Non-Traditional Debt Can Fund Energy Projects in Uncertain Times

Q: What were the opportunities that led to Finergreen's expansion into Mexico?

A: Finergreen started operating 10 years ago in France with a focus on financial consulting for the development of renewable energy projects. It operated initially in Europe, but now also in emerging countries where the energy needs are the greatest. As a result, today we have offices in Africa, our first territorial expansion, the Middle East, Southeast Asia and Latin America.

In mid-2018, the firm made the decision to expand to Latin America and Mexico emerged as the country with the best conditions to locate our regional office. The size of its population, the wide availability of renewable resources, a high project implementation potential, the proximity to the US market and the availability of skilled talent are key strategic advantages the country offered. The decision to open the Latin America office was made during the 2018 presidential elections that led to President López Obrador’s administration. At that time, a change in energy policy was not foreseen.

Finergreen’s Mexican office covers the entire Latin American region, except for Brazil, which is covered with a dedicated office in São Paulo. Currently, Latin America represents between 10 and 20 percent of the international consortium's annual revenues. A part of our mandate is to serve European clients in this part of the world and to start developing new business lines with the US and Canada.

Q: How has the recent increase in interest rates influenced the feasibility of new renewable energy project financing?

A: Due to rising inflation in various international markets, interest rates, which had remained at attractive levels during the pandemic, began to increase. This raises both the cost of financing and the amount of CAPEX needed for project development. However, the power purchase agreements (PPA) that were negotiated and signed during the pandemic years did not increase in price. The pressure from higher financing costs without a real increase in revenues from power production projects has ultimately complicated the financing of new projects through traditional debt schemes.

These traditional debt sources, mainly banks, are putting up less of the total amount of capital needed to complete a project. Moreover, companies also cannot buy as much with their available capital due to rising supply prices. In parallel, amid factors that include a focus on ESG criteria and carbon neutrality as well as the promotion of sustainable investments, the renewable energy sector has continued to mature. To date in Latin America, there has been little deployment of non-traditional debt for wind, solar and biomass projects, and as a result, there is an opportunity in the market to continue to fund these projects through non-traditional debt mechanisms, such as subordinated and mezzanine debt, preferred equity investments and bridge loans. All these schemes have comparatively more flexibility regarding the amount borrowed and the repayment conditions. These debt classes have been little used in Latin America in relation to investments in renewable energy infrastructure projects, so they have a great potential to support the market with liquidity.

Q: How has the appetite for risk among investors been impacted by recent industry developments?

A: Despite adverse macroeconomic conditions and constant regulatory changes, the renewable energy market in Mexico has continued its maturation process. This has led to investments in energy projects evolving into more common investment choices instead of being solely a niche investment intended for adventurous investors or sector experts. Today, all major institutional investors have exposure to renewable energy; it has become a staple in all multinational asset managers’ portfolios.

Secondly, with the change in the criteria of traditional debt sources, a gap has been created that presents an attractive area of opportunity for new sources of funding and financing. Now, with the contraction of traditional debt participation in the Mexican sector, there is a demand for alternative sources of financing where new investors can participate.

Q: How has this environment of regulatory uncertainty affected project finance in Mexico?

A: When we opened our offices three and a half years ago, we never considered that this scenario would be possible. The constant change of rules not only scares away traditional investors, but non-traditional investors too. In the end, you need the certainty that agreements will be respected, regardless of the degree of risk an investment carries. The effect on financing has various sides. On the one hand, investors who have always been willing to invest in the sector have decreased their overall exposure. On the other hand, many new entrants decided not to start investing or to suspend their current investments. Because of the lack of financing generated by these two conditions, there is an opportunity for new investors with non-traditional mechanisms to invest in the sector.

Q: Which Mexican renewable energy projects have taken optimal advantage of non-traditional financing schemes so far?

A: This would be distributed generation (DG) projects in a commercial portfolio. In this case, uncertainty lies in the pace at which the projects can be signed and built. A traditional debt scheme with a rigid amortization is not compatible with a scheme where the deployment of the projects will be irregular. In this segment, there has been a great deal of creativity in creating new approaches to fund the growth of DG. DG is an interesting and attractive power production option, where commercial and industrial (C&I) offtakers are strongly encouraged to explore new and alternative financing schemes to mitigate the high electricity rates they currently pay.

Q: What does the Mexican market need to increase the accessibility to financing for new energy projects?

A: There is enough appetite and desire on behalf of different investors, such as banks, funds and energy companies. Removing the amount of noise around the government's current energy policy vision is essential. Even if it went at a slower pace, the reduction in unnecessary noise caused by changes in energy policy would reactivate some investments in the sector. Threats, such as curtailment, sudden changes in regulation, breaches of signed PPAs and interconnection processes whose commercial operation date (COD) is arbitrarily withheld, alter investment decisions and keep the sector at a relative standstill.

Beyond the lack of clarity in the rules of the game, reliability in the application of the established rules is imperative. Consistency provides certainty that contracts will be respected, which is essential, especially when dealing with medium and long-term investments. As long as Mexico's energy policy lacks clarity and consistency, it will not be possible to move forward with the necessary investments to implement the energy transition that the current context demands.

Finergreen is a financial advisory boutique specialized in the energy transition and renewable energy. Founded in 2013, the company has already completed 150 transactions for a total of US$3 billion. With 70 people based in 10 offices across the world, the company provides M&A, project finance and strategic advisory services. In 2021, the company was ranked first by deal count in Inframation’s League Tables, with 30 transactions executed in the renewable energy industry.