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Watch the Cycle

Can the upward swing in global power infrastructure investment be sustained?

Fortnightly Magazine - February 2007

concerns. Lenders apparently believe that any political tensions or destabilizing activity in the region will be short-term in nature.

GCC power and water projects are expected to be buffered largely from global cyclicality in the sector. Projects in the region, however, would be affected if there were to be a dramatic and extended decline in global oil prices (as would the overall economies of the region). Given current supply-and-demand dynamics, this is not anticipated.

Latin America

Private participation in Latin American power during the past five years has averaged approximately $4.5 billion annually, and deals in the region during the first half of 2006 totaled $1.4 billion. Brazil is the largest market by far with more than $15 billion of investment since 2000, followed by Mexico with $6.5 billion. While the pace of development has reflected the slow pace of reform throughout the region, the overall investment environment has improved steadily since 2003 for a number of reasons. Demand growth has been strong, ranging from 4 percent to 8 percent across the region, local currencies have strengthened against the dollar, and most countries have been able to access favorable financing terms. Cash flows linked to strengthening local currencies, together with overall growth, have allowed companies to de-leverage balance sheets, extend tenors, and reduce foreign exchange and interest rate risk on outstanding debt. The majority of project financings in the region are funded with conventional bank debt and bonds.

Barriers to project development in the region remain, and generally include political, regulatory, tariff, and tax-related uncertainties. Despite these, numerous successes can be pointed to during the past couple years. For example, after a four-year delay, during which time numerous rounds of agreed tariffs had to be renegotiated, the 310-MW TermoFortaleza combined-cycle gas turbine plant in the underdeveloped region of northeast Brazil achieved financial closure in early 2006. Spanish utility Endesa, via Endesa Brasil, is the sole equity partner in the project. The risks of regulatory backtracking on PPA agreements and tariff levels, however, were reflected in the financing costs. Senior debt of $55 million from the IFC was priced at Libor+250 basis points, and an IFC-syndicated loan of $68 million was priced at Libor+225 basis points. Notably, however, these margins were much below the earlier negotiated prices of greater than 400 basis points back in 2001. Other large power-project financings have been undertaken elsewhere in Latin America during 2006, including the $245 million 143-MW Olmos Hydro and Irrigation Project in Peru and the $370 million Brazil PCH Small Hydro Projects.

A range of factors should continue to support this cyclical trend: ongoing deregulation globally, high energy prices, modest interest-rate environments across most regions, and large pools of investment capital focused toward infrastructure.

Financial investors increasingly have become aggressive, reducing pricing margins dramatically as available capital competes for quality deals. Asset valuations are being pushed to new highs, and companies once again are increasing their financial leverage at the expense of more rational balance sheets and credit ratings.

Power utilities in the United States and Europe now seem intent on increasing their size and