Dalian Water Supply Project

1
Dalian Water Supply Project

• February 26, 2004
• Alyona Dubrovina
• Jim Horiuchi
• Henning Hummervoll

2
Context
Background Project Description Analysis
Conclusion

• China, 1994
• Asian Development Bank considers 160 M
  investment in a water supply project

3
17 Infant mortality rate Cambodia
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Aids spreading in Africa
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75 million living below poverty line in China
6
Problem definition

• Which project should be financed?

7
Agenda

• Background
• Project description
• Analysis
• Conclusion

8
China
Background Project Description Analysis
Conclusion

• 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

9
Dalian Municipality
Background Project Description Analysis
Conclusion

• 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

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Project description
Background Project Description Analysis
Conclusion
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Scope of Project
Background Project Description Analysis
Conclusion

• 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

12
Project Mechanism
Background Project Description 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

13
Project Location
Background Project Description Analysis
Conclusion
14
Stakeholders
Background Project Description Analysis
Conclusion

• 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

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Financial Structure Use of Cash
Background Project Description Analysis
Conclusionv

• Total project cost 379.9 million

16
Financial Structure
Background Project Description 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 municipalitys own resources

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Financial Structure (continued)
Background Project Description Analysis
Conclusion

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

Local Commercial Banks
ADB
Debt Service

• Execution Agents
• Dalian Water Supply Company
• Northern Water Supply Company

Disbursement
Debt Service

• Ministry of Water Resources
• State Planning Commission

Disbursement
Loan relent under separate loan agreements
Dalian Municipal Government
Grant
Debt Service
Central Government
Project Execution Management
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ADB Loan Terms Conditions
Background Project Description Analysis
Conclusion

• Summary of terms and conditions

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Analysis
20
Investment Criteria
Background Project Description Analysis
Conclusion
21
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

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Project risk analysis
Background Project Description 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

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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

Project most likely not attractive to private
investors
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Sensitivity Analysis Key Variables
Background Project Description Analysis
Conclusion

• Key variables
• Water Sales
• Water Tariff
• Raw water expense
• Power expense

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Sensitivity analysis NPV
Background Project Description Analysis
Conclusion

• Expected NPV (723)
• Less than 2 probability of positive NPV

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Sensitivity analysis IRR
Background Project Description Analysis
Conclusion

Expected IRR 7.93
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ADBs perspective

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

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Alternative sources of financing
Background Project Description 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

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Economic analysis
Background Project Description 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

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Conclusion
Background Project Description 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

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What happened
Background Project Description Analysis
Conclusion

• 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

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• Questions?