The Rush Into Latin America: Are Developers Making Money South of the Border?
A slowing market on the US mainland has sent developers scurrying into Mexico, Brazil, Chile, Peru and Puerto Rico, among other locations. Do these projects make money? What are the economics in these markets? What is the market potential? What are the main pitfalls compared to developing and financing projects on the US mainland and in Europe?
Two developers and two investors who are active in these markets shared their experiences at the Chadbourne global energy and finance conference in June. The panelists are Lachlan Creswell, a managing director of Macquarie Capital Mexico, Kim Oster, director of Latin American development
for First Solar, Lars Peter, a director with T-Solar Global, and Alok Garg, a director with Scotia Capital. The moderator is Rohit Chaudhry with Chadbourne in Washington.
MR. CHAUDHRY: Kim Oster, First Solar has been one of the most active solar developers in the United States. However, First Solar now seems increasingly focused on opportunities outside the US, including Latin America. What is driving this increased interest in Latin America?
MS. OSTER: We are really focused on markets that are sustainable, and electricity prices and demand for electricity are high in a number of countries in Latin America. These are ideal places for solar photovoltaic projects. Solar panel prices have fallen dramatically over the past few years, and this has been a game changer. We are starting to see places where we can compete head to head with other sources of electricity.
MR. CHAUDHRY: Lars Peter, is the interest of T-Solar in Latin America driven by attraction to the Latin American markets or are the head winds in the US renewables market driving some of that interest?
MR. PETER: The move into Latin America is not that closely related to the difficulties in the US market. We are a Spanish company; language and culture are not barriers to working in Latin America. The main reason for the move is the availability of the resources. If you look at Peru and the north of Mexico, there are really interesting spots where you have a lot of solar and wind resources. Some of those countries like Peru, Mexico and Chile came up with some really interesting regulations that create an opportunity to invest in solar PV. There are not many good markets left in the world. We are being driven out of the markets in Europe; if you look at a world map, you see that the US is still a viable market and what comes next is a move into Latin America.
MR. CHAUDHRY: Lachlan Creswell, Latin America lacks the potential scale of the markets in the US, Europe and Asia. Am I wrong? Do you see a big boom in renewables coming soon in Latin America? Has it already started?
MR. CRESWELL: In the case of Mexico and Brazil, it is well and truly underway. Brazil has just passed 1,000 megawatts of installed capacity, which is nothing compared to the US. The total installed capacity in Mexico is significantly smaller. There is certainly lots of space to move into for the renewable sector. There are great solar and wind resources, and the early projects are taking advantage of these very high-quality resources. Resource mapping is still at a relatively early stage. Good maps will create further opportunities as the sector matures.
MR. CHAUDHRY: Alok Garg, as a lender, do you find yourself shifting focus to Latin America? Do you see the boom now or is it premature?
MR. GARG: We see a tremendous number of opportunities in Latin America. Scotia Bank has an extensive presence in Latin America; we have significant local banking networks. As our clients exhaust the opportunities in the US and the returns are driven down, they start to look at opportunities where there is more country risk and more regulation risk, and that tends to give you higher returns. They are going south of the border, and we are following them.
MR. CHAUDHRY: Lachlan Creswell, getting into more specific markets as opposed to Latin America as a whole, which countries in Latin America do you find more interesting and why? You are based in Mexico City, so Mexico is an obvious example.
MR. CRESWELL: Mexico is interesting because of its scale within Latin America. The regulatory regime for independent power projects makes it an attractive spot to continue to focus. There are interesting opportunities in Chile with similar dynamics in that you have a very well understood regulatory regime; you have US dollar-based contracts and a high cost of power because of structural elements within that market. The country depends on imported fuels. If you can get a good resource, be it solar or wind, you will be competitive, particularly given some of the other pricing dynamics in the Chilean market.
Brazil certainly has lots of potential; it is a huge market and has lots of great natural resources. However, the local content requirements and the auction-driven approach to issuing power purchase agreements for renewables make that market a little more challenging for us.
MR. CHAUDHRY: Kim Oster, which markets in Latin America is First Solar focused on, and why?
MS. OSTER: We are focused on Chile where you have strong solar and wind resources, no internal source of fuel, high electricity costs, access to low cost financing, PPAs that are dollar denominated, offtakers with great credit and clear environmental laws. We are also focused on Mexico because of the high price that we see from the industrials and a high solar resource in some areas. There are lots of opportunities in theory in Brazil. It is a large and growing market and there are areas in the northeast that have a high solar resource, but the utility-scale market barely has yet to open up, and there have been no federal options.
Wholesale Electricity Prices
MR. CHAUDHRY: Lars Peter, I am eager to hear about the kinds of wholesale prices you see on offer to renewable energy developers in the four markets to the extent you can share it: Chile, Peru, Mexico and Puerto Rico.
MR. PETER: Puerto Rico is amazing. Retail electricity prices are very high, making solar cost competitive. Mexico is on the verge of bringing out a new energy regulation; the first prices we have seen are around $200 a megawatt hour.
We have installations in Peru where we get $180 to $220 a megawatt hour, but it is just the first round, and they have already had the second round bids and awarded some contracts at a lower price around $120 a megawatt hour. It is getting tougher to be competitive there.
We had a look at Chile. You can get private contracts from the mining companies that are coming in with prices around $200 a megawatt hour. You need to be one of the first movers; otherwise you lose out as we saw in Peru. Prices have tended to decrease dramatically over time.
MR. CHAUDHRY: In Peru, you mentioned in this second round the price is down to $120 a megawatt hour. At those prices, does Peru remain an interesting market for you?
MR. PETER: Yes, absolutely, because if you look at the irradiation map, there is 50% more irradiation than in southern California.
MR. CHAUDHRY: Puerto Rico is another strong market for renewables. The number of wind deals and solar deals that people seem to be doing there is disproportionately higher than what one would expect given the population. Is it purely prices, or are there other factors driving interest in Puerto Rico?
MR. GARG: The retail price for electricity is about 20¢ per megawatt hour. Puerto Rico is a US territory, so you still get all the tax incentives that you get on the US mainland. It is a dollar-denominated country. You are not dealing with significant regulatory risk. The local distribution company has learned how to do these projects, and interconnections have been more forthcoming.
Developer Rates of Return
MR. CHAUDHRY: What rates of returns do developers typically expect in different markets? Let’s start with
MR. GARG: It is question of what kind of cost structure in the awarded PPAs. Developers have bid unleveraged returns in the mid-teens.
MR. CHAUDHRY: Lars Peter, what kind of returns do you expect?
MR. PETER: That is a difficult question. You need up to two years to get a solar project done. You need additional returns to compensate for the period at risk. Permitting is really hard. There are hidden costs that do not become apparent until after development is well underway. Developer returns are probably in the range of 15% to 18%.
MR. CHAUDHRY: Kim Oster, how do the returns that people are expecting from projects in Latin America compare with what developers would expect in from a project in the United States?
MS. OSTER: They are higher in Latin America. We have also found that local investors evaluate projects differently than the US. For example, in Chile we see a focus on real return on assets versus return on equity. The returns are definitely starting in the mid- to high teens.
MR. CHAUDHRY: Alok Garg, do you want to comment
MR. GARG: In Mexico, we have seen a broad range of returns; they depend on the project structure. There are independent power projects that are basically PPAs tendered by the Comisión Federal de Electricidad in dollars. The CFE assumes a lot of the permitting risk, so you are down to a return on equity in the low double digits. In other projects where the developer bears contracting risk, permitting risk and the risk of taking control of the land, there is a lot more risk and the returns are necessarily higher.
Securing a Power Contract
MR. CHAUDHRY: An earlier panel talked about the difficulty of getting long-term power contracts for renewables, especially for wind projects. All of you suggest that the returns in Latin America are high compared to other places. How easy and what is the process for getting the PPA in these countries? Let’s start with Peru.
MR. PETER: Officially, it is easy because they come out of the public bidding. When you know about the possibility, it is already late; you should know before the request for proposals is announced. This is the first difficulty. You need local people, very good and involved people in the different authorities to find out when they will come out with new bidding. You need to have a very long-term fuel supply agreement because probably the prices you expect today will not be the prices in five to 10 years. We took part in the second bid and lost because the other bidders were more optimistic about fuel costs. A track record is very important to the government.
MR. CHAUDHRY: Kim Oster, the process in Chile is very different than the process in Peru. How difficult is it to get a PPA in Chile, and what is the process?
MS. OSTER: So far the PPAs have really been led by the mining companies themselves. What we are seeing right now is that solar a real plus given the pricing on solar and we are looking at direct PPAs and bilateral negotiations with the mining companies rather than with a government office.
MR. CHAUDHRY: Kim Oster, staying with you for a second and moving beyond PPAs, you spent a huge amount of time developing Desert Sunlight, which I am sure everyone knows is massive 550-megawatt solar project in California. You were the lead developer on that. Now you are developing projects in Chile. What are the differences in developing a project in the US versus in Latin America?
MS. OSTER: Chile has a 30% higher solar resource than southern California so you are able to compete against conventional fuel without any subsidy or tax incentives. We see a lot of similarities in terms of the permitting process. California has to be the most challenging market in terms of the complexity of permitting. You see a lot of the same focus on biological and cultural resources.
MR. CHAUDHRY: Lachlan Creswell, what are the toughest challenges to developing projects in Mexico and other places in Latin America?
MR. CRESWELL: It very much varies with local conditions. In Mexico, for example, the main constraint is transmission capacity and transmission access. The state utility has run an open season for the new capacity and there is still a lot of uncertainty around timing and actual cost for installing that. More generally it is true throughout Latin America that social and community relations issues are something that all developers need to focus on pretty carefully, particularly where indigenous communities are involved in land ownership.
MR. CHAUDHRY: Lars Peter, what do you think?
MR. PETER: Environmental regulation is generally more challenging in California than in Latin America. The big issue in Latin America is real estate. It is unclear in many places who owns the land. The zoning is not clear. Most of these countries lack a long-term policy and lack much experience with alternative energy. If you’re the first mover, you have to educate them and they have to fine tune the laws and fine tune the regulations, and you hit the wall every time you go there and want to move something forward, so it takes a lot of time.
MR. CHAUDHRY: Let’s move to financing of projects once people have surmounted these issues. We had a similar panel last year at this conference and I was surprised to hear from that panel that people said the commercial banks had barely financed any renewable energy projects in Latin America. They were chasing opportunities. The multilateral lending agencies and export credit agencies have financed a bunch of projects, but the banks were lagging behind. Is that still true? Or have the markets changed and have there been a bunch of deals financed in Latin America?
MS. OSTER: Chile is exceptional. There have been great projects that have been financed. People have been looking at hydro projects as well as wind and solar. Puerto Rico has had a number of financings close. I have not seen many other financings.
MR. GARG: The other day we were looking at the number of opportunities. There are about 20 different projects in various stages at which we are looking very seriously about financing. A lot of them will have some kind of export credit agency or multilateral lending agency involvement, but in terms of deal flow, there will be significant deal volume.
MR. CHAUDHRY: And the financing terms for these Latin American countries, how are they structured and how are they different than what you see in the US? When you’re sizing your debt, what kind of leverage are you looking for and what kind of coverage ratios are you looking for to provide financing?
MR. GARG: It is not significantly different from a credit perspective looking at a deal in Latin America versus the United States. You have the same constraints: 1.0 coverage ratio at P99, 1.45 at P50 and a minimum of 20% equity. We look for a strong developer, a good resource — all the things that you would look for in the United States. What you do see, though, in Latin America, is wider variances in pricing and tenor: for example, in Peru, the pricing tends to be in the 4+% range over LIBOR; in Chile, the pricing is more aggressive. In Mexico, it is more aggressive. There are some places in Latin America where it is hard to get commercial bank funding at all.
MR. CHAUDHRY: Lachlan Crewswell, you just closed a deal, Marñea Renovables, which is the largest wind deal to close in Latin America, but that had long tenors on the debt. How do you see the bank market: what terms are being offered to you? How aggressively are banks chasing you?
MR. CRESWELL: I think we were probably a little fortunate in the terms we were offered. Roughly 14 months passed before the financing closed, and we were able to hold the basic terms through the development phase and negotiation of the final terms. I see the kind of macro-trends that were talked about during another panel discussion this morning: the impact of regulation on bank capital and banks generally looking for shorter tenors. I think that will be an increasing feature of projects going forward in Mexico. Export credit agencies will play an important role in tapping what is left of the market capacity and obviously the development banks will as well. I think people are going to be left with a choice between focusing on export credit agency and development bank money and having some commercial bank financing come alongside that, or looking at mini-perm facilities from a broader commercial bank syndicate.
MR. CHAUDHRY: In addition to bank money and agency money, there seems to be talk about project bonds in Latin America, especially in Mexico. A lot of people are trying to structure project bonds for deals, including renewable deals. How real are they?
MR. GARG: There is a lot of local institutional money in these countries that is looking for places to be deployed. In Mexico, we have seen an issuance of project bonds in connection with a bid for a gas-fired project. We have been involved in project bonds in Peru. Chile has appetite as well. So we do see a project bond appetite. The issues you face are similar to what you face in the US market. The negative funding cost of issuing project bonds during construction is an issue. Clearly you want to have some operational history to get an investment-grade rating. We are very excited about the project bond market and are actively working to develop it.
MR. CHAUDHRY: Do you see much liquidity in the local markets? Can you do local currency debt? Are there a lot of local banks that could step up for your entire project?
MR. GARG: Local banks are not usually able to tackle
MR. CHAUDHRY: Let’s end with projections. Kim Oster, what do you project for renewables in Latin America or, perhaps more specifically, solar in Latin America?
MS. OSTER: The price of PV has come down dramatically. Back in 2004, modules were at $3 per watt. Now we are looking at a projection of 55¢ a watt. That continues to be a game changer in markets where you have a high cost of electricity and a high solar resource. So we see a lot of opportunities in Latin America as we are able to compete against conventional forms of energy.
MR. PETER: There are three types of countries in Latin America. There are the ones who do not need PV resources. Brazil is an example, because it has a lot of hydroelectric power. Then you have two others: countries like Argentina where we do not go because there is no stable regulation and you cannot really trust the government, and there are countries like Chile and Peru where there are governmental trust, good resources and a good market. The focus will remain on countries in the last category, Peru, Chile and Mexico, where you can see a lot of demand.
MR. CHAUDHRY: Alok Garg, your wife is Argentinean. Do you agree with this analysis of Argentina, and what do you project? [Laughter.]
MR. GARG: I wish we had more business to do in Argentina, but our bank is not comfortable with that country. We are working on a number of opportunities. It is a tremendous amount of work, but very few closings. That is the challenge with Latin America in general. We come from a US background, where things are modularized and you can take a deal from start to finish and in three to six months have a financier whereas, in Latin America, deals just take an inordinate amount of time and effort, especially with the various funding options, including export credit agency and development bank involvement. I am skeptical whether we will see more than a handful of actual closings.
MR. CHAUDHRY: Lachlan Creswell, you have the last word.
MR. CRESWELL: A key trend we will see is the focus on high-quality resources. We will eventually hit transmission constraints, as has already happened in Oaxaca and I think we are ultimately going to hit a constraint in terms of the number of projects that can be viably developed without further incentives. We have some high-price markets in Latin America, but ultimately as the resource quality starts to disappear, unless capital costs keep falling as they have with panels and wind turbines, then you need to look at different structures or further regulatory incentives to continue to build out the renewable energy sectors in these economies.