THE ANSWER, MY FRIEND,
IS BLOWING IN BRAZIL'S WIND

Alternative Views focuses on green infrastructure investment in Latin America.

SUMMARY

  • Renewable energy production in Latin America has grown dramatically over the last decade. The use of green technology like wind turbines and solar arrays continues to expand, as countries like Brazil seek to improve energy security and lower carbon emissions.
  • Given this energy revolution, the opportunity for private investment in renewable energy infrastructure in Latin America is robust.
  • These private investments are fueled by new public/private partnership frameworks, untapped topographical potential, and rising economic demand and stability.

 

The winds of change

Wind turbine technology thrives in Latin America

Climate concerns are driving change across Latin America, as countries embrace cleaner energy and look for more sustainable ways to increase power generation. Among those more sustainable ways is wind turbine tech-nology—considered one of the cleanest sources of energy on the planet.

Globally, from 2000 to 2017, wind capacity increased from 17,000 mega-watts to more than 500,000 megawatts, according to the International Renewable Energy Agency (IRENA). Latin America is at the forefront of this revolution. Twenty-six of the 62 renewable energy deals recorded in South America since 2013 were in the wind energy space. In fact, Brazil is the most advanced country in the region in terms of wind power utili-zation. As of 2017, the nation has 447 wind farms with an installed capacity of 11 gigawatts (GW)—enough to power more than 10 million homes1. In addition, the country has committed to expand non-hydropower renewables, such as wind turbine technology, to at least 20% by 2030. The Brazilian Energy Research Company has forecast more than 24 GW of wind power capacity is expected to be added to the energy matrix by 20272.

 

BRAZIL IS AMONG THE WORLD’S LARGEST POWER SYSTEMS, PRESENTING GREAT OPPORTUNITY FOR GROWTH AND EFFICIENCY GAINS

Exhibit 1: Brazilian electricity grid
As of July 2017

Exhibit 1: Brazilian electricity grid
Source : National Grid Operator (“Operador Nacional do Sistema”–ONS) 2017–2019 expansion and reinforcement plan as of July 2017.

 

Investing where the wind takes you

The opportunity for infrastructure investment in Latin America is robust

Significant resources in the way of capital will be needed as countries like Brazil look to build out their renewable energy infrastructure. According to Forbes magazine, 226 energy infra-structure-related investments in 2017 were financed by $61.8 billion of foreign capital, and this trend is fore-cast to continue.

The U.S. Energy Information Administration (EIA) suggests that power generation in the region will have to double by 2030 to support the growing population. The Economic Commission for Latin America and the Caribbean (ECLAC) estimates the population will rise from 625 million today, to 779 million by 2050. This increase will require investments greater than $700 billion3. Renewable sources are expected to drive this expansion, particularly in Brazil, as the country reduces its dependence on large hydro-power generation. Through 2026, renewable infrastructure in Brazil—like wind power—is expected to grow faster than 8% year-over-year, representing more than half of the total capacity expansion for the period.

 

RENEWABLE ENERGY SOURCES EXPECTED TO DRIVE INFRASTRUCTURE GROWTH

Exhibit 2: Brazilian electricity matrix—planned expansion (Installed capacity in GW)
As of December 31, 2016

Exhibit 2: Brazilian electricity matrix—planned expansion
Source : Brazilian Power Research Corporation (“Empresa de Pesquisa Energética”—EPE) 10-year expansion plan as of 2016, most recent plan available. Past performance is not an indicator or guarantee of future performance.

 

Locally, there are obstacles for this type of fund raising. Most notable is the capital constraints within the region, including high levels of local debt and low levels of liquidity in the private sector. As such, outside private sector investors are uniquely placed to help fill this gap, but they must be able to recognize and address specific needs by project and country.4

Successful investment in the region’s infrastructure requires technical, financial and government expertise that are idiosyncratic to the market. Companies participating in infrastruc-ture projects can encounter a plethora of regulatory, political and financial hurdles that investors might have not experienced in other venues.

Broadly, however, the region may be an attractive target for foreign investors looking to develop renewable energy assets. Neighboring countries in the region have started developing regional power systems to connect electricity grids. This helps to alleviate the challenge of grid stability faced by intermittent energy sources like wind and solar. These grid enhancement projects present additional investment opportunities for private capital. According to a 2018 New York Times article, more than 12,000 km of trans-mission lines are needed in Latin America to make full use of the cross-border energy integration potential.

The Brazilian market

  • Brazil is one of the world’s biggest economies, and has the largest power market in Latin America, serving a population of 200 million.
  • Manufacturing, services and agri-culture sectors underpin a diverse economy. For example, Brazil is both an agricultural powerhouse and home country to one of the leading aircraft design and manu-facturing companies globally.

 

Country snapshot (2017)

Population5 208M
2017 GDP6 USD $2.1T
GDP rank6 8th globally
Inflation (IPCA)5 3.5%

  • In terms of wind power, the market is under expansion, with good opportunities in both brownfield* and greenfield**. Capacity grew from 0.2 GW to 12.8 GW in the last 10 years. Over 24 GW is expected to be implemented by 2027.
  • For solar power the market is still under-exploited, with high quality greenfield opportunities. Capacity grew from 0 MW to ~1 GW in the last 10 years, and is expected to grow more than 40% per annum over the next 5 years.
*Brownfield projects are built over land or building or infrastructure which is already in place but is no longer in use.
**Greenfield projects are built from scratch, lacking constraints of prior work. In these there is no existing building or infrastructure.

Source: Brazilian Power Research Corporation (“Empresa de Pesquisa Energética”—EPE) 10-year expansion plan as of 2007 and 2017. Past performance is not an indicator or guarantee of future performance.

 

Catalyst for energy change

The Brazilian government’s Alternative Energy Sources Incentives Program served as a catalyst for the shift toward renewable energy in the region. The program offered independent power producers attractively priced and flexible 20-year power purchase agreements (PPAs) with the govern-ment-owned entity Eletrobras. In addition, the largest development bank of Brazil, BNDES (Banco Nacional de Desenvolvimento Economico e Social), provided financing at low costs7.

As such, the segment has grown rapidly in the last 10 years, from 400 MW in 2008 to 13,667 MW in 2018, or 45% per annum. This can be attributed primarily to: (i) strong growth and diver-sification of the energy matrix; (ii) a reduction in the capital expenditures given technology improvements, and an increase in supply given the lower economic growth of developed coun-tries; and (iii), high capacity factors, significantly above global averages (i.e. 50% vs 20%)8.

 

A national emergency

In addition to government incentives, climate change has also served as a catalyst for wind technology. Between 2014 and 2017, Brazil faced some of the worst drought conditions in the country’s history. At one point in 2014, seventeen of the nation’s 18 largest reservoirs were drained to a mere 1% of capacity—their lowest levels since record-keeping began. More than four million people were affected, and cities across the country were forced to impose water rationing. In the northeastern city of Olinda, for example, authorities fully cut water supplies three days a week for two years. In São Paulo—the most populous city in South America and the worst hit by the crisis—water use was cut by as much as 40%.9

 

WIND, BIOMASS AND SOLAR POWER REPRESENT MORE THAN 40% OF TOTAL ADDITIONAL ENERGY CAPACITY AUCTIONED IN BRAZIL SINCE 2008

Exhibit 3: Additional capacity publicly auctioned
As of October 2018

Exhibit 3: Additional capacity publicly auctioned
Source : Brazilian Power Research Corporation (“Empresa de Pesquisa Energética”—EPE) 10-year expansion plan as of 2016, most recent plan available. Past performance is not an indicator or guarantee of future performance.

 

The energy industry felt the most pain

Obviously, the droughts significantly impacted the Brazilian economy and quality of life. Perhaps the most profound shock, however, was felt by the energy sector. This is because a significant source of power for the region—roughly 68%—has long been hydroelectricity.

Given the water shortages energy production was of course, severely hampered. Blackouts and brownouts rolled across the country for weeks. High temperatures and increased air conditioning demand overwhelmed grids. Lights and internet access were lost for days, subway trains were halted, and businesses shuttered.

 

Climate change a national security threat

Clearly, the droughts caused substantial distress. It should come as no surprise then: a 2017 Pew Research Center survey of 38 countries, Brazil, along with five other Latin American nations, ranked global climate change as the topmost threat to national security. A full 77% of the population identified climate change as an area of immediate concern.

According to a World Bank study, it seems their worry is well placed. Despite accounting for only 12.5% of global greenhouse gas emissions, if the earth’s temperatures rise more than 2°C, Latin America will be one of the most affected regions.

For example, the melting of glaciers in the Peruvian and Bolivian Andes will likely accelerate. Most ice-flows below 5,000 meters will possibly disap-pear, disrupting water supplies, and affecting agriculture and hydroelectricity for millions.

In addition, as storms intensify, flash flooding will likely increase as well.
In 2017, Peru and Columbia were pummeled by rains that led to cata-strophic floods and mudslides, killing hundreds. In Peru alone, more than 240 bridges and thousands of miles of roads were destroyed. The reconstruction bill was estimated to be around $6 billion, more than 3% of the country’s GDP.

In short, climate risk is real risk, espe-cially for Latin America. The region anticipates extreme weather events to become more frequent and intense due to global warming.

The challenge with hydropower is sustainability

Many Latin American countries, like Brazil and Paraguay, have long been global leaders in renewable energy. In 2016, the region produced 53%10 of its electricity from renewable resources, compared with the global average of just 22%.

It is important to note, however, the vast majority of this renewable energy is in the form of hydropower. In fact, according to the International Renewable Energy Agency (IRENA), hydropower accounts for 50% of the region’s electricity demand.

So the emphasis on renewables in the region has historically been a function of convenience versus a deliberate move towards greener energy production. With the many rivers and tributaries that intersect countries like Brazil and Paraguay, the use of hydroelectric power was a practical choice.

The problem with hydropower is sustainability. For example, as the frequency and severity of droughts in the region increase, capturing energy from flowing water is increasingly difficult.

Historically the country’s hydropower plants were built with considerable reser-voirs, where large inventories of water could be converted to power during dry periods. For environmental reasons many of these reservoirs in recent decades were converted to “run of river” systems, which hold less water by channeling a portion of the river through a canal.

With more “run of river” reservoirs, the country’s energy storage capacity as a percentage of total capacity has decreased. During severe dry spells, such as those that occurred in 2001, 2002, 2014, and most recently in 2017, supply cannot support demand. As such, thermoelectric energy is often required to compensate11. Finally, while hydropower is technically renewable, it is not always green, as large hydro plants, dams and lock systems may create environmental complications.

 

Wind is an ideal solution to hydropower disruption

Wind energy is an ideal solution to supplement hydroelectric plants in the Latin American region. This is because even if there are no droughts, dry seasons still occur, and this still limits the generation of hydroelectric power. Renewables, like wind, round out hydro generation. It is during the dry season when wind energy produc-tion is usually the strongest.

 

The answer, my friend, is blowing in Brazil’s wind

Why is Brazil so suitable for wind power?

The website Go-kite.com, the self-pro-fessed “preeminent kitesurf travel guide in the world”, proclaims the northeast coast of Brazil to be among the world’s best locations for kitesurfing. They describe it as a “kite paradise,” where adventurous kite surfers will find the “gnarliest of gnarly” winds.

It is not just the adrenaline junkies that have discovered the Brazilian coastline for its superior breeze. Brazil is also recognized by the energy industry as one of the best locations for wind farm development. Because of the steady winds that blow up and down its eastern seaboard, the region is ideally suited for capturing wind power. For example, in the state of Ceara in northeast Brazil, in-season winds average 22 knots. Moving further up the coast towards the northwest, the winds get slightly stronger, averaging 30 knots in Prea and Jericoacoara. It is not just the wind speed that is significant, it is the direction and the consistency as well. The vast majority of the year the winds blow onshore from the east,and generally the gusts are sustained but not excessive. These conditions are ideal for wind turbines seeking to wring power from the air.

There are likely a host of meteorological, environmental, and geographic factors contributing to this dynamic. Perhaps the most obvious are the country possesses an immense coastline, is near the equator, and is relatively undeveloped along the shore. This contributes to the region’s proclivity for steady wind. Consider wind is essen-tially the movement of air from a high pressure area to a low pressure area. This movement is triggered by the sun heating the earth’s surface unevenly. As hot air rises, cooler air moves in to fill the void. In essence, as long as the sun is shining the wind will eventually blow—and there is certainly a lot of sun in equatorial Brazil.

Conclusion

The opportunity for renewable infra-structure investment in Latin America, specifically in Brazil, appears significant. Demographic changes, government incentive plans, and geographic factors have all dovetailed in recent years to create a sort of perfect storm for green energy develop-ment. Wind farms in particular are especially vital, as countries like Brazil look to mitigate their heavy reliance on hydropower with other sources of energy. Wind energy is an ideal solution to supplement hydroelectric plants. It is during the dry season when wind production is typically the strongest.

Demographically the area appears ripe for investment as well, as population growth and associated economic development are predicted to increase.

The U.S. Energy Information Administration (EIA) suggests that power generation in Latin America will have to double by 2030 to support the growing population. Renewable sources are expected to underpin this expansion.

To develop these green infrastructure facilities capital will be needed. Locally there are obstacles for this type of fund raising. Most notable are the capital constraints within the region, including high levels of local debt and low levels of liquidity in the private sector. As such outside private sector investors are uniquely placed to help fill this gap.

 

BRAZIL’S HEAVY RELIANCE ON HYDROPOWER

Exhibit 4: Energy generation by type

Exhibit 4: Energy generation by type
Source : ONS, Brazilian Government Energy Operator, as of 2018.

Did you know?12,13

  • Germany and Spain lead the world in terms of power generated by wind.
  • Windmills have been in use since 2000 BC. They were first used in Persia and China to pump water for crop irrigation.
  • The first modern wind turbine was built in 1940 in Vermont. It oper-ated for 1100 hours before one of the fan blades failed. Engineers were aware of the structural defi-ciency, but had to make do because of material shortages from war-time rationing. This would be the largest wind turbine built until 1979.
  • Today the largest wind turbines are operated off the coast of Belgium. The fan blades are 80-meters long, the length of an American football field, and have a sweep area of 21,124 meters-squared. The turbines are bigger than the London Eye and a single fan can power an average of 8,300 households.

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NOTES:

1. Sources : Wind Investors Blow into Latin America. Forbes. July 14, 2017.
2. Sources : Brazilian government presents 10-year energy plan (PDE 2026). Medium.com. July 19, 2017.
3. Sources : “Latin America population will reach 625,000,000 inhabitants by 2016. According to ECLAC estimates”. February 2, 2016.
4. Sources : Renewables 2018 Global Status Report.
5. Sources : Historical data from The Brazilian Institute of Geography and Statistics (IBGE); World Bank, October 2018.
6. Sources : International Energy Agency.
7. Sources : International Energy Agency.
8. Sources : BTG Research as of February 14, 2019.
9. Sources : Brazil‘s worst drought in history prompts protests and blackouts. The Guardian. January 23, 2015.
10. Sources : World Bank.
11. Sources : Recent transformations of Brazilian matrix of generation electrical energy-causes and main impacts. March 2010.
12. Sources : 14 little-known facts about wind energy. May, 2016.
13. Sources : Wind Power, National Geographic.

 


Franklin Templeton Thinks: Alternative Views highlights our alternative investment teams’ insights about the opportunities and risks in the current market environment. Each issue spotlights our experts’ thinking on different macro forces, and particular sector views that drive our investment process.


Darby Private Equity
Darby specializes in emerging markets infrastructure and private debt within the Franklin Templeton global integrated platform. Darby is headquartered in Washington, D.C., United States and has been physically present since 1997 in Brazil.


Primary contributors to this issue

Andrew Gunther Managing Director
Latin America Infrastructure

Paulo de Meira Lins Managing Director
Darby Brazil

Valentina Cumo Senior Vice President
Darby Brazil