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The speed and relative simplicity with which the financing arrangements for the Tuxpan V Project were consummated is good news for Mexico's power sector. With the demand for power in Mexico continuing to surge at a faster pace than overall economic growth in the country, and national electric utility Comision Federal de Electricidad (CFE) planning to add over 25,000MW in generation capacity between now and 2012 in order to meet demand and prevent predicted power shortages, the successful closing of the financing documentation for the Tuxpan V Power Project demonstrates that experienced project sponsors, motivated lenders and energetic counsel will have a definite edge in helping Mexico achieve its aggressive energy sector goals.

The financing documents for the Tuxpan V project were executed on 19 July, less than six months after the execution of the Power Purchase Agreement (PPA) between CFE and the Project Company. This rapid time frame represents a significant improvement over the long lead time necessary to structure a contractual framework considered financeable by lenders to several recent Mexican power projects, such as Campeche, Altamira II, Naco Nogales, and Tuxpan III and IV, where CFE no longer agreed to absorb fuel supply risk by taking contractual responsibility for the supply of adequate fuel to the projects, instead requiring the project company to execute its own fuel supply arrangements, in most cases directly with Petroleos Mexicanos (PEMEX) affiliate PGPB. Unfortunately, in those deals the fuel supply agreements offered by PGPB contained material mismatches with the PPA, which led to protracted negotiations between project lenders and sponsors, and in some cases, between project lenders and CFE, delaying the consummation of the financing for several months.

CFE seems to have taken fuel supply risk off of the table in its recent round of awarded power projects, including Tuxpan V, where CFE is contractually responsible for the supply of fuel necessary for the project to generate dispatched capacity (so long as agreed fuel efficiency levels are met by the project). In reality, CFE is acting primarily as an intermediary for PGPB, which is facing potentially severe gas shortages in the near future, as gas production fails to keep pace with the rapid growth in demand. This ultimately means that CFE (as a result of the government force majeure protections contained in the Mexico PPA) could find itself in the unenviable position of being required to pay capacity charges to IPPs under numerous PPAs without having an adequate supply of natural gas to enable CFE to dispatch these IPP projects. As a practical matter, it is questionable how long CFE would be able (or willing) to continue to meet its capacity payment obligations under the government force majeure clauses of the PPAs in cases where CFE is not able to dispatch power plants due to natural gas shortages. But in the short term, this does not seem to have affected the ability of project sponsors to obtain competitive pricing for project financings in Mexico.

Transaction Overview

Overview of contractual structure: the diagram summarizes the project's overall contractual structure, as well as the project financing arrangements.

Sponsor Parties: The Project Company, Electricidad Sol de Tuxpan, S. de R.L. de C.V. (EST) is jointly owned by Japanese sponsors Mitsubishi Corporation and Kyushu Electric Power Co., Inc. (KEPCO), with Mitsubishi owning 70% and KEPCO owning the remaining 30% through its subsidiary Kyuden International Corporation. Mitsubishi and KEPCO brought significant recent experience to the transaction, having also jointly developed the Tuxpan II Project (495MW), while Mitsubishi also recently partnered with Electricité de France (EDF) in sponsoring the Altamira II Project (495 MW). Mitsubishi Corp and Mitsubishi Heavy Industries have an extensive track record as EPC contractor for numerous Mexican power projects.

Mexico project agreements: The Tuxpan V Project is a combined-cycle, natural gas-fired power facility with a capacity of approximately 495MW, located near the city of Tuxpan de Rodriguez Cano, in the State of Veracruz. EST executed a 25-year PPA with CFE on 23 January 2004, concurrently executing a Fuel Supply Agreement (FSA) with a term of 25 years from the commercial operation date of the plant, which is scheduled to be 1 September 2006. Consistent with previous power project financings in Mexico, the lenders required clarification agreements from CFE addressing the interpretation of certain ambiguous provisions of the PPA and FSA. The financing process for Mexican power projects has been somewhat streamlined by the fact that CFE has incorporated many of the clarifications required by lenders in past financing transactions into the provisions of the PPA itself, eliminating the need for protracted negotiations between CFE and project lenders. However, certain ambiguities and internal inconsistencies remain in CFE's forms, requiring at least one round of clarification negotiations between CFE and the project lenders. In order to minimize the potential for delay in obtaining CFE's agreement to the desired clarifications, the project lenders mainly proposed clarifications that were consistent with specific language agreed by CFE in prior deals.

Construction contracts: The main components of the power plant were constructed pursuant to an onshore construction contract with Mitsubishi Heavy Industries and an offshore engineering, procurement and supply contract (EPS) with Mitsubishi Corporation. Given Mitsubishi's successful track record of building combined-cycle natural gas-fired power projects and its majority ownership of the Project, Mitsubishi's involvement is a significant risk mitigant for the Project's lenders.

Project operation and maintenance: Operation and maintenance of the plant is contracted to NAES Mexico, S. de R.L. de C.V. pursuant to a six-year O&M Contract (O&M). The obligations of the operator under the O&M are guaranteed by the operator's parent company North America Energy Services Company.

Sponsor support: The Sponsors provided a limited support package that included the following customary elements: each of Mitsubishi and Kyuden committed, on a several basis in proportion to its ownership interest in the Project, to fund base shareholder contributions up to an aggregate amount equal to approximately 30% of $300 million projected project costs, to provide a letter of credit to back-stop its required base equity contributions, to fund the debt service reserve account in an aggregate amount equal to six months of debt service, to provide funds (in addition to those available under a committed loan facility) to the extent necessary for the payment by the Project Company of any required Mexican value-added taxes, and to obtain, maintain and replenish the letters of credit required by CFE as security for the Project Company's performance under the PPA.

Financing Overview

JBIC facility loan agreement: Approximately 42% of the $300 million projected project costs are to be funded under the overseas investment credit program of the Japan Bank for International Cooperation (JBIC) pursuant to a JBIC Facility Loan Agreement, under which JBIC is committed to provide $126 million in direct loans, subject to the satisfaction of customary conditions precedent. The JBIC loans bear interest at a fixed rate, interest and principal amortization payments are required semi-annually, and final repayment of the JBIC Facility Loans is scheduled to occur on 15 June 2020, thus providing a maximum repayment period of 14 years. Mizuho Corporate Bank Ltd. is acting as JBIC Agent.

Commercial Bank Facility Loan agreement: Approximately 28% of the $300 million projected project costs are to be funded by the Commercial Bank Lenders pursuant to a Senior Credit Facility, under which the Commercial Lenders are committed to provide $84 million in direct loans, subject to the satisfaction of customary conditions precedent. The Commercial Facility Bank Loans bear interest at Libor plus an agreed margin (which varies over the life of the loan), interest and principal amortization payments are required semi-annually, and final repayment of the Commercial Bank Facility Loans is scheduled to occur on 15 June 2020, thus providing a maximum repayment period of 14 years. Mizuho Corporate Bank, Ltd. is the Lead Arranger and Administrative Agent for the Commercial Bank Lenders, and is the Technical Agent, Insurance Agent and Modeling Bank for all of the project lenders, itself committing to provide $30 million in project loans. Other lenders The Bank of Tokyo-Mitsubishi and Standard Chartered Bank also committed to provide project loans in the amounts of $30 million and $24 million, respectively.

JBIC political risk guarantee: 97.5% of the Commercial Bank Loans under the Commercial Bank Facility Loan Agreement are covered by a political risk guarantee from JBIC. JBIC's guarantee is a highly effective means of mitigating most of the perceived Mexico risks, ensuring that the due diligence process with respect to the CFE and its obligations under the PPA and FSA did not derail the Sponsors' proposed accelerated time schedule for putting in place committed loan facilities.

Common Terms and Security Agreement: The project loans from JBIC and the Commercial Bank Lenders are subject to identical representations and warranties, information reporting requirements, covenants, prepayments, insurance repair and rebuild provisions, dividend restrictions, project completion conditions, events of default and other documentary requirements pursuant to a Common Terms and Security Agreement (CTSA). The CTSA also contains standard pro visions providing for the grant of a New York law security interest on behalf of the project lenders in all of FET's rights under the project agreements, project permits and other governmental approvals, inventory, equipment, bank accounts, accounts receivable, project equity and inter-company indebtedness, and the proceeds thereof, except to the extent that such collateral is located in Mexico and otherwise subjected to a security interest in favor of the project lenders pursuant to the Mexico Security Package. The CTSA contains customary provisions regulating the cash flows of the Project and directing proceeds through a waterfall of accounts prior to allowing the Project Company to pay dividends to its equity owners.

Mexico security package: EST granted the project lenders Mexico law security interests pursuant to various agreements covering all of its assets and properties in Mexico, and the Members granted a lien over their equity interests in EST.

Other lender parties: Bank of Tokyo Mitsubishi Trust Company is acting as Collateral Trustee and Account Holder for the project lenders, and Banamex is acting as Onshore Collateral Agent with respect to the Mexico Security package.

Closing the Financing in Record Time

It is not uncommon for sponsors to announce to their lenders at the outset of a project financing that the financing is "required" to close within a ridiculously short time frame, insisting that the parties commit to a time schedule for the completion of the lenders' due diligence, finalization of the term sheet, distributions of drafts of documents, meetings and, ultimately, closing and first disbursement of the loans that is unrealistically aggressive or already obsolete as it is being proposed. Particularly if the sponsors themselves do not comply with their own deadlines or if they balk at agreeing to customary financing terms, this can lead to a credibility gap, and none of the parties feel compelled to adhere to any schedule. This scheduling dynamic can be further complicated when lenders, eager to keep their optimistic borrowing customers satisfied, do not even attempt to set an achievable schedule at the outset or point out obvious flaws or unrealistic assumptions in the sponsors' schedules. The result in such a case can be disappointed sponsors, defensive lenders, and finger pointing on all sides as to the actual cause of the delay.

At the outset of the financing, the Tuxpan V sponsors had a very specific goal in mind: to execute the financing documents on or prior to the date that the notice to proceed would be issued to the EPC Contractor, which was scheduled to take place a little over four months after approval by the sponsors of the engagement of the lenders' legal advisors. This meant that due diligence, developing the appropriate deal terms and documenting the transaction to the satisfaction of all parties in such a short time would be a challenge.

For a variety of reasons, the project participants were able to meet the challenge, the financing documents were executed on 19 July and the Sponsors expect to meet the conditions to the first disbursement of the loans by the middle to end of September.

First and foremost, the Tuxpan II Project financing, which involved the same sponsors and lenders, provided an ideal template for the project agreements and financing documentation, and most of the theoretical or philosophical issues embedded in basic provisions had been previously brokered. Accordingly, lengthy discussions over fundamental issues, which have slowed the pace of negotiations in other project financings, did not need to take place.

Additionally, the sponsors and lenders engaged counsel and other advisors who had recently represented and advised them on recent Mexico power projects, ensuring extensive familiarity with CFE's practices and policies, hot button items for their own clients, and customary forms of project and financing documents in Mexico. The firms selected as counsel to the principal parties assigned energetic, experienced individuals to the team, who understood implicitly that cordial working relationships and realistic compromises would be necessary for the parties. Legal counsel to the sponsors was Paul Hastings Janofsky and Walker and to the lead arranger was Shearman & Sterling. Morrison & Foerster advised JBIC. Due diligence review of the PPA, FSA and EPC Contracts, which itself can take several weeks, was assigned as the primary scope for JBIC's legal counsel, and accomplished within a little over one week. Drafting of the Term Sheet and main Financing Agreements took place contemporaneously with the due diligence process, and was assigned to Mizuho's legal counsel. This double track process proved to be a very effective means to shorten the time frames necessary to document the transaction.

The Sponsors were able to achieve their goals by being highly responsive to lender concerns. For example, due to the Sponsors' choice of site, which was different than the project site originally preferred by CFE, certain contractual protections were not offered under the PPA with respect to risks associated with the site, such as schedule relief for delays associated with any inability of the project to obtain the necessary rights of way to construct and operate the project. In order to address the Lenders' concerns with respect to the risk of delay, the Sponsors agreed to obtain substantially all of the necessary rights of way as a condition precedent to the first disbursement of the loans.

Ultimately, the fast-track signing of the Tuxpan V Project proves that project financing need not be a protracted and painful process for all participants. With focused sponsors, motivated lenders, experienced counsel, and cooperative parties who have worked together on previous transactions, project deals can be churned out at a quick enough pace to keep the lights on in Mexico.