Having survived the global financial crisis virtually unscathed, Turkey's export-driven economy is expected to show growth upwards of 5% for 2010, after recording an unprecedented 10% growth over the first quarter of the year. But based largely on growing industrial output, Turkey's continuing economic growth is also mirrored by a growing appetite for power to keep the factories operating and to meet the rising living standards of the country's young, dynamic population of 73 million.
Power consumption had been growing at almost 8% a year before the crisis, leaving the newly liberalised power sector struggling to keep up. A dip in demand in 2008 and 2009 actually helped prevent a generation shortfall, allowing projects under construction to come on stream before growth resumed this year.
The rise in demand averaged at 8.3% during 2010, and Turkey's state grid operator, TEIAS, forecasts demand for electricity will increase between 6% and 7% a year over the next decade, making the country the single fastest growing electricity market in Europe. These same forecasts predict that Turkey will need to double its current installed capacity of 46,000 megawatts (MW) over the same period, at an estimated cost of $80bn.
At the same time, Turkey's own energy policy requires it both to reduce dependence on imported natural gas – currently used to generate about half of electricity consumed in the country – and to increase the amount of power produced from renewable resources to a minimum of 30% by 2023. To complicate matters further, policy also requires the creation of a fully liberalised power market. This is a move that, more than a decade on from the first efforts at introducing market-based reforms, is a long way from being realised.
Competition heats up
This presents a series of challenges for the banks, legislators and bureaucrats – challenges not made any easier by the global financial crisis.
The credit squeeze forced the temporary suspension of the project loan syndication market, driving up interest rates while reducing available terms from 12 to 13 years down to eight to 10 years.
Having arranged $3.2bn of financing for the construction of 50 power plants totalling 4000MW before the crisis hit, Garanti Bankasi has been actively competing with Turkey's other leading banks – Akbank, Yapi Kredi, Is Bank and TSKB - to finance new energy projects. And with Turkey's three remaining state banks also entering the fray, one market participant says competition between the banks to take part in deals is beginning to become "quite aggressive". Mustafa Tiftikcioglu, head of project and acquisition finance at Garanti, agrees with this assessment.
"Conditions have improved over the past year. The local banks' appetite for risk has increased and the ticket sizes are getting larger. Maturities are now longer and there is significant competition between banks for certain projects with margins lower even than pre-crisis," he says.
However, he cautions that while experienced sponsors with feasible projects who can provide the required equity will always find funding, many power developers face an uphill struggle.
"The market is still not familiar with the dynamics of project finance," he says, adding that many sponsors have to be convinced of the necessity of having a bankable engineering and procurement contract, power purchase agreement and, in the case of thermal plants, a long-term fuel agreement.
Mustafa Tiftikcioglu, head of project and acquisition finance at Garanti Mustafa Tiftikcioglu, head of project and acquisition finance at Garanti Foreign banks return
In the absence of such contracts and agreements, Mr Tiftikcioglu says international banks have not been very active in funding power projects in Turkey, preferring to avoid risk. Instead, foreign banks tend to restrict activity to choice projects sponsored by Turkey's larger and higher-rated conglomerates, or to joining 'club' structures for financing larger projects of $200 to $300m.
International banks are beginning to return to Turkey, however, as pressure on them to avoid unnecessary risk outside their home markets reduces. But their greater aversion to risk, together with the high liquidity of local banks, has limited the ability of foreign players to compete.
"Our activities have largely been in relation to project and export financings, especially in the wind energy sector, as a financier as well as in an advisory capacity, where we provide our global know-how in order to structure complex transactions," says Yusuf Macun, director of power and renewables project finance at HSBC, who leads its wind farm finance activities in Europe.
Alan Teraillon, the European Investment Bank's representative in Istanbul, confirms that foreign banks are returning to take a more active role in the market. He predicts a growing trend towards the use of export credit financing by international companies realising big public sector infrastructure projects in Turkey. This approach can play a significant role in the energy sector, where much of the capital investment is in imported equipment and services.
"In my view, we will see export credit being used increasingly by the private sector to realise energy projects," he says. Examples include Turkish oil refiner Tupras, which is utilising Spanish export credits for a planned refinery upgrade, and US giant GE, which Mr Teraillon explains has been lobbying US Export-Import Bank to back energy projects it plans with its Turkish partner, Gama.
Alan Teraillon, the European Investment Bank's representative in Istanbul Alan Teraillon, the European Investment Bank's representative in Istanbul Regulatory issues
While both the need for new power plants and the appetite for risk from the banks that are financing the investments is growing rapidly, so too is the need for a regulatory framework that reflects the growing complexity of Turkey's power market.
Described by many within both the power and the banking sectors as "a work in progress", the growth of Turkey's liberalised power market has been hampered by uncertainty on a number of key issues, including the 'stranded costs' caused by generous treasury guarantees of investments in redundant infrastructure to the country's first private power plants in the 1990s, and which in 2009 supplied 43% of the power consumed in Turkey.
Further uncertainty exists over the future obligations of the 20 regional distribution companies under privatisation, of which half have now been transferred to the private sector. Also in question is the future of the state-owned power plants. These make up about a third of the country's total installed capacity and are all slated for sale.
"With no clear medium- or long-term purchase agreement market, lenders are exposed to the risky proposition of a market where power volumes available and the prices that can be obtained for them are variable," says HSBC's Mr Macun.
Problems are most acute for developers of renewable energy projects, which account for the bulk of new generating projects. A long-planned renewable energy bill has failed to materialise, with guaranteed feed-in tariffs fixed at a blanket €0.055 per kilowatt hour (KWh) for all types of project.
The government has said it does not plan to increase tariffs for either hydro or wind projects, despite European norms for wind being €0.08 to €0.09 per KWh. As a result, both developers and banks are warning that without a slight increase in tariffs, many wind projects that are technically feasible may never be built, making it difficult for the government to meet its target of 10,000MW of wind plant power by 2020. Market participants point out that although current free market prices are running at €0.065 per KWh, these prices offer no guarantee to lenders and do little to help developers secure necessary funding.
Further problems lie ahead, with a planned grid access tender for new wind plants in which developers will bid on the level of royalty they will pay to be allowed to develop prime sites.
"The level of royalties will further affect the feasibility of many projects," warns Mr Tiftikcioglu of Garanti, which has funded about half of Turkey's 36 existing wind farms.
Hydro power projects also face increasingly stiff challenges to find funding. This is especially true for several hundred ready-licensed projects developed by Turkey's state water authority, DSI, and sold to the private sector in competitive tender. Unfamiliarity with the mechanics of project finance led the buyers to overpay for some of the projects, making it impossible for them to secure either their own finance or to 'flip' the projects at a profit to other developers who could meet equity requirements.
Hydro projects also face challenges from Turkey's active environmental lobby, which, coupled with uncertainties over the implementation of Turkey's existing environmental legislation, presents a serious challenge for both developers and lenders. In September last year, a regional state environmental protection agency bowed to pressure from lobbyists and blocked the development of 18 licensed hydro dams, a move that prompted the government to draft a new law entitling it to overrule such decisions.
"Turkish environmental law is very much in line with EU law but the way it is applied creates a lot of uncertainty. Projects can be approved and licensed and only then find they are stopped," says Mr Terraillon.
While potentially controversial hydro projects may find it easy to pass the licensing process, securing funding is a different matter.
"As a local bank, we have to be sensitive to the environment. We appoint experts to analyse the project in detail as it will not be financed [if there are environmental risks]," says Mr Tiftikcioglu.
New lease of life
The difficulties faced by developers in obtaining non-recourse finance in Turkey have led some financial institutions to look for more creative ways of making financing available for power plant projects. One route that has already been tried successfully is leasing, and three wind farms already under construction were funded using this model.
Turkish regulations restrict leasing companies to funding equipment purchases. This makes the model especially suitable for energy projects where construction is only a small part of the overall development cost. In hydro projects, the bulk of costs are accounted for by construction. For other renewable energy projects such as wind generation, the leasing model is attractive as construction typically accounts for 20% or less of the overall project cost, with specialised equipment the main expense.
According to Burcu Sirin, head of vendor and international sales at Yapi Kredi Leasing, the leasing model offers developers two key advantages over traditional financing models: the greater flexibility of leasing companies compared to banks, and the fact that the leasing companies take care of the entire purchasing operation.
"It is a one-stop solution. As we own the equipment, we do everything from purchasing and importation through to negotiating with insurance companies. This is much more convenient for developers," she says.
Yapi Kredi Leasing is Turkey's biggest leasing company and an arm of Turkey's Yapi Kredi Bank, in which Italy's UniCredit holds a large stake. To date, Yapi Kredi has funded two wind farm projects totalling 80MW using the leasing model, both for Turkey's Eksim Group.
However, with Turkey's target of generating 30% of its electricity from renewables by 2023, Ms Sirin explains that the number of developers opting for the leasing model is expected to grow exponentially.
With this in mind, Yapi Kredi Leasing plans to capitalise on the experience of its co-parents, Yapi Kredi Bank project finance team and UniCredit. The Italian banking giant owns the biggest leasing company in Europe and has been successfully using the model in other European markets for many years. As such, it has long-standing ties with equipment suppliers and operates a renewable energy competence centre in Vienna.
Solar rise
Until now, most interest in Turkey has been from developers of wind farms, but Ms Sirin explains it can also be applied to solar plants. She adds that equipment is even leasable for geothermal plants once the drilling phase has been completed.
Development of commercial solar power plants in Turkey is currently stalled, awaiting the passing of a new renewable energy law that is expected to fix guaranteed feed-in tariffs for solar plants at €0.10 per KWh. This is almost double the current €0.055 per KWh that developers say is insufficient to allow them to invest. The new law, which should be passed in early 2011, will be followed by an open tender for solar power projects that is expected to generate intense interest from potential developers bidding for licences for sites with the highest levels of sunlight.
Also slated for next year is a grid tender for developers of 665 applications for licences for new wind farms totalling more than 70,000MW. Officials have stated that 8500MW will be licensed - more than enough to ensure a busy few years for Turkey's leasing sector.
