(Fitch Ratings, 27.May.2020) — The economic contraction due to the coronavirus exacerbates the negative revenue effect of the rate freeze in place on Chilean power projects with regulated power purchase agreements (PPAs), Fitch Ratings says. The pandemic and efforts to contain the virus are expected to push the country into recession and have led to sharp Chilean peso depreciation and declines in energy demand. This will cause revenue erosion across project finance structured power assets much more quickly than originally anticipated under the rate freeze and could result in negative rating actions.
The Chilean Senate froze electricity rates in October 2019 in response to protests over national economic conditions and policies. As a result, power projects with regulated PPAs with distribution companies (Discos) will not receive inflation indexation in 2020. Regulated PPA revenue declines were expected to last only one year, and losses were projected to begin to be recouped in 2021, when Discos could charge more than the average PPA price, allowing them to begin to pay back projects for lost revenues.
However, because of the coronavirus-related downturn, projects are expected to experience much larger revenue losses than originally anticipated and for a longer period of time, potentially through 2022. It is possible that the rate freeze could be extended even if accumulated generator losses in the system breach the cap of USD1.35 billion before 2023, as established under the law, as end users are even less able to absorb electricity tariff increases than last year.
The National Energy Commission’s recent projections, last updated in December 2019, have indicated the percentage of energy withdrawn under regulated PPAs will fall below 70% in future years. Demand will likely be even lower than this, as energy demand is correlated to GDP, and in light of the pandemic, Chile’s GDP is now expected to fall nearly 4% in 2020. Declines in regulated energy demand are expected to lead to revenue erosion since volumes sold under regulated PPAs will decline and prolong the duration of the rate stabilization mechanism, as the cap in permitted generator losses will take longer to reach.
Since electricity tariffs are paid in Chilean pesos and regulated PPAs are priced in US dollars, the rate freeze exposes power projects to Chilean peso depreciation, which was significant since last fall, and is expected to depreciate further due to the economic contraction, causing the gap between the set electricity tariff and the average PPA price to be wider and last longer than originally anticipated.
Renewable power projects that were granted cheaper PPAs during previous auctions were expected to come online in 2021, reducing the average PPA price. There is increased risk that projects under construction will be delayed due to supply chain issues caused by the coronavirus pandemic, implying a larger gap between the stabilized electricity tariff and the average PPA price, unless these projects have back-up PPAs in place to mitigate delays.
Should energy demand decline as expected and the Chilean peso continues to depreciate, resulting in sustained weaker revenues, projects will be more likely to draw on debt service reserve funds (DSRFs) to meet debt service obligations. Significant draws on DSRFs increase the risk of payment default and would lead to negative rating actions.
Federal Chilean law states Discos must pay-back power projects for lost PPA revenues by December 2027. The timing and extent of this pay-back remains unclear, but the National Energy Commission is expected to clarify these expectations. Fitch believes this pay-back may begin in 2024, once cheaper PPAs from the 2017 auctions enter the system. An earlier than originally expected payback could positively affect credit quality.