Jaime M Senior Fernández and Mary Fernández Rodríguez of Headrick Rizik Alvarez & Fernández in Santo Domingo consider the opportunities available to investors in the energy and infrastructure markets
1 Introduction – Economic and political stability and a strategic location
The Dominican Republic is well known – and rightly so – in the world community for its tourism industry and agro-industrial exports. However, during the past decade, the Dominican Republic’s reputation as a stable and promising investment destination in other areas has continued to increase.
Part of the reason that the Dominican Republic continues to interest foreign investors is due to its strategic location in the heart of the Caribbean Sea, and it is roughly equidistant between key cities in North and South America. The country has a number of international airports, ports and new highways, which continue to facilitate international commerce (the challenges and opportunities in this sector will be discussed below). Furthermore, the state-of-the-art telecommunications networks – considered to be among the best in Latin America – that have been built in the Dominican Republic are an important asset in ensuring the country’s connectivity with the world at large.
The country has also been politically and economically stable during the past few decades. In fact, during the worldwide economic crisis of 2008-2010, the economy of the Dominican Republic continued to grow. Foreign direct investment from 2010 through 2013 totaled approximately $10 billion and as of 2013, per capita GDP reached $9,700, placing the country squarely in the midst of emerging markets and middle income economies around the world. Inflation has also been contained, averaging 3-5% during the past few years.
Politically, the country has open, free and fair elections, with a vibrant press and civil society organisations. The current government has increased its focus on education and eradicating illiteracy, with the aim of making the labour force more competitive and attractive for business. Regulation tends to be principle-based, with regulators often seeking to proactively engage industry and society in regulatory reforms and consultations.
2 Challenges – The energy sector
Unlike other nations in Latin America, the Dominican Republic does not produce or extract fossil fuels of any kind. Thus, the country is dependent on imports of crude and refined oil, natural gas, coal and other fuels in order to meet its energy supply needs (as of 2013, approximately 90% of electric generation in the country is based on the consumption of fossil fuels). For the economy at large, this reliance on imports means that energy production tends to be more expensive than it otherwise could be.
Similarly, most of the electric energy production in the country is based on fuel oil generation. While fuel oil generators tend to be less expensive to build and are less technically complex than other forms of generation, the distinct disadvantage to such an approach is that the fuel (based on current trends and market prices) is more expensive than coal or natural gas based solutions. For a country like the Dominican Republic, this entails greater expense and has a direct negative impact on its current account balance and international reserves.
Also of interest is the composition of the electric energy production and distribution markets in the country. Electric energy production is primarily a private sector endeavour, with the Dominican government having a negligible impact on production (a recent law authorised the government to increase its participation in the production market via the building of two power plants; however, the same law provides that such participation should be temporary). In contrast, the Dominican government is the owner of the main electric distribution companies in the country. From a production standpoint, the positive aspect of this arrangement is that the Dominican State is the counterparty, meaning that payment risk can be considered to be lower than it would otherwise be for private distributors. However, the government’s interest is not necessarily to ensure that all users pay for their electric consumption, as political considerations can often cloud such judgements. Accordingly, the Dominican State indirectly subsidises electric power consumption in the Dominican Republic, causing the State to run deficits and for consumption to be less efficient and focused.
With respect to the refining crude oil, there is only one refinery in the Dominican Republic, and that refinery is co-owned by the Dominican and Venezuelan governments (the Dominican government is the controlling party). While the facility has a well-earned reputation for being an efficient and well-run enterprise, the fact that there is only one such facility in the entire country means that industry and energy production are unduly reliant on that source. Likewise, the country is otherwise forced to import refined crude products, which tends to be more expensive than importing unrefined crude oil and undertaking the refining process closer to where the fuel will ultimately be used or consumed.
Finally, the emphasis on fossil fuels has left a substantial need for exploring alternative and renewable sources of energy in the country. While there are a number of hydroelectric sources in the Dominican Republic, no new hydro plant has been built during the last few years (the Dominican government has typically taken the lead in building and operating hydro plants). The private sector has built a large wind energy installation in the country (the “Los Cocos” wind plant), and there is widely dispersed solar energy use, but there has not been a consistent policy of expanding and increasing the use of renewable energy sources to improve the energy mix in the country and for economic opportunity purposes.
3 Opportunities for investment – The energy sector
The Dominican Republic’s growing economy has necessarily meant that its energy supply needs have continued to increase, and in fact outpace current production. Thus, there exists a large need for construction of new electric generating plants in the country. In fact, recognising this need, the Dominican Government recently approved the construction of two new electric generation plants – one coal-fired and one natural gas-fired – in the country, both of which will be owned, for a time, by the Dominican State.
In terms of structuring an investment in the construction and operation of an electric generation plant in the Dominican Republic, the State has worked to incentivise investors and to make such an investment an attractive proposition. In prior transactions, the electric distributors – which are owned by the Dominican State – have offered electric generators long term power purchase agreements, usually for 10 to 20 years, with a per kilowatt hour purchase price of approximately twenty (20) US cents, which is an attractive rate by international standards. In addition, the Dominican Government has issued full State guarantees with respect to such long-term power purchase agreements, further increasing the attractiveness of the opportunity for investors by directly decreasing the credit risk. The Dominican State has also provided consent to pledging the interests under the power purchase agreement in order to secure international financing for such construction, and to explicitly provide for the State guarantee to inure in favor of the lenders under such financing.
Another opportunity in the Dominican energy sector involves the conversion of existing electric generation plants from fuel-oil to either coal or natural gas (with the possibility of dual cycle conversions for natural gas). Such conversions represent important opportunities for international construction companies and energy consultants, as the savings that can be achieved through such conversions are substantial and may entice both the electric generation companies as well as the Dominican State.
The construction and operation of a new oil refinery in the Dominican Republic represents yet another potential avenue for investment in the country. Given the increasing affluence of the country, as more people purchase cars and motorbikes, consumption of gasoline and diesel fuel is expected to increase. In addition, the vibrant aviation sector demands high-quality jet fuel (avtur) and the electric generation sector is expected to continue to heavily rely on fuel oil for the foreseeable future. Thus, building a refinery in the country to supplement the one refinery that currently exists could fill a market void, and thus reduce the need to import costly refined oil products.
4 Challenges – The infrastructure sector
The Dominican Republic has been fortunate to continue to present steady and consistent economic growth, utilising its existing infrastructure platform to the fullest. However, as the economy continues to grow, the limits of the country’s existing infrastructure will become more readily apparent and may represent a clear inhibitor to the continued economic vibrancy of the country. While the Dominican Government is well aware of these issues – and has taken some steps to begin to address them – only increased investment by the private sector can possibly fill the gap.
Beginning with the largest cities, Santo Domingo and Santiago, traffic continues to represent a major and growing threat to economic growth. The government has responded to this issue by building several tunnels, underpasses and overpasses at busy intersections and by beginning to build a metro (subway) system (one line has already been built in Santo Domingo; a second line is under construction). However, these investments have only served to maintain the status quo of long traffic jams, which entail waste of fuel and productivity losses. Only through major investments in building other traffic efficiency devices (tunnels, underpasses and overpasses) and continuing a rapid expansion of mass transportation will the traffic situation improve.
The country currently has a basic highway system that allows for access to all major regions of the country. However, this system is quite basic, and in many cases the roads are beginning to deteriorate or are only two-lane roads, limiting traffic therein. Likewise, many smaller and less developed regions of the country do not have reliable highways, limiting their potential for economic development. Finally, a better highway system will serve the country well in marketing and improving its tourism industry – for example, a private developer recently completed two private toll roads, which significantly cut the travel time between the Samaná and Las Terrenas regions and Santo Domingo.
Related to the foregoing is the fact that there are currently no heavy transportation options, such as railroads, in the country. While it may be determined that it is not economically feasible or desirable to invest in building a railroad in the country, the fact remains that the insufficient highway system creates inefficiencies and bottlenecks in the transportation of people and goods in the country.
On the plus side, the Dominican Republic currently has eight international airports in operation (two in the Santo Domingo region, and one in each of Barahona, La Romana, Puerto Plata, Punta Cana, Samaná and Santiago). However, even these airports are limited in the scope and quality of services that they provide, which may serve to limit the potential economic benefits that the country could receive from having airport facilities that are world-class.
The expansion of the Panama Canal is the most important event in the recent history of global transportation. Its expansion, which will be ready in 2013, will have a significant impact for the ports of the region, among which the Dominican Republic boasts to have several which are strategically located and with the conditions to serve as catalyst these advantages and absorb at least a good part of the additional flow of maritime cargo that will pass near our shores. The necessary infrastructure already exists and the country is very well positioned to serve the market of the CARICOM countries as well as the routes to the east of the United States, South America and Europe.
5 Opportunities for investment – The infrastructure sector
As mentioned in the previous section, the highway system of the Dominican Republic is in need of substantial upgrades and investment. In recent years, the Dominican government has sought to make direct investments in these areas, but the considerable challenges and scope for investment have led the government to conclude that inviting private capital to assist in bridging this challenge is essential. Accordingly, investors have contributed by building two private toll roads (a third private toll road was contemplated, but was not built). But there remains a sizeable need for additional investment and construction in this area.
Likewise, while intra-city transport is likely to remain a priority for the Dominican Republic and represents a compelling opportunity for investment, development and construction of mass transit and improved roads in large cities is another avenue for investment. As the Dominican government increasingly recognises that inefficiencies in intra-city transportation represent significant brakes on growth, the need to invest in improving these systems will only increase. Thus, the government will be forced to either directly invest in these improvements, thus opening opportunities for investors in inter-city transport investments, or will directly open up investment in intra-city transportation improvements to private investors.
In addition to the ground transport sectors, the air and sea transport sectors of the Dominican economy are open for investment and remain attractive opportunities. Of particular note is the expansion of the Panama Canal as noted above, which many believe is likely to increase container traffic through the Caribbean basin. This expansion could prove to be an opportunity to expand this sector, as the country has limited ports and is also in need of services for consolidation and redistribution of merchandise to other ports of the region. In addition, with a sizeable industrial base and very large tourist market (and an increasing use of ports for docking cruise ships), the need to continue to improve these modes of transportation will only increase in the coming years.
Finally, “core” infrastructure projects in the Dominican Republic remain attractive for private capital, both from construction and financing standpoints. The country continues to rapidly improve its water distribution, sanitation, bridges and similar infrastructure items. To the extent that the economy continues to grow and land, sea and air transportation options improve, it can be expected that these “core” projects will continue to become more important, which can only mean that investment in this area will increase.
6 Legal framework for investment in the Dominican Republic
The Dominican Republic has a stable legal system that is primarily based on the French civil code system, although it is increasingly influenced by the United States and other international actors. With respect to foreign investment, Law No. 16-95 on Foreign Investment was the primary driver in the elimination of many barriers and disincentives to foreign investment. The same served as a catalyst to orienting the Dominican Government´s view on foreign investment towards an international vision that champions legal security and welcomes investment. There are also a number of laws and regulations currently in force to promote and facilitate investment, such as laws establishing industrial free zones, promoting development of tourism projects, creating the Centre for Export and Investment of the Dominican Republic, as well as modern laws protecting intellectual property, regulating the debt and equity markets, the financial system, the telecommunications market and e-commerce.
With respect to the energy and infrastructure sectors, most contracts and investments are governed by the country’s general laws. However, there are a number of specific laws and regulations, such as Law No. 125-01 on the Electric Sector, Law No. 57-07 on Tax Incentives for Renewable Energy and Law No. 100-13 on the Creation of the Ministry of Energy and Mines (which recently entered into effect), that impact the energy sector. As previously mentioned, investments in the energy production sector are typically backed by long-term power purchase agreements, and in many cases by State guarantees (which require Congressional approval). Concessions for private toll roads and the like also require Congressional approval.
With respect to repatriation of capital, dividends or other flows of capital, there are currently no restrictions or limitations in respect thereof. There is, however, a requirement that significant foreign exchange transactions be reported, for statistical purposes, to the Central Bank of the Dominican Republic.
The Dominican Republic is currently party to a number of free trade and bilateral investment agreements, each of which facilitates trade and investment as well as offer protections to foreign investors. Of particular interest are the Dominican Republic-Central America Free Trade Agreement with the United States, a free trade agreement with the Central American region and the countries in the Caribbean basin and an Economic Association Agreement with the European Union. In addition, the country is party to least eight bilateral investment treaties and a number of tax sparing and/or double-taxation treaties, and is also a member of the World Trade Organisation.
In terms of ensuring that arbitration is a valid means of dispute resolution – which is of particular importance and interest to foreign investors – it is critical to note that the right to participate in arbitration as a means for dispute resolution is constitutionally recognised. In addition, Law No. 498-08 on Arbitration reinforced these principles regarding the power of parties to enter into and enforce arbitration provisions in contracts. In fact, the same law specifically provides that the Dominican State may agree to arbitration provisions, and such provisions are binding on the State. Finally, the country is party to the 1958 New York Convention on Recognition and Enforcement of Foreign Arbitral Awards.
Conclusion – Ample opportunities in the energy and infrastructure sectors of the Dominican Republic
The Dominican Republic is located in the heart of the Caribbean Sea – strategically located for both air and sea shipping to and from North America and South America. Capitalising on this location, along with the consistent economic growth that the country has exhibited during the past decades, the accompanying political stability and friendly legal framework, present a compelling opportunity for any investor.
In terms of investments in the Dominican energy market, the country’s increased needs for affordable power generation represent a crucial investment opportunity, with construction of new electric generation plants, conversion of existing fuel oil plants to coal and natural gas and the construction of new refineries highlighting the opportunities. With respect to the infrastructure market, private investment in the highway network (private toll roads) and other transportation systems, as well as investments in building new facilities such as ports, terminals, water distribution and sanitation plants represent sizeable opportunities.
In short, the energy and infrastructure sectors of the Dominican Republic are ripe and open for investment.
Jaime M Senior Fernández
Partner
Headrick Rizik Alvarez & Fernández
Santo Domingo
About the author
Jaime M Senior Fernández is a partner at Headrick Rizik Alvarez & Fernández. Mr Senior concentrates his practice in matters of civil, commercial and business organisational laws generally, with an emphasis on banking and financial transactions and foreign investment. Mr Senior regularly counsels foreign and domestic clients in mergers and acquisitions, the negotiation of all types of commercial agreements, tax matters, financings, corporate reorganisations as well as tourism and industrial free zones investments. Additionally, Mr Senior is experienced in the supervision and strategy of dispute resolution matters, with an emphasis on disputes related to foreign investment and products liability matters. Prior to joining the firm as a partner, Mr Senior worked for six years as an associate in the New York office of Sidley Austin. In addition to a Dominican law degree, Mr Senior holds a JD from Cornell Law School and is admitted in New York.
Mary Fernández Rodríguez
Partner
Headrick Rizik Alvarez & Fernández
Santo Domingo
About the author
Mary Fernández is a founding partner at Headrick Rizik Alvarez & Fernández. She serves as counsel to national and international clients in matters of foreign investment, corporate law, banking and international finances, negotiation and execution of contracts involving public or private entities; franchising and distribution relations; structuring and implementation of real estate and tourist projects, aviation law and intellectual property matters in general, including litigation. She currently presides over the Legal Committee of the American Chamber of Commerce of the Dominican Republic and is a member of the Board of the Centre for Resolution of Conflicts. Her professional practice has been recognised by Chambers Global and Chambers Latin America – Latin America’s Leading Lawyers for Business 2014 edition and by Latin Lawyer 250 – Latin America Leading’s Business Law Firms 2014 edition, being praised in the latter for her outstanding work in the areas of corporate law and intellectual property.
