Tuesday, 17 July 2018

Green bucks

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As carbon credit systems evolve and environmental awareness grows around the world, Latin America is in the forefront of what could become a significant market in the future. For now, however, it remains, essentially, just an idea. Environmental finance has been limited to a few big renewable energy producers tapping equity and debt markets. Christopher Langner reports

As on so many other fronts, Latin America has huge untapped potential when it comes to environmental financing. The Southern Cone is especially well positioned to capitalise, using mostly clean hydroelectric power and being home to both the largest tropical forest and the most important fresh water complex in the world – the Amazon and the Guarani Aquifer systems.

Most of the projects related to conservation are still funded with government and multilateral money. Carbon credit generation and marketing is incipient and has potential to mature.

Ideas to generate revenue and facilitate lending to environment-friendly projects are emerging slowly. Recently they have started making more economic sense. As the ethanol industry develops and more global-warming-conscious international players enter the business, financing for co-generation and carbon-credit generation is becoming more common.

So far, the core of the business has been generated in Brazil – expected to be the main market anyway – focusing on the alternative energy industry. According to the world bank, Brazil alone generated 4% of the world’s carbon credits in 2006.

International players entering joint-ventures with local ethanol producers have started to use future flows of co-generation from the mills to get better loans rates to finance new projects. Some are already considering the carbon-credit potential of new projects in their spreadsheets.

Such talk is arguably premature. Even talking about private environmental financing in Latin America still seems somewhat far-fetched. To date, apart from state funded and executed projects, environmental finance has been limited to alternative energy companies tapping equity and debt markets – the former more than the latter. According to a study by Brazilian researcher Carlos Eduardo Frickmann Young, the state still provides more than 90% of the funding for environmental projects.

Renewable equity

Most of the so-called private environmental financing has been limited to market funding deals for renewable energy companies. Brazilian ethanol producer Cosan kick-started funding for alternative energy companies with an IPO in November 2005, with which it raised R$886m (US$521.2m at the current exchange rate). The deal saw huge demand, requiring the local regulator to impose a cooling off period to avoid a disproportional price overshoot. Shares still priced at R$48 each, above the suggested range of R$40-R$46 at the time.

Cosan was followed in November 2006 by Brasil Ecodiesel, which promised to bank on the rise of biodiesel production in Brazil, and on new local regulations which require 2% of all diesel sold in the country be produced from renewable sources.

That, however, failed to emulate Cosan's investor allure, and since the IPO the stock has seen huge swings. The company priced its shares at R$12 originally. After falling to R$8.8 it shot up to R$14.5 in July last year, and they were recently being traded at R$4.8 in Bovespa. It indicates investors are not overly confident on the future prospects of the company.

The volatility experienced by Brasil Ecodiesel also scared away potential issuers from the same sector. The biodiesel units of meatpacker Bertin, energy concern Petrosul and palm-oil producer Agropalma are among intended spin-offs that failed to materialise.

Cosan was also the first alternative energy producer to tap international debt capital markets. The company priced its first cross-border deal in 2004, when it sold US$150m in five-year unsecured notes with a coupon of 9.5%. As the market became more familiar with its activities and name, Cosan got better terms and last year it financed the buyback of the same five-year notes with a 10-year note which priced to yield 7.25%.

Cosan itself cooled out investor interest in other ethanol producers, after a share restructuring, culminating in a second IPO for a Bermuda-based company – Cosan Ltd – controlling the original listed company. It was a move that sent the sugar and ethanol producer's stock down the drain to a low of R$23. It also left investors suspicious of the sector: the newly created company controlling Cosan issued supershares to Rubens Ometto, its chairman and CEO, to ensure he would retain control. Despite the share price debacle, Cosan still raised US$1bn with the share offer, most of which was earmarked for green-field projects.

Ethanol SPACs

Another company that raised money in international capital markets and banked on the appeal of renewable energy sources was Infinity. The special purpose vehicle headed by controversial executive Sergio Thompson Flores raised US$300m with a stock listing in the Alternative Investment Market of London in 2005. The company went on with a string of acquisitions, though its results have been mixed. It was heard mulling a local Brazilian listing last year, but pulled the deal after volatility all but closed the IPO market there.

Despite the equity avenue, the alternative energy financing has mostly been limited to private loans and direct stake acquisitions by private equity firms. The fact that the companies in the sector are almost all family-owned and, in general, have very poor disclosure, partly explains this.

Some of these companies have been in the hands of a single family for centuries, and such dynasties often resist giving up ownership. "The Brazilian ethanol industry is a small club in which everybody knows each other, and foreign investors often are gobbled up," said the chief operational officer of a German renewable energy company (which failed to reach agreements with local companies after several attempts, due to management and disclosure issues).

Others, like Clean Energy Brazil (CEB) have been more successful. The Isle Of Man-based company started as a special purpose acquisition company listed in the London Stock Exchange. It was headed by Brazilian executives who used a careful strategy, creating joint-ventures and facilitating financing for local ethanol concerns, instead of pursuing full-blown buyouts.

CEB is banking on the growing unregulated energy market in Brazil, where co-generation plants can sell their excess energy for around R$240 per Megawatt. "The real kickback for the investors – usually hedge funds and less traditional lenders – is that they will participate on the offtake in the electricity sector," said Peter Thompson, the company’s chief executive.

To help finance one of the green field projects under its first joint-venture - Usina - CEB used future flows from a co-generation energy plant in the sugar mill, being built as collateral to get better terms on bank loans.

Carbon credit securitisation

Using the same line of thought, some companies have started to consider securitising future flows from carbon credits. "It is feasible, though no one in Brazil has done it yet." said Gustavo Soares, senior investment manager at E+Co, a Brazilian private equity firm.

There is a potential market of US$300m for creation of carbon credits in the next five years in Brazil alone, according to Soares, a pool of credits that could eventually be fully securitised. It will take a big producer of carbon credits to get the first deal done and set the precedent. A couple of years ago, a big utility in Sao Paulo looked into the idea but it never got off the drawing board. If it had materialised it could have kick-started the market.

For now, getting the carbon credits at all is an achievement. E+Co offers money and consulting to small firms with credit generating potential on how fulfill their potential. It gets paid from a cut of profits and proceeds from the eventual sale of the carbon offsetting rights sale.

Instead of acquiring a stake in the company or starting a joint-venture, E+Co has chosen a debt approach, offering funding at attractive rates to companies with carbon emission reduction (CER) credit potential. It focuses on renewable energy and has concentrated its investments in biogas projects. It has, so far, committed about US$4m to its investments but it plans to reach US$20m in a few years.

E+Co is just one of the firms doing that. Currently, the biggest player in the area is UK-based Ecosecurities. Brazil represents 16% of the US$292m in projects in the company's portfolio. Most of Ecosecurities' Brazilian investments are concentrated on small scale hydroelectric plants.

Ecosecurities has also already started to sell derivatives of CERs in international markets. It was the first company to launch a securitisation of a diversified portfolio of emission reduction purchase agreement (ERPA) contracts via Credit Suisse last year. The novelty could soon catch up and become a major market.

There is already a lot of potential for that kind of debt transaction and Latin America could represent a major market, considering the existing pool of assets. According to the United Nations Framework Convention on Climate Change (UNFCC), until March Latin America had 331 carbon emission reduction credits registered – 34.3% of all worldwide projects. The UNFCC estimates global aggregate volume in all listed project design documents is up to 2.6bn tonnes of CO2 until 2012.

Despite its significant importance as a generator of carbon credits, Latin America has made little impact in terms of sales of carbon credits. According to the World Bank Asia commands 80% of that market, with China alone contracted to provide 61% of the CERs purchased by industrialised countries. There is therefore plenty of room for growth before Latin America fulfills its potential in this burgeoning industry.

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