Acknowledgments This paper was prepared by a team consisting of David Loew (World Bank), Stephen Nash (Kuungana Advisory), and Tim Boyd (Kuungana Advisory). The paper was prepared as part of a wider analytical program on West African utility performance led by David Loew, under the strategic guidance and direction of Ashish Khanna. The financial support of ESMAP is gratefully acknowledged. ESMAP is a partnership between the World Bank and over 20 partners to help low- and middle-income countries reduce poverty and boost growth through sustainable energy solutions. ESMAP’s analytical and advisory services are fully integrated within the World Bank’s country financing and policy dialogue in the energy sector. Through the World Bank (WB), ESMAP works to accelerate the energy transition required to achieve Sustainable Development Goal 7 (SDG7) to ensure access to affordable, reliable, sustainable, and modern energy for all. It helps to shape WB strategies and programs to achieve the WB Climate Change Action Plan targets. Acknowledgments i Contents Acknowledgmentsi Prefaceiii Key Findings & Recommendations iv 1. Overview of West African Balance Sheets and the Case for Optimization 1 1.1. Background 1 1.2. Indicators of balance sheet stress 5 1.3. Objectives of balance sheet restructuring 7 2. Balance Sheet Restructuring Options 9 2.1. Reallocating liabilities 10 2.2. Renegotiating liabilities 12 2.3. Implementation considerations for reallocation and renegotiation of liabilities 14 2.4. Removing liabilities (or underperforming assets) 16 2.5. Offsetting/netting 19 2.6. Revaluation 20 3. Summary of Case Studies 22 Annexes Annex A: Balance Sheet Basics – Definitions and Accounting Terminology 24 Annex B: Debt Refinancing and Payables Extension in Albania 26 Annex C: Debt and Arrears Refinancing in Côte d’Ivoire with World Bank Guarantee 34 Annex D: Cross-Debt Cancellation and Debt Refinancing in Jordan 42 ii Balance Sheets in West Africa Strengthening Utility  Preface Most power utilities in West Africa are not financially sustainable. Of the 25 West African utilities included in the World Bank’s Utility Performance and Behavior Today (UPBEAT) database, only six are able to recover their operating and debt service costs—the bare minimum for financial sustainability— even when operating subsidies are included (as reported in utilities’ income statements). Without operating subsidies, this number drops to three. Poor cost recovery often drives a vicious cycle of underperformance, in which inadequate funding for investment leads to higher losses and lower service quality, which in turn reduces utility revenues. Several interrelated factors cause these performance issues, but dependence on liquid fuels, poor governance, insufficient use of IT, and weak balance sheets are particularly common and acute challenges. Utilities with high shares of liquid fuels in their generation mixes face high and volatile power purchase costs. The resulting financial instability not only eats into utilities’ bottom lines but also impedes effective financial planning. Utilities with poor governance and inadequate use of IT tools lack robust procurement systems and are less able and incentivized to monitor and implement efficiency in operations. Weak balance sheets—arising when utilities have accumulated liabilities that they are unable to sustainably service—drive up utilities’ financing costs and make them riskier targets for investment. Together, these factors represent significant sources of inefficiency. Addressing them could reduce utilities’ costs of service and reduce or eliminate the need for higher tariffs to achieve cost-recovery. This paper is one of a series of three that aim to help West African utilities and governments— and the development financiers that support them—better understand and respond to these issues. The focus in the papers is primarily on utilities with a distribution function (that is, distribution-only utilities, transmission & distribution utilities, or vertically integrated utilities), but examples from other types of utilities (transmission only, generation & transmission) are drawn on when instructive. Though each paper’s approach is tailored to its topic, they share common features. Each paper contains: i) a stocktaking of the scope of the challenge in West African utilities, sometimes informed by new data collected for that paper; ii) conceptual frameworks to help readers deepen their understanding of the topic; and iii) real-world country examples in the form of case studies and/or utility deep dives. The insights presented in these papers draw on lessons learned from past World Bank engagement with client utilities and, in turn, have helped shape ongoing Bank operations. Preface iii Key Findings & Recommendations Key Findings  Key Finding #1: Many utilities in West Africa show signs of balance sheet distress. Liquidity and capital structure ratios are weak across the region. For instance, only six of the 25 utilities sampled in this paper have receivables balances of less than six months’ worth of revenue— already a low bar for collection efficiency—suggesting that poor collections are a significant driver of poor cost recovery. Many utilities in West Africa lack access to affordable financing options to bridge gaps in cost recovery. For these utilities, delaying payments to suppliers is often the most readily available source of liquidity, and over 70 percent of West African utilities examined have outstanding payment balances to suppliers totaling more than six months. In addition to high payables, many utilities in West Africa also carry debt they are unable to service. More than half the sample has interest coverage ratios below 1.5, suggesting that these utilities struggle to meet their financing costs.  Key Finding #2: Utility balance sheet deterioration often follows a similar pattern. High costs, low tariffs, high power losses, poor collections, or external shocks lead to utilities’ cash flows becoming inadequate to cover their operating costs and debt service obligations. As a first line of recourse, utilities often delay payments to suppliers to generate liquidity, which can be an attractive short-term solution especially if suppliers (such as generators) are also state-owned. Eventually, however, suppliers have to be paid and utilities resort to expensive short-term borrowing, using the proceeds of these loans to pay down their payables balances. The high costs and short tenors of these loans create significant debt service obligations that are not well matched with the long lifetimes of many utility assets.  Key Finding #3: Balance sheet restructuring is not a quick fix to improve utility performance: to be sustainable, it must be accompanied by actions addressing the cause of deterioration. There are a range of balance sheet restructuring options that are available to utilities and that have been deployed by utilities in World Bank client countries. These include comparatively cosmetic actions that improve the presentation of financial statements without necessarily freeing up additional cash—such as netting off intra-sector arrears—as well as refinancing or restructuring liabilities to improve the capacity of the utility to repay them. However, these actions will not typically by themselves lead to sustained performance improvement. To succeed, they must be part of a more comprehensive reform program that addresses the factors that led—and in many iv Balance Sheets in West Africa Strengthening Utility  countries continue to lead—to balance sheet deterioration in the first place. Even if successful, the impact of balance sheet restructuring on utility performance may be negligible compared to the impact of the wider reform program.  Key Finding #4: Balance sheet restructuring has shown mixed success for World Bank client utilities. Analysis of recent transactions in the case studies shows that, while in many cases the restructuring transaction itself achieved its specific outcomes, too often the sector issues that led to the accumulation of balance sheet distress are inadequately addressed or resurface after the balance sheet restructuring transaction has concluded. Complementary reforms, including tariff adjustments and governance improvements, were not always fully implemented.  Key Finding #5: Balance sheet restructuring of World Bank client utilities is often made possible or enhanced by the complementary use of concessional instruments. Concessional instruments can be direct (the availability of loans on terms that are favorable compared to those offered by the market) or indirect (guarantees or other risk mitigation instruments that allow commercial lenders to offer more favorable terms). In several examples, these instruments meant that debt was available at lower rates, at longer tenors, or from other sources than would otherwise have been the case. Recommendations Balance sheet restructuring is no substitute for sound sector fundamentals: utilities must be able to bill and collect enough revenue from tariffs (or subsidies, if applicable) to cover reasonable operating and capital costs. Without these elements in place, balance sheet measures are, at best, stopgap solutions. Restructuring transactions can be highly complex and entail significant costs and execution times and must be accompanied by more comprehensive reform actions to ensure that benefits are sustained. Nonetheless, there are some no-regret, low-cost, high-impact actions that governments and utilities can take immediately to improve utility balance sheets and increase the odds of success for future balance sheet restructuring.  Recommendation #1: Improve payment discipline between sector entities and clean up inter- entity arrears. Several of the cases examined show that balance sheet deterioration often begins with build-ups of arrears between sector entities. For instance, the distribution company creates short-term liquidity for itself by delaying payments to the generation company, which delays loan payments to the ministry of finance, and, in turn, government clients stop paying the distribution company for power. These circular debts, even though they may not impact net utility cash flows, may still diminish utility creditworthiness; for instance, if there is a perceived risk that the utility will be forced to pay its payables but is unable to collect its receivables. Offsetting or “netting” these arrears presents a low-cost option to improve utility balance sheet presentation, provided that sector entities agree on the balances in question and that offsetting is accompanied by measures to improve payment discipline. Key Findings & Recommendations v  Recommendation #2: Enhance utility financial planning capacity. Experience working with West African Utilities—including in preparing this paper—shows that many do not have the tools or capacity to make informed decisions about balance sheet optimization options. These include a detailed, consolidated, up-to-date inventory of liabilities and their associated maturities, costs, and penalties, as well as robust, regularly updated financial models. Without these, utilities are less able to gauge the impact of financial decisions on future performance and are less prepared to execute balance sheet restructuring transactions.  Recommendation #3: Ensure timely preparation and publication of audited financials. Publishing audited financial statements regularly and on time strengthens a utility’s financial credibility and transparency with customers, regulators, and investors. Though utilities may fear that disclosure of weak financials diminishes their negotiating position with investors, including as part of a restructuring exercise, the opposite is likely true. Audited and reliable financials support better-informed negotiations with creditors, suppliers, and investors, who can better assess risks and may be more willing to participate when they have access to high-quality information. Maintaining reliable financials will also reduce due diligence timelines and transaction costs. vi Balance Sheets in West Africa Strengthening Utility  1. Overview of West African Balance Sheets and the Case for Optimization 1.1. Background This Paper explores the ways utilities can reduce the financial burden of their accumulated liabilities. This is often referred to as “balance sheet restructuring” or “balance sheet optimization”, defined here as the refinancing, renegotiating, disposing of, or direct adjusting of balance sheet items. There are a range of balance sheet restructuring options and their objective and mechanism are often poorly understood. This Paper begins by developing a typology of different balance sheet restructuring options that may be available to utilities in West Africa and other World Bank client countries. Case studies on balance sheet restructuring operations undertaken by utilities in Albania, Côte d’Ivoire, and Jordan are included as annexes. Utilities in West Africa operate in challenging environments and often fail to recover costs. Figure 1.1 shows operating and debt service cost recovery for utilities in West Africa in the World Bank’s Utility Performance & Behavior Today database (UPBEAT) database.1 The figure shows cost recovery for the latest year available for all utilities with data from 2020 onward (unless otherwise noted, all figures in this paper reflect the most recent data available since 2020). A utility that recovers its operating costs and its debt service costs has a cost recovery of more than one. Before subsidies are included, only three of the 25 utilities in West Africa recover their operating and debt service costs. Utilities not recovering their costs frequently report operating subsidies. Cost recovery is low for African utilities for many reasons. Cost of supply is often high due to poor operational efficiency (high technical and commercial losses) and heavy use of liquid fuels. Additionally, tariffs are frequently regulated at levels that do not allow for the recovery of costs, as policy-makers aim to reduce electricity costs for income-constrained consumers. Furthermore, utilities are frequently required to make investments to achieve policy objectives; for example, extending electricity access to poor rural communities. The resulting costs are often not recovered through tariffs, meaning that it is difficult for utilities to service financing put in place to fund these investments. High costs and low tariffs are exacerbated by utilities’ difficulty in collecting receivables. Receivable balances among West African utilities are substantial, corresponding to over six months of operations for most utilities (Figure 1.2 left), and have been increasing over time (Figure 1.2 right). Public-sector and government clients often account for a disproportionate share of receivables, as they both consume 1 Utility Performance and Behavior Today (UPBEAT) database. This paper uses the UPBEAT definition of cost recovery: (cash collected from operations) divided by (operating costs plus debt service). 1. Overview of West African Balance Sheets and the Case for Optimization 1 Figure 1.1: Cost recovery of utilities in West Africa 140% Subsidies improving cost Utilities recovery for some utilities recovering costs 120% 100% O&D cost recovery 80% 60% Utilities not recovering 40% costs 20% 0% -20% -40% Nigeria-Ikeja Nigeria-YEDC Guinea-EDG CIV-CIENERGIES Ghana-ECG Nigeria-Kaduna Liberia-LEC Nigeria-IBEDC Nigeria-PHED Mali-EDM Mauritania-SOMELEC Senegal-Senelec Ghana-GRIDCo Cameroon-Eneo Niger-NIGELEC Nigeria-KEDCO Togo-CEET Nigeria-EKEDC Nigeria-EEDC Nigeria-AEDC CIV-CIE Benin-SBEE Burkina F.-SONABEL Nigeria-TCN CAR-ENERCA With subsidy Without subsidy Note: Negative cost recovery implies that a utility’s increase in receivables exceeded its revenue in that year. Source: UPBEAT database. large amounts of power and may have worse payment discipline. As a result, cash collection is often poor and this results in lower cost recovery. Bad balance sheets are almost always the result of bad cash flows. When utilities are unable to recover their costs from their revenues or subsidies, they resort to alternative sources of liquidity— most commonly accumulating unpaid balances to suppliers, in particular power suppliers, and taking on short-term debt—that reflect as growing liabilities on their balance sheet. These utilities’ urgent need for liquidity, their riskiness, and the shallowness of local financial markets put utilities in weak bargaining positions relative to their creditors, and these growing liabilities often carry high costs in the form of interest rates or penalties, which can compound and cause these liabilities to grow rapidly. To manage the liquidity challenges caused by poor cost recovery, utilities frequently delay paying suppliers, resulting in high levels of outstanding payables. Payable balances are therefore also high, corresponding to over six months of operations for most utilities (Figure 1.2 left). Utilities are unable to pay down the large outstanding balances without increasing cash from operations (that is, improved cost recovery). Delaying payments to creditors can temporarily improve a utility’s liquidity but it damages the supplier’s liquidity, shifting rather than resolving the problem, and disincentivizing new private investment in lower-cost generation and network infrastructure. Taking out debt is another way to improve liquidity (provided the debt is sufficiently long-term), but debt makes up a small proportion of liabilities for most utilities in West Africa, suggesting limited access to finance. A utility can only reliably access debt if lenders are confident that the utility will be able to reliably meet debt service obligations. The orange bars in Figure 1.3 show debt as a proportion of assets (top) and liabilities (bottom) for utilities in West Africa in the UPBEAT 2 Balance Sheets in West Africa Strengthening Utility  Figure 1.2: Left: Number of utilities by age of receivables and payables; Right: median age of receivables and payables 30 14 25 12 10 Number of utilities 20 10 12 8 Months 15 6 8 10 77 4 5 2 7 66 0 0 Age of payables Age of receivables 2014 2015 2016 2017 2018 2019 2020 <6 months 6-12 months >12 months Age of payables Age of receivables Source: UPBEAT database. database. The utilities are arranged from the utility with the highest liabilities relative to total assets on the left to the utility with the lowest liabilities relative to total assets on the right. The role of debt within liabilities is low: the median debt-to-assets ratio is 24 percent, and few utilities have debts that exceed 50 percent of their assets. There is no trend between a utility’s overall indebtedness (that is, total liabilities/total assets) and its debt to equity, suggesting that most utilities in the region struggled to use debt effectively within their capital structure. Anecdotally, where utilities do access debt as a source of liquidity, it is often short-term and only provides very temporary liquidity relief (see case studies). Despite limited access to debt, many West African utilities’ total liabilities are a high proportion of assets, and seven utilities have negative equity, meaning they have more liabilities than assets. Payables are the most significant liability on utilities’ balance sheets. Most utilities, and especially those with very high total liabilities, have more payables outstanding than debt. Utilities with a more sustainable total liabilities balance tend to use debt more effectively, with debt being higher than payables. Liabilities can also accumulate as a result of poor incentives or governance. If there are no incentives to encourage timely payments, a utility could choose not to settle outstanding balances to suppliers to improve its liquidity position. This dynamic is most likely between state-owned enterprises (SOEs), which may face less of a commercial imperative to enforce payments. Conversely, a private independent power producer (IPP) is more likely to refuse to supply power until payment is made. Accumulated payables or debt eventually require restructuring because:  The large outstanding liabilities undermine the viability of the sector. Suppliers may refuse to provide services until they receive payment. Suppliers and lenders will be less likely to extend credit in future. Investors (for example, IPPs) will be less likely to develop new projects if they have concerns about a utility’s ability to service its liabilities. 1. Overview of West African Balance Sheets and the Case for Optimization 3 Figure 1.3: Components of liabilities of utilities in West Africa 300% 250% Utilities with liabilities > 200% assets Utilities with liabilities < % of assets assets 150% Negative equity 100% 50% 0% 100% 90% 80% 70% % of liabilities 60% 50% 40% 30% 20% 10% 0% Nigeria-KEDCO Nigeria-EEDC Mali-EDM Nigeria-Kaduna Togo-CEET CIV-CIE Liberia-LEC Guinea-EDG Mauritania-SOMELEC Nigeria-PHED Nigeria-AEDC Cameroon-Eneo Nigeria-YEDC Nigeria-Ikeja Nigeria-IBEDC Nigeria-EKEDC Ghana-ECG Niger-NIGELEC Senegal-Senelec Benin-SBEE Ghana-GRIDCo Burkina F.-SONABEL CAR-ENERCA CIV-CIENERGIES Nigeria-TCN Debt Payables Other liabilities Source: UPBEAT database.  Debts that incur interest will compound if the debt is not serviced. If interest expenses are not paid, they will result in higher debt balances and larger interest expenses in future. Figure 1.4 shows the interest coverage ratio2 for utilities in West Africa, from worst (left) to best (right). Many utilities are not covering their interest expense (that is, interest coverage ratio < 1). This results in interest compounding and debt balances accumulating. 2 Interest coverage ratio is defined as earnings before interest and tax (EBIT) divided by interest expense. 4 Balance Sheets in West Africa Strengthening Utility  Figure 1.4: Interest coverage ratios of West African utilities 50 40 30 20 Interest coverage ratio 10 0 -10 -20 -30 -40 -50 Nigeria-Ikeja Nigeria-YEDC Guinea-EDG Mauritania-SOMELEC Nigeria-Kaduna Mali-EDM Liberia-LEC Togo-CEET Nigeria-PHED Nigeria-EKEDC Nigeria-EEDC CIV-CIENERGIES CAR-ENERCA Nigeria-AEDC Niger-NIGELEC Cameroon-Eneo Nigeria-IBEDC Nigeria-KEDCO Senegal-Senelec Burkina F.-SONABEL CIV-CIE Ghana-ECG Benin-SBEE Ghana-GRIDCo Nigeria-TCN Source: UPBEAT database. 1.2. Indicators of balance sheet stress Liquidity and capital structure indicators can be used to probe a utility’s balance sheet and provide information on what balance sheet stresses a utility is experiencing. The World Bank’s UPBEAT database identifies three categories of financial performance indicators, which can be used to give a complete view of a utility’s financial performance.  Cost recovery and profitability: Measures a utility’s ability to recover its costs.  Liquidity: Measures a utility’s ability to meet its short-term obligations.  Capital structure: Measures the composition of a utility’s financing (for example, the relative roles of debt and equity). Table 1.1 describes how different financial performance indicators can be used when diagnosing the causes and effects of balance sheet stress on a utility. Many utilities in West Africa have financial performance indicators outside the range typical for a financially sustainable utility. The thresholds in Table 1.1 are only illustrative, because in practice such values are context-specific. 1. Overview of West African Balance Sheets and the Case for Optimization 5 Table 1.1: Using indicators to diagnose balance sheet stress Metric Calculation Type Cause Warning sign Indicative Number of (flow or or effect value for a West African stock) financially utilities sustainable within this utility range Cost recovery and profitability Net profit Net income/ Flow Cause Low profitability may >0% 13 out of 25 margin Revenue result in a utility being utilities unable to service its liabilities, leading to balance sheet deterioration. Difference Net income Flow Effect Large differences indicate <20% 18 out of 25 between net – EBIT debt service is a large utilities profit margin (earnings burden for the utility, and earnings before and the debt may need before interest interest and restructuring. and tax margin tax) Operating and Operating Flow Cause Persistently failing to >100% 3 out of 25 debt service income/ recover costs (indicator utilities (excl. cost recovery operating and value <1) is likely to cause subsidies) debt service an accumulation of costs liabilities, which may need restructuring. Difference Operating Flow Effect Large differences indicate <20% 21 out of 25 between cost recovery debt service is a large utilities (excl. operating cost minus burden for the utility, subsidies) recovery and operating & and the debt may need operating & debt service restructuring. debt service cost recovery cost recovery Liquidity Age of Trade Mix of Cause High values indicate poor <6 months 6 out of 25 receivables receivables/ stock collections resulting in utilities (months) revenue x 12 and flow poor cost recovery and a potential accumulation of liabilities. Age of Trade Mix of Effect High values indicate the <6 months 7 out of 25 payables payables/cost stock utility has been unable to utilities of sales x12 and flow service its payables. Current ratio Current Stock Effect Low values suggest that >1 6 out of 25 assets/current a utility does not have utilities liabilities enough current assets to meet current liabilities. 6 Balance Sheets in West Africa Strengthening Utility  Metric Calculation Type Cause Warning sign Indicative Number of (flow or or effect value for a West African stock) financially utilities sustainable within this utility range Interest EBIT/interest Flow Effect Low values indicate that a >1 16 out of 25 coverage ratio expense utility is unable to pay its utilities interest cost, leading to accumulating liabilities or loan default. Capital structure Debt-to-assets Debt/total Stock Effect High values may indicate <0.6 24 out of 25 ratio assets that a utility has a large utilities amount of debt and may struggle to meet its debt service obligations. Effective cost Interest Mix of Effect A high cost of debt could <15% 22 out of 25 of debt expense/debt stock make it more difficult for a utilities and flow utility to service its debts. A high cost of debt may also be the result of other performance challenges that increase the perceived risk to lenders. 1.3. Objectives of balance sheet restructuring Balance sheet restructuring aims to address one or more specific objectives, such as reducing debt service costs. Table 1.2 presents some common examples of the objectives of balance sheet restructuring. Table 1.2: Example objectives of balance sheet restructuring Objective Example application Pay down liabilities taken Commodity price spikes or shortages in generation inputs can dramatically out to address acute increase the costs incurred by a utility. It is not always possible to pass these operation challenges costs onto income-constrained consumers. Taking out debt could provide liquidity to meet acute challenges. The accumulated debt will need to be repaid, but this could be restructured to be paid down over a longer period of time. Reduce debt service costs Short repayment terms or high interest rates could result in high ongoing debt service requirements that are difficult to maintain. A utility might choose to restructure its debt to reduce the burden of these obligations. Reduce debt between Large payables to suppliers may threaten operations, as these payables may sector entities incur late payment fees, or the suppliers may refuse service until the payables are paid down. Refinancing payables with loans can reduce outstanding debt between sector entities and improve liquidity in the sector. 1. Overview of West African Balance Sheets and the Case for Optimization 7 Objective Example application Attract outside investment Utilities that are better able to meet future payment obligations and are typically more attractive targets for outside investment, whether that be new debt or equity. Dispose of unproductive Utilities might sell off assets to external investors to offload assets that do not assets earn adequate returns. Several factors need to be considered alongside these objectives to ensure benefits are sustained over time. The ability to maintain benefits over time will often depend on a mix of operational, policy, and regulatory enabling conditions, some of which may have contributed to the deterioration of a utility’s balance sheet in the first place. Typically, sector reforms address the “flow” problems that led to the accumulation of problematic “stock” items on the balance sheet. In the absence of other sector reforms, balance sheet restructuring may only temporarily reduce the stock of unpaid obligations. For example, if tariffs do not allow for full recovery of costs, arrears will reaccumulate. Sustained financial performance improvements are only possible if a utility’s revenues (and subsidies) cover operating costs and financial obligations, including debt service. Achieving this minimum condition will typically require, among other things: 1. Cost-reflective tariffs or, if necessary, a durable subsidy mechanism to make up for any shortfalls; 2. Related to 1., technical and commercial losses kept at sustainable levels (which will require continuous investment in maintaining system performance); 3. Related to 1., a sufficiently low-cost basis, combined with the use of least-cost planning to maintain costs at a level where they can be fully passed through to consumers; 4. Ability to turn revenue into cash through collections, including from public-sector consumers; 5. A certain degree of macro stability. For instance, if a utility’s balance sheet issues are the result of USD-denominated power purchase costs increasing with local currency deprecation (which will also increase the value of USD-denominated power purchase arrears in local currency terms), balance sheet restructuring is unlikely to be more than a stopgap solution; and 6. Sound utility and sector governance to ensure that decisions on incurring new liabilities, raising new equity, or selling assets are made on commercial rather than political principles. In summary, balance sheet restructuring is most likely to result in sustained improvements in financial performance by utilities that are already performing well financially, or at least are operating in sectors that provide the preconditions for success. 8 Balance Sheets in West Africa Strengthening Utility  2. Balance Sheet Restructuring Options Table 2.1 presents a typology of the different ways in which a utility’s balance sheet can be restructured. The restructuring options have two broad purposes: directly changing instruments on the balance sheet to improve the utility’s financial performance (the first three options) and making adjustments to financial reporting that do not directly impact financial performance but nonetheless may unlock other benefits, such as making a utility more creditworthy (the last two options). These interventions are discussed in more detail in the remainder of this section. Table 2.1: Categories of balance sheet restructuring options Type of Examples When to implement Considerations Purpose restructuring Reallocating yy Taking out new debt to A utility is struggling yy Need sufficient access Improve liabilities pay off existing debt or to service its debts on to financial markets financial liabilities (“refinancing”) a timely basis, or debt yy May incur early performance yy Debt to equity service obligations payment penalties conversions are particularly high Renegotiating yy Renegotiation of loan Same as above, but yy May cause liabilities terms without material loss utility is unable to reputational damage to lender (“reprofiling”) refinance at attractive and limit access to yy Renegotiation of loan terms future financing terms with material loss to lender (i.e., “haircuts” or “restructuring”) Removing yy State assumption of Utility has yy Requires fiscal space liabilities onerous debts unproductive assets yy Most appropriate (or assets) yy Asset divestiture or onerous liabilities for debts that ought on balance sheet, never to have been on especially ones that utility’s balance sheet are not part of utility’s yy May perpetuate poor core business payment discipline if used regularly Offsetting/ yy Offsetting payables and Debts between yy Does not generate Improve netting receivables sector participants cash, but can mitigate presentation are damaging perceived risk of financial the perceived yy Can be challenging position creditworthiness of to agree on amounts utilities owed Revaluation yy Increase value of PP&E Book value of assets yy Does not generate yy Receivable write-downs has diverged from fair cash, but can improve market value capital structure ratios 2. Balance Sheet Restructuring Options 9 2.1. Reallocating liabilities In this paper, reallocation refers to the use of new or alternative forms of financing to replace current forms of financing. The refinancing will change the composition of a utility’s capital structure (for example, the split between liabilities and equity, or the split between different types of liability) to improve the profiling, or to reduce the debt service burden associated with future payment obligations. One method of reallocating between different types of financing is by refinancing. Refinancing simply involves paying down existing liabilities with new liabilities to optimize future payment obligations. The most obvious way of achieving this is to take on a new loan, on more favorable terms, to pay off either an existing loan or accumulated arrears. Figure 2.1 illustrates the refinancing of a short-term debt, which is rolled over annually and incurs a 10 percent interest rate. This debt is refinanced with a 25- year concessional loan at five percent interest. The refinancing would reduce debt service costs even after including principal repayments. If available, such a refinancing would reduce debt service costs, allow the utility to pay down its debt balance over time, and reduce the volume of debt that has to be rolled over annually. Rolling over debt annually imposes costs in terms of the time and effort taken to arrange this, and increases risk because banks could refuse to roll over the debt if they start to doubt the utility’s creditworthiness. Figure 2.1: Refinancing payables with debt to reduce costs Liability balances Debt service costs Short-term debt that is being rolled over is The interest charge (5%) for the concessional loan is refinanced with a 25-year tenor concessional loan in half that for the short-term debt (10%), so even with 2032. After refinancing no debt needs rolling over. principal payments debt service costs are reduced. 120 12 Refinance using Refinance using concessinal debt concessinal debt 100 10 Debt service costs ($m) Debt balances ($m) 80 8 60 6 40 4 20 2 0 0 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 Short-term debt Long-term debt Debt rolled over Interest on debt Principal repayable Nevertheless, reallocation might not be entirely free of costs as early repayment of loans may incur penalties. Existing loan agreements might include penalties for early repayment that would need to be considered when deciding whether to refinance. However, penalties for early repayment would typically already be specified in the loan agreement and would not, therefore, entail contract renegotiation or modification per se. Refinancing generally occurs within the boundaries of existing contracts and loan agreements, so the impact on investors’ perception of a utility’s risk is typically low. Refinancing is unlikely to impact the ability to access debt financing in future. 10 Balance Sheets in West Africa Strengthening Utility  Another method of reallocating between different types of financing is by converting debt to equity. Debt-to-equity conversions involve converting part or all of a lender’s (typically the government’s) remaining loan balance to a utility into equity in that utility. This conversion has the benefit of providing relief to the utility from the fixed payments that exist in a loan agreement while also reducing indebtedness (leverage). In practice, the feasibility and usefulness of debt-to-equity conversion will depend, among other factors, on whether both the lender and the utility’s owners are public or private (see Table 2.2). Debt-to-equity conversions often take place after several previous efforts to improve utility financial performance have failed—often including renegotiation or refinancing of loans—and the lender is now trying to minimize losses. Table 2.2: Impacts of debt-to-equity conversions Lender Public Private Private Increases public ownership share (partial Lenders may agree to a debt-to-equity nationalization) conversion as a last resort yy The conversion will increase the public yy Private lenders may have ownership share, so it is a partial limited appetite for a stake in an nationalization. underperforming utility. yy Nationalization may be politically yy Existing shares are diluted. undesirable and have contractual or regulatory implications. Mixed public/ Increases public ownership share Decreases public ownership share private (partial nationalization) (partial privatization) yy The conversion will increase the public yy The conversion will increase the private ownership share, so it is a partial ownership share, so it is a partial nationalization. privatization. yy Existing shares are diluted. yy Existing shares are diluted. Owner yy Private lenders may have limited appetite for a stake in an underperforming utility. Public Effectively, a subsidy to the utility Decreases public ownership share yy The conversion is a form of public loan (privatization) forgiveness. yy The conversion will give the private yy The government is accepting that it will sector an ownership share, so it is a not receive payment from the utility. privatization. yy This forgiveness is a subsidy from the yy Privatization may be politically government to the utility. undesirable and/or have complex legal/ yy The utility’s future payment obligations regulatory implications. are reduced. yy Private lenders may have yy The conversion does not affect public/ limited appetite for a stake in an private ownership shares. underperforming utility (especially a public one). 2. Balance Sheet Restructuring Options 11 2.2. Renegotiating liabilities Changing the repayment profile of an existing liability without changing the total amount owed is often referred to as “reprofiling”. Unlike refinancing, in which a new liability is incurred to pay down an existing liability, reprofiling typically involves amending the terms of an existing liability to optimize (from the utility’s perspective) the repayment profile for a loan (that is, when payments fall due), without changing the total amount owed. This renegotiation could, for instance, involve extending the maturity of a loan to reduce the burden of individual debt payments. Figure 2.2 presents a stylized example showing how increasing a loan’s tenor (term or remaining term) can reduce debt repayments. Alternatively, reprofiling could focus on outstanding accounts payable. For example, a payment plan could be agreed with suppliers to pay back power supply arrears. Reprofiling would typically require amendments to existing commercial arrangements, such as loan agreements or power supply contracts (unless these already contain extensive provisions for rectifying default). Amendment of existing agreements may impact the perceived credit risk for a utility and thus the conditions under which it is able to sign similar contracts in future. However, this risk may be limited if the reprofiling does not involve a material financial loss to creditors such as lenders or suppliers.3 Figure 2.2: Impact of increasing loan tenor on debt repayments Before: 10-year tenor After: 15-year tenor 10-year tenor, $100 m principal, 5% interest 15-year tenor, $100 m principal, 5% interest 15 15 10 10 $m $m 5 5 0 0 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 Interest Repayments Interest Repayments 2040 Renegotiating onto a longer tenor loan: yy Reduces annual payments as increasing tenor delays paying down the liability. yy For a given interest rate, increasing tenor increases the total amount of interest paid. yy An upward-sloping yield curve (most typical) may require paying higher interest rates for longer tenor loans. 3 What constitutes a “material financial loss” may not always be obvious. For instance, if the renegotiation does not alter the nominal amount of remaining debt service but postpones a higher share of the debt service to a later time, lenders will likely record a lower return on their investment and consider this a loss. 12 Balance Sheets in West Africa Strengthening Utility  Material changes to the terms of a loan that result in a loss to the lender are often referred to as debt restructuring.4 This could involve changes in interest rates or applied penalties, or even full or partial write-offs of the amount owed (often referred to as a “haircut”). Figure 2.3. shows the impact on debt repayments of a partial write-off of principal (that is, how much is owed). Haircuts can lead to a material and immediate benefit to the utility by reducing debt service obligations. However, they are a form of loan default and may significantly impact a utility’s creditworthiness and its ability to enter into similar contracts in future. Figure 2.3: Impact of a haircut on loan repayments Before: original loan After: with haircut to principal 10-year tenor, $100 m principal, 5% interest 10-year tenor, $60 m principal, 5% interest 15 15 10 10 $m $m 5 5 0 0 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 Interest Repayments Interest Repayments A haircut to the principal: yy Reduces annual payments as the total amount to repay is lower. yy Reduces the total amount of interest paid. yy Will make accessing debt financing more difficult in future as the utility will be perceived as riskier. Indicators of the potential to refinance or renegotiate liabilities Indicators showing there are large liabilities: Large debt-to-assets ratio or age of payables value. Indicators highlighting a negative impact of debt service obligations on financial flows: A high cost of debt, a significant difference between EBIT and net profit margin, or a substantial difference between operating cost recovery and operating & debt service cost recovery all indicate debt service is impacting flows. Assessing proposed solutions: Modeling the impact of different financing structures on profitability and cost recovery indicators can help to evaluate the effect of restructuring on financial flows. Table 2.3 summarizes the differences between relocation, reprofiling, and restructuring. Broadly, reallocation is a minor intervention compared to reprofiling, which in turn is less significant than restructuring. 4 This is distinct from the broader concept of “balance sheet restructuring”, which is the category under which all interventions discussed in this paper fall. 2. Balance Sheet Restructuring Options 13 Table 2.3: Differences between reallocation, reprofiling, and restructuring of liabilities Reallocation Reprofiling Restructuring Paying down one financing Altering the repayments profile Reducing the total repayment instrument with another. of existing liabilities without amount with the lender achieving a decreasing the lender's return. lower rate of return. Examples include: Examples include: Examples include: yy Repaying a loan with a high- yy Agreeing a long-term payment yy A cut to the principal of a loan interest rate using a low-interest plan for payables yy Decreasing the interest rate on rate loan yy Increasing the tenor of a loan a loan yy Converting debt to equity 2.3. Implementation considerations for reallocation and renegotiation of liabilities There are several factors to consider when deciding whether and how to reallocate or renegotiate existing liabilities. These include:  Cost-benefit analysis: Suppose a utility is considering taking out a new loan to prepay (refinance and effectively replace) an existing loan, and the new loan has a longer tenor but a higher interest rate. It might not be immediately obvious which of these loans is “better”. An initial quantitative assessment can be obtained by calculating and comparing the present value (PV) of the cash flows under each scenario, considering all cash flows related to the refinancing (principal repayments, interest payments, prepayment penalties for old loan, commitment fees for new loan, and so forth). The lower the PV of the debt service, the more attractive the loan—in theory—though this must also be compared to how much cash the utility is able to reasonably commit to debt service each year given its expected cash flows. For a utility, comprehensive financial modeling is key to these assessments.  Choice of discount rate for cost-benefit analysis: The cost-benefit analysis outlined above will depend critically on the discount rate used for future cash flows. Determining an appropriate discount rate can be more art than science: and subject to negotiation. Companies often use the Weighted Average Cost of Capital (WACC) as their discount rates in assessing projects (and loan refinancing can be thought of as a type of value-generating project),5 but for many utilities in developing countries—especially publicly-owned utilities—the cost of (government-held) equity can be hard to define and determine. In well-regulated sectors, a useful alternative to the WACC is the return on assets that the regulator allows the utility to collect through tariffs. This has the advantage of i) reflecting the regulator’s best effort to determine a reasonable cost of capital; and ii) having public credibility by virtue of the regulatory process. Where regulatory benchmarks 5 The WACC is a weighted average of a company’s cost of equity and cost of debt. Companies often use it as a discount rate because it reflects a company’s cost of capital and thus a minimum required return to make a project viable. 14 Balance Sheets in West Africa Strengthening Utility  do not exist, the utility’s marginal cost of debt (the interest rate it could realistically obtain on a new loan) could also be used. To illustrate the impact of discount rates, assume a utility wants to renegotiate the terms of a $10 million loan it has on its books. The loan has an interest rate of 10 percent and a remaining maturity of 10 years. Table compares the present value (PV) of the debt service (principal + interest) of the loan for various interest rates and tenors, assuming the utility has a discount rate of 10 percent. Unsurprisingly, the PV of the loan’s debt service is always reduced by lowering the cost of debt. However, extending the tenor will only lower the PV if the loan’s interest rate is below the utility’s discount rate.6 If the interest rate is higher than the discount rate,7 then extending the tenor of the loan would likely reduce how much the utility pays in annual debt service—and thus help the utility manage its cash flows—but would increase the PV of the loan. Whether or not this is desirable from the utility’s perspective will depend on whether the intent of the restructuring is more to optimize the total burden of its liabilities (lower PV) or more to manage any short-term liquidity issues (lower annual debt service). Table 2.4: Impact on PV of renegotiating the tenor and interest rate of a $10m loan for a utility with a 10% discount rate Loan tenor PV 5 years 10 years 15 years Loan interest 9% $9.8m $9.6m $9.5m rate 10% $10.0m $10.0m $10.0m 11% $10.2m $10.4m $10.5m Note: the utility is assumed to have a 10 percent discount rate. Prior to renegotiation, the loan has an interest rate of 10 percent and a remaining tenor of 10 years.  Sources of capital and the need for transaction advisory services: Utilities in West Africa and other World Bank client countries often operate in shallow financial markets. Several African utilities have in the past accumulated arrears to power suppliers to the tune of hundreds of millions or even billions of US dollars, sums that soon exceeded what local financial markets were realistically able to provide. In cases where liabilities are large enough to require urgent restructuring, access to international capital markets may be required to raise the necessary amounts. This poses its own challenges, as many West African utilities have very limited access and experience with international capital markets, and underscores the need for experienced transaction advisors to help arrange these sorts of deals. This may have benefits beyond the immediate transaction, as the process may require utilities to develop materials (for example, financial models) that can be used for subsequent transactions, or even to obtain credit ratings (see Côte d’Ivoire Case Study, below). 6 As may be the case, for instance, if the loan is concessional and is cheaper than the utility’s current cost of capital. 7 As may be the case, for instance, if the loan was taken on at a time when adverse market conditions meant the utility only had access to more expensive debt. 2. Balance Sheet Restructuring Options 15  Transaction costs & ticket sizes: Depending on the complexity of the transaction, balance sheet restructuring can incur significant costs, both in financial terms for advisory and legal fees and in terms of utility staff time and effort. These costs need to be weighed against the benefits of the proposed restructuring, especially for smaller ticket sizes. For instance, using the hypothetical loan in Table 2.4, moving from an interest rate of 10 to 9 percent and extending the tenor from 10 to 15 years would likely represent a major success in terms of the outcome of the transaction, but only generates PV savings of $0.5 million. This may well not be sufficient to cover the cost of the transaction (advisors, legal fees, and so forth).  Wider implications of default: Failure to service arrears to generators could lead to interruption of power supply until disputes are resolved, and engender difficulties entering similar contracts in future. Default on a loan agreement may mean that the lender has recourse to a utility’s assets or cash flows. For both debt and supply contracts, default will likely make it more difficult for a utility to enter into similar agreements in future or may increase the cost of doing so.  Type of counterparty: Lenders and suppliers may have different business models, skillsets, experience, and amenability to negotiation.  Seniority and legal issues: Local laws and regulations as well as individual contracts with suppliers and lenders may impact which entities have preferential recourse to utility cash flows. Some lenders may be in a more powerful negotiating position and resistant to renegotiation, instead seeking to push any losses to more junior lenders.  Principal agent problem: Many of the key success factors for sustainable balance sheet restructuring (such as tariff adequacy, sound capacity planning, macro framework, governance) are often beyond the control of the implementing entity—the utility. Successful restructuring requires significant cooperation and buy-in from regulators, policy-makers, and other stakeholders. If this buy-in cannot be obtained, the utility should consider if the expected benefit from a restructuring will, in fact, be realized, and, if so, whether that benefit is sustainable. 2.4. Removing liabilities (or underperforming assets) Removing selected assets or liabilities can strengthen a utility’s balance sheet by disposing of unproductive assets or unserviceable liabilities. This might include removing ‘bad’ parts of the balance sheet, such as liabilities that cannot be serviced by ongoing cash flows or assets that are known to be nonrecoverable. Separation of select assets or liabilities is often, but not always, associated with preparing a utility for privatization. The privatization process can broadly be split into preparing the utility and the privatization event. Separating select assets or liabilities is commonly part of preparing the utility for privatization to make public utilities investable. Table 2. summarizes when assets/liabilities would be separated from a utility and how this relates to privatization. 16 Balance Sheets in West Africa Strengthening Utility  Table 2.5: Separation of select assets/liabilities and its relationship with privatization Privatization Outside of privatization Preparation Event Asset/liability divestiture Description Restructuring to ensure The privatization event This involves the removal the utility contains assets happens via the sale of of unproductive assets or or liabilities that can be equity in the utility or a burdensome liabilities from managed by the private concession agreement to the utility’s balance sheet sector and exclude any that operate the utility. through the sale of assets or are best handled by the government absorption of public sector. liabilities. Balance sheet Separation of select assets/ May not impact the balance Separation of select assets/ restructuring liabilities sheet liabilities type Examples yy Removing legacy yy Sale of equity yy Sale of nonproductive receivables yy Injection of equity assets yy Reassignment of on-lent development loans In preparing a utility for privatization, a full balance sheet review should be completed, evaluating whether the private sector is best placed to manage a given asset or liability. This review would be part of preparing the utility for privatization, as summarized in Table 2.5 above. Another component of the balance sheet review would involve revaluation of the utility’s assets. In some cases, the private sector might help improve the performance of a given balance sheet item. For example, a private- sector entity, motivated by improved returns, might be better at collecting legacy receivables. A privatization might include an incentive for the privatized utility to collect such receivables on behalf of the state. The overall aim is to include assets and liabilities that are best managed by the private sector on the utility’s balance sheet while the state retains assets and liabilities that are unattractive to the private sector. The process of allocating assets/liabilities between the public and private sectors during a privatization is often contentious. The utility’s balance sheet must be clean enough to attract private- sector bidders, but if too many liabilities are left with the government, the government may deem the privatization to be of insufficient benefit. As part of the privatization process, both the bidder and government will perform valuations to determine a fair market value for the utility. Valuation of a utility will involve considering wide-ranging factors including future earnings prospects, market value of assets, and capital structure. The valuation will often be performed by financial advisory firms and often involves large fees. The valuation process can be complex and time-consuming. If a utility’s assets and liabilities are not clearly defined on the balance sheet, bidders are likely to take a conservative view and assume the worst case. This would result in low valuations and low bids. A utility may divest nonperforming assets outside of a privatization. Asset divestment involves the sale of unproductive or underperforming assets to external parties. This is analogous to privatization, except privatization consists of selling an ownership stake in the company, whereas asset divestment 2. Balance Sheet Restructuring Options 17 does not result in the utility’s equity changing hands. Examples could include a vertically integrated utility selling specific underperforming generation assets to an IPP (with more experience in managing that class of generation asset) but retaining ownership and control of the rest of the utility. The government may absorb unserviceable liabilities that threaten the viability of the sector and this can be done either preparing for privatization or outside of a privatization. For example, many transmission and distribution utilities in West Africa have dual mandates of commercial operation of transmission and/or distribution functions as well as implementation of social energy sector objectives. A widespread example is last-mile electrification projects in countries that still have significant access gaps. These activities are sometimes reflected in utilities’ balance sheets as large balances of development loans. If not properly compensated for through tariffs, these loans may reduce utilities’ ability to attract debt for more commercial purposes. One way this has been addressed in some countries is for these social loans to be reallocated to the entity whose social objectives they serve (typically the government through ministries of finance). Alternatively, the responsibility for delivering the social energy sector objectives could be transferred to a separate public-sector organization (for example, Rural Electrification Agency of Uganda) that is funded by the government, and the on-lent development loans removed from the utility’s balance sheet. In Uganda, this step was taken to prepare the utility for privatization as it was considered that the state was better placed to manage the financing of electrification than the private sector (USAID 2014).8 Government absorption of debt can also be linked to the utility meeting certain performance targets. This can be an effective way for governments to provide one-off relief to utilities under the weight of legacy liabilities while also addressing and closely monitoring the inefficiencies that led to liabilities accumulating in the first place. For instance, South Africa’s National Treasury took over a portion of the utility’s (Eskom) debt in exchange for Eskom meeting governance and operational performance KPIs. These included steps toward sector unbundling and the establishment of a transmission company within the utility. This approach must be balanced against the impact of debt absorption on sovereign indebtedness (though in the case of publicly owned utilities, SOE debt may already count toward public debt) and against equity concerns around socializing the unpaid costs of electricity service provision among the wider public, not all of whom may have access to grid power. While balance sheet restructuring is typical in preparing for privatization, the privatization event does not necessarily impact the balance sheet. Equity investment is often included as an option in discussions around balance sheet “restructuring”, though any impact of such investment on a utility’s balance sheet will depend on whether it involves simply transferring existing equity from one party to another or whether it involves new equity being injected to the company:  Transfer of existing equity: Governments (or existing private owners), often seek to bring in private-sector operational expertise and discipline and/or to raise immediate cash, selling part or all of their ownership stake in a utility to a private investor. From the point of view of a utility and its balance sheet, nothing essential has thereby changed, as an existing quantity of equity (shares) has merely changed hands.  Injection of new equity: In this case, governments (or existing private owners) retain their shareholding in a utility, and new equity is injected by existing or new investors. This equity 8 USAID (2014): Ghanaians Discuss Privatization Options with India and Uganda. 18 Balance Sheets in West Africa Strengthening Utility  injection does affect the utility’s balance sheet as the utility’s equity will increase (as will its cash asset or whatever assets the new equity is being used to fund). This approach aims to raise cash, improve a utility’s capital structure (that is, reduce leverage), or both. This approach has been rare for privatized utilities in West Africa, especially without significant accompanying restructuring of not just balance sheets, but the entire industry. This restructuring could involve forming new companies, unbundling, or both. The goal is often less a matter of improved performance by a specific entity than reorganization and improvement of the entire sector. Injecting equity is more common in public utilities in West Africa as the government may inject equity into the utility periodically to subsidize operations. 2.5. Offsetting/netting Utilities in West Africa often owe money to the same entity that owes them money, or to entities that are related, particularly in the public sector. For instance, utilities may owe governments payments for loans, including for on-lent concessional loans from development partners, while government departments might owe utilities amounts for power or other services. Sometimes, these payments can be offset or “netted out” without any cash changing hands, thereby reducing liabilities and assets. Figure 2.4 presents a stylized example to show how, for example, receivables and payables can be reduced through netting. As no cash changes hands, offsetting does not release cash or decrease the cost of servicing liabilities within the sector. As a result, offsetting does not directly improve the sector’s liquidity. As described in Table 2.1, some restructuring options directly improve financial performance, while others enhance the presentation of financials without improving performance. Figure 2.4: Impact of offsetting payables and receivables O set payables and receivables Receivables Payables Receivables Payables Before o setting After o setting Receivable from government Payable to government Other receivables Other payables Even though offsetting does not free up cash for the utility, there are indirect benefits of offsetting liabilities, such as an improved credit profile, which may improve access to debt. Without offsetting, lenders will be concerned about a worst-case scenario in which the asset cannot be collected but the liability has to be paid. With the balances grossed up, a potential lender will assess the risks independently and likely be concerned about the worst-case scenario. As a result, lenders will likely view the asset and liability asymmetrically to the detriment of the utility. 2. Balance Sheet Restructuring Options 19 Offsetting will impact the financial ratios used to assess utility creditworthiness. Offsetting payables and receivables will reduce the age of payables and receivables, which would be viewed positively by an IPP trying to evaluate the likelihood it will be paid. However, debt-to-asset ratios will have worsened due to lower total assets. On the other hand, if the offsetting mechanism includes a debt instrument on the utility’s balance sheet, offsetting would improve debt-to-assets and debt-to-equity ratios. Offsetting can have a material impact on the financial ratios used by investors to assess a utility’s creditworthiness and, as such, a real impact on investor’s perception of how risky a utility is. In most cases, offsetting will improve financial ratios and investors’ perceptions of a utility. A “reset” of selected assets and liabilities could be a good starting point for future sector payment discipline. While there are large outstanding debts, sector participants are not motivated to have good payment discipline. If balances are reduced to lower levels, alongside other measures that may be required for sector participants to be confident that they will generate sufficient cash to manage their payables balances on an ongoing basis, offsetting could improve payment discipline within the sector. However, offsetting can come with its own challenges, both in implementation and in perpetuating sector governance issues. For one, sector participants may disagree on the amounts of the outstanding balances. The fact that balances have built up may indicate disagreement between the parties on the amounts actually owed. This can make it difficult to agree to an adjustment. For another, offsetting is most effective when used as a one-off cosmetic balance sheet enhancement. Using offsetting as a substitute for payment between sector entities can perpetuate poor payment discipline and also deprives utilities of the ability to allocate scarce liquidity where it is most needed. Indicators of the potential to offset liabilities Indicators showing there may be cross debts: High values for debtor days and creditor days may indicate an accumulation of debts between sector institutions. If similar patterns are seen in multiple institutions, it may be possible to net some of these balances. Confirm cross debts exist: Analyze the breakdown of receivables and payables to identify balances between market participants. Consider the extent to which balances that have accumulated are interrelated. Assessing feasibility: Where balances are interrelated, check whether market participants agree on the amounts owed. Where they align, offsetting may be a restructuring option to consider. If there are disagreements on the amounts owed, a reconciliation exercise would be required prior to offsetting debts. 2.6. Revaluation Utilities often revalue items on their balance sheets, which can impact capital structure and be considered a restructuring. Accounting standards often require companies to ensure that assets and liabilities are recognized at their market values. Material revaluations can impact the capital structure of a utility and, therefore, the financing options available to it. An upward revaluation of assets is a material gain to a utility. Its assets have more value than what was recorded in the financial statements, so it can sell them for more, or will have to invest less in future than it would if they were not revalued. An example where an upward revaluation might be appropriate is if a utility’s transmission assets have undergone significant upgrades or market-driven increases in replacement cost. There is no immediate cash gain for the utility, but in future, it will have to spend 20 Balance Sheets in West Africa Strengthening Utility  less on transmission infrastructure, so the increase in asset value will be transferred to cash through increased profits. While revaluation does not directly result in a cash gain to the utility, upward revaluations will improve the financial ratios that lenders use in assessing creditworthiness. For example, consider an upward revaluation of transmission assets, under which a utility will have more assets but no more debt, so a lower debt-to-assets ratio. In some cases, the improved financial ratio may improve access to financing and likely mean that utilities can access debt finance on better terms (for example, lower interest rates). As an illustration, Figure 2.5 shows the impact of upward revaluations of property, plant & equipment (PP&E) on UETCL (Uganda Electricity Transmission Company Limited) and ZESCO’s (Zambia Electricity Supply Corporation Limited) balance sheets. The motivation for PP&E revaluation is not provided in either utility’s financial reporting, but in both cases, the revaluation was performed by independent engineering consultancies. These consultancies would have been a fairly substantial expense, so the revaluation exercises were likely performed when it was clear that the value of PP&E was materially different from market value (for example, for transmission lines that have outlived their expected lifetime). In both cases, total assets and equity increased, reducing gearing. For ZESCO, there was a coincident (but smaller) increase in noncurrent liabilities. This liability increase is triggered by an accounting entry resulting from the timing difference between the accounting depreciation charged to the asset and the tax benefit associated with the original capital expenditure. Figure 2.5: UETCL and ZESCO’s capital structures before and after PP&E revaluations 100% $618 m $763 m 80% $206 m $214 m 60% Proportion of total assets 40% $2,407 m $5,051 m $287 m 20% $172 m 0% -20% $95 m $767 m $244 m $2,470 m -40% $807 m $156 m -60% $1,179 m $121 m -80% $1,451 m $135 m $2,165 m $128 m -100% 2013 (before) 2014 (after) 2016 (before) 2017 (after) UETCL ZESCO Non-current assets Current assets Equity Non-current liabilities Current liabilities Source: UETCL (2014) and ZESCO (2017) financial statements However, revaluation can also result in losses for the utility and, as a result, a deterioration in equity position. Items commonly revalued downwards include receivables (when it becomes clear large amounts will not be paid) or PP&E (if they are damaged or nonperforming). A downward revaluation will harm capital structure indicators (for example, debt-to-assets). If the downward revaluation results in a utility breaching a debt covenant, the utility will technically default on its debt. 2. Balance Sheet Restructuring Options 21 3. Summary of Case Studies To illustrate the concepts discussed in Section 2, this paper analyzes three cases of balance sheet restructuring in World Bank client countries. The case studies look at examples of balance sheet restructuring used to address accumulated liabilities. The causes of the accrued liabilities are a mixture of short-term (for example, disrupted gas supplied in Jordan) and long-term (for example, hydro output variability in Albania and poor collection in Côte d’Ivoire) performance issues. Refinancing short-term debt with long-term (frequently concessional) debt is the most common type of restructuring, performed in two of the three case studies. The case studies also include examples where offsetting liabilities, renegotiating payment obligations, and separating select assets and liabilities were undertaken. Table 3.1 provides a high-level summary, while the full case studies are presented as annexes to this paper. Table 3.1: Summary of balance sheet restructuring case studies Country Jordan Albania Côte d’Ivoire Utilities NEPCO KESH and OSHEE CIE and CI-ENERGIES Why was balance sheet The Arab Spring Albania’s electricity It built up short-term restructuring needed? disrupted gas supplies, so sector depends primarily liabilities because of poor HFO was used instead. on hydro and its output collections (especially This was funded by debt varies between years. In from public-sector taken out by NEPCO years of low hydro output, customers and exports) and Ministry of Finance imports were acquired at and cost recovery. advances. a higher cost. Short-term These liabilities included debt has been used to payables and short- finance the import costs. term debt and were undermining sector viability. Aim of balance sheet Address accumulated Address accumulated Address accumulated restructuring liabilities liabilities liabilities 22 Balance Sheets in West Africa Strengthening Utility  Country Jordan Albania Côte d’Ivoire What was done? Offsetting/netting: Cross- Reallocation: A loan Reallocation: A World debt cancellation to from EBRD was used to Bank guarantee was used reduce liabilities between refinance short-term debt. to access EUR 400m of the government and Renegotiation: A long- new commercial finance. NEPCO. term payables plan for Reallocation: Consolidate OSHEE’s payables to many short-term loans KESH was devised. into fewer long-term loans. Was it successful? Impacts have been Impacts have been Impacts have been mixed: Payables to the mixed: Refinancing mixed: The guarantee government have been prevented a liquidity allowed CI‑ENERGIES declining. Debt balances crisis, but sector to access commercial have remained stubbornly performance is still debt and pay suppliers. high, partly because of susceptible to hydrology However, liabilities more recent commodity conditions. have subsequently price volatility and partly reaccumulated partly as because the total debt a result of events beyond is very high in absolute the utility’s control terms. (for example, COVID, regional instability). 3. Summary of Case Studies 23 Annex A: Balance Sheet Basics – Definitions and Accounting Terminology A company’s balance sheet (also referred to as “statement of financial position”) is a summary of what the company owns (“assets”) vs. the financing it has used to pay for these assets (that is, what it owes, “liabilities” and “equity”). Common assets on utility balance sheets include cash held by the company, payments owed to the utility by customers, and fixed assets including physical infrastructure. Common liabilities on utility balance sheets include payments owed by the utility to suppliers of power and other inputs, and the outstanding value of principal on debt owed to lenders. Table A1 briefly explains some of the items commonly seen on a balance sheet. Equity represents the “net worth” of the utility, that is, the residual value of its assets after subtracting the value of its liabilities (therefore equity + liabilities = assets). Equity is determined by how much external cash has been put into and taken out of the utility by its owners over time, as well as by the profits that the utility has generated from operations. Table A.1: Example balance sheet structure and items Balance sheet item Value Description Noncurrent assets Long-term assets that are expected to be used to generate income over a longer period than one year. Property, Plant, and A Fixed assets such as transmission and distribution lines and Equipment (PP&E) generation capacity. Other noncurrent B Including items such as intangible assets (for example, assets right-to-operate assets held by a concession), bonds held to maturity, patents, and trademarks. Total noncurrent C=A+B assets Current assets Assets that can be quickly converted to cash and used to meet short-term liabilities. Inventory D Raw materials (for example, fuel reserves) used in the production of goods (for example, electricity). Net trade receivables E The money owed by customers that is likely to be paid. Cash and equivalents F Cash held in bank accounts and assets that can be quickly liquidated (for example, marketable securities). Other current assets G Including items such as prepayments made by the utility. 24 Balance Sheets in West Africa Strengthening Utility  Balance sheet item Value Description Total current assets H=D+E+F+G Total assets I=C+H Equity The residual value to shareholders after debts and liabilities have been settled. Contributed capital J The amount of cash and assets contributed by shareholders in exchange for shares in the utility. Retained earnings K Cumulative net income after any dividends paid are subtracted. Total equity L=J+K Long-term liabilities Liabilities that are not expected to fall due within the next year. Long-term debt M Loans with a maturity of longer than one year. Other long-term N Including items such as long-term leases on assets held by liabilities the utility. Total long-term O=M+N liabilities Current liabilities Liabilities that are expected to fall due within the next year. Trade payables P Amounts owed to suppliers. Short-term debt Q Debt instruments with maturities of less than one year. Other current liabilities R Including items such as income tax and wages accumulated but not yet paid. Total current liabilities S=P+Q+R Total liabilities T=O+S Total liabilities + equity U=L+T Items on the balance sheet are sometimes referred to as stock variables, that is, a snapshot of the items at a particular point in time. Similarly, the income and cash flow statements are referred to as showing flow variables: quantities that measure performance over a certain period (for example, revenue, operating costs, interest payments). The stock variables in a company’s balance sheet are closely linked to the flow variables in its income statement and cash flow statements. For example, as a company pays down its debt (a flow), its stock of debt will decrease. The less cash a utility is able to generate from operations (a flow) and pay to its power suppliers, the more its stock of arrears to power suppliers will increase. Normal utility business activities that are not restructuring activities will also impact the balance sheet. For instance, if a utility invests in a smart metering program and, as a result, is able to improve its collections, this will have a very real impact on its balance sheet. Fixed assets and borrowing may increase but, if the program is successful, the accounts receivable asset will decrease and the cash asset will increase. Any bad debt expense suffered by the utility should decrease, improving flows. Annex A: Balance Sheet Basics – Definitions and Accounting Terminology 25 Annex B: Debt Refinancing and Payables Extension in Albania Sector context Albania’s electricity sector has been unbundled into generation, distribution, and transmission utilities. Figure B.1 shows the main institutions. Domestic generation is from a public generation utility, Korporata Elektroenergjitike Shqiptare (KESH), and independent power producers (IPPs). Operatori i Sistemit Te Transmetimit (OST) is the transmission utility, and Operatori i Shpërndarjes së Energjisë Elektrike (OSHEE) the distribution utility. Albania’s three main electrical utilities—KESH, OST, and OSHEE—are state-owned. An attempt to privatize OSHEE was made in 2009, with the Czech utility CEZ acquiring ownership of 76 percent of the shares. However, there were several disagreements between the state and private owners, and OSHEE was renationalized in 2014.9 Figure B.1: Albania’s electricity market structure Generation KESH IPPs Transmission OST Distribution OSHEE Consumption Consumers Source: EBRD (2021): VISP, OSHEE Covid-19 Response, Board Report. Why was balance sheet restructuring needed? Hydropower provides most electricity in Albania, but output is volatile. Figure B.2 shows the sources of energy meeting Albania’s power demand. Hydro output meets most of the demand but varies substantially between years, and when hydro output is low, imports fill the gap. In recent years, solar PV has played a small but growing role. As KESH’s generation assets are fully depreciated hydro plants, imports cost a lot more than power from KESH. For example, in 2019, power from KESH 9 World Bank (2021): Power Recovery Project, Implementation Completion and Results Report. 26 Balance Sheets in West Africa Strengthening Utility  was supplied at a regulated tariff of 1,500 ALL/MWh (US¢ 1.4/kWh), while power from other suppliers was purchased at 8,770 ALL/MWh (US¢ 8.0/MWh).10 The other purchases include hydro run under concession agreements as well as the imports, so the cost of importing power is likely underestimated. Figure B.2: Generation sources 10 8 6 Generation (TWh) 4 2 0 -2 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Hydro Oil Solar PV Net imports Source: IEA World Energy Balances. Distribution losses were greater than 45 percent in 2012 but have subsequently been falling (Figure B.3). The very high losses were in part due to extensive electricity theft.11 Another reason for high losses was a large technical loss component that required additional supply to compensate. In times of low-hydro output this supply would have had to come from imports. Distribution losses have declined to less than half of what they were in 2012 due to a crackdown on electricity theft and investments in the distribution system. The World Bank supported the efforts to reduce distribution Figure B.3: System losses 50% 45% 40% 35% 30% Losses 25% 20% 15% 10% 5% 0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Transmission Distribution Source: Global tracking framework database 10 OSHEE (2019): Financial Statements 11 EBRD (2021): Vital Infrastructure Support Program, OSHEE Covid-19 Response, Board Report. Annex B: Debt Refinancing and Payables Extension in Albania 27 losses by providing US$ 44 million of finance as part of an International Bank for Reconstruction and Development (IBRD) loan to support the upgrade of distribution infrastructure. This was part of a broader power sector recovery project approved in 2014.12 In many years, OSHEE’s average cost of supply was above its average tariff, so it has not been able to recover costs (Figure B.4). The high costs of supply in 2012 and 2013 were driven by high distribution losses and low hydrological output, meaning large volumes of imports were required. As part of the Power Sector Recovery Project, the World Bank provided US$ 26 million in finance as part of an IBRD loan to support the purchase of power imports necessitated by low hydrological output.13 Figure B.4: Average cost of supply and tariff 18 16 14 12 10 $c/kWh 8 6 4 2 0 2012 2013 2014 2015 2016 2017 2018 2019 Average tari Average cost of supply Note: Cost of supply in this graph includes operating and debt service costs Source: OSHEE financial statements To manage the impact of low cost recovery on cash balances, OSHEE delayed payment to KESH. Figure B.5 shows how OSHEE’s trade payable balances accumulated over time and that most of the growing debt is in the balance owed to KESH. Figure B.5: OSHEE’s trade payables 0.8 0.7 0.6 0.5 $ bn 0.4 0.3 0.2 0.1 0 2012 2013 2014 2015 2016 2017 2018 2019 Trade payables to KESH Other trade payables Source: OSHEE and KESH financial statements 12 World Bank (2021): Power Recovery Project, Implementation Completion and Results Report. 13 Ibid. 28 Balance Sheets in West Africa Strengthening Utility  To make up the cash shortfall from the large trade receivables, KESH had to use more debt, much of which was sourced through bank overdrafts. Figure B.6 compares KESH’s trade receivable and debt balance in 2016. The trade receivables exceeded KESH’s short-term debt holdings. The bank overdrafts had to be approved annually and had maturities of less than one year.14,15 Bank overdrafts were US$ 250 million at the end of 2016. The requirement for annual reapproval created uncertainty and instability in the sector, reducing the ability to focus on long-term goals. Figure B.6: KESH’s trade receivable and debt balances in 2016 0.7 0.6 0.5 0.4 $ bn 0.3 0.2 0.1 0 Trade receivables Debt Trade receivable from OSHEE Current: Bank overdrafts Other trade receivables Current: Borrowings from banks Current: Government loans Non-current: Borrowings from banks Non-current: Government loans Source: KESH financial statements What was done? EBRD provided a senior, sovereign-guaranteed EUR 218 million restructuring loan. The loan was separated into two tranches, the first disbursed in 2018 and the second in 2020. This loan was designed to allow KESH to refinance the bank overdrafts onto longer tenors. Figure B.7 shows how the size of the loan compared to KESH’s total debt. Figure B.7: Size of loan EUR 218 million restructuring loan compared to KESH’s debt 0.7 0.6 0.5 0.4 $ bn 0.3 0.2 0.1 0 Debt €218 million EBRD loan Current: Bank overdrafts Current: Borrowings from banks Current: Government loans Non-current: Borrowings from banks Non-current: Government loans €218 million: EBRD loan Source: KESH financial statements 14 EBRD (2016): KESH Restructuring Project, Project Summary Document. 15 KESH (2020): Financial Statements. Annex B: Debt Refinancing and Payables Extension in Albania 29 In 2018, under a subagreement, OSHEE agreed to pay down its payables to KESH over a 28-year period.16,17 This subagreement was possible because the EBRD restructuring loan improved KESH’s liquidity, meaning KESH could accommodate the delayed payment of receivables. This subagreement aimed to provide a way for OSHEE to pay its outstanding debts sustainably. The agreement for OSHEE to pay down its payables to KESH over 28 years means that a large portion of OSHEE’s short-term payables was restructured to become long-term payables.18 OSHEE’s payables to KESH were US$ 460 m; under the payment plan, only US$ 16m was due to be paid in 2018. Figure B.8 shows that the payment agreement means most payables will not be paid in the short term and are effectively long-term liabilities. This restructuring of liabilities reduced the amount of short-term liabilities from 90 percent to 47 percent of total liabilities. Figure B.8: Impact of restructuring of payables on OSHEE’s 2018 liabilities 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Without long-term payment agreement With long-term payment agreement Short-term trade payables Other short-term liabilities Restructured payables to KESH Other long-term liabilities Source: OSHEE financial statements Until 2017, there were disagreements arising from OSHEE’s and KESH’s conflicting understanding of the amounts due to be paid by OSHEE; these had to be reconciled to enable the subagreement. In Figure B.9, the blue bar shows the trade receivable from OSHEE reported in KESH’s accounts, and the orange bar shows the trade payable to KESH reported in OSHEE’s accounts. The difference between the orange bar and the solid line illustrates the disagreement, which was reconciled in 2017, allowing KESH and OSHEE to agree on the payment plan for the outstanding receivables. Was it a success? Figure B.10 shows the composition of KESH’s borrowing, and it can be seen that the loan has enabled KESH to reduce its use of bank overdrafts by US$ 230 million (76 percent). The reduction 16 Albania Ministria e Financave dhe Ekonomise (2023): Prospectus 9 Qershore. 17 KESH (2020): Financial Statements. 18 Despite the subagreement substantially impacting OSHEE’s repayment requirements, in OSHEE’s financial statements, payables to KESH continue to be reported as current. This reporting choice is likely because it is normal practice to report most trade payables balances in current liabilities, so the agreement was mentioned in the notes to the financial statements, but payables were reported as current. 30 Balance Sheets in West Africa Strengthening Utility  Figure B.9: OSHEE trade payables to KESH 0.6 0.5 0.4 $ bn 0.3 0.2 0.1 0 2014 2015 2016 2017 2018 2019 Trade payables to KESH Trade receivable from OSHEE Source: OSHEE and KESH financial statements occurred over a few years because the loan was disbursed in two tranches.19 The first tranche of EUR 118 million was disbursed in 2018, and the second, of EUR 100 million, was disbursed in 2020. KESH’s short-term debt holdings decreased by US$ 90 million (18 percent), while total debt increased by US$ 100 million (15 percent). Short-term debt use has declined slightly, while total debt has increased, resulting in KESH’s capital structure shifting toward a higher proportion of long-term debt. Using a larger proportion of longer-term debt means KESH has to refinance much smaller proportions of debt annually. The smaller proportion of short-term debt reduces exposure to interest rate changes (thus recent interest rate hikes will have impacted KESH less than would have been the case without the restructuring). Figure B.10: Composition of KESH’s borrowings 0.9 0.8 Total debt up by $100 m, 0.7 15% 0.6 0.5 $ bn 0.4 Short-term debt down by 0.3 $90 m, 18% 0.2 Overdrafts down by 0.1 $230 m, 76% 0 2017 2018 2019 2020 Bank overdrafts Other current borrowing Non-current borrowing Source: KESH financial statements 19 EBRD (2021): KESH floating solar PV, Board Report, Annex 8. Annex B: Debt Refinancing and Payables Extension in Albania 31 The agreement of a long-term payment schedule for OSHEE’s payables to KESH has improved OSHEE’s liquidity metrics. For example, Figure B.11 shows the impact of the long-term agreement for payables on OSHEE’s current ratio, which significantly improved, increasing from 0.35 to 0.68 when current trade payables are adjusted to account for the restructuring of the payable owed to KESH. It is important to note that even after the agreement, the current ratio remains below 1, meaning OSHEE still has more current liabilities than current assets. The agreement has helped, but has not resolved OSHEE’s acute liquidity problems. Figure B.11: OSHEE’s current ratio 0.8 Agreed to pay down payables over 28 0.7 years 0.6 0.5 Current ratio 0.4 0.3 0.2 0.1 0 2015 2016 2017 2018 2019 Excluding agreement Including agreement Source: OSHEE financial statements Liquidity in the sector has remained a challenge, and the COVID-19 pandemic has been highly problematic for Albania’s power sector. Lockdowns and an associated reduction in GDP adversely affected OSHEE’s cash collections.20 As a result of these cash shortfalls, EBRD provided a EUR 50 million working capital loan to OSHEE in 2021 to address short-term liquidity problems. Furthermore, these challenges meant OSHEE failed to keep to the payment schedule agreed with KESH, and both KESH and OSHEE delayed nonessential investments.21 Figure B.12 and the following description summarize this case study:  Albania’s electricity sector depends primarily on hydro and its output varies between years. In years of low hydro output, imports were acquired at a higher cost. Tariffs could not recover these higher costs, so liquidity was managed by delaying payments to suppliers and taking out short- term debt.  The loan from EBRD successfully enabled KESH to reduce its reliance on bank overdrafts as a source of debt. The lower proportion of short-term debt will have reduced the proportion of debt that requires annual refinancing. This refinancing was the main component of the restructuring, and it successfully achieved its stated aims, which were limited in scope. 20 EBRD (2021): Vital Infrastructure Support Program, OSHEE Covid-19 Response, Board Report. 21 Albania Ministria e Financave dhe Ekonomise (2023): Prospectus 9 Qershore. 32 Balance Sheets in West Africa Strengthening Utility   OSHEE benefited indirectly from the EBRD loan to KESH as it facilitated the agreement of a long- term payment plan for payables owed to KESH. However, while the payment plan had some impact on improving OSHEE’s liquidity, it remained strained, and further support was required during the pandemic. As a result, reforms within the sector are ongoing. Figure B.12: Balance sheet restructure impact on KESH’s current ratio First tranche of Second tranche of 1.6 EBRD loan EBRD loan disbursed disbursed 1.4 Without collection of receivables from 1.2 OSHEE KESH has poor liquidity KESH’s current ratio 1.0 Repayment plan for OSHEE payables to 0.8 KESH agreed 0.6 0.4 0.2 0 2015 2016 2017 2018 2019 2020 Including OSHEE receivables Excluding OSHEE receivables Source: KESH financial statements Key lessons  Consolidating many short-term loans into fewer long-term loans allows utilities to reduce the volume of debt they have to refinance annually and may help lower the cost of debt, as well as transaction costs.  Concessional debt instruments can enhance these benefits.  Institutions can benefit if other sector players improve their financial stability. In this case study, OSHEE benefits from a repayment agreement made possible by KESH’s improved liquidity after receiving the restructuring loan from EBRD.  Any restructuring agreements between sector entities depend on mutual agreement of these entities’ obligations to one another. KESH and OSHEE started out with very different interpretations of how much each entity owed to or was owed by the other. This had to be reconciled for a payables financing plan from OSHEE to KESH to be workable.  The energy sector is often exposed to macroeconomic externalities. Economic headwinds (for example, the sudden economic downturn triggered by the COVID-19 pandemic) can mean that restructuring efforts do not realize their full intended benefits. Annex B: Debt Refinancing and Payables Extension in Albania 33 Annex C: Debt and Arrears Refinancing in Côte d’Ivoire with World Bank Guarantee Sector Context The electricity sector in Côte d’Ivoire contains a mixture of private- and public-sector companies. Société des Energies de Côte d’Ivoire (CI‑ENERGIES) is a state-owned asset-holding company responsible for overseeing the operations of public energy sector assets, as well as planning and procuring new assets either via independent power producers (IPPs) or directly.22 CI‑ENERGIES oversees the operation of public assets by holding a 15-year affermage contract with Compagnie Ivoirienne d’Electricité (CIE), a private company. An affermage is similar to a concession agreement, except that it excludes responsibility for financing investments. This means the affermage contract requires CIE to operate the transmission, distribution, and some state-owned hydro generation plants on behalf of CI‑ENERGIES. However, CI-ENERGIES retains responsibility for the financing of most new investments. Approximately 75 percent of generation comes from gas-fired plants operated by several IPPs that use gas from domestic reserves.23 Private producers, including Foxtrot and Canadian Natural Resources (CNR), are responsible for the production of natural gas. CI‑ENERGIES is the contractual counterparty for both the IPPs and the gas suppliers. However, CIE pays the IPPs and gas suppliers directly on behalf of CI‑ENERGIES, based on a contractually stipulated cash waterfall. Figure C.1 summarizes the sector’s institutions and the relationships between them. Figure C.1: Côte d’Ivoire electricity sector structure Cashflows Contractual counterparts Consumers CIE A ermage CIE CI-ENERGIES Gas supply PPA agreement CI-ENERGIES IPPs suppliers Gas Gas IPPs Gas suppliers Source: World Bank (2018): CI-Energies Guarantee Project, Project Appraisal Document. 22 World Bank (2018): CI-Energies Guarantee Project, Project Appraisal Document. 23 IEA World Energy Balances 34 Balance Sheets in West Africa Strengthening Utility  Why was balance sheet restructuring needed? CIE revenues would generally have been sufficient to cover its costs in the absence of collection issues. Figure C.2 shows that the average revenue (per kWh) recorded by CIE has consistently been above its average cost of supplying power. There has been relatively little variation in the average cost of supply, which is generally US$¢ 10–12/kWh. Gas prices in Côte d’Ivoire are indexed to an average of the last 12 months of West Texas Intermediate (WTI) crude prices.24 This indexing method is designed to reduce price volatility and partially explains the low variability in the cost of supply. Indexing to WTI prices means local gas prices increase if the CFA franc (CFAF) depreciates relative to the dollar (as occurred between 2013 and 2015). Figure C.2: Average tariff and cost of supply 14 12 10 $c/kWh 8 6 4 2 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 Average tari Cost of supply Source: CIE financial statements However, collections issues have resulted in CIE accumulating large receivables. Figure C.3 shows CIE’s collection rate and receivable balances. In several years, roughly 20 percent of revenue was not collected. This low collection rate resulted in receivables accumulating, which caused poor liquidity within the sector. In 2013, CIE had 16 months of receivables outstanding, which increased to 18 months in 2016. Despite some reduction in 2017,25 large receivables balances remained. Figure C.3: CIE receivable balances (bars, left axis) and collection rate (line, right axis) 1,500 150% 1,250 125% Receivables ($m) Collection rate 1,000 100% 750 75% 500 50% 250 25% 0 0% 2013 2014 2015 2016 2017 Receivables - CIE Collection rate - CIE Source: CIE and CI-ENERGIES financial statements 24 China University of Geosciences (2016): Analysis of Gas Sector in Cote d’Ivoire. 25 Our understanding is that this reduction may, in part, be a result of some balances being reallocated to CI-ENERGIES, although the utilities’ financial statements do not provide sufficient detail to confirm this. Either way, receivables balances remain high. Annex C: Debt and Arrears Refinancing in Côte d’Ivoire with World Bank Guarantee 35 To finance the increase in receivables, CIE and CI‑ENERGIES delayed payments to IPPs and gas suppliers and took out short-term debt. Figure C.4 shows payables and short-term debt as receivable balances rose. Initially, CIE was able to manage liquidity purely by delaying payments to suppliers. In 2016 and 2017, CIE took out short-term debt from local banks, on behalf of CI‑ENERGIES, to meet the sector’s liquidity demands. The high outstanding payables resulted in tense relationships with the IPPs and gas suppliers, and clearing arrears was considered a precondition to moving forward with sector investments, in particular extending PPAs and attracting new IPPs critical to meet growing demand.26 Therefore, CIE paid down some payables and partially financed this using short-term debt in 2017. From 2016 to 2017 CIE’s payables balances decreased from 15 to 10 months of operating expenses. Figure C.4: CIE’s payables and debt 1,400 1,200 1,000 800 $m 600 400 200 0 2013 2014 2015 2016 2017 Payables - CIE Short-term debt - CIE Long-term debt - CIE Source: CIE financial statements What was done? The World Bank and CI‑ENERGIES developed a project agreement in which the World Bank provided an International Development Association (IDA) guarantee for a new commercial loan facility taken out by CI‑ENERGIES.27 This guarantee enabled CI‑ENERGIES to use commercial debt to improve the sector’s liquidity and refinance existing debt on better terms. The World Bank provided the IDA guarantee to a commercial lender, who provided CI‑ENERGIES with a loan. Figure C.5 summarizes the structure of the agreement. Figure C.5: Guarantee structure CI-ENERGIES Loan Owner Project Commercial lender Government of Côte d’Ivoire agreement Guarantee Indemnity World Bank agreement Source: World Bank (2018): CI-Energies Guarantee Project, Project Appraisal Document. 26 World Bank (2023): CI-Energies Guarantee Project, Implementation Completion and Results Report. 27 World Bank (2018): CI-Energies Guarantee Project, Project Appraisal Document. 36 Balance Sheets in West Africa Strengthening Utility  The project directly or indirectly benefits most parties within the sector. Table 2 explains how different parties benefit from the guarantee. CI‑ENERGIES and commercial lenders are direct beneficiaries as CI‑ENERGIES receives a loan and commercial lenders receive a guarantee. CIE, IPPs, and gas suppliers all benefit indirectly. Table C.1: Project beneficiaries Beneficiary Type Impact CI-ENERGIES Direct Access long-term commercial financing and obtain a credit history Commercial lenders Direct Lending is guaranteed CIE Indirect Pay down short-term debt taken out on CI‑ENERGIES behalf IPPs and gas suppliers Indirect Clearance of arrears enabling them to resume investments in new capacity Source: World Bank (2018): CI-Energies Guarantee Project, Project Appraisal Document. The guarantee aimed to enable more investment within the sector and improve financial sustainability. It was hoped that the clearance of arrears to IPPs and gas suppliers would enable them to resume investing in new capacity (which turned out to be correct). Furthermore, the guarantee aimed to reduce debt service costs by allowing access to lower cost and longer-term debt. CI-ENERGIES has been able to raise private capital, and the guarantee was used to cover 60 percent of the principal of a EUR 300 million international loan from Deutsche Bank.28 The remaining 40 percent was covered by the African Trade Insurance Agency (ATI) guarantee. To arrange the loan, CI‑ENERGIES negotiated with several international banks to competitively procure the best terms possible. The loan had a 12-year maturity with a three-year grace period and was fully disbursed by the start of June 2019. An additional  CFAF 95  billion was raised from two local banks (Société Générale Côte d’Ivoire and NSIA Banque). This financing did not receive direct support from the guarantee but reportedly benefited from the positive signaling that the guarantee provided.29 The local bank financing had a seven-year maturity with a two-year grace period, which compares very favorably with the short-term financing used previously (generally less than two-year maturity). These loans were agreed in 2019 and disbursed shortly afterwards. Additionally, CI‑ENERGIES has accumulated long-term debt from the construction of the Soubré hydropower plant and the associated grid reinforcement.30 Most of the associated new debt was from Exim Bank China, which financed 85 percent of the hydro plant construction costs and most of the transmission infrastructure investments. The increase in debt held by CI‑ENERGIES is shown in Figure C.6. Other significant creditors include the EU (US$ 190 m), AfDB (US$ 150 m), and AFD (US$ 130 m).31 28 World Bank (2023): CI-Energies Guarantee Project, Implementation Completion and Results Report. 29 Ibid. 30 AFDB (2016): Power Transmission and Distribution Networks Reinforcement Project, Appraisal Report. 31 World Bank (2023): CI-Energies Guarantee Project, Implementation Completion and Results Report. Annex C: Debt and Arrears Refinancing in Côte d’Ivoire with World Bank Guarantee 37 Figure C.6: CI-ENERGIES debt balances after receiving the guarantee 3,000 2,500 2,000 $m 1,500 1,000 500 0 2017 2018 2019 2020 Deutsche Bank Local banks Exim Bank China Other Source: CI-ENERGIES financial statements and World Bank (2023): CI-Energies Guarantee Project, Implementation Completion and Results Report. The proceeds of the new loans have been used to pay down some debts within the sector. CIE’s payable balances decreased from 10 to seven months in 2019, as CI‑ENERGIES partially used the proceeds of the guaranteed loan to pay down payables that were on CIE’s balance sheet. Figure C.7 shows CIE’s payable balances. There was a US$ 214 million reduction in payables, less than the roughly US$ 500 million of debt taken out to improve liquidity. However, payables started to re-accumulate in 2020, increasing to eight months of operating expenses. Figure C.7: CIE payable balance 900 800 700 600 500 $m 400 300 200 100 0 2017 2018 2019 2020 Source: CIE and CI-ENERGIES financial statements Was it a success? Figure C.8 shows that collection has remained a problem, with collection rates remaining low and receivables accumulating. Collections issues have particularly emanated from public-sector clients, including exports to neighboring countries. CIE’s collection rate was higher than usual in 2017, and in 2018 almost 100 percent, before returning to roughly 80 percent in 2019. Several factors contributed to the accumulation of receivables, especially in 2020, including: 38 Balance Sheets in West Africa Strengthening Utility   Collections have not improved;  Consumers were allowed a three-month payment delay in 2020 due to the COVID-19 pandemic; and  Receivables from exports to Mali rose sharply in 2020 (partly related to a coup in that year).32 Figure C.8: CIE receivables balances (bars, left axis) and collection rate (line, right axis) 2,000 200% 1,750 175% 1,500 150% Receivables ($m) Collection rate 1,250 125% 1,000 100% 750 75% 500 50% 250 25% 0 0% 2017 2018 2019 2020 Receivables - CIE Collection rate - CIE Source: CIE and CI-ENERGIES financial statements As a result of the poor collections, CIE has had to take out more short-term debt to address liquidity constraints. Figure C.9 shows CIE’s debt balances increasing. While CI‑ENERGIES’ new debt did allow a temporary step down in CIE’s payables, it did not enable CIE to reduce its debt holdings. Figure C.9: CIE’s debt balances 1,200 1,000 800 $m 600 400 200 0 2017 2018 2019 2020 Short-term debt - CIE Long-term debt - CIE Source: CIE financial statements However, since receiving the guarantee, CI‑ENERGIES has obtained a credit rating from both Moody’s and S&P. Moody’s rates CI‑ENERGIES as B1 and S&P as B+, which indicates the relatively high risk present in the sector. However, holding a credit rating is already a significant achievement that will allow CI‑ENERGIES to develop a credit history and access a broader range of funders in future. 32 Ibid. Annex C: Debt and Arrears Refinancing in Côte d’Ivoire with World Bank Guarantee 39 Figure C.10 and the following description summarize this case study:  Poor payment discipline from public-sector clients and exports to neighboring countries meant that CIE accumulated large liabilities to manage liquidity. At first, CIE delayed payments to suppliers. However, suppliers responded by delaying investments and threatening to suspend supply, so delaying payment to suppliers was unsustainable. CIE subsequently took out additional debt to manage liquidity. Most of this debt was short-term and high-cost. Due to the structure of the concession agreement, CI‑ENERGIES was ultimately responsible for these liabilities.  In the context of significant sector liabilities, the World Bank and CI‑ENERGIES developed a project agreement under which the World Bank would guarantee a new commercial loan taken out by CI‑ENERGIES. This agreement aimed to allow CI-ENERGIES to access finance that would not otherwise have been available, with the funds released being used to repay suppliers and short-term debt holdings.  As a result of the guarantee, CI-ENERGIES was able to access a EUR 300 million international loan from Deutsche Bank and CFAF 95 billion from two local banks. CI‑ENERGIES now has a credit rating, allowing it to build a credit history and hopefully improve access to commercial debt in future. However, given the continued liquidity challenges, CI‑ENERGIES may face challenges in meeting its commitments in servicing these loans.  The debt allowed CIE to decrease its trade payables from 10 to seven months in 2019 (the year in which CI-ENERGIES took out the loans.  However, low collection rates have persisted, so receivables have continued to accumulate. As a result, increased short-term debt and payables balances have also increased. Financial restructuring can address short to medium-term liquidity constraints, but operational performance improvements (such as improving low collection rates) will be necessary to achieve longer-term financial sustainability. Figure C.10: Côte d’Ivoire case study summary 3) CI-ENERGIES takes out debt 4) Poor collections return 2,000 associated with the guarantee which so liabilities continue to was used to pay down payables accumulate 1,800 1,600 2) Improved collections 1) Liabilities accumulate stabilise liabilities 1,400 due to poor collections 1,200 $m 1,000 800 600 400 200 0 2013 2014 2015 2016 2017 2018 2019 2020 Payables - CIE Short-term debt - CIE Long-term debt - CIE Source: CIE financial statements 40 Balance Sheets in West Africa Strengthening Utility   Many of the factors responsible for continued poor liquidity were beyond the reasonable control of CIE or CI‑ENERGIES (for example, COVID-19 and a coup in Mali both resulted in further accumulation of receivables). If these factors had not occurred, the restructuring would likely have been more successful. Key lessons  Guarantees can act as a catalyst, allowing utilities to access commercial financing on favorable terms. Concessional guarantees offer an alternative to loans directly from donors.  If other operational challenges are not addressed, access to new commercial finance only offers a temporary improvement in liquidity.  Utilities are frequently exposed to challenges that are beyond their control (such as the impact of COVID-19, or, in the case of Côte d’Ivoire, the coup in Mali) and these challenges can undermine even the most carefully planned balance sheet restructuring efforts. Annex C: Debt and Arrears Refinancing in Côte d’Ivoire with World Bank Guarantee 41 Annex D: Cross-Debt Cancellation and Debt Refinancing in Jordan Sector structure Jordan’s electricity sector has adopted a single-buyer model. The electricity market structure is summarized in Figure D.1.33 The single buyer is the state-owned National Electrical Power Company (NEPCO). NEPCO’s primary roles are as the:  Single buyer of electricity;  Electricity transmission system operator;  Coordinator of generation dispatch; and  Single importer of hydrocarbons for the power sector. Electricity generation is carried out by a mixture of partially privatized generation companies (GENCOs), thermal independent power producers (IPPs), and renewable IPPs. NEPCO is the single importer of hydrocarbons for the power sector and purchases fuel for thermal generation capacity. There are three privatized distribution companies (DISCOs) to whom NEPCO sells power. NEPCO sells directly to large consumers domestically and small volumes of power across cross-border interconnectors to neighboring markets, including the West Bank, Egypt, and Syria. Figure D.1: Jordan’s electricity market structure Fuel suppliers GENCOs Thermal IPPs Renewable IPPs NEPCO DISCOs Residential and Large corporate and Exports small corporate industrial consumers Source: EBRD (2020): Vital Infrastructure Support Program, NEPCO: Liquidity Facility, Board Report, Annex 8. 33 For a fuller discussion of Jordan’s energy sector see World Bank (2023): Electricity Sector Efficiency and Supply Reliability Program for Results (P171296). 42 Balance Sheets in West Africa Strengthening Utility  Why was balance sheet restructuring needed? Jordan’s electricity sector was traditionally reliant on imported hydrocarbons.34 In 2011, the Arab Spring disrupted gas supplies from Egypt. As a result, Jordan’s plants—predominantly dual fuel— switched from using natural gas to expensive Heavy Fuel Oil (HFO) and diesel-fueled generation in the first half of the 2010s. The use of HFO generation resulted in a very high cost of supply during the early 2010s (Figure D.2). The tariffs NEPCO was allowed to charge remained far below the abnormally high cost of supply, so NEPCO accrued significant liabilities. Meanwhile, the privatized distribution companies had profits guaranteed by their licenses, so were not impacted by the cost of supply increases.35 Access to natural gas in 2015 resulted in the cost of supply declining to a similar level to the tariff NEPCO charged.36 In June 2015, a floating storage regasification unit went into service at Aqaba. Access to gas reduced the use of HFO to generate power, resulting in a lower cost of supply. Further cost reduction resulted from switching from LNG to piped gas from Israel and Egypt. Although most improvement in cost recovery came from lower costs due to natural gas access, tariff reform was an essential component of improved cost recovery. Figure D.2 shows that the cost of supply declined dramatically after the installation of a regasification unit in 2015. However, costs of supply never declined to the low levels of 2009 when Jordan had access to low-cost piped gas imports. The average tariff NEPCO charged DISCOs increased by 87 percent between 2010 and 2015, enabling NEPCO to recover the new, higher, cost of supply. Tariff reform and construction of an LNG regasification unit were both part of a US$ 2 billion stand-by arrangement between Jordan and the IMF, agreed in 2012.37 Figure D.2: Average cost of supply and average tariff 25 20 15 $c/kWh 10 5 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Average cost of supply Average tari Source: NEPCO financial statements and IEA World Energy Balances 34 IEA World Energy Balances. 35 IMF (2023): Jordan, Fifth Review Under the Extended Arrangement Under the Extended Fund Facility and Request for Modification of Performance Criteria. 36 IMF (2013): Jordan, Second Review Under the Stand-By Arrangement. 37 Ibid. Annex D: Cross-Debt Cancellation and Debt Refinancing in Jordan 43 As tariffs were far below costs during the 2011–15 period, NEPCO required other sources of finance to pay suppliers. In 2011 and 2012, NEPCO took on local market debt to finance the difference between the cost of supply and the tariff charged. As a result, the total debt on NEPCO’s balance sheet ballooned from US$ 350 million at the end of 2010 to US$ 2.8 billion in 2012 (Figure D.3). These debt balances are debt taken out by NEPCO but guaranteed by the government. After 2012, rather than accumulating additional long-term debt, the Ministry of Finance (MoF) paid advances on behalf of NEPCO for power supply to ensure that power generators were paid.38 These advances are recorded as payables (to MoF) in NEPCO’s accounts. NEPCO is charged no interest on these advances, which reached US$ 4.0 billion by the end of 2015. As MoF expects NEPCO to pay down the advances, they are effectively on-lent debt from government. NEPCO’s total payables and debt amounted to US$ 7.7 billion in 2015, equivalent to approximately 20 percent of GDP.39 In 2015, NEPCO had 3.3x as much commercial debt on its balance sheet as assets. In total, payables and debt came to 7.6x assets. This sovereign-backed debt was a quarter of Jordan’s total public-sector debt. It has been noted that these debts were so high that they “limit the Government’s ability to borrow”.40 Figure D.3: Payables and debt balances 9 8 7 6 5 $b 4 3 2 1 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Payable - MoF advances Payable - Power purchases Payable - Gas purchases Debt Payable - Other Source: NEPCO financial statements. An additional strain upon NEPCO had been an accumulation of receivables (Figure D.4). Most of these receivables were due from the DISCOs. A notable proportion of the receivables owed to the DISCOs were from state electricity consumption (frequently from the military), which had not been paid to the DISCOs, who in turn delayed payments to NEPCO.41 For example, Jordan Electric Power Company (JEPCO, the largest DISCO) had total receivables of US$ 832 million in 2018, of which 38 World Bank (2018): Jordan, First and Second Programmatic Energy and Water Sector Reforms Development Policy Loans, Implementation Completion and Results Report. 39 NEPCO financial statements and IMF World Economic Outlook data. 40 World Bank (2018): Jordan, First and Second Programmatic Energy and Water Sector Reforms Development Policy Loans, Implementation Completion and Results Report. 41 NEPCO: Financial Statements. 44 Balance Sheets in West Africa Strengthening Utility  US$ 112 million was from the military and US$ 130 million from other government debts.42 Geopolitical crises also contributed to the growing receivables. High demand growth (roughly four percent per year, 2010–2018),43 which was partly driven by an influx of refugees from Syria, contributed to the DISCOs’ revenue collection difficulties.44 Figure D.4: Trade receivables 1,000 900 800 Net trade receivables ($m) 700 600 500 400 300 200 100 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Distribution companies Other Source: NEPCO financial statements. What was done? A debt management plan was developed for NEPCO.45 The plan had four components: 1. Tariffs adjusted so that interest on all outstanding debt would be serviced through electricity revenues; 2. Advances from MoF would remain interest-free; 3. Existing commercial debt would be refinanced onto longer tenor loans; and 4. Available profits would be used to pay down existing debt. Adjusting tariffs to a level that services interest expense helps ensure that debt does not accumulate further. Where surplus cash flows are available, the allocation of these cash flows to paying down principal acts to reduce future debt service requirements. Refinancing onto longer tenor loans reduced the cost NEPCO pays for debt (Figure D.5). NEPCO’s average cost of debt declined from 4.2 percent in 2014 to 2.4 percent in 2022. New debt has come from a mixture of commercial and donor sources. Commercial sources have included Housing Bank, Islamic Bank of Jordan, and Sukuk bonds. Donor funding has included a US$ 250 million restructuring loan and a US$ 100 million liquidity facility from EBRD to NEPCO.46 42 JEPCO financial statements. 43 IEA World Energy Balances. 44 EBRD (2020): Vital Infrastructure Support Program, NEPCO: Liquidity Facility, Board Report. 45 World Bank (2018): Jordan, First and Second Programmatic Energy and Water Sector Reforms Development Policy Loans, Implementation Completion and Results Report. 46 EBRD (2020): Vital Infrastructure Support Program, NEPCO: Liquidity Facility, Board Report. Annex D: Cross-Debt Cancellation and Debt Refinancing in Jordan 45 Figure D.5: Composition of debt and cost of debt for NEPCO 100% 6.0% 75% 4.5% 50% 3.0% 25% 1.5% 0% 0.0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Local loans Foreign loans Bonds and Islamic Sukuk Due to banks Cost of debt Source: NEPCO financial statements. In addition to the debt management plan, amounts owed between government entities within the energy sector were netted down in 2019.47 The debt management plan did not specify how NEPCO’s payable to MoF would be paid. A separate plan was formulated to collect payment for the payables by cancelling intra-governmental debts. This cross-debt cancellation aimed to reduce the amount of debt within the sector. Reducing debt within the sector was a priority for the government as NEPCO’s debts were a noteworthy proportion of public-sector debt. The structure of debt cancellation is shown in Figure D.6. As stated earlier, government consumers had built up debts to the DISCOs. The DISCOs had, in turn, not paid NEPCO the amount still owed by government consumers. The resulting cash shortfall increased NEPCO’s reliance on advances from MoF. As part of the debt cancellation plan, MoF absorbed the debt of government electricity consumers by writing off amounts payable by NEPCO. In turn, NEPCO wrote off receivables from the DISCOs, and the DISCOs wrote off government consumer receivables. This approach has disadvantages compared to enforcing timely bill payment throughout the sector. For one, it allowed a culture of non-payment to endure, and for another, it did not generate any free liquidity for NEPCO. However, the approach was simpler to implement than directly paying public electricity bills, since the debts to NEPCO were not due from one specific government entity but a complex agglomeration of public sector debtors. Figure D.6: Structure of cross-debt cancellation Government consumers DISCOs The Ministry of Finance absorbed the debt of government electricity Payables due consumers by writing o amounts for electricity payable by NEPCO NEPCO Ministry of Finance Source: NEPCO (2019): Financial Statements. 47 IMF (2019): Jordan: Second Review Under the Extended Arrangement Under the Extended Fund Facility, Requests for a Waiver of Nonobservance of Performance Criterion, an Extension of the Arrangement, and Rephasing of Access-Press Release; Staff Report; and Statement by the Executive Director for Jordan, Box 2. 46 Balance Sheets in West Africa Strengthening Utility  This mechanism was limited by the volume of receivables that government-owned electricity consumers owed to the DISCOs, so significant payables remained. For example, government receivables were only 29 percent of NEPCO receivables in 2018. NEPCO’s payable balances were far larger than its receivables, so in 2019, the decrease in receivables of 36 percent corresponded to a reduction in payables of only 10 percent (Figure D.7). The changes in Figure D.7 are not only a result of cross-debt cancellation but also include any receivables or payables that accumulated or were paid down in 2019 (these accumulated or paid-down amounts explain why total movements do not match). Figure D.7: Receivable and payable balances before and after cross-debt cancellation 5,000 $450 m 4,500 10% 4,000 3,500 3,000 $m 2,500 2,000 1,500 $330 m 36% 1,000 500 0 2018 2019 2018 2019 Receivables Payables Source: NEPCO financial statements. As significant payables remained outstanding after 2019, public entities did not pay for electricity and NEPCO’s resultant receivables have been netted against MoF advances periodically.48 This is a continuation of the netting mechanism used in 2019, but with an understanding that public- sector entities are not expected to make cash payments for electricity. This structure ensures regular payment of NEPCO’s outstanding liabilities to MoF, but means that NEPCO is providing power for which it receives no cash payment. Figure D.8 shows how receivables changed after the cross-debt cancellation mechanism was enacted. In 2019, receivables were reduced in the first year as government debt was netted down. Subsequently, receivables have remained stable at a lower level.49 Figure D.8: Receivables balances after cross-debt cancellation enacted 1,000 Net trade receivables ($m) 900 800 700 600 500 400 300 200 100 0 2018 2019 2020 2021 2022 Distribution companies Other Source: NEPCO financial statements. 48 NEPCO: Financial Statements. 49 The World Bank’s 2023 Electricity Sector Efficiency and Supply Reliability Program for Results (P171296) aims to build on this progress, linking some of its financing to improved payment discipline from government agencies to NEPCO and a conversion of a portion of government loans on NEPCO’s balance sheet to equity. Annex D: Cross-Debt Cancellation and Debt Refinancing in Jordan 47 Was it a success? The cross-debt cancellation in 2019 reduced NEPCO’s total liabilities. However, the impact of this reduction on the total amount of outstanding liabilities was small because the amount of receivables from government organizations was much less than the amount of payables and debt NEPCO holds. The initial offsetting of liabilities may have improved how investors perceive NEPCO’s creditworthiness despite not releasing cash into the sector. Offsetting does not release cash into the sector, as it only cancels balances, but can influence how investors perceive a utility in various ways. For example, a lender may assume, in the absence of an offset, a worst-case scenario in which the utility cannot recover any of its receivables but is required to pay down the payables. If payables and receivables have been offset, this worst-case scenario is ruled out. Figure D.9 shows that since 2019, NEPCO’s payables to MoF have continued to decline. The mechanism of collecting payment for government electricity consumption by reducing NEPCO payables to MoF (for the advances paid by MoF) has resulted in a continued reduction in NEPCO’s payables to MoF. NEPCO’s payables have decreased by 24 percent between 2018 and 2022. This mechanism has meant NEPCO has been providing power to public-sector organizations for which it has received no cash payment. As the continued offset mechanism requires NEPCO to provide power for which it did not receive a cash payment, it will have had a negative impact on NEPCO’s liquidity. The ongoing offsetting of public-sector receivables reduced NEPCO’s charging base. For this to be sustainable, tariffs paid by other consumers would have had to increase to fund government consumption of electricity, which is inequitable, or cost savings would have had to be realized. There is no evidence that tariffs were adjusted to include the cost of supplying electricity to government consumers, so the mechanism is likely to be unsustainable. Further, after the legacy advances have been cleared, government consumers of electricity will need to restart payments for electricity. This adjustment may result in a shock to government budgets and may require additional funding from MoF. While payables to MoF have declined, NEPCO has been less successful in reducing its legacy debt liabilities, which increased by US$ 1.4 billion (38 percent) between 2018 and 2022. As a result of this increase, NEPCO’s combined payable and debt balances increased by US$ 0.2 billion (3 percent) between 2018 and 2022. This increase is partly because NEPCO has been supplying power to public-sector organizations without receiving cash payments. Additionally, to have been successful in paying down its liabilities, NEPCO would have needed to be profitable. However, NEPCO has not been profitable, owing in part to a series of exceptional economic challenges discussed further below. Given these shortcomings, the ongoing netting of public-sector electricity bills against outstanding payables to MoF could prove to be unsustainable. Ideally, a formal plan for paying down the legacy liabilities should have been formulated. This would have maintained the charging base, with tariffs for all customers adjusted to allow NEPCO to recover the cost of paying down legacy balances. 48 Balance Sheets in West Africa Strengthening Utility  Figure D.9: Debt and payable balances after cross-debt cancellation 10 Debt increased by $1.4bn, 38% 9 Payables + debt increased by $0.2bn, 3% 8 7 6 5 $b 4 3 Payables decreased by $1.1bn, 24% 2 1 0 2018 2019 2020 2021 2022 Payable - MoF advances Payable - Power purchases Payable - Gas purchases Payable - Other Debt Source: NEPCO financial statements. NEPCO has been facing some strong headwinds. Most notably:  The COVID-19 pandemic hit NEPCO particularly hard; in 2020, electricity consumption fell by roughly 10 percent while NEPCO was still required to meet take-or-pay obligations to electricity and fuel suppliers.50 Payments from DISCOs were interrupted and then severely delayed. These factors have limited NEPCO’s ability to start paying down its debt. To assist NEPCO, the EBRD provided a US$ 100 million liquidity facility.  Jordan imports natural gas for its power plants, and prices have increased since Russia’s invasion of Ukraine. NEPCO purchases natural gas on long-term contracts, with prices that are less volatile than global natural gas prices but that have nonetheless increased substantially.51 Despite some protection offered by its gas supply agreements, NEPCO remains vulnerable to rising commodity prices because price volatility is not fully passed through to end-consumers of electricity. The discrepancy between tariffs and the cost of supply was a driver behind the initial build-up in liabilities, and this experience has been repeated (albeit to a lesser extent) due to elevated natural gas prices. Figure D.10 and the following description summarize this case study:  NEPCO accumulated large liabilities due to HFO use in the early 2010s. HFO use is expensive, and regulations meant NEPCO could not charge the DISCOs a cost-recovering tariff. These liabilities were loans from financial institutions and payables for advances paid by MoF on NEPCO’s behalf.  Once Jordan regained access to gas supplies, a debt management plan was put in place. This plan increased tariffs to levels that could recover the interest on NEPCO’s debt holdings, which meant liabilities stopped compounding.  Cross-debt adjustment was put in place to reduce NEPCOs payables to MoF. In a narrow sense, the cross-debt adjustments have been successful. The amount NEPCO owes to the government for the previously outstanding advances has declined and continues to do so. 50 EBRD (2020): Vital Infrastructure Support Program, NEPCO: Liquidity Facility, Board Report, Annex 8. 51 IMF (2023): Fifth Review Under the Extended Arrangement Under the Extended Fund Facility and Request for Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Jordan. Annex D: Cross-Debt Cancellation and Debt Refinancing in Jordan 49  In the context of strong headwinds, the relative stability of NEPCO’s net asset position between 2020 and 2022 demonstrates the success of the restructuring attempts including the debt management plan.  However, the vast scale of NEPCO’s debts (20 percent of Jordanian GDP) means that there is no quick fix. The restructuring will take many years to succeed at the current rate of repayment.  Reforms to NEPCO have been seen as productive by credit rating agencies. For example, Moody’s described NEPCO’s restructuring as making “public finances more resilient to potential global energy price increases”52 while predicting Jordan’s debt-to-GDP ratios will gradually decline. Figure D.10: NEPCO’s net balance sheet position Debt management plan stops Cross-debt cancellation decreases 4 HFO use increases liabilities interest payments compounding current assets and current liabilities 2 0 -2 $b -4 -6 -8 -10 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Non-current assets Current assets Non-current liabilities Current liabilities Net-asset position Source: NEPCO financial statements. Key lessons  Consolidating many short-term loans into fewer long-term loans can reduce the cost of debt and reduce the burden and transaction costs of constantly being required to refinance debt.  Although a one-off cross-debt cancellation can result in limited benefits by increasing the cash flows available to service debt, this intervention does not release additional cash.  Offsetting of receivables and liabilities on a longer-term basis, as is taking place at NEPCO, appears to have even less benefit; forgoing cash from state-owned electricity users requires NEPCO to cut costs or increase tariffs recovered from the remaining charging base to pay back MoF over time.  Utilities considering a restructuring of this nature should ensure that they have a clear long-term plan for sustainable cost recovery in place. In NEPCO’s case, significant progress was made in improving cost recovery during the initial restructuring, but further reform (including reform supported by the World Bank) will be necessary to maintain this discipline, especially in the face of economic headwinds.53 52 Jordan Times (2019): Moody’s expects debt-to-GDP ratio to ‘gradually decline’. 53 World Bank (2023): Electricity Sector Efficiency and Supply Reliability Program for Results (P171296). 50 Balance Sheets in West Africa Strengthening Utility