Mexico plans to increase its generation fleet by over 50% over the next 13 years, a plan that will require the thousands of MW of new gas-fired generation. Mexican power projects have established a strong record – both as independent power projects and public works financings – so this slate presents some tempting investment opportunities. Gas pipeline projects may lure some of the biggest international players – and also potentially international financial sponsors. The wind and solar sectors, while comparatively immature, promise significant gains in the next decade.

But the obstacles to closing big-ticket financings in the Mexican market are significant. Some of the country’s most robust wind resources are well off Mexico’s grid. Mexican pension funds, or afores, are still building up experience in infrastructure. Sponsors face varied risks, including acquiring rights-of-way and managing the impact of currency fluctuations.

PRI regains primacy

On 1 December, Mexico will return to the leadership of the Institutional Revolutionary Party (PRI), the party that dominated the country for 71 consecutive years until 2000. Yet there is scant sense among investors and sponsors that they will be exposed to any heightened political risk under the eventual rule of president-elect Enrique Peña Nieto.

Most political observers believe that PRI has reformed itself during its 12 years in opposition, coinciding with a deepening of Mexico’s democratic roots. The PRI’s victory can’t be attributed simply to nostalgia; Peña Nieto won a plurality July 1, beating three other candidates, and while the second-placed candidate, Andrés Manuel López Obrador, demanded, and won a limited, recount, the PRI candidate is certain to be named winner before 6 September.

Significant change, however, isn’t expected in the power and infrastructure sectors. Peña Nieto, like his rivals in the presidential race, has pledged to sustain the efforts of his predecessor, Felipe Calderón, to build power generation and related energy infrastructure, as well as to bolster the country’s transport network.

If anything, Mexico may offer greater long-term clarity than some of its neighbours, including the US. In the US, investors are unclear whether the production tax credit – the longest established and least unpopular incentive to the development of wind capacity – will be available in 2013. In Mexico, state-owned power company the Comision Federal de Electricidad (CFE) has publicly identified long-term needs and procurement programmes, allowing sponsors to allocate resources to the sector with more confidence

Renewables plants closest to market

Mexico’s 15-year generation plan, in particular, is ambitious. The country had a generation fleet of 51,686MW in 2009. It anticipates a net gain of nearly 27GW by 2025, according to figures from Mexico’s Secretaría de Energía (Sener). Wind will comprise much of that growth. In 2007, Mexico had just 87MW of wind power installed. By next year, it will have more than 28 times that figure – over 2,500MW – installed. Almost 6,000MW of wind may be operational in Mexico by 2025. But even that number is set to surge. According to the local trade body for the wind industry, the Asociación Mexicana de Energía Eólica (Amdee), Mexico has a potential to generate 20,000MW in wind, including 5,000MW in the Oaxaca area, where Macquarie developed, and recently closed, the financing for the 396MW Mareňa Renovables plant.

Solar generation comprises a tiny proportion of Mexico’s power portfolio, but as with the country’s wind fleet, will gain market share. Developers are set to bring to market a series of modest-sized utility-scale plants and should complement those with a small number of large projects. At least one solar project under early development promises to rival the output of some of the large projects being built in the south-western US. A pair of US-based developers, SolFocus and Synergy Technologies, have formed a joint venture with Mexican real estate developer Grupo Musa to build a $1.5 billion, 450MW solar photovoltaic project near Tecate, Mexico, in Baja California. They say they plan to finance and build out the Tecate project in phases of 50MW, though the project lacks an announced power purchaser.

Bulking up in baseload

Mexico’s climate and the immense wind resource of Oaxaca have given Mexico a serious boost in intermittent renewables, but the country has a huge need for additional baseload generation. Gas-fired capacity currently enjoys an advantage over coal-fired plants, in part because of emissions concerns, and also because the upfront cost of gas plants is lower, but mostly because the price of gas has plummeted in the past five years, on the back of increases of supply in the US. The CFE wants to add 4.1GW of new generation in Mexico’s northern region by the end of 2016.

Accompanying this expansion to Mexico’s gas-fired fleet will be the pipeline infrastructure necessary to serve these facilities. The CFE plans a series of gas pipeline projects in the country’s north and west, which will import gas from Texas, and has several tenders pending. CFE will examine bidders’ operational experience and financing plans, including project and/or corporate debt structures. Market sources suggest that the CFE may require bidders to use balance sheet financing if they cannot complete a non-recourse deal within a particular timeframe. Potential bidders include Hyundai, Samsung and TransCanada, say market observers. Interest in the tenders is strong, financiers say, because the pipelines will feature manageable construction and operational risk and the CFE is an investment-grade offtaker (Standard & Poor’s rates CFE’s foreign long-term debt BBB and its local long-term debt A-).

There is also now a recent financing precedent. In April, Fermaca and Ospraie Capital Management signed a $378 million debt financing for the $472 million Tarahumara pipeline project, which funded in May. The 540km gas pipeline will run through the state of Chihuahua and sell its capacity to CFE under a 25-year contract. Fermaca is a Mexican midstream operator, while Ospraie is a New York-based hedge fund.

Tarahumara takes off

In the Tarahumara deal, Fermaca and Ospraie had to assemble a cost-effective financing for a modest-sized project in Latin America amid the most turbulent stretch of the euro-zone crisis. The two sponsors blended an Asian, Canadian and European bank group (Bank of Tokyo-Mitsubishi UFJ, Crédit Agricole, ING and Scotiabank) with local development banks Banamex, Banobras and Nafinsa. Local banks – as well as export credit agencies – generally are not essential for bank deals under $400 million, bankers say, but with liquidity in shorter supply than 18 months ago, financings that approach $1 billion certainly will need to bring in new players.

Fermaca and Ospraie mandated lenders in the fourth-quarter of 2011, months after S&P downgraded its US sovereign rating, and as several European banks reduced or eliminated their project finance offerings amid increases in their costs of funding. The sponsors understood that the bank climate had evolved, lenders say, noting that Fermaca and Ospraie smartly stayed within the limits of what banks could achieve.

Pricing starts at roughly 350bp over Libor, a margin that cleared participating banks’ minimum hurdles (and is a shade wider than most US project financings in recent months). The financing is a seven-year hard mini-perm, with a 20-year amortisation schedule. Such a maturity accommodates the impending introduction of the Basel III regulations, which will discourage the tenors of beyond 15 years that European lenders used to grant freely.

The Tamahumara deal was, like all previous CFE project financings, denominated in dollars. In this bank climate, peso-denominated deals will struggle to raise debt, bankers say, because most US and foreign lenders lack significant peso capacity, and the cross-currency swap market is still shallow enough that placing a large project financing would probably move the market.

Liquidity in the long-term

On its face, the Tarahumara deal seems fairly straightforward – a club of local and international lenders got behind an asset with a respected offtaker – but it featured risks that likely will confront investors and lenders in succeeding CFE pipeline financings.

Given the contraction in their funding base, European lenders are increasingly selective and favour relationship sponsors, a trend particularly apparent at the French banks.

Smaller or emerging sponsors that want to bid on the 2012 CFE slate will find raising financing daunting, whereas large Asian sponsors, in particular, should have an easier time. Asian sponsors could lean on Japanese banks, which can offer vastly longer tenors than their European counterparts, and local export credit agencies. Such a bank climate will encourage sponsors to consider alternative financing schemes, including bonds and private placements.

Deals mixing bank debt and bonds are also possible, whether in the global dollar or Mexican market. The pipeline projects, which do not feature commodity risk and have straightforward operational risks, may be prime candidates for the capital markets. The demise of a planned bond refinancing for GE and Abengoa’s Nuevo Pemex cogeneration plan provides a note of caution, however.

Local afores, the most obvious local investors in energy and infrastructure bonds, prefer peso-denominated financings, however, and have little appetite for construction risk. Asian, Australian, Canadian and European pension funds, however, typically prefer dollar-based deals. As long as the CFE and Pemex are prepared to offer US dollar-based payment obligations, international bonds would be more likely.

Land rights and wrongs

Tamahumara highlighted another issue that continues to bedevil the entire Mexican project finance market. On the deal, CFE declined to acquire rights-of-way for the pipeline, as it had in some other deals, notes Octavio Berrón Cámara, Fermaca’s chief financial officer. The sponsors needed to acquire both 35-year rights-of-way for the pipeline, and shorter-term rights of access during the construction process. Fermaca has an in-house rights-of-way group with expertise in procuring the necessary rights.

Observers of the CFE suspect sponsors will have to assume rights-of-way risk on future pipeline deals, though the form may change. CFE may, for instance, sell or transfer a trust possessing rights-of-way to winning project bidders.

It’s not just pipeline projects that require such efforts to acquire land for projects in Mexico. With the Marena Renovables wind project, Macquarie had to negotiate with 1,000 landowners for a 52km electricity line to ultimately connect the facility to the grid, notes Mark Ramsey, an executive director at Macquarie in Mexico. It also had to snag 63 environmental approvals for the project.

Outside the energy sector, the state of Puebla cancelled OHL’s concession to build a bypass around its eponymous state capital. The state pointed to some irregularities in the original tender, but the glacial pace at which OHL acquired rights-of-way gave the state additional ammunition. Delivering energy – whether gas or wind-powered electricity – from where the resources are abundant to where they are needed, will require sponsors to get much better at this.