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Ray of light

After a decade of prosperity during the 1990s, the major Latin American economies are now suffering from a shortage in investment in new energy projects. Could this be about to change?

Rafael A. Junquera
Editor, Potencia magazine

When Bruno J. M. Mejean, senior vice president at Norddeutsche Landesbank Girozentrale (Nord/Lb), said that during the collapse of the energy sector his bank was more happy to be caught with funds in Latin America than in the state of California, United States, it tells a story that few would explore when dealing with the financing of new power projects in Latin America. "No market has done so much damage to commercial banks than the United States," he says.

Local players are taking a more active role in power market investments in Latin America
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While there is no doubt that the current lack of new investment in the power sectors of major Latin American markets is partially attributable to the region's own historical ills repeating themselves, foreign investors' flirtation with high expectations in emerging markets during the 1990s is partially responsible for the unavailability of capital to invest in new infrastructure.

The credit agencies, such as Fitch Ratings or Standard & Poor's, that today will not recommend putting investors' money in the Latin American energy sector, also warn that the current lack of capital is not entirely the region's fault. A look at the international community shows that capital is very scarce and expensive everywhere, and that only a few companies with sound balance sheets have the ability to attract financing for new power projects.

Power projects are not only needed in emerging markets but also in industrialized countries. However, sponsors, equity and pension funds encounter the same opportunities in the USA as they do in Latin America, but without the political and economic risks.

On top of that, the capital that entered the region before the bubble crashed in 2000 is being vacuumed by the same sponsors that put it in. Serious financial problems in their local markets are forcing these companies to retreat from emerging markets to take care of their core business at home. To make things worse, 'distressed assets' in the region are difficult to sell because the traditional buyers are the ones selling.

An active role

The shortage of international funds is preventing investment in new energy infrastructure in Latin America. However, as Mejean says, investment has decreased dramatically but is still taking place where there are "good projects" in countries with a clear regulatory framework.

Agencies such as CDC Globeleq, a fund created by the UK government to assist emerging economies develop proper infrastructure, are still involved in new projects because that is the purpose of their existence. Tito Sanjurjo, director of acquisitions for Latin America at CDC Globeleq, says that for them the current climate is more suitable since prices are cheaper than during the 1990s.

Net inward foreign direct investment, 1999-2002 ($ million)
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Local players are also taking an active role at present. However, their capabilities are limited and the high interest they offer make any refinancing or financing of new projects an unviable proposition. New investment will come from local commercial banks and development banks such as BNDES in Brazil or Banobras in México.

The road to recovery

New investments are required to make sure countries such as Brazil, Argentina or even Chile do not suffer rationing or blackouts in the short- and mid-term.

In Brazil, a good rainy season and a demand contraction, mainly from the residential and small business segments, mean that demand is currently being met; the country is even experiencing an oversupply of energy at this point in time. However, this scenario will be short lived, since demand levels, which dropped to those recorded in 1995, are expected to recover with the economy early next year. As Roberto Pereira Daraujo, assistant to the president of Eletrobras, points out, rationing was not just the result of a lack of water but also a lack of investment.

But it is not just the threat of an increase in demand which threatens the sector's ability to perform, but also the likelihood of having a dry season in an industry heavily dependent on hydroelectric energy. The Brazilian government's attempts to promote investment in new thermal plants has failed due to continuous changes in the rules of the game. Part of the solution to the Brazilian dilemma could have been an increase in investment by state-owned companies, if they had not been prevented from doing so. The current situation in Brazil – and also in other Latin American countries – has provoked criticism of the government for not taking a more active role in covering the gap left by the private sector.

A look at public finances in Latin America, however, does not show an optimistic picture. Given current uncertainties, the international community is sceptical about the ability of governments in the region to pay back new loans used to ease the lack of investment in the region, says Rafael Heztberg, director of Interact Ltd. In Brazil, only budget changes and the elimination of other social benefits could raise money for the government to invest – although presumably not enough to cope with future needs.

The collapse of the economy in Argentina at the end of 2002 had a very negative impact on utilities due to devaluation. To make things worse, Argentina experienced over-investment throughout the 1990s, which resulted in an oversupply of energy. This put downward pressure on prices and is preventing new investments. It is precisely in the over-investment where the government can delay indefinitely action to correct a situation that is today considered by generators to be unsustainable.

Market opportunities

Capital, although scarce, has not disappeared completely for new projects in Latin America. México is a country where investors are still willing to bet their money. Political stability due mainly to the sector's control by the government, its economic fundamentals and its geographical proximity to the USA are key for México's attraction of new capital, since political risk coverage for new investments is not always required. Still the sector's reform is in a state of complete paralysis and the outcome of the ongoing discussions remain unclear.

Chile is also in need of new investment in generation plants, especially in the centre and southern area of the country in the Sistema Interconectado Central (SIC). Around 65 per cent of the SIC's energy is generated by hydropower plants and such dependence and the lack of new investment is threatening the area with possible shortages as early as 2005. Meanwhile, the north, Sistema Interconectado del Norte Grande (SING), with more abundance of thermal plants, has an oversupply. A new law, 'Ley Corta' (short law), has been designed to attract new capital to projects that can help balance the generation capabilities of the country by reducing hydropower exposure in the south with new thermal plants.

Because of the imbalance between the SIC and the SING, the construction of an interconnection line between the two has been proposed. This, however, is an option that, according to Celfin Capital, would only mitigate the problem and delay possible shortages by a couple of years. Celfin Capital argues that it would be more cost effective to invest in new thermal plants rather than a new interconnection line. Either option depends on investors' attitude towards the Ley Corta, still being agitatedly discussed as PEi went to press.

Necessary capacity installations to prevent power deficits in Chile (MW)
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Ignored during the hype, Central America has increased in relevance in recent years. According to Sanjurjo, the size and economic and political stability of Central America's markets enables them to provide a safe entrance for new companies ready to board the Latin American adventure. Dollarization in Panama and Guatemala are factors that have helped to attract investors.

Regional integration also plays a factor in seeing the whole region as a potential investment opportunity. The SIEPAC interconnection project promises to bring more efficiency to the whole power industry in that area, providing incentives for fewer but larger investments.

Moving forward

The good news is that according to Daniel R. Kastholm, managing director of Latin America Corporate Finance at Fitch Ratings, the situation bottomed out at the end of 2002 and will not get worse. Companies are improving their balance sheets, which means that once companies recover in the USA, they will look for other markets to invest capital, and emerging markets will again be their target. However, reaching that point of recovery will be painful and slow, Kastholm emphasizes.

While global markets get back on track, Latin American markets need, in most cases, to adjust their regulatory frameworks. Blaming just the region for the current problems is a shortsighted view of the situation. However, the global economy cannot be used as an excuse for the condition of the energy sector in the region.

It is worth pointing out that many governments in the region are making efforts to change the way their markets function. However, convincing the international community of the reliability of the resulting new frameworks will not be easy.

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