Study on the Feasibility of the Investment of Power Stations in the Philippines

Li Chenxiao

(University of Macau,Macau 999078)

Abstract: The “Belt and Road” initiative,proposed in 2013,is open,inclusive,and transparent,adhering to the principles of consultation,joint construction,and sharing.It aims to build a platform for international cooperation with broad participation and promote the economic and social development of the participating states.The initiative has provided an open multilateral cooperation platform to countries along the route,brought tangible benefits and promoted mutual trust among participating states and regions.With the implementation of the Initiative,the ties between the Philippines and China is getting closer and closer.While the Philippines is rich in electricity resources,could China try to profitably build power stations in the Philippines? To address this issue,this paper firstly sets out to explore the investment and financing background,including investment attraction,infrastructure construction,attraction of foreign capital,foreign exchange control,financial regulation,and land policy towards foreign-capital enterprises.Then it makes a comparison between different financing modes of the World Bank,the Asian Development Bank,Commercial Banks,and the bond market to draw a conclusion of which mode the Chinese investor should choose.And then it selects the type of corporation that suits the investors overseas according to the legal legislation of the Philippines.To this end,this paper focuses on four major risks -capital,tax,foreign exchange and credit risks and the corresponding coping strategies.Finally,a conclusion was drawn that it is feasible to build power stations in the Philippines with the help of a properly-structured legal framework and risk coping strategies.

Key words: Foreign Investment Law;“Belt and Road” initiative;Philippines

1 Project background

1.1 Socioeconomic background:

The Philippines,which is located across the sea from China,serves as a crucial link between China and Southeast Asian.It is close to the geographical center of East Asia and is the only country where the major capitals can be reached within 4 hours.Following the state visit of the new president Rodrigo Duterte to China,bilateral economic and trade cooperation is anticipated to resume as usual.A favorable climate with strong and stable economic growth is now foreseeable in Southeast Asia,one of the world’s most dynamic and promising areas[1]. According to the World Bank,Philippines is one of the fastest growing economies in the future,with a growth rate of 6.2%[2].

Recently,on July 6,2022,local time,Wang Yi and Luis Enrique Manalo,State Councilor and Foreign Minister of the Philippines held a meeting[3].The Philippine government is pursuing the “Build,Build,Build” infrastructure initiative and is ready to strengthen infrastructure cooperation with China within the “Belt and Road” framework[4].Bilateral trade between the two is expanding steadily.

1.2 Electricity market

The energy demand,and in particular electricity,is closely related to people’s livelihood[5].The conflict between power supply and demand is prominent in the Philippines.With the rapid growth of the population and continuous improvement of the industrial chain and sustained economic development,the Philippines is under great pressure in terms of power supply.Not excluding the capital Manila,Cebu,and several other major cities,most areas are facing severe power shortages.According to relevant survey,the Philippines faces three energy insecurity issues,a rapid growth in electricity demand,the insufficient supply of electricity,and the discrepancy in electrification rate between cities and rural areas[6].

In addition,the electricity prices in the Philippines are high.Severe electricity shortages and high electricity prices have made Philippines one of the most expensive countries in the world for residential and industrial electricity.The Philippines recorded a total peak demand of 15,581 MW in 2019,with a 6.3% increase in total electricity sales and consumption[7].

2 Project Overview

The project address shall be selected by relevant organization.The plan is to adopt clean coal technology,and according to the demand of the power supply market,it is suggested that the project be invested in batches and constructed in two phases.After the signing of the contract,financing will be completed within 12 months.The first unit will generate power in the 40th month,and the second unit the 46th month.In the 46th month,the second phase would be kicked off.

2.1 Investment attraction of the Philippines

The Philippines’ biggest advantage is its large pool of a large,cheap,educated,English-speaking workforce.According to the latest UN statistics,the Philippines has a literacy rate of 97.75 percent,ranking first among Southeast Asia and one of the highest in Asia[8].With a population of more than 100 million,the Philippines has a strong willingness to consume,which indicates that the domestic market is promising.And resource and energy reserves are abundant.Gold,silver,copper,iron,chromium,nickel,geothermal and other resources,and energy reserves are among the largest in Asia and even the world,with high forest cover and rich aquatic resources.Due to the above-mentioned,the US and the EU have granted corresponding preferential tariff treatment to Philippine exports,respectively.In particular,since 2015,the EU has granted the Philippines the EU Generalized Scheme of preferences plus (GSP+),which allows more than 6,000 Philippine products to be exported to the EU at zero tariffs[9].

However,the disadvantage is evident too.The legal policy on foreign investment is highly restrictive.There are restrictions on foreign investment in public utilities,natural resource tapping,and ownership of public land,as well as the proportion of foreign investment in other industries.Administrative inefficiency is a prominent issue in the Philippines.In addition,High operating costs pose a serious threat to foreign-owned enterprises.There are various types of taxes,high tax rates,heavy tax burdens,and long and demanding tax audit cycles.Coupled with a severe shortage of electricity and high electricity prices.Furthermore the monopoly of raw materials such as cement,which creates barriers to imports.

2.2 Infrastructure status

The Philippine is relatively underdeveloped in terms of infrastructure.But in recent years,more and more has been spent on infrastructure.

Duterte has prioritized infrastructure construction by proposing the infrastructure initiative “Build,Build,Build”,and the BBB Program aims to accelerate public infrastructure expenditure,which would cost around 8 to 9 trillion pesos from 2016 to 2022[10].

2.3 Absorption of foreign capital

According to data released by the Central Bank,net foreign direct investment to the Philippines in 2019 was $7.647 billion,down 23.1 percent year-on-year.These investments mainly come from Singapore,the US,Japan,South Korea,China,Thailand,Chinese Taipei,Mauritius,Hong Kong,and Germany,and mainly flow to finance and insurance,power and gas supply,manufacturing,real estate,transportation and warehousing,construction,communication,and other sectors.

2.4 The foreign exchange management

Foreign enterprises registered in the Philippines may open foreign exchange accounts in Philippine banks for import and export settlement.When exporting commodities,exporters are required to apply for an “Export Declaration” from commercial banks.Payment for exports may be made in the following ways:licensed,other licensed,and convertible foreign currency.And foreigners working in the Philippines can transfer out all their legal after-tax income.

2.5 Provisions on land acquisition by foreign-capital enterprises

2.5.1 Purchase restrictions

Under the Philippine Constitution,all lands in the public domain are owned by the State.With the exception of agricultural lands,all other natural resources shall not be transferred.To acquire land,a foreign citizen or a company,can set up a company in the Philippines-with up to(and including) 40% foreign ownership and more than(and including) 60% Filipino ownership,and with at least 5 persons,upon establishment,the company shall open the company bank account,primarily in the Philippines,which may be opened separately for foreign citizens,funds from property income can be controlled by foreign citizens and the company must obtain permission from the Philippine Board of Investment (BOI) to buy or sell land.

2.5.2 Lease provisions

Any foreign investor in the Philippines shall be allowed to lease private lands in accordance with the laws of the Republic of the Philippines providing the following conditions: The term of the lease contract shall not exceed fifty years,renewable once for a period not exceeding twenty-five years;the leased area shall be used solely for the purpose of the investment upon the mutual consent of the parties;The leased premises shall comprise such area as may reasonably be required for the purpose of the investment subject however to the Comprehensive Agrarian Reform Law and the Local Government Code.

3 Design of financing framework for overseas power plant projects

3.1 Basic principles of the financing framework:

The lender will focus on risk assessment and countermeasures,the contractual structure and security structures,the implementation of the project’s own funds,and other schemes.

3.2 Specific project

3.2.1 Composition of project shareholders

The first issue to be addressed in the project financing framework is the composition of project shareholders and the proportion of their equity investment.According to the result of risk assessment,in the typical structure of the government,Chinese investment,and local investment company,the structure of equity investment of the three parties can be negotiated on the basis of 40%,25% and 35%.What’s more,according to the actual status of the project and the capacity of the shareholders,the three parties need to carry out the transformation and adjustment between risk-taking and investment rights and interests through negotiation.

3.2.2 Contractual relationship

The Contractual relationship of the power plant for foreign investor in the Philippines is very complicated.And the schematic diagram has been marked above.EPC refers to the whole process or several stages of contracting for the design,procurement,construction,and commissioning in accordance with the contract[11].As shown in this framework above,usually a fixed-term general project contract would be adopted,where the contractor would come to the Philippines for project construction,and the contract scope includes project design,civil construction,equipment procurement,construction,installation,performance testing,completion and warranty period and the year’s nanny service.

The contractor shall be liable for delays of schedule or the technical specifications that do not meet the standards specified in the EPC contract,compensation for the loss caused by the contrator,and incentives for early completion of the project.The copper key contract,which clearly stipulates that the project will be completed on time,with quality and quantity,and the majority of the risk of completion will be borne by the general contractor.

Operation &Maintenance Agreements (O&M Agreements) are project finance documents that establish a contractual relationship between the project company and a professional management company to operate and maintain the project[12].An O&M contract was signed between Chinese investor and the project company.After the completion of construction,the service will enter the operation period.The contract was signed between the project company and the operating company,and the general operation period is years.O&M contracts are generally required to be signed during the project financing stage,and well-experienced power plants as service providers need to be sought.

PPAs can define every aspect of the project,including: the terms construction,operation and maintenance(O&M),insurance,the interconnection and grid,government involvement in the project,the delivery of energy,and any other third party involvement in the project[13].Often,PPAs are viewed as the relationship between the utility (Buyer) and the generator (Seller),however,in this paper,the PPA was viewed as a plan with specific features defined for the success of the wind farm and all the parties involved,such as the cost of energy and energy delivery constraints[14].The Longterm PPA is an agreement signed between the power generation company and the local government department or the national power company,which consists of the agreement equipment of hours each year (purchasing power),price,payment and time,the duration of the electricity purchasing (must be at least longer than the loan payback period),and is used to to determine the power purchase price or price calculation.The long-term PPA is the guarantee of revenue for the power project,only by signing it can enable a stable source rod revenue to generate stable cash flow and ensure the repayment of the project loan.In long-term PPA negotiations,the project company shall negotiate a suitable price with the government and allow the company to adjust prices to cover all costs,including power generation costs,investment returns,and principal and interest expenses on the bank loan to ensure its investment income and the capacity to repay the principal and interest of bank loan.

In the long-term PPA,the term of power purchase,the number of generating hours of equipment,the determination of fixed electricity price,and the adjustment method of electricity price are all closely related to the projected revenue,so they are the focus of financing banks in calculating the projected revenue.Usually,longterm PPA and franchise agreements are a package of framework contracts,the signing of which is one of the prerequisites for banks to financing power projects.

A concession contract is a contract between an investor or operator and the public sector regarding exclusive or monopoly power within a certain time limit and within the scope of the development and utilization of natural resources.Concession contracts can be classified into a lump-sum,annual rent,revenue sharing,and hybrid policies[15].In other words,it means “to attract private capital to participate in the construction and operation of concession projects”.A container-terminal operator who leases a container terminal from the port authority pays a fixed rental fee every year,which is one of the many popular schemes.

Concession contract is aimed at the exploitation and utilization of natural resources,the construction of public infrastructure,the provision of public utility products,and the provision of specific services.In this case,it refers to the utilization of electric power.

3.2.3 Guarantee and insurance

The aim of a credit guarantee is to mitigate inefficient credit allocation caused by information asymmetry between borrowers and lenders[16].To finance from the bank,the authenticity shall be audited.The export credit industry requires companies to provide project-related information.

As for financing structure,the export buyer’s credit insurance is purchased for the export part of the total investment in equipment,which is provided by another domestic bank because of the nature of the two different insurances.Export buyer’s credit insurance is policy-supported with the domestic lending bank as the insured and the principal and interest of the loan agreement as the subject of insurance.The upper limit of the indemnity ratio of this insurance is 95%,which means 95% of the total principal and interest of the loan is covered at most,and the protection scope is 95% political insurance and 95% commercial insurance.“Political risks”includes exchange restrictions,trade embargo or revocation of import licenses,issue of the deferred payment order,war,commotions,acts of terrorism,and other political events specified by the insurer.“Commercial insurance” refers to non-performance of the principal and interest on the loan agreement by the borrower,as well as bankruptcy and dissolution.While overseas investment insurance is an important means to encourage overseas investment of Chinese investors,which aim to compensate investors for economic losses caused by host exchange restrictions,tax,war,and political unrest,as well as the risk of default,with a fundamental political insurance coverage of 95%,and a maximum default compensation under the highest percentage of 95%.

As for the completion guarantees,due to the prominent risks during the construction of the power plant,whether the project can be completed on schedule will affect the generation capacity of the power plant and thus the projected revenue.Therefore,a guarantee should be provided by the general contractor for the completion of the project.The main way to offer the completion guarantee is to organize a competent team within the enterprise and to select a competent contractor in the design,procurement,and civil construction and other subcontracting aspects to make the contract terms consistent with the completion guarantee.

3.3 Capital flow

Firstly,the declaration and settlement of the international balance of payments of loan funds are presented.

In essence,this loan is the direct creditor-debtor relationship between domestic banks and overseas borrowers.Domestic export enterprises are only the recipients of loans,and there is no lending relationship with domestic banks.The money received by an exporter is essentially its current account (trade in goods or services)rather than its capital account.

Specifically,it shall be declared under according to the nature of transactions,and the words “using the buyer’s credit provided by the domestic bank” shall be mentioned in the postscript of the transaction.

Then the issue of collecting foreign exchange funds to do lowrisk business will be discussed.In this case,the domestic investor and the overseas project company belong to the same group,so all financing under the project is under the unified management of the group.As mentioned above,the loan funds of export buyer’s credit are part of the exporting enterprises’ current account,so this part of foreign currency funds can be settled in foreign exchange,or transferred to the same account of the enterprise by US dollar deposit certificate or original currency in the non-lending bank.In the context of the rising of the US dollar interest rate,export enterprises can handle the pledge of US dollar certificates of deposit,and then require commercial banks to handle low-risk businesses such as banknotes and domestic certificates,by holding foreign currency assets and taking the initiative to assume RMB liabilities,enterprises can maximize their capital gains.

3.4 Risk analysis

Risk assessment and management focus on the identification of assets,the analysis of vulnerabilities,and the evaluation and measurement of potential damages[17].In a context where the construction objectives of complex projects are under serious threat,it is imperative to fully identify the risk factors,explore the interactions among risk factors,and establish suitable risk coping strategies[18].The types of risk include capital risk,tax risk,foreign exchange risk,and credit risk.

3.5 Capital risk

Capital is the “blood”the for smooth running of overseas projects,thereby capital management is central to the effective promotion of overseas projects and the key to financial management.

Security risk refers to the hidden danger in the deposit,flow,and operation of the whole capital chain.Due to the national differences between material and equipment suppliers and service providers,the payment involves multiple currencies and diversified payment methods;All these pose security risks to the deposit and use of funds.

Liquidity risk can be described as a state when a bank failed to partially or completely fulfil all the depository needs of its customers for a period of time[19].Therefore,liquidity risk can affect the flow of funds.The inflow rate of funds is restricted by factors such as long capital settlement cycle,cumbersome formalities of measurement confirmation and approval,and complex procedures of international payment.Fund gap occurs occasionally,which is caused by such factors as delays in the availability of settlement funds and investment over-schedule.

Benefit-risk refers to the risk affecting the benefit of capital.Firstly,it is about capital buffer risk,where capital is time-sensitive and if not tapped or utilized in a timely manner,not only will there be capital cost over time,but also the risk of currency devaluation losses.Then it is about managing risk,where the fund expenditure is not planned,focused,and prioritized to fit into project schedules due to inadequate fund management.

3.6 Tax risk

Tax risk is defined as the likelihood that tax outcome differs from expectations due to a variety of reasons,for example,the judicial proceedings,amendment of the law,changes in business assumptions,an increased intensity of audits,and ambiguity in the interpretation of the law;and any action emanating from the tax function that subjects the company to adverse publicity[20].In recent years,Investors have showed heightened interest in firms’ tax avoidance activities[21].Evidence suggests that investment managers tend to take a firm’s tax management practices into account when making investment decisions[22].During the life of the contract,investors shall fulfill their tax payment obligations in accordance with the requirements of relevant tax law of the host country.

However,there are significant differences in taxation systems of the host countries,including tax objects,tax rates,tax payment procedures,periods,preferential tax policies,penalties,and tax collection and administration levels.At the same time,the contract is relatively comprehensive and involves complex tax matters.Hence,It is necessary to avoid economic penalty and reduce tax costs,and prevent the damage of reputation due to the failure of project tax management,short-sighted behavior,negligence of consciousness,lack of expertise,dereliction of management and other factors.

3.7 Foreign exchange risk:

Firms that engage in foreign operations are subject to a special type of risk,namely,foreign exchange risk.Foreign operations are obliged to hold assets,incur operating costs,and/or receive revenues whose domestic currency value will fluctuate when foreign price levels and the exchange rate change[23].Depreciation risk refers to the loss in both directions when less than the standard currency funds is received or more than the standard currency funds is paid than the bidding price specified in the project contract,caused by changes in the exchange rate.Depreciation risk contains two forms,namely,the devaluation of hard currency and the devaluation of local currency in the host country respectively.

4 Risk response strategy

4.1 Strategies for coping with capital risks

Only by focusing on capital management,establishing a perfect capital management system,and implementing effective control measures could capital risks be better controlled.

4.1.1 Improve and strictly implement the fund control system

Speed up the inflow of funds and clarify the settlement procedures of owners’ funds.Strictly control the outflow of funds,establish and perfect the internal control system,implement the authorization and approval system of fund payment,adopt quota management of fund expenditure,and initiate a democratic decision-making system.Establish the management system of fund budget,prepare and revise the fund plan according to actual status,strictly control the unplanned fund expenditure,balance the profits and losses of funds,and accelerate the flow rate and utilization efficiency of project funds.Strengthen the management of overseas capital business,especially the letters of guarantee,letters of credit and currency exchange.

4.1.2 Formulate project fund planning scientifically

Formulate a scientific fund management model to ensure the safety of the deposit and flow of funds,strengthen the centralized management of funds,and give full play to the coordination ability of the capital pool.Make every effort to achieve the balance of project funds,formulate a fund plan in consistency with the project schedule,and enhance the efficiency of funds utilization.To prepare feasible solutions to the funding gap through predicting the short-term gap or working capital buffer,strictly control the extrabudgetary buffer to ensure the smooth progress of the project.Raise the owners’ risk awareness of capital settlement,give early warning of potential risk and prepare countermeasures in advance.And propose fund management measures to cope with emergencies.

4.2 Tax risk response strategy

The tax management of overseas projects should adhere to the basic principles of tax compliance and risk control,that is,carrying out scientific tax planning on the basis of compliance with the tax laws and regulations of the countries where the projects are located,and preventing tax risks in the process of implementation,so as to achieve the tax management objectives of enterprise projects.

4.2.1 Tax investigation is the core of tax planning

There are a variety of ways and means to conduct a comprehensive and systematic research of local taxation.For example,the tax law system and tax environment where the project is located,the determination and key research of taxes related to the project,import and export laws and regulations,management regulations of foreign exchange,preferential tax policies and special restrictions.

4.2.2 Contract agreement is the key to tax planning

Both parties shall strive to bring the project contract within the scope of the preferential tax policies to reduce the project tax cost,furthermore,take the cost of taxes and fees into consideration,and specify the tax liabilities and obligations of both parties in the contract terms.Foreign investors should fully estimate the cost of taxes and fees of their projects,and strive to include it into the adjustment of the contract price,especially in countries where tax policies change frequently.

4.2.3 Scientific planning and implementation

In the execution stage of the contract,a scientific and comprehensive tax planning of the project is in place,and control measures are taken for unavoidable tax risks while subsequent key points and daily tax work are carefully deployed to ensure the realization of tax management objectives through strict implementation.

Refine procedures and clarify responsibilities to maximize the benefits of domestic tax reduction,export tax rebate,and income tax credit.Carry out in-depth scientific planning and propose effective solutions to further reduce the cost of taxes and fees on the basis of legal compliance.In addition,strengthening daily regulation and evaluation.

4.3 Strategies for dealing with foreign exchange risks

Foreign exchange risk can be managed in various ways.The risk manager’s choice of the different types of hedging techniques may,however,be influenced by costs,taxes,effects on accounting conventions and regulations[24].Chinese engineering enterprises must raise an awareness of foreign exchange risk management of overseas EPCF projects,take precautions and make full use of modern financial instruments to maintain foreign exchange value and strive for value addition.

4.3.1 Choose a reasonable settlement currency

According to the degree of currency exposure and risk resistance,the following priority order shall be adopted,which is RMB settlement,settlement in hard currency such as euro;US dollar,and the British pound;combined currency settlement with local currency and RMB or hard currency.Although the exchange rate risk is dispersed to a certain extent and the cost of local currency expenditure is reduced,the proportion of funds in each currency should still be reasonably determined to prevent the loss of foreign exchange.

4.3.2 Financial instruments transfer risks

Financial instruments can be divided into three categories.Hedging,which means using forward foreign exchange contracts,options,and futures to cushion risks,creditor’s rights factoring: the enterprise transfers confirmed foreign exchange receivable claims to relevant financial institutions,which can not only recover the payment in advance but also effectively avoid the exchange rate risk;letter of guarantee replacement: the enterprise can recover the quality guarantee deposit receivable from the owner in advance through a letter of guarantee replacement to avoid the exchange rate risk caused by delayed collection.

4.3.3 Management measures to control losses

Management modes can be classified into three types according to different control measures and methods,which are payment management,exchange management,and plan management.As for payment managementm,under the circumstance that the settlement currency of the EPCF project contract is determined,the subcontracts,procurement contracts,and lease contracts signed with foreign countries should be settled and paid in the same currency as the settlement currency of the owner’s contract,which not only saves the cost of settlement and exchange but also serves to transfer the exchange rate risk to the subcontractors and suppliers.As far as the exchange management is concerned.enterprises should strengthen the management of foreign exchange business.To reduce losses and increase gains,the amount and time of foreign exchange should be determined in a scientific manner by observing the trend of changes in the foreign exchange market and combining with the progress of the project.When it comes to plan management,enterprises should strengthen the management of foreign exchange revenue and expenditure,assume overall responsibility,plan ahead and strictly control unplanned expenditure,especially foreign exchange transfer limit,strictly contract return profit plan and take the local currency devaluation and the international balance of the illiquid plan into account.

4.4 Strategies for coping with financing risks

Enterprises should strengthen the financing management of overseas projects,rationally choose project operation mode and financing channels,balance the financing benefits and transfer financing risks.

Make full use of preferential national policies.and actively explore and rationally select project operation mode: BT,BOT,PPP.Employ diversified financing channels: capital market,financial market,trade financing,asset securities.

4.5 COVID-19 response

The world is witnessing the coronavirus pandemic declared by the World Health Organization (WHO)[25].The ongoing COVID-19 pandemic has exerted a profound impact on the economic and financial system[26].Periods of exceptional uncertainty and crisis induce lenders to re-balance their portfolios either in favor of domestic borrowers,which is the so-called ‘flight home’ effect[27].

Contractors must thoroughly study the terms of the commercial contract,perform their duties in strict accordance with the terms of the EPC contract,coordinate and share the risks with stakeholders of the project,and improve the anti-risk capability through refined risk control measures.

The contractor shall carefully review the contents of the insurance policy,and clarify the scope of insurance,restrictive clauses and special clauses,to prevent the occurrence of defaults under the policy and avoid the situation of failure to claim compensation.Due to the impact of COVID-19,most overseas projects are experiencing delays,increased costs,capacity decreases,customer losses and declining revenues.Therefore,when selecting a project,the contractor shall conduct a prior review of the relevant content and materials of the project.

5 Conclusion

Due to the socioeconomic background of linking China and southeast Asia and the expansion of the Philippines power market,the Philippines remains a good choice for investment overseas in terms of the investment attraction,infrastructure construction,attraction of foreign capital,exchange control,and financial regulation provided that a financing legal framework and risk response strategy are in place.