Latin America: How Big an Opportunity For Renewables?
The past two years have seen an explosion of activity in Latin America. A panel talked at the Chadbourne global energy and finance conference in June about whether the best opportunities are now south of the US border and the challenges of developing and financing projects in the region. The panelists are José Galindez, president of Spanish solar developer Solarpack, Michael Allison, managing director of Macquarie Capital Advisors, Morgan Landy, a senior manager with the International Finance Corporation, and Jared Brenner, executive director, Global Energy Group-Latin America with WestLB. The moderator is Rohit Chaudhry from the Chadbourne Washington office.
MR. CHAUDHRY: Jose Galindez, what are the key differences when you develop a project in the United States versus in Latin America?
MR. GALINDEZ: In the Un ited States, and also in Europe, political stability and discipline are taken for granted. When choosing where in South America to be active, you must choose a country that you expect to be stable for a while. The second difference is the currency. Power sector assets depreciate over very long periods. Make sure that the assets are denominated in hard currencies or in currencies that can stand long-term financing in local currencies.
MR. ALLISON: Securing title to land is more complicated than in the United States because land is often owned by the community. This is true in Mexico, for example. Security is another difference. When we were negotiating a construction contract for a wind farm in Mexico, we spent a lot of time talking about physical access versus legal access to the site. It is a small but important point. Another difference is resource differentiation. There is a lot less differentiation from one available site to the next today in the US market than there was five years ago. This is not true in Latin America.
MR. CHAUDHRY: Michael Allison, what makes a market attractive to you? Jose Galindez mentioned political stability. What do you look for before diving into Mexico, for instance, or even more broadly into other countries in Latin America?
MR. ALLISON: Growth prospects are important. We do not want to go to an area, especially outside our home base, and do just one deal. We want to have the opportunity to do multiple transactions. A stable regulatory regime is important. How do we get our money out after we have invested? There must be a clear exit strategy. It is also important for whomever we are backing to have a local presence. Renewables are international in that capital and equipment comes from all over the world, but it is important that the developer have local roots. It is very hard to do fly-in and fly-out development. At Macquarie, we need a local office and people on the ground before we will feel comfortable investing capital.
MR. CHAUDHRY: Jose Galindez, you are doing projects in Chile and Peru. What makes those markets attractive and are there other countries in Latin America that you find as attractive?
MR. GALINDEZ: We started in Chile three years ago, and I think at the time, we were the only large developer doing solar there. Besides the reasons that I already mentioned — a stable politcal system and convertible currency — Chile has perhaps the best solar resources in the world. Electricity prices are high enough in areas where there is a high consumption of electricity, like the north where the mining industry is located, to make solar energy economic. All of these factors make it a very attractive market, although the size of the market is not large. We have to take into consideration the sizes of the markets we are talking about: Chile and Peru are much smaller opportunities than Brazil and Mexico.
MR. CHAUDHRY: Mike Allison touched upon this in his earlier response when he talked about Mexico. What are the toughest issues you face in trying to develop projects in Chile and Peru?
MR. GALINDEZ: The issues are not very different from the ones we have faced in Spain or we are still facing in France. You have to deal in some cases with land that is government owned. It is time consuming to get permission to use it. Interconnection is maybe the largest developing nightmare all over the world. Those are the two main challenges. When it comes to getting a power contract, Peru and Chile are different. Chile is driven by the private sector. The government tries to intervene as little as possible, and the market is responding to a very light policy of encouraging renewable energy. Peru is more state-driven, so you get a power contract, if at all, in a government auction.
MR. CHAUDHRY: Morgan Landy, the International Finance Corporation has financed projects all over Latin America. What are the toughest issues you see as a lender when trying to finance these projects?
MR. LANDY: Our goal as a member of the World Bank Group is to support the energy sector in these countries. We have to start by asking what alternatives each country has besides renewables. Each country has a different profile in terms of the history and politics. For example, in Mexico, which has some of the best wind resources in the world, the IFC has had done two transactions — a 250-megawatt plant and then a 67-megawatt plant — in the past two years. Each country has made a different policy decision whether and how to promote renewable energy. Mexico does not have a feed-in tariff, but because the wind is so strong, wind developers can compete effectively with the alternative sources of power. Chile has a fully deregulated market. The government has put in place a renewable energy purchase obligation for big utilities, so the utilities must buy, but a developer is not guaranteed a price.
It really comes down to resources first and then regulation. For example, wind is fantastic in Mexico, solar in Chile and hydro in Brazil. Once you confirm the existence of the resource, what is the role for the particular technology and what is the government support mechanism? We have heard a lot about the political aspects of investing in renewables in the United States; public policy support for renewables waxes and wanes. It is the same in every country. If you can’t figure out the politics around the regulations or the subsidy or the feed in tariff, you are really at risk. I agree that when doing business in a place like Latin America, Eastern Europe or any emerging market, you need to get close to the local players to make sure you are not making a mistake.
MR. BRENNER: I agree with Morgan Landy; the regulations vary considerably from one country to the next. However, in all of these countries, you have had a relatively stable regulatory regime for a number of years that has survived several changes of government. We take comfort from that, but we also recognize the risk of backtracking, as we have seen in Spain and Italy recently. I don’t see Latin America as any different from Europe or the United States in that respect.
MR. CHAUDHRY: Renewable energy projects are facing some significant headwinds in the United States. It is difficult to get a long-term power contract to sell the output. Do you see similar issues in Latin America?
MR. GALINDEZ: With the exception of Chile, all the rest of Latin America is driven by state auctions for PPAs. You have to wait until there is an international tender like the one last year in Peru. In Brazil, there was the first reverse auction in wind, and we are expecting one in solar sometime soon. There is
little opportunity, apart from Chile, to do a purely private
MR. ALLISON: Latin America is a relatively small and new market. Renewables are only a couple of years old in these countries. While electricity is sold for the most part through government tenders, the market is transparent. There are a number of creditworthy developers already on the ground in the region. The competition is high.
MR. CHAUDHRY: Morgan Landy, you have a good view of the entire region. Where are the opportunities for renewable energy developers?
MR. LANDY: A lot of the renewable energy development that we have seen in Latin America has been hydropower. Given the significant resource endowment, renewable energy has been a traditional source of power, but it is also an important part of the future. Whether it is large hydroelectric facilities in Columbia and Brazil or small hydro projects in Peru and Chile, we see a lot of opportunities for new investment there.
Moving beyond hydro, the next most active area we see is wind, where there are about 2,000 megawatts already installed in Latin America. The bulk of that is in Brazil and Mexico. Solar is just beginning to show some life. As Jose Galindez mentioned, his company is really a pioneer in getting solar projects done in Chile and Peru. In geothermal, we financed our first geothermal plant recently in Central America in Nicaragua. The west coast of Latin America sits atop a ring of fire; there are plentiful geothermal resources stretching from Chile all the way up through Central America, which is potentially a fantastic resource for the region.
In Brazil, there have been government auctions of power contracts. The auctions have attracted a huge amount of interest, but primarily from local investors. The financing is largely guaranteed by the Brazilian Development Bank and is long-term financing in local currency. From an investor perspective, if you take the financing risk off the table because the Brazilian Development Bank is there to finance all projects, then you are really just bidding on equity risk. Investors seem willing to take relatively low returns.
In Peru, the situation is different. You have cheap natural gas that is heavily subsidized by the government. The challenge for solar, wind and even hydro is how you compete with electricity generators who are using subsidized gas. The government set up auctions by technology, for example, by taking bids of 500 megawatts of hydro or 200 megawatts of wind or 60 megawatts of solar. The plan is to have a diversified mix of energy.
In Mexico, it is different again. The market is much more competitive. It is up to each bidder to come up with an offtake agreement. In the two deals we financed recently, the power contracts has terms of 20 to 25 years. One was in US dollars, and one was in pesos. The financing mirrored the power contracts. In offtake with Cemex, the big Mexican cement company, the offtake was in dollars and the financing was in dollars. We had to raise local currency funding to finance the peso power contract. A key part of the risk matrix for that project was not so much the cost of the funding, but can one get liquidity in long-term pesos.
The point is that the situation varies by country. The best thing a government can do is to run an auction and then take steps to reduce the risk profile.
MR. ALLISON: Seventy percent of electricity generation in Brazil is from hydro and is obviously inexpensive. Electricity prices run from $13 to $30 an megawatt hour. Having that proportion of your generation mix in a single fuel source is risky and has led to periodic blackouts There was a blackout earlier this year that affected 2.5 million people in São Paulo and drove prices to $340 a megawatt hour. When Brazil went out for tenders in 2009, the backup fuels to hydro were fuel oil and gas. Fuel oil power contracts were written at $390 a megawatt hour and gas at $94 a megawatt hour. The wind tender, in comparison, came in at $84 a megawatt hour. While there is no direct subsidy for these renewable technologies in these markets, they are certainly cost competitive when you think about them as an alternative fuel source.
MR. CHAUDHRY: Jose Galindez, what level of tariffs are you seeing in Peru and Chile?
Mr. GALINDEZ: Our power contract in Peru is public because it was awarded in an open auction. It was at $210 a megawatt hour in February last year. We expect prices in future power contracts will be lower because the cost of the equipment
The contracts in Chile are private. We are now building a 1-megawatt project for Codelco that has sparked an interest in solar among other mining companies and has led to some private company auctions in the northern part of Chile. We believe market prices for solar in northern Chile are in the low teens.
MR. CHAUDHRY: Do you have sense for where electricity prices are for wind?
MR. GALINDEZ: In Chile at least, the wind resource is less competitive than solar. The insolation levels in the northern part of Chile are 50% higher than in the central valley in California.
MR. CHAUDHRY: Mike Allison, what tariffs are you seeing in Mexico where Macquarie has a wind farm?
MR. ALLISON: I don’t want to “out” our power contract in public, but . . . .
MR. CHAUDHRY: The neighboring project — what is it being paid?
MR. ALLISON: Its contract is above $100 a megawatt hour. These are projects where the offtaker is buying power at a discount to the power that is available in the spot market. While the price seems high, there is a huge economic incentive for consumers of energy to buy this power.
MR. CHAUDHRY: You told me yesterday that there is no solar development in Mexico. Why is that?
MR. ALLISON: The cost of solar is too high. Solar developers are not in a position to offer electricity at a discount to the current market.
MR. CHAUDHRY: Let’s talk about resource studies, which are very important for renewable energy projects. What kind of resource data do you see in different jurisdictions in Latin America? Is it of a quality and of a duration that makes you comfortable to do projects there? What about solar resource data?
MR. GALINDEZ: We do not see much difference from what we have in other places. We always try to check the satellite database with local meteorological stations, although there are areas of Chile and Peru without many such local stations. We do not feel uncomfortable with the data we have or with our experience in translating satellite data into actual production.
MR. CHAUDHRY: And for wind?
MR. ALLISON: In wind, we can usually get good meteorological data of sufficient duration. However, the maps and long-term reference data are not as good quality as in the United States.
MR. CHAUDHRY: Jared Brenner, what resource data do lenders typically want when financing a project? What do you require when you do a wind or a solar project in Latin America?
MR. BRENNER: We look for a minimum of two to three years of on-site data and a longer period, if possible, of correlative data — especially for a wind farm. As was just mentioned, the correlative data is often lacking, so what we are sometimes forced to do is commence work on the basis of an exceptional resource report but require wind data collection to continue while we are working on the financing with the understanding that everything will be reevaluated prior to closing when there will be another six to nine months of additional data.
MR. CHAUDHRY: Morgan Landy, do lenders discount the data because the quality may not be as good as in other regions or do you give full credit for the data?
MR. LANDY: It works the same as in the United States. We hire an independent consultant to review the data. The lender’s best case is always based on a revised cropped number. As the valuations get higher and higher, and people realize the extent to which the quality of the data contributes to a higher valuation, I think greater effort will be put into maps and data collection in the region. A market will develop. Developers who do the proper homework can borrow a higher percentage of the project cost. Debt is cheaper capital than equity.
MR. CHAUDHRY: Do you see development agencies like the World Bank contributing toward the cost of resource mapping across countries in Latin American?
MR. LANDY: The IFC is a private part of the World Bank, and our job is to finance private investment either as a lender or equity investor in the developing world. We generally do not cover the costs of resource mapping, but our colleagues at the World Bank, which works with governments do provide this type of support. There are also other donor-type agencies that are helping governments do resource maps.
MR. CHAUDHRY: Let’s move onto the next topic: government support. The sense I am getting from this panel, based on initial comments, is that there really is not much need for government support for renewable enegy projects in Latin America. Jose Galindez, do you agree?
MR. GALINDEZ: It is very important in Chile to require that at least 5% of electricity come from renewable sources. Apart from Chile, I think we are still some years away from doing renewables without subsidies. The resource is so amazingly good, particularly for solar, all over South America, from Chile up to the north of Peru, that we are so close, but not yet without government support
MR. CHAUDHRY: Morgan Landy, you mentioned that your projects in Mexico were done without government support. How critical do you think government support is in different jurisdictions in Latin America?
MR. LANDY: Maybe I should restate. In the Mexican deals we closed, we did not have direct support from the government, but it was important to have a regulatory framework to allow the wind farms to connect directly to grid and to be able to draw backup power from the grid, if necessary. While we did not get direct financial support from the government, the enabling environment to make sure that wind could fit into the system and to give it a reasonable chance of getting a reasonable power contract was critical.
We see more and more interested pools of soft money and grants for clean energy in the emerging markets. There are important policy questions in the region: Who will pay for electricity from wind or solar if it costs more than electricity from coal or gas? Is it fair to put the burden of diversifying on the consumer? There are growing pools of money. We use some of it in Mexico — something called the Clean Technology Fund where we put in deeply-subordinated debt to help reduce the capital cost of projects, which helps make the projects more bankable and lowers the tariff that otherwise would have to be charged. We see more such money becoming available for solar.
MR. ALLISON: Mexico has a postage stamp-type rate for transmission where you pay the same price no matter how far the electricity is transported. If that goes away, then wind projects would be unlikely to offer their electricity at a discount to the CFE standard rates. The point is there is indirect government support that is critical to the projects.
MR. CHAUDHRY: Government support can be withdrawn as we have seen in Spain and Germany, even for projects that are already in operation. To what extent does this political risk factor into your analysis of doing projects in Latin America?
MR. BRENNER: It factors in, but we do not view Latin American countries any differently than any other country in terms of this risk. It is present everywhere in the world. What happened in Spain and Germany is that the programs were open ended and created bubbles. There was overdevelopment. The subsidy started to distort the market. In Latin America, we are still at the very beginning of the development of renewables. Take the project that we are working on in Peru with Solarpack as an example. The contract price for electricity is more than $200 a megawatt hour in a market with abundant electricity from hydro and gas that can be purchased at 25% of the solar contract price. The solar development underway currently is less than 1% of total system demand. It is too small to distort the market. It is not a burden. Cost might become a factor down the road, but at this point, we are pretty comfortable that government support will not be withdrawn.
MR. CHAUDHRY: Let’s move to financing of projects. Jared Brenner, you told me some time ago that no renewable enegy project in Latin America, and maybe even in any emerging market, had closed with purely commercial bank financing. Is that still true? Or have commercial banks, without agency support, now closed renewable projects in Latin America?
MR. BRENNER: There are at least two wind deals in Mexico that are being done without agency support. In the countries we have been talking about, it is largely a question of economics and what makes the most sense for the developer. The banks are not requiring some sort of quasi-political risk coverage to get comfortable.
MR. CHAUDHRY: Morgan Landy, in terms of the scale of the market, how many renewable energy deals have agencies closed in Latin America?
MR. LANDY: Latin American is really lagging behind other regions. For example, the United States has 40,000 megawatts of wind; Latin America has 2,000, and Asia has about 70,000, with China being a huge part of that.
There is some perceived regulatory risk. Organizations like IFC play a role to get the first deals done. Mexico is a good example where, one or two years ago, the IFC was involved with financing some of the first deals to help work out the regulatory issues, and now we see deals getting done without agency participation. We see our job as moving to the frontier and going to Peru or Central America or Colombia, where the next developments have to take place and the banks may be more nervous. That said, we see a fair amount of liquidity, even in what would be considered more exotic countries like Peru, which adopted the very well-developed regulatory regime in Chile with which the banks are comfortable.
MR. CHAUDHRY: Is it true that renewable energy projects are being financed on a merchant basis in Latin America?
MR. LANDY: In Latin America, IFC is financing between three and five renewable energy deals every year. Some of them are very small. Some are larger. They are project financings or corporate financings or even start-up equity investments in small, renewable developers in the region. In Chile, we financed a 50-megawatt merchant plant about two years ago. The project is selling its electricity on the spot market, so we did a lot of modeling of the market and we put on a very conservative debt-to-equity ratio, structured to protect the lenders against downside price risk, but it made sense for the equity, given the high prices currently in the market and the view that the government’s incentive program will remain in place. It is possible to do a merchant plant, although it is obviously not easy, and many of the commercial banks remain uneasy with merchant projects based on experiences elsewhere.
MR. CHAUDHRY: Jared Brenner, are merchant financings unique to Chile?
MR. BRENNER: We do not see a trend toward merchant financings in Latin America. The commercial banks still want to see at least 50% of the output contracted. There was a fair amount of risk in the Chilean project to which Morgan referred. I do not think our bank would have been comfortable with that level of risk. The bet the IFC made worked out very well given the drought in Chile, but if there had been more water, it might have been a tighter situation. Agency support was essential to get that project financed.
MR. CHAUDHRY: Where do you see the renewables markets in Latin America headed in the next five to 10 years?
MR. GALINDEZ: We will see an expansion in several key markets. Chile will grow to 13,000 megawatts, Peru maybe to 6,000 or 7,000 and other countries, like Brazil and Mexico, will reach a much larger scale. We will also see a bigger selection of investment-grade countries rather than speculative countries.
MR. LANDY: The opportunities are going to get bigger and bigger in Latin America for renewables. You have abundant resources in wind, solar and geothermal. The cost of equipment is declining. IFC is also investing in solar manufacturing facilities in Asia that hope to sell into Latin America. As equipment costs fall, renewables will become more and more attractive. The biggest risk to renewables, not only in Latin America but also in the United States, is shale gas. Potential investors in the sector are still thinking about how to hedge against that risk. But overall, I see opportunities and more investors and banks will start taking Latin America more seriously as governments open up opportunities.
MR. ALLISON: At a macro level, we see 5% to 10% annual GDP growth in the region. We see demand for electricity growing at about the same pace. Brazil is expected to need a 70% increase in generating capacity by 2019. With 65 million people in the region who do not have access to stable electricity at home, there is obviously opportunity in those markets.
MR. BRENNER: I agree. GDP and load growth in the region are outstripping growth in North America and Europe. Latin American governments are moving to integrate renewables into their systems on the basis of environmental benefits. As costs equalize, there will be even more such projects. ¥