Summary: RenovAr’s Round One and 1.5 were successful, but pricing is now below true country risk, distorted in part by low-cost Chinese capital supplying technology. This has created a buyer’s market for projects, which are burdened by two shortcomings: a lack of debt availability at favorable rates and imperfect project development.
About the Author: Carlos St. James is a leading advisor to energy investors and developers in emerging markets since 2005 through Santiago & Sinclair, LLC. He co-founded and presided over the Argentine Renewable Energies Chamber from 2005-2011; has been a board member of the Latin American & Caribbean Council on Renewable Energy (LAC-CORE) since 2010; and publishes the Latin American Energy Review in his free time.
He will speak at the upcoming LAC-CORE Finance Summit to be held next June 2017 in Miami, Florida.
The first batch of Argentina’s renewable energy auctions have been successful. Following Rounds One and 1.5 of the government’s RenovAr program, 2423 megawatts (MW) worth of utility scale projects were approved at an average price of US$57.44 per megawatt-hour (MWh). These winners will sign 20-year U.S. dollar power purchase agreements (PPAs).
The lowest overall winning price was $46/MWh for a 100 MW wind project – using Chinese technology and capital. We now estimate that no less than 884 MW (37% of all the wind and solar projects) have Chinese capital and/or technology from the get-go. This has had a distortive effect on pricing, to the detriment of the nascent industry’s stability as a whole (see the analysis of the effects of Chinese investment in Argentina here). With the focus now on raising capital, this percentage is only likely to increase and may crowd out other investors — and non-Chinese technology vendors.
Meanwhile, many of the remaining winners are selling their projects for two primary reasons: (1) internal rates of return (IRRs) are now too low. Only better-prepared number crunchers and more experienced teams might wrestle decent returns out of them; and (2) the projects themselves — in general – are not developed to international standards and will require more work before lenders or investors can participate.
The issue of getting money
The energy ministry’s first auction was actually last May when it sought 1000 MW of thermal standby energy. Like the renewables auction, it was also oversubscribed — to the tune of 6.6 gigawatts (GW). After a few rounds of price fine-tuning, 2.8 GW were ultimately approved. These thermal units, quick to install, are meant to help minimize the upcoming summer blackouts and were borne of distorted residential electricity demand in the country, as explained in this earlier analysis.
But here we have the beginning of an unfortunate theme: many of these have still not come on line for lack of available financing. So it’ll be another hot summer in Buenos Aires.
In round numbers, those 2.8 GW of thermal projects plus the 1.1 GW of Round One and the 1.3 GW of Round 1.5 make for well over 5 GW’s worth of new installed capacity in the next couple years. That represents about $6 billion in investment; using a normal 30/70 equity/debt ratio, that’s almost $2 billion of equity plus more than $4 billion of long term debt needed.
Is this feasible and at attractive returns? The short answer is No: it won’t all get built. In the case of RenovAr, the energy ministry has consciously taken a shotgun approach and approved every project that had an acceptable price, knowing full well that not all will be built anytime soon. This creates a buyer’s market for investors — but will require good due diligence.
“Is this feasible? The short answer is No: not all winning projects will get built.”
Before Round One there was a lot of speculation on where prices needed to be for twenty year PPAs in the new Argentina. Our firm commissioned a survey whose results indicated that winning prices would have to be in the high $60s-low $70s to provide adequate returns to compensate for Argentine risk. But Round One winners ended up priced about $10/MWh lower: $58 for wind and $60 for solar on average — and in each technology the lowest prices were supplied by projects with Chinese investors and technology. This turned out to be the unexpected wild card that distorted pricing.
But in any event IRRs were squeezed significantly in Round One.
Then Round 1.5 resulted in bids dropping by an additional 30% from first round levels (in some cases because Chinese investors acquired some Round One losers and re-bid them). Solar pricing dropped almost 31% while wind projects dropped by 29% on average. (Remember, these are the same projects with no changes to Terms & Conditions — just a price squeeze.) Some re-pricings were significant: on both the solar as well as wind side there were instances of declines of over 50% in bid price from Round One to 1.5. It makes you wonder if they suddenly got really good at financial analysis or if they’re simply shooting in the dark and hoping for the best.
By and large it is the latter.
Almost none of the winners have firm capital commitments. On the other hand, some of the Chinese bidders had access to multiple sources of debt and equity to play with to find the ideal combination. As for the rest, each made assumptions on cost of capital that in the coming months may prove to have been optimistic.
DCDB Research, based in Buenos Aires, provided the financial engineering for one of the biggest (Chinese) wind winners in Round One. As an ex-banker, I found that they understand financial analysis like few I’ve ever come across and we have partnered up for ongoing analysis and fundraising.
“The ministry has consciously taken a shotgun approach and approved every project that had an acceptable price, knowing that not all will be built.”
Regarding the quality of projects
The technical barriers to entry into RenovAr were low and the overall quality of projects’ development revealed it.
Those winners that elect to make use of the World Bank guarantee (outlined here) will have to comply with its strict environmental requirements such as IFC Performance Standards. All others seeking debt of any kind will come across a term still largely unknown in Argentina: the Equator Principles, a risk management framework now adopted by virtually all international lenders that assesses and manages environmental and social risks in projects and provides a minimum standard for due diligence. Our firm has elected to work with a Chilean consultancy that helped devise and incorporate the Principles in that country, have extensive experience, and can get Argentine projects to comply with the required standards.
The average time winning wind projects committed to reach a Commercial Operation Date (COD) is 22 months. The quickest – and by a noticeable margin – is an optimistic 15 months for a 100 MW (Chinese, of course) project in the province of Buenos Aires. But there are a number of upcoming bottlenecks that few yet see: for example, some 700 wind towers will need to be erected in Argentina in the coming two years alone, yet there are only a handful of the 600-ton cranes necessary to do this in-country. Our firm has decided to address this bottleneck in advance and are working with investors looking to provide capital for this burgeoning service segment.
The average time winning solar projects have committed to reach COD is understandably quicker at 19 months. But one group took the cautious route and used the maximum allowable 900 days (30 months) to COD and won a handful of projects at an average price of $53/MWh. Projects like these may be of particular interest to investors: they provide extra time to sort matters out, to allow Argentine country risk and debt pricing to decline — and to allow for solar technology costs to drop further.
So how will all this be resolved? How will IRRs get bumped up? Increasing leverage is one way to do it, but international lenders are still not interested in Argentina. Watch for an increase in the role of RenovAr’s government-issued trust fund, FODER (see here for a description of stakeholders). The government is likely to get increasingly involved in the business of project financing, which is a solution — just not a good one: it opens the door to skullduggery and temptation.
And in case you haven’t noticed, PPAs for Round One winners have yet to be signed. They’ve been delayed because winners are now seeking additional concessions and guarantees to reduce risk. Presumably any changes will be available to all equally, and this may ease some of the IRR pressure. An important negotiating point: reduction in penalties for delayed CODs. Investors have a big incentive to delay financial closing – but the government desperately needs the installed capacity to announce the end of the energy crisis.
Finally, investors might choose to pursue any of the 61 projects totaling 3889 MW that bid in Rounds One and 1.5 but lost. These can be prepped for Round Two, which has been confirmed for 2017 but may contain a requirement to include additional infrastructure, as nodes begin to get congested.
Poster map of Argentina’s projects available soon!
For those who (like me) are very visual people, we have commissioned a beautifully detailed poster-size map of Argentina that shows the country’s transmission grid and the location of all 59 approved projects so that they can be located more easily, along with basic information on each one. It will help pinpoint future node congestion, an issue that has caused significant heartache in Chile (see analysis here) and could affect Round Two. Should anyone be interested in a copy please write to info[@]santiagosinclair.com with subject, “Map”. Sponsors welcome too. We’re doing the same for every major Latin American market, too. What the hell.
© Latin American Energy Review 2016
About the Author: Carlos St. James is a leading advisor in energy in emerging markets (see his biography on Wikipedia here). He is the Managing Director of Santiago & Sinclair, LLC, a US-based advisory firm focused on renewables in emerging markets with a sterling reputation for quality services. Carlos also co-founded the Argentine Renewable Energies Chamber (CADER, by its initials in Spanish) and was its first President until 2011. He is a board member and was elected the first President of the Latin American & Caribbean Council on Renewable Energy (LAC-CORE); is the founder and chairman of the Middle East-Americas Energy Council (MEAMEC); and founder and publisher of The Latin American Energy Review. His private sector background is focused primarily on finance and bringing together stakeholders so that deals get done. He advises governments on renewable energy policy, counsels private equity firms seeking to enter the region; and brings together stakeholders, including investors, for new energy projects.
He obtained his undergraduate degree in international economics from DePaul University and his masters in international relations from the Fletcher School at Tufts University.
He can be reached at cstjames[@]santiagosinclair.com.