Date: October, 12, 2014

To: Dr. Kalyan Singhal

From: Gregory Steinbrenner
RE: Analysis of InterGen and the Quezon Power Project


The Quezon Project

The Quezon project involved the construction and activation of a 440-megawatt coal-
powered electric generating plan on the island of Luzon. The project was managed by
International Generating Company (InterGen). Quezon was the first private power plant built in
the country without a sovereign debt guarantee, the first to sell directly to a distribution
company, and the first to raise project financing in the U.S. capital markets. The Quezon project
was scheduled to come on-line in January 2000. In additional to the coal-fired electric
generation plant, the project also included installation of a 31-kilometer 230-kilovolt
transmission line, and construction of other related facilities.
The Project required complex set of operating contracts including but not limited to:
1. the management services contract with InterGen,
2. the operations and maintenance contract with Ogden,
3. the power purchase agreement with Meralco,
4. the agreements with Meralco to lease land for the generating plan and transmission line,
5. the EPCM contracts with Bechtel affiliates BOC and OBI,
6. the coal supply agreements.
Project Risks
There were four major risks associated with the Quezon Project. The first was approval
risk. There was some opposition to construction of the power plant from both official and
unofficial sources. However, this was mitigated because the country desperately needed power.
In addition, InterGen invested in community development programs to get local support.
The second source was construction risk. This was minimized by the expertise from
Bechtel in building and servicing power plants for more than for years. In addition, the
Engineering, Procurement, and Construction Management (EPCM) contracts guaranteed the
December 1999 completion date as well as operating and environmental performance levels.
Further, the EPCM contract contained substantial penalties if provisions were not met.
The third source was financial risk. This was somewhat greater than the approval and
construction risk. The project was the first significant one in the Philippines without a sovereign
guarantee. This essentially meant that there was not guarantee by the government that all
obligations would be satisfied when and if the primary obligor went into default. Therefore, the
cost of capital for the project would be higher. The projects investment bankers were optimistic
about the prospects of a successful offering, but nothing was assured until a major lender had
signed on.
The fourth source of risk was operating risk. This was expected to be minimal because of
InterGen and Bechtels extensive experience in constructing and operating similar plants in
emerging markets. In addition, the Meralco agreement obligated them to cover all fixed and
variable operating costs. InterGen had also established long-term contracts with coal suppliers.
The only major concern was Quezon was relying on Meralco as it single customer. Meralcos
franchise to serve the city of Manila was due to expire, and currency risk by Meralco could cause
them to lose profits on the power purchasing agreement with Quezon.
The final source of risk was currency and country risk. In order to minimize this risk,
both the debt and the Meralco contract were denominated in U.S. dollars because of the reduced
volatility in U.S currency. In addition, InterGen believed that the Philippines country risk
would decline over time as a result of the democratic movement in the country.
Because the majority of the risks had been minimized by InterGens management, the
project was expected to have strong financial returns. By the time project construction was
completed, the NPV of the project was estimated at $139.8 million and equity estimated at
$114.2 million. However, the Philippines Department of Energy (DOE) started to approve new
gas fired projects which would have lower operating costs than the Quezon plant. This could
reduce the operating income of the plant because Meralco may choose to renegotiate its power
purchasing rates. In addition, in 1997 and 1998, there was an Asian financial crisis which
reduced the value of Philippine currency. This resulted in slower economic growth in the
country. All of the factors reduced would impact the NPV value of the project.
Recommendations
Power Investments Limited (PIL) has offered to buy half of Intergens equity for $85
million. Even though the PIL offer looks attractive, Greg Daul should recommend turning down
the offer for the following reasons. Most of the project risks have been minimized which why he
should feel comfortable with his discount rate of 14% in 2000 and estimated equity value of
$179.4 million.
This is supported by the following. They have a contract guaranteeing completion of the
construction. In addition, they have operating contracts that minimize operating risk. Although,
the DOEs approval could impact the NPV of the project, the economic growth in the
Philippines has been a strong 5 6 % which should provide strong enough demand to offset and
growth in supply in the region. In addition, demand for power was expected to growth more
than 7 percent annually through 2010. Further, it is estimated that more than 24,000 megawatts
(MW) of power will needed to be built to handle this demand. Quezon was only going to
provide 440 MW which is only 1.8% of this demand. Therefore, the impact of other suppliers
entering the market should be minimal the Quezon. In addition, this will also not impact
Meralco for the same reasons.
In regards to the Asian financial crisis, this could provide a negative short-term impact on
the value of the project, but the growing demand for power will offset any potential short-term
slowing in economic growth. In addition, the management of the project risks stated above will
make the long-term benefits and value from the project far outweigh any short-term issues such
as the Asian financial crisis. Finally, InterGen has protected itself by setting up contracts in U.S.
dollars. Therefore, InterGen should hold onto it 47.875% equity in the Quezon project.