Why Latin American Renewable Energy Will (Likely) Survive Cheap Oil

Feb 22, 2015

It is tempting to assert that cheap oil foretells a bleak future for renewable energy in general.  This assertion would certainly be true in a perfect market where energy consumers and investors made choices exclusively based on the price of a barrel of oil relative to the price of renewable alternatives on any given day, while excluding all other exogenous factors.  We, of course, do not live in such perfect market; the relative price of a barrel of oil is but one of many factors that influence energy consumers’ and investors’ choices, and these numerous other factors continue to point toward a promising future for renewable energy in Latin America and the Caribbean despite the current cheap oil environment.

There are several reasons for which it would be unwise to think that, looking ahead, cheap oil today will adversely affect renewable energy roll-out in LAC countries across the board tomorrow.  Chief among them is the likelihood that oil prices will again increase in the next few years.  The shale oil revolution in the United States has helped oil prices plummet, and swing OPEC producers’ desire to retain market share has helped keep these prices low; however, such market conditions have adversely affected the attractiveness of investing in US shale oil, and have caused a consolidation among exploration and production players in this industry.  Less investment and fewer players in the US shale oil industry in the short-run likely spell reduced production and/or higher prices of US shale oil in the medium- to long-run.

Higher future oil prices are relevant to the viability of renewable energy in LAC countries because of the long-term commitment investors make to renewable energy projects, not unlike the long-term commitment oil investors make to exploration and production projects.  The key thing to understand in this respect is that, while oil economists are looking at a one- to three-year slump in oil prices, renewable energy investors are looking at the viability of solar and wind parks with a useful life of 20 to 30 years, or at 15- or 20-year power purchase agreements.  With a very well-managed solar or wind project taking approximately two to three years to come online, from the pre-feasibility stage through turn-key, renewable energy investors are considering the profitability of such projects in operation against the likely backdrop of higher oil prices.

Another weakness of the assertion that cheap oil is across the board bad for renewable energy in Latin America is the very heterogeneous nature of the LAC countries’ power sources.  Such countries as Bahamas, Barbados, Dominican Republic, Guyana, Haiti, Honduras, Jamaica and Nicaragua derive the majority of their power from mostly imported, expensive diesel/bunker, which does mean that cheap oil could make power from renewable sources appear relatively expensive in the short-term.  However, several LAC countries, among them such key regional growth markets as Mexico, Brazil, Colombia, Peru, Chile and Costa Rica, derive less than a quarter of their power from diesel/bunker-fueled generation, thus limiting the impact cheap oil can have on the economics of renewable energy roll-out in these countries.

Turning back to many of the Caribbean countries that currently derive the majority of their power from diesel/bunker-fueled thermal generation, that oil prices will likely rise again in the coming years presents a sizeable opportunity to supplant this thermal generation with renewable generation when these prices rise.  Additionally, it remains unclear whether Venezuela’s generous credit terms will still exist two, three or five years from now, and the eagerness displayed by sovereign attendees at the late-January Caribbean Energy Summit in Washington certainly suggest that these Caribbean countries are keenly interested in diversifying not only the source of their fossil fuels, but also in diversifying toward renewable power generation.

Now, while the price of oil does has a varying degree of influence on clean energy roll-out in different LAC countries, I’d like to address other, equally important factors for clean energy investors, which continue to augur well for clean renewable energy in LAC countries:

  • Policy Environment.  Even countries with fantastic wind, solar or geothermal resources can miss a great opportunity to lead the way on renewable energy if they do not put policies in place to foster such projects.  Fortunately, several LAC countries have implemented such policies in very proactive way.  For example, Nexant has worked with renewable projects in Guatemala eligible for generous tax incentives relating to import duties, VAT and income taxes.  Similarly, Panama has held a couple of reverse auctions specifically for renewable generating capacity.  Honduras has implemented a feed-in tariff regime to encourage investment particularly in solar energy development.  Tax breaks, reverse auctions and feed-in tariffs are but three among many policy tools LAC governments have at their disposal and have used to encourage renewable energy roll-out; other common policy tools employed in LAC countries include renewable portfolio standards (RPS), net metering regulations and biofuel blending mandates.  What is important to note here is that these policy tools are not mere afterthoughts for investors and financiers but, rather, key elements built into their project finance models that have had positive impacts on project IRRs and debt service coverage ratios.
  • Debt Markets.  Access to debt capital has historically been difficult for renewable energy projects in emerging markets, given that local banks are often risk averse and have a preference for asset-backed loans in traditional sectors such as food stuffs.  Nonetheless, unorthodox financing mechanisms have afforded renewable energy projects access to debt capital.  In Mexico, for example, we have seen lenders pooling funds in order to limit the exposure any one lender has to any given large-scale project.  In regard to smaller-scale projects, Nicaragua and El Salvador have shown promising results with green microfinance, and the hundreds of completed transactions speak well of the viability of this type of lending for renewable energy in LAC countries.
  • Local Know-How and/or Original Equipment Manufacturers (OEMs).  The feasibility, construction and operation and maintenance stages of any renewable energy project require highly specialized knowledge, and sourcing it and, if possible, the renewable energy equipment locally can represent not only significant monetary savings but, also, more straight-forward project logistics.  For example, that the list of successful renewable energy projects in Chile grows by the day has afforded Nexant access to myriad local and affordable renewable energy professionals with on-the-ground experience and an ability to mobilize in short-order.  In a similar project, we have seen that Mexico has the added advantage of having domestic renewable energy OEMs, such that Mexico has a growing body of professionals with the technical know-how from the equipment manufacturing stage through project turnkey.  In many key LAC growth markets for renewable energy, we are seeing a growing consensus among government, educational institutions and the private sectors that increasing access to training in technical fields applicable to renewable energy should be a priority, and such consensus will undoubtedly bear fruits in years to come.
  • Carbon Incentives.  Although carbon incentives is really a policy tool I should have mentioned before, it is something that deserves separate recognition due to its potential importance in the coming years in such countries as Mexico.  Mexico, in the context of its recent energy reform has released initial guidelines for the issuance of Clean Energy Certificates (CELs), and Mexico will further define how the Clean Energy Certificate regime will work when it releases the Initial Wholesale Power Market Rules later this year.  These market rules will allow us to determine to what degree the sale of Clean Energy Certificates on the part of renewable energy projects could positively impact the economics of such projects and boost renewable energy roll-out in Mexico in general.  Such emissions trading, while still occurring in a very imperfect market, is an element we already build into our renewable energy project finance models in Mexico, and, in combination with taxes on carbon in Mexico, sets favorable conditions for renewable energy roll-out in this key renewable energy growth market.

By way of wrapping up, the message I’d like to transmit about renewable energy in LAC countries in a cheap oil context is this: we should resist the temptation to think that cheap oil automatically spells trouble for renewable energy.  Forecasts from reputable sources point to oil prices rising over the next one to three years, not all LAC power markets perceive the same windfall from cheap oil, and the price of oil is but one among many factors that will influence renewable energy roll-out in Latin America and the Caribbean moving forward.  Clean energy investors and financiers generally take the long-view, and their assessment of possible renewable energy ventures involves great nuance, such that cheap oil today has not caused and will not likely cause a mass exodus from the renewable energy space in Latin America and the Caribbean.