Iceland Submarine Cable - Fuqua School of Business



The Icelandic Submarine Cable

In January 2001, after several years of deliberation and debate, the Icelandic government had finally decided to pursue the Icelandic Submarine Cable Project (ISCP). This project proposed to export 25% of the country’s electricity generation potential to the European continent. In order to undertake this €6.3 billion project - which represented over 80% of the annual GDP of the entire nation - the prime minister of Iceland and the president of the state-owned energy company, Landsvirkjun, first needed to arrange the project’s financing.

The Icelandic government put together a financial plan so that they could pitch the idea to an investment bank that could help identify potential investors in the project. Their greatest concern involved identifying a lead equity investor who could lure additional equity capital while improving the possibility of issuing an investment-grade bond for the debt on this monumental construction endeavor. The magnitude of the project was such that it would take at least five years to complete the initial stages of construction. Arranging a financial structure that was attractive to each investor involved was necessary if the Icelanders were to realize their dream.

The Republic of Iceland

ICELAND IS A VOLCANIC ISLAND LOCATED IN THE NORTH ATLANTIC OCEAN, LYING APPROXIMATELY 2,600 MILES NORTHEAST OF NEW YORK AND 500 MILES NORTHWEST OF SCOTLAND, JUST SOUTH OF THE ARCTIC CIRCLE. MOST OF ICELAND’S LAND IS UNINHABITED (NEARLY 99%) AS IT CONSISTS LARGELY OF LAKES, RIVERS, GLACIERS AND A MOUNTAINOUS LAVA DESERT.

Although the country is a member of the North Atlantic Treaty Organization (NATO), it was the only member without its own military. Since 1951, Iceland had been protected by the Icelandic Defense Force, which was controlled by the United States Military.

Iceland’s population of 285,000 was growing at an annual rate of 1.1%, with a 99.9% literacy rate and less than 2.0% unemployment[i]. The Icelandic Gross Domestic Product (GDP) for 2000 was estimated at only $8.6 billion with forecasted annual growth of 1.6% in 2001.[ii] Recent historic inflation had averaged 3.1% (for additional macroeconomic data see Exhibit 1A). Annually, Iceland maintained no national budget deficit, but its annual trade deficit was $600 million. Although Iceland’s recent €200 million bond issue received a rating of A+, Standard and Poor’s (S&P) continued to be concerned with a

Duke MBA candidates Tom Cowhey, David Helgerson, Jason LaRose, Paul Timm and Bill Wiseman prepared this case under the supervision of Professor Campbell R. Harvey as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

Copyright ( 2001 Duke University, Fuqua School of Business.

“still-high external debt burden and weak external liquidity” which “compare unfavorably with single-‘A’ and double ‘A’ rated countries.” S&P continued to say that “these levels may prove challenging if there is a sudden shift in confidence in the banking system, or if the current account deficit is not reduced.”[iii] (also see Exhibit 1B).

Over 70% of Iceland’s exports were marine products, however, there had been a recent push to diversify the country’s exports and reduce their dependence on the marine and fishing industries. Of note, the aluminum smelting industry was growing rapidly within Iceland, primarily to take advantage of the island’s excess electricity capacity (see Exhibit 2 on Iceland Electricity Sales). To bring this power-intensive industry to its shores, the Icelandic government had avoided granting exceptions to its 30% corporate tax rate[iv], but it did construct a $1 billion power station. This facility was selling electricity to the U.S.-owned aluminum smelters at $.02/kWh, slightly above its variable cost. At the time, fossil fuels made up less than .1% of Iceland’s energy consumption, and no nuclear power was in use. But, the country still produced more than 400 million excess kilowatt hours (kWh) annually.[v]

Iceland’s unique position straddling the Mid-Atlantic Ridge and its low population density (approximately 2.8 people per km2) provided the country a unique economic opportunity. Although Landsvirkjun, the national power company, controlled all 7 terawatt hours (TWh)[vi] of annual electricity generation within Iceland, this represented only 17% of the total renewable energy potential within the country[vii]. It was estimated that at least another 35 TWh remained to be tapped annually from Iceland’s geothermal and hydroelectric energy reserves (see Exhibit 3). It was a portion of this untapped potential that the ISCP wished to capture and send to the green-energy hungry European Union.

Geothermal and Hydroelectric Energy

GEOTHERMAL ENERGY IS HEAT DERIVED FROM THE ROCK AND FLUID THAT FLOW WITHIN THE EARTH’S CRUST AND KEEP THE PLANET FROM COOLING. THE THERMAL ENERGY FROM THE ROCK IS USED TO HEAT WATER TO TEMPERATURES BETWEEN 100(F AND 300(F EITHER DIRECTLY OR THROUGH THE USE OF PUMPS.[viii] THE STEAM FROM THE WATER IS THEN USED TO GENERATE ELECTRICITY (SEE SECTION ON HARNESSING ICELAND’S RENEWABLE ENERGY FOR ELECTRICITY GENERATION FOR MORE INFORMATION ON GEOTHERMAL PLANTS). HYDROELECTRIC POWER IS GENERATED WITH THE USE OF LARGE TURBINES. THESE TURBINES SPIN AS MOVING WATER PASSES THROUGH THEM; THIS SPINNING MOTION IS THEN USED TO GENERATE ELECTRICITY. (A BREAKDOWN OF WORLD ENERGY PRODUCTION AND CONSUMPTION FROM RENEWABLE SOURCES IS INCLUDED IN EXHIBIT 4).

Historically, it had been difficult to convince energy companies (who often own the fossil fuel raw material resources) to invest in geothermal or hydroelectric plants instead of fossil-fired plants (see Exhibit 5 on world electricity generation). Accordingly, very little of the earth’s geothermal and hydroelectric energy potential had been harnessed. However, the importance of these environmentally friendly energy sources continued to grow along with the awareness that burning fossil fuels was releasing alarming amounts of harmful CO2 emissions into the earth’s atmosphere. (The potential renewable energy from hydroelectric and geothermal sources is listed country by country in Exhibit 6).

Iceland’s Natural Environment

HYDROPOWER DEVELOPMENTS, SPECIFICALLY WITHIN ICELAND, COULD HAVE VARIOUS ENVIRONMENTAL IMPACTS, MOST NOTABLY TIED TO THE CONSTRUCTION OF THE RESERVOIRS NEEDED FOR WATER STORAGE FROM ONE SEASON TO ANOTHER.[ix] RESERVOIRS OFTEN COVER VEGETATED AREAS, WHICH COULD REDUCE VALUABLE GRAZING LAND FOR SHEEP WHILE ALSO VISUALLY IMPACTING THE LAND. OTHER FORMS OF IMPACT INVOLVED REDUCED FLOW OF WATERFALLS, AND PROBLEMS WITH SEDIMENT TRANSPORT IN GLACIAL RIVERS, AFFECTING WATER CONDITIONS FOR FRESH-WATER FISHING.

In addition, geothermal energy developments within Iceland could negatively impact the natural environment. First, geothermal power plants could (depending on the quality of the resource) marginally increase air pollution, although their impact was significantly less than fossil fuel plants. (For example, some countries with lower quality geothermal reserves such as Italy, experienced problems with mercury gases and sulfurous odors in the areas surrounding the power plants. These problems stalled the development of further Italian geothermal generation.) Second, tapping into geothermal reserves may lead to a drying up of natural hot springs. Finally, the high-temperature fields could cause air pollution themselves by increasing H2S emissions from the fields.[x]

The Icelandic Ministry for the Environment in Reykjavik formulated the country’s national environmental strategy to include the following top three objectives[xi]:

1. Reduce local pollution, waste generation and pollution of the atmosphere

2. Complete improvements in waste management

3. Attain sustainable use of natural resources

To drive home the point of these objectives, many citizens rallied against the government’s recent decision to bring aluminum smelters to Iceland because of associated increases in local pollution and use of the country’s natural power reserves by foreign-owned companies.

On the same note, the World Wildlife Foundation’s Arctic Program included a plan to escalate its campaign to establish a protective national park in a region in Iceland that included some geothermal activity. The Ministry of the Environment was scheduled to hear their case in March of 2001 and vote on the issue within three months.[xii]

Electricity in the European Union

THE EUROPEAN UNION (EU) WAS FORMED IN 1993 TO PROMOTE THE ECONOMIC AND POLITICAL INTEGRATION OF EUROPE. THE EU CONSISTED OF FIFTEEN MEMBER COUNTRIES: AUSTRIA, BELGIUM, DENMARK, FINLAND, FRANCE, GERMANY, GREECE, IRELAND, ITALY, LUXEMBOURG, NETHERLANDS, PORTUGAL, SPAIN, SWEDEN AND THE UNITED KINGDOM[xiii]. WITH THE EXCEPTION OF THE UNITED KINGDOM AND TEMPORARILY GREECE, THE EU ADOPTED THE EURO AS A SINGLE CURRENCY IN 1999.

The European Union played a significant role in its member’s domestic energy policies. These countries collectively deregulated their energy industry in 1999 under the 1996 EU “Directive on Electricity,” mandating that countries completely open up their markets to competition within two years. Many countries liberalized their electricity markets ahead of schedule, and there was an immediate and precipitous decrease in electricity prices as a result.[xiv] The domestic electricity generation capacity and usage figures for each of the member countries can be found in Exhibit 8.

On December 11, 1997, the Kyoto Protocol was introduced at a meeting of the United Nations in Japan. This protocol called for a 60% reduction in worldwide CO2 emissions by 2050 along with dramatic reductions in the use of nuclear power. The protocol was signed by all of the European Union member countries and its impact was already being felt on the energy market in early 2001. As a net importer of energy, the European Union consumed 16% of the world’s energy, yet produced just 8%. Heavily dependent on fossil fuels, EU member countries produced roughly 895 million metric tons of carbon dioxide in 1998.[xv] They had collectively agreed to lower their emissions by 25% before 2010[xvi].

The electricity sector was one where demand had been particularly constant, and was forecasted to grow at 1.7% a year. The EU was expecting a major shift in the breakdown of its electricity sources over the next 20 years due to its environmental policies. Throughout the entire EU, nuclear-sourced electricity was expected to drop from 33% of the market in 1997 to 25% of the market by 2020. Natural gas was expected to replace nuclear as the dominant fuel in the EU, accounting for 28% of fuel in 2020. Coal and oil, 24% and 8% of the Western European market, respectively, had been dropping in use since 1970. Electricity from coal was expected to drop from 24% to 16% by 2020.[xvii]

In accordance with the Kyoto Protocol, the European Union also agreed to increase its total energy contributions from renewable sources (wind, hydroelectric and geothermal) from 6% in 2000 to 14% by 2001. To achieve this goal within the electricity sector, the European Union would have to raise its share of renewable sources for electricity from 14% to 22% over the next 10 years.[xviii] For every terawatt of electricity generated from a renewable source instead of a fossil fuel, CO2 emissions in the union would decline by nearly 0.3 million metric tons. In addition to these fossil fuel concessions, the union members agreed to build no additional nuclear capacity.[xix]

To help drive its commitment to the Kyoto Protocol, the European Parliament discussed the implementation of an energy tax on all forms of non-renewable energy production including coal, lignite, peat, natural gas, mineral oils, ethyl and methyl alcohols. The tax would also likely apply to nuclear energy as well to provide incentive for member countries to accelerate the process of reducing their reliance on nuclear energy sources.[xx]

The Submarine Cable Project

IN LIGHT OF THESE TRENDS IN THE EUROPEAN UNION, MEMBERS OF THE ISCP WERE CONVINCED THAT THE TIMING WAS RIGHT TO BUILD THEIR LONG RESEARCHED CABLE. COMPLETION OF THE PROPOSED ENERGY EXPORT PROJECT INVOLVED THREE MAIN COMPONENTS: BUILDING POWER CAPACITY IN ICELAND, DETERMINING A EUROPEAN ENDPOINT FOR THE CABLE, AND LAYING THE CABLE ALONG THE OCEAN FLOOR FROM ICELAND TO THE EUROPEAN CONTINENT.

At the time, Landsvirkjun was generating 7 TWh of electricity per year in Iceland, which represented nearly all of its installed capacity. The proposed submarine cable project would involve harnessing 10 TWh annually to export, and would require the construction of additional power facilities. It was anticipated that these facilities could be constructed at a cost of approximately €1,900 million. In addition, new infrastructure would need to be built to harness this energy and transport it to the cable endpoint within Iceland, which would cost an additional €236 million.

The closest (and most cost effective) endpoint for the cable was in the United Kingdom, but the Icelandic government was unsure if this was the best location for the cable since the U.K. was a net exporter of energy. Therefore, power shipped to the U.K. would have to be passed on through the European power grid to other countries with greater demands for electricity. While the E.U had recently begun initiatives to connect all of the member state power grids (See Exhibit 10 for data on the status of the E.U. power grid), the ISCP members preferred to ship their power to a country that already had demand for their electricity. While a cable to Norway was another possibility, but since the country was not a member of the European Union, the ISCP members were hesitant to consider a Scandinavian endpoint. Therefore, the next, most logical choice for the cable endpoint was Germany. The recent historic electricity prices for Germany and a recent cross-section of European energy prices are provided in Exhibit 11 and Exhibit 12, respectively.

The Icelandic government had already discussed the project with Pirelli, the worldwide leader in cable and rubber production. Pirelli had both the capacity to build the cable and expertise in laying subterrain and submarine power cables. They estimated the costs of producing and laying the cable to Germany at €3,500 million.

In order to determine the feasibility of selling green energy to Europe, in 1993 Landsvirkjun conducted a study with Pirelli, Wattenfall Engineering AB of Sweden, and the US ABB Transmission Technology Institute. The study determined that it would be technically feasible to harness a portion of Iceland’s untapped energy resources and transport electricity via a submarine cable to Europe. More recent studies by Scottish Hydro Electric plc and the Icenet Gruppe (comprised of several European energy companies) also confirmed the project’s feasibility. Total construction would take approximately 10 years (with the first power transport feasible in year 5), and would involve three major developmental blocks:

• Harnessing up to an additional 20% of Iceland’s power reserves and building transmission lines to transport this electricity to a coastal site,

• Laying a submarine cable from the Icelandic coast to a site in the UK or mainland Europe, and,

• Building converter stations at the cable destination.

Landsvirkjun had vast experience in harnessing both hydro and geothermal power resources, and would lead development projects for generating electricity in Iceland. Pirelli Cable Systems would construct and lay the submarine cable. Depending on the terminus of the cable, a third party would oversee the development of converter stations (at an estimated additional cost of €375 million) and take on marketing responsibilities within the destination country.

A map detailing the expected cable route and estimated costs is contained in Exhibit 13. However, additional detail on each portion of the cable project is provided below.

Harnessing Iceland’s Renewable Energy. Development of geothermal power sources represents one methodology for harnessing green energy for electricity generation. Wells are drilled into the earth’s crust in locations where magma pockets rise near the surface. Water is run onto the magma pocket, generating steam, which in turn drives a turbine to generate electricity. A graphical depiction of this process can be found in Exhibit 14.

Geothermal electricity generation facilities have significant operating leverage. Investment is required for exploration, well drilling, plant installation, and creation of a steam field. The capital costs for geothermal generation are substantially larger on a per Megawatt basis than fossil fuel fired generating facilities. However, the lack of required input materials in geothermal facilities make them insensitive to volatile fossil fuel prices. Furthermore, the variable cost per kilowatt-hour produced at geothermal sites is nearly zero.

Other than the high capital cost, the only significant problem associated with geothermal electricity production is a sulfurous odor that emanates from the production facilities. Magma pockets contain substantial concentrations of hydrogen sulfide, a foul smelling chemical that the human nose can detect at the parts per billion level. Iceland was ideally suited for geothermal generation, as the country’s populace inhabited only 1% of its landmass.

Landsvirkjun conducted thorough studies of Iceland and had identified numerous sites that were well suited for geothermal electricity generation. The power company estimated that Iceland could harness over 20 Terawatt-hours of electricity per annum from geothermal sources. Exhibit 15 shows potential geothermal energy sites within Iceland. Over 30 geothermal sites would require harnessing in order to produce the 10 Terawatt-hours of power required to fill the capacity of the submarine cable. The electricity generated from these sites would need to be transported over land to the coastal site where the cable was installed. Cost estimates for geothermal electricity generation and transmission line construction can be found in Exhibit 16.

Landsvirkjun estimated that construction of 10 Terawatt-hours of geothermal generating capacity would take 10 years. The expected timing of capital expenditure can be found in Exhibit 18. Individual plants would come on-line at a rate of 4 per year after an initial development period of 3 years. If construction of the submarine cable preceded completion of generation facilities, Landsvirkjun agreed to supply approximately 2 Terawatt-hours of power from its existing infrastructure at the wholesale price of electricity in Iceland. Wholesale electricity in Iceland had historically been sold at €1.50 to €2.00 per 100 kilowatt-hours and was not expected to change in the foreseeable future.

The Cable. The large-scale transmission of electricity from Iceland to Europe would require a massive submarine cable. This cable would be longer than any submarine cable in use at the time. Significant progress had been made in the manufacture and installation of such cables since the early 1990s, leading to reduced power losses and increased system up-times. The 1993 Pirelli study showed such a project to be technically feasible, but not without its challenges.

Long-haul electricity transmission systems had undergone significant technological development since the 1950s. The preferred technology to transfer large amounts of electricity over long distances was the high voltage direct current (HVDC) transmission system. HVDC was the preferred system as it was the most economically viable and provided for maximum flow control and flexibility. HVDC transmission systems were used on every continent in the world, save Antarctica.

The largest above ground HVDC system in the world was the Itaipu project in Brazil, which connected a massive hydropower generating plant to the Sao Paulo electricity grid (approximately 785 kilometers). The cable was rated at 6.3 Gigawatts, providing an annual power transfer capacity of over 50 Terawatt-hours. The most well-known submarine cable project connected the Swedish island of Gotland in the Baltic Sea to the city of Visby, some 70 kilometers away. This cable provided an annual power transfer capacity of 0.4 Terawatt-hours.[xxi]

In contrast, the Iceland project would transfer a maximum of 9.56 Terawatt-hours per year over a distance exceeding 1800 kilometers. The cable would reach depths of up to 1100 meters under the North Sea. No submarine cable of comparable length had ever been laid before. In their 1999 study, Pirelli recommended using two cables, each rated at 550MW, providing a total annual power transfer capacity of 9.56 Terawatt-hours per year. However, given the likelihood of intermittent failures, Pirelli estimated that the cable would have an operating time of 94%. Each cable would also incur transmission losses of approximately 48 Megawatts, bringing the maximum transferable power down to 8.2 Terawatt-hours per year.

Production and installation of one 550MW cable would take 4-6 years, with the second cable following in 6-10 years from project commencement. Times were dependent on Pirelli’s manufacturing capacity and weather conditions in the North Atlantic. The total cost for both cables was estimated at €3,506 million, spread evenly over the length of installation. Increased competition within the submarine cable industry made this figure unlikely to change over the next several years. Detailed technical and economic specifications for the Iceland-Europe submarine cables can be found in Exhibit 17.

Converter Stations. Deregulation of the European power industry led to the construction of several grid extensions that would link all of the EU countries together, allowing the easy transfer of energy between member nations. However, even with these additions to the current grid structure, converter stations were required at the termination of the cable in order to convert HVDC electricity into an alternating current form at the proper frequency of the European power grid. These converter stations would cost approximately €50 million per TWh of capacity to construct. In addition, their construction would involve a private European energy company willing to participate in the sale of Iceland’s renewable energy on the European continent. The energy would then be sold through an independent Transmission System Operator (TSO) to access the high voltage transmission grid; the TSO was required to provide third party access to the transport wires unless prevented by public service obligations.

Germany[xxii]

GERMANY HAD VERY LIMITED DOMESTIC ENERGY SOURCES AND WAS HEAVILY IMPORT-RELIANT TO MEET ITS TOTAL ENERGY NEEDS. THE GERMAN ELECTRICITY MARKET WAS THE LARGEST IN EUROPE, CONSUMING 488 BILLION KWH. DUE TO ITS HEAVY RELIANCE ON COAL (50%) AND NUCLEAR RESOURCES (31%), GERMANY HAD BEEN ABLE TO DOMESTICALLY GENERATE ENOUGH ELECTRICITY TO MEET ITS LOCAL DEMAND, ALTHOUGH THEIR DOMESTIC ELECTRICITY DEMAND HAD INCREASED AS DEREGULATION LOWERED LOCAL PRICES.[xxiii] HOWEVER, CHANCELLOR GERHARD SCHROEDER WAS A STAUNCH ADVOCATE OF ELIMINATING GERMANY’S NUCLEAR ENERGY PLANTS. AS A MEMBER OF THE MAJORITY GREEN PARTY, HE ORIGINALLY DECREED THAT ALL DOMESTIC NUCLEAR PLANTS (30% OF GERMAN ELECTRICITY[xxiv]) WOULD BE CLOSED BY 2005, ONLY TO RESCIND HIS POSITION IN THE WAKE OF POLITICAL BACKLASH. HIS COMPROMISE WAS TO ELIMINATE ALL NUCLEAR ENERGY PRODUCTION BY 2021,[xxv] WHICH STILL WOULD REQUIRE DRAMATIC INCREASES IN ENERGY PRODUCTION FROM NATURAL GAS AND RENEWABLE SOURCES.

Germany had been particularly active in promoting renewable energy. The German Feed Law of 1991 required utilities to accept all electricity generated by renewable energy, at somewhat discounted prices. In 1998, the Feed Law was modified to require utilities’ acceptance of just 5% of total electricity from renewable sources. Soon after, however, Chancellor Schroeder stated that Germany would reach their Kyoto Protocol emissions targets by levying “eco-taxes” to advance renewable energy projects. On April 1, 1999 the first phase of the tax was implemented on gasoline and electricity. The second phase, currently underway, would raise energy prices about 10% over the next three years. Most analysts believed this tax was imminent given Germany’s existing 16% V.A.T. on energy consumption and the staggering 300% tax on gasoline. Although renewable energy was not initially exempt from the tax, the revenue generated by the tax would be used to fund and aid renewable energy programs.[xxvi] Germany had been a leading proponent of EU-mandated carbon emissions taxes, as well. Although previous attempts to mandate EU coal and natural gas excise taxes were narrowly defeated, they were still under consideration for the future.

Funding the Project

ICELAND’S BOND RATING WAS INVESTMENT GRADE IN 2001, BUT THE SHEAR SIZE OF THE SUBMARINE CABLE PROJECT MADE IT IMPOSSIBLE FOR THE GOVERNMENT TO CONSIDER FUNDING IT ALONE. IN ADDITION, THE GOVERNMENT WAS UNWILLING TO SOLELY TAKE ON ALL OF THE PROJECT RISKS KNOWING THAT SO MANY OF THE FACTORS INFLUENCING THEIR SUCCESS WERE COMPLETELY BEYOND THEIR CONTROL.

The Icelandic government knew that debt would be a very significant portion of this project since project finance often involved debt to capitalization ratios of 60-70%[xxvii]. Such a range of capital structures would still require between €1.95 billion and €2.60 billion in equity capital. In addition, an investment grade bond rating would require that the holding company meet a debt service coverage ration (DSCR) of 1.5 on average and no lower than 1.2 in stress cases.[xxviii]

Because the project involved three components, the power plants, the conversion stations, and the cable itself, sole ownership of any one piece would place an equity investor in a position to halt the export of power at any time. Therefore, the proposed deal structure involved the formation of an offshore holding company whose assets included all of the project’s components. The Icelandic government would be one stakeholder in the holding company and other equity investors would be solicited.

Beyond the possibility of raising equity capital from unrelated institutional investors, the Icelandic government felt that it should identify equity investors with a strategic tie to the submarine cable project. While no particular players had committed to the project, there were several that seemed to make the most sense.

Pirelli, a world leader in cable systems, was one potential investor whose expertise in laying subterrain and submarine cables could add value to the project. The Icenet Gruppe, a European energy syndicate, could provide capital as well as a termination site for the cable and conversion station. Regional power companies such as Hamburg Electricity Works AG (HEW) in Germany, Scottish Hydro-Electric plc, and the National Power Company of Norway were other entities that had been invested in project studies thus far. Finally, a global energy company whose portfolio included little or no renewable energy production might look to invest in a project that could provide it with positive environmental publicity and expertise for future renewable energy projects.

In addition to the organizations above, the ISCP team was evaluating whether they would be eligible for European Investment Bank (EIB) funding. The EIB was the European Union’s long term lending institution, and has helped finance numerous large multi-million and billion dollar European infrastructure projects in the past month in areas such as water management, air traffic control, and electricity networks. Projects in the past have received up to 50% of investment costs, but this was just one option the Icelanders were considering.[xxix]

The Decision

IN ORDER TO PITCH THE SUBMARINE CABLE PROJECT TO A POTENTIAL LEAD INVESTOR, THE ICELANDIC GOVERNMENT HAD TO EVALUATE THIS PROJECT FROM THE OTHER SIDE OF THE TABLE. ALTHOUGH THERE COULD BE HIDDEN STRATEGIC VALUE IN THEIR PROJECT, THEY UNDERSTOOD THAT ANY LEAD INVESTOR WOULD REQUIRE A FAIR RETURN ON ITS EQUITY.

So, could this project generate enough revenue to entice a large investor large who could handle the size of such an equity investment? Could enough of the risks involved be managed or mitigated to make this investment attractive? How much equity capital would be required to obtain an investment grade rating for the project debt? And what other issues would be key factors in the value of their project? These questions danced in their heads as they thought about pitching their pipeline dream.

Exhibit Index

1. ICELAND ECONOMIC DATA (A) AND ICELAND RATINGS AGENCY DATA, 1989-PRESENT (B)

2. Iceland Electricity Sales, 1950-2002E

3. Iceland Electrical Power Usage and Reserves

4. Energy Production and Consumption from Renewable Sources (1000 Metric TOE)

5. World Electricity Generation, 1970-2020E

6. Selected Installed Geothermal Electricity Generation Capacity

7. Gaseous Emissions from Electricity Production

8. European Energy Demand and Consumption, 1998

9. Variable Cost Comparison of Electricity Generation Facilities

10. European Union Power Grid and Proposed Electrical Infrastructure Projects

11. German Industrial Electrical Prices (10MW), bi-annual, 1990-2000

12. Cross Section of Selected European Industrial Electrical Prices (10MW), July 2000

13. Proposed Submarine Cable Route and Summary Construction Cost Data

14. Fundamentals of Extracting Geothermal Energy and Plant Diagram

15. Hydroelectric and Geothermal Sites in Iceland

16. Estimated Cost of Geothermal Energy Production

17. Technical and Economic Specifications for the Submarine Cables

18. Income Statement and Summary Cash Flows for Proposed Icelandic Submarine Cable Project

19. Comparable European Integrated Electric Utility Firms

20. Corporate Bond Yields and Rating Comparisons

Exhibit 1A – Iceland Economic Data

Source: National Economic Institute, Iceland

1) Estimate.

2) Forecast, December 2000.

3) Labour Force Survey.

4) 16-24 years.

Exhibit 1B – Iceland Ratings Agency Data, 1989-Present

Source: Standard & Poor’s Ratings Agency.

On February 23, 2000, Standard & Poor’s assigned its “A+” long-term rating to the Republic of Iceland’s seven-year €200 million bond.

Exhibit 2 – Iceland Electricity Sales, 1950-2002E

Source: Invest in Iceland Agency

Exhibit 3 – Iceland Power Usage, including Geothermal and Hydrogen Reserves

Source: Invest in Iceland Agency, February 2000

Exhibit 4 – Energy Production and Consumption from Renewable Sources (1000 Metric TOE)

Source: International Energy Agency, Organization for Economic Cooperation and Development.

Exhibit 5 – World Electricity Generation, 1970–2020E

[pic]

Source: International Energy Agency

Exhibit 6 – Selected Installed Geothermal Electricity Generation Capacity

Source: World Energy Council.

Exhibit 7 – Gaseous Emissions from Electricity Production

Source: World Energy Council; "Survey of Energy Resources - Geothermal Energy Commentary"

Exhibit 8 – European Energy Demand and Consumption, 1998 (Quadrillion Btu)

[pic]

Source: Energy Information Administration[xxx]

Exhibit 9 – Variable Cost Comparison of Electricity Generation Facilities

Source: The World Bank Group

Exhibit 10 – European Union Power Grid and Proposed Electrical Infrastructure Projects

[pic]

Source: European Commission – Directorate-Generale For Energy (DG XVII)

Exhibit 11A – Recent Historic Electricity Prices in Germany (Euros / 100KWh)

Source: Eurostat.[xxxi]

Exhibit 11B – Recent Historic Electricity Prices in Germany (Euros / 100KWh), 1990-2000

Source: Eurostat.

Exhibit 12 – Cross Section of Selected European Industrial Electrical Prices (10MW), July 2000

Source: Eurostat.

Exhibit 13A – Proposed Submarine Cable Route and Summary Construction Cost Data

Exhibit 13B – Macroeconomic Statistics for the Faroe Islands

• Population 45,296

• 90% of GDP comes from fishing industry

• Self-governing division of the Kingdom of Denmark since 1948

• GDP per capita - $16,000

• Fish and fish products account for 92% of exports

• Territorial Sea – 3 nautical miles

• Exclusive Fishing Zone – 200 nautical miles

• External Debt - $767 million

Source: CIA World Factbook, Faroe Islands, cia/publications/factbook/geos/fo.html

Exhibit 14A – Fundamentals of Extracting Geothermal Energy

[pic]

Source: Princeton University Press.

Exhibit 14B – Geothermal Plant Diagram

[pic]

Source: Sustainable Development Information Service.

Exhibit 15A – Estimated Harnessable Hydro Power in Iceland

Source: Landsvirkjun, Iceland National Power Company

Exhibit 15B – Estimated Geothermal Resources in Iceland

Source: Invest in Iceland Agency

Exhibit 16 – Estimated Cost of Geothermal Energy Production

Source: The World Bank Group.

Exhibit 17 – Technical and Economic Specifications for the Submarine Cables

Source: Submarine Cable From Iceland: Export of Electricity to Europe; Iceland Ministry of Industry and Commerce

Exhibit 18 – Projected Income Statement & Summary Cash Flows

Exhibit 18 – Projected Income Statement & Summary Cash Flows (Continued)

Exhibit 19 – Comparable European Integrated Electric Utility Firms

Source: Bloomberg.

Note: Equity Betas represent “Adjusted Equity Betas” using BE500 as Relative Index over 4 years.

Firms selected as comparables were European vertically integrated electric utilities, with divisions ranging from raw material extraction and electricity generation to distribution of power.

Exhibit 20 – Corporate Bond Yields and Rating Comparisons[xxxii]

Endnotes

-----------------------

[i] National Economic Statistics, Iceland, January 2001.

[ii] Ibid

[iii] Standard & Poor’s Ratings Services, March 6, 2000.

[iv] Iceland Internal Revenue Directorate: rsk.is/skattyfirvold/annad/income.asp.

[v] CIA World Fact Book:

[vi] One terawatt hour = 1,000 megawatt hours = 1,000,000 kilowatt hours = 1,000,000,000 watt hours

[vii] Landsvirkjun: lv.is/lv.nsf/pages/power_potential-ens.html.

[viii] The Geothermal Resources Council: whatgeo.html.

[ix] Iceland Ministry of Industry and Commerce: .

[x] Landsvirkjun: lv.is/lv.nsf/pages/power_potential-ens.html.

[xi] Iceland Ministry for the Environment: wdces/ic93_721.html.

[xii] World Wildlife Foundation Arctic Program: ngo.grida.no/wwfap/iceland.html

[xiii] European Union:

[xiv] “Opening Up to Choice: The Single Electricity Market,” European Commission, January 1, 1999.

[xv] International Energy Agency, Regional Indicators: The European Union, August 2000:

[xvi] The Kyoto Protocol: kyotoprotocol.de

[xvii] US Department of Energy, Energy Information Administration, “International Energy Outlook 2000.”

[xviii] “Recent Progress with Building the Internal Electricity Market,” Communication from the Commission to the Council and the European Parliament, Commission of the European Communities, May 16, 2000.

[xix] The Kyoto Protocol: kyotoprotocol.de

[xx] The European Union:

[xxi] Rudervall, R., J.P. Charpentier, and Raghuveer Sharma. ”High Voltage Direct Current Transmission Systems Technology Review Paper” ABB Power Systems, 2000.

[xxii] For the previous ten years, German inflation had averaged 2.3%. Source: Eurostat

[xxiii] The Energy Information Administration of the U.S. Department of Energy eia.cabs/germany2/html.

[xxiv] Ibid

[xxv] Ibid

[xxvi] Ibid

[xxvii] Esty, Ben, Journal of Applied Corporate Finance, Volume 12, No. 3; October 1998.

[xxviii] Standard and Poor’s

[xxix] The European Investment Bank: web site

[xxx] U.S. Department of Energy, Energy Information Association, eia.

[xxxi] It should be noted that in slightly more mature deregulated market, such as the California electricity market, the standard deviation of annual price changes was approximately 5.3% between 1998-1999. Source: California Power Exchange.

[xxxii] The estimated U.S equity risk premium at the time of the case was 7.5%

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