Argentina expands offerings with renewable energy and offshore drilling auctions

With a strained electricity grid and officials aiming to bring in more income to prop up the economy, the administration of President Mauricio Macri is expanding sector offerings for foreign investors. The government has been promoting renewable energy sources since 2016, and with offshore block auctions expected at the end of 2018, these two segments represent the most promising prospects for growth over the coming year. Following three successful rounds of renewable energy auctions in 2016 and 2017, the growing subsector is reaping the benefits of a thoroughly planned and well-executed market development strategy, with further auction rounds expected in 2018 and beyond. At the same time, upcoming offshore auction rounds scheduled for November 2018 – the first in almost three decades – are attracting investor interest.

While the outlook for these types of projects appears bright, a number of challenges lie ahead. Further investor incentives and regulatory changes will be key to the sector’s long-term success amid strong regional competition from countries such as Brazil and Mexico, which have large proven oil reserves and established renewables programmes.

Progress Made

With the support of the World Bank, the government has already attracted foreign investments worth $2.5bn in renewables projects since 2016, spanning wind, solar, biomass and hydropower. As of May 2018 five of the 147 projects awarded under phase 1, 1.5 and 2 of the RenovAr renewables auction programme in 2016 and 2017 had begun commercial operations, while 36 were under construction. Together the 41 projects represent almost 1600 MW of power generation capacity.

Offshore oil and gas exploration is in a much earlier phase, with seismic surveying only beginning in late 2017. Searcher Seismic of Australia is building a database composed of 97,000 km of 2D data and 1800 sq km of 3D data that the Ministry of Energy and Mining will use to parcel out blocks for upcoming offshore auctions and that prospective companies will use to assess their potential. With the first exploration and production blocks set to be auctioned in late 2018, multiple foreign investors – including Norway’s Statoil, US oil company Anadarko, the China National Offshore Oil Corporation and Petronas of Malaysia – have already expressed interest. Although the government was still finalising the terms and offerings of the auctions as of mid-2018, blocks will reportedly be located in the Colorado Marina, Malvinas and Austral basins, and range in size from 3000 sq km to 10,000 sq km for a total of approximately 240,000 sq km across the three areas. Companies with winning bids can expect to be awarded exploration periods of up to 10 years.

Incentive

As demonstrated by the first rounds of RenovAr, interest in Argentina’s renewables market is strong, underpinned by pro-business reforms, financial incentives and guarantees for investors. Updates to investment laws have centred around promotional tax regimes, including accelerated depreciation, early recovery of value-added tax, and relief from minimal notional income tax, import duties and other related taxes. Reforms to ease investment and guarantee payment to renewables producers are also key factors behind the segment’s growth. Moreover, in 2016 the government created the Argentina Investment and Trade Promotion Agency (Agencia Argentina de Inversiones y Comercio Internacional, AAICI), which followed a 2015 reform that created an overarching national-level policy to promote renewable energy.

Still, financing issues and credit ratings are of concern, as none of Argentina’s state agencies have had investment-grade ratings since the sovereign debt crises in the early 2000s. To address the funding aspect, in 2016 the government created the Trust Fund for Renewable Energy (Fondo Fiduciario para Energías Renovables, FODER) with AR12bn ($621m) that guarantees payment for electricity produced and sold to the Wholesale Electricity Market Management Company (Compañía Administradora del Mercado Mayorista Eléctrico, CAMMESA). As part of the World Bank’s support for the government’s roll out of green energy tenders, in 2017 the organisation provided additional reinforcement to FODER in the form of $480m in financial backing.

Financial incentives for exploration and production of conventional offshore oil and gas deposits are again more limited, although the 2014 amendment to the Hydrocarbons Law did increase the attractiveness of the market by offering producers reduced provincial-level royalties; it also extended offshore concession periods to 30 years. There are ongoing lobbying efforts by private companies to persuade the government to extend existing above-market price incentives for non-conventional gas producers to conventional offshore gas producers. However, these efforts have yet to bear any fruit, as the administration is instead prioritising renewables and unconventional shale oil and gas production at the Vaca Muerta formation (see analysis).

Relaxing Regulations

Assigning concrete targets to the emphasis on renewable energy, the government calls for green sources to make up at least 8% of domestic power use from 2019 onwards, and 20% by 2025. In order to attain these goals, the authorities have taken steps to relax supply laws and foster greater competition in the market. In August 2017 the Macri administration enacted a reform to allow large power users to meet their renewable energy obligations through direct private supply contracts with renewables producers. These power purchase agreements (PPAs) have 20-year term limits – higher than in most other countries, including in Chile, where the limit is typically 15 years. Revisions to PPA regulations are a potential game changer for the renewables segment, allowing local and foreign power producers to directly supply large local users and CAMMESA. Argentine and foreign renewables producers have been quick to take advantage of this rule. For example, Genneia, a local wind power provider, signed two contracts between October 2017 and April 2018 to supply power to a cement producer and a mining company. Similarly, in June 2018 Equinor – a Norwegian multinational energy company– bought into a $95m PPA to provide solar power to households and other entities for a 20-year period. The government expects PPAs to bring up to $6bn in renewables investment by 2020.

Argentina also has a robust regulatory framework for foreign companies looking to invest in offshore oil and gas exploration and production. However, industry experts have highlighted the need for the government to modernise the scheme on topics such as unitisation if the country aims to compete with mature offshore markets such as Brazil. Current regulations on unitisation are relatively restrictive and still mainly apply to unconventional concession blocks. With Brazil, Mexico, Ecuador and Uruguay all auctioning offshore blocks in 2018, and oil and gas company budgets almost halved from pre-2014 levels after the fall of oil prices, the government will need to implement further competitive regulatory changes to draw in foreign investment.

Industry Challenges

Although renewable energy in Argentina is supported by an attractive legal and regulatory framework, a number of hurdles remain, including logistical constraints and financing limitations. According to local industry experts, solar and wind power projects, in particular, face potential supply chain bottlenecks associated with importing machinery and transporting equipment to isolated parts of the country. In a statement to attendees at an energy conference in March 2018, Andrés Tahta, vice-president of the AAICI, highlighted the ongoing logistical challenges in transporting solar panels and wind turbines from ports in Argentina and across the border from Chile to remote areas of the country. Electricity transmission lines that are unable to handle demand and properly link cities to renewables projects are another constraint.

However, financing is perhaps the most significant challenge for investors in green energy projects. Obtaining long-term funding from local banks has been described by industry players as the “missing link” in Argentina’s renewables programme, with some companies that won bids at RenovAr auctions subsequently failing to secure financing. Speaking to industry press in March 2018, Verónica Geese, secretary of state for energy in Santa Fe Province, said, “Argentina needs to learn that, by trying to do things too quickly, there are consequences, and there will be penalties for those developers that fail to deliver projects on time.” Geese believes the government should wait longer between RenovAr auctions, given the subsequent uncertainty and delay of projects’ financing and development.

For investors in offshore assets, challenges relate to regulations affecting the wider oil and gas sector. In the conventional oil and gas industry, a changing regulatory framework for the retail fuel market – which has seen the current administration try to defer fuel price increases to the second half of 2018 amid economic strain – is complicating sales terms for refiners. Furthermore, royalty rates paid to the government were revised in the 2014 amendment to the Hydrocarbons Law, but despite a lowering of provincial royalties, they are still slightly higher than in other regional economies. Argentina’s current royalty rate is 12% of the value of crude oil extracted, higher than in Brazil (10%) and less flexible than in Mexico, which has set a minimum rate of 7.5% that can increase depending on market oil prices.

Long-term Growth

While working to address challenges and concerns, the government is pressing ahead with additional auctions. Round 3 of RenovAr is scheduled for October 2018, but compared to previous auctions, it is being approached more cautiously by some players in the industry. “Generally speaking, tender prices for RenovAr round 1 and 2 were attractive, with good external financing, single-digit internal rates of return and acceptable interest rates,” Marcelo Rodríguez, president of Latinoamericana de Energía, told OBG. “However, with the current turmoil in Argentina in relation to exchange and interest rates, there is some uncertainty among bidding companies as to what conditions will be laid out for RenovAr round 3.”

Concerted efforts are indeed being made to address industry challenges and provide a strong operating environment. For example, the AAICI has established a coordination committee with various ministries to overcome logistical bottlenecks facing the renewables segment. An infrastructure development programme focused on expanding electricity transmission lines and upgrading road networks – to which the Inter-American Development Bank granted a $500m investment guarantee facility in March 2018 – is also likely to further ease logistical problems and lower costs for producers. Furthermore, in March 2018 Dutch firm Vestas Wind Systems announced that it would build a €15m wind turbine factory in Buenos Aires Province to support local supply chains. Domestically manufactured renewables equipment would help address high import and transport costs, and also reduce project start-up delays.

In offshore hydrocarbons activity, more than 60 firms are expected to bid for blocks in 2018, despite the considerable up-front investment required. This is a positive development for a country that in 2012 expropriated the assets of Spanish energy giant Repsol, a move that damaged Argentina’s investment profile. The offering of vast tracts of the country’s continental shelf to offshore exploration and production could prove highly profitable for investors and a key source of state revenue in the long term.