The combination of an emerging and strongly regulated renewable energy market is at the same time inviting and baffling. Especially if this market is in the midst of an institutional crisis. Such complexity calls for a strict risk management in order to evidence chances and mitigate risks. Yet, the benefits of risk management in Brazil have not been fully recognized.
Last week, during a business trip to Brazil, I had the chance in two occasions to dive into Brazilians’ risk perception towards the renewable energy market: the first one during a risk management conference by VIEX Americas and the second at the Intersolar South America.
It went beyond the surface. Project development in Brazil is trapped between a very regulated market and a systemic lack of financing. The business case for large scale capacity results exclusively out of auctioned PPAs. Financing is almost exclusively provided by governmental institutions at subsidized interest rates, leaving the commercial sector with their hands behind their back. Alongside with singing a PPA and getting public financing for up to 70% of the investment costs, there are two further challenges: arranging for the necessary guarantees and aligning the supply chain. This is almost a natural selection process and it is estimated that the larger part of the projects contemplated in the 2014 and 2015 auctions won’t actually be built.
Risks are underestimated during execution
For those that will be built, there is a point at which risk management seems to stop being a concern. Market concentration, cultural and especially institutional tolerance for delays, combined with low cost capital result into relative low diligence during the execution phase. I was quite surprised to discuss this topic with developers, lawyers and insurers, and to learn that there is no systematic approach for risk and contract management.
In part, this is understandable. Most of the plants are being built in a BOO model. Besides, project financing in Brazil is not purely non-recourse, hence there is little tradition in demanding higher diligence levels. However, I expect this scenario to change. Once institutional investors start being serious about investing into operating assets, the sector may expect more scrutiny. This is not a far in the future option. Actually, a tendency for long term foreign investments can be already observed in other asset classes, such as public bonds.
The bright side
It is during the commercialization phase that risk management emerges to be taken seriously. During the past decade, the electricity market in Brazil has become over regulated. Both bilaterally contracted prices and spot prices are subjected to a national liquidation scheme. Pricing mechanisms lack transparency and are bound to regulations and not really supply and demand. Further, outdated calculation methods expose distributors to additional risks.
But, as the awareness around these risks is growing, the market is evolving. Many of the agencies responsible for regulating the electricity market is experiencing a new, more market oriented administration. There is a professional and sophisticated scene already working on mitigating the unknown and at the same time engaged in a dialogue to shape the future. In some cases, it is almost a self-fulfilling prophecy, as the strong claim for more liberalization becomes hands-on. An example is the outset of derivative contracts exchanged in the BM&F.
In conclusion, the value added by managing risks and investing in transparency during project execution has not yet been fully recognized. The regulated nature of the generation market is not giving the same motivations as a commercial market would. But as the commercialization, and not generation, is increasing the pressure for more market liberalization, I expect a push and pull effect. By turning investors’ concerns (risks) into opportunities (chances), more liquidity can be expected, what will eventually increase the market attractiveness as a whole.