This year is shaping up to be one of two stories for Latin American infrastructure and energy finance. Overall, project finance loans slumped from $3.97 billion in the first quarter of 2015 to $2.37 billion in the same period this year, and deals fell by two-thirds, according to Dealogic data.
But while deal flow has slowed in several countries, only Brazil seems to offer real cause for pessimism. The rest of the region continues to excite investors with healthy project pipelines, and new financing techniques are emerging.
The fall in Brazil’s gross domestic product, combined with a public budgetary crunch and political upheaval, has put the brakes on what otherwise could have been an impressive pipeline of new infrastructure deals. “Brazil, in terms of new projects, has been very quiet,” says Glaucia Galp, a managing director at Fitch Ratings in Bogota.
In June 2015, the federal government presented the latest version of its transport investment plan, estimated to cost 198.4 billion reais ($61.9 billion). It has yet to award those those projects, and although the interim administration of Vice President Michel Temer is promising to get more projects done, their financial models may need reworking to reassure investors in the current climate.
But Brazil has successfully awarded projects in both infrastructure and energy before, and industry players do not doubt the country will do so again. “The fundamentals are already there,” Gema Sacristán, chief of investment operations at the Inter-American Investment Corp., says. “The situation is a little bit better, but we need to see if the market stabilizes. We are confident, but we need to wait a bit.” The downturn is coming to an end, she believes, but reforms will be needed.
In the meantime, Brazil’s troubles continue to yield M&A opportunities: Eletrobras and Petrobras plan more asset sales to shore up their balance sheets, while Odebrecht, the country’s biggest infrastructure developer, has begun to sell projects to meet assets financial penalties from the Lava Jato corruption scandal.
Mexico and Chile power forward
The economies of Mexico and Chile are as tied to commodity prices as that of Brazil. Yet the mood of investors is strikingly different. Mexico’s energy liberalization policy starts to bear fruit, and Chile – despite a reduction in power demand from mining developers – looks to deliver further rounds of renewable power projects.
In Mexico this year, for the first time, private-sector developers have submitted bids to the government for long-term purchase agreements with another auction due in September. The developers bid highly competitive power tariffs, and international banks are keen to finance the resulting projects.
Pemex’s efforts to strengthen its balance sheet are expected to generate sale and leaseback transactions that will attract cross-border investors and lenders.
While the cost of renewable power in Mexico is roughly the same as conventional power, Chilean renewables undercut high conventional power prices. The country’s annual power prices – the latest of which, in August 2016, resulted in the lowest solar power price ever bid anywhere – provide opportunities for new market entrants to undercut established power providers, with strong support from cross-border lenders. The latest auction cover over 1GW of new wind capacity and a likely investment of close to $2 billion.
Beyond Brazil, deal flow show pick up soon. Peru, which for several years has been awarding steady volumes of energy and infrastructure projects through its Proinversión investment promotion agency, has seen a downtick this year amid electoral uncertainty. But the new president has signaled he intends to get investment flowing again.
“We have a lot of hope next year for Peru,” says Aitor Alava, head of global infrastructure and project finance for Latin America at Natixis in New York. “There are still some transactions going on – not the same number of deals that we have seen in the last year – but we expect the activity to pick up in the next months.”
Other markets are appearing or maturing. Paraguay, for example, has recently completed the bidding process for its Ruta II and Ruta VII road public-private partnerships, under the auspices of a PPPs passed in 2013. “I think this is a really important milestone for Paraguay as a country”, Sacristán says.
A much bigger market has emerged this year in Argentina, which was due to open bids in September for new renewable energy capacity.
International developers are very keen on the renewables program, but market observers agree that commercial lenders are unlikely to participate in the first round of projects. “The first deals may get done with more ECAs [export credit agencies] and multilateral backing, but as the country improves – and it has a large economy – people are always going to be interested in going back in”, suggests Ralph Scholtz, managing director and head of Latin American project finance at Mitsubishi UFJ Financial Group.
As 2016 comes to a close, Colombia has proved its mettle in procuring infrastructure projects. At least five financings for its 4G road concessions have closed this year, Those concession feature some dollar revenues and attracted debt from local and international commercial banks, development bank debt, debt funds, and local and international capital markets.
“Some of those projects have some challenges in terms of construction complexity –large viaducts and/or tunnels – and strength of some of the local sponsors, but these projects are overcoming their difficulties and are getting financed,” Alava comments.
But if the whole program is to advance, more dollar financing will have to be accommodated, he adds. “I think Colombian banks are getting to their capacity to finance, and I guess the government will have to think of alternatives for some of these projects,” Alava says.
Pools of capital
Nonetheless, Latin America as a whole does not appear short of projects – and local investors are participating more and more. Even Uruguay, with a modest pipeline of projects, now warrants its own infrastructure fund, managed by development bank CAF and funded by local pension funds.
“I think, as of today, we have more capital than bankable projects,” Sacristán says. “Hopefully in the future it’s going to be different. I think we are going to see more projects, because the infrastructure gap is huge in the region. Governments will not be able to fill the multibillion infrastructure gap by themselves, so there’s more space for the private sector, but it’s important to have viable projects.”
The diversity of sources as well as the amount of capital on offer look set to increase. Project bonds will likely increase in importance in 2017, not least as the implementation of Basel III makes its presence felt on the debt maturities that banks can offer. “I think there’s been a gradual move towards shorter-term transactions,” Scholtz comments. “There were a number of banks that could provide long-term capital, but the market forces are driving all banks towards shorter-term deals.”
And indeed, there seems to be no shortage of investors ready to buy project bonds, with three infrastructure debt funds in Colombia alone, and BlackRock and a team of Sumitomo Mitsui Banking Corp. and BTG Pactual are setting up a fourth and fifth targeting the 4G program.
It would be foolish, however, to imagine that project bonds are going to spread across the region by themselves. Peru, arguably the regional leader in project bonds, and Colombia have attracted bond financing to their projects in recent years by retaining several project risks and because their pension funds have enough capital and appetite to write reasonably sized tickets.
The Peruvian model, which uses unconditional government payment obligations, is particularly challenging to replicate in a constrained public-sector debt environment, Sacristán suggests. Mexico could theoretically raise dollar-denominated bonds for some of its upcoming pipeline projects, but banks are likely to bid too aggressively, one source suggests, proposing Chile as a likelier candidate. One $1 billion-plus Mexican bond deal, for the state-owned new airport operator Grupo Aeroportuario de la Ciudad de México, is expected to come to market later this year, however.
“The key is who is taking construction risk,” Sacristán says. “It’s quite difficult for some institutional investors, pension funds and also insurance companies to take on construction risk – this is what we are seeing.” With this in mind, bridge-to-bond deals look set to increase in popularity. US developer Invenergy closed a bridge financing for its Campo Palomas wind project in Uruguay in April, in what Sacristán calls a “really innovative structure”.
Investors look set to continue to innovate across the region in the year ahead. But the critical factor may be the familiar one – how many bankable projects are there? LF