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Editor's Note
Well, that’s the theory.
Ultra-competitive bidding in the renewable energy auctions that have swept South America in recent years have pulled down power prices and squeezed the premium for perceived country risk to a sliver. And to lock in whatever premium is left, it will take more than jumping on a flight to Santiago and hiring a local law firm.
The developer or lender landing in Latin America is immediately confronted with a complex patchwork of political and regulatory regimes and financial institutions and markets. Depending on the country, a project sponsor can choose between commercial bank loans, project bonds in the local or international capital markets and a range of financing products offered by what one market participant memorably describes as “a myriad of multilaterals.”
Not only is the situation complex, but it appears to be constantly in flux. Elections can result in the renegotiation of key contracts or the overhaul of an entire procurement program. Since this roundtable discussion took place, massive demonstrations have rocked what was previously considered to be one of the most stable jurisdictions in the region, Chile, resulting in, among other things, cuts to electricity rates that have put generators’ teeth on edge.
And the strategies of the project developers themselves are constantly evolving, as they pivot from a reliance on government-issued contracts to a hybrid approach—using power purchase agreements won at rock-bottom prices to secure a priority slot in the interconnection queue while leaving capacity available for more lucrative private customers or spot market sales.
What is needed, clearly, is a combination of local and international expertise and experience to navigate both the situation on the ground and international project finance trends. That is why Power Finance & Risk has brought together a group of seasoned professionals, including developers, a lender and an attorney, to discuss the opportunities and pitfalls.
Enjoy!
Richard Metcalf
Editor
Participants:
Greg Cardenas, Senior Director, Canadian Solar
Craig Howard, Senior Director, 174 Power Global
Mathieu Rousson, Director, Crédit Agricole CIB
Elie Villeda, Business Development Manager, First Solar
Dorina Yessios, Partner, Allen & Overy
Shravan Bhat, Power Finance & Risk (moderator)
PFR: To begin with, can you give examples of where having specific local expertise on the ground in Latin America really helps to get a deal over the line?
Elie Villeda, First Solar: Having a really local presence, really understanding how the politics work in a country, gets you an edge and gives you the advantage to secure something. You can see this in the Mexican pipelines issue that we just had a couple of months ago. If you talked with people outside of Mexico, they said, “Ah, no, the U.S. firms are going to win. Nothing’s going to happen.” But in the end, you had a win-win for U.S. companies and Mexican companies and the CFE [Comisión Federal de Electricidad]. I think that level of expertise on the ground is helpful. Sometimes you need the international expertise to secure these kinds of big deals, but for those local issues, understanding the culture is really important.
Dorina Yessios, Allen & Overy: Yes, it’s helpful to have relevant local experience and an understanding of the country in which you’re working, and we see a lot of investors, when they go and invest locally, they team up with a local player. You need a little bit of both, though, and obviously it depends on the size of what you’re investing in as well. A lot of trends that we see, whether it’s financing structures or project structures in Latin America, usually originate in the U.S. or, sometimes, in Europe or the Middle East.
Greg Cardenas, Canadian Solar: I would second that. You need both a strong local team that can take ownership of the day-to-day execution of matters in the host market, such as permitting, real estate and utility interface-related issues, as well as a highly experienced management team that knows how to structure the project agreements that will be sufficient to support non-recourse financing and produce an investment profile that will be attractive to institutional or strategic investors. Our success in Mexico and Brazil was only possible because Canadian Solar has been able to build strong teams that work towards this common goal.
PFR: In Latin America, there is a lot of hydro, and with climate change and changes to hydrology, the capacity factors of those hydro plants has been volatile recently. What have you been seeing on that front?
Mathieu Rousson, Crédit Agricole CIB: As a lender to renewables projects over the past decade, we’ve lived through the impacts of the El Niño effect, or climate effects like that, and the power price volatility they can entail—particularly in Chile and Peru. One key lesson learned is that for those assets, you do not want them to be contracted too much—your worst enemy is the replacement power risk, especially when underperformance on generation due to climate effects has a strong correlation on driving power prices up. We have lived through that on one particular asset and had to go through a debt restructuring under which the immediate best course of action was actually to terminate the PPA. Next thing you know though, prices started to stabilize and initiated a downward trend, a familiar pattern across the world due to penetration of solar and wind generation, but at least the asset has been making money.
PFR: People often talk about political risk in Latin America. But then, there’s political risk here in the U.S. What is your view on that? How does that have an impact on the kinds of deals that you can do or the kinds of markets that you can go into?
Villeda, First Solar: Everything that happens here in the U.S. has an impact on Mexico, even politically, and the unfortunate thing about Mexico is that economics and politics are really tied up. I think that there is a risk that something bad really happens in the Mexican government.
In other Latin American countries, for example, Brazil, I see it as a minimal risk. Some other countries, for example, Argentina, I don’t think there’s a political risk right now, but more in terms of finance. Everyone is waiting to see what’s going to happen after the elections to really see if they’re going to finance or on what terms they’re going to finance.
Rousson, CA CIB: This is also why global banks like ours see value in having boots on the ground in regions like Latin America. The local, untold story on a particular area of political risk, you would only have a good grasp of it through local contacts. This is an essential complement to the reputable industry sources we have access to or to what rating agencies factor in in their sovereign rating. This is particularly true in Latin America where history has shown that politics can create high market volatility. It is true of many jurisdictions in the world but some, like the U.S., do benefit from a halo effect.
Yessios, A&O: When you watch what’s happened in Mexico over the last year, even before Andrés Manuel López Obrador took office as President, it’s very disruptive and it’s definitely distracting but, in the end, no foreign investors appear to have lost money. The ones who are paying the price are the Mexican taxpayers.
Having done this for a number of years now, what I find fascinating is that when I first started doing deals in Latin America, we always had back-to-back security—New York law security agreements. We always had an offshore pledge to make sure you could always enforce in an outside jurisdiction, and this has largely changed. I’m working on two U.S. private placements in Chile and all the security is in Chile, except in one case for some of the bank accounts, which are in New York. I am working on a renewables deal in Mexico and all of the security is in Mexico, including all of the bank accounts.
Cardenas, Canadian Solar: It may be easier to work in a market where there are plenty of precedent transactions. Rightly or wrongly, we generally equate a historically active market with one that has lower risk—but this isn’t necessarily true. As more and more developers compete for business in overcrowded markets, we see economic returns suffering and sponsors having to take on more risk just to have a chance of winning business. On the other hand, if you look at markets such as Mexico and Brazil where they really did not have a PV solar market just five years ago, one might think that these markets presented a much higher risk profile, but in fact the regulatory reforms, government support for private sector investment, and strong financial support led primarily by development banks all created the conditions that allowed private capital to successfully develop thousands of megawatts of projects and to successfully sell the completed projects to strategic and institutional investors.
PFR: How has the role of development banking institutions and export credit agencies changed over the last few years?
Yessios, A&O: I don’t think their role necessarily has changed. What I think has changed is the breadth of financing structures that we’re seeing and the different options for borrowing from different types of lenders, particularly in countries like Mexico and Chile, which are more mature. Even Peru, before they slowed down significantly because of the corruption scandals.
Clearly, IDB is doing a lot more as well. It’s a necessary part in some of these tricky jurisdictions. I’m working on a transmission line financing in Colombia which would have been very difficult to bank if it was with commercial banks, because there’s just a lot of risk on this transaction. The more interesting thing is how many more different types of financing structures we’re seeing and different types of lenders.
Craig Howard, 174 Power Global: Development banks still play an important role in Mexico as they are willing to take more risk to support the development of the energy market. The Mexican development banks will finance merchant projects. Ellie, do local commercial banks have merchant appetite?
Villeda, First Solar: Local banks have a limited ability to finance merchant. What we have been hearing is OPIC, rather, entering Mexico, and the Mexican government loves OPIC and they want to push more projects using OPIC. OPIC said that they were going to finance merchant and they have done it in the past, but in Mexico, I think that they said around October, they were going to finalize the type of contract they were going to set up.
Cardenas, Canadian Solar: We closed a 68 MW project financing in December with a commercial bank and a development bank in Mexico. At the time, only the development banks were willing to lend against both contracted and merchant cash flows. Today, we are working with two commercial banks who will be providing construction and term financing for a P.V. project with a slightly higher percentage of merchant revenues than what was financed by our last project. So we are happy to see that we have not had to rely solely on the development banks in Mexico.
In other markets, such as Brazil and Argentina, we have relied on development banks or multilaterals to underpin the financing since they are the only lenders capable of offering the long tenor financing that our projects require to be economically competitive. Unfortunately, commercial banks just are not capable of offering the tenor and pricing that is needed to make these projects work.
Rousson, CA CIB: IFC and Bancomext have done a pure merchant deal.
Villeda, First Solar: Yes, but that’s changing now. You had, in the past, three local development banks. Now, Bancomext is the only one that could do infrastructure projects and that’s now their new directive. Things have shaken up a lot.
Rousson, CA CIB: The role of DFIs in a continent or an area like LatAm is essential but can be tricky for several reasons. There are so many differences between the different DFIs. You look at Brazil with BNB and BNDES—they play, on their own, a central part in the project finance market. This is how Brazil has worked and to a large extent continues to work, even if we see that there start to be more and more opportunities for commercial banks and private institutional capital.
In Mexico, it is a crossroad of a myriad of multilaterals—beyond the IFC and IADB, you also have NAD Bank, OPIC and several export credit agencies—and local development banks like Banobras and Bancomext. These institutions are precious sources of capital for sponsors, especially when you have new risks—like merchant risk—in the equation, but (1) they are a learning curve for sponsors, and (2) they can be somewhat unpredictable over the long gestation cycle of a project finance transaction, especially when you have changes in governments.
The other point I would mention on Mexico—as a commercial bank that took a positive view on the bankability of the renewable auctions projects early, we felt that sponsors managed to turn the development bank capital to their advantage, but in a way that sometimes made it more difficult for commercial banks to compete. In a regulatory environment where European and other commercial banks have new challenges with providing long-tenor financing on balance sheet, for example, the sweet-spot structures for financing long-term project cashflows are either mini-perms—long-term underlying risk profile with shorter tenor financing—or project bonds. And you do want a new framework like the Mexican Energy Reform to be supported by global sources of capital as a way to cross-pollinate the international expertise and the lessons learned from other geographies, especially for highly-structured financing techniques like project finance. That’s why, as a commercial bank, you want to maintain a good dialogue with DFIs at large—another important aspect of having boots on the ground to constantly exchange ideas with local players. For example, we’ve discussed, at a very early stage, with Banobras about the guarantee products they offer and how they could be used to cover part of merchant risk in our projects. We see those types of products finding their way into deals, although we’ve not closed one yet.
Yessios, A&O: OPIC has just changed its mandate a bit and they’re going to be less focused on U.S. ownership, which will open them up to doing more projects. OPIC and IDB were two of the key DFI-type lenders who were banking a lot of merchant power deals in Chile. We all know how that went. I find it interesting that they’re looking to do it in Mexico.
Cardenas, Canadian Solar: When I spoke to OPIC several months ago I believe they were looking at 18 years maturity for 20-year PPAs in Mexico. The two financings that we’ve been working on have tenors of roughly 17-and-a-half, 18 years.
Howard, 174 Power Global: Were those auction PPAs?
Cardenas, Canadian Solar: Yes, they are. The first and third auction. Other than the merchant curve assumption, one of the most important factors that limits leverage is the amount of loan that the lenders are willing to allow to be outstanding at the end of the 15-year contracted energy term. We generally see around 30% to 35% as the limit of what lenders will allow to be outstanding at the end of the contracted energy term. In addition, it is common to have some type of a look forward test based on a revised merchant study that might trigger a mandatory prepayment provision via a cash sweep of some sort. The concept is straightforward but the details are subject to robust negotiation.
Yessios, A&O: Is that structure with commercial banks or with DFIs?
Cardenas, Canadian Solar: Commercial banks.
PFR: One of the themes that had struck me was the world-record low PPA prices in renewables auctions. Are those financeable? If so, what are the equity returns?
Cardenas, Canadian Solar: Yes, they are definitely financeable. It’s not just about the PPA price, but the combination of the total revenues which of course depends on the total generation and the prevailing spot price. The three third-auction projects that we were awarded ranged from around $20/MWh to $22/MWh. The tenor and leverage will be sufficient to allow us to meet the returns required by investors.
PFR: What are the equity yields that you would see, generally speaking?
Cardenas, Canadian Solar: Whatever they are, we are meeting the demands of the marketplace with the PPA pricing that was awarded in a competitive auction. I understand that the U.S. market is around 8%, plus or minus. Mexico might be up to a couple of hundred basis points above that. In Brazil, we are seeing a tightening of spreads and there is a significant pool of investors looking to acquire projects in Brazil.
Howard, 174 Power Global: For fully contracted solar in the U.S., you’re not going to get 8%. It’s sub-8%, for sure. I see very high single digits levered returns in Mexico. I think that works and, yes, you can get there. We won a PPA in the second auction and then lost in the third auction. We were surprised how low the prices were. However, in the fourth auction, we were prepared to get to the pricing levels of the third auction. We could maintain returns due to the reduction in equipment costs. You can still attain acceptable returns there, although I am a little concerned about the political risk that has manifested in the market.
Cardenas, Canadian Solar: In my example, when we bid, I gave you the exit IRR—the IRR for the investor. If we were the sponsor and we kept it, it would, of course, be north of that.
Villeda, First Solar: There are some social and environment constraints. There’s a lot of projects right now from the third auction that are stalled. They are already financed. What’s going to happen to those projects? What’s going to happen to interconnections? Those PPAs were really low because they were mixing merchant with those PPAs just to secure the interconnection. You have this mix of maybe 60% to the auction and the rest merchant. Those mixes are going to keep Mexican PPA prices really low.
Rousson, CA CIB: I do think that sponsors that have secured a portfolio of PPAs from the auction have a great asset from a bankability standpoint and a decent risk/return profile for long-term equity players like Canadian pension funds or Asian investors. Alternatively, if such projects or portfolios have excess uncontracted generation, they still have options (1) to go hybrid, as Greg was mentioning, and that has been banked in Chile and Mexico—for some degree of structural mitigation against merchant risk in their financing of course; in terms of returns, it tends to be a fully merchant play for the equity though, as debt service will be using all of the contracted cashflows, and (2) to add some good private PPAs in the mix on top of what they’ve secured in the auctions.
PFR: Where are you seeing construction debt versus term debt pricing at the moment for contracted renewables in Mexico?
Rousson, CA CIB: For us, construction risk is what we do. We’re not necessarily pricing pre-construction or post-construction individually though, especially for assets like renewables where construction risk is fairly low, save for specific environmental and social risks. We’ve lived through a variety of situations in Mexico and we know how tricky this can get. The first recommendation we give sponsors is always to be properly advised on environmental and social and budget accordingly.
PFR: There was one large deal in Mexico that priced at Libor plus 225 basis points last year. More recently, market participants say that pricing may come down below 200 bp.
Howard, 174 Power Global: Yes, that’s the range where our financing got done. The 20-year CFE contracts are no longer available. The contracts are getting shorter, more merchant risk is a bigger part of the story. I don’t know if pricing will go down too much.
Yessios, A&O: Especially with the political situation.
PFR: For a degree of merchant risk plus political risk, what would be the premium?
Howard, 174 Power Global: We haven’t gone there yet, so I don’t know. Certainly, the development banks seem very comfortable. They want to support the market and they’re willing to take merchant risk.
Cardenas, Canadian Solar: It’s not only pricing, because you have protections via the conservatism that’s built into the debt sizing on the merchant cash flow projections.
Rousson, CA CIB: Usually, if we’re in a jurisdiction where we’re not comfortable with political risk, you just don’t finance it. That’s been the case in Argentina. We have actually project-financed one transaction in Argentina—the repayment profile fitted within President Mauricio Macri’s mandate, so we did it. Actually, it was one of the first project finance deals for an open-cycle portfolio. For project finance in Latin America, we take a long-term view on risk in a very practical, common-sense way. A track record like Argentina’s is not one that we can rationally take a long-term view on as a non-recourse debt provider to power generation assets. An equity view of the world is so much different, but we’re not getting remunerated for the upside.
PFR: What are you seeing on natural gas-fired plants in Mexico?
Rousson, CA CIB: We’ve extensively financed this asset class in Mexico on a fully contracted basis—former CFE IPP Pidiregas, new market PPAs with CFE Calificados. More recently, we have been actively but selectively analysing several plants with some merchant exposure and ways to structurally mitigate such risk. At the end of the day, given Mexico’s generation mix, there is an undeniable need for efficient baseload sources of generation and CCGTs are the logical candidate.
Where merchant risk is involved, financing goes naturally to the mini-perm end of the spectrum. Crédit Agricole CIB has been selectively active in the U.S. in PJM Interconnection and other merchant markets and has financed dozens of U.S. merchant deals. Our institution knows well the “cookie-cutter” templates that have been used to structure such gas-driven merchant risk. Obviously, we need to adapt it to the Mexican context, where for example the commercial capacity product—Potencia—is a whole different animal that does not give you price predictability as in the U.S. markets, but there are ways to adapt the financing structure accordingly. Obviously, a key aspect is to analyse the plant’s access to gas in an educated way and this has been one of the challenges in Mexico—the most bankable projects would need to secure long-term gas transportation and supply that pretty much only CFE is providing today and they have done so in a very selective manner since the change in Administration.
As a consequence to these intricacies, we see that the pool of liquidity from the banks is very limited, because you need institutions with expertise in the U.S. merchant markets, which is the better proxy for the merchant risk in Mexico, and comfortable with Mexico from a political risk standpoint. As such, the DFIs would be the logical good add-on, at least for larger transactions.
Howard, 174 Power Global: We see CFE building and owning new gas-fired projects, and letting the developers—the private capital—build the solar. We think there’s more opportunity in solar than gas.
Yessios, A&O: Are any of you looking at private PPAs?
Cardenas, Canadian Solar: Yes.
Howard, 174 Power Global: Yes, absolutely. You have to.
Yessios, A&O: Is the development of that side of the business far enough along that you will be financing these projects soon?
Villeda, First Solar: It’s difficult to educate the corporate offtakers, because in the minds of business leaders, only CFE exists. You have qualified suppliers coming into play in Mexico and you have to compete directly with them, because they offer shorter terms—five years, 10 years tops—and your PPA will be 10 to 15 years. It’s hard to tell them, “you’re going to get this price, you’re going to get these hours.” They don’t know that much about energy regulation. Not too many companies have an energy manager, for example. You also have to go directly to the consultants to explain your business model.
Cardenas, Canadian Solar: They’re not contracting for sustainability or for solar projects on their annual report. They price their contract for bottom-line cost reductions. There are some auctions going on in Mexico or about to happen now with private party PPAs. I think many of us are looking at the private PPA market given the pause in the government auctions.
Villeda, First Solar: There are more avenues, I think. I’ve been hearing about a lot of regional auctions. State governments want to take the lead on that and say “we don’t have to depend on the federal government to do our own auctions”. You have the private auction held by Bravos Energia. That’s another auction. You have now, another one by Vitol. The market is responding to that constraint of the government and the government is seeing it because they said, “We don’t want to be left behind. We’re going to launch, maybe, a regional auction.” Let’s see who does it first.
Yessios, A&O But there was a rich history with the self-supply permit regime in Mexico. I found it interesting that all that got wiped away with all of the changes in the regulations. In some respects, I guess we’re just coming full circle.
Rousson, CA CIB: From a bankability standpoint, we’ve looked at dozens of private PPA arrangements in Mexico and it does give the impression that it’s a market that is still searching for the right model. Especially when we talk about solar, the big issue is: you generate during the day, you’ve got consumers that are most often 24/7. Who’s taking the risk at night? It’s very challenging to bank such a structure as it is, as you’re essentially financing a solar plant during the day and trader at night—a great story for credit committees in general. In addition, you also have the issue of internodal cost risk between the node where the plant injects power and the node of the end user. This is where we think qualified suppliers have a key role to play in Mexico. If you have some good, cheap renewable generation combined with some gas assets, you become a player that is able to hedge that intra-day risk at a very competitive cost of supply. Then, the question for lenders becomes, “are these players bankable?” Well, it depends, but let’s say that those having the ability to provide solid security package/parent guarantees into their PPAs have a clear advantage. This is not to say that such types of companies cannot become bankable in the future, but track record on the Mexican wholesale market is just not there yet. This is where the portfolio approach or a clearing house with different players can make sense.
PFR: What’s your take on the latest auctions in Brazil?
Cardenas, Canadian Solar: It’s our largest market. People want to get across the finish line and, as a result, they’re bidding aggressively. With any large sample, you’re going to have some where you have to question, are they going to get there? We’ve won projects in each of the six government-run auctions. We’ve won projects in a couple of private PPA auctions as well and financed the vast majority.
Rousson, CA CIB: In Brazil, we own a full-fledged bank there and we can source local reais and participate selectively in some of these project finance lending opportunities. However, this is an extremely competitive market. I think there was 100 GW worth of bids in the October 2018 A-6 auction, 70% more than the prior one. When you talk to clients and sum up their different projects, you easily get to gigawatt-sized portfolios per client.
PFR: One of the trends is sponsors splitting their offtake between government and private PPAs. How does that work in practice and how does that affect your conversations with lenders?
Cardenas, Canadian Solar: The lenders expect it, first of all, because there’s three different revenue streams, essentially. There’s the anticipated revenue. You have a date when your PPA goes to commercial operations and you want to complete it as early as possible, so you can sell at a higher rate during that short-term period. Those revenues matter a lot in terms of driving returns. Then you have revenues under contract corresponding to committed energy. Finally, energy generated in excess of the amount committed under contract would be sold in the free market.
Villeda, First Solar: We see this as an important market and to me, the sole Mexican at the table, I see all the finance that was supposed to go to Mexico is going to Brazil. They drove those really low prices to secure the interconnection time and they are mixing it up with the private PPAs.
But one important aspect to have in consideration is the finance. You can have BNB financing projects because of the region but if you mix it up with Exim Bank you have a really good mix to lower those interest rates. That’s how we are playing the market—using Exim finance to secure more contracts and more modules and cells.
Rousson, CA CIB: In Brazil, it’s a game of scale, and so you do see that there’s a potential for even lower prices than before on the contracted, regulated side. Now, what could be bankable? Obviously, these auction PPAs will always be bankable. It’s just there will be less cash flow available for debt service so you’ll get lower leverage.
If the offtakers are sub-investment grade, that becomes almost more of a corporate play for the banks. If you know the corporate that’s sub-investment grade, you’ve got a 30-year relationship with them, that’s one story, but that becomes very difficult to read for sponsors.
Big international firms could be jointly liable for their PPA, and that could be a solution for bankability. There could be a way to present PPAs with a dollar denomination, and I know there’s a bill or a draft law that’s being looked at. That would be an interesting avenue for banks like us, because even if those projects are bankable, we know that BNB, BNDES will be there, and it’s going to be hard to compete, even though as a bank, we have the capability to offer the suite of BNDES and BNB products.
PFR: Dorina, when you are speaking with clients who want to do business in Brazil, what are some of the risks that they are wary of and how do you find ways to mitigate that?
Yessios, A&O: I think currency risk is a big issue for a lot of clients, whether they’re sitting on the equity side or on the debt side. It’s interesting to hear that all the sponsors that had been financing Mexican projects are now going to Brazil, because two years ago, it was going in the opposite direction. I think Brazil is one of those markets—and I would actually categorize Argentina like this as well—where people either get it or they don’t. They’re comfortable with the local country’s risks and nuances or they’re not.
Brazil is a massive country, a massive economy. It will bounce back. I personally have no doubts. In some respects, they’re ahead of other countries in terms of cleaning house to make sure all of the corruption is rooted out. They’re very focused. There are some companies, you look at Brookfield, for example, or Canadian Solar—they get Brazil. They’ve got their people on the ground. They understand it and so they will stay there.
I think with Brazil, the political risk has been a huge issue. Not everyone is yet as comfortable that they’re out of the woods, frankly. They’re a little in regrowth, but we are seeing a lot more activity in the space, and I think the CELSE transaction was one of the first really, really big ones that closed last year.
Rousson, CA CIB: In Brazil, the first question is: how do you get the gas? The reason why we see LNG-to-power is the historical monopoly on gas from Petrobras. How their priority works between feeding their own plants or a third-party private plants has been a source of discomfort for sponsors. The private LNG-to-power type of assets are not the easiest ones to finance—either you finance them separately and you have project-on-project risk, which is a no-go in terms of bankability, or you finance as a whole, but then you need investors comfortable with both areas of expertise, which is not for everyone.
PFR: How do the debt structures in Brazil vary for contracted renewables and for gas?
Rousson, CA CIB: I have to say that it’s not a market where it is easy to have a good read on pricing. It’s going to depend if you go the BNDES or BNB route or more of a standalone financing. Local banks have also been quite competitive on that front.
Howard, 174 Power Global: Last time we looked into Brazil, which was a couple of years ago, BNDES debt priced at 7% all-in while commercial banks priced at double, 14%. BNDES required that projects utilize locally produced content. Have the market dynamics changed?
Villeda, First Solar: It’s using BNB, most of the time. We see it like that.
Cardenas, Canadian Solar: For BNB you don’t necessarily need locally manufactured models, although you do need local content. There are several sources of debt financing beyond BNB and BNDES, including the local debentures market.
PFR: Let’s end by talking about Chile, because it’s a mature market. There have been lots of deals, goldmines signing PPAs, all kinds of cool stuff happening there. One area that did catch my eye was transmission lines. What do you think?
Yessios, A&O: Those are projects which people have been talking about for a very long time. Chile’s got its own transmission issues right now, internally. Whether resources will be put into addressing that first or connecting to other countries, who knows? I think the last time I discussed it, I had a very extensive conversation, particularly about the Peru-Chile line. The challenge is also just getting everyone to agree. In the case of Peru and Chile, they’re still disagreeing over who owns certain pieces of land that sit at their border. I was told that until that gets resolved, they are unlikely to interconnect.
With the line to Argentina, again, it is an opportunity given the current situation in Argentina, it just makes it more difficult because you’ve got to finance on both sides.
PFR: In your conversations with sponsors and lenders looking at Chile, what are the interesting innovations?
Yessios, A&O: Putting aside some of the commodity risk that comes with Chile being a mining-oriented country/economy, perhaps certain presidential tenures have made it a little bit less busy or the growth not quite as high. In my mind, it’s proven to be one of the more stable countries in Latin America, if not the most stable, even from a political risk perspective. We’re currently working on three different U.S. private placements, all in the Chilean renewable space.
PFR: What is the transmission issue?
Yessios, A&O: There’s over-capacity in the north because it’s so sunny and Chile is divided up into regions, in terms of transmission, and it’s not all interconnected. There’s not as strong of an ability to move the power from the north down to the south, where it’s actually needed. The south’s very hydro-dependent.
PFR: Are there issues with permitting for new transmission lines?
Yessios, A&O Permitting is a whole other can of worms, but that’s true in every country. Chile’s probably one of the strongest in terms of actually having organized groups and non-profits around environmental and social issues. Chile is a key country in Latin America where we’ve seen the highest number of permits yanked through judicial proceedings and those result in whole projects all of a sudden being grounded.
Cardenas, Canadian Solar: It’s very encouraging to see, for a solar developer or wind developer, the decarbonization mandate in Chile. It’s a very big development and so, hopefully, that will therefore create opportunity for renewables to meet that missing capacity. The country gave up generating capacity from coal. Now, will they have an easy path to permitting replacement intermittent generation?
Yessios, A&O: Chile has basically said they’re going to get rid of all their coal plants by 2024. That’s fairly soon, and there are some companies that have quite a bit of coal. Presumably, they’ll have to decommission them in some form.
Rousson, CA CIB: You could also convert existing plants to gas. That’s another path that some of our clients are looking at. Battery storage still seems a bit early-stage, although many sponsors are looking at it seriously. Although Chile has been investing regularly into strengthening their transmission infrastructure, the geography is not helping, obviously.
The good thing about Chile is that most of the asset classes are dollarized, which is a huge advantage when you compare to Colombia, for example. It’s also been quite consistent and has a very good track record, but when you look at power prices in history, there is volatility and not only because of climate-related effects: one CCGT plant being unavailable for a number of hours creates price volatility because the energy consumption pool is not as large as in other geographies.
Chile has been a recurring source of transactions for us. It is market we know very well. We see it as very competitive from a financing standpoint—tenor, pricing, all of the above. Even for private PPAs, we have just advised and lent into a P.V. project with a PPA from a strong and reputable counterparty which achieved record-level terms.
Clearly, there’s a lot of appetite from banks and there’s also the effect of dearth of deals in the region. All of the capital that used to be split between Mexico and Brazil, but mostly Mexico, is now flowing into Chile.
PFR: Colombia has tweaked its auctions, but they will still be in local currency. Will those get built and financed and if so, who will do it?
Villeda, First Solar: Yes, they are in Colombian peso. They didn’t want to change it into USD-denominated, but they can do the swap with a local bank. We are seeing Exim Bank as a big tool for us, if you manufacture in the U.S. If you go there at the right time—and I think that is right now—and present them the option of U.S.-denominated with an Exim finance option, they will like it.
Yessios, A&O: How about the local banks?
Cardenas, Canadian Solar: There’s very strong interest in the local banks. There are quite a few lenders and so we’re hopeful.
I think that two, three years down the road, when people can see that transactions actually got funded and digested by the market, it’ll be a lot easier to say that this is a market where they want to continue to see development.
Yessios, A&O: We have almost come full circle to your original question about the role of DFIs. The DFIs were the ones who opened the Chilean renewables market, and Colombia is interesting in that the 4G roads program has been a largely local currency program—although there are also dollar denominated deals. The transmission lines are all in local currency, and they don’t have a written concession—you’re relying on a governmental award, which, when tied with local currency regimes, creates challenges for some lenders. It is the way this market works, and it goes back to whether you’re comfortable with Colombia, whether you can get comfortable with the currency risk. I think it’s interesting that U.S. Exim is looking at Colombia very seriously. OPIC and IDB, I’m sure, will as well.
Rousson, CA CIB: We are following closely the development of renewables in Colombia but we think auction PPAs remain a tough sell for several reasons—even in the most recent version, they have kept the peso-denomination; offtaker visibility seems to be still a question mark; and most projects we looked at were quite small. As I understand it, this was in part because of anti-competition-related constraints in the bidding rules and the fact that many sponsors wanted to start small. However, the lack of USD-denominated cash flows in contracts is probably the main hurdle at this stage for foreign banks to be attractive. The only way we can support sponsors is synthetically through peso-to-dollar swaps. We may also see palatable opportunities on the private PPA front from companies whose revenues are primarily USD-indexed.
However, we do think foreign banks have an important part to play, because the local banks are not project finance banks in their DNA. Some of them have been educated to project finance through the 4G highway program, which Crédit Agricole CIB has financed and advised on. In many of our discussions, we could see that there was a lot of name-based lending logic from local banks, away from some of the non-recourse finance principles. This is understandable, as there is a high degree of trust and longstanding relationships between local banks and large industrial conglomerates in Colombia.
The FDN [Financiera de Desarrollo Nacional], which was created in the context of the 4G program, is also an important partner. Their role has been managed very smartly, in our view, for the financing of the 4G program—they’ve let private sector actors position themselves in their respective pockets of liquidity. We saw project bonds. We saw international banks, local banks, multilaterals and other foreign DFIs. FDN came in a step later to complement what they were seeing.
As a conclusion, we saw an interesting pipeline of opportunities in Colombia but this is a financing market difficult to navigate, so close dialogue with local stakeholders is key. This is in part the value we see in having re-opened our local office in Bogotá last year.
