Any way you look at it, Latin America is a green leader. The only country in the world with a 100% renewable energy grid is Costa Rica. Two of only three carbon negative countries in the world are Latin American – Panama and Suriname. Most of the world’s copper and lithium – the most important energy transition metals – are found in Latin America. Brazil is planet’s second-largest producer of both hydropower and biofuel, while Chile’s Atacama Desert has the highest level of solar radiation on the planet.
Of course, it is easy to pick out extreme examples, but Latin America still impresses with its averages. For example, around 50% of the region’s electricity comes from renewable sources, far higher than the global average. Even when you look at total energy demand, which takes other consumption, such as car journeys and industrial use, into account Latin America still does well. According to an OECD report, renewable energy resources represent 33% of its total energy supply compared to 13% globally.
But despite Latin America’s strong clean energy position, there is still massive potential for new projects. That’s because the bulk of Latin American renewable energy today is provided by hydroelectric power. Yet – and this is partly down to climate change – rainfall across the region is becoming more erratic. As a result, various countries across the region are expanding their solar and wind generation capacities. We look at some of the most exciting opportunities below.
Putin derails transition?
Some analysts worry that Russia’s invasion of Ukraine, which saw European renewable advocates, such as Germany, turn coal-fired plants back on in a bid to maintain energy security, will stop the energy transition. Yet Alfredo Mordezki, Head of Latin American Fixed Income for Santander Asset Management, believes any delay will be temporary.
“The long-term trend is still there. At COP26 last year it was clear that there is political motivation to make renewables a much higher percentage of the energy matrix. Indeed, Latin America is already a leader in this regard because it benefits from a huge amount of hydro built in the 50s and 60s. That means the electricity matrix is already over 50% renewable in many countries. For example, the power grid is more than 50% renewable in Brazil, Colombia, Uruguay, Peru and Ecuador. Chile and Mexico are notable exceptions, although a pipeline of projects that are planned in Chile will make the matrix a lot greener in the future. As for Mexico, for the last century it has relied on its major discoveries of oil.
“The starting point for Latin America then is that the matrix is already quite clean. That said, the potential for additional solar and wind is enormous, so the grid can be made even more renewable at low prices. That is the logical direction of travel, though we will see different countries move at different speeds. Chile has a well-established energy transition law, while Colombia has made great strides in renewable energy over the past few years. The war causes a distraction from the energy transition but it won’t derail it. I think COP27 will be a wake-up call, where people realise how far they have deviated from the spirit of COP26.
“But the pre-war ESG trend will prevail again. 2022 saw the hottest summer on record in Europe, with terrible wildfires. Those types of environmental emergencies will keep the pressure for more ESG investment.”
Martin Vogt, CEO of MPC Energy Solutions, a Latin America-focused renewable energy firm believes the disruption caused by the sanctions against Russia will accelerate the transition in the region. “The US is now exporting massive amounts of LNG to Europe, which has driven up prices for Latin American buyers. Even in the US we saw the cost of natural gas go from $3 per MMBTU to $9 per MMBTU. If you look at El Salvador, where a 300 MW LNG plant has been built, you see prices went up significantly. Most of these countries didn’t have long-term supply contracts in place so the cost of importing quickly became more expensive. Jamaica and the DR are other examples of small markets that have suffered tremendously.
“Some countries in the region bet big on replacing diesel with LNG because it was cheaper. But now they have seen that when there is a crisis the world’s limited LNG supplies will go to other markets. So that is a big boost for renewable energy because governments see that natural gas is not the Holy Grail. Coal users also suffered. Germany began importing huge amounts of coal from Colombia, which increased the price for local users by 400%. Renewable energy has emerged as the only way to get away from expensive import dependencies and exposure to geopolitical shocks like the Russian invasion.”
Latin America is already a renewable leader and has potential for more projects but that doesn’t guarantee investors in the theme an easy ride. In addition to heading Santander Asset Management’s fixed income team in Latin America, Mordezki also manages a regional ESG fund. It has had a tough 12 months.
“The building blocks of the fund’s performance are bonds”, explains Mordezki. “When we launched in February 2021 the yield of the portfolio was 2.7% - it is now 6%, which means the price has fallen and our performance has been bad in absolute terms. This is because the rise in risk-free rates of US Treasuries. The stock market and treasury market suffered, and we did too. So far this year, emerging market bond funds have seen outflows of $80billion. In the 25 years I have worked in the market I have never seen that level of outflows – so it has been a tough market.”
But it wasn’t all negative, says Mordezki. “One positive step we saw this year was that the SEC now requests further disclosure for ESG accounting. That will impact some of the Latin American names listed in the US. If you look at what in Europe we call “Article 8 ESG funds” – those that take ESG factors into account in security selection – we have seen $30billion of outflows this year. But ultimately these are vanilla funds made of up of equities and bonds, both of which did badly during the sell off. But if you look at European “Article 9 ESG funds”, which are a lot more ESG-dedicated, there you see that inflows increased. The investors in those types of funds are more committed and patient to the ESG movement. The typical investor might be a Northern European pension fund; not a Latin American high-net worth individual, so the approach to impact/financial return is different. An institutional investor with a focus on ESG is not going to suddenly jump into coal because it is having a good year.”
That means the more dedicated ESG investment vehicles should see greater investor loyalty. “Investors in Article 9 Funds will be prepared to ride out delays or underperformance because there is a clear environmental purpose attached to the investment. If the ESG strategy is not clearly shown and the ESG benefits aren’t obvious then investors may lose patience when the market falls.”
After seeing the share price of MPC Energy Solutions, which listed in Oslo last year, fall by two-thirds, Vogt empathises with Mordezki. But he is sanguine about stockmarket movements. “When you are a small company in a growth segment you live by your quarterly statements. But as a long-term infrastructure play you can’t translate success into quarterly statements. Also, the environment this year, with the Federal Reserve and other Central Banks raising interest rates hit a lot of stocks, including us.
“When you are in a hard asset sector like renewable energy and in emerging markets then the increasing dollar strength and rising interest rates are going to hit you. Investors become more cautious about allocating capital. And because we are a company whose shares have low liquidity - with 60% of our stock held by five shareholders – then small orders can have a big impact on our share price. But we are not too worried about the share price at the moment because our long-term shareholders understand that we are achieving our objectives.”
For those investors whose primary concern is fighting climate change – not short-term movements in the share price – Latin America is full of opportunities. Ecuador is a pretty good example of the trends shaping renewable energy in Latin America. It has strong hydro resources but is now exploring other technologies. “Ecuador has incredibly cheap energy costs”, says Hassan Becdach, President of HJ Becdach, an Ecuadorian natural resource consultancy. “We are the second-cheapest in the Americas, just after Paraguay. Moreover, our grid is 80% renewable. However, one problem we have is the Chinese-built hydro power plant Coca Coda Sinclair, which produces 40% of our renewable energy. It has lots of technical flaws that need to be fixed by the constructor. We have potential to do even more with solar and wind but the right conditions need to be created for investors. It helps that the cost of these alternative renewable energy technologies is coming down fast.” So a responsible wind or solar producer, ready to develop projects in-line with international best practices will be very welcome in Ecuador.
Vogt believes that MPC Energy Solutions’ relatively small size – its market cap is around $350million – allows it to “cherry pick” the best opportunities. “If you are a multi-billion dollar corporation you have to go for the massive volume markets like Brazil, Mexico and Argentina. But we can be more selective. The three factors that we consider are: counterparty; currency (because the US dollar is our functional balance sheet currency) and political exposure. By working across a range of niche markets we can increase our diversification for those three factors. That’s why we like Central America, the Caribbean Islands and the smaller Andean countries, like Ecuador. In general, we prefer markets that offer US dollar contracts, so in Jamaica, the Dominican Republic and St Kitts we earn in US dollars. We also look for long-term PPAs with a strong counterparty. For example, in El Salvador our off-taker is a subsidiary of AES.
“In El Salvador you have a government that is committed to the energy transition. Colombia is another preferred market because we have seen immense renewable progress in recent years and the size of the country allows us to build a pipeline of projects. There are also strong off-takers in Colombia. The only downside is that we have exposure to the Colombian peso, but you can’t have everything. The Dominican Republic really seems to be in a sweet spot for international investors. There are a lot of international companies that have recently entered the market – for example Total Energies has just committed to a 100 MW renewable energy project. The DR economy is very stable, you have big local banks and great renewable resources. We have also started to see some progress with Panama, which had made some early steps with wind and solar but now looks more attractive.”
As Vogt notes, the attractiveness of each investment opportunity depends on the criteria of the investor. But underpinning them is a robust regional economy. “Latin America has got an attractive macro environment with most countries outperforming the GDP expectations at the start of the year”, says Mordezki. “If you take the regional retail market, companies have more pricing power than their US peers, so the current rise in inflation did not hurt their margins that much.” We live in an era of corporate greenwashing, where everyone from airlines to zoos are keen to demonstrate how environmentally-sustainable their businesses are. But those nice PR statements contrasted with a ruthless market sell-off this year that wiped value off energy transition investments. That might seem like a massive contradiction but it’s just a question of timing. Capital markets react to short-term events while the renewable energy transition is a long-term trend. Investors with a mandate that allows them to ride out market turbulence will find exciting investment opportunities in Latin America.