Renewable energy and the cost of lending in Latin America

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Investment in renewable energy (RE) is on a healthy growth trajectory despite the slump in the price of oil, with developing countries taking an every greater share of it. According to the Trends in Private Sector Climate Finance report published at the end of 2015 by the Climate Change Support Team of the United Nations, global investment in RE projects increased by 55% from 2009-2014, and over 70% of it went to non-OECD countries.  Another promising trend identified in the report is the decline in the perception of risk related to RE technologies, which is reducing the cost of financing and creating conditions for long-term and widespread growth in the sector.

While the improvements in RE technology are bringing production costs in line with those of conventionally sourced energy, the costs of financing RE remain high, for developing countries in particular, for several reasons. RE projects have higher up-front capital costs. In order to spread these costs over time and fund them with the cash flow generated during the future operation of the project, investors need confidence in the long-term stability of this cash flow, and this is often not present in developing countries. The technology itself can be a source of uncertainty as investors have less confidence in their assessments of viability and risk. RE is intermittent, requiring a more sophisticated management of the electricity system. RE projects often face additional challenges related to siting: high land use; limited location options; and large distances to consumption centers, all of which require more intense engagement with regulatory authorities and local communities, and potentially, additional investment in infrastructure.

Latin America is expected to take the baton in RE growth in the coming decade. At present, RE represents only 6% of the Latin American market, but in 2013 the region accounted for 7% of global RE investment, signaling that the countries in the region are making a deliberate shift towards non-conventional and non-fossil sources of energy. Wind energy project have been particularly successful, accounting for the bulk of new investment. Brazil had 2,200 MW of installed capacity fueled by wind in 2013, and another 7,000 MW are expected by the end of this year.

Argentina is now attracting a lot of attention to its RE potential, in particular that of wind energy, which it has in abundance. The new government is moving at breakneck speed seeking to attract much needed investment into the energy sector and the economy overall through an RE tender announced for May 16. Since taking office in December 2015, the government has tackled the largest obstacles to new investment, passing new energy legislation that offers a roster of tax incentives, and settling its debt default with international lenders. A few weeks ago, the government of Argentina raised $16.5 billion in international markets, the largest ever issuance of debt by an emerging market economy. The offering attracted over 4 times the amount of debt sought, at a reasonable interest rate of 7.5%. Should we expect a similar second act at next week’s RE energy auction?

Answer is no. Like sovereign bond holders, investors in energy projects face risks related to the overall health of the economy, such as inflation and foreign exchange restrictions caused by fiscal account management problems. Unlike bond holders, however, investors in energy projects also face regulatory and political risks, resulting from inconsistent regulation and institutions with credibility problems. Energy firms have much more at stake: they invest a lot of money prospecting sites and assessing the quality of the energy source even before participating in competitive bids that they may not win.

It is curious, nonetheless, how different segments of the international financial market interpret the 15 years that have transpired since Argentina’s crisis and debt default in 2001. The default is perhaps a dim memory for bond buyers and the recent settlement with the holdouts confirms the belief that governments cannot go broke (at least not forever). Bond buyers are focused on the present, and engage in cross-sectional comparisons with other sovereign and corporate bond offerings when making investment decisions. Those in the business of lending to energy projects, on the other hand, appear to be more tuned in to the past history of the sector and the possibility that problems may linger or repeat themselves. Perhaps the big difference is that owners of infrastructure do not have the benefit of unloading their assets at the first sign of trouble, like bond holders do, and that that colors every calculation they make.

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