Exhibit 99.2
Business Strategy
The Company's mission is to help meet China's need for
electricity in a socially responsible manner, balancing the interests of
customers, partners, communities, suppliers, investors and its people. After the
Amalgamation, the Company's operations will be subject to certain limitations
under the AES Debt Covenants.
The Company's business strategy focuses on:
Experience in the China Market. The Company currently employs
47 people in the PRC with 25 people in Beijing and 22 people
in other parts of the country. The Company's principal office
is in Beijing. The Company also maintains an office in Hong
Kong with 22 people. This commitment to the PRC has enabled
the Company to build an expertise in the China power market.
Diversified Project Portfolio. The Company believes that
national diversification of projects in different provinces
reduces the risk of being overly dependent on a single power
purchaser or the demand for power in a single region. The
Company's Current Projects are located in six provinces.
Certain of the Company's Current Projects include smaller
projects that have been developed on a rapid time schedule.
These projects have enabled the Company to establish its
position in the market, develop strategic relationships and
generate immediate cash flow. Certain other of the Current
Projects and the Potential Projects have high visibility and
the support of the national government of the PRC and its
various ministries, agencies and commissions ("Central
Government"). These projects are expected to generate
substantial cash flow following the commencement of their
operation.
Strategic Relationships with Strong Partners. The Company
believes that its presence in China, its available capital and
the well-regarded reputation of AES have allowed the Company
to develop strategic relationships with key Chinese partners.
The Company has included ministry level companies and
affiliates of provincial and local economic commissions as
well as affiliates of regional, provincial and local power
bureaus as partners in its Joint Ventures. These partners
participate in the construction and operation of the Company's
Current Projects, expedite the approval process and mitigate
project construction, operation and tariff adjustment risks.
Similarly, the Company will seek to develop the Potential
Projects and other future projects in the PRC in cooperation
with strong Chinese business partners that have comparable
economic interests and a variety of complementary strengths,
including business experience and political relationships.
In a number of cases, AES Chigen's partner in a Joint Venture
controls or is affiliated with the power purchaser,
contractor, operator and/or fuel supplier of the project. It
is possible, in these cases, that such arrangements may result
in one or more of these parties having a conflict of interest
in a project, which could have an adverse effect on the Joint
Ventures' operations.
Location in Regions of High Power Demand. The Company believes
that its Current Projects and the Potential Projects are
located in regions of high power demand. In the course of
developing its projects, the Company carefully reviews the
regional and local demand and supply for power. In addition,
in the course of project development, the Company evaluates
the proposed power purchaser, usually a provincial or local
government power bureau, to determine its economic resources
and credit profile. One important criterion for any project
developed by the Company is that the tariff to be charged by
the proposed project must be affordable in light of the
overall rates charged in the region, while also being
competitive with the cost of new electric power.
Some regions or cities in the PRC have experienced slower
economic development in recent years. As a consequence, load
growth in the PRC, while generally increasing in the country
overall, has exhibited uneven development. Some of the Joint
Ventures' power plants are designed to provide peaking power.
Such plants are dispatched only after base load power stations
have been brought on-line and reached maximum capacity. If
electric power demand proves less than expected in an area,
additional peak or base load power may not be required in the
area or may be required at lower than expected levels. AES
Chigen's Joint Ventures seek to mitigate this risk by entering
into take-or-pay power purchase arrangements and by entering
into dispatch contracts with PRC electric power dispatching
authorities which obligate the dispatchers to dispatch the
power plants at their full capacity for a minimum number of
hours each year. There can be no assurance, however, that the
Joint Ventures will not experience difficulty in enforcing
take or pay contract obligations or such dispatch contract
obligations if electric power in an area proves not to be
needed by the affected power purchaser and dispatcher. The
term "dispatch" refers to the schedule of production for all
the generating units on a power system, which generally varies
from moment to moment to match production with demand. As a
verb, "dispatch" means to direct a plant to run.
Significant Participation in Operational Management. The
Company seeks to obtain, and has obtained in the case of the
Current Projects and the Potential Projects, significant
rights to participate in major decisions of the project
companies that own the power plants. The Company typically
exerts its influence through directors appointed to the board
of directors of the project companies and by appointing either
the general manager of the power plants and/or a deputy
general manager in charge of finance or operations for the
power plants. Several of the Company's officers have
significant prior experience with AES in the development and
operation of power plants in other countries. The Company is
also developing a core group of local managers who will be
focused on constructing and operating projects in China.
AES's Capabilities. The Company draws on AES's people and
expertise in development, construction oversight and operation
of independent electric power generation projects. In
particular, the Company draws on AES's extensive experience
operating coal-fired power plants around the world. The
Company believes this relationship has provided it with a
competitive advantage in the China power market, which relies
primarily on coal-fired power plants.
Principles and Practices
A core part of the AES Chigen culture is a commitment to
"shared principles." The Company tries to adhere to these principles -- even
though doing so might result in diminished or foregone opportunities.
These principles are:
Integrity - The Company will strive to act with integrity, or
"wholeness." The Company will seek to honor its commitments.
The goal is that the things people say and do in all parts of
the Company should fit together with truth and consistency.
Fairness - The Company wants to treat fairly its people, its
customers, its suppliers, its shareholders, governments and
the communities in which it operates. Defining what is fair is
often difficult, but the Company believes it is helpful to
routinely question the relative fairness of alternative
courses of action.
Fun - The Company desires that people employed by the Company
and those people with whom the Company interacts have fun in
their work. The Company's goal is to create and maintain an
environment in which each person can flourish in the use of
his or her gifts and skills and thereby enjoy the time spent
at the Company.
Social Responsibility - The Company believes that the Company
has a responsibility to be involved in projects that provide
social benefits, such as lower costs to customers, a high
degree of safety and reliability, increased employment and a
cleaner environment.
The Company and AES seek to adhere to these principles not as
a means to achieve economic success, but because adherence is a worthwhile goal
in and of itself. However, if the Company and AES perceive a conflict between
these principles and profits, the Company and AES will try to adhere to these
principles -- even though doing so might result in diminished or foregone
opportunities.
Project Specific Strategies
Subject to the limitations that would be imposed by the AES
Debt Covenants following the Amalgamation, the Company will continue to seek,
when evaluating or developing project opportunities in the PRC, to utilize
project structures and contractual terms which generally have been proven to be
effective in international independent power projects for reducing risks,
obtaining financing and achieving commercially sound projects. The Company
realizes, however, that projects in China will often differ significantly from
the typical project finance model. In addition, the Company recognizes that,
because foreign investment in PRC power projects is in its early stages, in
order to finalize binding contractual documentation with respect to any project,
the Company is sometimes required or elects to assume certain risks not
typically assumed by project sponsors in an international independent power
project. These risks may be associated with construction (such as completion
risk), operations (such as fuel supply or transportation risks), foreign
exchange convertibility and, to the extent that the Company cannot negotiate
contracts that adjust its revenues for changes in exchange rates, exchange rate
fluctuations. Accordingly, while the Company utilizes, where possible, the
strategies summarized below, it also seeks to maintain flexibility in
negotiations and to adopt alternative strategies where appropriate.
Long-Term Power Purchase. It is planned that each project
company in which the Company invests will sell electricity
under one or more long-term power purchase contracts to
regional, provincial, municipal or county electric power
organizations, including power bureaus and electricity
management offices, or industrial customers which the Company
believes will be able to perform their obligations under the
power purchase contracts. It is planned that the power
purchaser will be required to purchase a specified minimum
amount of electricity generated by the plant during the term
of the power purchase contract based on an agreed pricing
formula. These tariff formulas are designed, based on the
minimum take obligation of the power purchaser, to be
sufficient to pay the operating expenses and the financing
costs of the project and to enable the Company to realize a
return on its investment. The Company attempts to negotiate
power purchase contracts that contain provisions requiring the
purchaser to purchase a specified minimum number of kilowatt
hours ("kWh") or to make specified minimum payments even if
the power is not dispatched. The Company seeks to include in
its power purchase contracts incentives to encourage the
purchase of additional kWh over an agreed minimum amount. The
Company attempts, whenever possible, to structure changes in
the revenue component of a power purchase contract to
correspond, as closely as possible, to changes in operating
(primarily fuel) and capital costs of a power plant and
fluctuations in foreign exchange rates.
Construction and Equipment Procurement. The Company seeks to
arrange construction and equipment procurement contracts with
experienced, creditworthy international or Chinese contractors
and suppliers. In a typical international independent power
project one contractor assumes responsibility under a
fixed-price, fixed-schedule turnkey contract for the design,
engineering, equipment procurement, construction,
installation, commissioning, staff training and start-up of a
project. While the Company seeks this type of arrangement when
possible, such a turnkey arrangement is often not available
for PRC power projects. Therefore, where possible, the Company
seeks to have its project companies enter into arrangements
with construction and equipment procurement consortiums in
which the various major responsibilities typically assumed by
one turnkey contractor in the international model are
allocated to individual members of the consortium. The Company
seeks to negotiate contracts pursuant to which equipment
suppliers and contractors agree to pay liquidated damages for
delays and non-performance. The Company also attempts, where
appropriate, to utilize established foreign equipment
manufacturers who are able to provide warranties and service
contracts for their equipment as well as to utilize proven
Chinese technology from well-established Chinese equipment
manufacturers. In some cases, the Company may elect to have
its Joint Ventures manage the construction directly, possibly
with the assistance of reputable Chinese or international
engineering companies.
The construction of an electric power generation plant,
including its ancillary facilities such as a transmission line
or substation, may be adversely affected by many factors
commonly associated with the construction of infrastructure
projects, including shortages of equipment, materials and
labor, as well as labor disputes, adverse weather conditions,
natural disasters, accidents and other unforeseen
circumstances and problems. Any of these could cause
completion delays and cost overruns. Delays in obtaining
requisite licenses, permits or approvals from government
agencies or authorities could also increase the cost or delay
or prevent the commercial operation of a project. Construction
delays can result in the loss or delayed receipt of revenues
and, if completion is delayed beyond the completion date
specified in the power purchase contract, the payment of
penalties. Additionally, the failure to complete construction
according to specifications can result in reduced plant
efficiency, higher operating costs and reduced or delayed
earnings.
AES Chigen's Joint Ventures all rely on PRC contractors for
the construction of their electric power plants. While there
are a number of PRC contractors with substantial construction
experience, there are only a limited number that have
experience constructing plants on a turnkey basis. In only a
few cases has AES Chigen been able to enter into a turnkey
contract with a Chinese contractor which includes a guaranteed
fixed price and/or contractor obligations to pay liquidated
damages for delays in completion or for shortfalls in
performance. In the case of one project, AES Chigen's Joint
Venture has experienced delays in installation and defects in
the quality of equipment. The delays have been mitigated by
the payment of damages by the contractor. AES Chigen seeks to
mitigate construction risk in a number of ways: carefully
choosing its contractors; closely supervising the construction
of its projects or retaining internationally recognized
construction managers to supervise construction; and, in some
cases, by utilizing established foreign equipment
manufacturers and vendors who are able to directly pass
through to the Joint Ventures their equipment and performance
warranties or, where appropriate, by utilizing proven Chinese
equipment and technology. Despite such mitigation efforts, no
assurance can be given that AES Chigen's Joint Ventures will
not experience construction delays or difficulties, or that
any such delays or difficulties will not have a material
adverse effect on the operations of AES Chigen's Joint
Ventures.
Fuel Supply. Whenever possible, fuel for the Company's
operating plants is purchased under long-term supply contracts
with suppliers that have sufficient, and preferably dedicated,
reserves of fuel stock to meet the project's operating
requirements and that have economic interests aligned with the
joint venture partners. In certain circumstances, including
where a plant is located in close proximity to a reliable fuel
source, the Company may deem it advisable for a project
company to purchase its fuel on the spot market in order to
take advantage of lower fuel prices. In such circumstances,
the Company may contract with fuel brokers or government
companies with appropriate guarantees or other performance
supports. In other circumstances, the power purchaser may be
obligated to supply a project's fuel requirements. The Company
attempts, when possible, to have its fuel supply contracts set
out delivery and testing procedures and penalties for delays
or non-performance. Approval of a project by the State
Planning Commission of the Central Government ("State Planning
Commission" or "SPC"), which is required for larger projects,
ordinarily includes a provision for the allocation of fuel,
which reduces the fuel supply risk for such projects.
Most of the Joint Ventures' power projects utilize coal, fuel
oils or natural gas for the generation of electricity. The
power purchase contracts which have been entered into by the
Joint Ventures provide for a pass-through to the power
purchasers of increases in the cost of fuel. In the case of
most of the Joint Ventures, under normal circumstances, the
procedures of the local government pricing bureaus allow
tariff adjustments reflecting fuel cost changes to be made
only once a year. As a result, in these cases AES Chigen's
Joint Ventures may not be able to receive compensation for
increased fuel costs until sometime after the date they are
incurred.
Fuel Transportation. Whenever possible, the Company arranges
with a carrier for transportation of fuel from the fuel source
to the Company's operating plants under long-term
transportation contracts or the Company will obtain
satisfactory assurances that transportation services will be
available to the project. Due to the underdeveloped
transportation infrastructure in China, the Company sometimes
considers more favorably projects located in fuel-rich
regions, such as projects located near coal mines. Approval of
a project by the State Planning Commission, which is required
for larger projects, ordinarily includes a provision for fuel
transportation, which reduces the fuel transportation risk for
such projects.
For coal projects which are not "mine mouth" projects, coal
must be supplied to the project site from the interior
provinces of China. The affected Joint Ventures seek to
mitigate this transportation risk by entering into long term
contracts for the transportation of coal. However, where rail
is utilized as the means of coal transportation, the coal
transporters may experience significant delays due to the
limited capacity of the PRC's rail system. Because of this
lack of capacity, the Central Government rations the
allocation of rail cars. In one project which requires the
transportation of coal by rail, AES Chigen's Joint Venture has
obtained an administrative allocation of rail cars from the
Central Government. However, there can be no assurance that a
satisfactory allocation of rail cars will be available in all
future cases to ensure that the coal supply requirements of
the affected projects will be timely met.
Electricity Transmission. The Chinese electric power
transmission system is not fully interconnected. Some parts of
the transmission system contain isolated grids. Three of AES
Chigen's Joint Ventures are located in areas served by
isolated transmission grids. As a result, if demand in these
areas is less than forecasted, it may be difficult or
impossible for the affected Joint Venture to transmit the
project's available power to a region which has a demand for
it. The Company does not intend to bear the risk of the
construction of transmission lines. Although PRC law prohibits
foreign investment enterprises from constructing, owning or
maintaining a transmission line, in many cases, it may be
necessary for a project company to finance the construction of
the transmission line which is required to connect the power
plant to a nearby electric power grid. In these cases, in
addition to providing financing, the Company will seek to
structure its power purchase contracts in a manner which
places the risk of delays and failure to complete the
construction of the transmission line on the power purchaser.
In order to take advantage of a broader market and an
additional power purchaser, one of the Joint Ventures is
planning to incur additional costs to build a low-voltage
local transmission line to interconnect its power plant with a
larger grid.
Government Approvals. The Company seeks to ensure that its
joint ventures and joint venture partners obtain and comply
with all PRC approvals and laws and regulations and that
project budgets reflect compliance with all then-existing and
applicable PRC environmental protection laws and regulations.
In each case prior to funding its equity portion of the
registered capital of a joint venture, the Company seeks to
obtain a legal opinion from counsel qualified to practice PRC
law regarding, among other things, the validity and
sufficiency of all approvals for the project and joint
venture. The Company also seeks to receive letters of support
from the local governments in areas in which its projects are
located.
Foreign Exchange. The Company attempts to mitigate its foreign
exchange risks by structuring its joint venture contracts and
power purchase contracts to include hedges which provide for
adjustments in equity distributions to joint venture partners
and in electricity payments for changes in the exchange rate
between the Renminbi Yuan, the lawful currency of the PRC
("Renminbi," and "RMB(Y)"), and the US dollar. In instances in
which the Company seeks State Planning Commission approvals
for a project, the Company will also seek to receive an
approval which includes an allocation of foreign exchange to
the project.
Power Plant Management. The Company wants its power plants to
be managed efficiently, as well as in a manner consistent with
Company principles and practices. In pursuit of this goal, the
Company seeks to appoint experienced general managers and/or
deputy general managers with significant decision making
authority at the power plants and to install operating systems
at the power plants which are consistent with AES's operating
approach. The Company also seeks to have key members of a
plant's management team, including the general manager and
deputy general manager, acquire specific AES experience by
working at AES facilities worldwide.
The operation of an electric power generation plant may be
adversely affected by many factors such as the breakdown or
failure of equipment or processes, performance below expected
levels of output or efficiency, labor disputes, operational
errors, natural disasters, and the need to comply with the
directions of the relevant government authorities, the
dispatcher and power purchaser of a power plant. In addition,
such operation may be hampered by insufficient or poor quality
fuel caused by either inadequate supply or transportation or
arrangements therefor.
AES Chigen is not the operator of any of its power plants
either directly or by means of traditional operation and
maintenance agreements with internationally recognized power
plant operators. In some cases, AES Chigen's Joint Ventures
have contracted with the power purchaser to operate a power
plant. In such instances, the power purchaser is obligated
under the power purchase contract to purchase the annual
minimum quantity of electric power regardless of the power
plant being unavailable due to the fault of the operator. In
other cases, the Joint Ventures themselves are operating the
plant. In these instances, AES Chigen may affect the operation
of a power plant through the appointment of a general manager
and/or deputy general manager of the plant.
Insurance. The Company seeks to obtain insurance for its
projects from reputable insurance companies permitted to
insure projects in China for risks during construction and
operation, including business interruption insurance. The
Company typically retains an international insurance
consultant to advise the Company on the insurance coverage and
limits which are appropriate for the relevant hazards. Where
appropriate, the Company may seek to obtain Multilateral
Investment Guarantee Agency insurance coverage of certain
political risks associated with the PRC.
Water Usage Rights. The Company seeks to obtain long-term
water usage rights for the Company's operating plants.
In all of its projects, AES Chigen and its Joint Ventures are
relying on the reliability and creditworthiness of PRC entities such as its
partners, contractors, customers, suppliers, operators, guarantors, lenders and
others who are parties to agreements with AES Chigen or its Joint Ventures.
While AES Chigen believes that these counterparties have the ability to perform
and will perform their obligations, the reliability and creditworthiness of PRC
entities are difficult to ascertain. In most cases, AES Chigen, in assessing the
reliability and credit standing of counterparties, is relying on financial or
other information provided to AES Chigen or its Joint Ventures by such parties
or others, or from information and sources publicly available in the PRC. AES
Chigen can offer no assurance that this information is accurate or that these
counterparties will meet their contractual obligations. The failure of any one
of these counterparties to fulfill its obligations to a Joint Venture could have
a substantial negative impact on such Joint Venture's operations.
The People's Republic of China
The statistics set out in this section have been extracted
from various international organization, government and private publications.
The Company makes no representation as to the accuracy of the information
contained in this section. Furthermore, no representation is made that any
correlation exists between China or its economy in general and the performance
of the Company or the Company's Joint Ventures. Although statistics with respect
to the economy of China generally accord with observed economic trends, some
statistics may not correspond to Western measures, or may be flawed by
ineffective collection methods or other problems. Due to such factors,
statistical information regarding the economy of China may be inaccurate or not
comparable to statistical information with respect to other economies.
General
Since 1978, the Central Government and local governments of
China (together with the Central Government, the "PRC Government") have been
implementing market oriented economic reforms in an effort to revitalize the
PRC's economy and improve its citizens' standard of living. The reforms have
marked a shift from a more rigid, centrally-planned economy to a more mixed
economy in which market forces play an increased role and the government has a
reduced role. Enterprises owned or under the administrative control of the
Central Government ("State-owned") still constitute the largest sector of the
economy, but implementation of the economic reforms has led to, among other
things, the delegation to managers of enterprises of more decision-making powers
and responsibilities regarding matters such as production, marketing, use of
funds and employment of people. Other reform measures have included the
conversion of selected State-owned enterprises into joint stock limited
companies which have issued shares to the public and private investors
(including their employees); the gradual reduction of PRC Government control
over producer prices; and the designation of certain coastal areas and cities as
special economic development zones with greater local autonomy. The PRC
Government has also implemented policies designed to attract foreign investment
and technology. The PRC Government's reforms have resulted in significant
economic growth. The gross domestic product of China increased at an average
annual rate of 12.1% during the period from 1991 to 1995. The growth rate of
gross domestic product was 9.7%.
General economic conditions in the PRC could have a
significant impact on the business prospects of AES Chigen. The economy of the
PRC differs from the economies of most countries belonging to the Organization
for Economic Co-operation and Development in such respects as structure,
government involvement, level of development, growth rate, capital reinvestment,
allocation of resources, self-sufficiency, rate of inflation and balance of
payments position, among others. For over 40 years, the economy of the PRC has
been primarily a planned economy characterized by state ownership and control of
productive assets and the management of such assets through a series of economic
and social development plans. Although the majority of the PRC's productive
assets are still owned by the PRC Government, the adoption of economic reform
policies since 1978 has resulted in a gradual reduction in the role of state
economic plans in the allocation of resources, pricing and management of such
assets, an increased emphasis on the utilization of market forces, and rapid
growth in the PRC economy. However, such growth has been uneven among various
regions of the country and among various sectors of the economy. The success of
AES Chigen depends in part on the continued economic growth of the regions where
the Joint Ventures are located. At times, the economic reform measures adopted
by the PRC Government may be inconsistent or ineffectual, and therefore the
Joint Ventures may not be able to enjoy the potential benefits of such reforms.
Further, these measures may be adjusted or modified in particular ways in
particular areas, possibly resulting in such economic liberalization measures
being inconsistent from time to time or from industry to industry or across
different regions of the PRC.
AES Chigen may also be adversely affected by changes in the
political and social conditions in the PRC, and by changes in governmental
policies with respect to laws and regulations, methods to address inflation,
currency conversion, rates and methods of taxation, or the method by which
electricity tariffs are set and approved, among other things. While the PRC
Government is expected to continue its economic reform policies, many of the
reforms are new or experimental and may be refined or changed. It is also
possible that a change in the PRC Government leadership could lead to changes in
economic policy.
The PRC economy has experienced rapid growth in the past five
years. This growth has also been accompanied by rising inflation, which reached
an annual rate of 21.7% in 1994. The PRC Government has implemented policies
from time to time to restrain the rate of such economic growth and control
inflation in order to achieve coordinated economic development. In July 1993,
the Central Government began implementation of a number of austerity measures to
control economic growth and curb inflation, including increasing interest rates
on bank loans and deposits and postponing certain planned price reforms. While
inflation has since moderated to 6.1% for 1996, there can be no assurance that
such austerity measures will will not be discontinued or result in future severe
dislocations in the PRC economy. Austerity measures intended to slow economic
growth may affect the demand for electricity and the prospects for the financing
of some of the Joint Ventures. Depending on the nature and implementation of
such additional measures, the Joint Ventures' economic prospects at times may be
adversely affected through, among other possible measures, placing additional
controls on the increase of electric power rates. Any such development could
also adversely affect the Joint Ventures' operations or the ability of the Joint
Ventures' customers to honor their obligations under their power purchase
contracts, which could adversely affect AES Chigen.
A significant portion of the economic activity in the PRC is
related to exports and may therefore be affected by developments in the
economies of the PRC's principal trading partners. Trade sanctions imposed by
the PRC's main trading partners, including the revocation or conditional
extension by the United States of China's Most Favored Nation trading status,
could adversely affect the trade and economic development of the PRC and the
ability of the Joint Ventures' customers to honor their obligations under their
power purchase contracts with the Joint Ventures. In addition, current or future
disputes between the PRC and its main trading partners over specific trade
issues, such as intellectual property, the balance of trade or other political
issues, such as regional affairs or arms sales policies, could lead to the
imposition of trade or other sanctions which could adversely affect the demand
for power in the PRC.
China's legal system is relatively new, and the government is
still in the process of developing a comprehensive system of laws, a process
that has been ongoing since 1979. Considerable progress has been made in the
promulgation of laws and regulations dealing with economic matters such as
corporate organization and governance, foreign investment, commerce, taxation
and trade. Such legislation has significantly enhanced the protection afforded
to foreign investors. However, foreign investors may be adversely affected by
new laws, changes to existing laws (or interpretations thereof) and preemption
of provincial or local regulations by national laws or regulations. Moreover,
experience with respect to the implementation, interpretation and enforcement of
such laws and regulations is limited. Such administrative and judicial
interpretation and implementation and the enforcement of commercial claims and
resolution of commercial disputes may be subject to the exercise of considerable
discretion by both administrative and judicial organs and may be influenced by
external forces unrelated to the legal merits of a particular matter or dispute.
Even where adequate laws exist and contractual terms are clearly stated, there
can be no assurance that AES Chigen or a Joint Venture will obtain swift and
equitable enforcement of its rights.
The China Power Market
At the end of 1995, China had an aggregate installed electric
power generation capacity of approximately 217,220 MW, making China's electric
power generation capacity the second largest in the world. In 1995, about 17,323
MW of installed capacity was added. China's electric power industry produced
approximately 1,007 terawatt (one million megawatts) hours ("TWh") of
electricity in 1995. This represents an addition of nearly 80 TWh from 1994,
making China's electricity industry one of the fastest growing in the world.
Despite its size, China's electric power system is inadequate to meet current
and expected demand, and the consequent shortage is one of the major obstacles
to economic growth in the PRC. In addition, approximately 110 million people do
not yet have access to electricity. The following table highlights this
situation on a comparative basis, indicating with respect to the PRC that, while
its economic growth rate is among the highest of the countries mentioned, the
PRC is considerably below average in installed capacity and consumption of
electricity.
1994 1994 1994
Per Capita Per Capita Per Capita
Installed Electricity GDP --
Capacity(1) Consumption(1) Nominal Real GDP Growth Rate% (3)
--------------------------------------------------------------
(Watts) (kWh) US$(2) 1991 1992 1993 1994 1995 1996
-------------- -------------- ----------- ---- ---- ---- ---- ---- ----
(projected)
- --------------
U.S 2,812 11,256 25,850 (1.0) 2.7 2.7 3.5 2.0 2.4
- --------------
Japan 1,552 6,837 36,845 4.0 1.1 1.1 0.5 0.9 3.5
- --------------
Singapore 1,222 5,696 16,700 6.7 6.0 10.1 10.1 8.9 7.5
- --------------
Hong Kong 1,492 4,546 21,750 5.1 6.3 6.4 5.4 5.0 5.0
- --------------
South Korea 687 3,261 8,528 9.1 5.1 5.8 8.6 9.0 7.2
- --------------
Malaysia 352 1,669 3,627 8.6 7.8 8.3 9.2 9.5 8.8
- --------------
Thailand 233 1,080 2,423 8.1 8.1 8.3 8.8 8.7 8.3
- --------------
PRC 153 671 430 9.3 14.2 13.5 12.6 10.2 9.0
- --------------
Philippines 101 290 937 (0.6) 0.3 2.1 4.4 4.8 5.9
- --------------
Indonesia 83 278 874 8.9 7.2 7.3 7.5 8.1 7.8
- ---------------------------
Sources:
(1) U.S. Department of Energy, Energy Information Administration, Office of
Energy Markets and End Use, International Database (August 1996).
(2) U.S. Department of Commerce, Economics and Statistics Administration,
Office of Business Analysis, National Data Bank (August 1996).
(3) International Monetary Fund, World Economic Outlook (October 1996).
Developments in the PRC's Power Industry
Under the PRC's Eighth Five-Year Plan (1991-1995), increasing
demands for electricity resulted in the rapid increase in the PRC's total annual
electricity generation. A total of 65,747 MW of electric power generating
capacity was installed during the five-year period from 1991-1995, representing
an average annual increase of more than 16,000 MW. Notwithstanding such
increase, the PRC's average annual growth rate for electricity generation
between 1991 and 1995 (approximately 10.4%) did not keep pace with the average
annual growth rate of the PRC's Gross Domestic Product ("GDP") (approximately
12.1%) during such time. The following table sets forth figures for installed
capacity, increases in installed capacity, electricity generation and percentage
increases in electric power generation in China for the years 1986 to 1995.
Increase in Increase in
Installed Installed Electricity Electricity
Capacity Capacity Generation Generation
Year (MW) (MW) (TWh) (%)
------------------- ---------- ----------- ----------- -------------
1986 93,818.5 6,795.3 449.6 9.5%
1987 102,897.0 9,078.5 497.3 10.6
1988 115,497.1 12,600.1 545.2 9.6
1989 126,638.6 11,141.5 584.8 7.3
1990 137,890.0 11,251.4 621.2 6.3
1991 151,473.1 13,583.1 677.5 9.0
1992 166,532.4 15,059.3 754.2 11.3
1993 182,910.7 16,378.3 836.4 10.9
1994 199,897.2 16,986.5 927.9 10.9
1995 (estimated)(1) 217,220.0 17,322.8 1,007.0 8.5
- ---------------------------
Source: Ministry of Electric Power, Electric Power Industry in China (1996).
(1) Based on various published statements from MOEP officials.
Based on statements by the Ministry of Electric Power ("MOEP"
or the "Ministry of Electric Power"), China will need an average of
approximately 16,000 MW of new electric generating capacity annually through the
year 2000 (or an aggregate of approximately 80,000 MW of new electric generating
capacity in the Ninth Five-Year Plan period ending 2000). Since domestic savings
are insufficient to fund the PRC's requirements, the Ministry of Electric Power
has adopted plans to attract foreign capital and projects that 20% of the
capital for power industry development will come from foreign investors, 40%
from local governments and enterprises and the remaining 40% from the Central
Government during the five-year period ending December 31, 2000. MOEP estimates
that approximately $20 billion of overseas investment will be needed to reach
the MOEP's target of increasing installed capacity to 290,000 MW by 2000.
Energy Resources
China's main energy resources for power generation, coal and
hydropower, are not evenly dispersed geographically. Two-thirds of China's coal
reserves are located in the northern provinces of Shanxi, Shaanxi and the Inner
Mongolia Autonomous Region, and more than 90% of the PRC's hydropower resources
are concentrated in the western part of the country. Because China's
economically developed regions are principally located in the eastern and
southern coastal areas, the Ministry of Electric Power plans to expand the
interconnected power networks by installing high voltage transmission lines to
facilitate the transmission of power from the west to the east, as well as from
the north to the south. The Ministry of Electric Power has also indicated that
an increased focus should be placed on coal-fired electric power generating
projects which are located in close proximity to coal mines. The Company's
proposed Yangcheng Sun City power plant is an example of such a project. See
"Description of the Potential Projects -- Yangcheng Sun City."
China is rich in coal resources, with proven coal reserves of
966.7 billion tons. The PRC leads the world in coal production, with 1995
production of approximately 1.3 billion tons. Coal accounted for approximately
75% of electricity production in 1995, and approximately 77% of aggregate
domestic commercial energy consumption. The PRC intends to continue to rely on
coal as its primary fuel resource for electric power generation. However, the
PRC is also increasing its utilization of other fuels. Of the 16,987 MW of
electric power generation capacity added in 1994, hydropower accounted for
approximately 24.0%, nuclear power accounted for approximately 14.0% and fossil
fuels accounted for approximately 61.0%.
Organization of the PRC's Electric Power Industry
The PRC's electricity industry is controlled by the Ministry
of Electric Power, which was established by the Eighth National People's
Congress at its first session held in March 1993. Prior to March 1993, the
electric power industry was under the jurisdiction of the Ministry of Energy,
which itself was created in 1988 from parts of the former ministries which
oversaw the coal industry, the nuclear industry, the petroleum industry, water
resources and electric power.
The Ministry of Electric Power is responsible for formulating
development strategies and policies, including: investment, technical and
production and consumption policies relating to electric power development;
formulating unified electric power industry planning in collaboration with the
State Planning Commission and other government agencies; overseeing the
implementation of such planning; supervising the implementation of related
national policies, decrees and plans; and providing services to electric power
enterprises.
The Ministry of Electric Power manages five interprovincial
power groups ("Regional Power Groups") and ten provincial power bureaus. The
Regional Power Groups (i) manage their respective regional power grids, (ii)
dispatch, either directly or indirectly through lower level power bureaus, the
power plants connected to such grids and (iii) supervise the power bureaus at
lower administrative levels (primarily provincial but also certain large
municipalities and other areas). The Regional Power Groups also act through
power companies which develop, construct, own and operate certain power plants
and transmission facilities within their respective jurisdictions.
A similar structure exists for the provincial power bureaus
under the Regional Power Groups and the ten provincial power bureaus directly
managed by the Ministry of Electric Power. Each provincial power bureau manages
its provincial power grid and dispatches the power plants connected to such grid
to meet local demand. Many provincial power bureaus also act through power
companies which operate certain power plants and transmission facilities within
their respective provinces. Counties and municipalities directly under the
administration of the provinces may have power bureaus which perform, under the
administration of the power bureau at the next higher level of government,
similar functions within their respective jurisdictions.
The key personnel of the Regional Power Groups are appointed
by the Ministry of Electric Power, and the key personnel of the provincial power
bureaus are appointed by the provincial governments in consultation with the
Ministry of Electric Power.
In January 1996, the China National Power Corporation ("CNPC")
and the China Federation of Power Enterprises ("CFPE") were established pursuant
to the Central Government's policy to separate the regulatory and commercial
functions of the electric power industry. The PRC Government has announced plans
that the Ministry of Electric Power will be dissolved and its functions
transferred to CFPE and CNPC. CFPE will assume the Ministry of Electric Power's
regulatory functions. CNPC will serve as the PRC's principal investor in and/or
operator of wholly or partially State-owned facilities in the electric power
industry. CNPC also will be responsible for the operation of interregional
transmission facilities and the development of a national power grid.
Investment in the Electric Power Industry
Prior to 1985, virtually all investment in China's electric
power industry was financed by the Central Government. In 1985, the Central
Government began to implement a policy of using a variety of financing methods
to develop the PRC's electric power industry. Such policies included: (i)
allowing local governments to participate in the development and ownership of
power generating facilities in their areas, (ii) loaning (as opposed to directly
allocating) funds to local and provincial power bureaus for the development and
construction of such projects, and (iii) permitting foreign investment and
participation in the development and operation of power plants in China. Hong
Kong investment companies and developers were the first foreign companies to
invest in the industry. More recently, however, developers and investors from
other countries have begun pursuing investment opportunities in various electric
power projects in China. Between 1979 and 1995, 77 large and medium-sized
foreign-invested power projects were constructed, with a total installed
capacity of 49,740 MW, of which 24,290 MW had been put into operation by the end
of 1995. The total contracted foreign investment in power projects has reached
$17.2 billion, of which $11.5 billion had been invested by the end of 1995. In
1995, China launched the first Central Government sponsored pilot build, own and
transfer program to attract foreign investment in infrastructure projects. The
first project under this competitive bidding program is the proposed $600
million, 700 MW coal-fired Laibin project in Laibin County, Guangxi Zhuang
Autonomous Region.
In 1988, as part of the system of investment reform in power
development, the State Council of the PRC (the "State Council"), the highest
administrative organ of the Central Government, organized the State Energy
Investment Corporation (the "SEIC") to represent the PRC Government in the
development and financing of large power plants. Also in 1988, the China Huaneng
Group was formed primarily as a developer and operator of power plants. In March
1994, the State Council announced the absorption of the SEIC into the State
Development Bank ("State Development Bank"), as well as its intention to
transfer the SEIC's personnel to various Central Government enterprises and to
the State Development Investment Company under the State Development Bank.
To finance the expansion of the electric power industry, the
State Council, in 1995, approved the establishment of China Power Investment
Corporation ("CPIC") in China and China Power International Holdings Limited
("CPI"), CPIC's wholly owned subsidiary, in Hong Kong. CPIC was established by
the Ministry of Electric Power to raise funds in the international capital
markets to invest in PRC power projects. CPI has been authorized to sell
interests in State-owned power utilities, issue debt, establish investment funds
for the electric power industry and raise foreign funds for investment in the
electric power industry. CPI is one of the Company's Joint Venture partners in
the Wuhu Grassy Lake project and one of the Company's project partners in the
Nanpu Southern Delta project. See "Description of the Current Projects" and
"Description of the Potential Projects."
With appropriate PRC Government approvals, power bureaus may
form directly managed power companies, which may develop, construct, own and
operate power plants in their respective territories.
Tariff Setting Mechanisms
For power plants that the Ministry of Electric Power directly
or indirectly manages, the tariff is generally set under the plans devised and
implemented by the PRC Government in relation to the economic and social
development of the PRC ("State Plan"). The tariff varies according to the
category and location of the users. Thus, most electricity has been purchased
from power plants at State Plan tariffs. These State Plan tariffs have been
maintained at a low level, due to subsidization by the PRC Government. One of
the stated goals of the Ministry of Electric Power is to reform power pricing
consistent with the development of the market economy in the PRC. The Ministry
of Electric Power has commenced the trial implementation of a pricing policy
which charges consumers higher tariffs for peak load periods and lower tariffs
for off-peak load periods. Allowing the market to influence the setting of power
tariffs is intended to provide incentives for greater efficiency in energy
production, reduction of energy use per unit of industrial output and promotion
of conservation technologies. As of 1994, more than ten power grids have
implemented this pricing policy.
The tariffs of sino-foreign joint venture power projects
generally have been established by negotiations among the sino-foreign joint
ventures, the prospective power purchasers, the relevant local governments,
planning commissions, pricing bureaus and power bureaus. The tariffs or tariff
formulas are typically set forth in power purchase contracts. The pricing
bureaus are responsible for approving and adjusting the tariffs, usually on an
annual basis.
Electric Power Law
In April 1996, a new national law governing the electric power
sector in the PRC came into effect. The law is intended to protect the
legitimate interests of investors, operators and consumers. It provides a
framework within which the PRC Government intends to guide investment in the
electric power sector. The law also establishes, among other things, broad
principles with respect to the methodology of calculating and setting electric
power tariffs. The principles state that electricity tariffs shall be based on
reasonable compensation for the costs of generation and payment of taxes, the
recovery of reasonable profits and the promotion of the construction of electric
power generating facilities. Detailed regulation with respect to tariff
calculation and tariff setting are expected to be promulgated by the Ministry of
Electric Power in the near future. The impact of the new law will depend on its
implementing regulations and the manner in which the law is interpreted.
Transmission and Dispatch
The main system for the dispatch, transmission and
distribution of electric power in China consists of the five interprovincial
power grids managed by their respective Regional Power Groups, one
interprovincial power grid, which consists of four semi-independent provincial
grids managed by their respective four provincial power bureaus, and the six
independent provincial power grids managed by their respective provincial power
bureaus. The table below shows the aggregate installed capacity of the power
plants connected to the grids managed by such power bureaus and the total
electricity generated on those grids in 1994.
1994 1994
Installed Total Electricity
Capacity Generation
Power Grids (MW) (TWh)
--------------------------- --------- ------------------
East China Power Grid 31,673.2 164.358
Northeast Power Grid 26,534.4 124.531
Central China Power Grid 27,602.2 132.047
North China Power Grid 27,146.4 140.087
Northwest Power Grid 11,483.0 60.423
Guangdong Power Grid(1) 19,009.7 73.916
Shandong Power Grid 11,518.2 67.183
Sichuan Power Grid 10,095.8 47.328
Guangxi Power Grid(1) 4,230.7 16.854
Fujian Power Grid 4,960.3 21.605
Yunnan Power Grid(1) 4,082.9 16.939
Guizhou Power Grid(1) 3,253.8 15.206
Xinjiang Autonomous Region 2,865.1 10.617
Hainan Power Grid 1,057.3 2.869
Tibet Autonomous Region 176.6 0.427
- ---------------------------
Source: Ministry of Electric Power, Electric Power Industry in China (1996).
(1) Part of the Southern Interconnected Power Grid established in 1993.
In 1994, the PRC had almost 540,000 kilometers of transmission
lines with a capacity of 35 kilovolts ("kV") or greater. The power grids
primarily use 500, 330, 220 and 110 kV transmission lines.
All electricity produced in China is dispatched by the power
bureaus, except for that generated by units not connected to a grid. The grids
and the electric power dispatched to each grid are administered by dispatch
centers ("Dispatch Centers") operated by the power bureaus. In November 1993,
the State Council issued the Administrative Regulations Concerning Grid Dispatch
("Dispatch Regulations"), the first nationwide regulations in China governing
the dispatch of electric power. The Dispatch Regulations are intended to help
the PRC achieve a more efficient and rational dispatch of electric power. Under
the Dispatch Regulations, Dispatch Centers were established at each of five
levels: the National Dispatch Center, the Dispatch Centers of the Regional Power
Groups, the Dispatch Centers of the provincial power bureaus, the Dispatch
Centers of the power bureaus of municipalities under provinces and the Dispatch
Centers of the county power bureaus. Pursuant to the principles of unified
dispatch, set forth in the Dispatch Regulations, Dispatch Centers at lower
levels are required to comply with the dispatch instructions of higher level
Dispatch Centers.
Dispatch Centers are charged with setting production levels
for the various power plants connected to the grid. To effect this
determination, each power plant receives daily from its local Dispatch Center an
expected hour-by-hour output schedule for the following day, based on expected
demand, the weather and other factors. The Dispatch Centers must dispatch
electric power according to, among other things, (i) power supply agreements
entered into between a power bureau and certain large or primary electricity
customers, where such agreements take into account the electric power generation
and consumption plans formulated annually by the PRC Government and set forth in
the State Plan, (ii) agreements entered into between a Dispatch Center and each
power plant subject to its dispatch, (iii) interconnection agreements between
power bureaus, and (iv) the actual conditions of the grid, including equipment
capabilities and safety reserve margins.
Peak and Seasonal Demands
The demand for electric power experiences fairly predictable
daily and other periodic cycles. The peak periods of power use in China are in
the early morning and evening when industrial, commercial and residential use is
highest. Peak power is in great demand in many cities which have rapid economic
growth. Because the PRC has a significant shortage of electric generating
capacity, the Dispatch Centers restrict the access to electricity of certain
users during peak periods of demand. As a result, the peak load demand in China
does not accurately reflect the extent of the total demand for power. While
power plants operate at less than full capacity during off-peak periods,
virtually all available power plants operate at or near full capacity during
peak periods, subject to grid-wide safety reserve margins. Four of the Joint
Ventures' power plants currently in operation or under construction -- Chengdu
Lotus City, Hefei Prosperity Lake, Wuxi Tin Hill and Yangchun Sun Spring -- are
designed to provide peaking power. The Company believes that each of these
plants will be able to take advantage of the demand for peak power in its
region. However, such plants are typically dispatched only after base load power
plants have been brought on-line and reached maximum capacity. If electric power
demand proves less than expected in an area, additional peak or base load power
may not be required in the area or may be required at lower than expected
levels.
Because the combustion of coal provides most of China's
space-heating needs and because air conditioning is not yet prevalent in most
regions of China, seasonal variations in the demand for electricity are less
than in many developed countries.
Joint Venture Companies
Foreign investment in the PRC may take a number of forms,
including joint ventures, wholly foreign-owned enterprises, branches of foreign
companies and shareholdings in limited liability companies and joint stock
limited companies. The Company currently invests through the joint venture
structure. The Company's current joint venture partners are PRC entities. The
Company anticipates that its future joint venture partners will be PRC entities
although non-Chinese partners may be included as partners, if appropriate. Joint
ventures between Chinese and foreign parties in the PRC take two basic forms:
equity joint ventures and cooperative joint ventures. Equity joint ventures are
governed by the Law of the People's Republic of China on Joint Ventures Using
Chinese and Foreign Investment and the implementing regulations related thereto.
Cooperative joint ventures are governed by the Law of the People's Republic of
China on Chinese and Foreign Cooperative Joint Venture Enterprises and the
implementing regulations related thereto ("Cooperative Joint Venture Law").
A cooperative joint venture may be structured as an entity
similar to a partnership (in which case it will not be separately qualified as a
legal person under Chinese law) or it may be structured as a limited liability
company (in which case it will be qualified as a legal person under Chinese
law). In most cases, cooperative joint ventures are formed as limited liability
companies. Cooperative joint ventures allow more flexibility than equity joint
ventures in structuring the terms of the joint venture arrangement. For example,
in a cooperative joint venture the rights of a party to share in the profits of
the joint venture need not correspond to its contributions to the registered
capital (equity) of the joint venture relative to other parties. In addition,
subject to government approval, the Cooperative Joint Venture Law permits
recovery of the foreign party's registered capital during the venture term.
However, the Cooperative Joint Venture Law requires that the fixed assets of the
joint venture be transferred to the Chinese parties without charge at the end of
the venture term if the foreign party recovers all of its equity capital during
the term of the venture. Cooperative joint ventures are subject to laws and
regulations with respect to such matters as the contribution of registered
capital, debt-equity leverage ratios, accounting, taxation, foreign exchange,
labor and liquidation and dissolution. Transfer of an interest in a cooperative
joint venture requires government approval and unanimous agreement among the
parties.
An equity joint venture enterprise is a distinct legal entity
established and registered as a limited liability company. The parties to an
equity joint venture have rights to share in the profits of the joint venture in
proportion to their respective contributions to the registered capital of the
joint venture. The operations of equity joint ventures are subject to many of
the same laws and regulations as cooperative joint ventures. Transfer of an
interest in an equity joint venture requires government approval and unanimous
agreement among the parties. In addition, in an equity joint venture, the
parties may not reduce the amount of their registered capital until the
expiration of the term of the joint venture or its dissolution in accordance
with PRC law.
Typically, dividends are paid by a joint venture in accordance
with the profit distribution plan adopted by the joint venture's board of
directors. Except as mentioned above, PRC laws and regulations provide that only
accounting profits (after payment of taxes, provision for losses for prior years
and contributions to special funds for enterprise expansion, employee welfare
and bonuses and a general reserve) are available for dividend distributions to
the parties of a joint venture.
In addition to contributions of registered capital, joint
ventures may be financed by debt, including shareholder loans. Foreign currency
loans to a joint venture, however, must be registered with the local branch of
the State Administration of Foreign Exchange of the Central Government ("State
Administration of Foreign Exchange" or "SAFE") in the location in which the
joint venture is situated.
Foreign investment enterprises are permitted under PRC laws
and regulations to convert their Renminbi earnings into foreign exchange for
certain purposes, including to pay their foreign currency obligations, to pay
dividends and other distributions to foreign shareholders and to make payment of
interest and principal with respect to foreign currency loans (both third party
and shareholder debt) incurred by the joint venture. To effect such conversions,
joint ventures must comply with certain procedures required by PRC laws and
regulations.
Government Approvals
China's electric power industry is highly regulated, both in
terms of operating existing power plants and developing new power projects. All
electric power projects in China and all foreign investments are required to
obtain approvals from one or more central, provincial or local government
authorities. While the regulations governing and the procedures for obtaining
approvals for foreign investment projects are generally well-understood, the
specific regulations and procedures for the approval of electric power projects
with foreign investment in the PRC and associated foreign investment enterprises
are not entirely transparent. Project approvals and foreign investment approvals
are required, but follow separate procedures. At the highest level, the right to
approve projects in the PRC is vested in the State Council. The State Council
has reserved to itself the authority to approve any project with a total
investment which exceeds $100 million. Pursuant to various internal PRC
Government notices, the State Council has delegated the authority to approve any
project with a total investment of less than $100 million to various ministries
and ministry level entities, including the SPC. The SPC and certain ministries
and other ministry level entities have, in turn, adopted a policy, also by
internal directives, of further delegating authority to approve projects with a
total investment of less than $30 million to provincial governments, provincial
level bureaus of the Central Government and certain municipalities. The project
approval authority of local governments is, therefore, generally limited to not
more than $30 million. Separate from project approval, foreign investment must
be approved by The Ministry of Foreign Trade and Economic Cooperation of the
Central Government ("Ministry of Foreign Trade and Economic Cooperation or
"MOFTEC"), or one of its departments at the provincial or local government
level, should the total investment amount be below $30 million. Accordingly,
foreign investment enterprises proposing to undertake projects must obtain
approvals for the projects from the appropriate government level planning
authorities and approvals for the foreign investment from a similar level
department of MOFTEC.
Generally, the approval process can be divided into three
major stages. First, following preliminary planning by the Chinese party and, in
some instances, initial negotiations with the foreign party and the execution of
a letter of intent by the parties, a project proposal (including a preliminary
feasibility study report and an environmental impact report) is submitted to the
appropriate level planning authorities for approval.
In the second stage, a more detailed joint feasibility study
report and a more detailed environmental impact report will be prepared. During
this stage, the foreign and local parties will negotiate and execute a legally
binding joint venture contract and articles of association. The approval of the
local government authorities for both the project and the foreign investment is
required. Additionally, as stated above, depending on the amount of total
investment in the proposed project and joint venture, the approval of the
Central Government may be required. Approval may also be required from other
central, provincial and local government ministries and agencies, with respect
to, among other matters, foreign exchange plans, allocations of fuel supplies
and related transportation, land use, tax preferences, electricity pricing, grid
access, operations and maintenance arrangements, loan and guarantee arrangements
and design and engineering arrangements.
In the final stage, following approval of the joint venture by
the relevant department of MOFTEC, the joint venture must register with and
obtain a preliminary business license from the State Administration of Industry
and Commerce ("SAIC") or a branch thereof. Following the completion of these
formalities, the parties are required to contribute their agreed upon registered
capital and, upon verification thereof, the joint venture is issued a permanent
business license by the SAIC.
The approval process outlined above could take several years.
Therefore, in some instances, the Company may pursue opportunities for
investments in power projects that are in advanced stages of development or for
which significant approvals have already been obtained or construction has
commenced or been completed.
Two of AES Chigen's power plants have been structured as
multiple projects and joint ventures, each project and joint venture with a
total investment below the $30 million threshold, and have obtained local
government approvals on this basis. It is possible that projects structured in
this fashion could be viewed by the Central Government approval authorities as a
single project. In several other cases, AES Chigen's projects and Joint Ventures
have obtained local government approvals on the basis of anticipated total
investments which were less than $30 million at the time the approvals were
obtained, but will, when construction is completed, exceed the $30 million
approval threshold. While it is common in the PRC for projects and joint
ventures such as these to obtain and rely on only local government approvals, it
is unclear whether such approvals are sufficient. There can be no assurance,
therefore, that the absence of Central Government approvals will not adversely
affect the Joint Ventures and their projects in any of such cases.
In addition to such project and foreign investment approvals,
the tariffs payable under the relevant power purchase contract is established on
the basis of a tariff formula agreed upon through discussions among the Company,
its partners, the prospective power purchaser, the relevant local government,
the relevant pricing bureaus and the relevant planning commission. Once
established, the tariffs are subject to annual review by the relevant local
pricing bureaus and adjustment in accordance with the formula. The tariff
formulas contained in the power purchase contracts entered into by AES Chigen's
Joint Ventures are structured to permit the Joint Ventures to pay the operating
expenses of the plant, the financing costs of each particular project and to
enable AES Chigen to realize a return on its investment. While the relevant PRC
pricing bureaus have committed to utilize the Joint Ventures' formulas in
establishing and adjusting tariffs, there can be no assurance that the relevant
pricing bureaus will calculate and adjust tariffs in accordance with these
tariff formulas. On April 1, 1996, a new law governing the electric power sector
in the PRC came into effect. The law establishes, among other things, broad
principles with respect to the methodology of calculating and setting electric
power tariffs. Detailed regulations with respect to tariff calculation and
tariff setting are expected to be promulgated in the near future by the Central
Government. There can be no assurance that such regulations, when promulgated,
will not adversely affect the tariff structures which AES Chigen's Joint
Ventures have adopted.
Environmental Regulation
The Joint Ventures are subject to various PRC environmental
laws and regulations which are administered by both Central Government and local
government environmental protection bureaus. Approval or review by the relevant
environmental protection bureaus is required at each of the project proposal,
feasibility study, design and commissioning stages of a project. Filing of an
environmental impact statement or, in some cases, an environmental impact
assessment outline is required before the planning commission for the same level
of government can issue its approval. The filing must demonstrate that the
project conforms to applicable environmental standards. Approvals and permits
generally have been issued for projects utilizing modern pollution control
technology. Pollution sources are also required to report their pollution
discharges in terms of types and amounts of pollutants discharged into the water
and air, and to secure discharge permits for their wastewater discharges,
airborne emissions and, from April 1, 1996, solid waste shipments to ensure
compliance with relevant emissions standards.
The PRC's environmental laws and regulations establish
standards for the discharge of emissions into the air and water. The rules set
forth schedules of base-level discharge fees for various polluting substances
and specify that, if such levels are exceeded, the polluting entity will be
required to pay an excess discharge fee to the local government. The local
environmental rules do not make it a violation to exceed these limits, but
rather set forth a set of graduated scale of fees that are required for each
incremental unit of excess discharge. Up to a certain level, as the discharge
levels increase, the fee per unit also increases. Above a certain limit, local
governments may issue orders to cease or reduce such discharge levels which, if
not complied with, will after three years from the date of the order, result in
an annual increase of 5% in the pollution fees assessed. Where pollution is
causing environmental damage, the local governments also have the authority to
issue orders requiring the polluting entities to cure the problem within a
certain period of time. Non-compliance with such orders may result in the
entities being shut down.
The PRC is a party to the Climate Change Convention ("Climate
Change Convention"), which is intended to limit or capture emissions of
greenhouse gases, such as carbon dioxide. Ceilings on such emissions could limit
the production of electricity from fossil fuels, particularly coal, or increase
the costs of such production. Ceilings on the emissions of greenhouse gases have
not been assigned to developing countries such as the PRC under the Climate
Change Convention and the PRC has objected to the possibility of the imposition
of such ceilings. If the PRC were to agree to such ceilings, or otherwise reduce
its reliance on coal-fired power plants, the business prospects of AES Chigen
could be adversely affected. Under the Air Pollution Prevention and Control Law
of the PRC, as amended in 1995, regulatory preferences are given to the use of
low sulfur-content, low ash coal, and to plants in urban areas that generate
steam as well as electricity. The SPC also has stated that it favors the
construction of more plants relying on clean fuels.
MOEP has established technical standards for environmental
monitoring and exercises certain disciplinary functions with regard to
environmental compliance in connection with the construction and operation of
power plants. Environmental protection equipment is required to be designed,
installed and commissioned in tandem with the design, construction and
commissioning of the generator or plant. Before commencing operations, each
plant or generator must be tested and qualified with regard to emissions levels
and abatement equipment. The Company believes the environmental protection
systems and facilities of its Current Projects are in compliance with applicable
PRC national and local environmental protection requirements.
AES Chigen's Joint Ventures with power plants in operation
have received the environmental approvals from the PRC Government environmental
authorities required for them to operate their respective electric power plants.
Inasmuch as the Joint Ventures' electric power plants currently under
construction are typically among the most modern in the areas in which they are
located, AES Chigen believes that these plants will also receive all required
environmental approvals. There can be no assurance, however, that the
requirements to obtain such approvals may not be made more stringent in the
future. If such a change in policy occurs, there can be no assurance that all
such requirements will be met and that future approvals for existing or
potential projects will be granted. If a change in environmental requirements
leads to an increase in costs, an affected Joint Venture is able to receive an
adjustment in the tariff it charges for electric power pursuant to its power
purchase contract.