LexisNexis

‘Turnkey’ German system for electric power transmission projects in Paraguay

Tuesday 8 June 2021

Martin Carlevaro

BKM Berkemeyer, Asuncion

martin.carlevaro@berke.com.py

Introduction

Paraguay would seem to be a clear example of a favourable ecosystem for private investment in public infrastructure through various procurement mechanisms. In recent decades, a remarkable macroeconomic, tax and currency stability has been established and consolidated with a neat and careful management of public accounts, as well as respect for long term compromises which provide a safe framework for investors. All these factors add to the good profitability rates the country offers based on a very convenient cost structure (labour, taxes, energy, among others) and a wide range of business opportunities, considering it is a country still with many economic sectors in development. These conditions that Paraguay has been building over the years encourage long-term investments in the real economy and generate private sector confidence, including investment in public or private infrastructure.

It should also be noted that Covid-19 and government measures to combat the pandemic have had a negative affect on the economy, and the country has post-pandemic recovery plans on hold. In the short term, these plans aim to inject resources for economic recovery and boosting production, including investment in infrastructure projects, given the multiplier effect this type of investment has on GDP growth.

However, Paraguay requires a significant investment in infrastructure, a sector with a deficit of about US$27,000m (including in transport, social infrastructure, health and energy transmission) and a resources shortage,[1] to face such deficit from the public sector, based on scarce tax collection. This is exacerbated by the current level of the fiscal deficit, which exceeds the threshold imposed by fiscal responsibility law,[2] due to increases in public expenditure triggered by the pandemic. Moreover, this double deficit (in both resources and infrastructure) slows down the promising GDP growth Paraguay has been showing ion recent years, acting as an impasse by substantially raising logistics costs for the transfer of products, exports, etc.

Methods of public procurement

The conditions described above broke the impulse for different processes of procurement process beyond the traditional public works that require available public resources or public debt which are not always possible or convenient. This therefore puts the Public Private Partnerships (PPP) process in a strong position, since with an adequate design and efficient risk distribution, private investments in infrastructure can be achieved without necessarily increasing levels of public and fiscal deficit. Paraguay’s PPP law was enacted in 2013 and there is a current project which had already obtained financial closure in 2019 through the issuing of international project bonds and support from a multilateral entity, specifically the National Routes 2 and 7 project, an investment of US$550m in respect of a 30-year concession.

Another procurement process used in Paraguay which allows the temporary supply of public resources is called ‘Turnkey’, also known as public work with funding from the private sector or as Design, Build and Financing (DBF), commonly called the ‘German System’.

This method extends the payment term for works by the state instead of facing periodic payments such as monthly certificates for design and construction during the execution of works (with an advance payment) as provided in traditional public works under Law 2051/2003. Typically, a turnkey project allows the state to start paying capital and interest once the work has been completed, in ten-year six-monthly instalments with a three-year grace period, according to bidding terms. This not only allows for delayed payment of infrastructure projects (of course, with the consequent payment of higher financial costs) but also transfers construction and other risks to the private sector, for which the government only starts to pay only once the works are complete and under the ‘lump sum turnkey’ process, which evidently increases chances of project completion on time, as the contractor is only paid on completion. There are also fewer chances of having claims for higher costs than those offered in the bid which was awarded to the most competitive offer under the fixed lump sum system, instead of unit prices as typically happens in traditional procurement. This is achieved given that incentives for both parties are aligned to completing the work on time. In addition, transfer of several risks to the private contractor allows the costs overruns to be absorbed by the private party, preventing claims and the works coming to a halt.

There are three awarded DBF road projects in Paraguay, two of which have already been funded: Naranjal (US$60m) fully executed (completed in 2020), and Bioceanic Corridor (US$450m), funded in 2019 by the first issuing of an international project bond (144A/Reg S) in Paraguay.[3]

These projects were publicly tendered under Law 5074/2013 which complements and regulates Law 2051/03 on public procurement, providing the DBF regime referred to above.

There are also other method of public procurement but these are rarely used in Paraguay today, including shared risk contracts (joint ventures). This was entered into by the state and private companies for developing activities under Law 117/1991. In addition, there is the Concession Law No 1618/2000 which grants public works and services as concessions through a delegation (by a law for each project), signing a concession contract with the concessionaire for a certain period. There is currently a road concession on Route 7 granted to Tape Pora as concessionaire, initially set to expire in 2023 but extended to 2053 by a Congress law.[4]

Electric power transmission DBF projects

First, it is important to note that Law 5074/2013 has already provided for the possibility of tendering electricity transmission lines under the turnkey process. However, it is a prevailing interpretation that this law only allows Central Administration authorities to act as contractors (namely national ministries) preventing a decentralised entity such as ANDE (National Electricity Administration) from being a contractor. That would be the case unless an interjurisdictional agreement is signed with the central administration as, for example, happened with the US$600m investment DBF sanitary sewerage project in 2016, where the Ministry of Public Works signed an agreement with ESSAP (Empresa de Servicios Sanitarios de Paraguay).

ANDE is an institution, decentralised from the public administration with a legal status and its own equity that has among its functions the acquisition of electricity, generation, transmission and distribution works, and other facilities and means necessary for the normal operation of Paraguay’s electric services.

In view of the above, Law No 6324 was enacted in 2019 enabling ANDE to tender for this type of project – DBF transmission projects. The new legislation also took the opportunity to introduce several improvements considering lessons learnt from projects tendered previously, under Law 5074.

In summary, the aforementioned law grants a sovereign guarantee from the Paraguayan State over certain electricity distribution and transmission works to be implemented by contractors to be selected by ANDE. It offers the following facets as innovation:

  • Authorisation for a package of 24 specific works detailed in the Law, a total estimated value that is up to US$300m.[5] However, ANDE, with the authorisation of the Executive Branch, can add other works that are considered necessary.
  • Works must be carried out under a process based on private financing provided by the supplier or private contractor.
  • Sovereign guarantee is implemented according to a regulation from the Executive Branch. As of the date of this article, this regulation is pending being issued.
  • ANDE as contractor and the Paraguayan State as guarantor will sign the necessary certificates to implement the recognition of the obligation to pay for the works (as each stage of the project is met), known as CROPs[6] and, such titles are transferable, unconditional, irrevocable, and autonomous from the underlying contracts.
  • Bidders must have secured the necessary funding for the complete execution of the works, including the respective projects, consultancies and works audits.
  • Although works contracts would in principle be governed by the law and jurisdiction of Paraguay, the Executive Branch can choose the laws of New York or London as applicable and choose jurisdictions in favour of those courts.
  • In the event of breach of the construction contract or the guarantee of the Paraguayan State and in the event of litigation, Paraguay cannot assert sovereign immunity in its defence.
  • The State and ANDE are authorised to approve provider credits with a guarantee from the Multilateral Investment Guarantee Agency (MIGA) of the World Bank or other similar agencies (ECAs).

Recommendations

It is expected that the bidding terms and the regulation to be issued by the executive branch for this specific turnkey legal framework for ANDE’s projects will introduce certain additional improvements that potential bidders (and lenders) interested in participating. Such parties could realistically expect the following in the structuring of these projects:

  • CROPs should be allowed to be assigned without prior authorisation from the state (Panama or Peru).
  • Under no circumstance shall a void contract affect issued CROPs.
  • The date of fixing the interest rate to the state (implicit in the CROP) is adjusted to the date of the financial closing and not to the date of awarding the contract. This will help to make the rate (and therefore the offer) more competitive.
  • Provide conditions in terms of management of RoW, licences and other risks retained by the public sector in order to reduce timing between award and financial closure. This will reduce uncertainties in terms of applicable final interest rate.
  • Larger sectioning or number of stages (and therefore more CROPs), lowering the scope of each of them (individually) in order to reduce working capital needs.
  • The possibility that certification of equipment and materials in warehouses may also be considered as stages in accordance with the conditions established in the bidding terms, and CROPs may be issued on verification of receipt of those materials.
  • Clear establishment of the items of investments already made (and not amortised) that will be paid on early termination such as financial costs, breakage costs, independent engineer fees, mobilisation and demobilisation costs, administration expenses, etc. and an interest rate counted from the termination date (and not from the date of determination of the amount to be paid) must be clearly set.
  • Making the conditions of supplementary working capital letters more flexible, giving them similar characteristics to letters of intent. The fact that the lender’s letter submitted in the bid is not a firm compromise will save costs and increase the number of potential bidders.
  • Provision for the possibility of awarding by lots (more than one), in which case the bidders may present improvements in their financing terms in the event of awarding more than one lot simultaneously to take advantage of economies of scale.

If the regulations and bidding terms include the improvements outlined above, the success of this type of financing is ensured, as many international bidders (and lenders) are certain to participate. Consequently, these projects, so necessary for the effective and safe transmission of electricity will be implemented in Paraguay, a country which produces abundant hydropower.​​​​​​​

 

Notes

[1] Due to the lower level of activity caused by the Covid-19 pandemic, and very low tax rates compared to other countries in the region (VAT and income tax both at ten per cent).

[2] The fiscal deficit increased from 2.8 per cent in 2019 to 2020 (pandemic year) and went up to 6.5 per cent of GDP due to debt taken on sovereign bonds (and other sources) for healthcare expenditure. The maximum limit established by the fiscal responsibility law for the deficit is 1.5 per cent, or up to three per cent in exceptional cases.

[3] ‘Bioceanic Road Corridor Consortium’s $433m Financing of Bioceanic Corridor Section Loma Plata-Carmelo Peralta in the Western Region of Paraguay project’, Global Legal Chronicle, 18 May 2019, see https://www.globallegalchronicle.com/consorcio-corredor-vial-bioceanicos-433-million-financing-of-corredor-bioceanico-tramo-loma-plata-carmelo-peralta-en-la-region-occidental-de-paraguay-project, accessed 25 May 2021.

[4] Horacio Cartes, ‘Executive Branch promulgates extension for Tapa Porã’, ABC Color, 1 July 2016, see https://www.pressreader.com/paraguay/abc-color/20160701/281767038538061, accessed 25 May 2021.

[5] It is expected that these 24 works (including substations, medium voltage lines, distribution networks) will be tendered and grouped into two or three projects to generate a volume attractive to large international lenders and construction groups.

[6] Certificates of Acknowledgment of Payment Obligation, Certificados de Reconocimiento de Obligación de Pago (CROP) in Spanish.