Until recently, large power plants were beyond the pale for Israeli financial institutions. The huge construction costs and difficulties in securing financing, complicated regulations, and technical complexity, deterred the institutions.
Last week's financial closing for the Dorad Energy Ltd. power plant may herald a change in the attitude of investment institutions toward the energy industry. Alongside the problems mentioned above, a number of major advantages have suddenly emerged to favor investment in private power ventures: electricity tariffs that offer incentives to private power producers, high returns on capital, start-up hedges; and supportive regulations, which make investing in private power plants feasible.
Israel's private electricity market, which has emerged in the past decade, currently generates only 500 megawatts - less than 5% of the country's electricity consumption. Most of the power plants are small, such as the ones at Paz Oil Company Ltd. (TASE:PZOL) Paz Ashdod Refinery, Delek Group Ltd's (TASE: DLEKG) Ashkelon desalination plant, and the Nesher Israel Cement Enterprises Ltd. factory at Ramle. Most of the electricity generated by these power plants are used by the adjacent facilities, with the surplus (if any) sold to the national grid.
Israel has a strong interest in encouraging the construction of large private power plants, which could immediately boost the country's electricity reserves, and later compete against the production monopoly of Israel Electric Corporation (IEC) (TASE: ELEC.B22). The government has said in the past that it wants private power plants to generate at least a third of Israel's electricity.
There are three big names in Israel independent power production (IPP) market, and none of them has even begun to build a power plant: OPC Rotem Ltd., owned by Israel Corporation (TASE: ILCO) and Veolia Environnement SA (NYSE: VE; Euronext: VIE) subsidiary Dalkia Israel Ltd., which is due to build a 420-MW plant at Mishor Rotem, and whose capacity may be doubled; Dalia Power Energies Ltd., owned by Hiram Epsilon Ltd., Israel Infrastructures Fund (IFF), and Energy Economy Ltd, which is due to build an 870-MW power plant at Tzafit on the Coastal Plain; and the 840-MW plant to built by Dorad, owned by Eilat Israel Pipeline Company Ltd. (EAPC), Turkish conglomerate Zorlu Industrial and Energy Holding AS (the project contractor), Adeltech Ltd. unit Adelcom Ltd., and Uri Dori Engineering Works Corp. (TASE: DORI) unit U. Dori Energy Infrastructures Ltd.
Interminable delays
The Dorad power plant is the oldest of the three ventures, and has become a symbol of the private power industry's labor pains. The project got underway in 2003, when the company signed power purchasing agreements with two strategic customers - Mekorot National Water Company and the Ministry of Defense - but government obstacles, technical difficulties, and financial problems dogged the company, delaying the project interminably.
Until a few days ago, many Ministry of Finance officials, as well as figures in the electricity market and private sector, said that Dorad would never achieve financial closing, but last week, the company proved its doubters wrong, securing financing and a vote of confidence from a syndicate of 14 leading Israeli financial institutions.
The way the company removed the final obstacle to the financing is as interesting as the closing itself. A few days before the financial closing, Ellomay Capital Ltd. (Bulletin Board: EMYCF), controlled by former Bank Hapoalim chairman Shlomo Nehama, signed an agreement to acquire 40% of Dori subsidiary Dori Energy Infrastructures Ltd. for NIS 50 million. Ellomay also paid Dori Energy's NIS 200 million in shareholders' equity and guarantees for Dorad's power plant project.
Energy financing consultant Shachar Harari told "Globes", "Nehama and his partners at Ellomay made a deal at a good price and with perfect timing. A power plant like Dorad can achieve a return on capital of 20% or more, provided it finds the right mix between the variable availability model and sales to private customers."
Harari previous served as a director at IEC and CFO at Veolia Israel. In 2008, Harari chaired a Public Utilities Authority (Electricity) subcommittee, which built the business and financial model for private power producers and published the criteria and electricity tariffs for the power plants. He therefore believes that private power production is an excellent low-risk investment for investment institutions.
"Globes": What is the significance of Dorad's financial closing for the private electricity market>
Harari: "The private power production reform we made in 2008 was intended to ensure that the sector would attract investors and financial institutions by adopting the financial world's rules of the game for projects in the power production market. Dorad's financial closing cut the path through the minefield for other private power producers. I believe that the next financial closings will be much easier.
"By the way, it is interesting to note that Dorad's financing costs are lower than IEC's financing costs, even thought IEC, as a government company, is seen as having lower risk debt."
How did that happen?
"Dorad's project obtained a high credit rating (AA-), from which a fairly low long-term shekel interest rate was derived. In contrast, IEC's ability to raise shekel debt is limited, so it is forced to raise capital in foreign currency abroad, which is naturally rated at relatively low international ratings.
"My question is why the financial institutions are satisfied with a 5% return on the senior debt, rather than invest in the equity, i.e. the special purpose company, as well. That would have given them a much higher return. Israeli private power producers aren’t Eastern European income-producing real estate companies. This is a long-term non-financial, low-risk CPI-linked shekel investment that suits their obligations to invest in AA- rated projects."
That's still not enough to turn it into a solid investment.
"In view of what happened in financial markets in the past couple of years, maybe the time has come to wise up from the concept of solid investment. There's no such thing as a risk-free investment in the world of financial management.
"In this case, there's also strong government backing. It's important to realize that the government strongly wants private power producers to enter the market, in order to open it to competition and immediately increase electricity reserves. The government is prepared to provide set-up hedges, such as guarantees against IEC failing to meet its commitments to buy from the private producers.
"In addition, there is full recognition of set-up, operating, and fuel procurement costs. I believe that the fixed availability model makes it possible to achieve an annual return of 15-18%, when in practice it is possible that the power plant may only operate during peak power demand. There's a rare window of opportunity here, because the incentives policy of the Public Utilities Authority is limited to a quota of 2,500 megawatts, which is the current electricity reserves shortfall."
So what deterred financial institutions until now?
"Investing in electricity production is extremely complicated financially and requires special expertise, much more than income-producing real estate. Building and operating a power plant requires 15 different contracts, each of which requires specialist expertise.
"On top of that, it's necessary to add the statutory procedures needed to build a power plant, and you get a very centralized project that requires specialized know-how on the part of the financial institutions. To date, these institutions have had no departments with this knowledge or experience, which I consider to be critical."
What will the private electricity market look like in a few years?
"I believe that by the end of the first quarter of 2011, the picture of the large controlling shareholders in Israel's private electricity market will begin to clear: Dalia Power Energies, Israel Corporation, and Dorad. Just as the mobile market is dominated by three carriers, the independent power producers market is suitable for three to four large, strong players. Economies of scale are critical here, because operational flexibility equals the ability sell at a larger discount. I believe that we'll ultimately see real competition in the market."
Published by Globes [online], Israel business news - www.globes-online.com - on December 5, 2010
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