PURRED BY FLAT POWER DEMAND AT HOME IN RESIDENTIAL and industrial markets, U.S. utilities are taking huge risks in Latin America. Why? They are enticed by the promise of high-yield returns on generation, distribution and transmission deals.

Yet only some of the companies getting in on the ground floor of privatization or winning concessions in the Latin American energy market stand to make huge profits. Others, too slow to beat competitors, or not savvy enough to skirt political and regulatory land mines, could lose their shirts.

This much is clear: The markets will mature much more rapidly than they did in the United States. As the Latin American market story goes on, risks will rise, potential margins will shrink and ventures will fail. Nowhere is this scenario more true than in the copper mining region of northern Chile, where three utility groups are targeting a growing demand for electricity. Investments range from $440 million to $850 million.

Despite the risks, foreign investment units of U.S. utilities are staking billions in Latin America, long term. They're often more comfortable with the tradition of standard contracts and common languages there in Asia, with its less-robust market.

"The opportunities in Brazil are significant," says Bill Holden of Southern Energy Inc., a $400-million investor in the region. "There are some things that are going to happen in the next year or two that we will be very active at pursuing. There are also opportunities in Chile and Argentina¼ You will see more of an integration of markets in southern South America. You don't see [that] anywhere else in the world where privatization has been conducted on such a scale."

Scale means prolonged growth, analysts confirm.

"What the [U.S.] utilities are getting in Latin America is volume growth [population growth] that they can't get in the United States or in Europe,"says Sandra Boente, senior utilities analyst at Salomon Smith Barney's Latin America Equity Research office. "So overall, it's a very promising market. Even if the pricing in Latin America is mediocre."

Higher risks are driven by volatile markets, fuzzy regulations or more purely political variables. Risk also arises when foreign competition to get into a given market is heated. Then, a nominally lucrative investment can transform into a microcosm of the more mature home market.

The interests of the U.S. utility, of the local project sponsor and of the shareholders can be at odds, particularly when the project is a gamble. For example, while far-sighted U.S. utilities are investing billions in Chilean electricity, Boente warns shareholders that over the coming year they should "avoid the generators, avoid the sector, avoid the [Chilean] market."

Big electrical power developments in the region also make strange bedfellows of some U.S. utilities, which may assess risk differently at corporate levels. Southern Energy, for example, is regarded as a cautious, conservative investor in the region. AES Corp., of Arlington, Va., is seen as an aggressive, high-stakes player. Yet the two are partners in a $1-billion minority investment in Brazil's Cemig, in the state of Minas Gerais, the largest electric utility distributor in Latin America.

One Southern Co. official in Brazil, who asked not to be named, says: "We look at what [AES is] doing in some places and say 'Gee, I wish we could do that.' In other places, we wonder, 'How can they sell a deal like that to the board?'"

Both Southern and AES look to gain control of Cemig in an auction this year as yet-undefined implementing regulations skew solid assessments of such a multi-

billion-dollar investment.

"Generation and transmission regulations are not as clear in Brazil as distribution regulations are, unlike in Argentina and Chile, where the regulations have already been issued," observes Boente. Although Brazil has yet to finalize regulations on generation, U.S. investors have staked billions in such capacity, gambling that regulators won't strand investments.

Still, investor funds for Latin America-focused U.S. utilities seem to be abundantly available. The California Public Employees Retirement System, for example, recently pumped $500 million into a partnership with Houston's Enron Corp. The venture is aimed at international electricity and gas opportunities, including Latin America, says Brad Pacheco, a Calpers financial analyst. Calpers holds substantial equity in other U.S. utilities also pursuing Latin American opportunities. It has found such investments lucrative.

"We had a previous joint energy development investment with Enron, and got bought out with a 23-percent return," Pacheco says. He adds that the emerging market, including the Latin American energy sector, offers growth.

Other institutional investors agree that investor funds are available and that there's growth potential.

"The infrastructure needs of Latin America are not any less than before the Asian crash, and the fundamentals of infrastructure there are still very much alive and well," says Everett Santos, CEO of the Emerging Markets Partnership and chief adviser to the AIG-GE Capital Latin American Infrastructure Fund. The fund began a few years ago as a $1 billion-plus venture that will finance (em and profit from (em the need for Latin American infrastructure that sovereign and state governments can no longer afford.

Power Poker Across the Andes?

The fate of one set of competing power projects being backed by several risk-conditioned U.S. utilities has been battered by the winds of fate several times since initial plans were announced.

That's in the copper mining region of northern Chile, the Sistema Interconectado del Norte Grande, or SING. The three utility groups targeting the growing demand for electricity there have lined up investments as high as $850 million to serve this market, based on Argentine natural gas resources.

But as strong as the SING market may be, the expected electrical demand will support only two of the three projects.

"There's room for two¼ but to go so far as to say plenty of room for two, no," says Robert Simmons, director of the Power & Infrastructure Utilities Group at Deutsche Morgan Grenfell. "If only one is built, and finished, then it's a great story. If two get built, it's probably a reasonable story, depending on what the forecast [for power] is. If three get built, it's close to a disaster."

The first project involves Endesa, Chile's largest electricity generation and transmission utility, CMS Energy (the international unit of Consumers Power Co.), and two smaller stakeholders. The group plans to transport gas from Cornejo, Argentina to Mejillones, Chile via a 930-kilometer pipeline. The pipe would end at a 600-megawatt, combined-cycle generation plant that would serve the SING. Endesa and CMS each hold a 40 percent share in the GasAtacama venture, estimated at $700 million.

A similar plan, the NorAndino project, is being developed by Brussels-based Tractebel and Southern Energy. It will transport gas across the Andes from Argentina to a 740-MW generating plant to be built in the SING, for about $850 million. The generating unit will be built by 67 percent Southern Co.-owned Chilean utility Edelnor, and financed by its customers.

Finally, Chilgener, Chile's second-largest electric generation utility, plans a 632-MW, combined-cycle, natural gas-fired generation plant at Salta, Argentina, along with a 450-kilometer electric transmission line to carry the power to the SING, estimated at $440 million.

All three projects are expected to come on line next year. CMS has secured the necessary concessions, environmental approvals and permits for its Chile development, but is awaiting an Argentine approval for the pipeline section in that country, says Kelly Farr, a company spokesman in Dearborn. "We don't expect any trouble."

The two other competing projects still must secure a number of approvals as well, he adds.

So while Argentina and Chile have transparent development and investment regulations, government approvals could yet trip up one or another of the deals. While that's not likely in these countries (em unlike some Latin American countries (em approval delays conceivably could be used by a government to cull a weak project.

Three Suppliers, Too Much Demand?

Predictions differ on which (em and how many (em of the three trans-Andean power projects will be built.

"The deals themselves are so fundamentally different that it is really hard to compare them," reckons Simmons. His investment bank and Banco Bilbao Vizcaya are providing a 10-year, $314-million project-financed credit to the Chilgener project. "The product at the end of the day is a megawatt," he says, "and each of the projects is delivering a megawatt at close to the same price.

"But if I had to bet, I would wager that one gas pipeline will be built in addition to the [Chilgener] transmission line. The only party left in Norgas [NorAndino] is Tractebel; the other parties kind of walked away, so I don't think that deal's going to come to fruition."

Since Chilgener is converting Argentine gas to electricity within Argentina, then transporting electricity over the Andes, its capital costs are lower than that of the two gas pipeline projects, which will convert the gas in Chile. Chilgener is confident enough in its numbers to continue, despite the threat of overcapacity, which has hammered its stock value by as much as 30 percent.

"Obviously if the two gas pipelines are both done, the rate of return will be much lower," says Mercedes Poblete, a Chilgener investor relations official in Santiago. "But we think rationality will prevail at the end. Nevertheless, our new plant in Salta will produce electricity for 9 to 10 mills per kilowatt, so we will be the lowest-cost producer in the zone (em that's what we tell our investors."

There is no regulation of gas pipeline rates, giving markets a strong say in exactly what the rate of return will be.

If the Chilgener project is more of a sure bet because of its lower capital cost, then the intense focus of the SING race is on the two pipelines. Outside financing (em and assumption of risk (em sometimes decides such contests. The key to third-party support is power purchase agreements that permit international project finance.

The NorAndino project claims to be holding the best cards when it comes to power purchase agreements. It has long had contracts for 550 MW, says Yves Jourdain, vice president for Latin America at Tractebel's holding company in the region, Inversora Eletrica Andina S.A. Moving up fast, however, is CMS, which announced in late January that GasAtacama secured 150 MW worth of power purchase agreements through competitive bidding against NorAndino. Analysts suggest that CMS hopes to sway current NorAndino signers over to GasAtacama. Chilgener trails with 110 MW in agreements from mining companies. It expects to sell the remaining power at local spot prices, Poblete says.

This situation might suggest GasAtacama and InterAndes developers have few financing options other than their corporate balance sheets.

"If Tractebel decides to proceed with NorAndino, then Endesa-CMS would have to finance GasAtacama from its own balance sheet," says David Hurd, a Merrill Lynch equity analyst in Santiago.

Should sufficient financing keyed on power purchase agreements fail to show, would CMS be willing to open its corporate coffers to finance a lion's share of GasAtacama?

"Yes, we would," says Farr, the CMS spokesman. "Our power purchase agreement is another nail in the coffin of the NorAndino project."

Holden, the Southern vice president for Latin America, says his company will complete NorAndino for strategic reasons. "For Edelnor, we believe it is vital that we continue to maintain a position as the current low-cost [electricity] producer in northern Chile," he says. "In the long run¼we are convinced it's the right thing to do for the shareholders."

Demand growth for power in the SING is strong. But it's unpredictable, given the large size and global copper pricing exposure of the mining customers that define most of the consumption base.

"Over the past five years, the demand growth rate has been 16 percent to 17 percent per year," says Poblete. "So we think the growth rate for the next few years should be between 15 percent to 17 percent. But it depends on the copper mines¼ it's not a stable rate."

Lower Prices, Paper Tricks

Contract power prices in the SING were in the $30-per-megawatt-hour range not long ago, one Wall Street wag says. Now Merrill Lynch projects that the spot price for power in the SING will drop to less than $19 per MW by 1999, when planned new capacity comes on stream. Furthermore, "due to excess capacity, we do not contemplate rising marginal costs nor contract prices [from] 1999 to 2005," Hurd predicts.

But the pricing drop is expected. It's built into projections, notes Karl Wittbold, CMS vice president for gas transmission business development, in Dearborn. "Our new, low-cost gas technology is replacing older, less efficient oil and coal-based capacity¼ When we first started looking at the SING, prices were 30 percent higher¼ as the price of energy in the region is coming down, the mines are considering projects that add value to their product, which might not have been cost-effective in past. They may now smelt and refine copper concentrate in Chile instead of shipping it to Japan."

Although power purchase agreements permit third-party, dollar-based project financing, some agreements actually may be worth little.

"If a mine asks for 150 megawatts and then postpones its development plans for one year, that changes the picture completely," says Jourdain. Still, "while copper is very cyclical, Chile is the¼ lowest cost¼ producer in the world. So a lot of other producers will be shutting down before they do here."

The Chilean economy has been hurt so badly by the crash in Asia, which traditionally takes a third of Chile's exports, that the government has cut by 12 percent the budget at copper giant Corporacion Nacional del Cobre de Chile, or Codelco, a federally owned plant. Luckily, the government has an estimated $1.9-billion copper price hedge fund, which will soften the blow of falling commodity prices for exporters over the short- to mid-term, if needed.

Since electricity infrastructure investments are made with long-term amortization calculations, the short-term view is less critical to these projects than in other businesses, some analysts say.

"Even if all three projects are completed and there is an oversupply for five years, these [developing] companies are looking at 20-year to 30-year facility lifetimes, and the overcapacity [eventually] will be deleted," says Boente.

This doesn't mean every planned electricity development project merits investment, though. "There is no justification for many of the prices paid [for acquisitions or investments] in electricity (em it's just irrational," Santos says. "There is no way you can put pencil on paper and show the numbers."

Sprinting for the Lead

Despite its nominal, low-capital-cost position, in mid-January, Chilgener was said to be reconsidering building its electric transmission line from Argentina to Chile. Instead, it planned for power sales to the local grid from its Argentine generation investment. The determining factor would be a drop in SING electricity prices to anything under $25 per MW, Boente says.

Other analysts see the option as an advantage for Chilgener. "There are embedded alternatives in InterAndino, because of the generating capacity being tied into the Argentine grid," says another analyst. "Just because there is a dedicated transmission line to Chile, it doesn't mean the power has to go there."

A few months before, Chilgener and its bankers had trumpeted the expected financial closing for its project, including the transmission line.

"What we have done is underwritten an obligation to Chilgener on InterAndes and are proceeding with documenting a financing structure," Simmons says. "The form of the financing is completely decided: it will be an Argentine debt capitalization through a floating-rate note structure. To say it has already been financed is irresponsible, but it is very close."

Poblete insists Chilgener stands firm on the completion of its entire project. Owned 49 percent by Chilean pension funds, which have few options for foreign investments, Chilgener is expected by most analysts to forge ahead, regardless of what becomes of the two gas pipeline competitors.

Shareholders Sweat the Risks

Chilgener no longer needs much shareholder support. Last July, the utility issued $488 million in new stock; 80 percent was bought locally and 20 percent through American Depositary Receipts on the New York Stock Exchange. Stock prices tumbled since then, but Chilgener has its war chest ready.

CMS, too, has issued stock and has broad international investment funds. GasAtacama costs are commingled with those funds. Southern Co., which in November made an unspecified financial commitment to the NorAndino project, plans to continue to finance its Latin American projects out of deep U.S. pockets.

Should shareholders be concerned about the impact of the risk of a project like Atacama on a $10 billion U.S. utility?

"Our 1997 earnings were up 12 percent," says Wittbold. "That's a cause for shareholder celebration, not concern."

But no company wants to take the last, hardest hit in this race. Hurd pushes the logic of competitive financing a bit further, suggesting "a third option is the joining of the two pipeline projects. Although this option has been denied by both parties, high-level discussions between Endesa-CMS and Tractebel continue."

Neither CMS nor SEI officials would confirm talks, but one Southern official says, "In a project like this, you don't want to rule anything out."

Another option may be more modest, or staged new generation capacity installations in the SING. Holden notes that public reports coming out of Chile suggest both InterAndes and Atacama are scaling back the amount of capacity they're going to add to the SING, which would take off some of the heat when it comes to overcapacity.

Place your bets.

Charles W. Thurston is a Willow, New York-based freelance writer who covers Latin American infrastructure and finance.

Articles found on this page are available to Internet subscribers only. For more information about obtaining a username and password, please call our Customer Service Department at 1-800-368-5001.