Financing Alternatives for Energy
Cooperation in Northeast Asia
October 2002
Jang-Yung Lee
Senior Counselor to the Minister
Ministry of Finance and EconomySeoul, Korea
1. Need to Support North Korea’s
Economic Development
• North Korea’s transition to a market economy and
opening to the outside need to be supported
• Northeast Asia’s investment climate be improved
• Political stability on the Korean peninsula depends
on a progress in economic development
• Hopes for the Korean reunification can be raised
2.Jump-start of Investment is necessary
• Need for infrastructure investment
=> Return on other investment will be high
=> Repair and rebuild the transport,
communication, power and utilities urgent
• Investment in key productive sectors
• Assist with food security
3. Prospects of Private/Official Financing
• Flows of private investments likely to be small
will take years to create minimum necessary
confidence in the North Korean economy
* East European countries took 7-8 years of reforms
** TRDP failed because of the uncertainty in policies (esp. trade,
movement of people, foreigner’s right to establish)
• Need to rely on official capital flows, for the time being
=> Multilateral development banks (e.g. IBRD)
=> Bilateral donor countries (e.g. Japan and South Korea)
4. North Korean membership in IFIs
• Lengthy period of entry negotiation
• Obstacles in NK’s membership negotiation
=> lack of political consensus on substantial reforms
(e.g., private ownership, decentralized decision-making)
=> compliance with IFIs’ surveillance unacceptable
(e.g., disclosure of key economic data and information)
=> normalization of economic/financial relationship
(e.g., the defaulted bank debt of 1970’s owed mostly to the
Japanese banks should be resolved first)
5. Is special assistance program for
non-members available to NK?
• Is North Korea eligible for Special Trust Fund ?
• Reconstruction support designed for the post-conflict
countries
=> IBRD’s definition: Countries with widespread violence,
armed warfare, or where the state has failed
*Examples of post-conflict infrastructure program
=> IBRD’s Special Trust Fund for Gaza and West Bank (1993),
Bosnia and Herzegovina (1996)
=> ADB’s Post-conflict program for Tajikistan (1998)
6. Cost of Infrastructure Investment
• General state of NK’s infrastructure in 1998
: comparable to South Korea’s 1975
• Estimate of the infra improvement (CERI)
=> Target ‘80: 19 tril. Won (Power: 2.9 tril.Won)
=> Target ‘85: 44 tril. Won (Power: 7.3 tril Won)
=> Target ‘90: 72 tril. Won (Power: 10 tril.Won)
7. Long-term Cost of Korean Reunification
• Dfn: Extra fiscal need due to unification
=> repayment of external debt in arrear + public
sector maintenance cost + income subsidies + cost
of economic development
• KDI’s estimate: 400 trillion (US$363 billion)
• Choi, Joonook (1997): US$78 - 354 billion
under 3 different scenarios regarding government
investment for economic development
8. Financing Alternatives
• Use of the two S.K’s government funds
=> South-Korea Cooperation Fund (SNCF)
: 500 billion won
=> EDCF, pending diplomatic normalization
• Assistance from Japanese government
=> Post-war indemnification ($5 – $12 billion?)
=> ODA fund flow to N.K
• Assistance from multilateral organizations
=> membership is required
9. Project Financing As an Alternative
• Valuable tool for infrastructure investment
(1) finance large high-risk projects without extra
sponsor guarantee (limited-recourse financing)
(2) project’s own cash flows are important
(3) alleviates investment risk thru risk-sharing
=> facilitates public-private partnership
(4) make possible low-cost financing
(5) allow 3rd-party scrutiny of the project’s merits
(economic/technical feasibility analysis)
10. Sample Structure of Project Finance
•
Risk Allocation Scheme
(1) Cost-overrun risk with the contractor
(2) Operation risk with the operator
(3) Market risk with the long-term off-taker
(4) Financing risk with investors and lenders
(5) Supply risk with feedstock supplier
(6) Political risk with various insurance agencies
11. Sample Structure of Project Finance (1)
Financial Advisor
Costruction
Contract
Advisory
Contract
Contractor
Operator
Feedstock
Supplier
Off-Take
Agreement
Partnership
Agreement
Equity
Participants
O&M
Contract
Project
Company
Investors
Feedstock
Contract
Off-Take
Contract
Finance
Agreement
Lenders
Political
Risk Cover
12. Sample Structure of Project Finance (2)
NK central gov’t
(sponsor)
SK central gov’t
(sponsor)
equity participation
NK Authority
(regulator)
license
approve
N.K.Power Co.
(project company)
construction
lend
Off-take agreement
Raw material
G.E
(operator)
Working
capital
KEPCO
(off-taker)
revenues
Citi Bank
(escrow account)
Mitsubishi
Engineering
(constructor)
repay
Western bank
(syndicate)
Shell Oil Co.
(supplier)
Repay debt svcs
13. Special Relevance of PF for North Korea (1)
• Make long-term financing available to
large-scale infrastructure projects in a
country where
perceptions of project risk remain high
: those projects without any prior track record
Govt’s debt repayment capacity is limited
:can protect the sponsor’s capital base
14. Special Relevance of PF for North Korea (2)
• The project company’s right to build and
operate the plant can be assured
 Through Build-Transfer-Operate (BTO) contract
• If the power off-taker is a NK entity, its
default risk gets higher
=> Possibility that electricity price will be politically
set below the market prices
=> Lenders may ask the NK government’s
guarantee against the default risk
15. Major obstacles for PF in N.K.
• Legal and judicial framework do not exist in N.K
=> contract may not be legally enforceable
• Unstable macroeconomic environment
• Inconsistent policy environment
=> high political risk of change in laws and taxes
How to mitigate project risks ?
=> support from host government
- guarantee against the political risk
- assurance against the FX control
- a grant of land free of charge, tax holidays, etc.
Involvement of Multilateral Financial Institutions
in Developing Countries’ Project Finance, 1994-97
(percent)
Sector
Country risk grade
80-60
60-40
40-20
20-0
Water and Sewerage
0
29
89
100
Road and rail
11
11
78
0
Agriculture
0
0
60
100
Oil and gas/upstream
0
25
40
60
Mining
0
26
30
71
Property
0
3
56
50
Power
22
27
51
38
Oil and gas/downstream
6
22
35
20
Telecommunications
0
21
29
25
Manufacturing
6
10
17
29
Transport/shipping
0
0
30
21
Total
45
174
515
514
Note : Percentage of transactions in which a multilateral of bilateral agency or an expert credit agency Participated.
Country risk ratings are Institutional Investor ratings.
Source : Oliver Wyman and Company, based in Capital DATA Project Finance Ware
16. How to mitigate project risks in
North Korea
• Mitigate project risks (esp. political risk)
=> use risk cover from OECD countries
(e.g. U.S EXIM Bank’s political risk cover)
=> transfer to multilateral organizations
(e.g. IFC’s partial risk guarantee)
(e.g. MIGA’s political risk cover program)
=> transfer to private insurers
(e.g. Lloyd’s of London’s underwriting)
• Financial advisor’s role is important
=> arrange the contractually defined structure
17. Rationales of Northeast Asian
Development Bank (NEADB)
• A supplementary source of development financing
=> IBRD, ADB, EBRD are limited in loans and
guarantees they can have outstanding
• Facilitate funding from other private investors
=> catalytic funtion (confidence signaling)
• Provide political risk cover & Coordination role
=> Orchestrate the diverse activities of the P.F.