Dalian Water Supply Project
February 26, 2004
Alyona Dubrovina
Jim Horiuchi
Henning Hummervoll
Background
Project Description
Context
Analysis
Conclusion
• China, 1994
• Asian Development Bank considers $160 M investment in
a water supply project
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
Background
Project Description
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
Analysis
Conclusion
Background
Project Description
Dalian Municipality
Analysis
Conclusion
• Important seaport
• Technology Development Area
• Growing population
– 4.7 million in 1997 growing at 3% pa
• Water supply shortage
– Lowest average supply
Water Supply (lpcd)
Dalian
China
Asia
155
170
300
– Static water tariff level 1952-1992
Background
Project Description
Analysis
Conclusion
Project description
Background
Project Description
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
Analysis
Conclusion
Background
Project Description
Project Mechanism
Analysis
Conclusion
• 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
Project Location
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
Analysis
Conclusion
Biliuhe Reservoir
Part A:
Northern
Conveyor (68 km)
Transporting raw
water to Wazidian
Reservoir
Wazidian Pumping
Station: Sales of
raw water to
DWSC takes place
Dalian City
Background
Project Description
Stakeholders
Analysis
Conclusion
• Executing Agencies
– Dalian Water Supply Company
– Northern Water Supply Company
• Debt holders
– Dalian Municipality Government
– Asian Development Bank
Foreign
Local
– China Construction
Bank and
ajor Components
Currency Currency
other commercial
banks Total
Cost
Major Components
Cost
ost • Other stakeholders
orks
$15.0
$124.9
$139.9
– Dalian population,
farming
ent and Materials
$112.8
$8.8 $121.7
community
and
industries
ing Services and Training
$2.2
$7.6
$9.8
(land, resettlement, etc.)
$16.8 $16.8
al
$130.0
$158.1 $288.1
l and Price Contingencies
$17.5
$40.0 $57.4
t During Construction
$16.6
$17.5 $34.2
ect Cost
$164.1
$215.6 $379.7
Loans:
Asian Development Bank
Ministry of Water Resources
PRC State Planning Commission
Local Commercial Banks
Total Loans
Central Government Grant
Dalian Municipal Government
Total Project Cost
Foreign
Local
Currency Currency
Cost
Cost
$160.0
$160.0
$4.1
$164.1
$23.0
$11.5
$18.5
$53.0
$11.5
$151.2
$215.6
Total
$160.0
$23.0
$11.5
$18.5
$213.0
$11.5
$155.3
$379.7
Background
Project Description
Financial Structure: Use of Cash
Analysis
Conclusionv
• Total project cost: $379.9 million
Interest During
Construction
9.0%
Local Currency
Components
56.8%
Foreign Currency
Components
43.2%
Physical and Price
Contingencies
15.1%
Others (land,
resettlement)
4.4%
Consulting
Services and
Training
2.6%
Civil Works
36.8%
Equipment and
Materials
32.0%
Background
Project Description
Financial Structure
•
Analysis
Conclusion
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
Dalian Municipal
Government
40.9%
Central
Government Grant
3.0%
Commercial Banks
4.9%
Asian
Development Bank
Loan
42.1%
Ministry of Water
Resources
PRC State
6.1%
Planning
Commission
3.0%
Background
Project Description
Financial Structure (continued)
Analysis
Conclusion
• Effectively “all-PRC” funding other than ADB Loan
– Enhancement of credibility
Local
Commercial
Banks
ADB
Debt Service
Disbursement
Debt Service
Loan relent under
separate loan
agreements
Debt Service
Central
Government
Execution Agents
• Dalian Water
Supply Company
• Northern Water
Supply Company
Disbursement
Grant
Project
Execution &
Management
• Ministry of Water
Resources
• State Planning
Commission
Dalian
Municipal
Government
Background
Project Description
ADB Loan: Terms & Conditions
Analysis
Conclusion
• Summary of terms and 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
Analysis
Background
Project Description
Investment Criteria
Goal
Analysis
Conclusion
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
Project cost of capital
• 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
Analysis
Conclusion
Background
Project Description
Project risk analysis
-
Analysis
Conclusion
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
Results of financial analysis
Analysis
Conclusion
– Negative NPV $(474.9)M
– IRR 8.9%
– Growth rate and discount rate sensitivity:
Growth Rate
• Base case: Growth rate 9%, discount rate 10.5%
5.0%
7.0%
9.0%
11.0%
13.0%
8.5%
63.0
103.9
144.7
185.5
226.3
Discount Rate
10.5%
12.5%
14.5%
(531.8)
(923.5) (1,179.2)
(502.9)
(902.8) (1,164.2)
(474.0)
(882.0) (1,149.2)
(445.1)
(861.3) (1,134.2)
(416.2)
(840.6) (1,119.2)
16.5%
(1,343.2)
(1,332.2)
(1,321.2)
(1,310.2)
(1,299.2)
Project most likely not attractive to private investors
Background
Project Description
Sensitivity Analysis: Key Variables
Analysis
Conclusion
Sensitivity Analysis - Impact on NPV
DWSC Ind water tariff
0.9
1.1
DWSC Ind water sales
0.9
1.1
DWSC raw water expense
DWSC institutional water tariff
1.1
0.9
0.9
DWSC power expense
1.1
1.1
0.9
DWSC domestic water sales
0.9
1.1
DWSC domestic water tariff
0.9
1.1
DWSC institutional water sales
0.9
1.1
NWSC Ind water tariff
0.9
1.1
NWSC Ind water sales
0.9
1.1
NWSC institutional water tariff
0.9
NWSC domestic water sales
0.9
1.1
NWSC domestic water tariff
0.9
1.1
NWSC raw water expense
1.1
NWSC institutional water sales
1.1
NWSC power expense
1.1
NWSC salaries expense
($1,000.00)
0.9
0.9
DWSC salaries expense
1.1
0.9
0.9
1.1
0.9
($800.00)
($600.00)
Key variables:
1.1
($400.00)
NPV
− Water Sales
− Water Tariff
− Raw water expense
− Power expense
($200.00)
$0.00
Background
Project Description
Sensitivity analysis: NPV
Analysis
Conclusion
Forecast: NPV at WACC
.0 3 3
33
.0 2 5
2 4. 7 5
.0 1 7
1 6. 5
.0 0 8
8 .2 5
.0 0 0
0
($ 1 ,5 5 7. 67 )
•
992 Displ ayed
Freq uency Char t
1,000 Tr ials
($ 1 ,1 3 7. 25 )
($ 7 1 6. 84 )
($ 2 9 6. 42 )
C e rta in ty i s 9 8. 60 % fro m -In fi ni ty to $ 0 .0 0
•Expected NPV $(723)
•Less than 2% probability of positive NPV
$ 12 3 .9 9
Background
Project Description
Sensitivity analysis: IRR
Analysis
Conclusion
Forecast: IR R
1,000 Tr ials
Freq uency Char t
986 Displ ayed
.0 3 5
35
.0 2 6
2 6. 2 5
.0 1 8
1 7. 5
.0 0 9
8 .7 5
.0 0 0
0
4 .4 5 %
6 .1 8 %
7 .9 2 %
9 .6 6 %
C e rta in ty i s 5 4. 50 % fro m 7 .9 3 % t o +I n fin it y
•
Expected IRR 7.93%
1 1. 4 0%
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
Background
Project Description
Alternative sources of financing
Analysis
Conclusion
• 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
Economic analysis
Analysis
Conclusion
• 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
Conclusion
Analysis
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
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
Analysis
Conclusion
Questions?