Dalian Water Supply Project

February 26, 2004

Alyona DubrovinaJim Horiuchi

Henning Hummervoll

Context

• China, 1994• Asian Development Bank considers $160 M investment in

a water supply project

Background

Project Description

Analysis

Conclusion

17% Infant mortality rate Cambodia

Aids spreading in Africa

75 million living below poverty line in China

Problem definition

• Which project should be financed?

Agenda

• Background

• Project description

• Analysis

• Conclusion

China

• 1.17 billion people (1994)• Steady reforms since 1978

– GDP growth of 9% per annum– Infrastructure bottlenecks

• Tight political controls• Pressures for reforms

– Increased trade– WTO

Background

Project Description

Analysis

Conclusion

Dalian Municipality

• Important seaport • Technology Development Area• Growing population

– 4.7 million in 1997 growing at 3% pa

• Water supply shortage– Lowest average supply

– Static water tariff level 1952-1992

Dalian China Asia

Water Supply (lpcd) 155 170 300

Background

Project Description

Analysis

Conclusion

Project description

Background

Project Description

Analysis

Conclusion

Scope of Project

• Increase water supply – 220 lpcd per person– 2.2 million residents, farming and industry

• Project goals – Alleviate water shortage – Improve public health – Support regional growth– Increase water treatment capacity

Background

Project Description

Analysis

Conclusion

Project Mechanism

• Transport water – Biliuhe Reservoir Dalian (160 km or 100 miles)

• Total project cost: $379.7 million• Project components:

• Water conveyor (68 km)• Two pipelines (94 km and 79 km)• Two new pumping stations• Water treatment plant near Dalian• Distribution lines + storage tanks

• Project completion by September of 1998

Background

Project Description

Analysis

Conclusion

Project Location

Biliuhe Reservoir

Dalian City

Part A:Northern Conveyor (68 km)Transporting raw water to Wazidian Reservoir

Part B:Southern Conveyor (2 pipelines of 68 km and 79 km)• Conveying raw water to pumping stations and water treatment plant• Transport treated water through water distribution lines

Wazidian Pumping Station: Sales of raw water to DWSC takes place

Background

Project Description

Analysis

Conclusion

Stakeholders

• Executing Agencies – Dalian Water Supply Company

– Northern Water Supply Company

• Debt holders– Dalian Municipality Government

– Asian Development Bank

– China Construction Bank and other commercial banks

• Other stakeholders– Dalian population, farming

community and industries

Background

Project Description

Analysis

Conclusion

Financial Structure: Use of Cash

• Total project cost: $379.9 million

Background

Project Description

Analysis

Conclusionv

Financial Structure

• Sources of Cash– Loans:

• ADB

• Local commercial banks

(China Construction Bank)

• PRC government

– Ministry of Water Resources

– State Planning Commission

– Gant from PRC government

– Dalian municipality’s own resources

Background

Project Description

Analysis

Conclusion

Financial Structure (continued)

• Effectively “all-PRC” funding other than ADB Loan– Enhancement of credibility

Execution Agents

• Dalian Water Supply Company

• Northern Water Supply Company

ADB

Loan relent under separate loan agreements

Debt ServiceDisbursement

Debt Service

Local Commercial

Banks

• Ministry of Water Resources

• State Planning Commission

Dalian Municipal

Government

Debt Service

Disbursement

Grant

Project Execution & Management

Central Government

Background

Project Description

Analysis

Conclusion

ADB Loan: Terms & Conditions

Currency & Loan Amount

US$160 million

Purpose To finance the foreign-currency component of the Dalian Water Supply Project

Borrower The People’s Republic of China

Interest Type Floater based on ADB’s pool-based rate lending system (similar to cost of funding)

Grace Period 5 years

Repayment 20 years commencing 6 months from the end of grace period

Total Term 25 years

Commitment Fee 0.75% p.a. on undisbursed balance

Covenants - DSCR to be maintained at minimum of 1.2x - No additional debt without prior consent of ADB

• Summary of terms and conditions

Background

Project Description

Analysis

Conclusion

Analysis

Investment Criteria

Goal Criteria

• Project sustainability Returns exceed project cost of capital

• ADB’s sustainability Returns exceed ADB’s cost of capital

• Achieve economic growth

Maximize economic benefits

Background

Project Description

Analysis

Conclusion

Project cost of capital

Background

Project Description

Analysis

Conclusion

• Cost of debt 8.51%– US 30-year treasury 7.37%

– 1994 Chinese government bonds spread 1.14%

– Risk mitigation factors (discussed later)

• Cost of equity 15.82%– Market risk premium 3.5%

– Sovereign risk premium 8.51%

– Equity beta 0.3

– Risk mitigation factors (discussed later)

• WACC 10.5%– Capital structure: 53% equity, 47% debt

Project risk analysis

- Dependence on completion of environmental protection and wastewater programs

- Agency risks associated with large project and no direct foreign involvement

- Availability of inputs- Size and sustainability of reservoir- Stability and cost of power supply

- Dependence on tariff increases for profitability- Currency risk

- Possible floating of Yuan could result in devaluation and difficulties in repayment of loans in USD as income is in Yuan

Background

Project Description

Analysis

Conclusion

Results of financial analysis

Background

Project Description

Analysis

Conclusion

– Negative NPV $(474.9)M– IRR 8.9%– Growth rate and discount rate sensitivity:

• Base case: Growth rate 9%, discount rate 10.5%

8.5% 10.5% 12.5% 14.5% 16.5%5.0% 63.0 (531.8) (923.5) (1,179.2) (1,343.2)7.0% 103.9 (502.9) (902.8) (1,164.2) (1,332.2)9.0% 144.7 (474.0) (882.0) (1,149.2) (1,321.2)

11.0% 185.5 (445.1) (861.3) (1,134.2) (1,310.2)13.0% 226.3 (416.2) (840.6) (1,119.2) (1,299.2)

Discount Rate

Gro

wth

Ra

te

Project most likely not attractive to private investors

Sensitivity Analysis: Key Variables

Background

Project Description

Analysis

Conclusion

Sensitivity Analysis - Impact on NPV

0.9

0.9

0.9

0.9

0.9

0.9

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0.9

1.1

1.1

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1.1

($1,000.00) ($800.00) ($600.00) ($400.00) ($200.00) $0.00

DWSC Ind water tariff

DWSC Ind water sales

DWSC raw water expense

DWSC institutional water tariff

DWSC power expense

DWSC domestic water sales

DWSC domestic water tariff

DWSC institutional water sales

NWSC Ind water tariff

NWSC Ind water sales

NWSC institutional water tariff

NWSC domestic water sales

NWSC domestic water tariff

NWSC raw water expense

NWSC institutional water sales

DWSC salaries expense

NWSC power expense

NWSC salaries expense

NPV

Key variables:

− Water Sales

− Water Tariff

− Raw water expense

− Power expense

Sensitivity analysis: NPV

•

Background

Project Description

Analysis

Conclusion

Frequency Chart

Certainty i s 98.60% from -Infi ni ty to $0.00

.000

.008

.017

.025

.033

0

8.25

16.5

24.75

33

($1,557.67) ($1,137.25) ($716.84) ($296.42) $123.99

1,000 Trials 992 Displayed

Forecast: NPV at WACC

•Expected NPV $(723)

•Less than 2% probability of positive NPV

Sensitivity analysis: IRR

•

Background

Project Description

Analysis

Conclusion

Frequency Chart

Certainty i s 54.50% from 7.93% to +Infinity

.000

.009

.018

.026

.035

0

8.75

17.5

26.25

35

4.45% 6.18% 7.92% 9.66% 11.40%

1,000 Trials 986 Displayed

Forecast: IRR

Expected IRR 7.93%

ADB’s perspective

• Returns to ADB equal interest rate • Variable interest rate exceeding cost of capital• High probability of default on debt payments 83%• ADB’s debt is expected to be honored at the expense

of other debt holders

Alternative sources of financing

• Corporate finance– Municipality owned operating agencies: inefficiencies and

agency problems– Illiquid assets

Private sources: Highly unlikely

• Limited recourse project finance– Elimination of agency problem– Local and state government resistance– Not a Greenfield development– More expensive

Private sources: Highly unlikely

Background

Project Description

Analysis

Conclusion

Economic analysis

• Benefits: High– Increase GDP, productivity, foreign investment– Improve public health– Eliminate inefficiencies in water sector

• Costs: Low– Wastewater treatment– Additional subsidy– Opportunity costs

• Risks: Low– In case of operational success economic benefits

will be achieved

Background

Project Description

Analysis

Conclusion

Conclusion

• Financial analysis should be enhanced by economic analysis– Unconvincing financial projections– Strong economic benefits and low risks

• We recommend to invest in the project

Background

Project Description

Analysis

Conclusion

What happened

• Loan approved for $160 million• Reappraisal in 1997 extended scope

– 2 subprojects implemented to utilize northern conveyor

• Economic internal rate of return estimated at 13.4%• Projected completed on time• Knowledge and project skill transfer deemed successful• Opened up for 8 more water supply and wastewater

management projects including BOT and international investments

Background

Project Description

Analysis

Conclusion

Questions?