Summary: Significant declines in renewable energy PPA pricing in the region makes clear we are dealing with a commodity with understandable and quantifiable technology risks – a business model that has not really changed since inception a century ago. Yet the true energy revolution that will transform the way citizens power their lives has yet to capture the imagination of our region. This brief analysis makes the case that once it does, it is likely to be stronger in Latin America than anywhere else.
About the Author: Carlos St. James is 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; founded the Middle East-Americas Energy Council in 2014; and publishes the Latin American Energy Review in his free time.
He was recently named Summit Chairman of the upcoming LAC-CORE Finance Summit held at the Ritz Carlton in Miami, Florida this October, which will include discussions on the opportunities in smart grids.
Within the world of renewables, utility scale new generation attracts the most capital and almost all the attention. What’s not to like? The typical transaction size alone is very sexy, each one in the tens of millions of dollars or above, and there are more and more of these deals getting put together each year. But at its core it is a pretty well-trodden business model:
- sign a long term agreement with a credible offtaker to make your Return On Investment more or less predictable;
- ensure you can get the electricity to market via transmission grids;
- build your coal or bunker wind or solar-powered generation plant;
- sell it to an investor with a different risk profile for a multiple of its cashflow;
We imagine that we have entered a brave new world because we are transitioning from fossil-fueled generation to wind and solar. Yet the rapidly falling prices on long term offtaker contracts, as seen in the recent solar and wind auctions (e.g., in Peru, Brazil and Mexico, in our region) make clear we are dealing with a commodity like any other, where technological risk is low and quantifiable. The business model remains essentially unchanged. No real revolution has taken place.
The true revolución energética is looking us straight in the eye and is as unstoppable as the growth of wind farms and solar parks has been around the world in the last decade. But we’re ignoring it because we don’t fully understand it – and this creates the illusion of greater risk than actually exists. Yet that difference in risk perception vs. reality, that delta, is exactly where enormous profits can be found to those that are willing to embrace la revolución.
An analogy from the recent past may help make this clearer.
Just a few decades ago, the woefully outdated, inefficient and inadequate telephone landlines of Latin America set the stage to be unexpectedly overtaken by a revolutionary new market solution: cellular technology. Today less than 20% of Latin Americans have fixed landlines (compared to over 50% in, say, the United States), and the region has a higher per capita saturation of cell phones than, for example, Canada. Latin America effectively made a technological leapfrog over the rest of the world in telecommunications.
Now the woefully outdated, inefficient and inadequate electricity transmission lines of Latin America set the stage for history to repeat itself in electricity markets. Costly problems abound and utilities’ customer service sucks:
- The extremely elevated cost of updating transmission grids make you wonder if this will ultimately be money well spent. According to various studies, some $700 billion will have to be spent upgrading and expanding transmission grids in Latin America in the next fifteen years;
- Technical assessments and approvals for a new project’s ability to offload its energy onto a grid are increasingly pessimistic across the region. Two examples: solar projects connecting to the same nodes are causing serious congestion and are a major blow to spot prices — as seen famously in Chile (see analysis here); grid inadequacy will soon limit Argentina’s windswept Patagonian potential (see analysis here);
- Electricity losses in the region are staggering: one third of all world electricity losses occur in Latin America and the Caribbean. The regional average loss is 17% (versus 6% in OECD countries and 15% in Low Income Countries), costs about $15 billion a year and is rising. Losses in the three largest economies, Brazil, Mexico and Argentina, are all between 15-16%, and all of this for technical and market reasons;
- Enormous amounts of capital (financial and political) and time (politicians’ and lawyers’) are being invested in coordinating international grids across the region – money that might be better spent elsewhere, especially if the trend is towards smaller and more intelligent energy solutions rather than more monolithic stuff;
- I have only anecdotal evidence to claim that most Latin Americans hate their local utility, but have lived in a number of countries and traveled everywhere and experienced it firsthand — and challenge anyone to show me a study saying otherwise.
The 21st century global electricity model is changing dramatically and – make no mistake – will ultimately be dominated by smaller and far more efficient smart grids. And once again, as with telephony, Latin America and the Caribbean will make the technological leapfrog and become leaders in this sector. But it will require a greater push by the public sector; it will require that development banks put money into it to create the initial incentives; for civil societies to place it on their agendas; and for investors to begin sniffing out opportunities more aggressively.
The United Nations, through its Economic Commission for Latin America and the Caribbean (ECLAC — or CEPAL in Spanish), has undertaken this role. My friend Manlio Coviello co-wrote the definitive starting point with the document, Smart grids in Latin America and the Caribbean, (click here to access the document).
One of the salient features of smart grids is not only that they are smaller and easier to manage, but their ability to allow bi-directional power flows (blowing away the 20th century uni-directional model) to and from the user, who can now become active players in the electricity market. The technologies that characterize this include advanced metering systems (with net metering as a first step); storage devices used to mitigate the variability of generation and loads; power electronics (inverters, converters, rectifiers, etc.), used to connect all types of generators and loads to the network; and electric vehicles, whose charging system is very deeply integrated into the smart grids control system. (This last item – automobiles as energy storage devices — is a particularly hot topic on small islands. I wrote an analysis of renewables on the Falklands/Malvinas Islands a couple years ago — see here — and mentioned it, not realizing its significance.)
Thus, smart grids are particularly adept at integrating very large shares of variable renewable energy sources, handle the flexibility in loads permitted by the demand response techniques, the reduced level of losses, the superior power quality, the increased security of supply and reliability, and allows for a higher level of market transparency. This is exactly what is needed in Latin America/Caribbean — even more than in mature markets.
It is smart grids and related technologies that take us to intelligent systems: those that will have the ability to learn. Not only will energy costs fall, brownouts can be eliminated, a middleman cut out of the process, and renewables more easily integrated. We will be able to manage home and business energy use from a smartphone: change heating/air conditioning from a distance; store solar energy during the day to use that evening; charge the car at night; get dinner cooking; know what food is in the fridge and what needs to get bought; manage and monitor home security systems; letting the dog out/back in; etc. Does anyone imagine a near future that does NOT include all this, and where consumers have far greater energy independence and do not depend on stodgy utilities and their increasingly common blackouts?
Herein lies the real energy revolution.
In 2010 the International Smart Grid Action Network (ISGAN) was established with eighteen member countries. Mexico was the only founding member from Latin America/Caribbean. The Latin American renewable energy community needs to take heed, further the dialogue and convert it into action. I push the topic at every civil society organization of which I’m a board member, and am insisting that the topic be included in conferences in which I might have some influence over the agenda: in Argentina this September; in Miami early October; and in Chile mid-October. Would love to see you there to discuss this further.
Viva la revolución, carajo!
© Latin American Energy Review 2016
About the Author: Carlos St. James is the Managing Director of Santiago & Sinclair, LLC, a financial advisory firm focused on renewables in emerging markets. 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.