Quezon Power would be subject to a take-or-pay Power Purchase Agreement (PPA), which obliged Manila Electric Company (Meralco) (the Philippine power distribution company) to pay both fixed and variable costs of the plant in question. These costs would be established on the basis of parameters linked to the progress of the construction work and the performance of the plant as set down in the relative legal agreements.
C3.1.1 Project Sponsors, Ownership Structure, and Basic Terms of Financing The Quezon Power Project was born out of the close relations between Meralco and PMR Power Ltd (“PMR”), a Philippine de jure company. The consulting company Pacific Manufacturing Resources controlled 50% of PMR, while the other 50% was in the hands of a group of Filipino power sector executives to whom PMR turned to develop the Quezon Project. Meralco had worked with PMR in the past on a total quality management project. Following the intensification of the Philippine energy crisis, PMR considered the possibility of developing a power generation project with Meralco by founding an ad hoc SPV. PMR made an initial proposal to its partner in August of 1992, which Meralco rejected because talks were already under way with another power developer that the company had contacted. Only after these negotiations failed in mid-1993 did Meralco and PMR sign a memorandum of agreement (MoA). Subsequent to this, PMR convened several Filipino managers who worked in the power sector and founded PMR Power Ltd., the first sponsor of the Quezon Power Project, in early 1994.
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FIGURE C3.1 Geographic location of the Quezon power plant. Source: Kennedy (2000).
In the meantime, the newly established company started the search for a U.S. partner who would collaborate on project development and become co-owner of the plant. Covanta Energy Corporation (Covanta) was chosen from the various possible candidates who had expressed an interest in joining the project. Covanta was an American leader in the sector of designing and developing privately owned power plants. Originally called Ogden Energy Corp., the company changed its name to Covanta Energy Corp. following a reorganization aimed at refocusing its core business in March of 2001. Negotiations between Covanta, PMR, and Meralco led to the signing of the take-or-pay power purchase agreement (PPA) in August of 1994 by the Philippine power distribution company. Finally, in September of 1994 Covanta signed a co-development agreement with Bechtel, the third project sponsor, who granted PMR Power Ltd. voting interests of 2% in Quezon Power, without requiring any equity contribution. After InterGen was founded in 1995, Bechtel transferred its interest in the Quezon project to its affiliate; InterGen was controlled through subsidiaries by Bechtel Enterprises (Bechtel) and Royal Dutch/Shell Group (Shell). InterGen was founded in early 1995 following the acquisition by Bechtel and PG&E Enterprises (PG&E, a subsidiary of Pacific Gas and Electric Company) of J. Makowski Corporation (JMC, a U.S. company, founded in 1972 as a developer of small hydroelectric power plants). JMC handled cogeneration and development of private projects for power production. InterGen was created with an eye to tapping JMC’s experience in private projects involving the construction of power plants. This would be combined with Bechtel’s competencies in terms of developing, financing, and building, and PG&E’s expertise in fuel negotiations; the aim was to realize projects that served to satisfy the growing demand of private players in the power production sector in
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emerging countries. In late 1996, PG&E sold its participation in InterGen to Bechtel, which later set up a partnership with Shell to run the project. The final ownership structure of the Quezon Project was as shown in Figure C3.2. The initial financial structure called for a debt equity ratio of 75/25. Equity amounted to U.S. dollars (USD) 202.2m, wholly paid up by the American sponsors. In fact, the Philippine sponsor PMR was granted voting interests in the SPV without having to contribute equity to the project company (Table C3.1). The debt portion in the plant construction phase, totaling USD 578.2m, consisted of five-year syndicated loans, the most important being: • USD 405m: loan underwritten by the Union Bank of Switzerland (UBS) with a guarantee against political risk provided by the Export-Import Bank of the United States1 (Ex-Im Bank); • USD 100m: loan granted by the Overseas Private Investment Corporation (OPIC – U.S.).
FIGURE C3.2 Ownership structure of Quezon Power. Source: Standard and Poor’s. 1.
Ex-Im Bank is the independent U.S. governmental agency that promotes and finances various kinds of projects the world over, primarily in emerging countries. Its aim is to encourage export of U.S. goods and services to international markets.
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Table C3.1 Voting Interests and Equity Contribution Voting Interests InterGen Covanta PMR Power
71.875% 26.125% 2%
Equity Contribution 72.5% 27.5% -
USD 146.6m USD 55.6m -
Source: Kennedy (2000).
Close to the termination of the construction phase (scheduled for December 1999), Quezon would be refinanced by: • USD 215m: a 20-year, fixed coupon (8.86% per annum paid quarterly) project bond (2017 maturity) issued on the U.S. market in USD on July 3, 1997, with Salomon Brothers in the role of lead manager of the deal; • USD 392m: loan directly issued by Ex-Im Bank.
C3.1.2 The Contractual Structure of Quezon Power Project The Quezon project involved several contracts that served to allocate project risks and responsibilities to participants in such a way as to minimize the possibility that negative events might jeopardize the cash flows generated by the project (Figure C3.3).
C3.1.2.1 Power Purchase Agreement (PPA) In August 1994, Quezon drew up a 25-year contract with Meralco agreeing to sell the power produced by the plant to this counterparty. The PPA was structured as a take-or-pay, which ensured Quezon a stable and predictable flow of revenues, and was based on a minimum availability factor between 82% and 88%, on average 85% over the 25-year contract period. No force majeure event or unanticipated occurrence in the Meralco system would exonerate the offtaker from making the monthly payments stipulated in the contract, which were set on the basis of the fixed and variable costs the plant would incur. In addition, payments were indexed to the USD exchange rate, thereby reducing the risk of a devaluation of the local currency affecting the SPV’s cash flows. (The bond earmarked for refinancing would be issued in 1997 and stated in USD.) For the entire duration of the contract, Quezon was obliged to deliver, and Meralco to receive and pay for, at least the minimum guaranteed quantity of electricity every month (Table C3.2), as established in the PPA. If the plant could not supply the stipulated quantity of power, Quezon would be required to pay Meralco liquidated damages, which were relatively low as compared to the plant’s tariffs. The total amount of liquidated damages would depend on Meralco’s power needs and the possibility of finding alternative energy suppliers. More specifically, Quezon would pay Meralco 0.26 Philippine pesos (PHP) for every kilowatt hour (kWh) that it could not supply; this amount would escalate to PHP 0.52 per kWh if the offtaker could not procure the power it needed from an alternative supplier.
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FIGURE C3.3 Contract structure of Quezon Power. Source: Standard and Poor’s
Table C3.2 Guaranteed Minimum Quantity of Electricity Years
Annual Guaranteed Minimum Quantity of Electricity (MWh)
Year 1 Year 2 Years 3e15 Years 16e25
3,149,267 3,268,858 3,388,452 3,288,791
Source: Standard and Poor’s.
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According to the PPA, Meralco was to pay the following: • Capacity fees: USD 0.029546 per kWh, which would be gauged as a function of variations in the U.S. consumer price index from the date that the PPA was finalized (August 1994). Monthly payments would equal the capacity fee multiplied by 1/12 of the relative annual minimum guaranteed quantity of power. • Operating fees: One portion of these fees was stated in local currency and another in U.S. dollars. The fixed operating fee was set at USD 0.0104 per kWh and PHP 0.0323 per kWh; the variable operating fee instead was USD 0.0015 per kWh and PHP 0.0937 per kWh. These per unit amounts were to be adjusted to variations in the U.S. and Philippine consumer price indices, respectively, as measured from the date the PPA was signed. The monthly fixed cost payment was computed as the fixed operating fee multiplied by 1/12 of the respective annual minimum guaranteed quantity of electricity, while the monthly variable cost payment was equal to the variable operating fee multiplied by the plant’s output. • Energy payments: These payments were 1.06575 times the costs incurred for procuring fuel per every million British Thermal Unit (BTU), multiplied by the product of the net output in kWh and 0.00975 million BTUs per kWh. The PPA allowed Quezon to deliver power in excess of the minimum quantity set in the contract priced at 70% of the capacity fee and 100% of the fixed and variable operating fees. If Meralco was not able to buy all or part of the plant’s output, Quezon would have the right to sell this energy to an alternative buyer. In this case, Quezon would have the option to deduct the payments received from third party buyers from Meralco’s payment obligations.
C3.1.2.2 Leases Meralco leased its property rights to the site where the power plant and transmission plants were built to Quezon for as long as the duration of the PPA. In fact, Philippine law allows only citizens or companies controlled by Filipinos to own land or hold property rights on land within national borders. This being the case, the project was structured so that Meralco was listed as holding property rights and relative easements on the land where the power plant and transmission plant were built.
C3.1.2.3 Transmission Line Agreement This established the remuneration that Meralco would make for the use of Quezon’s power transmission network. Payment, which was to be absolute and unconditional, was set at approximately USD 13.8m per year. In other words, the offtaker was obliged to pay even if a force majeure event or a defect in the Meralco system made reception of the power transmitted by the plant impossible.2 2. The agreement was modified in April 2003 when Quezon assented to relinquish 54% of transmission costs upon request by Meralco, a figure that amounted to USD 646,000 monthly. This came after the Energy Regulatory Commission (ECR) (the authority responsible for power distribution tariffs in the Philippines) determined that Meralco was not authorized to charge its customers for transmission costs. Later, in October 2004, following an investigation conducted to ascertain the transmission costs incurred by Quezon, the ECR allowed Meralco to charge its customers 70% of transmission costs. Since that time, the offtaker began to pay Quezon the sums set down in the Transmission Line Agreement, equal to the amounts established in the 2003 amendment. Quezon assumed it could cover the lower takings with a boost in sales of USD 40m in the six years following the agreement, sales that would be made to Meralco within the framework of the PPA. In so doing, the impact of the changes to the Transmission Line Agreement on the SPV’s cash flows would become nearly negligible.
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Furthermore, the Transmission Line Agreement named Quezon as the party responsible for obtaining the necessary permits and for building, financing, and running the transmission line. This accord also granted a building lease to Quezon for the land where the transmission plant was built; Meralco was recorded as owner of this land, in accordance with the Philippine law cited above. Monthly payments to be made by Meralco can be broken down into two components: • Capital cost recovery payments: Relative amounts were earmarked to compensate Quezon for costs incurred for building the transmission plant. Such monthly payments were calculated on the basis of an initial estimated total cost of construction (equal to approximately $500,000 per month), to be adjusted to reflect the actual capital cost of the line incurred by Quezon. • Transmission line operating payments: Monthly payments based on operating and maintenance (O&M) expenses and a portion of some financing fees.3
C3.1.2.4 Engineering, Procurement Contract (EPC), and Construction Management These are agreements signed between Quezon and Bechtel subsidiaries Overseas Bechtel and Bechtel Overseas Corp. (see Figure C3.3). These accords assigned the latter two the task of carrying out all actions and underwriting all contracts needed to set up preliminary projects, to obtain permits, and to build the plant.
C3.1.2.5 Management Service This is a 25-year agreement between Quezon and InterGen pertaining to project administration in the postconstruction phase. It stipulated that Quezon would make monthly payments to InterGen equal to costs incurred, plus a fixed commission of USD 400,000, which was subject to periodic increases over the term of validity of the contract.
C3.1.2.6 Operation and Maintenance (O&M) This is an agreement between Quezon and Covanta pertaining to operating and maintaining the power generation plant in accordance with sector standards. The accord stipulated that Quezon would reimburse all plant-related costs, in addition to a monthly commission of USD 160,000. Further, the O&M provided for the payment of bonuses based on the electric energy output, and on the attainment of pre-set budget targets.
C3.1.2.7 Coal Supply Agreement This is a long-term agreement signed between Quezon and two Indonesian companies, PT Adaro and PT Kaltim, for the supply of coal needed to run the plant. The former was to provide 67% of the required feedstock, and the latter to cover the remaining 33%. In any case, if the two suppliers were not able to respect their contractual obligations, the geographical location of the plant was ideal for receiving fuel from alternative coal suppliers.
3.
Meralco therefore bore both the risk of the possibility that actual costs for the maintenance of the transmission line might be higher than estimated costs and the risk of any potential additional capital spending.
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C3.1.2.8 Wheeling Agreement This is an agreement between Meralco, Quezon, and the National Power Corporation (NPC) for the transmission of electric power from the production plant to Meralco upon payment of a commission.
C3.2 THE PROBLEM Suppose you represented a bank invited by UBS to participate in the five-year syndicated loan discussed in Section C3.1.1. Would you feel comfortable with the contractual structure envisaged for the project? In particular, are there any risks in the PPA agreement signed by Meralco that could create problems for Quezon Power once the financial close is reached? How could you measure the impact of possible troubles faced by Meralco regarding the soundness of Quezon Power?
Quezon Power Ltd. Co. Veronica Bonetti and Stefano Gatti
C3.1 THE PROJECT In the early 1990s, the Philippines were hit by a major energy crisis. The Quezon Power Project was undertaken in an attempt to find a solution to this critical macroeconomic problem. By means of this initiative, in fact, the Philippine government would improve national energy planning by diversifying the mix of sources utilized to generate electric power in the country. In addition, the project would make it possible to extend the power supply to developing parts of the country and to stabilize the electrical energy distribution system. The project consisted of building and running an electric power plant. The plant would be designed, constructed, and operated by the SPV Quezon Power, a Limited Company with legal headquarters in the Philippines. The facility in question, which was to generate 440 megawatts of electricity, would be built on the island of Luzon and fired by pulverized coal (Figure C3.1). The low-sulfur coal used as feedstock for the plant would be imported from Kalimantan, Indonesia, and a sea water desalination facility located within the plant itself would supply the necessary water. In addition to the power generation plant, Quezon was to operate a 31-kilometer, 230-kilovolt transmission line. The electricity produced by Quezon Power would be subject to a take-or-pay Power Purchase Agreement (PPA), which obliged Manila Electric Company (Meralco) (the Philippine power distribution company) to pay both fixed and variable costs of the plant in question. These costs would be established on the basis of parameters linked to the progress of the construction work and the performance of the plant as set down in the relative legal agreements.
C3.1.1 Project Sponsors, Ownership Structure, and Basic Terms of Financing The Quezon Power Project was born out of the close relations between Meralco and PMR Power Ltd (“PMR”), a Philippine de jure company. The consulting company Pacific Manufacturing Resources controlled 50% of PMR, while the other 50% was in the hands of a group of Filipino power sector executives to whom PMR turned to develop the Quezon Project. Meralco had worked with PMR in the past on a total quality management project. Following the intensification of the Philippine energy crisis, PMR considered the possibility of developing a power generation project with Meralco by founding an ad hoc SPV. PMR made an initial proposal to its partner in August of 1992, which Meralco rejected because talks were already under way with another power developer that the company had contacted. Only after these negotiations failed in mid-1993 did Meralco and PMR sign a memorandum of agreement (MoA). Subsequent to this, PMR convened several Filipino managers who worked in the power sector and founded PMR Power Ltd., the first sponsor of the Quezon Power Project, in early 1994.
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FIGURE C3.1 Geographic location of the Quezon power plant. Source: Kennedy (2000).
In the meantime, the newly established company started the search for a U.S. partner who would collaborate on project development and become co-owner of the plant. Covanta Energy Corporation (Covanta) was chosen from the various possible candidates who had expressed an interest in joining the project. Covanta was an American leader in the sector of designing and developing privately owned power plants. Originally called Ogden Energy Corp., the company changed its name to Covanta Energy Corp. following a reorganization aimed at refocusing its core business in March of 2001. Negotiations between Covanta, PMR, and Meralco led to the signing of the take-or-pay power purchase agreement (PPA) in August of 1994 by the Philippine power distribution company. Finally, in September of 1994 Covanta signed a co-development agreement with Bechtel, the third project sponsor, who granted PMR Power Ltd. voting interests of 2% in Quezon Power, without requiring any equity contribution. After InterGen was founded in 1995, Bechtel transferred its interest in the Quezon project to its affiliate; InterGen was controlled through subsidiaries by Bechtel Enterprises (Bechtel) and Royal Dutch/Shell Group (Shell). InterGen was founded in early 1995 following the acquisition by Bechtel and PG&E Enterprises (PG&E, a subsidiary of Pacific Gas and Electric Company) of J. Makowski Corporation (JMC, a U.S. company, founded in 1972 as a developer of small hydroelectric power plants). JMC handled cogeneration and development of private projects for power production. InterGen was created with an eye to tapping JMC’s experience in private projects involving the construction of power plants. This would be combined with Bechtel’s competencies in terms of developing, financing, and building, and PG&E’s expertise in fuel negotiations; the aim was to realize projects that served to satisfy the growing demand of private players in the power production sector in
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emerging countries. In late 1996, PG&E sold its participation in InterGen to Bechtel, which later set up a partnership with Shell to run the project. The final ownership structure of the Quezon Project was as shown in Figure C3.2. The initial financial structure called for a debt equity ratio of 75/25. Equity amounted to U.S. dollars (USD) 202.2m, wholly paid up by the American sponsors. In fact, the Philippine sponsor PMR was granted voting interests in the SPV without having to contribute equity to the project company (Table C3.1). The debt portion in the plant construction phase, totaling USD 578.2m, consisted of five-year syndicated loans, the most important being: • USD 405m: loan underwritten by the Union Bank of Switzerland (UBS) with a guarantee against political risk provided by the Export-Import Bank of the United States1 (Ex-Im Bank); • USD 100m: loan granted by the Overseas Private Investment Corporation (OPIC – U.S.).
FIGURE C3.2 Ownership structure of Quezon Power. Source: Standard and Poor’s. 1.
Ex-Im Bank is the independent U.S. governmental agency that promotes and finances various kinds of projects the world over, primarily in emerging countries. Its aim is to encourage export of U.S. goods and services to international markets.
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Table C3.1 Voting Interests and Equity Contribution Voting Interests InterGen Covanta PMR Power
71.875% 26.125% 2%
Equity Contribution 72.5% 27.5% -
USD 146.6m USD 55.6m -
Source: Kennedy (2000).
Close to the termination of the construction phase (scheduled for December 1999), Quezon would be refinanced by: • USD 215m: a 20-year, fixed coupon (8.86% per annum paid quarterly) project bond (2017 maturity) issued on the U.S. market in USD on July 3, 1997, with Salomon Brothers in the role of lead manager of the deal; • USD 392m: loan directly issued by Ex-Im Bank.
C3.1.2 The Contractual Structure of Quezon Power Project The Quezon project involved several contracts that served to allocate project risks and responsibilities to participants in such a way as to minimize the possibility that negative events might jeopardize the cash flows generated by the project (Figure C3.3).
C3.1.2.1 Power Purchase Agreement (PPA) In August 1994, Quezon drew up a 25-year contract with Meralco agreeing to sell the power produced by the plant to this counterparty. The PPA was structured as a take-or-pay, which ensured Quezon a stable and predictable flow of revenues, and was based on a minimum availability factor between 82% and 88%, on average 85% over the 25-year contract period. No force majeure event or unanticipated occurrence in the Meralco system would exonerate the offtaker from making the monthly payments stipulated in the contract, which were set on the basis of the fixed and variable costs the plant would incur. In addition, payments were indexed to the USD exchange rate, thereby reducing the risk of a devaluation of the local currency affecting the SPV’s cash flows. (The bond earmarked for refinancing would be issued in 1997 and stated in USD.) For the entire duration of the contract, Quezon was obliged to deliver, and Meralco to receive and pay for, at least the minimum guaranteed quantity of electricity every month (Table C3.2), as established in the PPA. If the plant could not supply the stipulated quantity of power, Quezon would be required to pay Meralco liquidated damages, which were relatively low as compared to the plant’s tariffs. The total amount of liquidated damages would depend on Meralco’s power needs and the possibility of finding alternative energy suppliers. More specifically, Quezon would pay Meralco 0.26 Philippine pesos (PHP) for every kilowatt hour (kWh) that it could not supply; this amount would escalate to PHP 0.52 per kWh if the offtaker could not procure the power it needed from an alternative supplier.
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FIGURE C3.3 Contract structure of Quezon Power. Source: Standard and Poor’s
Table C3.2 Guaranteed Minimum Quantity of Electricity Years
Annual Guaranteed Minimum Quantity of Electricity (MWh)
Year 1 Year 2 Years 3e15 Years 16e25
3,149,267 3,268,858 3,388,452 3,288,791
Source: Standard and Poor’s.
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According to the PPA, Meralco was to pay the following: • Capacity fees: USD 0.029546 per kWh, which would be gauged as a function of variations in the U.S. consumer price index from the date that the PPA was finalized (August 1994). Monthly payments would equal the capacity fee multiplied by 1/12 of the relative annual minimum guaranteed quantity of power. • Operating fees: One portion of these fees was stated in local currency and another in U.S. dollars. The fixed operating fee was set at USD 0.0104 per kWh and PHP 0.0323 per kWh; the variable operating fee instead was USD 0.0015 per kWh and PHP 0.0937 per kWh. These per unit amounts were to be adjusted to variations in the U.S. and Philippine consumer price indices, respectively, as measured from the date the PPA was signed. The monthly fixed cost payment was computed as the fixed operating fee multiplied by 1/12 of the respective annual minimum guaranteed quantity of electricity, while the monthly variable cost payment was equal to the variable operating fee multiplied by the plant’s output. • Energy payments: These payments were 1.06575 times the costs incurred for procuring fuel per every million British Thermal Unit (BTU), multiplied by the product of the net output in kWh and 0.00975 million BTUs per kWh. The PPA allowed Quezon to deliver power in excess of the minimum quantity set in the contract priced at 70% of the capacity fee and 100% of the fixed and variable operating fees. If Meralco was not able to buy all or part of the plant’s output, Quezon would have the right to sell this energy to an alternative buyer. In this case, Quezon would have the option to deduct the payments received from third party buyers from Meralco’s payment obligations.
C3.1.2.2 Leases Meralco leased its property rights to the site where the power plant and transmission plants were built to Quezon for as long as the duration of the PPA. In fact, Philippine law allows only citizens or companies controlled by Filipinos to own land or hold property rights on land within national borders. This being the case, the project was structured so that Meralco was listed as holding property rights and relative easements on the land where the power plant and transmission plant were built.
C3.1.2.3 Transmission Line Agreement This established the remuneration that Meralco would make for the use of Quezon’s power transmission network. Payment, which was to be absolute and unconditional, was set at approximately USD 13.8m per year. In other words, the offtaker was obliged to pay even if a force majeure event or a defect in the Meralco system made reception of the power transmitted by the plant impossible.2 2. The agreement was modified in April 2003 when Quezon assented to relinquish 54% of transmission costs upon request by Meralco, a figure that amounted to USD 646,000 monthly. This came after the Energy Regulatory Commission (ECR) (the authority responsible for power distribution tariffs in the Philippines) determined that Meralco was not authorized to charge its customers for transmission costs. Later, in October 2004, following an investigation conducted to ascertain the transmission costs incurred by Quezon, the ECR allowed Meralco to charge its customers 70% of transmission costs. Since that time, the offtaker began to pay Quezon the sums set down in the Transmission Line Agreement, equal to the amounts established in the 2003 amendment. Quezon assumed it could cover the lower takings with a boost in sales of USD 40m in the six years following the agreement, sales that would be made to Meralco within the framework of the PPA. In so doing, the impact of the changes to the Transmission Line Agreement on the SPV’s cash flows would become nearly negligible.
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Furthermore, the Transmission Line Agreement named Quezon as the party responsible for obtaining the necessary permits and for building, financing, and running the transmission line. This accord also granted a building lease to Quezon for the land where the transmission plant was built; Meralco was recorded as owner of this land, in accordance with the Philippine law cited above. Monthly payments to be made by Meralco can be broken down into two components: • Capital cost recovery payments: Relative amounts were earmarked to compensate Quezon for costs incurred for building the transmission plant. Such monthly payments were calculated on the basis of an initial estimated total cost of construction (equal to approximately $500,000 per month), to be adjusted to reflect the actual capital cost of the line incurred by Quezon. • Transmission line operating payments: Monthly payments based on operating and maintenance (O&M) expenses and a portion of some financing fees.3
C3.1.2.4 Engineering, Procurement Contract (EPC), and Construction Management These are agreements signed between Quezon and Bechtel subsidiaries Overseas Bechtel and Bechtel Overseas Corp. (see Figure C3.3). These accords assigned the latter two the task of carrying out all actions and underwriting all contracts needed to set up preliminary projects, to obtain permits, and to build the plant.
C3.1.2.5 Management Service This is a 25-year agreement between Quezon and InterGen pertaining to project administration in the postconstruction phase. It stipulated that Quezon would make monthly payments to InterGen equal to costs incurred, plus a fixed commission of USD 400,000, which was subject to periodic increases over the term of validity of the contract.
C3.1.2.6 Operation and Maintenance (O&M) This is an agreement between Quezon and Covanta pertaining to operating and maintaining the power generation plant in accordance with sector standards. The accord stipulated that Quezon would reimburse all plant-related costs, in addition to a monthly commission of USD 160,000. Further, the O&M provided for the payment of bonuses based on the electric energy output, and on the attainment of pre-set budget targets.
C3.1.2.7 Coal Supply Agreement This is a long-term agreement signed between Quezon and two Indonesian companies, PT Adaro and PT Kaltim, for the supply of coal needed to run the plant. The former was to provide 67% of the required feedstock, and the latter to cover the remaining 33%. In any case, if the two suppliers were not able to respect their contractual obligations, the geographical location of the plant was ideal for receiving fuel from alternative coal suppliers.
3.
Meralco therefore bore both the risk of the possibility that actual costs for the maintenance of the transmission line might be higher than estimated costs and the risk of any potential additional capital spending.
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C3.1.2.8 Wheeling Agreement This is an agreement between Meralco, Quezon, and the National Power Corporation (NPC) for the transmission of electric power from the production plant to Meralco upon payment of a commission.
C3.2 THE PROBLEM Suppose you represented a bank invited by UBS to participate in the five-year syndicated loan discussed in Section C3.1.1. Would you feel comfortable with the contractual structure envisaged for the project? In particular, are there any risks in the PPA agreement signed by Meralco that could create problems for Quezon Power once the financial close is reached? How could you measure the impact of possible troubles faced by Meralco regarding the soundness of Quezon Power?