It's a Gas Thing
2001 was meant to be the year when project financing for power
plants was to take off ? and no self-respecting bank, sponsor or
advisor would say otherwise. Brazil has a number of fast-track
plants ? 49 by some estimates ? with government backing on the
drawing board, one of the most competent and commercially-minded
national oil and gas producers in the region and rapidly growing
demand for power. Progress, however, has been slim, and a palpable
sense of frustration emerged from those attending.
There are several obvious reasons for the delays, the most recent of which is a period of currency devaluation that appears to have been partially exported from Argentina. The Real has lost 20% of its value since the start of the year, and has continued to slide, despite a central bank programme to sell $6 billion in reserves. These are the sort of numbers that make sponsors of gas-fired plants nervous.
Thermal plants have been conspicuous by their absence from the market. But a series of hydroelectric financings demonstrate the first use of structures that could be very useful to gas-fired projects.
Cana Brava, a 450MW hydro plant located in Goias, can justly lay claim to being the first international project financing under the new fast-track framework. As Marc Verstreate , from Tractebel's Brazilian subsidiary and effective financing vehicle Gerasul, noted, the 14-year, $165 million A-B Loan structure from the Inter-American Development Bank (IDB) is a useful reference point for future financings.
The second study, Ita, is equally interesting. Gerasul is a 48.75% owner of the project and, as in Cana Brava, the principal offtaker. Whilst financing from domestic development bank BNDES was considered for Cana Brava, the possibility of higher leverage, higher rate transparency and the unattractiveness of currency basket financing drove that project into the arms of the IDB. BNDES, however, has advantages when structuring a domestic capital markets transaction.
Ita is essentially the first appearance of a Brazilian capital markets project bond, and certainly a first for the power sector. Ita, through project company ITASA, raised R710 million from BNDES, including a R242 million direct loan, a R300 million indirect loan through Unibanco, Bradesco, Itau, Safra and Votorantim, and a R168 million 12-year debenture issue. The role of BNDES in the two-series note issue is that the debentures can be put to the bank in 2003 and 2004, respectively.
According to Marcio Guedes, Head of Debt Capital Markets at bookrunner Unibanco, after the bank began to approach institutions at an initial coupon of IGP-M +12.9% demand was overwhelming and the macroeconomic situation improved. In the end the issue came out at +11.2% until 2003 and +9.4% thereafter for both series. Like the bank portions, the notes benefit from security over the concession subsidiary, shares and credit rights over the PPA. Local currency financing, at roughly 12% and without the currency mismatch, can be very attractive, especially for hydro projects that can source sufficient local content.
And the environment for issuing local currency bonds is improving, since pricing increasingly reflects both interest rates and an element of indexation. Acceptance of this, coupled with useful maturities, should give local issues the edge over dollar-denominated bonds. There remains, however, the possibility of a decisive change in both government and energy policy, with the forthcoming 2002 presidential election. Continuation of President Cardoso's plans depends partly upon his current response to the energy and economic situations. Paul Bydalek, president of Brazilian ratings agency Atlantic Rating, says that project developers would be advised to involve as many sources of government financing as possible, whether to act as guides through bureaucracy or to provide a level of insulation to future political changes.
In international financings, however, sponsors have only just begun to explore some of the enhancements available. As Daniel Kastholm, Managing Director at Fitch and the day's chairman, notes, there are a number of credit enhancing structures that have been used to finance energy projects. The major integrated oil and gas companies, including Pemex, PDVSA and YPF, have effectively utilized export finance structures to lower borrowing costs for specific projects as well as general corporate purposes. But, he continues, these structures have found limited use in the power sector, which generally tends not to export product and generate hard currency (US dollars). However for the power sector, there are other reliable credit enhancing structures that have been successfully utilized including multi-lateral A-B loan structures, and political risk insurance provided by bodies such as OPIC, IFC and IDB or by third party private sector insurers.
Deal enhancements
The two most interesting enhancements involve capital markets transactions. The first of these comes from the IDB, which has been offering a currency transfer and convertibility product with which to wrap bonds. This has really only got off the ground for projects with very strong fundamentals and slight risk perceptions, as the San Pedro de Macoris deal in the Dominican Republic demonstrated. Nevertheless, the IDB is pressing on with the development of other guarantee products for non-commercial risks.
The IDB's Capital Markets Department has been stepping up its activities recently. The unit's head, Ellis J. Juan, outlined the various products in development, which include credit enhancement of project bonds and securitisations of future flows as well as the establishment of support for credit intermediaries acting as guarantors in local markets as well as supporting local on-lending to highly developmental activities. For the following 18 months, the first two will probably make up the bulk of the IDB's deal flow.
Equally promising is the new devaluation policy touted by Opic. This debuted in the AES Tiete deal, a $300 million international capital markets financing of a portfolio of hydro plants purchased by AES during the early stages of the privatization period. The policy acts more as a revolving credit, to be topped up and called upon as and when devaluation will lead to a mismatch between revenues and debt service.
Opic might be expected to be a major force in the drive to build new thermal plants ? it has commitments to four projects totalling $625 million. Opic, like most other agencies of its kind, does have project caps ($200 million apiece), and country limits, as well as less-defined industry limits. According to Nancy Rivera, project finance manager at Opic, however, serious hurdles remain, including currency and legal constraints and a lengthy and complex permitting process. Power purchase agreements (PPAs) are often renegotiated and indexation of fuel costs is not allowed. It is the annual process of fuel cost adjustments that is believed to have drawn most fire from Enron and AES recently.
But Petrobras looks more and more likely to take on a lead role in getting new plants off the ground. Opic's Rivera, when faced with the question of how to exploit the now much less aptly-named fast-track process in Brazil, is blunt: ?It's a simple answer ? partner up with Petrobras and let them do the deal. Petrobras has pretty significant debt issuance on its own but its CFO knows that although oil and gas can be financed in the capital markets, energy projects such as these have a different set of priorities?. Paulo Brito, managing director and regional head at WestLB, adds ?Petrobras is also advantageous in terms of tax treatment because LDCs cannot compensate for gas sales to thermal generation plants?.
Petrobras was on hand to outline what it can and cannot do. Antonio Monteiro de Castro, general manager for ventures and business assessment, is positive. ?Petrobras wants to monetise its gas reserves and we don't want to put obstacles in the way, although it is easier when we are a sponsor?, he says. ?But many worries about our involvement as a government entity are less about a role as a sponsor than the guarantees we extend to tolling agreements?. Dealing with other offtakers does not cause as much worry, even in the developing privatization situation because, as Rivera says ?it's something we've dealt with before. We deal with the strong utilities, but they are all candidates for privatization. Private offtakers have the edge for us because we require an offshore holding company for the SPV, which is difficult for the private sector?.
Getting a reliable gas supply is another problem for Brazil, since the country is not yet exposed to competition and the recent edging up in gas prices globally has not been kind to producers paid in Reais. A great deal of new pipeline capacity has been proposed, either through the GasAndes pipeline from Bolivia or from Argentina, which currently has plenty of gas to export. Rivera notes, however, that paying for gas under an import contract may be impossible under the present framework. However, far more important than availability is pricing, as Jeff Lewis, partner at Cleary Gottlieb Steen & Hamilton, notes: ?capacity is much less important than pricing, as we saw in California. There can be no fast track if there is not enough of an incentive to build new plants?.
But it would be unwise to expect the market for electricity to improve to any great degree either. The eventual aim for the Brazilian power developer would be to operate in a merchant environment but this situation is a very long way off. Whilst Enron has apparently made very good money out of operating plants on a day-to-day basis, it has had little luck in taking the plants off balance sheet. Brito at WestLB gives a lenders perspective. ?Too much of the generation capacity remains in public hands, so there is too little impetus to create a spot market?, he says. ?In the long-term in Brazil, as a bank looking at projects, we want to know what the system is going to be for thermal plants integrating with hydro units. We need to know how PPA plants will be dispatched, and we need to know how the central bank will react on gas imports. But the spot market is hard to talk about when so much capacity is in public hands?.
A spot market would also have to build up a track record before firms became comfortable with using it. Rivera says ?there needs to be a firm buttressing of what roles players will take in the spot market. A number of layers of credit enhancement will be necessary?. Jose Emilio Nunes Pinto, partner at Brazilian law firm Tozzini Freire Teixera e Silva, adds ?enhancement is a key word. This market will survive if we have a large number of solid transactions go through?. Laurent Vermer, from Tractebel South America believes that ?we should also look at the type of assets and the volumes involved. Development will be closely tied to the progress of the fast-track Thermal Plants Program ? it won't work just with hydro plants that typically sell their output through PPAs. Without a strong basis of thermal generation, the spot market will lack breath and depth and will be extremely volatile. Consequently the market for derivatives will not mature?. This last to a question on whether such instruments would ease the entry of sponsors into competitive energy markets. Enron is marketing weather derivatives, but the consensus is that these are too expensive to be deployed yet, with the possible exception, laid out by Jeff Lewis, of such support being provided by a sponsor to a project.
Brazil has instituted electricity rationing as a reaction to drought conditions and the sluggish pace of plant development. This has not yet concentrated the minds of the authorities, although it might lead to other creative solutions, including a possible resurgence of coal in the country. The chances of coal taking anything more than a token slice of the power market is slim, and as Rivera points out, World Bank guidelines make coal development tortuous. ?Lignite has potential but it is an environmental challenge. We have looked at coal only when the alternatives are much worse?, she says. European sponsors such as Tractebel and Steag have considerable form with coal plant development. Dr. Hermann Romer, general manager at Steag do Brasil, says ?we have found that coal can get very great political support when the government wants to diversify and have lower exposure to foreign risk. There are issues with the price per MWh and emissions and desulphurisation but it is something worth considering?. Other issues worth mulling over is how coal would fit in with the VN formula used to calculate gas prices, and whether the government would give priority to such an unpopular fuel when sitting on such large reserves of gas.
The last two issues that need to be overcome are turbine and financing availability. Both Enron an El Paso have apparently put turbines into synthetic leasing trusts with a view to installing them at projects in brazil. Signs are that elements in the US congress want to place obstacles in the way of much-needed turbines leaving the country. Some sponsors have reported having difficulties with coming back to manufacturers with changed sets of specifications. Such are the challenges of applying the rules forged in the white-hot US power market to a more relaxed environment such as Brazil.
In financing, the signs are much better ? not least tentative indications that BNDES might be willing to act as a co-lender, rather than extend its own separate facilities to projects. One participant in the Cana Brava deal recalls that the financing ran on two different tracks, which were pasted together at the end only with some difficulty. BNDES probably needs to take on more staff or advisory firms before it can get into some sort of synch with commercial lenders, but the logic behind the move is clear. As Ellis Juan from the IDB says, ?After some operations together, we and the IFC now have more similar credit documentation. We have law firms that are included in the short lists of both institutions, and so on ...Given the way the debt markets are behaving in the region it will be hard to finance without multiple sources and their increased transaction costs in the near term?.
Roundtable participants:
Chairman: Richard Cooper, US Chairman of the International Project Finance Association
Paulo Brito, Managing Director and Regional Head, WestLB
Ellis Juan, Co-head, Capital Markets Unit, Inter-American Development Bank
Antonio Eduardo Monteiro de Castro, General Manager for Ventures and Business Assessment, Petrobras
Jose Emilio Nunes Pinto, partner, Tozzini Freire Teixera e Silva
Nancy Rivera, Manger, Project Finance, Overseas Private Investment Corporation
Guilherme Noschese, Atlantic Rating
Jeff Lewis, Partner, Cleary Gottlieb Steen & Hamilton
There are several obvious reasons for the delays, the most recent of which is a period of currency devaluation that appears to have been partially exported from Argentina. The Real has lost 20% of its value since the start of the year, and has continued to slide, despite a central bank programme to sell $6 billion in reserves. These are the sort of numbers that make sponsors of gas-fired plants nervous.
Thermal plants have been conspicuous by their absence from the market. But a series of hydroelectric financings demonstrate the first use of structures that could be very useful to gas-fired projects.
Cana Brava, a 450MW hydro plant located in Goias, can justly lay claim to being the first international project financing under the new fast-track framework. As Marc Verstreate , from Tractebel's Brazilian subsidiary and effective financing vehicle Gerasul, noted, the 14-year, $165 million A-B Loan structure from the Inter-American Development Bank (IDB) is a useful reference point for future financings.
The second study, Ita, is equally interesting. Gerasul is a 48.75% owner of the project and, as in Cana Brava, the principal offtaker. Whilst financing from domestic development bank BNDES was considered for Cana Brava, the possibility of higher leverage, higher rate transparency and the unattractiveness of currency basket financing drove that project into the arms of the IDB. BNDES, however, has advantages when structuring a domestic capital markets transaction.
Ita is essentially the first appearance of a Brazilian capital markets project bond, and certainly a first for the power sector. Ita, through project company ITASA, raised R710 million from BNDES, including a R242 million direct loan, a R300 million indirect loan through Unibanco, Bradesco, Itau, Safra and Votorantim, and a R168 million 12-year debenture issue. The role of BNDES in the two-series note issue is that the debentures can be put to the bank in 2003 and 2004, respectively.
According to Marcio Guedes, Head of Debt Capital Markets at bookrunner Unibanco, after the bank began to approach institutions at an initial coupon of IGP-M +12.9% demand was overwhelming and the macroeconomic situation improved. In the end the issue came out at +11.2% until 2003 and +9.4% thereafter for both series. Like the bank portions, the notes benefit from security over the concession subsidiary, shares and credit rights over the PPA. Local currency financing, at roughly 12% and without the currency mismatch, can be very attractive, especially for hydro projects that can source sufficient local content.
And the environment for issuing local currency bonds is improving, since pricing increasingly reflects both interest rates and an element of indexation. Acceptance of this, coupled with useful maturities, should give local issues the edge over dollar-denominated bonds. There remains, however, the possibility of a decisive change in both government and energy policy, with the forthcoming 2002 presidential election. Continuation of President Cardoso's plans depends partly upon his current response to the energy and economic situations. Paul Bydalek, president of Brazilian ratings agency Atlantic Rating, says that project developers would be advised to involve as many sources of government financing as possible, whether to act as guides through bureaucracy or to provide a level of insulation to future political changes.
In international financings, however, sponsors have only just begun to explore some of the enhancements available. As Daniel Kastholm, Managing Director at Fitch and the day's chairman, notes, there are a number of credit enhancing structures that have been used to finance energy projects. The major integrated oil and gas companies, including Pemex, PDVSA and YPF, have effectively utilized export finance structures to lower borrowing costs for specific projects as well as general corporate purposes. But, he continues, these structures have found limited use in the power sector, which generally tends not to export product and generate hard currency (US dollars). However for the power sector, there are other reliable credit enhancing structures that have been successfully utilized including multi-lateral A-B loan structures, and political risk insurance provided by bodies such as OPIC, IFC and IDB or by third party private sector insurers.
Deal enhancements
The two most interesting enhancements involve capital markets transactions. The first of these comes from the IDB, which has been offering a currency transfer and convertibility product with which to wrap bonds. This has really only got off the ground for projects with very strong fundamentals and slight risk perceptions, as the San Pedro de Macoris deal in the Dominican Republic demonstrated. Nevertheless, the IDB is pressing on with the development of other guarantee products for non-commercial risks.
The IDB's Capital Markets Department has been stepping up its activities recently. The unit's head, Ellis J. Juan, outlined the various products in development, which include credit enhancement of project bonds and securitisations of future flows as well as the establishment of support for credit intermediaries acting as guarantors in local markets as well as supporting local on-lending to highly developmental activities. For the following 18 months, the first two will probably make up the bulk of the IDB's deal flow.
Equally promising is the new devaluation policy touted by Opic. This debuted in the AES Tiete deal, a $300 million international capital markets financing of a portfolio of hydro plants purchased by AES during the early stages of the privatization period. The policy acts more as a revolving credit, to be topped up and called upon as and when devaluation will lead to a mismatch between revenues and debt service.
Opic might be expected to be a major force in the drive to build new thermal plants ? it has commitments to four projects totalling $625 million. Opic, like most other agencies of its kind, does have project caps ($200 million apiece), and country limits, as well as less-defined industry limits. According to Nancy Rivera, project finance manager at Opic, however, serious hurdles remain, including currency and legal constraints and a lengthy and complex permitting process. Power purchase agreements (PPAs) are often renegotiated and indexation of fuel costs is not allowed. It is the annual process of fuel cost adjustments that is believed to have drawn most fire from Enron and AES recently.
But Petrobras looks more and more likely to take on a lead role in getting new plants off the ground. Opic's Rivera, when faced with the question of how to exploit the now much less aptly-named fast-track process in Brazil, is blunt: ?It's a simple answer ? partner up with Petrobras and let them do the deal. Petrobras has pretty significant debt issuance on its own but its CFO knows that although oil and gas can be financed in the capital markets, energy projects such as these have a different set of priorities?. Paulo Brito, managing director and regional head at WestLB, adds ?Petrobras is also advantageous in terms of tax treatment because LDCs cannot compensate for gas sales to thermal generation plants?.
Petrobras was on hand to outline what it can and cannot do. Antonio Monteiro de Castro, general manager for ventures and business assessment, is positive. ?Petrobras wants to monetise its gas reserves and we don't want to put obstacles in the way, although it is easier when we are a sponsor?, he says. ?But many worries about our involvement as a government entity are less about a role as a sponsor than the guarantees we extend to tolling agreements?. Dealing with other offtakers does not cause as much worry, even in the developing privatization situation because, as Rivera says ?it's something we've dealt with before. We deal with the strong utilities, but they are all candidates for privatization. Private offtakers have the edge for us because we require an offshore holding company for the SPV, which is difficult for the private sector?.
Getting a reliable gas supply is another problem for Brazil, since the country is not yet exposed to competition and the recent edging up in gas prices globally has not been kind to producers paid in Reais. A great deal of new pipeline capacity has been proposed, either through the GasAndes pipeline from Bolivia or from Argentina, which currently has plenty of gas to export. Rivera notes, however, that paying for gas under an import contract may be impossible under the present framework. However, far more important than availability is pricing, as Jeff Lewis, partner at Cleary Gottlieb Steen & Hamilton, notes: ?capacity is much less important than pricing, as we saw in California. There can be no fast track if there is not enough of an incentive to build new plants?.
But it would be unwise to expect the market for electricity to improve to any great degree either. The eventual aim for the Brazilian power developer would be to operate in a merchant environment but this situation is a very long way off. Whilst Enron has apparently made very good money out of operating plants on a day-to-day basis, it has had little luck in taking the plants off balance sheet. Brito at WestLB gives a lenders perspective. ?Too much of the generation capacity remains in public hands, so there is too little impetus to create a spot market?, he says. ?In the long-term in Brazil, as a bank looking at projects, we want to know what the system is going to be for thermal plants integrating with hydro units. We need to know how PPA plants will be dispatched, and we need to know how the central bank will react on gas imports. But the spot market is hard to talk about when so much capacity is in public hands?.
A spot market would also have to build up a track record before firms became comfortable with using it. Rivera says ?there needs to be a firm buttressing of what roles players will take in the spot market. A number of layers of credit enhancement will be necessary?. Jose Emilio Nunes Pinto, partner at Brazilian law firm Tozzini Freire Teixera e Silva, adds ?enhancement is a key word. This market will survive if we have a large number of solid transactions go through?. Laurent Vermer, from Tractebel South America believes that ?we should also look at the type of assets and the volumes involved. Development will be closely tied to the progress of the fast-track Thermal Plants Program ? it won't work just with hydro plants that typically sell their output through PPAs. Without a strong basis of thermal generation, the spot market will lack breath and depth and will be extremely volatile. Consequently the market for derivatives will not mature?. This last to a question on whether such instruments would ease the entry of sponsors into competitive energy markets. Enron is marketing weather derivatives, but the consensus is that these are too expensive to be deployed yet, with the possible exception, laid out by Jeff Lewis, of such support being provided by a sponsor to a project.
Brazil has instituted electricity rationing as a reaction to drought conditions and the sluggish pace of plant development. This has not yet concentrated the minds of the authorities, although it might lead to other creative solutions, including a possible resurgence of coal in the country. The chances of coal taking anything more than a token slice of the power market is slim, and as Rivera points out, World Bank guidelines make coal development tortuous. ?Lignite has potential but it is an environmental challenge. We have looked at coal only when the alternatives are much worse?, she says. European sponsors such as Tractebel and Steag have considerable form with coal plant development. Dr. Hermann Romer, general manager at Steag do Brasil, says ?we have found that coal can get very great political support when the government wants to diversify and have lower exposure to foreign risk. There are issues with the price per MWh and emissions and desulphurisation but it is something worth considering?. Other issues worth mulling over is how coal would fit in with the VN formula used to calculate gas prices, and whether the government would give priority to such an unpopular fuel when sitting on such large reserves of gas.
The last two issues that need to be overcome are turbine and financing availability. Both Enron an El Paso have apparently put turbines into synthetic leasing trusts with a view to installing them at projects in brazil. Signs are that elements in the US congress want to place obstacles in the way of much-needed turbines leaving the country. Some sponsors have reported having difficulties with coming back to manufacturers with changed sets of specifications. Such are the challenges of applying the rules forged in the white-hot US power market to a more relaxed environment such as Brazil.
In financing, the signs are much better ? not least tentative indications that BNDES might be willing to act as a co-lender, rather than extend its own separate facilities to projects. One participant in the Cana Brava deal recalls that the financing ran on two different tracks, which were pasted together at the end only with some difficulty. BNDES probably needs to take on more staff or advisory firms before it can get into some sort of synch with commercial lenders, but the logic behind the move is clear. As Ellis Juan from the IDB says, ?After some operations together, we and the IFC now have more similar credit documentation. We have law firms that are included in the short lists of both institutions, and so on ...Given the way the debt markets are behaving in the region it will be hard to finance without multiple sources and their increased transaction costs in the near term?.
Roundtable participants:
Chairman: Richard Cooper, US Chairman of the International Project Finance Association
Paulo Brito, Managing Director and Regional Head, WestLB
Ellis Juan, Co-head, Capital Markets Unit, Inter-American Development Bank
Antonio Eduardo Monteiro de Castro, General Manager for Ventures and Business Assessment, Petrobras
Jose Emilio Nunes Pinto, partner, Tozzini Freire Teixera e Silva
Nancy Rivera, Manger, Project Finance, Overseas Private Investment Corporation
Guilherme Noschese, Atlantic Rating
Jeff Lewis, Partner, Cleary Gottlieb Steen & Hamilton
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