CUSTOMER:

National Irrigation Administration, Government of the Philippines

SERVICE PROVIDER:

Cal Energy (and local investors)

TRANSACTION STRUCTURE:

Design, Build, Operate, Finance a Power Facility

YEAR:

1995                                             DURATION: 20 years

ILLUSTRATION: This case study illustrates how an equitable risk allocation resulted in a financeable project with the shifting of significant technological risk to the private sector. Identifying government objectives and developing a risk allocation that supports those objectives can result in the transfer of key performance risk, as well as an expedited procurement process. In this project, the government of the Philippines adopted a risk-sharing scheme that appropriately assumed risks which were out of the contractor's control, yet transferred significant technological and performance risks which the contractor was prepared to accept This case study also illustrates how the private sector risks can be allocated among the developer's team.

BACKGROUND: The CE Casecnan Water & Energy Project was conceived in the late 1970s by government planners in the Philippines. The hydrologic and geologic conditions were well studied and the potential for the project clearly defined. Due to recurring rice shortages and frequent brown-outs, the government adopted privatization guidelines that it thought would facilitate private investment in thermal power and hydroelectric facilities. The CE Casecnan Water & Energy Project was particularly appealing because it would serve the dual purpose of addressing the country's rice shortages through providing needed irrigation resources and it would provide power during peak consumption periods. As a result, the project enjoyed widespread political support.

TERMS OF CONTRACT/RISK ALLOCATION: Under the government's privatization guidelines, the government assumed risks that were generally out of the contractor's control including: hydrology risk, currency risk, payment risks, force majeure events, change in law, watershed maintenance, and the risk of institutional changes within the Philippine government. In return, the contractor guaranteed a minimum amount of energy during peak periods at rates which were fixed through the duration of the project (with the exception of adjustment for in Ration). In addition, the contractor guaranteed the collection and delivery of water to a distribution point for irrigation. Since the project involved the construction of 23 kilometers of tunnels at depths of up to 1400 meters, the technical risks associated with this project were considerable.

ISSUES CONFRONTED: Although developers are generally comfortable with the types of risks associated with designing, constructing, and operating a power facility, few developers have been asked to assume sub-surface or geologic conditions risk. Therefore, the developer sought to allocate the risk of the project to its subcontractors, namely its construction contractor. To mat end, the contractor secured a Fixed-price, date-certain construction contract for all the civil works and generation facilities associated with the project. This was the first such tunneling project to be procured under a fixed price. Due to the technical risks involved, the construction contractor supported his bid with liquidated damages of 100% of the contract price for lack of performance or scheduled delays. This was supported by a standby Letter of Credit for 50% of the amount of liquidated damages.

OUTCOME/CURRENT STATUS: After making initial progress in the site development work, the construction contractor, for reasons unrelated to this project, became insolvent. Since this was a default condition under its agreement with the developer, the developer terminated the contractor and drew on the Letter of Credit for damages. In addition, the developer entered into a new agreement with a different construction contractor. Should this problem result in a delay of the project's start date, the developer will use the proceeds from the liquidated damages to serve as debt until the facility becomes operational.