Challenges and Opportunities in Energy

17 BOT STRUCTURES

BOT allows Paolo Lombardo

governments Senior Investment Officer, Private Sector Group
to tap private
resources by
giving private What Is a BOT?
entities a
number of

B
OTs are widely seen as one of the preferred forms of
years in which infrastructure financing, not only in Asia but in many
they can build countries around the world. However, the actual number of
and operate a true BOT transactions that was closed anywhere in the last 12 to 24
facility. months was low.
A BOT is a complicated mechanism that allows governments to
tap private sector resources. Basically, it is an alternative form of
financing for government infrastructure development programs.
Usually, governments give private entities a number of years in
which they can build and operate the facility. After that period it is
quite typical for the infrastructure to be handed over to the
government.
But a true BOT is a project finance transaction, in which
investors base their investment decisions solely on the financial
viability of the project.
They do not look at government guarantees and they do not
look at corporate guarantees of sponsors – they look at the project
itself.
BOT is not an instrument that can be used for all projects – for
instance, manufacturing service industries cannot use the structure.
Even within the infrastructure sector there are areas that are more
suitable for BOTs than others.
There have been some BOTs in telecoms and transport, but the
greatest number of deals has been in the energy sector – power
generation and transmission (see Figure 17.1).
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Figure 17.1: Typical Private Power Project Structure

Two keys to the suitability of a project are:

• stable revenue stream: The less stable the revenue stream, the more difficult it
is to restructure an infrastructure project as a BOT. Energy projects – in
particular, power projects – tend to be more successful, because it is easier to
project revenues, which are the basis for the financial viability of the project;
and
• size: The larger the project the better the costs can be spread, because at the
end of the day, the government is going to foot the bill. If the cost of
developing a project in BOT form is high, it is going to be reflected in the tariff
the government will pay.

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BOTs are often expensive because of the high number of parties involved. In the
financing world, it is common to conduct transactions on a one-to-one basis – there is
a borrower and a bank, a financier. In BOTs, the number of players is much higher.
They include:

• government: the ultimate client. It is the government that wants to build the
infrastructure but does not have the money;
• utility: This might be the power distribution company that is the operating arm
of the government. It may not have the resources or the know-how and
therefore goes into the market place and looks for a private party to help
develop the infrastructure;
• sponsor: Normally foreign players that operate under different rules have
different mindsets;
• lenders: It is the lenders that provide typically three quarters of the financing
of projects. If the government, sponsors, utilities or whoever ignore the
presence of the lenders and their concerns, there is a high chance the project
will fail;
• fuel suppliers: The suppliers to power transactions;
• turn-key contractors: It is quite typical to have a separate company other than
the sponsors to carry out the construction work; and
• project company: an independent operator that runs the project (in some cases).

The relationship between these players must be governed somehow and that is
normally the government’s task through complicated contractual arrangements. The
key to the success of a BOT project is the deep understanding by all parties of three
matters:

• the risks involved;

• allocating the risk between the participants; and
• how cash flow is generated.

BOT Risks

A true BOT is a project finance transaction in which there is no safety net; the
government is not going to bale out the project, or guarantee whether or not the
operation is successful. The equity risk is always there. Sponsors have the upside
potential, but they also risk losing all their money. Financial risks must be shared
between the lenders and the sponsors.
Other project risks will be left with the sponsors, who are most concerned about
the prospects for an interruption of cash flow. This could be caused, for example,
by:

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• political interference;
• technical problems; or
• political violence.

They are going to look at all these possibilities. If there is any category risk that they
are uncomfortable with, somebody else – most likely the government – will have to
pay, possibly in the form of a higher tariff or a higher interest rate on loans.
There are various risk categories and their allocations that are to be considered by
sponsors (see Figure 17.2):

• political risk: This might take the form of political interference by the
governments. Or perhaps this will be the risk of nonperformance by
government’s executing agencies or utility. The government typically is going
to take political risk, although not always 100 percent of it. There are
instances where the sponsors take political risk, but that varies from project to
project and from country to country;
• project specific risk: An example is preconstruction risks. Building a power
station in Asia is not an easy task. For power stations, large pieces of
equipment have to be brought to places that often have no roads or have poor
traffic conditions. Project risks are left with the sponsors;

Figure 17.2: BOT Risk Allocation

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• construction risk: Sometimes there are technology problems that need to be

looked at carefully. Sponsors usually do not want to take any construction
risk, although they do not always get their way on this. They will aim for the
best contractor possible and execute an agreement under which the
contractor undertakes to build the infrastructure in a given period of time at a
fixed price. If the contractor fails, it is going to pay; and
• operational risk: Once all the hurdles are passed, and the infrastructure
project is built, it still has to be run and make money. The sponsor often lays
down that the operator will produce a certain performance from the
completed unit, or else it will be liable to pay.

Risk Mitigation

Anyone who has worked in this sector will find that most of the time is spent trying to
convince sponsors, lenders, and contractors that the risk is either not there or if it is
there, can be mitigated.
Everybody is paranoid about risk because once you put a turbine in a middle of a
desert, it might be yours, but if the project does not work you cannot take the turbine
back with you and then sell it.
It is important not only to identify the risks but also to mitigate them among
participants. Risk mitigation is a key to the success of BOT. A BOT only “flies” if the
risk structure and related allocation is sufficiently robust to survive a combination of
pessimistic scenarios affecting various key players.

Contracts

The first form of mitigation is to have a clear and tight contractual structure that
leaves no holes that can cause problems later. This is difficult given the complexity of
these projects.

Financial measures

Lenders typically require that cash flow streams are sufficiently large and that there
are enough cushions for any hiccups in the implementation of a project. Things can go
wrong in emerging markets, so this must be anticipated and provided for.

Other forms of mitigation

Sometimes sponsors agree to take more risk than they might usually do, depending
on the project. There is also insurance, which will not cover everything and is highly
expensive.
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Risk Allocation

Risks borne by the government

In the case of a power type BOT, once a group of investors decides to invest a billion
dollars in physical assets for a country, such as a power transmission line, that
investment is there for good – it cannot be taken away. So the investors are in the hands
of the government. If the government decides to do something, for example, not to run
the power station, how is the sponsor group – the investor group – going to get its
money back?

Minimum off-take agreements

When a big power station is built, the government undertakes that under all
circumstances it will buy a percentage of the capacity of the power station at a fixed
price. This will be a heavily negotiated point because it ensures that the investors will
have enough money to repay their lenders and their shareholders.

The tariff

This is also negotiated heavily and is usually a painful exercise. It often happens that
the government will have to undertake to perform the contractual undertakings of any
underperforming government entity, according to its contract.

Foreign exchange risk

Who will guarantee that there would be enough dollars to take out of the country to
repay the debt? The answer is the government, which must make available sufficient
amounts of hard currency.

Stable legal framework

BOTs are complicated negotiating exercises that result in the signing of dozens of
documents that set the rules for the implementation of the project. The government has
the power to alter the rules of the game at any point, as it has the sovereign right to
change laws.
If it does so five years after a project has begun construction, the sponsor cannot
do anything about it.
So typically governments must provide strong assurances that there will not be any
change in the rules of the game for the duration of the project.
That is an essential point. If there is no such undertaking, the chances of the project
not going forward are high.
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Government Commitments

A typical contractual structure of a private power project includes a number of

agreements.

Implementation/concession agreement

This is an umbrella contract that keeps the whole thing together. The government
has to formally declare its commitment to the infrastructure development project. If
the government is not behind it in writing, it will be difficult to get investors to come to
any country to finance projects.

Political risk

A typical commitment is to guarantee that there will be no change of law.

Government interference

When building a transmission line, a power station, or a telephone network, it has to

be clear to private investors that for ten, 20 years, or whatever, that it is going to be
their project and the government is not going to interfere. There have to be written
obligations from the government to this effect. Also, private developers have big
difficulties in coping with bureaucracy. The government has to undertake to help them
where it has the power to do so.

Other guarantees

In the case of a fuel supplier that is a state-owned entity – such as a state-owned oil
company that is near bankruptcy – the government will have to back the entity with
guarantees that may even survive privatization. Certain events may occur that should not
result in the government penalizing the sponsors. If a government opts for BOT rather than
a BOO structure, then it will have to deal with the issue of termination – what is going to
happen at the end of 15 or 20 years? And there is also the issue of how to transfer the
facility. The government wants to protect itself to ensure that on transference, something –
say a power station – that is in operational condition is well-maintained.

Conclusion

BOTs are extremely powerful mechanisms. A government can raise a large amount of
money if it plans the deal right. But BOTs are not an easy option. Based on the Bank’s
experience of BOTs, there are several factors that can be identified as contributing to a
country’s success:

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• sound policy and regulatory framework: There should be a BOT Law, some
sort of foreign investment law that sets the general rules of the game,
otherwise it will make investors’ life more difficult and will reduce the
likelihood of projects succeeding;
• strong government support: The government is the client, therefore it is in its
interest to facilitate the process. The problem cannot simply be handed to the
private sector. BOTs are a partnership between the private sector and the
public sector. As in any partnership if one of the two partners does not play his
or her part, it is not going to work. Instead, the amount of work is probably
going to rise exponentially. The two parties have to be side by side, working
together to ensure success. It takes years, in which either the government
develops a good relationship or the project will not go ahead;
• clarity: The project formulation and documentation have to be as clear as
possible. Some countries opt for standard documents given to all the parties
involved in power projects. In some cases this strategy works, but at other
times it causes governments headaches because every project is different. A
perfect standard document has to be adopted for every single project.
Whatever the case, the documents have to be clear and transparent;
• real priority projects: There is no point in chasing projects that are not a
priority, because they are going to have a high chance of falling apart. It would
be wasting resources and investors’ time;
• transparency: It is fundamental that the selection process of sponsors be
carried out in a transparent manner;
• responsible sponsors: Governments should deal with responsible sponsors.
Responsible does not simply mean lots of money. It means people who know
what they are doing and have a long-term commitment to a country;
• profitable: Projects that might barely break-even should not be attempted,
because nobody is going to finance them. Sustainability is an element of
profitability. Projects cannot be based on heavy subsidies because one day the
government may not be able to sustain the hidden costs; and
• fair deal for all parties: This is the most important of all. If the private sector
investors are taking advantage of the government, the deal is going to go
under. If the government takes advantage somehow of the private sector, the
deal again is going to fall through. It must be a win-win situation.

The Bank’s Private Sector Group

The Bank has a group that specializes in private sector infrastructure financing,
including BOTs, called the Private Sector Group, which can be approached
directly or through the public sector side.

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