Rising infrastructure investments have confirmed China’s interest in forging links with Latin America beyond buying commodities, and energy projects have been at the heart of the developing relationship.
Brazil, with its rushing rivers, eager consumer base and local construction and funding resources, has attracted particular attention from China’s massive state-owned enterprises. “Brazil is a top destination for these companies, but it is also a showcase. It is part of a broader Chinese plan for infrastructure investment and diversification in the region,” says Margaret Myers, director of the China-Latin America Initiative at the Inter-American Dialogue, a Washington DC-based think tank. “Investments are very limited elsewhere, where we have seen smaller deals.”
She points to opportunities in power transmission in Ecuador and Mexico, especially with respect to the latter country’s new energy reforms. “Whether or not the country goes for the Chinese company is another question,” Myers says.
Li Yinsheng, the head of China Three Gorges (CTG) in Brazil, says Latin America’s largest market offers unmatched opportunities. “We have some teams in Latin America, but Brazil is by far our priority,” he says. In fact, the company’s website identifies Brazil as CTG’s top focus globally.
The investment spree in Latin America is part of the strategy of the Chinese government to export its experience and the expertise of its power transmission companies, such as CTG and State Grid.
Last year, almost half of the $12.6 billion in investments that Chinese companies announced in Brazil related to the power sector, according to the China-Brazil Business Council, a Rio de Janeiro-based business group. Moreover, Chinese companies topped the M&A rankings in Brazil during the first quarter of 2017, representing 37.5% of total investment in the country, according to Dealogic.
“The value of this year’s deals may be even greater than last year’s,” says Fernando Camargo, a partner at the local consulting firm LCA Consultores, adding that State Grid has completed its acquisition of a controlling stake in CPFL Energia and also invested in the renewable energy provider CPFL Energia Renováveis. Other transactions are pending. “We are going to have more news in terms of large Chinese investment in this sector,” Camargo says.
China’s state-owned companies have taken the Brazilian market by storm in recent years. State Grid has invested heavily in power transmission since the beginning of the decade, including transmission lines between the Belo Monte power station in the Amazon and the industrialized southeast region. CTG started monitoring the Brazilian market closely in 2010 and set up a subsidiary in the country three years later. “We did enough work before we started taking action,” Li says.
Within the past four years, CTG has invested 23 billion reais ($7.2 billion) and is generating 8.27 GW, mostly from hydropower stations. As a result, it has become one of the leaders in electricity generation in Brazil. CTG’s acquisitions include the Jupiá and Ilha Solteira plants from São Paulo’s state-run power company Cesp for $3.7 billion, along with two hydroelectric plants from the local construction company Triunfo for 1.72 billion reais and Duke Energy’s business in Brazil for $1.2 billion.
“This is exactly the kind of assets that the Chinese like. They don’t like small stuff. It is in their DNA. They are used to operating with large volumes of around 100 GW,” Camargo says. The current situation in Brazil, where some companies “are in trouble” and the Chinese have a big appetite, offers a “perfect match,” he adds.
Chinese contenders, including State Grid and the State Power Investment Corp (SPIC), have been negotiating the purchase of assets from the Spanish developer Abengoa, and the Brazilian government has rolled out plans to privatize as many as 14 power companies that belong to the Eletrobras holding bloc.
“There is a sustained interest in consolidation,” says Reinaldo Ma, a coordinator of the China practice group at the Brazilian law firm TozziniFreire. “Chinese investors will play a relevant role in the privatization of Eletrobras companies for sure,” says Pedro Seraphim, the head of TozziniFreire’s energy practice.
Chinese investors have become known for their deep pockets. “They are very aggressive in terms of price, generally,” says Ana Karina de Souza, a partner at the local law firm Machado Meyer.
The regulatory risks may present hurdles, but the rewards are high. “In a meeting, State Grid legal executives mentioned that the rate of return on energy projects was around 18%,” Ma says. “In mature markets, the average would be around 9%.” The message, he says: “Brazil has now gained enough stability. Let’s invest in these projects.”
The Chinese companies have moved into the next phase of their Brazil power game and shown an increasing willingness to go it alone. After a series of acquisitions, Li says, CTG now intends to focus on organic growth. “For the next five years, we will continue to look for M&A opportunities, but it will not be our priority.” Pointing out that the company has accumulated 8.2 GW in capacity, mostly from hydroelectric power, he says it makes sense to slow down and incorporate the new assets. “It does not mean we will stop investing. But our priority will be greenfield.”
LCA’s Camargo also predicts that Chinese companies are gearing up to develop greenfield projects, just as State Grid did in power transmission. This “welcome development,” as Camargo describes it, will demonstrate the appetite of Chinese companies for risk in Brazil. “Buying an asset that is already on stream, with money coming in, is one thing, But buying a license to build a new generation asset, and having to face all the risks involved — environment, construction and operations — is something else,” he says.
Li says CTG’s decision to focus on greenfield investments puts the onus back on the Brazilian government and on the power sector’s regulatory framework. “The regulations need to be reviewed, to be fine-tuned, in order to better allocate risk among the players,” he says. “We are happy to see the government tries to bring different opinions to make a better framework,” Li says.
Government capital has supported China’s investment drive in the power sector. China’s investment fund for Latin America, called the CLAI Fund, bought a third of the generating capacity from the assets that CTG acquired from Duke Energy last year. Nevertheless, CTG has sought to diversify its funding. “At present, we have 44% debt and 56% equity. Regarding this 44% of debt, we have a wide range of sources — BNDES loans, Brazilian commercial banks, Japanese banks, including MUFG, and Chinese banks,” Li says. CTG will also tap the local financial market. In August, it was due to complete a debenture issue for 420 million reais for its Rio Paranapanema plant. “That is the best option now, as our revenues are in Brazilian reais. It makes sense to have local currency loans and use them as a hedge,” he says.
Bond buyers appear willing. “There is a large market for infrastructure debentures with fiscal incentives here in Brazil,” says Renato Polizzi, head of investment banking at Banco Modal in São Paulo. “Companies from the power sector have featured among the leading issuers to meet their funding needs on a day-to-day basis,” he says.
The Brazilian bank partnered with Australia’s Macquarie Capital and China Communications Construction Company (CCCC) in 2014 to form Macquarie Development Corporation (MDC) to put equity into pre-construction infrastructure projects in Latin America. It has already invested in a hydro plant in Colombia and is considering other developments in Brazil and Argentina.
Back in China, the government acted last year to curb capital flight and imposed investment restrictions in certain industries. But the measures do not seem to have dampened interest in Latin America’s power sector. “Our view is that such restrictions have not affected and will not affect Brazil,” says TozziniFreire’s Seraphim.
“They started investing before this decision was taken by the government,” says Tulio Cariello, coordinator of research and analysis at the China-Brazil Business Council (CBBC). Capital flight “is not a problem in the power industry.”
Indeed, the push of large Chinese companies into Latin America is expected to continue, according to LCA’s Camargo, who cites large state-owned enterprises with nearly unlimited fiscal resources. “The whole Brazilian electricity grid amounts to roughly 140 GW of installed capacity. This is equivalent to 10% of China’s installed capacity.”
He suggests at least 10 Chinese firms with annual sales of around $200 billion to $300 billion and “huge installed capacities” match the scale of the companies that are already in Brazil, including SPIC, which acquired the Brazilian subsidiary of Pacific Hydro in April last year and a small hydropower station in Chile. LF