Coal and hydro are emerging as the mixture of fuels that will power the growth in Chile’s generating fleet. Both have their drawbacks, including the environmental permitting issues with both hydro and coal, and concerns over the emissions of carbon dioxide and other gases from coal-fired facilities. But given that Chile lacks other large-scale generating options or an effective renewable energy incentive programme, they are the only feasible options on the table.

After the permitting crunch, the PPA crunch

At least five big coal-fired and hydro power projects could reach financial close in 2012.

AES Gener, E-CL and MPX Energia are between them looking to add an additional 4.29GW of capacity, split between the separate northern Sistema Interconectado del Norte Grande (Sing) grid in the north and Sistema Interconectado Central (Sic) central grid. These include the 2.3GW Central Castilla coal-fired plant (MPX), 750MW Infraestructura Energetica Mejillones coal plant (E-CL), 560MW Cochrane coal plant (AES Gener), 531MW Alto Maipo hydro plant (AES Gener) and 152MW Guacolda V coal plant expansion (AES Gener). While they all have their environmental approvals from the government – no insignificant feat in environmentally sensitive Chile – they lack the power purchase agreements (PPA) necessary to raise project debt.

“It remains to be seen when and which of these projects actually come to market,” says Nicolas Uauy, Santiago-based managing director of corporate and investment banking at Banco Santander. “All of the projects are approved and waiting to sign PPAs with offtakers.” He adds that mining companies will most likely be the offtakers, except for Alto Maipo, which is close enough to the Santiago metropolitan area that it could end up signing an agreement with one of the electric utilities serving the area.

Any deal would be welcome. Environmental issues have delayed or cancelled every conventional power project since Pacific Hydro closed a $172 million non-recourse loan for its 106MW Chacayes hydro project with Calyon, DnB Nor, Societe General and WestLB in May 2009. Chilean president Sebastian Pinera’s August 2010 phone call to GDF Suez, asking it to cancel the approved (though not financed) $1.1 billion, 540MW Barrancones coal plant, bowing to public opposition, was a low point.

Chile needs the power. The average marginal cost for electricity, which is indexed to the US dollar, is about $160 per MW, but it has peaked at more than $200 per MW during the past year. The country competes with Uruguay for the dubious distinction of having the highest electricity prices in Latin

America. Demand for electricity is expected to increase by about 6% annually, with increased demand coming mostly from new mining projects, in both the Sing and Sic grids, as well as general economic growth.

Environmental question

Environmental issues are the most significant hurdle facing project developers in Chile. Numerous market participants agree that this is the reason why there were no greenfield conventional power deals in Chile during the past two years. Still, developers are eager to move forward with projects, since the persistent gap between demand growth and the capacity that can get permitted promises healthy ongoing profits.

Gener’s 270MW Campiche coal-fired plant is an example of the challenges. The $550 million Campiche project received its environmental approvals in April 2008 and construction began the following month. However in June 2009 Chile’s supreme court suspended its environmental license, which halted construction. Then, later that year, the local municipality issued a demolition order for the 40% of the plant that had already been built. Construction did not resume until the fourth quarter of 2010 after its license was reinstated and the sponsor agreed to invest more than $50 million in additional environmental protection systems and local social programmes.

Environmental issues killed the project financing for Campiche. Gener launched a $445 million, 10-year loan, arranged by Calyon and Fortis, at the beginning of 2009. However, it was unable to close the loan before construction was halted in June, even after cutting the size of the package to a $220 million and shortening the tenor to 7 years. The plant was funded on the sponsor’s balance sheet once construction restarted.

Barrancones never got as far as Campiche. The project was cancelled at the request of president Pinera less than a week after it received its environmental approvals in August 2010. Despite using technology that reduces emissions and pollutants, its location near the Punta de Choros marine wildlife sanctuary proved more controversial than GDF Suez expected and prompted a wave of national protests.

Perseverance is a key in-house capability at Chilean sponsors. Gener’s $900 million Alto Maipo run-of-river hydro project would have collapsed if not for corporate support. The project includes two facilities, the 275MW Alfalfal II in the Colorado River sub- basin and 256MW Las Lajas on the Maipo River, west of Santiago. The developer originally submitted an environmental impact statement for the plant in 2006 but had to resubmit a revised version following complaints in 2008. It received approval in 2009 but construction has yet to begin. The National Sanitation Service Authority began an investigation into Alto Maipo’s water rights agreement with Aguas Andinas, which the developer says is legal, at the request of the national legislature in September 2011. Gener still expects financing to close and construction to begin before the end of the year. Claro y Cia is legal counsel to the developer.

The environmental issues come after a decade of seesawing between fuel choices. Nuclear was under discussion, with varying levels of sincerity, in seismically active Chile until the Fukushima Daiichi meltdown following the Tohoku earthquake in Japan in March 2011. Natural gas was the favoured fuel early in the last decade – until Argentina cut off gas exports in 2004. Even hydro’s popularity has waxed and waned, such as when drought left many turbines idle in the late 1990s.

Natural gas generated 34.3% of Chile’s electricity in October 2011, according to the most recent data available from the country’s Comision Nacional de Energia. Coal generated an additional 27.5% and hydro 23.4%, with the remainder provided by various types of oil and a few wind plants. Numbers include only the Sing and Sic grids, which serve the vast majority of Chile’s electricity load.

Banks still ready

Lenders still have a healthy appetite for the slate of proposed power projects. This includes local and foreign banks, as well as multilaterals and export credit agencies (ECA). Project loans are the preferred source of debt but bonds are an option if projects can achieve a BBB- or better rating and have full completion guarantees.

E-CL’s Mejillones is ready for the market once it finds an offtaker. The $1.5 billion coal plant is located near the Mejillones liquefied natural gas import terminal in the town of the same name in the northern Sing grid. The developer, 60% owned by GDF, predicts demand for at least 570MW of new electricity generating capacity from mining companies by 2015. Collahuasi’s phases one and two, Quadra FNX’s Sierra Gorda, Teck’s Quebrada Blanca copper mining projects, which are scheduled to come online between 2015 and 2018, are potential offtakers.

Lenders do not need contracts for a plant’s full output. E-CL expects to close debt financing for Mejillones with contracts for about 50% of its capacity. Bank of Tokyo Mitsubishi UFJ (BTMU), HSBC, Mizuho, Scotia Capital and Sumitomo Mitsui Banking Corporation (SMBC) are talking with the developer regarding a deal. Other thermal projects, especially those in the Sing grid, where there are numerous additional mining projects planned, can probably close financing with partial offtake contracts.

Local banks have the capacity to lend up to about $300 million per project, with tenors of 10 to 15 years, according to various banking sources, and Corpbanca, Banchile and Banco BICE are all active in the market. However, that debt comes with a higher all-in cost of financing to project companies because the lenders have to raise US dollar capital through either currency swaps or the Chilean central bank. Lower fees charged by local law firms can at least partially offset these costs.

International banks can also support a tranche of about $300 million, but at tenors of only about 10 years. Financing costs are lower but international lawyers, as one sponsor points out, are more expensive than local ones. Canadian, Japanese and select European banks are still active in the market.

Multilateral and ECA debt is the most bountiful source of financing. Developers should be able to source about $700 million in debt for projects, which could be joined with commercial bank debt either through an A/B loan or a guaranteed/unguaranteed structure to raise more than $1 billion. This is attractive for large projects but has the drawback of typically slower approvals processes and country-specific content requirements.

Renewable pop

Several wind projects may close before some of these utility-scale thermal plants. These often face less environmental opposition and approvals are relatively easy to obtain, especially in Sing, according to one developer active in the market. Offtake contracts and financing are not quite as straightforward.

Chile’s non-conventional renewable energy programme is not supportive of easy project financings. It requires that 5% of the electricity sold by power companies must come from renewable sources (not including large hydro) but the penalty for not meeting this requirement is often cheaper than the cost difference between producing electricity from a renewable source and using a conventional one. In addition, capacity factors for wind in Chile are typically around 25%, compared to a global average of about 35%. “It is often cheaper for a utility like us to just pay the penalty than it is to build and sell electricity from a [wind or solar] plant,” says the sponsor.

Mining companies are willing to sign renewables PPAs. Electricity generated from these sources can be economically competitive without incentives due to the high average marginal cost of electricity in Chile. However, the slow development of the industry is often attributed more to a lack of familiarity with the technologies than anything else. Pattern Energy’s 115MW El Arrayan wind farm in the Sing, E-CL’s 100MW Calama wind farm in the Sing and Bosques de Chiloe’s 36MW San Pedro wind farm in the Sic are expected to come to market soon.

BTMU and SMBC are leading a $200 million club loan for El Arrayan, which local banks are expected to join. It has one of the few signed PPAs in the sector, a 20-year agreement for 40MW of capacity with Antofagasta Minerals subsidiary Minera Los Pelambres. The offtaker also has the option to buy a 30% equity stake in the plant, which will be the largest wind facility in the country when it opens in the second half of 2013. AEI Energy bought 55% of the project from Pattern in January 2010, following a joint development agreement covering Brazil, Argentina and Chile that the two signed in November 2009.

Calama and San Pedro do not yet have PPAs. The $280 million Calama is likely to sign an agreement with a mining company, based on E-CL’s outlook for demand growth in the Sing. The plant, which received its environmental approval in December 2011, will use 55 turbines and includes 28.5km of transmission lines. San Pedro’s developer is likely to sign a PPA soon because it is already in talks with BBVA and Banco Santander for a $100 million loan, according a source familiar with the process. The plant will use 20 1.8MW turbines.

Power plant financings could dominate the Chilean market this year. This is especially true as lenders look to the sector to pick up the slack left by a lull in the country’s infrastructure concession programme. Renewable energy will grab headlines, but conventional deals are critical to the country’s continuing growth and development.