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
0.9
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0.9
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0.9
1.1
1.1
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?