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Financing of gas distribution projects in TurkeyClifford Chance: Riko Vanezis Fidan&Fidan: Erdoğan Fidan
9-10 June 2009 – Istanbul
A worker checks a pipeline in Siberia. Source: www.spiegel.de
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 2
Overview
Privatisation in the gas sector (including structuring issues)
Risk factors in gas distribution projects. The Turkish experience versus the expectations of international lenders and investors:
Security of supplyLender step-inChange in law
Privatisation in the Turkish gas sector: The legislative framework
A worker checks a pipeline in Siberia. Source: www.spiegel.de
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 4
The legislative framework: general overview Natural gas market activities are regulated by the Natural Gas Market
Law (Law No. 4646)(the “Natural Gas Market Law”) and the attendant secondary regulations
Natural gas market activities regulated under existing legislation are: Import Transmission Storage Wholesale Export Distribution CNG (transmission and distribution)
The production of natural gas is regulated by the Petroleum Market Law (Law No. 5015) and is not considered a natural gas market activity
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: licensing regime A licence from the Energy Market Regulatory Authority (“EMRA”) is
required to carry out any natural gas market activity Licensing is chiefly regulated by the Natural Gas Market Licensing
Regulation A separate licence is required for each type of market activity as well as
for each facility Types of licences mirror the classification of natural gas market activities
and are as follows: (i) import licence; (ii) transmission licence; (iii) storage licence; (iv) distribution licence; (v) wholesale licence; (vi) CNG licence; and (vii) export licence
Licences are granted for a term of 10 to 30 years and may be extended upon Licensee’s request for a term of 10 to 30 years at the discretion of EMRA
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: the unbundling of BOTAŞ and the liberalisation programme
The unbundling of BOTAŞ As per the Natural Gas Market Law, BOTAŞ is to be unbundled
by type of activity starting in 2009 The privatisation of local gas distribution networks, however, was
commenced with immediate effect from the effective date of the Natural Gas Market Law
Except for gas transmission, the separate entities formed upon the unbundling of BOTAŞ will be privatised within 2 years
In the end, the title “BOTAŞ” will only refer to the gas import entity
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: The unbundling of BOTAŞ and the liberalisation programme
The gas liberalisation programme The Natural Gas Market Law requires BOTAŞ to transfer
gradually the greater part of its import operations to private entities
BOTAŞ is to tender its import contracts until the amount of its imports decreases to a level as low as 20% of the country’s annual consumption. (Must have been achieved by the end of 2009.) Market players would like to see this requirement satisfied fully.
Each year BOTAŞ must tender import contracts accounting for at least 10% of its aggregate import commitments outstanding as at the effective date of the Natural Gas Market Law
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: Privatisation of local gas distribution The Natural Gas Market Law contemplates the privatisation of
local gas distribution networks by way of public tender The Natural Gas Market Law contains specific provisions in
respect of the privatisation of Eskişehir, Bursa and Ankara gas distribution networks
The “Natural Gas Market Distribution and Customer Services Regulation” (the “Distribution Regulation”) sets out guidelines in respect of the privatisation of local gas distribution networks in any given city (including tender procedures and formalities) as well as general service standards to be met by the incumbent distribution company
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: Privatisation of local gas distribution networks As per the Distribution Regulation, EMRA is authorised to identify
cities whose local gas distribution networks will be tendered and to determine the licence period (taking into account the characteristics of the relevant city) as well as any other matter in relation to the tender
Tenders comprise the right to a “Distribution Licence” along with title to the infrastructure comprising the local gas distribution network
Prequalification is based on financial strength and relevant previous experience of the bidder(s)
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: certain obligations attaching to a Distribution Licence
An incumbent distribution company must: Undertake extension/development works in relation to the distribution
infrastructure to the extent required under, and as per the terms of, its Distribution Licence, the share sale and purchase agreement and the applicable tender specifications
Connect all customers (whether Eligible Customers or not) in its designated area to the network and sell and deliver gas to the same save when doing so is technically or economically unfeasible (in case of conflict, EMRA will have the final say)
Provide transport and other ancillary services to Eligible Customers and their suppliers on request
From time to time provide evidence to EMRA that its operations are cost-effective, efficient and safe
Unless otherwise allowed by EMRA, not source more than 50% of its gas from the same supplier
Not have more than two Distribution Licences in Turkey unless otherwise approved by EMRA
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: certain obligations attaching to a Distribution Licence – The Municipality share
The incumbent distribution company must offer to the Municipality (or its affiliate) at least 10% of the shares in the distribution company without requiring any corresponding capital commitment from the Municipality
The Municipality may request an additional 10% of the shares in the distribution company by committing the corresponding capital (so long as the Municipality is not indebted to the Treasury and does not use Treasury guaranteed funding to that end)
In the event the Municipality's shareholding falls short of securing a seat on the Board of Directors of the distribution company, the Municipality may require the distribution company to provide it with seat(s) on the Board of Directors and the Board of Auditors as per Article 275 of the Turkish Commercial Code
The legislation is silent as to whether this is a Day One obligation or whether the Municipality share must be maintained at all times
This is particularly relevant in a project finance where Shareholders (in their role as Sponsors) are required from time to time to inject equity into the Project Company – What will happen if the Municipality is diluted as a result of Sponsors’ equity contributions which increase the share capital of the Project Company?
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: certain rights attaching to a Distribution Licence
An incumbent distribution company: Has exclusive rights in sales to Non-Eligible Customers in its
designated area May, subject to EMRA approval, sell and transfer within the
licence period the distribution network as a whole to a third party(EMRA approval depends on, inter alia, whether the distribution network will be sold and transferred as a whole, the services will not be interrupted and the consumers not adversely affected and whether the third party has the eligibility requirements for holding a Distribution Licence)
May request the extension of its licence period by applying to EMRA one year prior to the expiry of the licence period
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The legislative framework: Eligible Customers An Eligible Customer is a customer:
Whose annual consumption level is above a limit determined by EMRA from time to time;
Which purchases gas for the purpose of generating electricity; Which is a cogeneration facility generating heat and
electricity; or Which is a domestic natural gas producer
An Eligible Customer is not subject to the territorial exclusivity of local gas distribution companies and has the right to choose its supplier
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 15
Structuring the deal: a few words In principle, how could the local gas distribution network be privatised?
If the asset already exists (i.e. the network is already built), BOT structure inappropriate. However, the network could be extended: this would bring an element of ‘B’ to ‘BOT’
Transfer of operating rights / Concession Agreement Share sale
In practice, explaining structuring requires concrete facts. Every deal is different: Different players and different public sector interests. Is the public sector primarily trying
to improve its balance sheet by privatising the local gas distribution network? The pros and cons of a Concession Agreement regime versus a share sale may vary
from case to case Overall, however, both the private and the public sector may prefer a share sale
structure because:– The private sector gains the benefit of taking over a company holding a Distribution Licence with employees who
know the local gas distribution network; and– The public sector gains the benefit of having their (public sector) employees learn new methods of working from the
private sector We will assume:
Pre-existing local gas distribution network; Private sector Sponsors, financial and strategic; and The private sector will take over the company which presently runs the local gas
distribution network through a share sale
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 16
Structuring the deal: share sale issues Which method of share sale / merger under Turkish law will be utilised? Due Diligence of the Target
What to check?: pre-existing liabilities and major sources of revenue, for example. Environmental issues will be high on the Lender list of concerns
Who should do the checking?: Sponsor-purchasers, financiers, specialist advisers. Only one point of contact with the public sector?
Who is the private sector’s counterparty? In respect of payment of the purchase price? In respect of on-going support (post-share sale)? Is there any recourse against the public sector? Are any Representations and Warranties made
by the public sector? How will the purchase price be structured and how does that fit with the financing?
Upfront 100% payment? Partial payments
EMRA approval required for sale of shares What does one actually purchase with the shares?
Does the public sector retain control over certain assets? Can it influence decisions even after relinquishing ownership?
What will be the share transfer procedure and the attendant timing?
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 17
Structuring the deal: share sale issues (continued) The expertise of the private sector may not be in BidCo. How does
one involve the company with that expertise? Service Agreements Secondment Agreements
Who will be the Borrower under the financing, before the share sale / merger, and after?
The operations needing financing are in the Target The acquisition financing – for the purchase of the shares – must be
made to the BidCo Downstreaming funds (e.g. shareholder loans) Upstreaming funds (e.g. dividends, service payments, guarantees?) Employment issues are ever-present:
Issues with unions Pension liabilities Employment claims
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 18
Privatisation by way of share sale: the financing If it is a share sale, the financing must be Acquisition Finance as opposed to
Project Finance, right? Not necessarily, but the final answer depends on the financing structure
Lenders issues: They will consider whether the local gas distribution network has a proven commercial track record against
which to lend. The more ‘unknowns’, the less likely Acquisition Finance would be considered appropriate; and Are the Lenders, therefore, financing an actual definable business or only a cashflow?
Nevertheless, Lenders must recognise that: The local gas distribution network is an active commercial venture serving customers; and The Sponsors will require some financing flexibility in executing the share sale and readjusting the commercial
operations of the Target local gas distribution company, post-Closing Elements of Acquisition Finance, therefore, can be valuable in creating more
flexibility for the Sponsors; for example: Types of loans: Working Capital, Revolving; Representations; Covenants; Events of Default; Insurance
Over what can security be taken? Difference between Project Finance (greater security) and Acquisition Finance (more flexibility) EMRA approval
Do the Sponsors have a real plan, post-purchase?
Bankability issues: (1) Security of supply
A worker checks a pipeline in Siberia. Source: www.spiegel.de
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Turkey’s position in the European gas network
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Russian Gas Distribution. Source: Energy Information Administration (www.eia.doe.gov)
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
The social, geographical, economic and political context
Turkey has a strategically important position between Western Europe and the Middle East / Caspian Sea
Turkey has a growing population and energy needs The Russian question. The Iranian dilemma
Over 70% or even 80% (depending on one’s source of information) of Turkey’s gas needs come from abroad with Russia as the biggest supplier
Who needs the gas in Turkey? Who needs the gas passing through Turkey?
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Security of supply: Lender expectations
Lenders look to predictability of supply, both in terms of volume and price
They look at every link in the chain: gas supplying nations, national gas suppliers, local distribution companies, end customers
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Security of supply: ‘Getting to the border’
Doubts have been raised about the reliability of certain gas-producing nations:
Politically reliable (e.g. Iran, Russia)?Sufficiently rich in gas (e.g. Caspian Sea
producing nations and the Nabucco Pipeline Project)?
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Security of supply: ‘We’re in. What now?’
BOTAŞ’ monopoly position in (domestic) Turkish gas supply. A benefit or a risk?
Lenders also concerned about intermediate links in the chain:
Are there any participants between BOTAŞ and the local gas distribution company?
What is their role and how important is that role?
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Pricing and payment
Lenders will want transparency regarding the pricing which their Project Company borrower needs to pay (to gas suppliers) and receives (from customers)
The timing and method of payment can also be key
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Pricing and payment (continued) Concerns of the Turkish gas supplier (i.e. BOTAŞ) versus
those of the local gas distribution company Vertical integration. Are there any intermediate agreements with
intermediate players? Is the local gas distribution company actually buying from BOTAŞ?
Are there individual contracts with large volume consumers? What are their terms? Who are the large volume customers (e.g. a power plant or a hospital)?
Fixed price? Volume discounts?
Residential customers may prefer to prepay in order to receive price discounts
Difficulty in determining what cash is effectively available. Prepaid amounts are not ‘real’ revenue because they are in respect of gas which will be supplied in the future and whose price at the date of supply may be greater than that at the time of prepayment
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Bankability issues: (2) Lender step-in
A worker checks a pipeline in Siberia. Source: www.spiegel.de
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 28
Step-in rights: Lender expectations Lenders expect to be able to step in and remedy breaches
by the Project Company in order to minimise the risk of termination of the Share Sale and Purchase Agreement / Distribution Licence by the Authority
Ideally, Lenders would want Direct Agreements to be entered into between the Authority, the Project Company and Lenders in order to provide a clear framework for rights and obligations in the event that the Project is in difficulty
The more favourable the termination compensation regime, the less important step-in rights become
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 29
Step-in rights: typical characteristics
Trigger events. Ideally linked to defaults under the Finance Documents and/or the Share Sale and Purchase Agreement / Distribution Licence
Cure periods and procedures may be heavily negotiated:
Lenders will want the greatest amount of time possible as well as the possibility to ‘wipe the slate clean’ if problems are fixed
The Authority will want uninterrupted services as well as a right to intervene
The Authority often requests that the Lenders (and not just any special purpose vehicle they may use) become jointly and severally liable for any Project Company liabilities
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Step-in rights: the Turkish experience To date, Direct Agreements with Turkish public authorities have not been
available We have seen:
Authorities undertaking to inform Lenders of their intention to terminate. But this has not been coupled with an opportunity for the Lenders to seek to cure breaches
In certain privatisations, a form of step-in right for the Lenders, but without any direct recourse to the Authority, has been granted to the Lenders
A requirement to obtain Authority consent (and other consents (e.g. EMRA)) when changing the Project Company
In gas distribution projects, Article 5 of the Natural Gas Market Licence Regulation grants a form of step-in right:
Beneficiaries: banks or financial institutions financing a company holding a Distribution Licence under a non-recourse or limited recourse project finance scheme
Such banks or financial institutions may request that EMRA substitute the relevant licence-holder company with another company on the condition that the substitute meets the eligibility requirements for holding a Distribution Licence and assumes and fulfils all obligations of the licence-holder company
EMRA step-in possible pursuant to the terms of the Distribution Licence
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Article 28, Natural Gas Market Licence Regulation A gas distribution company may sell its assets (such as the
distribution facilities/network) to another legal entity provided that EMRA approval is obtained and the Distribution Licence term has not expired (Article 28, Natural Gas Market Licence Regulation)
The entity purchasing the assets must ensure that it has been issued with a Distribution Licence prior to purchasing such assets
According to Article 32 of the Distribution Regulation, the sale proceeds obtained from the sale must be paid to the previous licence-holder, but Lenders should require that any funds remaining following the deduction of any sale-associated costs and expenses be assigned to the Lenders as security
Would a purchasing BidCo acquiring shares of a licence-holding company and then merging with such company require a Distribution Licence? No, not if the merger takes place by way of total succession merger
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 32
Lack of step-in rights: mitigation of risk
Share security Sale of shares to Lenders (or a substitute entity) may be subject to
Authority (and other public body) consent Can exercise security over voting rights
Step-in rights at subcontract level For example, EPC Contract, O&M Agreement
Ultimately, the aim is to deal with problems before they have a lasting effect on the Project Company’s ability to fulfil its obligations under the Share Sale and Purchase Agreement / Distribution Licence
Where no step-in rights are available, a risk mitigant may be the presence of an acceptable termination compensation regime
The Distribution Licence itself cannot be assigned (Article 5, Natural Gas Market Licence Regulation). But the receivables arising under the Distribution Licence may be assigned to third parties (e.g. to the Lenders) provided that EMRA approval has been obtained
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 33
Step-in rights: a comparative analysis
Step-in rights available in many jurisdictions For example, UK, Greece, Germany and to a
lesser extent, Spain In France, step-in rights not common
In some French privatisations, there are step-in rights in the Concession Agreements, but no Direct Agreement. Eurotunnel exceptionally had a Direct Agreement
In some recent PFI/PPP deals, there have been Direct Agreements
Consent from the Authority to a change in Project Company required as a matter of law
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 35
Change in law: Lender expectations
Change in law should be a shared risk (other than discriminatory or specific changes in law (which should be borne entirely by the Authority)) Thresholds
Relief for change in law includes: cost and expense compensation adjustment of the terms of the Share Sale and
Purchase Agreement / Distribution Licence extensions of construction and other deadlines
Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009
Change in law: the Turkish experience
Some instances of limited change in law protection in respect of capital costs of change (but no revenue or operation cost protection)
In relation to gas distribution projects, change in law may be relevant to the following:
Tariff levelsThe K-FactorTaxationDefinition of ‘Eligible Consumer’
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Fidan & Fidan Ingas 2009, Istanbul – 9-10 June 2009 37
Change in law: a comparative analysis
Varied experience Authority bears full risk
For example, Greece
Project Company bears full risk For example, Spain
Sharing of risk (as outlined above) For example, UK, France
Clifford Chance, Mainzer Landstraße 46, 60325 Frankfurt am Main, Deutschland
© Clifford Chance 2009
Clifford Chance Partnerschaftsgesellschaft von Rechtsanwälten, Wirtschaftsprüfern, Steuerberatern und Solicitors · Sitz: Frankfurt am Main · AG Frankfurt am Main PR 1000
Germany#934795-v5
Clifford Chance: Riko Vanezis Fidan&Fidan: Erdoğan Fidan
A worker checks a pipeline in Siberia. Source: www.spiegel.de