Monday, 17 December 2018

Building a prosperous future

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Like an oak tree planted in a terracotta pot, Latin America’s growth is being stunted by second-rate infrastructure. From the generators powering the factories to the roads transporting the goods they produce, Latin American governments realise stellar economic performance requires world class infrastructure, and many are turning to the market to ensure they deliver it, as Solomon Teague reports.

Latin America can crudely be divided into socialist and free-market camps and the financing of infrastructure projects is primarily a product of a country’s politics. The left-leaning block – including Venezuela, Argentina, Ecuador and Bolivia – see infrastructure as a necessity which it is the state’s duty to provide. The government therefore retains maximum control of the provision of all roads, railways, water, sewage systems and power.

Conversely, in Brazil, Chile, Peru, Mexico and Columbia there has been an increasing acceptance that the private sector has a role to play in the provision of infrastructure.

It has not always been an easy decision for the governments to make, noted Felipe Jens, head of project and investment finance at Odebrecht Investments Infrastructure, the group responsible for the funding of many of Odebrecht’s infrastructure projects. When the government of Luiz Inacio Lula da Silva came to power in Brazil there were few believers in the privatisation of state infrastructure in his party, he said.

Brazil, like most of the countries in Latin America, has enormous growth potential that is not currently being fully realised; the lack of ubiquitous power, transport links and water, taken for granted in the US and Europe, is one of the biggest obstacles to this growth.

At the beginning of Lula’s years in office key people in the government came to believe the state was not able to deliver infrastructure of the quality Brazil needed, Jens said. In 2006 a major campaign of infrastructure improvements running to 2011 was announced, in which the private sector is set to play a key role.

The Brazilian government has ambitious targets in this area, including plans to build 2,600km of new highways, 2,000km of power lines and a new north to south rail route, said Francisco Claudio Duda, managing director of capital markets and investments at Banco Do Brasil. This is a huge opportunity for investors, he noted, speaking at IFR’s Brazilian Corporates Forum in London in late 2007.

Jens cites local studies that have indicated Brazil will invest approximately R135.8bn (US$78.6bn) in infrastructure projects between 2008 and 2011, of which R50.4bn will go into minerals projects, R26.9bn into metals, R21bn into energy and R19bn into roads.

Other infrastructure developments such as water, sanitation and railways have been allocated smaller sums via concessions or public private partnership (PPP) schemes. The government usually provides a proportion of the overall financing in both instances through one of the Federal Banks: BNDES – Banco Nacional de Desenvolvimento Economico e Social or CEF – Caixa Economica Federal.

A concession is usually granted where there is little perceived risk to the project’s ability to raise financing, and where it is expected to generate sufficient revenue to pay debt and equity holders. In these situations the government provides no guarantee of extra capital, leaving the company to which the concession has been granted with the sole responsibility for receiving the project cashflow, Jens said.

The west portion of the Sao Paulo ring road, for example, was constructed over four years by the government through public works, and now has been delegated to the private initiative via a 30-year concession. The government of Sao Paulo will receive a down payment of R2bn in two years, plus 3% of the project revenue throughout the concession period. Currently the south portion of the ring road is under construction, of which R200m–R400m is being done by Odebrecht.

Where financing is harder to secure – either because revenue generation will not be forthcoming for a long time or because the there is uncertainty as to how profitable the project will prove – the government is likely to proceed with a PPP. This provides a government guarantee to ensure the project’s completion, and has been used recently in sanitation projects: Odebrecht has been awarded five sanitation contracts which are currently ongoing, of which three are PPPs and two are concessions.

Such investment opportunities are not confined to Brazil and can be found throughout the continent, where infrastructure is struggling to keep up with demographic trends and economic growth. Investors are especially eager to access infrastructure companies in difficult times, noted Peter Earl, managing director of Rurelec, a British company committed to the development and operation of power companies in Latin America and South Africa. Demand for basic necessities such as clean water and power is constant and returns on investment are predictable, he said.

This factor links infrastructure projects of otherwise different types and there are no clear trends about which type of financing works for which sector of infrastructure, added Jens. “The main considerations are where a project is and the political motivation to get it done,” he explained.

“Each project is different. You need to consider its likely capital structure and exposures. How much can it take in real, dollars or euros? If there is sufficient interest it pays to raise more in equity, and you need to make the terms appealing for that. But such investor interest is more likely once a type of project has a track record – when that type of project in that area has proved it can be profitable.”

For example, in Brazil a road is relatively easy to fund as there have been profitable projects in the past; the same is true for power projects. But water and sanitation projects are proving more challenging, Jens noted, though hopefully this will change as the first big projects prove a success.

In 2006-07 Odebrecht was awarded contracts for the construction of two toll roads in Peru on a PPP basis, IIRSA Norte and IIRSA Sur, as well as a concession – Olmos – to develop water transportation. Funding for the water project was secured predominantly through the local capital markets, especially from institutional investors including insurance companies and local pension funds. The toll roads attracted international financing, denominated in dollars.

Going offshore

International investors are increasingly interested in Latin America, not least because of the commodity exposure offered by some countries there. However, marketing Latin American securities to international investors is not without difficulties: “It is a huge challenge for Brazil to get real-denominated financing,” said Jens. “Multinationals and foreign institutional investors are concerned about investing in Brazil because of the currency mismatch exposure it entails.”

Jens does not believe the real’s value is likely to change dramatically against the dollar in the foreseeable future, yet investors with a long-term view are still troubled by any real-denominated exposures. While hedging is an option for smaller investments, Jens admitted the derivatives markets have insufficient depth for the numerous, billion dollar projects to which foreign investors might otherwise be attracted.

“Private equity companies can take the risk on R40m–R50m but for big projects like Odebrecht’s Madeira project [the construction of a dam for the generation of hydro-electric power] costing R10bn–R11bn, meaningful foreign investment is more challenging to secure,” Jens said.

Yet the macro economic case for Latin American infrastructure projects is overwhelmingly attractive.

There are no universally accepted, definitive figures for the relationship between infrastructure and economic growth, but there is no doubt power failures harm GDP growth. Bolivia has been growing at a rate of 5%-6%, its fastest rate in 10 years, said Rurelec’s Earl, unpinned by the reliable power supply it has enjoyed. However, population growth has been outstripping new power supply, threatening blackouts unless new capacity is built.

According to Earl, electricity consumption grows at approximately 1.5 times the speed of GDP. A country growing at 5% – typical in the region – would therefore expect to see electricity consumption grow at around 7.5% or more, meaning countries have to work hard on power generation just to stand still.

Empresa Guaracachi is a Bolivian subsidiary of Rurelec which has recently exploited an opportunity arising in Bolivia.

In late 2007 Empresa raised around US$40m in domestic bonds after receiving authorisation from the Superintendencia de Pensiones, Valores y Seguros, the Bolivian financial market regulator, for use in addressing Bolivia’s electricity shortfall.

The bonds were rated A+(Bol) by Fitch and placed with Bolivian financial institutions by Credibolsa, the brokerage arm of Banco de Credito de Peru. Its first tranche was worth US$20m, had a maturity of 10 years with principal payments of 33.33% in year eight, 33.33% in year nine and 33.33% in year 10, and an annual fixed interest rate of 8.55%, which will be paid semi-annually.

Supplementing this financing, it arranged a project loan of US$20m to convert capacity at the Santa Cruz de la Sierra power plant to combined cycle gas turbines (CCGT), making it the first CCGT plant in Bolivia. Empresa predicted the plant, upon completion in early 2009, will generate 96MW of electric output, representing more than 10% the country’s peak demand.

KfW, the German development bank, provided a subsidised tranche of lending in recognition of the importance of the CCGT project for the infrastructure expansion of Bolivia. Such arrangements are important to Rurelec and its subsidiaries, which count on the strategic importance of the power sector to governments, ensuring governments subsidise the private sector funding they receive. Earl noted Empresa was able to secure 10 year unsecured borrowing cheaper than Citi is able to fund itself, despite the negative sentiment in the debt markets in late 2007.

“The basic cost of the CCGT project is circa US$40m, or US$416,000 per MW of incremental capacity,” explained Earl. “The final funding requirement will also include Bolivian VAT and import duties as well as interest during construction. Taken together, these items add a further US$10m to the capital budget for the conversion and take the total funding requirement of the CCGT project to US$50m.”

Rurelec is underleveraged relative to its peers in the Latin American power sector, most of which have a gearing ration of around 2:1. It is therefore able to raise its capital on the debt markets without overstretching itself and having to resort to the equity markets, where it trades at a discount to its peers, for example Chilean generators.

Most of these competitors, Earl noted, are larger, attracting more interest from a range of interest, giving them more liquidity which inflates their price. Rurelec’s investors, on the other hand, are predominantly buy-and-hold, blue-chip, professional investors, he said, with a view on the long-term growth prospects of the company. The relative lack of liquidity acts as a drag on the share price, which dissuades Rurelec from regularly tapping the equity markets.

Guaracachi is also working closely with Rurelec to create a carbon financing programme which will provide further project funding. “Carbon will be an important form of financing in the future,” Earl said, noting this project exemplifies the spirit of Kyoto, with developed countries subsidising the creation of efficient, green technologies through the purchase of carbon credits. The carbon financing program will utilise the future revenues from the forward sale of carbon credits which will be generated by the CCGT plant when it opens. It is another interesting avenue for revenue generation and one with particular potential for Latin American countries. (For more on carbon and other green issues see page 18-19)

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