Latin America energy project finance: Where funds will likely flow

Latin America offers a wealth of business opportunities in the energy sector. But knowing the local landscape and the associated risks – and increasingly climate risk – is vital to any successful incursion.

In terms of securing the requisite financing to get energy projects built, winds of change are blowing as financial institutions – especially multilaterals – sharpen their focus on the environmental impact of projects that are seeking funds.

Projects that support decarbonization efforts are well-positioned to secure financing, with the winners being the non-conventional renewable energy, distributed generation and transmission segments, among others. And then there is the potential of green hydrogen and the marine power business.

Coal and oil projects face a future of restricted financing options amid global pressure over emissions. Financing of natural gas projects, since the hydrocarbon can support the energy transition by replacing liquid fuels, may remain more resilient.

To talk about energy project financing trends in the region, and more, BNamericas spoke, via email, with industry expert Keith Martin. A senior consultant in project finance and risk management, Martin has worked on the Latin American energy sector since 1998. He began his career at OPIC, now known as DFC, and MIGA. Martin has been based in Brazil since 2007, working for the private sector and the IFC.  

Martin spoke at the Latin America Energy Forum, held in June this year by British power sector events organizer EnergyNet. 

BNamericas: You have been involved in project finance for more than 20 years. What major changes have you seen in the energy project financing sphere in Latin America over that time?

Martin: As elsewhere, there is a certain cyclicality to PF (project finance). On the one hand, for commercial lenders, PF in Latin America depends on the broader returns available in the region and beyond. In other words, local factors – such as credit ratings – play an important role. But so do returns available in the US, Western Europe, Japan, China, etc. So, even the US bond market has an impact on the availability, tenor and pricing of PF for Latin America. 

On the other hand, for development finance institutions (DFIs), like IFC, IDB, CAF and the US Development Finance Corporation (formerly OPIC), there are also a host of non-commercial factors to be considered. The primary one across the board is that these institutions are increasingly focused on supporting renewable energy projects. In some cases, such as the European Investment Bank, they even have mandates now that prohibit them from supporting fossil fuel projects. This is having a major impact on PF, particularly in non-investment grade countries, where commercial banks are often reluctant to go it alone, without “cover” from a DFI.  

One area where we are seeing considerable interest from the DFIs is in financing regional transmission projects, such as connecting the Central American grid to the Andean one via Colombia. DFIs are well-placed to support such multi-country projects that depend on political, economic and juridical stability in two or more jurisdictions. 

BNamericas: Major economies Argentina, Brazil and Colombia have seen their sovereign ratings slide. In terms of energy project financing, what impact has this had?

Martin: There are two parts to the answer. First, there are the ratings themselves, which automatically mean that lending is more expensive, given the risk spreads, and usually for shorter tenors, too. When countries slip below investment grade, this also decreases the pool of potential lenders, since US and other pension funds, sovereign wealth funds and other institutional lenders often have requirements that they only invest in investment-grade projects. (There are ways to structure around this. In the past, for example, credit enhancements allowed OPIC- or MIGA-insured loans and bond offerings to pierce the sovereign ceiling and become investment grade. Also, there have been cases where specific private or public companies that depend on exports – such as Brazil’s Petrobras and Vale – had investment grade ratings, even when Brazil did not.)

The second part is more complex. The downgrades, particularly in Argentina and Brazil, were caused by political and economic issues in those countries, which have broader ramifications for foreign investors and lenders. 

If we look at Argentina, it was not just the fact that the Macri Plan basically fell apart. It was also that a new leftist-populist government took power – renewing concerns over government interference, expropriations, freezing of assets, sovereign default, inconvertibility, etc. Many investors and lenders still remember the re-nationalization of YPF from Repsol and the many other measures taken under the Kirchners’ time in office… It can just take a day or two for a government to lose credibility – and many years to regain it. 

Probably the greatest enemy of investors is volatility. Where the rules of the game are likely to change, it is very hard to predict returns and hence justify making an investment (or lending to a project). In this regard, we can also look at Brazil, which will have presidential elections next year. On the one hand, the investor community has responded favorably to the neoliberal, Chicago-educated “Super-Economics” Minister, Paulo Guedes. On the other, President [Jair] Bolsonaro has often made populist noises about the energy sector – and famously interfered to oust the then-president of Petrobras, because Petrobras had increased prices. (And next year’s elections promise to bring more instability, with President Bolsonaro threatening to cancel the elections – which he has no power to do – and the prospect of a center-left government under former President Lula coming back into power…) 

BNamericas: Several multilaterals, chief among them IDB and IDB Invest, provide financing and guarantees in the region. What trends are you seeing in terms of projects that they are willing to finance today?

Martin: As mentioned before, the most important background factor for DFIs now is climate change. Their shareholders – meaning mainly the developed economies – are pushing them to support only “green” projects that involve renewable energy. This trend has only become more pronounced with the new Biden administration, since the US is a large shareholder in many of these organizations. In practical terms, this means that there may still be some financing in the coming years for gas projects, particularly linked to LNG, but that money for coal and oil will be difficult to find. (This is one reason why some countries are turning to China for help in this regard…)

However, financing should be readily available for traditional renewables, as well as new sources, such as green hydrogen and wave power. 

Other areas where I see significant interest from the DFIs are: last mile and off-grid solutions for rural areas (which has a significant impact on poverty reduction, and includes supports for the smaller Caribbean island states, where scale is not possible); regional transmission projects (see above); and projects that promote energy efficiency (reducing transmission and distribution losses, enabling better storage of renewable energy, better insulation for homes and businesses, etc.) 

The other trend that has existed for years but will also factor ever more into DFIs’ decision-making is transparency and anti-corruption, including in procurement. This will reinforce a positive trend we have already seen in the region over the past decade toward more open bidding, more accountability and greater transparency.

BNamericas: Guyana and Suriname are drawing the interest of investors. What are the pros and cons of doing business, that is to say, financing energy projects in these jurisdictions?

Martin: Most hydrocarbon experts agree that the Guyana Basin (covering offshore Guyana and Suriname, as well as the northern tip of French Guyana) is the most exciting potential field in the world for the 2020s. Estimates are of at least 10Bb of oil and more than 30Tf3 of gas [World Oil data].

These deepwater fields are being explored by Tullow, Exxon and Petronas, among others. Tullow is bringing its Ghana deepwater experience to the region. In general, the technological breakthroughs in deepwater oil and gas production of the last 20 years, which have resulted in lower costs, make this a potentially very attractive commercial opportunity. 

Many investors are expressing an interest, in part due to the proximity of this area to the US and Western Europe, noting that it can help replace the Venezuelan supply. Also, there is a concern that Guyana and especially Suriname may turn to China and Russia for support in developing the basin, so better to try to preempt them.

There are several obstacles, however. First is the obvious one: hydrocarbons are not en vogue, so many lenders and investors may not want to come in. (Some may prefer gas for LNG over oil, too.). Another is that the maritime border between Guyana and Suriname has been subject to dispute over the decades. While it accepted a 2007 UN tribunal ruling favoring Guyana’s interpretation, there is still resentment in Suriname. Furthermore, there must be some question about the capacity of both countries to deal with such massive investments: Guyana has a population of less than 800,000, and Suriname is even smaller (less than 600,000). 

Finally, in the case of Suriname, a significant obstacle to international involvement was removed last year when long-serving President Desi Bouterse was replaced in democratic elections. Bouterse, who was convicted of drug smuggling in the Netherlands (leading to an Interpol warrant) and convicted of murder in Suriname, maintained close contact with Venezuela’s President [Nicolás] Maduro – and was viewed with concern by international investors. However, in both Guyana and Suriname, political instability – tied in some measure precisely to the massive sums at stake in the granting and executing of oil and gas licenses – is likely to continue being a concern. 

BNamericas: Argentina is looking to ramp up production at Vaca Muerta. Is the shale deposit’s potential a big enough carrot to tempt investors wary over the country’s track record of macroeconomic and policy instability? And could the proposed hydrocarbons bill potentially ease concerns?

Martin: First the good news. Vaca Muerta was already ramping up production (until COVID hit…), allowing Argentina to nearly reach energy self-sufficiency in 2019. Furthermore, the Argentine government and the IMF realize that Vaca Muerta is one of the only ways Argentina has to pay off its staggering foreign debt, so there is some domestic and international will to further expand production. The reserves are, of course, so large that they will always attract interest, as witnessed by the “who’s who” of the oil and gas industry already present in Vaca Muerta. Finally, the hydrocarbons bill could go some way to ease concerns if it is not watered down.   

Now for the bad news – or at least the complicating factors. First, that hydrocarbons bill is a good example. Sadly, Argentina’s record on respecting the rule of law and its engagements with international investors is abysmal (talk to Repsol about that…). Initially, a new bill will be just words on a piece of paper that can be ripped up – especially for investors and lenders who are being asked to put in billions of dollars and wait a decade or more to get their money back. (The best way around this would be some structuring mechanism that would hold some of the accounts offshore until investors and lenders are repaid. Other structuring and risk mitigation instruments could also be considered.)

Another complication is Argentina’s federal structure, which gives extensive rights – even over extractive industries – to the provinces. While the current government of the Province of Neuquén has been favorable to exploration, parts of the project are in other provinces, such as Mendoza (where Brazil’s Vale lost its Rio Colorado potassium investment). Construction of pipelines north and to the sea require the consent of (and compensation for) neighboring provinces. 

Finally, as indicated in the answers above, financing oil and gas projects with international funds (especially from DFIs) is becoming increasingly difficult due to the pressure to move towards green energy. This may also mean that some of the gas projects get preference over oil.  

BNamericas: To wrap up, for the region as a whole, what is the outlook for project finance? For example, which countries and sectors could drive demand over the next few years? For example, green hydrogen seems to be stirring up interest in Brazil, Chile, Colombia and Uruguay.

Martin: The main trend will be the increasingly relentless focus on renewable energy, particularly from the DFIs. We are likely to see additional, major investments in wind and solar throughout the region, but especially in Brazil and Argentina. 

Green hydrogen is also very appealing for the region, and we should see some lenders financing start-ups and experimental projects in this area. Central America and some pockets of South America (Chile and Bolivia, for example) also still have significant untapped geothermal potential – one of the most reliable sources of renewable energy. Finally, innovations in wave energy may bring new investments to Peru, Chile, Argentina and Brazil.

One interesting factor already being played out in Brazil is that climate change is affecting the existing grid, particularly as hydropower is concerned. Countries such as Brazil, Paraguay, Uruguay and Colombia that depend to some extent on hydropower will need to reinforce their backup capacities, as hydroelectric dams are likely to produce significantly less power than originally projected 20 or 30 years ago, due to droughts. (DFIs have funds available for so-called “climate change resilience” projects…).