JLS Newsletter - Latin America -TXF Americas 2018 Edition
Latin America: Regional Outlook
In advance of the upcoming TXF Americas Conference in Miami, for which JLS Capital is proud to be a sponsor, this edition of our newsletter focuses on energy investment in Latin America-- a story of increasing opportunity and persisting risks.
Higher oil prices are improving the environment for oil and gas investment, though price volatility remains an inherent risk. As in the past, prices for commodities gold, copper, and other commodities have tended to rise with oil prices, fueling a resurgence of mining investment in the region. However, investment in these broader sectors may be hampered by political forces, largely stemming from upcoming general elections in several key markets.
The trend of greater investment is perhaps strongest in the clean energy sector, where regional investment totaled $17.2 billion in 2017, growing by 65% compared to the global average of 3%. Government-led auctions in recent years have facilitated greater competition and pushed wind and solar tariffs to record lows in the region. Despite this positive shift, however, more competitive pricing in renewables will continue to erode margins, creating a more challenging operating environment for investors and developers.
Oil and Gas – Prices Trending Higher but Volatile
Despite continued volatility, higher oil prices are creating a better overall environment for oil investment and project development in Latin America. Crude oil prices ended 2017 at a near 3-year peak and are poised to continue recovering thanks to OPEC supply cuts and robust global demand. While expected to remain higher in in the short term, prices will continue to be volatile due largely to strong US shale production and uncertainty over OPEC-member compliance to pledged cuts.
The fluid situation in Venezuela also continues to drive uncertainty in oil markets and could exacerbate volatility and price increases if major production suddenly goes offline. Evidence of an improving regional outlook for the oil and gas sector can be found in a wave of recent and planned licensing rounds in Argentina, Brazil, Mexico and Uruguay. E&P activities in these countries will continue to benefit from higher oil prices, lower deep exploration costs and favorable regulatory changes, making the sector more accessible and attractive to foreign investment.
Brazil auctioned off six new oil and gas fields in 2017, with another auction planned for June, following a reduction in domestic content requirements in March 2017 and the opening of pre-salt oil fields to international oil companies (“IOCs”). Notable winners in the auctions include Petrobras, Exxon Mobil, Royal Dutch Shell, CNOOC, Statoil and BP. While this marks a positive shift for Brazil’s E&P sector, considerable headwinds remain given an ongoing corruption scandal and Petrobras’s large persisting debt burden.
The government of Mexico (“GOM”) just recently awarded 19 oil blocks in the Gulf of Mexico in its second deep-water auction and also plans to hold a shallow water auction in March and an onshore auction in July. Relatively weak interest for GOM’s auctions over the past two years should change with Brent Crude nearing $70/barrel and given the opportunity for more lucrative deep-water assets. Mexico’s eight auctions held to date are expected to generate some $61 billion of investments in the E&P sector.
In Argentina’s E&P sector, domestic firms and IOCs continue to target the country’s abundant shale reserves, namely in the Vaca Muerta fields. This year, the Argentinian government (“GOA”) plans to expand its focus to the offshore sector to compete with neighboring Brazil. Auctions for deep water exploration rights will be held later this year.
Mining – Increased Investment
Spurred by recovering oil prices, prices for mineral products such as coal and metals are expected to increase, driving greater regional investment in mining activities. Chile expects a resurgence in copper mining investment due to strong demand from China which has driven prices up by 21% since May. Meanwhile, Brazil is also targeting foreign investment by opening its northern region for exploration and changing certain foreign ownership limitations.
Elections – Possible Brakes on Reform?
Despite these trends, electoral uncertainties pose considerable risks to the state of market-oriented energy reforms across the region and could hinder progress in various long-term infrastructure and financing initiatives if populism and protectionism prevail. 2018 will witness general elections and potential administrative turnover in at least six Latin American countries—Brazil, Colombia, Costa Rica, Mexico, Chile and Paraguay. In Mexico and Brazil, the current front-runners strongly oppose recent reforms expanding oil and energy market access for international and private investors and could likely implement more nationalist-oriented policies.
Outlook for Clean Energy Investment Growth Tempered by Lower Prices and Margins
Renewable energy continues to be the region’s most dynamic sector for new investment, driven largely by government commitments to diversify their country’s respective energy sources, expand electrification and meet climate change commitments. Government-organized power auctions in 2017 saw prices for wind and solar PV power fall to record lows across much of the region. In addition to European and Asian companies, investors from Gulf countries like Saudi Arabia and Abu Dhabi are looking to Latin America as their next major market and are making significant investments in the region’s renewables sector. A key caveat however, is that such price competition will lead to shrinking profit margins for future developers which is a trend that should be monitored.
Brazil recently held its first renewable energy auctions in two years, awarding 574 MW and 1,387 MW of new solar and wind capacity, respectively, with tariffs falling to record lows of around $45/MWh for solar and $31/MWh for wind. At least two additional energy auctions are planned for 2018. A simultaneous transmission auction awarded over 3,000 miles of transmissions lines, primarily to foreign energy companies, and is expected to generate $2.6 billion in investment. A key factor behind the country’s increasingly competitive renewable energy bids has been Brazil’s wind availability, which produces among the highest capacity factors globally.
Challenges facing Brazil’s power sector in 2018 include the planned privatization of Eletrobras amid both political and public opposition and the creation of a free power market, as well as electricity price volatility due to drought conditions and Brazil’s high reliance on hydroelectric power generation. Brazil’s October elections are likely to hinder short to medium term progress in various longer-term infrastructure and financing initiatives, although support for renewables remains widespread.
Mexico’s third long-term power auction last November awarded contracts totaling 593 MW in generating capacity, achieving an average price of the $20.57/MWh—down from $33.47/MWh and $41.80/MWh in its first two power auctions. Mexico could add more than 3 GW of solar capacity in 2018, according to Bloomberg New Energy Finance. Also worth noting is Mexico’s clean energy certificate scheme commenced last month, increasing renewable requirements for suppliers and industrial consumers and further supporting the GOM’s investment initiatives over the medium to long-term.
Argentina’s government is diversifying its energy mix and reducing subsidies and energy prices for end consumers. Its goal is to achieve 20% of renewable generation by 2025 through the RenovAR auction process which to date has been very successful. Both auctions were well oversubscribed and achieved very competitive tariffs. In 2016, the RenovAR 1/1.5 program awarded a total of 2,423 MW at an average price $59/MWh for solar and $59/MWh for wind. In 2017, the GOA awarded a total of 2,042 MW under RenovAR 2/2.5 at an average price for solar at $43/MWh and $41/MWh for wind. The GOA will hold RenovAR 3 later this year as well as an auction focused on increasing and improving the country’s grid capacity and resilience.
Colombia is planning its first renewables auction later this year that could add up to 3GW of new capacity. The next few months will indicate whether the regulatory regime will harness the appropriate conditions for large scale foreign investment that will generate positive results much like its LatAm neighbors or if Colombia will continue to lag behind.