Coal Power Revives Left-for-Dead Bonds as Chile’s Drought Rages

(Bloomberg) -- Bonds backed by a coal-fired power plant in Chile are roaring back from a record low as an extended drought saps hydroelectric generation.

Reduced river flows have cut output from dams, forcing the country to turn to dirtier sources of electricity to keep the lights on. That’s been a boon for Guacolda Energia SA’s $500 million of notes due in 2025, which returned 21% in August for the biggest gains in Latin America. They’ve held onto the advance and now trade at 69 cents on the dollar, still deep in distressed territory but up from as low as 54 cents in July. 

Guacolda, whose only asset is the coal plant in Huasco, about 550 kilometers (340 miles) north of Santiago, got a new lease on life from the worst drought in Chile’s history, which has seen rain levels about 50% less than normal over the past eight months. It’s a turnaround from earlier this year, when the outlook for the bonds turned grim as lawmakers pushed for a law to phase out the use of coal plants by 2025. Second-quarter revenue tumbled 25% as long-term supply contracts that had provided the bulk of sales expired. 

The drought “reinforces the fact that coal is still needed in the system and that removing it from 2025 could be too early,” said Alejandro Toth, a credit analyst at Credicorp Capital in Santiago. “Also, droughts tend to increase spot prices, which should benefit a company like Guacolda in the short term.”

Coal supplied 39% of Chile’s power in July, up from 34% a year ago, according to the latest data available from the Energy Ministry. Hydro power fell to 14% from 26%. The balance of the supply came from natural gas-fired plants, as well as solar and wind installations.

Chile isn’t the only power market that’s been upended by unpredictable weather in the era of climate change. U.S. coal generation surged 34% in June from a year earlier, while hydro production dropped 14% amid historic droughts in the American West and higher prices for natural gas. In Brazil, president Jair Bolsonaro warned last month that hydro plants may go off line because of a drought.

While Guacolda’s bonds won some respite with the fresh demand for coal-fired power, issues that dogged the company earlier this year are still weighing on the notes.

In March, Fitch Ratings downgraded Guacolda even deeper into junk, to B from BB-, because of the expiration of its long-term supply contracts. Earlier this year, its controller AES Andes SA, which sports an investment-grade rating, sold its stake in the company as part of its strategy to rely more on renewable sources. 

The buyers were a local investment group that then transferred ownership to Santiago-based asset managers Capital Advisors, which now owns 100%. Capital Advisors declined to comment for this story, as did officials at Guacolda.

Another threat comes from an opposition-sponsored bill making its way through Congress that would bring forward the planned phasing out of coal-fired plants in Chile to 2025 from 2040. Such a move would be a “killer” for Guacolda bonds, Ezequiel Fernandez, an analyst at Buenos Aires-based Balanz Capital Valores, said in a note.

Other strategists are more optimistic on the bonds, even while acknowledging the risks that investors may not get their money back in full. Credicorp Capital points out that even if the company is only able to pay back $300 million when its note comes due, that would still give holders an annual yield of about 9% until then.

For now, forecasts call for Chile’s drought to continue. Rains in August only reduced the shortfall in precipitation this year to 50% from 60%, according to the Environment Ministry. 

Credicorp’s Toth says there’s no doubt that the long-term trend in Chile is for more renewable energy with lower costs, a shift that will leave coal-fired plants vulnerable.

“However, this will be a gradual process, and Guacolda should be one of the plants that remains operating for the longest period of time due to its efficiency,” Toth said.

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