KDC11- Anand Rohatgi, Synergy Consulting

Why District Cooling Under BOT/BOO Structure May Not Be For Private Sector Off-takers: Learnings from Dhahran District Cooling Project

For Kuwait District Cooling Conference26th January, 2011

Presented byAnand K Rohatgi

[email protected]

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Philosophy of a District Cooling Plant

Key Participants in District Cooling Project

Key Revenue Sources – The Tariff

Requirements for a Bankable Transaction

Profiling of Private Developer / Offtaker vs. Public Offtaker

Key Challenges for a Private Development

Dhahran Area DCP – A Case Study

Conclusion

Solution for Making Such Transactions Viable

Outline of the Presentation

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Highly Profitable From National Economy

Prospective

Presents Attractive Value Propositions To Building

Owners In Terms Of Space

Smart Energy Technology And Economically Efficient

Utility Service

Improvement In Carbon Footprints For The Economy

Lower Initial And Recurrent Operating Costs For DCP

Operator

Lower Cooling Costs To End Users

Reliability In Excess Of 99.7%

Smooth Load Distribution – Lower Cumulative Capacity

Requirements

Philosophy of District

Cooling

Philosophy of District Cooling

Motivational Factors Hygiene Factors

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Utility Guarantees

Offtake Agreement

Key Participants in a District Cooling Project

Lenders

Shareholder 2

Concession Agreement

EPC Contract

O&M Contract

Shareholders Support/Agreement

Shareholder 1

Project Company

EPC Contractor O&M Contractor

Concessionaire

Participant Name Role Of Participant

Shareholders• Project Conceptualization &

Development • Equity Infusion

Lenders • Provision Of Debt

EPC Contractor • Designing, Construction & Commissioning Of Plant

O&M Contractor • O&M Of Plant

Offtaker / End User

• Off Take of Cooling Services• Payment Of Tariff

Developer / Concessionaire

• Right Of Providing District Cooling Services In Development

Project Company

• Provision Of District Cooling Services To Offtaker/End User

• O&M Of Plant• Debt Service To Lenders• Dividend To Shareholders

Utilities • Providing Electricity, Water And Sewage

Utilities

Offtaker

Financing Agreement

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Revenue Sources : For Recovery of Costs Tariff Components

Connection Charge

• Payable to compensate Project Company for Capital Expenditure incurred.

• May include coverage for costs like: Service Line Costs Distribution System

Extension Costs Some Portion of

Other Capex

• One time Upfront fee payable on connection date

No Offtaker or End User = no Connection Charge

Capacity Charge

• Payable by Offtaker to Project Company to compensate for Capital costs.

• Is a function of Contracted Capacity

• Includes coverage for: Debt Service i.e.

Interest + Principal Equity returns for

investors i.e. ROE

• Paid From Date of Connection of Load No End User / load =

no Capacity Charge

Fixed O&M Charge

• Payable to compensate Project Company for Fixed O&M cost

• Includes coverage for costs like: Plant O& M Overhaul &

Replacement Plant G&A Other Fixed

Expenses

• Paid from Date of Connection of Load No End User / load =

no Fixed O&M Charge

Variable O&M / Consumption Charge

• Payable to compensate PC for Variable O&M cost

• Is a function of Actual Cooling provided, EFLH

• Includes coverage for costs like: Water Electricity Sewage Chemicals Variable O&M

• No Impact on Economics if Pass -Through

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Requirements for a Bankable Transaction

Interpretation

Impact

• Provides comfort to Lenders that Debt Service

shall be met within schedule

• Ensures balanced recovery of all project costs

• Ensures appropriate equity returns

• Ensures proper risk allocation

• Ensures availability of economical debt

• Ensures rationale equity return requirements

• Financial viability over the concession term

• Successful DC services

• Rationale tariff levels for the End Users

Key Success Factors

Credit Worthy Offtaker

• A credit worthy Offtaker ensures lower payment risk

• Thus enables access to competitive, long term and high level debt funding

Take or Pay

• Capacity planning should be such that complete capacity is utilized at commissioning

• In case of under-utilization, proper debt repayment should be ensured thru fixed revenues

Risk Allocation

• Contractual framework should be such that proper risk allocation is made to the entity who is best positioned of handling the risk

Tariff Structure

• Tariff structure should be designed so as to cover 100% of underlying costs (Fixed & Variable)

• Should be properly indexed to inflation

A Bankable Transaction

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Profiling of Private Developer / Offtaker vs. Public Offtaker

Aspect Public OfftakerPrivate Offtaker

Single Offtaker Multiple Off-takers

Ability to Project Future Load

High Mainly for Captive Use

Low Demand Linked to Ability to Sell (Real Estate Risk)

Very LowDemand Linked to Ability

to Sell + Use

Balance Sheet Strength / Credit Worthiness

Strong Balance Sheet Ability to Cover Payments

–Credit Worthiness

Weak Balance Sheet No Ability to Service Payments - Not So

Strong Credit Worthiness

No Balance Sheet No Ability to Service Payments - Not So

Strong Credit Worthiness

Contractual Framework Generally Strong Not Very Strong Not Very Strong

Utility GuaranteesAbility to Cover

Non-Availability / Influence Utilities

No Ability of Covering Non-Availability / Influence Utilities


Ability to Support Unrecovered Project Costs

High Low Nil

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Developer • Takes the financial onus of

unachievable projections

Project Company• Undesired increase in

costs absorbed by Public Offtaker

• Thus no impact

Lenders• Strong Balance Sheet

ensures timely debt repayment, thus provides required comfort

End User• Financial onus of wrong

projections on Offtaker• Tariff not prone to

changes

Impact on Stakeholders

• In a better position to project the demand figures as planning based on Captive requirements

• Lower probability of demand-supply mismatch due to planned requirements

• Can take the financial onus of inconsistent projections due to strong balance sheets

Public Sector Offtaker

Developer • Nil as generally may not

take any obligation

Project Company• Bears increase in costs due

to incorrect projections• Thus Higher contingency

requirements or failure to meet obligations

Lenders• May face a risk of delay in

debt repayments• Thus Project may not be

bankability

End User• Increase in tariff due to, if

borne by end users may lead to increased Tariff

• Or failure to receive DC services


• Higher probability of demand-supply mismatch as basic infrastructure for medium-term demand to be created upfront

• Demand linked to ability to sell (real estate risk)• Further offtake subject to start of utilization.• May have to infuse extra equity impacting overall Project IRR

Private Sector Offtaker

Challenge: Capacity Planning and Utilization…1/2

• Not Guaranteed Capacity Requirement Forecast

• No Fixed Schedule + level for such capacity utilization

Capacity Planning / Forecast

?

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Challenge: Capacity Planning and Utilization…2/2

Case Study *

Case Impact on Tariff(If IRR Held Constant)

Impact on IRR(If Tariff Held Constant)

Debt Service

Base Case X Y As scheduled

Case II Increase by 6% Reduction by 3% Can only be met if additional Equity infusion or tariff increased

Case III Increase by 100%(In first 2 Yrs) Reduction by 2% Can only be met if additional Equity

infusion or tariff doubled

Case IV Increase by 35% Reduction by 9% Can only be met if additional Equity infusion or tariff increased

Case V Increase by 15% Y As scheduled

Base Case

• 20,000 TR Capacity, scheduled to be commissioned in 2 phases of 10,000 TR each

• Phase II to start after one year of Phase I• 5% Annual Capex Inflation and 5% annual increase in O&M costs• Base Equity IRR of 15%

Case II • Phase II Moves Forward by 2 years (as compared to scheduled)

Case III • Phase II commissioned on time but demand delayed by2 years

Case IV • Phase II does not happens (Assuming 75% of CAPEX costs incurred in Phase I including that for common infrastructure)

Case V • Phase II not planned from start

* Only Elaborative in Nature

Inference

• Developers Prefer Proposals For Larger Capacity than Real

• Any Short Fall In Future Would Result in Costs to Be Covered by One of the Stakeholders

• If the End Users, Then Tariff May Become Unaffordable

• If the Project, Then May Make Project Unviable

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Developer • Water tight framework

ensures lower but defined / balanced risk

Project Company• Well defined rights and

obligations • Lower risk thus lower debt

and equity costs

Lenders• Well defined contractual

obligations • Acceptable protection for

client risks events• Acceptable project risk

End User• Well defined rights and

obligations • Lower tariff due to lower

overall project risk


• Ensure tight contractual framework with adequate penalties and remittances for appropriate events

• Can favorably influence regulatory aspects


Developer • Mostly nil, as offtaker

takes no obligations

Project Company• Exposed to risks as rights

and obligations not clear and balanced

• May fail to be viable in long term

Lenders• Exposed to substantial

project risk • Thus project not

financeable

End User• Unfavorable clauses may

lead to higher obligation or higher tariff or failure to receive district cooling


• May not ensure a water tight contractual framework leading to increased project risk

• Has little influence on the laws of regulations

• May tend to execute not very strong contracts


• Un-clear / un-balanced risk allocation

• Generally offtaker sided contracts

Weak Contractual Framework

Challenge: Not Very Strong Contractual Framework

?

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Developer • Nil

Project Company• Adequate utility supply

thus plant operational • No cash flow risks

Lenders• No Impact as defined

revenues to the Project for debt service

End User• Lower tariff due lower risk

on Project, Lenders and Shareholders


• Public Offtaker has better control over the public utilities

• Can support adequate and timely supply of utilities to keep the plant operational (utilities a part of overall development)

• Can support payments even if plant is un-operational


Developer • Nil

Project Company• May not be able operate

due to unavailability • Loss of revenue for such

periods

Lenders• May impact ability for

timely debt service• Thus project not bankable

End User• No district cooling service

for periods when plant does not receive utilities

• May result in higher overall costs


• Generally do not take any obligations related to utilities

• Cannot guarantee adequate and timely utility supply

• Poses high risk to the viability of the project


• Utilities may not guarantee adequate and timely supply

Utility Guarantees

Challenge: Utilities - Minimal Control and Full Risk

?

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Developer • Minimal impact as Public

Offtaker have the financial strength to make such payments

Project Company• No impact as payments

are received in full

Lenders• No Impact as defined

revenues to the Project for debt service

End User• May face disconnection (if

End User not same as Developer)


• Generally payments guaranteed by the Public Sector entity

• Public Sector entities tend and have the ability to fulfill their financial obligations


Developer • Nil

Project Company• Reduction in anticipated

revenues• Eventual failure to provide

service if cost unrecovered

Lenders• May put debt service at

risk• Thus project not bankable

End User• If recovered from existing

users - increase cost of services

• Or, no district cooling services


• Onus of tariff collections from End Users on Project Company

• Developers tend to back-end payments to ensure lower upfront to encourage sales. Thus higher risk

• Exposing Project to credit risk from non-payments later


• Risk of delay or non payment by end users

Non Payment by End Users

Challenge: High Payment / Credit Risk

?

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• Due to higher and sometimes unbalanced risks, lenders may not provide Long Term Debt but will only provide Short Term Corporate Finance

• In order to make the project viable, the revenues may need to be able to meet debt service i.e. meet DSCR requirements

• Thus for higher revenue levels, higher tariffs should be required (as compared to Long Term debt transaction)

Un-Competitive Debt Financing

Result: High & Un-Competitive Capital – Debt & Equity

• Due to higher and sometimes unbalanced risks, equity investors may need higher return

• Lender’s requirements of Corporate Guarantees for debt may result in increased equity risk (and thus pricing)

• In order to meet such return requirements, the revenues may need to be higher and thus higher tariffs

High Returns for Equity

8% 9% 10% 12% 14% 16% 18% 75

100

125

150

Tariff vs. IRR

Equity IRR

5 7 10 12 15 18 20 -

50

100

150

200

250

300

Tariff vs. Debt TenorTariff Inhouse ConsumptionTariff Inhouse O&M + CapexTariff DCP ConsumptionTariff DCP O&M + Capex

Debt Tenor Years

Nor

mal

izaed

Mon

thly

Pay

men

t per

TR

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Result: High Cost of Capital – Debt + Equity

8% 9% 10% 12% 14% 16% 18% 75

100

125

150

Tariff vs. IRR

Equity IRR

Assumptions:• In house cooling capex of SR 13,400 per TR of cooling with SR

2200 / TR as O&M each year• Debt interest rate is assumed to be 10% for the computations• Leverage of 70% and tariff is set while ensuring that the debt is

serviced in the required tenor• EFLH of 4,000 Hrs • A typical in-house cooling consumption charge of SR 0.481/TR-HR

whereas for DCP of SR 0.187/TR-HR

Inferences:• DC is viable in the long run due to better efficiency which can be

observed by comparing the consumption charges• The viability increases with the availability of longer term debt• In the above, DCP becomes viable if debt tenor is >9 years

5 7 10 12 15 18 20 -

50

100

150

200

250

300

Tariff vs. Debt TenorTariff Inhouse ConsumptionTariff Inhouse O&M + CapexTariff DCP ConsumptionTariff DCP O&M + Capex

Debt Tenor Years

Nor

mal

izaed

Mon

thly

Pay

men

t per

TR

Assumptions:• Leverage of 70%.• Various combinations of IRRs are used and the

increase in tariff required to meet the IRR is normalized and displayed

Inferences:• To double the IRR from 8% to 16% a 33% increase

in tariff is required in this particular example

To Make Tariff Attractive for End

Users

For Public Off-taker / Developer

For Private Off-taker / Developer

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Dhahran Area DCP – A Case Study

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About ProjectShowcasing the first scheme of its kind in the MENA region

• Saudi Tabreed as Project Developer is required to develop, own & operate a district cooling system to provide cooling services for offices at Dhahran.

• Cooling Capacity of 27,000 TR expandable to 32,000 TR

• Developed under Offtaker’s initiative towards energy conservation & environment protection since District Cooling consumes half the electrical energy as compared to traditional cooling.

• First District Cooling Project to be financed under long term non-recourse project financing structure.

• Project under “Take or Pay” Structure to ensure commercial viability of the Project

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Advantage All – With Public OfftakerPublic Offtaker

Public Offtaker Support• Credibility and strong balance sheet of Public Offtaker

lead to Long Term Non-Recourse debt funding

• Tariff components covered all underlying costs and thus assured returns on equity.

• Lower IRR requirements by equity as assured of repayment thus leading to lower tariff

Adequate Utility Supply• Offtaker agreed to pay capacity payments to Project

Company in case of failure of availability of utilities

• Cost of utility supply accepted as a pass-through cost

• Lead to lower risk of increase in tariff due to non availability of essential utilities

Take or Pay Tariff Structure• The Public Offtaker understood the consequences of

demand supply mismatch and agreed on a Take-or-Pay structure to ensure commercial viability of the project

• Essential so that Project Company can meet its debt obligations on time

Water Tight Contractual Framework• Ensured water tight contractual framework assuring

appropriate risk sharing mechanism

• Ensured low project risk with other supporting aspects for project financing such as termination payments, force majeure coverage, etc

Lower Tariff for End Users

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The Conclusion

Aspect Public OfftakerPrivate Offtaker

Single Offtaker Multiple Off-takers

Ability to Projected Future Load High Low Very Low

Balance Sheet Strength Strong Balance Sheet Not So Strong Balance Sheet No Balance Sheet

Contractual Framework Generally Water-Tight Not So Strong Not So Strong

Utility GuaranteesAbility to Cover

Non-Availability / Influence Utilities



Ability to Support Unrecovered Project Costs

High Low Nil

Projects with Private Off-takers May Not Be Viable

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The Solution: Support from All Stakeholders From Developers

• Consider DC as any other Utility

• Should not be treated as a Construction Contract and consider importance over Concession Term (15-20 Yrs)

• Important to balance between lower tariff & viability

• Work with the Project Company in defining the Project configuration (capacity, schedule, tariff , payments etc)

• Hold partial stake in Project to ensure balanced approach by Project Company

From Lenders

• Treat District Cooling like any other utility concession thus lower risk

• The risk of non-payment is lower as DC alike any other utility is a minimum requirement. Thus disconnection of DC services to End Users is not a likely option

From Shareholders

• Maintain balance between the profitability and viability of the project as this is a utility

• Should budget temporary plants to avoid phasing risk

• Should implement a granular design to avoid phasing risk, the additional cost is a reflection of reduced risk

• Should maintain transparency by involving all stakeholders in sharing both, the appropriate risks and the benefits

From End Users

• Realize the benefit of District Cooling over In-house Cooling

• Should accept a level of “Take or Pay” as may exist in any other utility (similar to power or water)

• Should accept that DC service in the initial period might cost more due to the presence of temporary chillers (ramp-up period) but should be beneficial over long term .

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Thank You

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AbbreviationsABBREVIATION EXPANSION DESCRIPTION

CTA Common Terms Agreement Agreement between the Project Company and the Lenders for the project

DCS / DCP District Cooling System District Cooling System / Plant

DSCR Debt Service Coverage Ratio Debt Service Coverage Ratio

EPC Engineering Procurement and Construction Engineering Procurement and Construction

IRR Internal rate of Return A profitability metric defined as the interest rate at which NPV is zero

O&M Operations & Maintenance Operations & Maintenance

TR Ton of Refrigeration Rate at which heat is removed.

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About Synergy…1/2

• Synergy is a team of 17 professionals• Mr. Anand K Rohatgi – Senior Vice President E-Mail: [email protected] Mobile: +91 9811964229• Website – www.synergyconsultinigfa.com

Foundation

• Financial Modeling & Analysis

• Project Development • Project Restructuring• Financial Restructuring

• Contract Design & Analysis• Structured & Project Finance• Investment Advisory• Mergers & Acquisitions

SYNERGY CONSULTING INC. is an International Financial Advisory firm founded in 2002, providing services in the areas of Investment Advisory, Project Finance, Financial Analysis, Financial Modeling, Project Restructuring, PPP Programs and Policy Reform for the infrastructure sector with focus on Energy, Water, Wastewater, District Cooling and Transport.

Presence

Team

• Offices in Virginia, USA and New Delhi, India• Associate Offices : Cairo, Egypt and Kuwait

Domain

mailto:[email protected]

http://www.synergyconsultinigfa.com/

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About Synergy…2/2An International Financial Advisory Services Company with experience in projects

across 36 countries spanning across most of the continents

Conventional Power

• Oil / Crude• Coal• Gas• IWPPs

Non-Conventional

Power• Solar• Hydro• Wind• Biomass

Water• Waste-Water

Treatment• Water

Treatment

Transportation• Railways• Airports• Air Cargo

District Cooling

and Heating

Other Infra Projects

• Tx Lines• Cement

Plants

Project Financing

Financial Modeling & Audit

Contract Design & Analysis

Debt and Equity Raising

Debt/ Equity

Structuring

Due Diligence

& Valuation

Financial Restructuri

ng

Training Programs

Boutique of Services Offered

Across All Infrastructure Sectors

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Disclaimer

This information has been prepared by Synergy Consulting Inc. for information purposes only and does not constitute an offer or commitment. This information does not constitute investment advice.

You acknowledge that you have read and understand the following terms:

– Any indicative price quotations, or scenarios have been prepared on assumptions and parameters that reflect good faith determinations by us and do not constitute advice by us.

– The assumptions, data and parameters used are not the only ones that might reasonably have been selected, and therefore no guarantee is given as to the accuracy, completeness or reasonableness of any such disclosures, analyses, or quotations.

– The analysis results are illustrative and are not intended to predict actual results, which may differ substantially from those reflected herein.

– Performance, scenario or historical analysis are based on certain assumptions with respect to significant factors that may prove not to be as assumed.

– The scenarios address only certain aspects of characteristics of the transaction and thus do not provide a complete assessment. You should consider whether the behavior of these financial instruments should be tested using assumptions different from those included herein.

– Before entering into any transaction you should ensure that you fully understand its potential risks and rewards and independently determine that it is appropriate for you given your objectives, financial and operational resources and other relevant circumstances.

KDC11- Anand Rohatgi, Synergy Consulting

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