Infrastructure thrives despite expropriations
Banks and investors are rushing to take stakes in infrastructure projects in Latin America, a region starved for everything from ports and warehouses to power and sanitation. This is despite the looming threat of expropriation and resource nationalism. Luis Waldmann reports.
According to World Bank estimates, Latin America and the Caribbean would need US$100bn a year for the next 20 years to redress a lack of infrastructure. Liquidity for longer-term projects is such that some financiers remain available – albeit very cautiously – for Venezuela and Bolivia, whose governments are nationalising privately-held companies.
Indeed, risks are rife and actions taken by Caracas and La Paz may trigger insurance claims this year, along with the Ecuadorian president threatening to partially renege on his country’s foreign debt.
To a smaller extent, currency issues still bring discomfort to projects with revenues in Colombian or Chilean pesos but owing in dollars. However, not only is it becoming easier to borrow in local currencies, but the harsh devaluations seen in Brazil and Argentina five years ago are talk of the past.
Infrastructure is also high on the Brazilian government’s agenda. A plan to shell out US$240bn over five years to spur economic growth seems encouraging to many banks.
Overall, players are open to every country in Latin America except Cuba for US institutions.
Warehouses, ports, barges
Noble Group, the Hong Kong-based commodities company, has committed about US$70mn in the last two years to warehouses, ports, barges and other assets so that commodities sourced in South America can flow to global markets.
Investing to build and improve facilities in Latin America is something “we see as very lucrative in the medium term,” asserts Ricardo Leiman, chief operating officer of Noble Group.
Costly transportation in many areas in Brazil led Noble to develop its own logistics, Leiman explains. The new property will lead to synergies with crop and trade financing, logistics and distribution.
“We see South America as the leading place for oilseed expansion.” says Leiman. Noble handles soybeans, soy oil, soy meal, cotton, corn, wheat, coal, iron ore, ethanol and sugar in the region.
Risks in the country are climate-related and regulatory when the Brazilian justice system rules farmers who fail to deliver commodities innocent.
“Brazil still has a long way to improve its legal framework,” Leiman says.
When pre-financing crops in Brazil, Noble takes cédulas de produto rural (CPRs) as guarantee from farmers, explains Leiman. The inventories guarantee post-crop lending, he adds.
In Argentina, Noble is building warehouses at its port in the Santa Fe Province and is negotiating locations for two more. The company trades soy, corn and wheat in the country, where it’s also developing a fertiliser terminal.
Argentina is the cheapest place in the world today to plant soy, says Leiman. However, if the real devalues slightly then Brazil will overcome Argentina’s competitiveness, he adds.
The system for warehouse receipts in Argentina is clearer than in Brazil, he asserts.
In Paraguay, Noble owns a barge-loading facility and plans to develop another one with a local partner. As for Uruguay, the company has the operating concession for a grain elevator and is in a joint venture to construct one more. It is also working on a barge convoy to ferry mostly soybeans from Brazil to export terminals in Argentina.
Noble has no projects in Bolivia because of political instability, Leiman says.
River shipping
Buenos Aires-headquartered Fluviomar, a river shipping company linking Brazil, Bolivia, Paraguay and Argentina, is working to take advantage of an immediate need for river transportation driven by higher demand for commodities worldwide, says Andres Guzman, the company’s president.
Fluviomar transports iron ore and agricultural products downriver to Argentina via barges, where most of its clients have crushing plants or ports. Upriver, fuel-laden tank barges set off to Paraguay and Bolivia.
Fluviomar borrowed US$16mn of mezzanine finance from Washington, DC-based Darby Overseas. This is Darby’s only interest in the country and matures in 2011.
Private companies and governments have invested to bring the local barge system to a level of reliability and cost efficiency adequate for multinational companies, Guzman says.
However, lack of legislation, poor dredging and signalisation are the biggest threats to Fluviomar and its competitors, Guzman says. He cites poor infrastructure along the river system as another obstacle.
The company plans to build a port to handle minerals and agricultural products and already constructs barges at a shipyard it owns in Brazil. All freight is paid in US dollars, not the currencies of Brazil, Argentina, Paraguay and Bolivia, he says.
Local currency fund
The eight-year-old Darby Latin American Mezzanine Fund, which raised US$195mn from investors including BBVA, Dresdner and Caracas-based Corporacin Andina de Fomento (CAF), has invested in Brazilian, Mexican, Colombian, Bolivian and Argentine infrastructure.
For now, Darby will launch a R400mn mezzanine finance fund in Brazil in the second quarter of 2007, says Pedro Batalla, managing director for Latin America at the firm.
Another fund amounting to US$300mn will be directed to Latin America, maturing in 12 years and not exclusively tied to infrastructure. Darby also has the US$600mn Korea infrastructure fund in local currency, brought up from local pension funds.
Government interference is the leading risk when investing in infrastructure, says Batalla. An independent judicial system is the best manner to offset that, “so if the government mistreats an investor, he can go to the courts,” he says.
Gas TransBoliviano, the company responsible for the Bolivian section of the US$2bn Bolivia-to-Brazil natural gas pipeline, has a US$16mn loan from Darby. Gas TransBoliviano is shielded from nationalisation for its a greenfield project that was never owned by the government, Batalla says.
Petrobras is the offtaker under a ship-or-pay contract, but Bolivia has threatened to shut natural gas shipments to Brazil if prices aren’t renegotiated. Darby’s interest in the pipeline has another five years to mature.
In February, Bolivia nationalised 50% of a tin smelter owned by Glencore, the Swiss commodities trader.
While Darby is not closed on Venezuela, it’s not looking for business there either, Batalla says. The nationalisation programme pursued by the governments of Venezuela, Bolivia and possibly Ecuador are sending shivers to investors worldwide.
“It’s either you do it or you’re out,” Batalla says of the situation. “There’s no middle ground, there’s no interest in negotiation.”
Prospects for Darby rely especially on toll-roads, water projects and airports in Mexico, Batalla concludes. He predicts that the bonanza in commodities prices will last five years more.
Generation plants and pipelines
The best opportunities for Latin Power 3, a US$393mn fund aimed at power projects in Latin America, lie on medium-sized generation plants and pipelines.
The region is growing rapidly and a shortage of local capital due to low domestic savings lead to opportunities to make good returns by investing in the region, says Scott Swensen, chairman of Conduit Capital Partners. New York-based Conduit owns Latin Power I, II and III.
Investors are more confident in Latin America also because of the absence of the currency problems seen in Argentina and Brazil in 2002.
However, political instability is the biggest threat to investments, Swensen says: “Changing the rules of the game after you’ve invested is the biggest risk.”
The Latin power funds have no investments in Bolivia.
“The best mitigant is to go to a country where there’s respect for foreign investment and we’ve got no money in Bolivia,” Swensen says. “We avoided Bolivia and in hindsight we believe it was the right decision.”
Concerning political risk insurance, Swensen’s preference is to use Opic or Miga rather than a commercial insurer because insurance companies backed or run by the US government have more leverage when dealing with international disputes, he says.
According to Philippe Valahu, acting director of operations at Miga in Washington, DC, the trend for infrastructure in Latin America is positive.
In the pipeline for 2007 Miga has projects in Brazil, Peru, Ecuador, Costa Rica and the Dominican Republic, with a mix of power transmission, generation, toll-roads, and other opportunities, he says. Investments in the water sector are missing because of perceptions of privatisations gone wrong, he says.
Earlier this decade, Latin America had about 55% of Miga’s exposure, but business fell in 2004 and 2005, Valahu says.
Last year saw a resurgence spearheaded by transmission line projects in Brazil and a toll-road in the Dominican Republic.
Miga works with the private insurance market in two fashions, Valahu explains: “They can reinsure us in a facultative basis, or we do on a coinsurance basis or syndication basis, where similar to the facultative, we are fronting and are syndicating our piece to the private insurance market.”
Valahu comments that investors buy insurance for two reasons. First, with the hope of acquiring, seeking or obtaining compensation when things go wrong. Second, they approach Miga to mediate disputes.
In its 18-year-old history, Miga has issued about US$18bn of guarantees, representing almost US$60bn of investments in developing countries. During that period, Miga had three claims for less than US$16mn, of which it recovered 95%, Valahu says.
Although Miga has traditionally supported US and European investors, it is increasingly working with companies in Brazil, Chile and other countries in the region attempting to invest outside their borders.
Costly PRI
Political risk insurance has become too expensive for banks grappling with tight margins in Latin America, notes Price Lowenstein, president and CEO of Bermuda-based political risk insurer Sovereign.
“What you’re seeing in Latin America is that the spreads are falling to such a degree in Brazil and Mexico that it’s very difficult for banks to afford political risk insurance,” Lowenstein says.
As a result, financial institutions are seeking transactions with higher margins in other parts of the world. Sovereign’s portfolio has moved away from Latin America towards Russia, Turkey and Africa.
To Valentino Gallo, Americas head of export and agency finance at Citigroup in New York, conditions will remain challenging as the international and local markets are extremely liquid and the top tier names will be less keen to commit to structured solutions.
The geographic focus of agency-related business has shifted as Mexico and Brazil have become more liquid and the top level names have been more able to tap different sources of financing, both locally and internationally, he comments.
“The most significant evolution compared to a few years ago is that local capital and bank markets have become more solid and liquid and are challenging the international capital and bank loan market as a source of financing for large infrastructure projects,” Gallo says.
To make up for stiffer rivalry, Citigroup differentiates itself by providing customers in the region with a strong local franchise, access to local and global markets, and structuring expertise.
Export credit agencies (ECAs) must also show flexibility and spirit of innovation to keep pace with the market, says Gallo.
He cites as a landmark deal the 2006 Citigroup-arranged US$600mn financing for Aluar, the Argentine aluminium producer (a GTR Best Deal of 2006). The loan was backed by Hemes of Germany and Coface of France and partially secured by the assignment of Argentine export receivables from Europe, North America and Asia.
Lowenstein believes there may be some claims in 2007 coming out of Ecuador if the government restructures its foreign debt, as well as Venezuela and Bolivia on nationalisation.
Sovereign has underwritten two oil and gas projects in the last six months in Argentina. Although it’s not closed on any country save Cuba, the insurance company is very selective in Venezuela, Bolivia and Ecuador.
“Resource nationalism isn’t just a political rhetoric anymore, it’s a realistic policy,” Lowenstein says.
He says although there isn’t much new business coming in Latin America, his exposure isn’t diminishing drastically.
There is need for insurance concerning export finance in the Dominican Republic and oil and gas in Argentina, Lowenstein says.
Also, a constant flow of opportunities makes mining Sovereign’s most active infrastructure sector. Mining infrastructure includes equipment, roads and technology.
Ultimately, the main risks in Latin America are developments in Bolivia, Ecuador and the policies of Venezuelan president, Hugo Chavez, ie, resource nationalism and increased government intervention in the economy, he says.
For insurer Zurich, demand for political risk insurance in Latin America has been picking up for infrastructure deals since mid 2005, says Dan Riordan, executive vice-president and managing director of the US-based company.
Transactions include mining, oil and gas, toll roads, airport rehabilitation, telecoms and ports in countries such as Peru, Argentina, Brazil, Mexico and Colombia.
“Project financing is becoming more apparent than we had seen in a few years, again tied to large commodity-type mining projects,” Riordan says.
However, Zurich has seen modest growth in the portfolio. “It certainly could be higher if there was a more favourable investment climate throughout the region.” Riordan remarks.
Asset expropriation and nationalisation in Venezuela and Bolivia, combined with sharp rhetoric by Ecuador’s newly-elected President Rafael Correa has staunched interest towards these three countries.
“No big surprise the perception of risk in Latin America is definitely on the rise,” Riordan says. “We’ll look at all the markets always, but we are certainly very cautious where there is potential for nationalisation and expropriations.”
Although insurance can help in these cases, “the first step to investors is not political risk insurance, but to look for favourable investment in a favourable investment climate.”
Exposure is ‘definitely’s not growing in Ecuador, Venezuela and Bolivia, he concedes.
In all, the threatening scenario is not all bad for business as the grim newspaper headlines help spur interest in insurance, Riordan says.
Zurich covers expropriation, which comprises confiscation and nationalisation, as well as political violence and currency inconvertibility. Political risk insurance policies can be as long as 15 years and amount to US$80mn.
In July 2006, Zurich paid US$17.8mn stemming from attacks on power lines in Colombia, which triggered a political violence claim. Likewise, the Dominican Republic failed to pay loans in time and 19 claims were set off between 2004 and 2005, which totalled US$19mn.
Currency mismatch
One of the main problems related to infrastructure in Latin America is currency risk, says Gallo at Citigroup. To offset the possibility of projects with revenue in local currency becoming unable to match dollar-denominated debt, Gallo advises borrowing funds domestically.
To Ralph Scholtz, head of BNP Paribas’s project finance Latin America team, the leading hurdles to support Latin American infrastructure are the credit standings of most countries and the currency mismatch.
Consequently, the Paris-based bank’s preferred sectors are those that generate or enjoy a link to hard currency, Scholtz reveals.
Development of the local capital markets is key to address the mismatch, Scholtz concludes. The bank provides local financing in certain markets including Brazil.
BNP Paribas is looking forward to working on projects related to natural resources, energy and infrastructure in Latin America in 2007.
Scholtz notes that the recipe for a successful project is to share risks and rewards fairly and ‘hopefully’s aligning the long-term interests of all parties involved.
“Countries with historic and perceived stability have an advantage in attracting private sector investment, particularly for sectors that provide market returns,” he says.
BNP Paribas works closely with international capital market participants including multilaterals such as the IADB and CAF, which provide a critical role in supplying long-term funding for projects that would otherwise have difficulty in attracting debt financing, according to Scholtz.
He comments that typically more guarantees are required during the construction phase of the project than when it achieves completion. Operating period guarantees are demanded to the extent that foreseeable events can affect the project’s ability to service debt, he adds.
The institution has been active in Latin America for many years in sectors such as power, toll-roads, airports, ports, and public sector projects, he says.
To Scholtz, energy projects are still feasible in Venezuela, Ecuador and Bolivia. The legal changes that these respective governments are in the process of implementing or may implement in the near future do create uncertainty for investors in the short run, he concedes, making raising debt for projects more challenging.
Citigroup’s Gallo expects to see significant new activity in Central America in 2007. Good momentum in Brazil will lead to robust activity as well, he notes.
Seven-year tenors are not uncommon in several Latin American countries, while 15 years may be reached when combined with agencies, Gallo says.
He adds that sectors such as logistics, transport and power are making a large push in the region.
Regarding Ecuador, Bolivia and Venezuela, Gallo comments that despite the volatile regulatory environment stymieing private sector investment, Citigroup is available to evaluate deals there. The bank is open for every country in the region except Cuba.
Guarantees from insurers such as Miga covering breach of contract by sovereign or state-owned entities are a useful mitigant to regulatory risks, Gallo notes.
Commodity price risks in export projects can be neutralised in the derivatives markets or through many forms of over collateralisation of cashflows, he notes. Two large obstacles remain undeveloped local capital markets and regulatory concerns, Gallo says.
Brazil’s growth bid
On January 22, the Brazilian government unveiled a four-year, R504bn (US$240bn) growth acceleration programme (PAC) to narrow the existing infrastructure investment gap and fuel economic growth.
Investments will concentrate on transportation, power and social infrastructure projects. The government will pay for the bulk of the programme, although private investments are expected.
“The stimulus to private investors should come from a general improvement in the financing conditions by public funding sources, a more favourable regulatory and business environment, some tax cuts for the sector and a long-term fiscal balance,” says Gallo.
He adds that among the measures contained in the PAC, it’s worth mentioning the creation of an infrastructure investment fund with public resources, a reduction of the interest rates and spreads charged by BNDES, a definition of the scope of environmental agencies to facilitate and speed up the licensing process and the approval of a regulatory framework for the sanitation sector and the proposal of a federal law for the natural gas.
He notes other governments have established or are setting up similar infrastructure funds, such as the Investment Fund of the Russian Federation, the Fondo Italiano Infrastrutture by the Italian government’s Cassa Depositi e Prestiti and the India Infrastructure Fund by Infrastructure Development Finance Corporation. Citigroup’s public sector and global infrastructure team are engaged in all three cases.
Mexico, Brazil and Chile
For Société Générale Corporate and Investment Banking (SG CIB), efforts are concentrated in Mexico, Brazil and Chile, says Frédéric Genet, global head of export finance at the Paris-headquartered bank. The leading sectors are oil and gas, energy and infrastructure, he adds.
The transportation sector is still active with ongoing underground projects in Chile, the Dominican Republic and “maybe” soon in Trinidad and Tobago, he anticipates. The most active country in terms of new such projects remains Venezuela.
“Unfortunately” Venezuela has no need for offshore financing and the extension of the Caracas underground is being paid cash, Genet says.
The main concerns regarding infrastructure projects in Latin America are political factors, including elections influencing decisions and leading to long delays in launching projects, he remarks.
The Suburbano train in Mexico, linking Buena Vista to Cuautitlan, is a good example, he says, where it took more than a decade to have all the decision-makers around the table and start the construction.
Moreover, the willingness to promote concessions in countries where the legal framework is not necessarily ready may also add significant delays, according to Genet.
The best risk situation is when one can structure a security package with a mix of available mitigants, bringing much flexibility and contributing to enhance the rating and pricing of the transaction, Genet comments.
Depending on the sectors, it’s possible to combine asset-based security interest, corporate guarantees, offtakes of a specific production and so on, he says.
SG CIB export finance may reach up to 15 years maturity including the construction period, while the average maturity is around seven years.
As an example, SG led a US$350mn loan to Mexican state energy company Pemex in February 2006. Spanish ECA Cesce insured the 10-year financing.
2006 did not bring much new infrastructure export finance business for SG in Latin America, therefore the bank did not observe a significant exposure change over the last 12 months, Genet says.
As for International Finance Corporation (IFC), in the present year it is aimed at supporting private sector investments in public utilities, power generation, water supply and sanitation projects in Latin America, says Rimas Puskorius, head of portfolio management for infrastructure in Latin America at IFC, based in Mexico City.
Ports, roads and other transactions aimed at improving logistics are also being targeted, “given the high cost of logistics in Latin America,” Puskorius says, adding that helping local companies develop and compete globally is a top priority.
As a result of the liquid Latin American market, IFC clients request not only capital, but social and environmental expertise and advisory in corporate governance. Mezzanine and structured financings, local currency financing and investment in equity are in high gear too, he says.
In all, well functioning and transparent regulatory frameworks and legal systems, and long-term local currency financing are catalysts to private investment in infrastructure in the region, Puskorius comments.
For project finance, IFC demands first security interest in all the assets of the borrower, says Rimas. The longest tenor is 20 years, while that of private sector infrastructure finance is anywhere between six and 15 years.
IFC committed US$955mn in 2006 in infrastructure worldwide and US$406mn to Latin America.
On Brazil’s behalf
SBCE, a private insurance company supporting medium and long-term exports on behalf of the Brazilian government, has experienced a large increase in its infrastructure-related exposure in South America in the past 12 months, with most of the projects demanding a political risk cover inasmuch as they are based on structures backed by the local governments, says Nelson Higino, president of the Rio de Janeiro-headquartered company.
For 2007, one of the important projects will be an urban transport system in South American cities. The main feature of these projects is the legal aspect that implies a management and traffic control system to provide the best service of transportation to the local population, Higino comments.
The US, Argentina, Venezuela and Dominican Republic make up most of the exposure. Transport, spanning civil aircraft, metro equipment and buses, and infrastructure projects entailing natural gas pipelines, metro, sewerage and water systems are the most important sectors, he notes.
When analysing an infrastructure project, SBCE’s medium and long-term (MLT) team usually demands offtake agreements and/or sovereign guarantees. Escrow and collection accounts may also integrate the risk mitigation packages whenever that sort of instrument is available, Higino remarks.
Most of them are structured case-by-case in a partnership amongst SBCE, exporters, financiers and buyers.
In 2006, the major infrastructure projects were two large natural gas pipelines and one aqueduct project in Argentina and two hydroelectric projects and one aqueduct venture in the Dominican Republic.
The main obstacle for export credit support in Latin America is the high-risk perception for some of the countries in the region, given that macroeconomic imbalances are still present, Higino states. Nevertheless, he observes that in the past couple of years the country risk rating for several of these countries have improved.
Having the current MLT portfolio of export credit insurance in mind, tenors have a weighted average of 12.9 years, while the longest period is 15 years. The amortisation period usually follows the OECD consensus mainly due to commercial purposes provided that Brazil is not an OECD member, Higino says.
SBCE is open for every Latin American country and projects are still feasible in Venezuela, Bolivia and Ecuador, Higino comments.
“These are countries where Brazil has maintained historic diplomatic relations and a fruitful partnership to date.”
Most infrastructure projects have been performed by Brazilian engineering enterprises with a strong track record in Latin America, he comments. Such companies are present in such countries for quite a long time and have experienced different political and economic environments although the current economic outlook for most of these countries is positive, Higino concludes.
Xiomara Creque, regional director, Latin America, at US Ex-Im Bank, says there are a lot of new projects in infrastructure in Latin America. For 2007 the main sector is oil and gas, but also agricultural equipment and transportation including port and airport improvement.
Main countries for the present year are Brazil and Mexico, with ‘tremendous’s interest from US exporters towards Peru, Colombia, Guatemala, Costa Rica, Dominican Republic, Nicaragua, Honduras and El Salvador.
US Ex-Im can do energy projects with up to 12-year terms, and environmental projects with up to 15 years. The institution is closed on Ecuador, Bolivia and Venezuela, therefore only offshore account structures can be considered in these countries.
