Latin America: Natural Resources Deal Flow Picks Up

Latin America: Natural Resources Deal Flow Picks Up

November 29, 2012 | By Raquel Bierzwinsky in New York|Mexico City

Over the last 12 to 18 months, the market has seen a flurry of investments in the natural resources sector in Latin America and an increased interest among North American, European and Chinese investors.

For Mexico and Brazil, the region’s largest economies, while investment in the last 12 months does not match the numbers of the past few years, it continues to be very  solid. Both countries continue to have a tremendous need for infrastructure to tap into and develop their vast natural resources. The massive pre-salt offshore fields in Brazil (Tupi) and the most recent onshore findings in Mexico (Chicontepec) call for billions of dollars in investments and, while the oil sector is controlled in
both countries by state-owned agencies — Petroleos Brasileiros (Petrobras) and Petroleos Mexicanos (Pemex) — respectively, the supply of technology, equipment and services to develop such resources requires significant participation by private entities.

Brazil, Colombia, Chile, Mexico and Peru are attracting much needed investment in the development, construction and operation of energy facilities to supply their  growing economies, either through independent power producer schemes, through
the sale to large industrials or sales on the spot market where permitted. Large hydroelectric projects have been announced in each of these countries. Examples include Ituango in Colombia, HidroAysén in Chile and Cerro del Águila in Peru.

In the particular case of Colombia, foreign direct investment has been surging for the past several years as a direct result of the commodities boom that emerged following the stabilization of the security environment. In the last few years, many
local and regional players have focused on investing in natural resources, principally in the oil, gas and hydro sectors. 

Best Opportunities

The renewable energy sector and the oil and gas sectors are going through a period of resurgence in Latin America.

Countries like Mexico, Brazil, Peru and Chile are seeing significant interest and investment in wind, solar and hydro projects.

The reasons include the fact that certain regions in these countries enjoy some of the best resources in the world for these types of projects, as well as the fact that investment in renewable energy projects in Europe and the United States is drying up due to the economic constraints and the phasing out of governmental incentives.

For example, the state of Oaxaca in Mexico has an estimated wind potential of over 10,000 megawatts. The Istmo de Tehuantepec region in that state offers some particularly advantageous conditions for wind power projects, as the average wind speed in Oaxaca has been recorded above 9 m/s and the measured load factor is above 50%. These conditions compensate for insufficient government incentives for investors.

In Peru, the government has taken an active role in attracting investment in renewable energy projects. The renewable energy law enacted in May 2008 provides a framework for investment in and development of projects. The Ministry of Energy and Mines has been conducting international tenders for solar, wind and hydro projects. Renewable energy generating facilities, if connected to the national grid, are granted priority in the dispatch of electricity and they are offered fixed-rate, 20-year power supply agreements, for a specific output (with built-in annual tariff adjustment mechanisms). The development of large-scale hydro plants in Peru has also been a priority for the government. The Cerro del Águila 500-megawatt run-of-the-river hydroelectric plant in central Peru, is one of the recent examples of projects
under development.
Chile has also seen the development of several wind farms and, most recently, solar projects in the Atacama desert. The huge demand for electricity consumption by mining companies has allowed renewable energy developers to enter into longterm power purchase agreements. Hydro plants are also a significant element of Chile’s national energy plan. AES Gener, ENDESA and Hydro Quebec, among others, have been active in the development of these types of facilities. 

The gas sector is also enjoying a growth spurt in the region. With low gas prices in the United States, new oil and gas reserves in Mexico, a tremendous demand for fuel for power projects and a clogged national gas pipeline system, Mexico is
expanding its gas pipeline system. Both Pemex Gas and Petroquímica Básica and the Comisión Federal de Electricidad (CFE) have been conducting international bidding processes to award contracts for the development, construction and operation of large gas pipeline projects in northern and southeastern Mexico. Some examples include the Gasoducto Chihuahua, Los Ramones, Mayakán and Topolobampo, to name a few. 

For its part, Peru has been very active in the development of its gas resources and the expansion of its pipeline system to deliver the fuel source to its main cities and industrial regions. 

Peru has plans to build the Gasoducto Andino del Sur, which will connect the Camisea field to Cusco, Puno, Arequipa and Moquegua, as well as the expansion of other Camisea-related pipeline systems to supply the rest of the country. Chile, which suffers from lack of domestic gas resources to feed its industry, is looking at
the development by private entities of LNG terminals. 

Colombia has seen renewed interest in investment in hydro facilities and in the oil and gas sector. In the hydro sector, while delayed by environmental constraints, EPM Ituango is in the process of developing the HidroItuango hydro project,
while Empresas Públicas de Medellín is constructing the Porce IV hydro project, and
Emgesa is constructing the Huila hydro plant.

Colombia’s oil and gas sector has seen a resurgence of private investment due to more stable investment conditions and the government’s efforts to spur investment in the country’s infrastructure. In the gas sector, Pacific Rubiales and Exmar are
planning an LNG export terminal in northern Colombia. Oil companies have commenced exploration and production. Investment in the industry is increasing, not only by the government-controlled oil company Ecopetrol, but also by foreign
energy and resource companies. Chevron has invested considerable funds in developing natural gas production, including commencing a multi-wall offshore drilling program due to the extension of a natural gas export agreement with  Venezuela. The country is also seeing extensive investment in the energy industry from small- to medium-cap companies such as Pacific Rubiales, Gran Terra Energy and Petrominerales.

Finally, investment in natural resources projects has also increased in Central America, particularly in hydro and other smaller-sized renewable energy projects. Guatemala, Honduras and Nicaragua have also attracted developers of wind and geothermal projects. And in the southern cone, Uruguay is in the process of implementing a government initiative to develop several wind projects that will sell power to the national grid under an independent power producer scheme.

Limited Government Incentives

Economic growth and stability in Brazil, Colombia, Chile, Mexico and Peru have led the governments in those countries to seek foreign direct investment in the natural resources and infrastructure sectors. In the energy sector, Mexico has for several years opened energy generation to private investment  through CFE’s independent power producer projects, in both conventional and renewable energy. With the enactment in November 2008 of the “Law for the Use of Renewable Energies and Financing of Energy Transition,” the Mexican government took the first steps to promote diversification of sources of energy through the use of renewables developed and operated by private entities. However, independent power producers using renewable energy are not subject to the new law, but rather continue to be subject to the “Electric Energy Public Service Law” that governs generation from conventional power  sources.

While the new renewable energy law has provided some incentives for developing renewable energy projects, it does not provide for a significant overhaul of the electricity sector. However, the Mexican government has adopted certain schemes to encourage privately-owned renewable projects,
including 100% depreciation in the first year for all renewable energy capital investments and the abatement of annual government fees. Most renewable energy projects in Mexico, particularly wind, are being developed as “inside-the-fence” projects under the “self-supply” (autoabastecimiento) scheme.
While most activities in the oil sector remain closed to private investment, the Mexican government allows participation in construction and sale of platforms and rigs for Pemex. 

Since the 1990s, Brazil has promoted private investment in the energy sector, particularly in hydro and biofuels. However, recent changes to electricity tariffs, which came as a surprise to many in the market, have dampened investor confidence in the sector. In the oil and gas sector, the new offshore “pre-salt” oil discoveries require massive capital investments and are attracting international oil services providers and investors from around the world who are bringing much needed technical expertise and financial resources.

In Peru, the government, through its investment agency — ProInversión — continues its long-standing policy of attracting private investment in energy broadly, including oil and gas. As previously mentioned, a new renewable energy law in Peru has opened up the development of renewables projects. A first wave of solar projects is under development and construction, with projects such as T-Solar’s Majes and Repartición commencing commercial operations and Solarpack’s and Gestamp’s Tacna and Panamerica projects to follow soon thereafter. The government has now also awarded contracts for wind projects that are now under development.

M&A Current Trends

M&A activity in the renewables sector often involves acquisition by deep-pocketed energy or infrastructure companies of early-stage development  companies. The acquisition is then followed by project financing or other funding and a subsequent sell-down of equity for substantial returns after the risk profile of the project has been reduced. Given the nature of the sector and the heavy investment requirements, it is not uncommon to see transactions between competitors. In these, increased attention is being paid to antimonopoly issues in jurisdictions such as Brazil that have moved to a pre-clearance regulatory scheme. 

Other transactions have involved consolidation or reorganization of Latin America investments held by international investors. In these, increased attention is being paid to corporate governance and minority protection issues by Latin American regulators, creating additional deal hurdles as valuation and deal structures receive enhanced scrutiny. Fairness opinions, independent valuations, independent committee approval and similar concepts are increasingly becoming part of the transactional environment in Latin American M&A transactions.

What the Future Holds

All signs in the most developed countries in the region point to an increase in deal flow, particularly given the difficulties facing the US and European economies. European, North American and Asian investors are more knowledgeable of and comfortable with the investment regimes in the region and are putting substantial resources into the region. The newest potential entrants may be investors from the Middle East, in particular from Qatar and the United Arab Emirates, in the oil and gas sector.

Notwithstanding the increased interest, investors should be mindful of existing challenges that may affect investment in the region.

The first is environmental permitting. Countries are becoming stricter in their assessment and granting of environmental impact authorizations. Several important projects, including, most prominently, HidroAysén in Chile, have faced roadblocks that have put into question the viability of the projects. This has also been a particular issue in Brazil where projects across a range of sectors have been delayed by permitting issues. Developers are placing significant resources into environmental studies and compliance assessments in the face of stricter regulatory standards, social pressure and requirements from their
sources of funding to comply with Equator principles and World Bank standards. 

More attention is being paid to local community issues and sensitivities. Sustainability of local communities is of increasing concern in projects involving natural resources. Not only are local governments demanding socially-responsible investments, but private equity funds, commercial banks and multilateral financial institutions and agencies have folded social policies into their investment and lending requirements. 

Change in law risk and changing government policies are always a concern, just as they are in other countries. Argentina, Bolivia, Ecuador and Venezuela have nationalized or expropriated enterprises with investments in natural resources. The circumstances surrounding these nationalizations or  expropriations vary, with some governments implementing measures to obtain control of natural resource companies as part of a broader government initiative to move away from private enterprise, while other governments, such as Argentina in the case of YPF, expropriated share interests of the controlling stockholder to reverse a declining trend of exploration and production. In the case of YPF, for example, the initial expropriation measures were followed less than six months later by public announcements of proposed joint ventures with major oil companies involving billions of dollars of investment to develop YPF’s shale gas reserves. 

Finally, international investors entering Latin America for the first time often underestimate the impact of contingencies, such as tax and labor claims, on valuation. They also are often insufficiently mindful of local law veil-piercing concepts in structuring their preliminary deal terms, especially in deals involving significant equity purchases.