Dalian Water Supply Project

1. Dalian Water Supply Project February 26, 2004 Alyona Dubrovina Jim Horiuchi Henning Hummervoll

2. Background Project Description Analysis Conclusion Context • China, 1994 • Asian Development Bank considers $160 M investment in a water supply project

3. 17% Infant mortality rate Cambodia

4. Aids spreading in Africa

5. 75 million living below poverty line in China

6. Problem definition • Which project should be financed?

7. Agenda • Background • Project description • Analysis • Conclusion

8. Background Project Description Analysis Conclusion 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

9. Background Project Description Analysis Conclusion Dalian Municipality • 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

10. Background Project Description Analysis Conclusion Project description

11. Background Project Description Analysis Conclusion 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

12. Background Project Description Analysis Conclusion Project Mechanism • 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. Biliuhe Reservoir • 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 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 Analysis Conclusion Project Location

14. Background Project Description Analysis Conclusion Stakeholders • 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

15. Background Project Description Analysis Conclusionv Financial Structure: Use of Cash • Total project cost: $379.9 million

16. Background Project Description Analysis Conclusion Financial Structure • 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

17. Background Project Description Analysis Conclusion Financial Structure (continued) • 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

18. Background Project Description Analysis Conclusion ADB Loan: Terms & Conditions • Summary of terms and conditions

19. Analysis

20. Background Project Description Analysis Conclusion Investment Criteria

21. Background Project Description Analysis Conclusion 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

22. Background Project Description Analysis Conclusion Project risk analysis • 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

23. Background Project Description Analysis Conclusion Results of financial analysis • 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

24. Background Project Description Analysis Conclusion Sensitivity Analysis: Key Variables • Key variables: • Water Sales • Water Tariff • Raw water expense • Power expense

25. Background Project Description Analysis Conclusion Sensitivity analysis: NPV • Expected NPV $(723) • Less than 2% probability of positive NPV

26. Background Project Description Analysis Conclusion Sensitivity analysis: IRR Expected IRR 7.93%

27. 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

28. Background Project Description Analysis Conclusion Alternative sources of financing • 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

29. Background Project Description Analysis Conclusion Economic analysis • 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

30. Background Project Description Analysis Conclusion 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

31. Background Project Description Analysis Conclusion 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

32. Questions?