Understanding Counterparty Risk Remains Essential In The Argentine Renewable Framework

 versión español

Cecilia Fullone 

Directora, S&P Global Ratings 

The Republic of Argentina has stepped up plans   to restructure its power markets to incorporate more   renewable energy sources. The government’s goal is for   renewables to represent roughly half of all new power   generation capacity within 10 years. Considering the   currently very narrow gap between peak-time energy   supply and demand and an environment vulnerable to   climate change, S&P Global Ratings believes Argentina   is on the road to address the potential and need for a   stronger renewable energy industry to support economic   growth over the next decade. Nevertheless, the road could   be bumpy given the country’s past default record.   Long term, the credit strength of the country’s   renewable energy projects depends on a well-established   predictable and transparent regulatory system. For the   plan to substantially increase renewable energy resources,   Argentina will also need to create a regulatory apparatus   that’s more investor-friendly. If the framework has large   gaps or isn’t clear, investors will likely to shy away from   renewable energy projects because of the potentially   weak risk-return tradeoff.   The renewable sector is growing fast, resulting in   increased demand for ratings on related projects. In this   light, we’ve outlined some of the key issues we would   consider when assessing renewable project financing in   Argentina. We’ve specifically focused on wind and solar   energy projects, which currently represent 98% of the recent   projects awarded. Moreover, we focus on counterparty   risk to address a number of the questions we’ve recently   received from market participants.  

Overview

   – Argentina aims to diversify its energy mix as well as   to mitigate climate change.   – The government’s goal is to invest $15 billion   in renewable energy projects, with a target of 10,000   megawatts by 2025.   – The country’s renewable program includes support   mechanisms to foster investments amid the still-weak   institutional environment.   – The credit quality of Argentina’s energy sector   remains fragile and limited by offtakers’ creditworthiness.   Argentina plans to invest $15 billion in renewable   sources to reach the ambitious target of 20% of its energy   mix—or around 10,000 megawatts (MW) compared with   the current 800 MW base—by 2025. Although Argentina   designed its new contractual renewable energy framework   to lower project risk and overcome the investment barriers   that haunted previous government attempts, we don’t   think it would be enough to delink a project from the   sovereign’s weak creditworthiness. We believe the longterm   credit strength of renewable energy projects depends   on a predictable and transparent regulatory system that is   sustainable over a long period. And, although the bidding   process for renewable energy started off well in 2016, we   still have doubts regarding the energy collection process   and offtaker risk, which, in the end, could hurt each project’s   credit quality.   Argentina’s wholesale power market administrator   and clearinghouse Compañía Administradora del Mercado   Eléctrico Mayorista S.A. (CAMMESA) acts as offtaker. The   entity has a track record of delaying payments to the market   players because of the system continuous deficits. Although   we don’t rate CAMMESA, we believe its credit quality could   be similar to that of Argentina (B-/Stable/–). As a result, we   think that for all projects, the offtaker counterparty risk will   limit each project’s credit quality.  

Argentina Needs To Increase Its Power Capacity As Soon   As Possible

   The Argentine power and energy sectors must increase   capacity to cover unsatisfied demand at peak times, and   significant investments are needed to meet that challenge.   Key characteristics of the country’s power market include   increasing demand for electric power, coupled with aging,   inefficient generating capacity, and high operating costs.   Together, these elements have narrowed the gap between   supply and demand, requiring Argentina to import electricity   from neighboring countries and program blackouts for   certain residential areas and industries.   Also, Argentina’s wholesale electricity prices had been   low and distorted since 2001, when Argentina declared itself   in default and experienced a large currency devaluation,   which discouraged private investment in power generation.   In this context, in 2016 and 2017, the new administration   substantially increased tariffs and called for bidding processes   for new power capacity, including renewables, with the aim   of diversifying its energy matrix, while benefiting from the   use of clean energies. According to the Ministry of Energy   and Mines (MINEM), Argentina needs to incorporate 10 GW   of generating capacity from conventional energy sources   and 10 GW ofgenerating capacity from renewable sources to   meet increasing demand over the next 10 years.  


Argentina’s Renewable Energy Targets Are Ambitious  

In late 2015, the government passed the Renewable   Energy Act 27,191, establishing the basis for a new   promotional legal framework, highlighting its effort   to advance renewable energy. We consider the targets   to increase renewable energy ambitious for the short,   mid, and long terms. To reach the 20% target by 2025,   installed renewable generation capacity must increase   to 10,000 MW from a current base of only 800 MW. In   other words, renewables are set to represent roughly   half of all new power generation capacity over the next   decade.   As a first step to comply with the Renewable   Energy Act 27,191, the government launched RenovAR   in May 2016. RenovAR is a public tendering program,   which provides for certain fiscal incentives and   financial support mechanisms, along with regulatory   and contractual enhancements aimed at boosting   investments in the renewable arena.   Under round 1 and round 1.5 of RenovAR, both   launched in the second half of 2016, the government has   received offers for 6.4 GW of new renewables generation   capacity, multiple times its original expectation, and   has awarded contracts totaling 2.4 GW—equivalent to   around $3 billion—to 59 clean energy projects.   The government will continue to promote the   installation of renewable generation by implementing   successive rounds of the RenovAR program starting   in 2017. In addition, in the second quarter of this year,   the government will release detailed regulations on the   private power-purchase agreement (PPA) market and   self-generation, applicable for wholesale market users   with annual demand in excess of an average of 300   kilowatts.  

The Government Has To Overcome Previous Failed   Attempts To Boost Renewable Investment

   RenovAR’s contractual framework rests on two   agreements that work in tandem to provide the elements   that are customary in a typical renewable energy PPA.   Both agreements are subject to Argentine law and include   the possibility of international arbitration.   Companies that are awarded projects enter into   a 20-year PPA with CAMMESA, which acts as offtaker on   behalf of distribution utilities and large wholesale market   users. Pursuant to the PPA, project companies assume   the obligation to construct and reach operations within   a timeframe set by each bidder in its proposal, generally   ranging between 13 and 30 months. Electricity generated   by the power plant is paid for at the awarded price (for   current projects about US$56/MW for wind, and US$60/   MW for solar) and adjusted annually by a minimum fixed   annual adjustment of 1.7% that could increase for projects   reaching commercial operations before the 24-month   maximum term set forth in RenovAR’s contractual   framework. Project companies have the obligation to   provide a minimum amount of electricity on an annual   basis and deficiencies are subject to make-up periods and/   or penalties.   Along with the PPA, the government created a   support mechanism to provide project companies with   guarantees that enhance the legal framework under   Argentina’s current—and still weak—market conditions.   The monthly payments under the PPA will be guaranteed   by Fondo Fiduciario de Energia Electrica (known as   FODER), which will have a single, segregated 12-month   reserve account to support monthly invoice payments to   generators. In addition, the bidders may opt to contract a   limited and conditional guarantee from the World Bank.   Projects will be financed with a combination of equity   and debt, through bank loans. A few companies, such as   Pampa Energia S.A.   (B-/Stable/–) and Genneia S.A. (not rated), have   recently issued bonds in the international markets partly to   fund the construction of the awarded wind farms, neither   of them done through a project finance mechanism.   We believe that to meet demand and exploit   potential export opportunities, Argentina will need foreign   investments that tap the bank and capital markets for   funding. Yet, in our view, the country’s credibility and   reliability is still weak and needs institutional improvements   such as a stronger rule of law and a more independent   judicial system in order to improve relations with global   and local investors. In addition, Argentina’s economy has   experienced significant volatility over the past decade,   including low growth or contraction, high inflation, and   currency devaluation, all of which impairs incentive to   invest in the country. We believe the country’s credibility will   take some time to repair, particularly in terms of restoring a   payment culture in light of Argentina defaulting in the past   15 years.  

Counterparty Risk: Still Not Mitigated

  If we were to analyze a RenovAR project under   our Project Finance Methodology, we would likely   conclude that the project’s energy offtaker would limit its   creditworthiness.   The key steps in our project finance rating process   are summarized in chart 3. First, we establish a project’s   stand-alone credit profile (SACP), which is an assessment   of its intrinsic creditworthiness. The SACP is the lower of   our assessments of the project’s construction phase SACP   and operations phase SACP. To arrive at the final rating,   we adjust this project SACP according to our assessment of   factors related to the transaction structure, extraordinary   government support, relevant sovereign ratings, and any   full credit guarantee, if there is one.   For most of the renewable projects we rate, we   don’t see construction as the primary risk and our main   consideration for assessing projects under RenovAR would   probably be operations. We typically consider photovoltaic   solar and onshore wind projects as relatively simple in terms   of construction. In addition, we expect most of the projects   to complete construction within the next two years–that   is, within the current administration’s term in office–thus   narrowing the risk of sudden policy or macroeconomic   changes.   Regarding operations, we believe that an offtaker’s   creditworthiness could limit a project’s rating. Our   counterparty revenue risk analysis is key to forecasting   expected cash flows for the term of the project finance debt.   Our criteria sets out a three-step process in assessing   how risks posed by revenue offtakers could constrain the   issue-level rating on a project:   – Identify the material counterparties. Material   counterparties are those that significantly affect the   timeframe or cash available to service debt. In the case of   RenovAR projects, we consider CAMMESA as a material   counterparty because it will govern all, or substantially all,   of a project’s revenues.   – Determine the replaceability or irreplaceability of   material counterparties. We would likely treat CAMMESA as   an irreplaceable counterparty because without its support   there is no market for a project’s output. Although the   project might sell the energy in the spot market, the price   may be lower.   – Determine the counterparty dependency assessment   (CDA). For irreplaceable counterparties, the CDA is linked to   the rating on the counterparties. We could consider raising   a rating when the service is regulated or essential and there   are regulatory or legal support of payments. Although   we don’t have a rating on CAMMESA, we believe its credit   quality would be closely linked to the one of Argentina (B-/   Stable/–). In addition, the criteria allows for a two-notch   uplift in cases where there is regulatory and legal precedent   to support payments. However, in the case of CAMMESA and   although renewable energy PPAs are senior to most other   payments in the wholesale market by law, the entity has   a track record of delaying payments to the market players   because of the system continuous deficits. As a result, we   consider that for RenovAR, the offtaker counterparty will   limit the projects’ credit quality.   Even though the program includes a three-level   guarantee, they’re not sufficient to disregard counterparty   risk completely, as we assess those relevant for the recovery   standpoint, but does not fully address the timely payment.   CAMMESA has the primary obligation to pay for electricity   on a monthly basis by using the available funds it holds   from regular collections and/or transfers from the   government. If CAMMESA is unable to pay in full for the   electricity on the due date, FODER backstops CAMMESA   by using funds that are kept in its “energy payment   guarantee account,” which the Ministry of Energy and   Mines funds from a specially preapproved budget. The   second-level guarantee consists of an option that project   companies hold to terminate the PPA when neither   CAMMESA nor FODER pays for the energy delivered after   four consecutive months or six nonconsecutive months   within any 12-month period. In that case, the project   company could keep the power plant and eventually   sell the energy in the spot market, potentially resulting   in lower revenues and probably hampering the project’s   ability to service debt obligations.   Alternatively, the project company could transfer the   project assets to FODER and receive cash compensation.   If FODER doesn’t provide the funds to pay the assets,   RenovAR is further strengthened by an additional US$500   million guarantee provided by the World Bank. However,   we would only consider those guarantees for our recovery   analysis, which estimate the percentage of principal and   accrued interest due at the point of a hypothetical default   on a company’s debt instruments that can be recovered   following its emergence from a hypothetical bankruptcy.   In our view, the long-term credit strength of   renewable energy projects depends on a predictable   and transparent regulatory system that is sustainable   over a long period. We believe Argentina has good solar   and wind resources, demand for power growing at least   3% per year, and a need to revamp on outdated power   system. Nevertheless, the essential ingredient to make the   country’s plan for increasing renewable energy resources   a reality would be to continue making its regulatory   apparatus more investor-friendly. If the regulatory   framework is not clear and cannot provide investors with   long-term legal certainty, characterized by an adequate   track record, the projects’ credit quality will be weak.