IFC’s Global Experience in Power Distribution

London

March 12-13, 2012

Russian Power

The World Bank Group

IBRDInternational

Bank for Reconstruction

and Development

IDAInternational Development Association

IFCInternational

Finance Corporation

MIGAMultilateral

Investment and Guarantee

Agency

Est. 1945 Est. 1960 Est. 1956 Est. 1998

Role To promote institutional, legal and regulatory reform

To promote institutional, legal and regulatory reform

To promote private sector development – portfolio end 2011: $42.8 billion in 127 countries

To reduce political investment risk

Clients Governments of member countries with per capita income between $1,025 and $6,055

Governments of poorest countries with per capita income of less than $1,025

Private companies in member countries – 1,737 currently in portfolio

Foreign investors in member countries

Products

• Technical Assistance

• Loans• Policy Advice

• Technical Assistance

• Interest Free Loans• Policy Advice

• Equity/Loans - $12.2 billion committed in 2011

• Risk Management• Advisory Services• Mobilized: $6.5

billion

• Political Risk Insurance

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IFC is a Leading Investor in Emerging Markets Power

• 200+ power investments in 57 countries

Generation – Financed 26,000+ MW across wide range of technologies

Transmission – Selected investments in transmission assets

Distribution - Current power portfolio reaches over 20 million customers around the world

• Typically play a leading role in financing early private investments in markets under reform

• Have not been able to do so in Russia, despite early engagement on reform - and financing Mosenergo

• We hope the distribution sector will soon offer an opportunity to contribute 3

Cumulative Commitments since 1967

Total Commitments = US$ 7.8 billion

IFC’s Experience in Distribution

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Project Name Country Sponsor

No. of Customers

GWh Served

IFC Investment

(US$ mm)Regulation

Wholesale Market

1 CAES & EEO & DEUSEM El Salvador AES 637,000 2,023 45 Yardstick Comp competitive 2 Electropaz Bolivia Iberdrola 330,436 935 25 Price-Cap competitive 3 Cepalco Philippines Local Group 88,674 556 15 Price-Cap regulated 4 KOE Ukraine AES 811,285 3,632 24 Price-Cap competitive 5 ROE Ukraine AES 404,387 1,839 11 Price-Cap competitive 6 EDC Venezuela AES 1,100,450 4,726 40 Cost-Plus regulated 7 CPFL Energia Brazil Local Group 4,990,747 34,583 40 Price-Cap competitive 8 AES - Telasi Georgia AES 370,000 1,565 30 Cost-Plus in transition 9 Mosenergo Russia Local Group 4,000,000 56,911 20 Cost-Plus regulated

10 RE & RED Centru & RED Sud Moldova Union Fenosa 738,921 1,710 40 Cost-Plus in transition 11 Edenor Argentina Endesa 2,272,020 14,734 45 Price-Cap competitive 12 ESM Macedonia EVN 700,000 4,618 50 Rev&Price-Cap regulated 13 KESC Pakistan Al Jomaih 2,000,000 8,505 100 Cost-Plus regulated 14 Sedas Turkey CEZ & Akkok 1,400,000 7515 Cemar Brazil Equatorial 1,400,000 3,400 100 Price-Cap competitive

Total 21,243,920 139,737 660

Some lessons distilled from that experience, follow

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Why are Distribution Systems Privatized?

•Govs may have set tariffs set below costs generating mounting subsidies •Billing and Collections: often weak; high arrears; culture of non-payment•Poor Customer Service •Staffing – high number of staff, bureaucratic internal organization •Operational Issues – High technical losses and poor maintenance as a result of sustained lack of proper funding•Private investors are expected to reduce losses, cut costs, improve service

Some combination of these issues triggers privatisation or concessioning of distribution

What the Distribution margin needs to cover

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Cost of Capital

This calculation is generally done at the beginning of the regulatory period (3 years or more)

Multi Year Tariff Regulation

What can go wrong…. Dilution of the Distribution Margin

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Power Purchase Cost and Asset Valuation

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Failure to allow full pass through of generation cost

•Regulatory risk is key – and the rules always change•All of the power sector’s policy mistakes tend to show up here•Often because the distributor not allowed to pass on full generation costs•An agreed level of losses included in costs- but may discover it is too low•Losses above that – valued at wholesale market price or at the import price? •Formula to fund smoothing of fluctuations in generation cost - beware •Devaluation will hit impact capital and maintenance costs•Inflation will impact staff and other overhead costs

Agreement that generation costs can be passed through to the consumer, can in practice, soon lead to a dispute which could bankrupt the distribution Co.

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Devaluation and no indexation

•Below cost tariffs policy – subsidies •Loss-making Billing and Collections – High arrears, culture of non-payment•Lack of Customer Service – No customer focus, lack of service and communication with customers•Staffing – high number of staff, bureaucratic internal organization •Institutional Set Up – Under the tutelage of one Ministry•Operational Issues – High technical losses and poor maintenance as a result of sustained lack of proper funding

Between 1992 and 1998, forty six electricity distribution companies

were privatized worldwide...…raising nearly $28 billion in sales

proceeds

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Privatization of distribution: boomed in the1990s

Since 2000, distribution companies were privatized in Armenia, Macedonia, Ukraine, Bulgaria, Slovakia, Uganda, Cameroon, Turkey,

Pakistan and India

Valuation: Enterprise Value per customer

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Did Privatization Work?

0%

5%

10%

15%

20%

25%

30%

1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Chilectra (Chile) Edesur (Argentina) Luz del Sur (Peru)

19.8%

6.0%

25.6%

8.1%

20.0%

10.1%

1

3

Tota

l Losses (

%)

Turnaround of Privatised Distribtion Cos can be quick

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Controllable costs cut quite quickly

Power Distribution: Main risks for investors

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South American Regulatory Models

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Romania - with a World Bank Guarantee of Gov. Obligations

•WACC: 12% for first regulatory period (FRP) of 3 years; 10% for second•Efficiency Factor: 1% for FRP. For second: 80% of actual over FRP•New investments agreed with Regulator & included in RAB at the start•Loss reduction linked to new capital investments plan. Starting at 13%•Quality Standards: Apply only from 2nd period. Tougher in 3rd

•RAB is indexed to inflation at the end of each regulatory period•Pass through of power purchase costs based on quarterly average•Investors see reliable, long term cash flow which they can borrow againstGovernment’s obligations under the concessions guaranteed

by World Bank

Distribution: Reducing Regulatory & Market Risks• Maximize “choice” at the distribution level through competition in

generation• Adjust and rebalance tariffs prior to privatisation: tariffs will always be

“political”• Establish a transition tariff formula for an initial period – at least 4 years• Establish detailed methodology with efficiency incentives – avoid auditing

costs• Avoid regulatory discretion by agreeing a market based return – e.g. a

utility index• Avoid regulatory discretion by assuming model capital structure e.g. D/E of

60:40• Include a formula to adjust tariffs monthly for inflation and devaluation• Establish a long concession period – 30 years?• Must specify what would happen if terminated – how assets are to be

transferred• Establish clear and measurable quality standards the concessionaire must

meet• Obtain technical audit of distribution losses - agree realistic loss reduction

targets• Obtain regulatory approval for investment program for first regulatory

period• Indicate the upper limit of the efficiency factor “X” for 2 regulatory periods• Obtain an audit for starting “accounts receivable” and what % of that is

“bad debt”

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Trust is All – Prices paid for Distribution Cos. (US$/customer)

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