Summary: Chile has a longstanding love of free markets — far more than anyone else in the region. And while this trait is one of the reasons clean energy investors have flocked to the country in the past, it has also led to losses, misapplied capital, and missed opportunities for growth. Investors are now thinking twice, as there seems to be inadequate support to allow for a coherent investment framework to take place.
About the Author: Carlos St. James is Managing Director of Santiago & Sinclair, LLC, an advisor to energy investors and developers in emerging markets. He co-founded the Argentine Renewable Energies Chamber in 2005; has been a board member of the Latin American & Caribbean Council on Renewable Energy since 2010; and publishes the Latin American Energy Review in his free time.
Earlier this year Chile made headline news when a solar project bid a new world record low price: $29.1/megawatt-hour (MWh). But it lasted only a month, until another project in Abu Dhabi returned the lowest-price prize to the Emirates with a deal at $24.2/MWh. But it brought to the fore Chile’s traditional role within the region as investors’ preferred first choice, in part because of the country’s unusual (for Latin America) love of free markets.
Yet the government’s hands-off approach may be backfiring. Its unwillingness to provide a safer framework is resulting in higher risk for investors and ultimately resulting in money being left on the table. This benefits no one, including its citizens.
That last auction may prove to be the tipping point. As usual, ENEL Green Power won a large part of it with aggressive bids averaging just under $51/MWh and without having to specify which technology it’ll use (of course: the government made the auction technology agnostic) – but it may become more selective in where it lowballs in the future: in the past six years the group’s consolidated net profit margin has steadily fallen by two-thirds; operating and net profit are both lower now than in 2010, while financing-related charges such as interest paid on loans have increased almost three times as asset grown has been fueled by a 170% increase in debt. But it still has net profits in the hundreds of millions of euros, dominant market shares – and its stock price remains higher today than six years ago, so clearly its investors agree with what they’re doing. ENEL remains a powerhouse and others seem to be attempting to emulate its strategy in what might prove to be the wrong country.
Ireland’s Mainstream Renewable Power took a page from the Italian playbook and won seven wind projects totaling 985 MW at that auction. They really squeezed prices, which ranged from $38.8 to $47.2/MWh. While these projects don’t have to be operational until 2021, Mainstream is a considerably smaller player and doesn’t have the same financial muscle, geographic risk diversification and technological sourcing capacity of the larger companies. It may have a hard time getting these projects built: wind technology costs are unlikely to drop significantly in the next few years; the capacity factors required to make the projects profitable would have to be uncommonly high for Chile; and access to bank financing remains a challenge. (A tip of the hat to the Breves de Energia team in Chile which first noticed this and wrote an insightful analysis.)
Because the bidding process is fairly straightforward in Chile, practically anyone can bid. This is after all a caveat emptor market. The penalties for not building those new wind farms aren’t that steep, an important consideration since to make matters harder, offtaker risk is complex: unlike most of Chile’s neighbors where the long term buyer is the government utility and hence seen as proxy for sovereign risk, in these auctions your counterpart is the entire private sector Chilean electricity market. Which roughly equates to a synthetic proxy for sovereign risk, but it still makes risk harder to assess for bankers. While Chile’s generation-distribution sector is dominated by a handful of large firms with varying levels of financial wherewithal (ENEL, AES, Colbun, Guacolda, etc.), there are also many smaller co-ops that have gone bankrupt in the past.
Even winners of previous auctions continue to struggle to get financing for projects with these long term PPAs, and so it could be that many of them simply do not get built — or end up in the hands of those with a unique combination of qualities: surplus manufacturing capacity; an abundance of liquidity in the form of equity and debt; and a long term perspective unique in the world. In other words, the Chinese. This is something we have seen recently in neighboring Argentina, as outlined in this analysis.
The PMGD Market
The Chilean government’s unwillingness to provide a more coherent structure for long term offtake solutions, coupled with a general shortage of private sector PPAs (industrial activity is dominated by the mining sector disinterested in intermittent power sources, and manufacturing is a small part of the economy), has led to a search for other ways to enter the power market.
When spot prices were consistently above $150/MWh a few years ago companies like SunEdison persuaded bankers that projects without PPAs were an acceptable risk. A number of projects were done on a merchant basis with disappointing results once spot prices plummeted, as outlined in this analysis.
So attention has turned to another segment, also fraught with its own oddities, called the PMGD sector. PMGD stands for Pequeños Medios de Generacion Distribuida. It was established back in 2006 as a way to breath life into distributed energy (its initial target was actually for mini-hydro and biomass projects) and provides benefits and simplified rules for renewable energy projects up to 9 MW.
A PMGD project can choose to sell into the spot market or into a “stabilized price” mechanism that is re-priced every six months — essentially a six-month fixed price contract. Once you choose one of these options you have to stick to it for four years.
While Chile’s spot price was high (and seemed destined to stay that way) no one wanted the stabilized price option. But now that it has fallen dramatically and on occasion drops to nil at some nodes, a stabilized price mechanism seems more appealing; it currently stands at about $63/MWh. (Click on graph to enlarge.) But it is still not a PPA.
And PMGD is now being used as a loophole to create larger utility scale deals that feed into the grid, defeating its intent as a tool for distributed energy development. Few developers are doing a single 1-to-9 MW renewable energy project (other than some of the more cautious types doing it with all equity, one at a time). Most are bundling them to get to a combined 50 MW or more so that banks might consider them for project financing. Yet bankers, after getting burned with merchant projects, remain unconvinced since there is a still a significant mismatch between the necessary tenor of their loans and electricity price lockups.
Today the Chilean market has about 270 MW (some 30 projects) of renewable PMGD projects operational, but the industry hopes it can reach one gigawatt before long. Should that happen, and should spot prices remain below the stabilized price, the financial pain could become intolerable and threaten the entire system since the market as a whole – i.e., the distributors – have to pay the difference. The fact that in each six month re-pricing changes are capped at 10% provides small comfort. The government meantime looks away, letting The Market sort itself out.
The seeds of discord exist on the legal front, too. PMGD was borne of Law #19.940 in 2004, was defined under Decree #244 in 2005 and later modified under Decree #101 of 2015. But the actual definition of the “stabilized price” itself has never been made, also highlighting the potential for conflict in the future.
Chile’s very active and talented private sector is being shortchanged by its government, unwilling to provide any noteworthy security to investors. They are overplaying the laissez-faire card and not serving their citizens properly. Last week the energy minister resigned; his replacement, however capable, has no background in energy. With presidential elections just a year away it is a safe bet that no bold new decisions will be made that might correct these odd market traits.
Chile is losing its golden luster as the first point of entry for any foreigner looking to invest in the region. And if investors get disenchanted with Chile, where will they go?
© Latin American Energy Review 2016
About the Author:
Carlos St. James is the Managing Director of Santiago & Sinclair, LLC, a US-based financial advisory firm focused on renewables in emerging markets that partners with DCDB Group in Buenos Aires. Carlos co-founded the Argentine Renewable Energies Chamber (CADER, by its initials in Spanish) and was its first President until 2011; 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.