FinanceAsia: You've said you want 33% of your revenues to come from non Hong Kong sources. How will you achieve that goal?
Brandler: We've set a working target of roughly one third of our earnings to come from non-SOC [scheme of control, Hong Kong's power regulatory regime] business by 2005. It's an "order of magnitude" and intended to give an indication of the direction we want to go in and the relative emphasis of the business over the next few years.
Our strategy on non-SOC is to grow in China and elsewhere in the region; we're going to focus on Asia Pacific where we know our way around. In particular we see China as an opportunity since we've been active there for many years and understand the industry and the players, our grid system has been integrated with Guangdong since 1979 and we have a number of successful investments there.
China is going through a major reform of its electricity industry and the State Power Corporation is being restructured. It's likely that there will be opportunities for us to grow through establishing JVs with some of the new Chinese power companies. However, we have to be cautious because the Chinese authorities have yet to announce how those reforms will play out. But we think we are very well positioned to be the partner of choice for the new generating companies as and when they're created.
But won't there be difficulties?
A lot of power investors have been a little skeptical about China. Some have been burnt before. We too have had overcome some challenges in China and we think we can find our way through.
China is keen to bring modern management methods to its power industry. It's keen to build successful companies with access to capital markets that will be attractive to international investors. We have a role to play as an investor and with management and operational skills, to help them get there.
One must remember that China requires huge investments. The Chinese mainland has 330,000 MW of installed capacity, which is growing at 6% to 7 % per annum, or around 22,000 MW a year.
So China does need huge investments in the power sector. It looks as if the reforms will play out so that there will be a number of independent generating companies created, which will need to have access to capital markets and therefore need to have returns that are acceptable to investors.
Are you looking for access to local capital markets in order to finance your Mainland power investments?
In the past, CLP has raised debt finance on a limited recourse basis through Chinese banks in RMB. Over time it is possible that some of the JVs will want to list, although we keep an open mind on whether to do it in China or overseas. There is a lot of liquidity in China. China has yet to announce how the reforms are going to play out and there is a degree of uncertainty as to how China may capitalize its generating companies. But the clear intent is to create entities that can raise capital to finance the investment China needs in its electricity industry.
Can you tell us what the latest status is on your bid for new assets in China, particularly Shenzhen Energy Group?
CLP is the first Hong Kong company that invested in the power sector in the Mainland upon the adoption of the Open Door Policy in 1979, and since then we have been actively studying investment opportunities in various parts of China. Shenzhen Energy has announced a plan to invite foreign investment, and we are one of a number of companies that have registered interest.
What are your expansion plans for the rest of Asia?
We are planning on consolidating in our existing markets, namely China, Taiwan, Thailand, India and Australia. We feel this approach is a better use of our capital than having one-off investments scattered all over the Region. It is better for us to put incremental investments on the ground in those market where we have existing investments, and which will be accretive to our current investments. It is a better use of our capital than just planting the flag in a new market.
That's not to say we are not going to look at new markets, but I think we should not be over-optimistic on new markets because most of the privatizations that are out there will probably be delayed.
So you are not interested in bidding for the assets on sale in Singapore, Korea and the Philippines?
A lot has changed in the five years since Korea, Singapore and the Philippines first started down the road to privatizing their power sectors. Problems have emerged in how to create a truly competitive market. The privatization and deregulation in the UK and Victoria, Australia are seen as being successful examples for these countries to follow, but we haven't yet seen the full investment cycle and the impact on new investment when it is required.
If you are a market like Korea that needs investment now, it is very risky to be trying to create a mechanism that relies solely on market forces, which if the pricing is wrong, means that you are going to have under investment.
Fundamentally the world has realized how difficult it is to create true markets in the electricity sector because it is very different from any other sector. It is a commodity that you cannot store or ship, it is undifferentiated and it is absolutely vital for economic activity. It is one thing to bring private sector discipline into the sector through privatization. Hong Kong's power industry is and always has been in the private sector and run on a commercial basis. But to create market mechanisms to allocate capital has many risks. I don't think these countries are well advised to go down the route of merchant or pool pricing regimes.
But on the other hand many governments in the region say they have been burnt with the long-term power purchase agreements (PPAs) that they have signed?
The industry as a whole is at a crossroads. The model of the long term PPA was designed to give assurance to investors in this industry, which is capital intensive and has long lead times. PPAs give investors the stability and predictability that they can recover their capital providing they meet contractual conditions. So long as the solicitation is done on a competitive basis, then governments can be assured that they are getting the best deal available in the market at that time.
The reason why the PPA model has gone more slowly recently is that governments have been tinkering with the idea of a power pool market, which does not sit well with the PPA model. But that power pool model, after California, is severely discredited. And especially in markets that require investment, there is nervousness among governments to be taking that risk with what is a vital industry. The industry is at a crossroads and people are debating which way is it going to go. I don't think these privatizations will move very quickly and if they do, they will happen along the PPA approach or with long term vesting contracts, which in essence amounts to the same risk / reward.
Given the problems in the US and European power markets, are there a lot of private sector power assets on the block in Asia?
A lot of the US electricity companies are looking to sell their Asian assets to raise capital to rebuild their balance sheets principally due to problems in their home markets. But there are not a huge amount of assets for sale as not a lot of deals actually got done.
Why have you announced that you are looking to sell your 5% stake in YTL in Malaysia? The company seems to be doing well at the moment.
YTL is a good company and we enjoy a good relationship with them. CLP bought a 5% stake in YTL in 1999 with a view to jointly exploring privatization of generating assets in the Malaysian power market. Unfortunately, the privatization process has not been moving smoothly and we have to assess where we apply our capital to maximum effect. We are therefore reviewing our position in the Malaysian market but nothing has been decided at this stage.
Moving back to Hong Kong, what are your thoughts on the possibility of changes to the regulatory regime here?
In the next few years, the Government will develop a roadmap for the post 2008 regulatory regime. Our belief is that the regulated structure of the scheme of control has served Hong Kong very well. It ensures Hong Kong gets an adequate and very good quality supply at the lowest reasonable cost. It is a proven model that has served Hong Kong and other countries well over many years.
It comes back to the question of what is the right model to take the electricity market forward? Is it a market model or a more planned mechanism? Pool prices in Australia are significantly lower than all the worst case scenarios when people invested there five years ago. In the UK and Victoria, power prices have gone far below new entrant level and so no new investments are being made.
The electricity industry is a unique industry that provides a vital service that cannot be stored nor easily shipped, requires massive capital investment, and has an extremely long investment cycle. The crisis in California has clearly shown that the market can fail with very damaging effects, in particular to consumers as well as investors. We keep an open mind on the future regulatory model for Hong Kong, but we think whatever way the regulatory regime would become, its objective should be to serve the best interest of society, which is an adequate supply of good quality and at the lowest reasonable cost.
