Update on Turkey BOT Power Plants

UNCLAS SECTION 01 OF 03 ANKARA 000886

SIPDIS

USDOC FOR 4212/ITA/MAC/CPD/DDEFALCO
DOE FOR C WASHINGTON
EXIM FOR P ROSS AND M KOSTIC
OPIC FOR R CORRIGAN, D SCHMITZER, AND T MAHAFFEY

SENSITIVE

E.O. 12958: N/A
TAGS: ENRG EINV TU
SUBJECT: Update on Turkey BOT Power Plants

REF: Ankara 566

04 Ankara 4601

Sensitive But Unclassified. Please Handle Accordingly.


1. (SBU) Summary. The importance for Turkey of
honoring its "BOT" contracts with independent power
projects despite their high cost has been on the U.S.-
Turkey economic agenda since the beginning of this
decade. Despite public blustering and pressure on the
companies to reduce prices, the government has allowed
the plants to operate and has not taken any unilateral
confiscatory or expropriatory action. The government
and the companies are currently negotiating contract
changes, but even if these negotiations are mainly
intended for public consumption, it is unlikely that
the government -- which needs to attract substantial
foreign and domestic private investment in generating
capacity over the next few years -- will take dramatic
action against the companies, which continue to involve
substantial, though declining, U.S. financial
interests. End Summary.

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The Longstanding Issue of BOTs
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2. (SBU) Since the late 1990s, the Turkish government
has grappled with the financial and domestic political
problems presented by "take or pay" contracts that
require it to purchase electricity from privately
developed independent power projects (IPPs) at high
guaranteed prices. At several points, especially
during and immediately after the 2000-01 financial
crisis, Turkish officials threatened to unilaterally
alter or abrogate these contracts. At other times they
have applied strong legal and regulatory pressures,
often amounting to harassment, in unsuccessful efforts
to convince IPP sponsors to agree to changes in
contract terms. With several of the plants having
public and private U.S. debt and equity exposure, U.S.
officials have continually urged Turkey not to take any
actions that would call into question the principle of
"contract sanctity" and thereby further damage Turkey's
already fragile business and investment climates as
well as U.S. commercial interests.

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BOT'S Become Political Issue
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3. (SBU) BOT's (Build-Operate-Transfer) account for
40% of the country's current electricity generation and
25% of installed capacity. Especially in the context
of severe government spending austerity since the
financial crisis, the contracts have become a sensitive
political issue. Popularity-seeking politicians have
made repeated promises to reduce electricity prices
paid by businesses and consumers, while the
sensationalist, nationalistic press constantly goads
the government and public on the issue.


4. (SBU) Two BOT gas-fired IPPs, Trakya Elektrik and
Doga Enerji, have attracted the most controversy.
Although the plants have never been issued formal
licenses, the government has allowed them to operate at
full capacity under the existing contracts. Thus, GOT
has taken and paid for the electricity produced per the
take-or-pay contracts. However, in an apparent effort
to pressure the companies, Turkish officials have
subjected them to intrusive tax and financial
inspections that the companies claim -- and Turkish
officials will privately admit -- has at times amounted
to harassment. At several points, the press has
reported that the government intended to seize the
plants. The most recent such reports, in October 2003,
were denied by the Energy Ministry.

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Mood Turns Toward Negotiations
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5. (SBU) More recently however, Turkish government
officials have adopted a different tone and apparently
a different approach to the problem, although the
investigations of potential "misconduct" continue (ref
B). Turkish officials tell us they recognize the
importance of not abrogating existing contracts.
Instead, they say they are looking for negotiated
"solutions," and have called for "voluntary reductions"
from four existing BOT projects that would be
negotiated between the government and investors. The
GOT and companies have recently entered into
negotiations for a compromise, although companies
continue to report an excess of inspection and pressure
to unilaterally cut prices.


6. (SBU) In late December 2004, the Energy Ministry
initiated negotiations with the BOT sponsors to seek a
solution to the BOT conundrum that does not disturb
investors. While citing the value of contract
sanctity, the MENR called for a voluntary reduction in
price in recognition of the changed market
circumstances. The BOT companies, quite naturally,
remain suspicious. A company official told us that the
Ministry implicitly threatened to pursue the results of
financial and customs inspections, without revealing
any potentially incriminating information it might
have. The Ministry initial set a public deadline of
January 15 for company offers and a determination to
solve the BOT problem by May. Without making any
"offers" on prices, the companies all sent letters to
the Ministry prior to January 15 asserting their
steadfast adhesion to contract provisions and good
faith intentions to seek a compromise with the Ministry
of Energy -- as a contract partner. The companies say
they now expect to receive a "reference price" from the
Ministry for discussion purposes and note that all
their foreign partners' and creditors' assent would be
needed for any deal. A senior Turkish energy official
told us that the government did not really expect the
negotiations to result in significant contract changes,
but that politicians needed to be "doing something"
that they could point to with constituents.

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Goal of Market Liberalization
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7. (SBU) Budak Dilli, MENR Energy Affairs DG,
reaffirmed to us on January 7 that the GOT would not
seek to unilaterally amend or cancel the contracts with
BOT's, noting the need to assure a transparent
investment environment, based on rule of law, which
would attract needed new capital. He emphasized that
the GOT was committed to moving to a liberalized
market, with reduced public obligations. Moreover,
Dilli stated that no matter how tough the investment
conditions were at the time these projects were
launched, the contracts were badly designed and too
expensive. Dilli said that the parties needed to
understand the changed situation and each others'
positions and work together to reach a compromise.
Energy Under Secretary Sami Demirbilek reiterated these
points in a January 28 meeting (ref A).


8. (SBU) The Ministry says that its objective is to
transition the energy sector to a liberal, market-
driven model, with which the high fixed price BOT
contracts are inconsistent. Dilli noted that the GOT
was working closely with the World Bank on an
Electricity Strategy Paper. He admitted that there had
been some delays, but he asserted that this showed that
the GOT was serious about laying adequate preparations
for successful liberalization and privatization of the
distribution and production facilities. He described
the challenges as three-fold: a) attracting new
investors given projections for increased energy
demand, b) establishing a new investment model that did
not depend on sovereign guarantees, and c) formulating
a smooth transition from the old system - with the
baggage of some "bad" contracts - to a new liberalized
system - without scaring off potential investors.
Dilli emphasized that transparency, an efficient legal
system, and minimized regulatory risk were vital for
investor confidence and liberalization.

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Declining U.S. Exposure
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9. (SBU) Meanwhile, U.S. private financial exposure
to the plants has been declining. In particular, the
U.S. Edison Mission company is reportedly selling its
interest in the 180 MW Doga Energi BOT project to a non-
U.S. investor. Similarly, we understand that Bechtel
and Shell are selling their interest in the three
"Intergen" BO projects (Adapazari - 777 MW, Gebze -
1554 MW, Izmir- 1550 MW) to their Turkish partner,
ENKA. Finally, we have heard that Prisma, as the
successor to Enron, may be interested in divesting
itself of its interest in the 480 MW "Trakya Electrik"
BOT project. Both EXIM and OPIC, however, may continue
to have exposure to these projects. In addition, EXIM
has credit outstanding to Turkish owned Baymina and
Zorlu (a corporate generating facility) projects.

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Comment
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10. (SBU) The issue of the BOT's appears to have
found a reasonably steady equilibrium. The projects
continue to operate according to their contracted terms
and the risk of unilateral action by the government is
still present, but is considerably less than it may
have been earlier in the decade. Contributing to this
has been the government's recognition that confiscatory
action would be contrary to its need to encourage
private foreign investment in the energy sector needed
to meet growing electricity demand, which could exceed
supply by 2007 according to some projections. Also,
the period of highest prices under the contracts has
been passed. There was 15% price step-down in 2005 and
there will be another in 2009. While the local
companies remain wary, they accept that they continue
to operate and receive their return on investment.


11. (SBU) Thus, Embassy does not believe that the
Turkish government will resort to outright contract
abrogation or seizure, as it is increasingly mindful of
the importance of rule of law to attract badly needed
foreign investment. As Turkey moves further towards
market based liberalization, it faces a special
challenge in assuring transparent contract-based
treatment of previous guaranteed (shielded from the
market) obligations. Although the country's lively and
unrestrained press will continue to (mis)inform and
exaggerate contentions, it seems to Post that the
period of greatest risk has passed, but we will
continue to monitor the situation closely.
Edelman