Renovatio’s Francisco Sanclemente Explains To Me The Inner Workings Of Colombia’s 1st Private Renewable Energy Auction
Last month, Grupo Renovatio launched the first private renewable energy auction in Colombia, perhaps the first in Latin America. Friday, December 4, the definitive terms and conditions will be published, and negotiations will continue through the end of the year. The potential implications of this auction, especially if it is able to become a standard purchase vehicle in the future, are hard to overstate. It enables renewable energy developers to more easily and inexpensively finance their projects, and it provides a stable, creditworthy purchaser for renewable energy at predictable pricing while increasing the consumption and viability of renewable energy in Colombia.
Finance Colombia executive editor Loren Moss was able to sit down with Grupo Renovatio general manager Francisco Sanclemente in Bogotá to understand the renewable energy auction and what it means for the industry, and for all Colombians.
Finance Colombia: Francisco, first, congratulations not only on your auction but I understand that you have a newborn at home and so because of that, I’ll keep my mask on during the interview. I really appreciate your time here today in Bogota coming into the office just for us at Finance Colombia. You’re the head of Renovatio. If you could first start off by telling us a little bit about Renovatio, giving us a brief introduction of Renovatio’s heritage, a little bit of your background and what Renovatio does here in Colombia?
Francisco Sanclemente: Alright, thank you Loren, thank you for having me and for congratulating me on my newborn, that’s why we’re taking so many precautions. Indeed I’m the General Manager of one line of business that Renovatio has here in Colombia. Renovatio arrived in 2013, mainly to develop wind projects in La Guajira, but it also started as an energy supply company, and that’s where we’re sitting now. They are two independent businesses: One develops wind projects in La Guajira as I already mentioned, and those projects that Renovatio developed were in the government auction last year. 60% of the capacity that was awarded in that auction was developed by Renovatio; mainly the four projects, two of them that were sold to Celsia and two of the other projects that were sold to EDPR, Energy of Portugal Renewables.
And then we have another line of business of which I am General Manager, which is the energy supply company, and that’s the company that is launching the auction. This company started also in 2013, mainly trading energy in the wholesale market, getting to final users or supplying energy directly to final users in 2015. First in the non-regulated market and then in the regulated market in 2017. We have had tremendous growth over the years, so even this year despite COVID, we will be twice the size we were in December of last year and by year end we will be the third largest independent energy supplying company in Colombia, supplying energy to final users.
Finance Colombia: So the company has done a lot in just a short time in arriving to Colombia. Now you guys recently had I believe it’s the first private renewable energy auction in Latin America last week, so congratulations for that! I was glad I was able to attend, you guys were able to do everything remotely, which was great. Tell me about why you saw a need for such an auction and what the purpose of that auction is.
Francisco Sanclemente: Thank you, yes renewable energy in Colombia is very interesting because everybody keeps talking about the potential we have as a country, but it really hasn’t taken off to the extent that everybody was waiting for a few years ago, because there are a lot of foreign investors that have watched the progress of renewal energy in the country, international banks, you name it, everybody is waiting to see what is going to happen.
“If I were to describe it in one word I would call it flexible because what we tried to do here was to launch a tender process that would be the dream of a project [developer]”–Francisco Sanclemente
Obviously, the reason why we’re doing the auction is a commercial reason because we’re a private business and we’re going to first increase our profitability but also provide competitive tariffs and clean energy to our final users, but also, we identified an opportunity in the market and we wanted to exploit it and I’ll explain that more in detail. The reason why renewables haven’t taken off in Colombia is because there are three main obstacles to renewable energy, the first two that are shared pretty much everywhere around the world, and the third one that is perhaps more specific to Colombia. So the first two is communities and environmental licenses and every country has that, some are faster some are slower but everybody has to do that process everywhere in the world. The second one is connection to the system, again some countries do it faster or slower, but everybody’s got to do it you need the technical feasibility of whether the project can be connected to the grid. Once projects surpass those first two obstacles in Colombia then they face the third obstacle, and it’s perhaps the one that has been a bit more tricky for projects to overcome which is the PPA, right? How to sell their energy into the future so that the banks can finance their projects and they can build their projects and get it into operation.
Finance Colombia: To save some viewers the embarrassment that I had when I first heard the term that’s Power Purchase Agreement, right?
Francisco Sanclemente: Indeed, yes, exactly. Why is it difficult in Colombia to sign a PPA? well there are three main reasons why it is difficult. The first one is the mentality of the energy market in Colombia, since the crisis of 1994, companies have preferred to sign short-term contracts because of the believe that since you don’t know what the price is going to be in 10 years, you don’t want to commit to a contract now with the chance that you will pay higher energy prices in the future that the ongoing rate, right?
And that mentality has is rooted so deeply that perhaps a long-term contract here, if you mention a long-term contract or if you would have mentioned a long-term contract five years ago, people would have understood four to five years, perhaps even three right? Of the more than 100 auctions for the regulated market that there have been since mid-2018 until now only 12% of the energy awarded in those tender processes have been for more than five years, and the majority 60% of them have been contracts of one to two years, right? So that tells you how strong the mentality towards short-term contracts has been and obviously you cannot finance a renewable energy project with a contract of one to two to five years, right? it’s not possible.
Finance Colombia: Have people offset that in the past and I don’t know how advanced the energy derivatives market is in Colombia, but are people able to arbitrage that risk and say maybe “I’m going to enter into a contract but I’m also going to hedge it” or I don’t know, maybe that that level of liquidity, or that market, or that you know those derivative structures don’t exist here I don’t know.
Francisco Sanclemente: They do exist, you can you have futures market for energy, the problem is that it’s very illiquid, that’s the first problem. The second problem that it has is that because of the structure of the market everybody tends to have to want to go in the same direction at the same time,
Finance Colombia: There’s no counterparty.
Francisco Sanclemente: So, you don’t find the counterparty or the spread between the offer and the ask price is too wide to reconcile, so you cannot at this point in time in Colombia, you cannot plan strategies using futures. You won’t find the offer that you need to develop those strategies.
Okay, so that was that’s the first problem with finding a long-term PPA, the second one it’s difficult to find a large off taker that will sign a long-term PPA, right? and the large off takers that are starting to get interested in renewable energy, they are building their own projects or commissioning a third party to build their own project anyway, reducing the pool of potential off takers that a developer could have to sell their energy, and the third obstacle is the structure of the market because the regulated market in Colombia, which is consumption under 50,000 kilowatt hours per month, you cannot aggregate it, right? So let’s say you have 2,000 stores nationwide but every individual store has a consumption below 50,000 kilowatt hours.
You cannot aggregate that demand and negotiate a long-term contract because you fall within the regulated markets, and the regulated market doesn’t allow the use of energy to negotiate their energy and they don’t have contracts…They have contracts but there are regulated like telecommunication contracts where the final users have an open-ended contract with a minimum permanence, that’s what you have. So that would be large if you aggregate all demand in the regulated market, even if they wanted to sign a long-term contract of taking the energy of a single project, that would be outside of the scope of the regulation, right? That already leaves about half of the energy of the country outside of that scope and so that’s when we started to think: “all right, there are over a hundred renewable projects that are being developed in Colombia that already have a connection approved to the grid, they can connect anytime now, but they cannot sign or they don’t have a contract, an energy, a PPA, and they cannot buy.”
Finance Colombia: They don’t have a solid purchaser.
Francisco Sanclemente: Exactly, so what we thought is, “all right, let’s make a tender of those projects, let’s organize our own tender where we would be the off taker” and—well, I forgot to mention, last year there was the government auction, it was very successful, nine projects were awarded, there were over a hundred projects that were eligible but then the government hasn’t signaled that they will do any more auctions. Instead they have signaled that it would be the private sector that should take it from there, trying to break that circle of short-term contracts.
The prices that were awarded in that government auction are 30% below the ongoing rates of contracts in the energy market in Colombia right now, so what we thought is, “all right, if we can get those prices or something that looks like those prices that would be something very good for us, and at the same time we’ll be providing a mechanism for these projects to sell their energy long term and finance their projects” so it’s a win-win.
Finance Colombia: Exactly. I would also imagine that, obviously not in this auction particularly but that is where Renovatio and companies like Renovatio have value, is that let’s suppose I’m I don’t know, a transportation company or a petroleum company and I’m trying to reduce my carbon footprint, then I can say look I want to buy renewable energy and I want to make sure that the renewable energy and even for larger consumers that are that are in that can go to the unregulated market whether it’s through an auction mechanism or not.
“I know that the auction is more for the sell side in this particular case, but still one of the values that a company or one of the functions that a company like Renovatio has is it enables a grocery store chain, I don’t know, Olympica or somebody like that can say “we want to reduce our carbon footprint and so we want to purchase this energy” and make sure or maybe we have a presence in the Caribbean and so—La Guajira, we can come back and say “listen we are using the energy that’s coming off of this this wind farm,” so it does have a local impact and I would imagine that there’s a lot of interest and growing interest in not just the financial part of it but the ecological aspect of what Renovatio is doing.
Francisco Sanclemente: Exactly, renewable energy is in our DNA. I mean, we, Renovatio arrived in Colombia to develop wind projects, and if we could, we would be supplying 100% renewable energy now. That’s our goal, but we cannot do it right now because there are only a handful of renewable energy projects operating in the country. So there’s got to be a transition period until we get there but that’s also one of the reasons why we wanted to be the first having a renewable energy auction, a private one because we want to be the first ones to get there. We want to give renewable energy to our final users and we have seen that in the past year or so companies are increasingly more interested in acquiring clean energy.
Finance Colombia: Great. I think it’s good because it really provides now a mechanism, it provides for better financing options for project developers, for renewable projects, it provides certainty but then it also it allows in the longer term I think, by doing it the way that you all are doing it, it creates more opportunity in that you can have small—the larger providers of course can participate—but you can have smaller energy providers that may want to participate on the buy side, not with this particular auction but if you look at how this impacts this the market structure, you’re going to be able to have smaller businesses then say “we want to make sure that the electricity that we purchase in Colombia is renewable,” is green energy and companies like Renovatio enable that and make that a possibility.
Francisco Sanclemente: Absolutely, the world is heading in that direction. I mean you see it in Japan, China, all these countries are saying that they will be carbon neutral by 2050. Colombia, we don’t have…It’s not as important here as in other countries because traditionally the grid of Colombia has been clean. 80% of the energy that is generated in Colombia traditionally comes from water resources, but that has been declining over time. Back in 2000, when you compared the water reserves in the country with the demand, you saw that those water resources would last for 13 weeks of demand, so if you wanted to put that water reserve in terms of a battery right and how many weeks of demand it will give me it was 13. This year we’re down to five or six and if it wasn’t for COVID, we would be down to 4 or 5 because the lockdown has really saved us from stressing the electricity market in Colombia.
If it wasn’t for COVID we could have had water reserves down to 40-45 percent back in mid-July, but it did drop to 50, and so you see a clear trend. If you see the graph you see a clear trend going from 13 back into 2000 to 56 this year, because you’re constantly adding more demand and not necessarily adding the same amount of reserves. We were hoping to do it with Ituango, but Ituango hasn’t happened and it’s been already two, three years.
Finance Colombia: Delayed.
Francisco Sanclemente: And it’s expected to be delayed at least until 2022-2023, nobody really knows, so that is going to make it so that that number of weeks that you can supply demand with water is going to keep reducing. It’s the perfect moment to introduce renewables, it’s not a matter of whether we have a clean grid or not because now we do. It’s a matter of can you sustain it over time as demand keeps growing and economies keep developing, can you sustain that clean grid? And you definitely need renewables, and you and the market need mechanisms like the one we have devised to offer alternatives to these projects to overcome the obstacle of the of the PPA.
Finance Colombia: So if you could just briefly explain to us, I know that the auction launched last week, so what what’s the timeline then? Companies need to submit their bid which is in the form I think of a proposal and then there’s an adjudication process and then there’s a reward process. If you could give me a brief understanding of the timeline and the parameters of how the auction works and then when we know who the winners are, so to speak?
Francisco Sanclemente: Absolutely, so as you mentioned the auction was launched last Wednesday, last Friday we published the terms of reference and the draft of the contract that will be awarded. Now we have a period of Q&A and clarifications until the 4th of December. The 4th of December we’ll be publishing the definitive terms of reference and the contract then the projects will have until the 30th of December to submit their offers that will be backed by a [surety] guarantee of the seriousness of the offer. We call it an assurance guarantee, and then we will take a full month to evaluate the offers and I will explain in a minute why we’ll take a full month.
Also, within that month we will be having conversations with the participants that submitted the best offers and the expectation is that the first of February we will be signing contracts with the best offers. That for the timeline, as for the parameters I think it’s a very innovative tender that we have launched. If I were to describe it in one word I would call it flexible because what we tried to do here was to launch a tender process that would be the dream of a project [developer], that’s what we tried to devise, the dream of the project. Why did we want to devise the dream of the project? Because we believe that if we devise the dream of the project, we will be rewarded in price: The more flexible the projects are in developing their offers, the more likely they will offer a better price, so what this results in is that the project can choose the length of the contract between 5 and 25 years. I’m not saying it doesn’t exist because I don’t know all the options in the world, but I haven’t seen it. Normally it comes with a fixed term for all the projects, even the one of the government auction of Colombia was 15 years. The one in Mexico was 15 years, in Brazil they have been15 and 18 years, I believe Argentina was 15 years, and we’re saying you can go up to 25 years if you want to, or down to 5.
Why? The more years of contract you have in a financial model or rather the more years of income that you have in a financial model that are backed by a contract, the higher the debt sizing of a project.
Finance Colombia: Right, the easier the financing becomes.
Francisco Sanclemente: Exactly, and the cheaper also, so that’s the first thing. The second thing it is a project that tells us when they want to start the contract, when is the plant operative, and we gave a range between 2022 and 2025, provided is the first day of any semester. We did that because what we want as energy suppliers is certainty of when the energy will become available.
Because otherwise we’ll have to go to the spot market, and we believe that we say if we set a date for all the projects, everybody will do their best effort to be able to be eligible for the for the auction, but the most likely result would have been that the projects would have been late, they would have delayed construction because they already pushed the times as much as they could to be able to participate in the auction.
Finance Colombia: This way they can tell you how much time they need but they have to commit to their word.
Francisco Sanclemente: Exactly.
Finance Colombia: Brilliant, and I think that’s great because you have projects that are at different stages of construction, and it allows them to breathe easier and say “look, we know we can have it done with 80% certainty by this time, but we know we can certainly have it done by this time, let’s go ahead and say when we can have it ready,” and that way they can still participate and not miss out if they need to set their time frame. If they’re ready to go now, great! If they need 18 more months to go great, they can still participate right now and this certainty because once if they enter into a successful bid in a successful arrangement then it makes their financing easier and like you said less expensive.
Francisco Sanclemente: That’s exactly right, and even if they come into the world, we still give them 12 months to be delayed, provided they deliver us the energy because there are financial contracts, but we won’t be executing guarantees for a period of 15 months. Our idea is not to execute a guarantee, we want the energy project operating.
Finance Colombia: And to have a sustainable model that you can have success after success, and show that it works and then that allows you to grow and to do more of them.
Francisco Sanclemente: Exactly, another important feature of the auction that I believe is also very innovative is that if the project wishes to, we will buy any surplus energy it generates, so the contract is a pay or take, but if they want, we can buy any surplus energy they supply . We have some incentives so that the surplus energy is not too big because again if it’s too big we cannot plan, so there are some price incentives that they try to make it as most or at least 90% percent of the energy they produce into the pay or take, or pay, right? And then we’ll be buying any surplus energy at a discount, and if the surplus becomes too big, we will buy at a discount against the spot price, so that way we almost guarantee we have sold it in advance anyway.
Finance Colombia: Right, and also that gives them some certainty that they know that they have a market for their excess production.
Francisco Sanclemente: Exactly because normally what happens here in Colombia is that when the projects go to the banks and say “look, this is my PPA, this is my forecast revenue and I have some energy, excess energy that I’m going to sell in the spot market,” normally what they do is they discount that from the model, because there’s uncertainty of revenue, whereas here they at least have the contract to argue the case that they can sell, they can have more revenues and thus a larger debt sizing and more finance.
Finance Colombia: I think that all of what you’re doing is really serving as an enabling vehicle that not only are you creating demand for their product and the demand that they can count on, but again it comes back to the finance and if you think about project financing I was reading the book that just came out on the how Viva Air got started on the way over here and it was interesting because at the beginning there were all these caveats and guarantees and it’s like “well to get your airplanes you first have to get your certifications, to get your certifications you’ve got to have your airplanes, you got to get your financing…” and it’s difficult at the beginning when you’re in that phase of construction or whatever, that when you’re not generating energy yet or you’re not flying passengers around yet or whatever the case is, the cost of financing and the ease of financing becomes so critical. Tecnoglass, another company in the news, a Colombian company, they just did a $300 million dollar financing package that reduces their interest expense by something like $11 million dollars a year, and again when they’re able to demonstrate—whether it be if you go by asset backed or backing revenue flows or whatever, but still that cost. It’s not even when…sometimes it’s not an issue of “yes there’s financing or no there’s not financing,” but the cost of the financing that’s available can make a project no longer make sense, as you know! I know you’re a CFA, nobody knows that better than a Certified Financial Analyst, right? (laughs).
I think that that’s why it’s so innovative what you guys are doing here and hopefully it’s a model that can be duplicated and it can be replicated. How can people—obviously in Finance Colombia we’re going to continue to cover what you’re doing closely, but what’s the company website?
Francisco Sanclemente: gruporenovatio.com
Finance Colombia: Perfect, I appreciate you coming in during the middle of a pandemic and taking the time and opening the office up for us here. We want to congratulate you again both on a successful auction and a newborn child.