PROJECT DEVELOPMENT & FINANCE | LNG/Power/Renewable & Alternative Energy/Oil & Gas – Latin America
Winds of Change in Latin America
Vera de Gyarfas and Evan Korngold, King & Spalding
On September 29, 2016, King & Spalding hosted an Energy Forum titled “Winds of Change in Latin America.” The purpose of the event was to discuss how the political and regulatory changes in Latin America could have an impact on investments in energy. With the election of President Macri in Argentina, Pedro Pablo Kuczynski in Peru, the impeachment of Dilma Roussef, and the low price commodity environment, several countries are making regulatory changes to promote foreign investment. Additionally, Mexico’s Energy Reform is creating new oil and gas markets, upstream, midstream and downstream investments. Various panels of experts discussed emerging issues in Latin American energy. The conclusion was that there are numerous areas for investment in energy in Latin America. Below is a synopsis of each panel and the relevant conclusions.
LNG to Power – Energizing Latin America
Hosted by Dan Rogers, Senior Partner in the Global Transactions group at King & Spalding, this panel discussion featured four legal and engineering experts on LNG to power operations. The panelists universally agreed that the demand for LNG to power in Latin America, particularly Brazil, can be summarized as a demand for quality over quantity. With Brazil currently producing close to 85% of its power through hydroelectric sources, the demand for LNG as a source of power arises not because of a lack of alternatives, but because of its consistency and reliability as a better power source. Citizens that were once tolerant of brown outs and periodic service interruptions have become increasingly dissatisfied with these impairments. Further, the realities of climate change have also changed the supply structure of Latin America, as changes to water and wind levels shift, some previously established resources are less efficient. The main benefit of LNG is its flexibility and consistency. Large offshore floating LNG facilities that were divested by Petrobras are still considered viable opportunities by foreign investors for development to provide LNG to Brazil for use in power development.
The panelists discussed that some countries within Latin America have long-standing natural gas pipeline agreements, notably Bolivia and Brazil, where the quantities of natural gas being transported have declined. The decline is a result of failure to invest in domestic exploration after Bolivia expelled foreign energy companies. The panelists agree that LNG is a viable source to supplant the decline in pipeline production throughout Latin America.
Brandt Liebe, partner in the Special Matters group at King & Spalding, led a panel discussion about recent updates in the area of the Foreign Corrupt Practices Act (“FCPA”) and enforcement of corruption internationally. The panel uniformly agreed that a major shift in Latin America has occurred with increased enforcement of existing anti-corruption laws. Large scale crackdowns such as the Brazilian “Car Wash” scandal have garnered significant media attention. The increase in enforcement has been bolstered by “grass roots” efforts from local citizens. According to the panelists, the mentality of “that is just how it is done here” is no longer tolerable.
Implementing FCPA compliance within the company
The panelists noted that essential aspects of preventing FCPA violations are to understand the means in which violations occur and the motivations of the bad actors. Focusing on the methods that employees and government officials use to extract money from corporations is essential to prevent illegal payments in the future. Specifically, according to one panel expert, false external vendors and inaccurate sales invoices are methods most commonly used by corrupt officials and employees. To combat these tactics, it is essential to create and enforce strict company policies and procedures regarding vendor and accounts payable processes. Without strict enforcement, even the most robust procedures will not prevent illicit payments. Management must provide training to all of its employees, not just those that have direct access to company funds, as logistics managers, field operators, and others have day-to-day job pressures that might incentivize them to violate the FCPA. Third party agents may also create problems, and it is thus important to make anti-corruption part of agent agreements and apply the same protocols to third-party agents as company employees.
Anti-corruption law beyond FCPA
Mexico and Brazil have made changes to their anti-corruption laws. Specifically, Brazil has a law that affects companies at the entity level and not at the individual level. This law has been on the books since before the Car Wash scandal, but has only recently been enforced rigorously.
Also, there are key differences between local laws in Mexico and the FCPA. Specifically, Mexican anti-corruption law applies actively and passively, meaning that both the party bribing and the party receiving the bribe may be punished. Further, Mexican law applies both to foreign and local government officials. In addition, unlike the FCPA there is no exception for facilitation payments. In addition, to discourage recently-departed government officials from seeking favors from contacts still within the government, there is a one year “cool off” period where companies cannot hire a former government official for one year after their departure from government. The panelists noted that there is uncertainty about whether the one year period applies to hiring of consultants that were government officials.
Punishment under the Mexican anti-corruption laws is severe. According to the panelists, violations include disgorgement of two times the profits as well as possibly dissolution of the entity.
Energy Infrastructure – Mexico
Moderated by Ken Culotta, head of the Global Transactions group and partner at King & Spalding, the panel noted that as a result of the Energy Reform which included an amendment of the Mexican constitution to allow foreign investment in the energy sector, there will be tremendous growth in Mexico across the entire value chain. Mexico expects to double its cross-border natural gas pipeline capacity by 2020. In conjunction with constitutional and regulatory energy reforms, Mexico has significant and expansive renewable energy goals that it seeks to have completed by 2035.
While Mexico has taken large steps toward liberalizing its energy markets, many issues remain. The panelists discussed some of the uncertainties with the continuing regulatory environment. Large regulatory bodies such as the CFE and CENEGAS act as the regulatory bodies for their respective areas, yet are also market participants in the power and natural gas markets. Mexico has made transparency a priority and the panel commended Mexico for the successful oil and gas bid process that are currently in its fourth state of implementation. The panelists believe that Mexico has shown a willingness to address concerns with its cumbersome and inconsistent regulatory landscape. The panelists are also confident that the government will take necessary steps to clarify situations where regulatory bodies also act as market participants.
Emergence of Renewable Energy in Latin America
Jim Alford, Counsel in the Global Transactions group at King & Spalding, moderated this panel and noted that Latin America will be a leader in growth in the renewable energy industry in the near future. The panelists contend that two highly attractive growth areas are Argentina and Mexico. The former because of increased government incentives, the latter because the irradiation levels and high winds make both solar and wind energy viable options. In conjunction with acceptance of renewable energy sources, technological advances across the solar and wind power generation industries have significantly decreased the costs and capital expenditure requirements needed.
Argentina has made political reforms that have made all investments, not just renewable energy, more attractive. These reforms include removal of foreign exchange restrictions on capital repatriation, a free floating exchange rate, abrogation of tax on dividends and new prices and tariffs for power and natural gas. Further, Argentina has implemented legislation that contains “mandatory targets” for the electricity market, most notably the requirement to increase renewable sources of energy from 8% to 20% by 2025. These changes are expected to encourage and incentivize foreign investment in Argentina.
Mexico currently generates over 80% of its power from coal, gas and oil. As noted by the panelists, the decreased costs, increased efficiency, and prime geographical attributes of Mexico make it a growth area. The principle areas of development will be the Baja California, Oaxaca, the north central region and the Gulf of Mexico. High winds and sun exposure make these areas ideal for development. Government reforms implemented in 2014 have also encouraged foreign investment through clear and transparent energy auction processes. The Government’s stated goals for this process is to attract investment, make existing technologies compete with each other, and to ensure efficiency to the customer. As the panelists stated, an increase in renewable energy will improve efficiency for all Mexican power consumers and drive down costs as well.
Upstream – Betting on Latin America in a Low Price Environment
Led by Vera De Brito de Gyarfas, partner in the Global Transactions group at King & Spalding, three industry experts provided their insights about upstream operations in Latin America in a low price environment. For large international energy companies, low priced environments cause increased internal competition for capital. As capital investments are decreased, companies focus only on the best opportunities as lower return opportunities are even less attractive. The panelists agreed that the main considerations for assessing a new upstream project include: (1) the quality of the resource, (2) the contractual and political risks, (3) the fiscal terms of the agreement, (4) the bidding process, and (5) any parent company guarantees. None of the panelists listed current commodity prices in the main considerations for investment decisions, recognizing the cyclical nature of prices and focusing on longer term considerations for investments.
To help mitigate the risks in a low price environment, energy companies look to partner with other companies through Joint Operating Agreements (“JOAs”). As one panelist noted this can be problematic in Mexico which has restrictions on JOAs. In addition to partnering with others, energy companies are forward-looking in their contracts and anticipate that energy prices will rise again. By doing so, both the host government and the contractor can be adequately compensated in both high and low price environments.
The panelists noted that market participants are wary of potential future political challenges as current incentives that are offered to encourage exploration may come under scrutiny in the future if prices rise. In a higher price environment, if the governments collect less than they deem reasonable, some politicians might raise questions about the wisdom of the initial arrangements and may try to renegotiate the contractual terms.
Latin America has suffered waves of resource nationalism, beginning in the 1930s with the Bolivian and Mexican nationalization of the oil industry, followed by Peru in 1968 and ending with Venezuela’s nationalization of the oil industry in 1975. In the 1990’s there were oil and gas privatization programs throughout Latin America, only to be followed by new re-nationalization measures / re-negotiation of contracts in 2002-2012 in Venezuela, Bolivia, Ecuador and Argentina. It seems that a new pro-investment cycle is beginning now in Latin America and hopefully this new environment will mitigate the risk of future re-negotiations and expropriations.
King & Spalding will be be participating at the CWC World LNG & Gas Series: Americas Summit in Houston, TX on 20-23 June 2017.