Brazilian Project Finance and Infrastructure Outlook: 2017 and Beyond
Brazilian Project Finance and Infrastructure Outlook: 2017 and Beyond
By José Virgílio Lopes Enei, Machado, Meyer, Sendacz e Opice
In this article José Virgilio Lopes Enei at Machado Meyer, Sendacz e Opice evaluates the current state and future outlook of the Brazilian project finance and infrastructure markets.
Highlights of the infrastructure and energy markets in Brazil
Brazil is a continental country with a population of over 200 million people, most of whom live in urban areas, particularly in the main cities. São Paulo, the most developed city in the country, is home to 21 million people living within its metropolitan area.
The country has a reasonably diversified economy, with a few world-class manufacturing industries (such as aircraft), a sizeable service sector (including some of the strongest financial institutions in Latin America) and notable strengths in the production and export of agricultural and mining commodities.
These characteristics make Brazil heavily dependent on suitable infrastructure and reliable energy sources, whether to handle logistical and energy needs of its manufacturing and commodity industries or to secure basic needs of its population.
Despite relevant public and private investments in infrastructure in the past two decades, Brazil has not yet developed a world-class infrastructure consistent with its needs or comparable to that of developed economies. This infrastructure bottleneck has an adverse impact on Brazilian productivity, competition and economic growth. However, it also offers relevant investment opportunities for local and international players interested in the infrastructure and energy industries. Listed below are some pertinent examples.
Brazil already has an extensive highway and toll road system, connecting its whole territory, but there is a clear need for further extensions, duplications and general improvement of road conditions. This is expected to be achieved through new rounds of concessions taking place regularly in both federal and state levels, including those awarded by the State of São Paulo in early 2017.
As of March 2017, 10 airports have been privatised. Many other major airports are to be privatised in subsequent rounds, and Brazil has also announced plans for privatisation or construction of hundreds of regional airports.
The railway system in Brazil is still precarious and inconsistent with its territory and freight needs. By 2015, the system had only 30,000km (with 23,000km in operation), compared to 228,000km in the US – even though the two countries are of a roughly similar size. Official plans announced in Lula’s and Dilma’s presidential mandates contemplated new projects under a reformulated unbundled model, to add at least 11,000 km to the system – but since then very little progress has been made. Under Temer’s government, the granting of concessions for relevant segments of the North-South Railway (EF-151), the Grain Railway (Ferrogrão – EF-170) and the East-West Railway (Fiol – EF-334) was made a priority, and is scheduled for the end of 2017. The traditional integrated model will be preserved.
Despite the construction or full renovation of a handful of relevant new port terminals in the last decade (both private ports (eg, Embraport, Portonave, Itapoa and Porto Açu) and public ports (eg, BTP in Santos)), the improvement of port capacity and related quality of services are still vital for raising competition within our imports and exports. By 2017, more than 100 port terminals in several public ports along Brazilian coast have had or were about to have their lease terms expired without further renewals – thus requiring their bidding to a new round of investors, which will then undertake necessary additional investments to keep up with current service and efficiency needs.
Oil and gas production
After little progress on the production-sharing contract regime for pre-salt areas, Petrobras’ mandatory role as operator was altered to a right of first priority. Two new rounds of pre-salt exploration blocks have been announced for 2017, and a third one to 2018. After the 13th round of non-pre-salt blocks offered under concession, which was completed in October 2013 with disappointing results, 14th and 15th rounds are expected within President Temer’s residual mandate. Petrobras will continue its divesture programme, including US$13 billion announced in 2016 and US$21 billion more projected for 2017.
Brazilian network of gas transportation pipelines is still in its infant stage of development. The sale of the pipeline network, originally in the hands of Petrobras, will be carried out in segments. The sale of a 90% stake in the Southern portion (NTS) was closed in 2017 to a group of private investors led by Brookfield. Pipeline capacity is clearly constrained and, accordingly, will need to expand quickly to handle expected increase of gas production (from pre-salt and onshore areas), without prejudice to growing imports of LNG made possible by investments in new regasification plants.
The vast extension of Brazilian territory, combined with the ever growing demand for power, a great part of which is produced in remote areas where hydro reserves are available (such as the Amazon region), impose the need for constant investments in transmission lines, which are satisfied by periodical rounds of new concessions. This is a segment used to attract a lot of interest from investors, considering its lower risk profile and potentially attractive returns. In April 2017, Temer Government awarded 31 new transmission projects to the private sector.
With the growing efficiency of wind, biomass and solar generation projects in the Brazilian territory, these renewable sources should continue to provide a reasonable share in the expansion of the Brazilian power generating capacity. Long-term PPA auctions for the captive market, served by power distributors or by the Chamber for the Commercialization of Electric Energy (CCEE) are offered periodically, usually more than once a year and experiencing a high level of competition.
Gas-fired power plants
Considering the growing scarcity and environmental challenges of large hydro projects, the Brazilian power generation matrix will need to rely more and more on gas-fired power plants. By first quarter of 2017, there were some large projects in the early stages of development – most of which were still dependent on long-term PPAs, not yet secured in the captive market auctions. Taking into account the unavailability of required volumes of gas from local production or imports from Bolivia, all these projects were based on LNG and existing or dedicated greenfield regasification plants. A PPA auction for thermal power projects is expected for the second half of 2017. Petrobras’ divesture plans in respect of all its thermal plants and regasification capacity should also be noted.
Water and sanitation projects
The level of Brazilian population covered by sanitation services and reliable water supply is still critical and will require massive investments in this sector for many decades to come. State-owned water and sanitation companies, such as CEDAE in Rio de Janeiro, are among those prioritised for privatisation.
Legal regimes for investments in infrastructure - planning and investment programmes
Infrastructure and energy activities are subject to different levels of regulation, in accordance with a multitude of sector specific laws.
In addition to, or in association with, the most traditional legal regimes for developing infrastructure activities – such as common concessions regarding public services, public-private partnerships (PPPs) in a strict sense, non-discretionary authorisations or mixed capital entities – there are several hybrid or alternative regimes.
Considering the central role still played by the public sector in the implementation, bidding and awarding or authorisation of infrastructure projects in Brazil, proper and long-term governmental planning is fundamental to set priorities, create conditions for a balanced and coordinated economical growth and to offer some predictability to the private sector.
Former presidents Lula and Dilma launched successive programmes for accelerated growth (PAC 1 and PAC 2) as well as the programme for investments in logistics (PIL), contemplating different stages and sector-specific chapters.
Although many projects were successfully launched during their mandates, these projects collectively have never accomplished more than a small fraction of targets set out by these programmes. There is a common perception that many of these programmes were set up more as a marketing and political tool, without concrete plans for their actual implementation.
Investments in infrastructure are capital-intensive and highly dependent on available sources of project financing, due to the inability or inconvenience of players raising financing solely on their balance sheets.
Throughout the last decade or so, BNDES received additional funding from the Brazilian treasury and substantially increased the amounts of project financing for infrastructure projects in general.
Because BNDES has traditionally offered the most subsidised source of financing, projects did not suffer from lack of financing, but market oriented sources of financing had little room to develop.
Subsidised costs absorbed by the government to secure continuous funding to BNDES and other state-owned financial institutions, as predominant source of project financing, have ultimately caused a material adverse effect contributing to the fiscal and economical crisis that erupted in Brazil as of 2015.
As a result, the federal government and BNDES have announced a radical change in their subsidised financing policies, which was intensified by Temer’s government. From now on, BNDES will make available only a minority of any given project’s financing needs; will reduce the level of subsidies; and will be much more selective in terms of eligible projects.
Such new policy will offer more room for, and require stronger participation of, international lenders and, mainly, institutional and other capital market investors through project bonds, especially infrastructure debentures.
This new scenario will also offer an important role for private commercial banks experienced in the sector, who traditionally cannot offer long term financing, but will be called to provide bridge loans and, most importantly, bank guarantees to back up infrastructure debentures until relevant project completion is achieved.
One could enquire as to whether capital market investors will be willing to provide long-term financing in the volumes no longer absorbed by BNDES. That has not been the case so far.
However, that has been the case in a context where no alternative source of financing could compete with BNDES cheap funding and there was plenty of BNDES funds available. Insofar as BNDES is no longer an option for a large number of projects, or even for the entire debt needs of those eligible ones, project developers will have to resort to a much greater extent to capital markets and will have to pay interests at market levels, that is, treasury bond interests (SELIC or IPCA plus a predetermined real interest rate) added by a reasonable premium in connection with infrastructure project risk.
This also means that government will need to set up minimum tariffs, granting fees or PPP financial support at levels that will be able to absorb these incremental financing costs, while controlling authorities will need to understand and become comfortable with this new reality. This translates into a more realistic – less subsidised – tariff policy, which should, at the end of the day, help the government to rebalance its fiscal budget and reduce market interest rates gradually, hopefully bringing back the economy to a virtuous cycle and growing mode.
The PPI - Programme for investment and partnerships
On the first day of his interim mandate, President Temer enacted Provisional Measure 727 of 7 May 2016, subsequently converted into Law 13,334 (the PPI Law), creating the PPI – a framework under which projects of different regimes could be qualified, so as to receive special priority from all relevant governmental authorities, as well as special assurances in terms of legal stability, relaxation of bureaucracy and other requisites for attracting the private sector.
The PPI Law created the PPI Committee, with powers to:
- recommend to the president the inclusion of projects in the PPI programme (thus benefiting from a special priority status);
- monitor the implementation of these projects;
- propose further legislation or regulation to relevant authorities;
- and to absorb the responsibilities formerly resting on the PPP Federal Committee, the National Council for Integration of Transportation Policies and the National Committee for Privatisation
The first resolution of the PPI Committee was enacted on 13 September 2016, outlining relevant guidance for the implementation of projects within the PPI programme.
By the end of April 2017, it was still too early to make reliable forecasts, but the general opinion among economic experts in Brazil was that recovery from economical crisis had begun. Although recovery should be a gradual and lengthy process, market confidence was slowly returning.
The government’s ability to advance major reforms such as labour and social security will be a key contribution to a long-term sustainable growth.