Case Study: When China Three Gorges went to Peru

22 August 2019 - 12:00 am UTC

In 2015, China’s President Xi Jinping said direct investment by Chinese companies in Latin America would reach USD 250bn over the next decade, in areas such as agriculture and livestock, as well as energy and infrastructure.


Chinese firms are already investing in Peru, especially in the mining and infrastructure sectors, and in late 2018 China Railway Construction Corp signed a USD 375m contract for the expansion of the Huánuco to Huallanca highway, its first infrastructure deal in Peru.


On April 25 this year, not too far away from that same highway, a Chinese consortium led by state-owned power company China Three Gorges (CTG) closed a USD 1.39bn deal to buy Peru’s 456MW Chaglla hydroelectric plant from disgraced Brazilian construction firm Odebrecht.


It marked CTG’s first foray into Peru as part of China’s growing interest in the region as Odebrecht sought to divest assets following its corruption and bribery scandal.


“It was a good business opportunity [for the Chinese consortium]… [with] a good price because the company they were acquiring was stressed,” says a Peru-based lawyer close to the deal.


Elsewhere in the region, China’s Sinohydro was reported to be interested in Odebrecht’s stake in the Navelena consortium that had been developing Colombia’s Magdalena River navigability project before the concession was cancelled in 2017.


But Chaglla is to date the first acquisition of a former Odebrecht asset by Chinese firms to reach financial close.


Two regulations


The CTG consortium is comprised of CTG subsidiary Hubei Energy Group (40%), CTG-affiliate ACE Investment Fund II LP (40%) and China’s CNIC Corp (20%).


Peru’s Economy Ministry and the Energy and Mining Ministry approved the sale of 100% of the shares of Empresa de Generación Huallaga – the Peruvian holding company of the Chaglla project – in December 2018.


The Chaglla plant’s installed capacity of 456MW accounts for approximately 5% of the total capacity in Peru and it is the country’s third largest hydroelectric plant, located in the department of Huánuco over the Huallaga River, in the country’s northern Andean mountain region.


The deal was made possible by two key pieces of regulation passed in Peru in 2017 in the wake of the Odebrecht scandal: emergency decree 003-2017 issued by the Ministry of Justice and anti-corruption law No. 30737.


According to these regulations, the government would clear the deal and the purchase price proceeds must flow through an escrow account, with 50% of the sale price going to the government in reparations, so that Odebrecht’s obligations to the government were satisfied.


The legislation meant the deal took longer. Xu Cheng, assistant deputy manager in the corporate department at project lender ICBC Perú, says it took two years to close the deal.


The consortium would have been unlikely to obtain financing from local banks given Odebrecht’s damaged reputation in the country, says a lawyer with knowledge of the deal.


In theory, the eventual debt financing should have been more expensive as some international banks refused to participate, hence less liquidity and a potentially higher price. However, in practice the Chinese consortium found enough liquidity at a “low price” since, according to law 30737, the assets are declared clean from any potential corrupt act by Odebrecht, says a bank executive close to the deal.


Building a bridge


The deal was partly financed through a USD 850m two-year bridge loan and letter of credit facility from Bank of China (Luxembourg branch), Industrial and Commercial Bank of China (ICBC) (Luxembourg branch) and BBVA Banco Continental.


The Bank of New York Mellon acted as offshore collateral agent, Scotiabank Perú as onshore agent and trustee, and ICBC Perú as debt and equity escrow agent. Even finding a local collateral agent and trustee took around six to eight months because of Odebrecht’s image problem in the country, say people close to the deal.


The bridge loan expires in 2021, after which the Chinese consortium may look to refinance the debt, possibly through the issuance of bank debt or project bonds, according to the same banker, adding that the rationale was to pursue a more simple acquisition bridge, “rather than to embark on a more complex permanent financing solution in the context of a very complex M&A transaction”.


The Export–Import Bank of China looked at the deal initially, but since the borrower is a Peruvian SPV, they could not participate due to internal regulations, says a project finance executive close to the deal.


Peru’s banking regulator – the SBS – authorized Bank of China to start operations in Peru in January, pending certain conditions, paving the way for Chaglla to become its first major financing in the country.


“It makes sense for [Bank of China] to put their foot in the door with a massive transaction like this one,” the lawyer says.


ICBC on the other hand has had an office in Peru since 2012. “We know Chinese companies better, so there is bigger chance we can support Chinese investors in Peru’s energy sector,” says Cheng at the bank.


But the fact that the buyer and lenders were mostly Chinese did create some challenges for the non-Chinese bank in the deal.


“The challenge is that, being all Chinese and therefore somehow related and potentially aligned, decision-making clauses needed a lot of work for [the non-Chinese] to avoid being left out of the process,” says a person with knowledge of the deal.


The remainder of the USD 1.39bn valuation was provided in equity by the Chinese consortium.


Spotting a crisis


Despite the current low prices in the Peruvian energy market, Empresa de Generación Huallaga’s revenue is assured through 2031 thanks to a 15-year PPA signed with state-owned Electroperú in 2011, which took effect in 2016. The PPA tender, in which only new hydroelectric projects could participate, fixed the energy price under a take-or-pay arrangement.


“Peru is one of the Latin American countries that provides long-term growth potential with a relatively well-developed and stable legal regime and an open view toward foreign investment,” says Sergio Galvis, a lawyer at NYC-based firm Sullivan & Cromwell that advised the buyers.


The PPA provides Chaglla’s main income and the price — around USD 54 per MW/h during peak hours plus a capacity payment — was considerably higher than the regulated price of around USD 40 per MW/h at the time of the auction, says Rene Vergara, head of Peruvian energy holding Ampato Energia, which owns the SPV Sulpay Energía that operates a 1,400MW thermoelectric plant in Peru. 


As a result of the hydro PPA tender, and the start of operations of several new hydroelectric projects, including Chaglla, there is an oversupply of power in the Peruvian energy market which has forced the spot price down in recent years.


“The actual crisis of low prices in the market is due to the existence of these [hydro] plants, which means the energy bought by Electroperú ends up being almost given away on the spot market,” Vergara says.


The government’s decision to tender power supplies exclusively for new hydroelectric projects — in theory, due to the fact that the maximum capacity of the Camisea natural gas pipeline in Peru, which transports gas from the country’s Amazonian region to the coast, had been reached — effectively “kidnapped” some of the demand, and artificially pushed up the prices of the PPAs, says Vergara.


After the Chaglla contract expires in 2031, the Chinese consortium will need to develop a new commercial offtake strategy. The spot market price is unlikely to fall below USD 40/MW given the projected increase in demand, mainly from new mining projects, say people spoken to for this article. 


Chaglla’s location — in northern Peru’s Andean region — makes it an important power supplier for Peru’s mining industry, which is expected to see strong investment growth in the coming years. Peru’s Economy Minister Carlos Oliva recently said that Peru’s portfolio of mining projects under construction, mainly copper mines, now totals some USD 9bn.


This includes Chinese-owned projects.


In middle of last year, Beijing-headquartered Aluminum Corporation of China (Chinalco), which has been operating in Peru for over a decade, started work on the USD 1.3bn expansion of its Toromocho copper mine in central Peru’s Junín region — some 200km from Chaglla — with plans to double its annual copper output to 300,000 metric tons.


Other mining projects in Peru have been postponed due to social opposition from local communities.


In the energy sector, Peru lags behind other countries in Latin America such as Chile in terms of renewable energy investment, and recent political turmoil — in part caused by the Odebrecht scandal — has not helped to define new policy for the sector.


“From 2022 there will be an energy crisis in Peru due to lack of installed capacity and demand growth… we will go from an oversupply situation to an energy deficit abruptly,” says Vergara.


Given Chaglla’s PPA with Electroperú, its new owners will hope to remain unaffected. Increasing energy prices and demand for power from mining projects could even attract further Chinese investment in Peru’s energy sector.


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