Coal has not played a major part in Latin America's generation sector. The region possesses a limited number of suitable mining resources, and has traditionally relied upon diesel, hydroelectric and, more recently, natural gas to produce electricity. But the failure of gas to stabilise power prices has led utilities and power producers to take a look at coal to fuel capacity additions.

The leader in adding coal-fired generating capacity is Chile, aided by a developed financial system, a Pacific coast to facilitate imports from Australia and Indonesia, a reliable electricity market, and a mining sector with a hunger for cheap power. Chile's switch to coal is the result of disruptions to its gas imports from Argentina.

Brazil responded to poor rainfall at the start of the decade with a small boom in gas generation, but its imports from Bolivia and, increasingly, as liquefied natural gas, have been insufficient to keep up with demand from industry and generation. An ambitious programme of new hydroelectric plants has increased, not decreased, the country's dependence on good rainfall, though the sheer size of Brazil means that a good transmission network can link areas of wildly different climate.

For Eike Batista, the founder of conglomerate EBX, the gap in Brazil's fuel mix looked like an opportunity. EBX has real estate holdings, and some entertainment properties, but its mining and energy holdings, as well as a developing infrastructure business, are attracting the most attention from equity investors and bankers.

EBX' power play

MMX, the mining and logistics arm, of which EBX owns 63%, plans to borrow $950 million over the next three years to fund its iron ore production and transportation projects. Ontario Teachers bought 15% of LLX, a ports and logistics subsidiary of MMX, in 2007. LLX signed a mandate letter with Bradesco in November 2007, covering a $300 million bridge loan and potential $750 million loan that the lender would provide under the repasse programme of Brazil's development bank, BNDES.

MPX Energia, the EBX group company responsible for power generation and coal mining, has a slate of eight power projects under development, with a total capacity of 9.6GW. Coal accounts for 5.9GW of this total. MPX, led by Eduardo Karrer, now has bridge loans in place for three coal projects, with a variety of Brazilian and International lenders.

On 18 January, MPX raised R$2 billion ($1.26 billion today, or $1.1 billion at the time) in an initial public offering. Following the offering, EBX and MPX management own roughly 74% of MPX, with a free float constituting the remainder. MPX has $530 million in closed and drawn bridge loans for its projects, plans to close financing for two of its four projects by the end of 2008, with another two to follow in 2009. Only Chile's Gener comes close to attempting this kind of rate of expansion, and it does so on existing sites within a much more supportive financial and regulatory framework.

However, MPX' roots go further back than the existing slate of coal projects. Its first venture was a 51% stake in the Termoceara gas-fired project, which was located in Ceara state and had an unhappy operating history. The 220MW plant, financed using, among other sources, a $30 million US Ex-Im guaranteed loan from BNP Paribas. It came online in January 2003, but the high gas prices of the following two years meant that the plant was rarely dispatched. After a dispute with Petrobras, which centred on the Brazilian oil company's contingent equity commitments, Petrobras decided to buy MPX out. According to MPX it realised a net gain of R$192 million on the R$324 million sale.

The slate of coal projects hinges on the EBX Group's existing skill at locating mineral reserves, negotiating coal contracts, and its plans to build port facilities to handle this coal. MPX has three sources of coal: imports, its reserves in Colombia, and some low-quality Brazilian reserves, which would be dedicated to a 600MW plant called Sieval. The three mines in Colombia and Brazil would cost roughly $100 million to develop, while MPX is currently studying using coal from its Colombian reserves and from locations such as South Africa.

Cash in the ground

While MPX has yet to complete a long-term financing for any of its projects, or start construction on them, it has sunk much of the proceeds from the bridge loans into turbine progress payments, and has been careful to lock in as many of the costs of its projects as possible. According to Rudolph Ihns, its vice-president, finance, MPX already has an EPC contract for Pecém with Mabe, a joint venture of Maire, EFACEC, BC Projectos and Alusa, and has locked in a boiler supplier in Babcock Doosan and a turbine from Siemens. Mabe also holds the EPC contract with Itaqui.

So far it has bridge financings in place on three of its projects – Pecém, Itaqui and Castilla – with a wide group of local and international lenders. It has raised $270 million for Pecém with Citigroup, which syndicated the debt down to Banco do Brasil, Banco Espirito Santo, Banco Comercial Portugues, ING, and WestLB , $160 million for Itaqui from Votorantim and Itau BBA, and a $100 million bridge for Castilla from Santander.

These lenders can, in theory, be relied upon to provide a longer-term package, although multilateral lenders will, in most cases, dominate the eventual financing. For instance, as Ihns notes, both the Inter-American Development Bank and BNDES have been approached to fund Pecém, while the IDB is also looking at providing some debt to Itaqui. They will be reassured by the 15-year regulated contracts from which the plants benefit, which allow for a pass-through of fuel costs, which are dollarised.

But in the current market, where a developed world banking crisis has morphed into pain for emerging markets investors, memories of Brazil's last raft of thermal power projects could become more prominent. Those deals, like Ceara, fell victim to high fuel costs and developer indifference, even as hydrological conditions made hydro power very expensive. Coal is still much cheaper than gas as a fuel, but also more expensive than hydro. 

But MPX can point to sustained spikes in spot market power prices, and convincing predictions of capacity shortfalls when talking to equity investors. Central to MPX' development efforts is bringing in joint venture partners to share this equity risk, which tends to be more focused on merchant power.

While Itaqui is a 100% MPX project, Pecém I and II are 50/50 joint venture with Energias de Portugal, and MPX is looking for equity partners on Açu, for which Credit Suisse is financial adviser, and Castilla, on which Santander is conducting a search for equity alongside its debt mandate. These attempts to bring in outside equity complement a long-standing EBX policy of bringing in both public and strategic energy sources into its ventures, even selling assets opportunistically when valuations look attractive enough.

MPX wants to have the long-term debt deals for the first phase of Pecém and Itaqui wrapped up, and get confirmation of eligibility for BNDES financing on Açu and Pecém II. It had originally hoped to complete the Açu long-term deal in 2008, but in the last two months has pushed back that deal to 2009, where Castilla is also set to close.

Fuel faith

Aside from its ambitious timeline, the MPX' fuel choice tends to raise the most scepticism from bankers familiar with its plan. The United States has, for now, turned its back on using coal to meet capacity needs, even though it benefits from substantial reserves.

In its enthusiasm for coal, however, Brazil could not match India and China, which have embarked on massive coal-plant building programmes. With its huge hydroelectric potential, Brazil is unlikely to come close, though MPX' coal slate matches the number of coal project financings that have come to market in Chile, another regional powerhouse that has turned its back on gas. But with the exception of gas-rich Russia, all three of the leading emerging economies are adding coal at a fast pace, putting to one side carbon questions.

Brazil, unlike the other two BRICs, lacks a banking system that is deep enough to finance long-lived coal assets. Thus, while Brazil, like Chile, puts carbon considerations a distant second to energy security, it has to rely on lenders who cannot be quite as blithe. The IDB, in particular, has been the repeated target of environmental activists, particularly with respect to its hydro and pipeline financing activities.

Still, as Ihns notes, MPX has been extremely forthcoming about its environmental compliance and is a rare sponsor that trumpets its willingness to comply with the Equator Principles, the commercial banks' guidelines for dealing with environmentally sensitive project lending. Such compliance will reassure activists that MPX is dealing with some harmful emissions, and broader social issues, though the Principles do not address carbon (a related initiative, the Carbon Principles, is confined to the US).

Until very recently, it has been tempting to predict the decoupling of emerging markets from the troubles of the US, and until very recently the Brazilian Bovespa stock market index would have supported the theory. In the last twelve months, however, both the Bovespa and the price of MPX have dropped precipitously, with MPX' fall outpacing that of the index.

For bankers, such a movement is little more than noise, provided MPX can meet its equity commitments, and provided the Brazilian economy remains robust enough to support strong electricity price margins in the coming years. For now, however, in common with much of the rest of the project finance market, MPX will need to wait and see what sort of resources its commercial banks can muster. MPX' first two plants are scheduled to come online in 2011. Only then will the results of its gambit be clear.

MPX battles market sentiment