The troubling trend towards increased speculation in the Latin American renewable energy sector

Summary: Many emerging market governments – including those in Latin America — are unwittingly promoting speculation in their renewable energy auctions, with developers and lenders getting caught up in it as well. This has a destabilizing effect on the energy sector and ultimately does not serve citizens’ or investors’ best interests. A brief analysis of the situation with recommendations.

About the publisherCarlos St. James is a leading advisor to energy investors, bankers and developers in at Wood plc. He is also a board member of the Latin American & Caribbean Council on Renewable Energy (LAC-CORE) and publishes the Latin American Energy Review to help generate debate on the industry’s issues.

He will next be speaking at the Andean Renewable Energy Congress in Bogota, Colombia, November 14-17, 2017.


We’ve seen the charts and graphs highlighting the increasingly low electricity prices obtained in renewable energy auctions in Latin America under government-sponsored power purchase agreements (PPAs). The announcement of a US$37 per megawatt-hour (MWh) bid achieved in Peru’s wind auctions gets overshadowed by the $29/MWh achieved by a solar project in Chile, which in turn become old news with a winning $27/MWh price in Mexico. And so on. Energy ministries avidly compete for these headlines.

Yet this push for ever-lower prices as sole determinant of success has an important distortional effect on energy markets. As it turns out, many of the lowest-priced winning bids do not get built because they are not financeable by banks (i.e., “bankable”) at those prices. Those that do get built with similarly low prices operate on a razor’s edge with no margin for error. This is not the ideal structure of a sound national energy matrix.

“Countries will not be able to develop sound capital markets if they remain dependent on subsidized lending.”

The need for bankable proposals

Banks typically need to see debt service coverage ratios of between 1.25-1.50 times (at P90) a project’s cash flow in order to lend. But because auctions are structured to only consider lowest price as determinant of success, they result in reduced cash flow from projects and in turn lower debt service ratios – below the levels banks can approve. And so banks shy away from them, resulting in two adverse effects:

  • continued dependence on development banks and export credit agency (ECA) guarantees to access financing, and
  • a rise in speculation by developers, scrambling to lower the quality and warranties on technology (solar panels and wind turbines) so capital expenditures and debt is lowered. Dependance on previouly-owned or otherwise rejected equipment is on the rise.

Emerging market countries will not be able to develop sound capital markets if they remain dependent on subsidized lending, and growing an energy matrix using firms who steer towards high risk solutions that don’t have correspondingly high upsides (as is the case with renewable energy auctions) is like playing with fire. Sooner or later you’re gonna get burned.

Turkish and Argentine cases

Turkey’s recent wind energy auction provides an example of what’s happening. See Graph A; click on images to enlarge. Eight large multinational conglomerates made initial bids for the 15-year power purchase agreements (PPAs) being offered by the energy ministry. The auction was to have a single winner. Prices in the initial round of bids were all between US$52 and 63/MWh. These were all bankable in the traditional sense: Turkey had lost its investment grade status in 2016, so these prices allowed for access to project financing at higher interest rates.

Graph A: Summary of results of Turkey’s renewable energy wind auction, August 2017. Data source: Bloomberg New Energy Finance and Citibank

But the government included numerous additional rounds whose sole objective was to lower the price. Five of the initial eight immediately dropped out; that in itself is significant. In the end a winning price of $34.80/MWh was obtained – a 38% drop from the first round’s average $56/MWh. (Bear in mind the best wind in Turkey is about 6 meters/second, roughly a wind power class of 2 or 3 — where class 7 represents the highest wind.)

This winning price is not bankable in the sense of using project financing debt as a primary source of capital. Commercial banks won’t touch it without further guarantees, so it is likely to be relegated to subsidized financing from development banks.

Within Latin America, there are a number of comparable examples. Let’s take a quick look at an admittedly unique situation: Argentina. See Graph B.

Last year’s RenovAr auctions, Rounds 1 and 1.5, were eye-opening on many levels and an unequivocal success from the government’s perspective. Argentina had been absent from international debt markets for about a decade and the local private sector had no experience developing or pricing renewable projects — and it showed. On the solar side there were 20 initial bids that also participated in Round 1.5.

Graph B: Summary results of solar PV bids in Argentina’s RenovAr Rounds 1 and 1.5 renewable energy auctions of 2017. Data source: Argentine ministry of energy

Round 1 had seen extremely wide prices ranging from US$63 to $99/MWh from this grouping; in Round 1.5 those very same projects presented new prices ranging from $48 to $59/MWh, a 31% drop on average but narrowing the range considerably. The most extreme case was a 52% drop in bid price.

These bidders were essentially shooting in the dark – with the government’s blessing. Save larger corporates that had access to institutional funding or were using their own balance sheets, bidders had no clear sense of cost of debt and were simply hoping to have a winning project to sell: they were speculating. The country remains dependent on development bank financing and ECA guarantees.

Additional considerations

Penalties for not building a winning project are typically not high; governments have decided they would rather have many market participants than simply good ones and to let market forces separate them. Three final examples from Mexico, Chile, and commercial banks:

In Mexico an unexpected twist took place: the last auction resulted in such low prices that the 15-year energy PPAs had insufficient tenor to repay debt (note that Turkey’s auction also has 15-year PPAs). Commercial lenders backed off after realizing they needed 18-20 years for debt to fully amortize at those prices, and so the government muscled the three national development banks to step in: institutions which, while very professional and capable, do not have significant experience in project finance nor renewables. Again: increased dependence on subsidized lending.

As mentioned in an earlier analysis, Chile’s current auctions allow for a six year period between signing the winning PPAs and commercial operation date. While ostensibly it allows winners more time to finish putting together their projects, it actually entices them to speculate on lower technology costs (namely cheaper solar panels). Yet too much can go wrong during this waiting period: interest rates may well rise, trade walls get built.

Commercial banks are looking for ways to not miss out on the opportunities, persuading themselves the projects can be made bankable. How? By adding merchant risk, i.e., betting on spot price sales of electricity to enhance cash flows. They’re allowing projects to be structured to have about three quarters of installed capacity sold under the long term fixed price PPAs — and the remainder sold at the open spot price. Since spot prices are usually higher than the fixed price of the long term PPAs it has the effect of increasing the weighted average overall price and therefore projected cashflows. This is even being considered in Chile, which had a painful experience from lending to merchant projects as outlined in this other analysis.

Increasing use of the spot price is already taking place in markets like the United States. But they aren’t comparable to Latin Americas’: they’re much larger, more sophisticated and efficient, and have numerous ways to box in uncertainty through hedging. Latin American energy markets are only in the very early stages of shifting from managing contracts to managing energy and risk.

Better ideas needed

One possible solution could be in the way emerging market governments structure their auctions. Rather than seeking the lowest price, they could seek assurance of bankability (tip of the hat to Mike Eckhart at Citibank from where this idea was born). Selecting the lowest price among bankable proposals would include a balanced evaluation comprised of three legs, each weighing about a third for purposes of decision making:

  • a financial plan that might include a letter from an accounting firm confirming its viability, or better yet, a commitment letter from a bank;
  • a price structure that includes escalators allowing for more breathing room in the project and for ownership changes once operational that can reduce return on investment requirements; and
  • technical evaluations: letters from independent engineering consultants stating that the projects as envisioned are indeed technically viable*.

The industry’s continued growth will be tested when the lowest-priced projects continue to fail at reaching financial closure — or worse, fail outright and weaken a country’s overall energy matrix. This is a very avoidable problem.


*in the interest of transparency, note that I work for one such technical advisory services firm – specifically one of the largest of its kind in the world, that has worked on more than 160 GW’s worth of renewable energy projects globally. Wood plc has pretty much seen it all.


© Latin American Energy Review 2017

This report has been prepared by Carlos St. James for The Latin American Energy Review. The views expressed on this site are his own and do not reflect the views of Wood plc, its affiliates or business partners. This report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The report is based on information obtained from sources believed to be reliable but is not guaranteed as being accurate, nor is it a complete statement or summary of the securities, markets or developments referred to in the report. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Any opinions expressed herewith are subject to change without notice and The Latin American Energy Review is not under any obligation to update or keep current the information contained herein. The Latin American Energy Review accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this report. Additional information will be made available upon request.
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