Chile Plans for Growth with "All the Options" Energy Mix

Ramona Tarta, Mark Storry, and Oliver Cushing, Global Business Reports

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A special report from Global Business Reports and POWER

Chile was considered a world leader for reforming and liberalizing its power sector as early as the 1980s. However, 25 years later, Chile is at a crossroads in terms of developing future capacity. With an estimated GDP growth rate of 2% to 3% during the current global financial crisis, a highly competitive economy, an established democracy, and a stable macroeconomic environment, Chile is considered a premium destination for foreign investment.

Chile has developed into a leader of the Latin American economy, boasting a gross domestic product (GDP) per capita of $14,300 — one of the highest in Latin America. This productivity, coupled with Chile’s position as the most business-friendly Latin American country, according to the World Economic Forum’s The Global Competitiveness Report 2009 – 2010, means that Chile is seen as an ideal location for the investor looking to target South America. However, despite countercyclical government policies, Chile remains dependant on the mining sector for its exports and, in turn, much of its energy demand is intrinsically linked to the price of copper and any fluctuations in that price.

As Figure 1 shows, the price of power increased about tenfold in Chile over the past three years, resulting in decreased industry competitiveness. For example, Claudio Ramirez of EDYCE, a large-scale steel producer, explained that the high cost of energy in 2008 forced his company to temporarily cancel its night shift. However, high marginal prices, together with low barriers to entry, made energy projects more attractive and helped to encourage a rush of investment into the energy sector.

1. Price spike. The cost of power in Chile increased roughly tenfold between mid-2006 and early 2008 due to the combination of droughts, gas reductions, and high oil prices. Source: CNE

Chile needs to boost its power generation capacity by 12,000 MW by 2020 to meet its expected growth in demand. This report, compiled after months of on-the-ground research, examines the challenges that need to be tackled for Chile to fully achieve its potential.

A Brief History of Power in Chile

Chile was seen as a torch bearer of liberalization and privatization in the energy sector. Under the military dictatorship of Augusto Pinochet the first steps were taken to shift the balance from state to private ownership, a path continued under subsequent civilian governments. The formerly state-owned monopoly, ENDESA, was privatized beginning in 1987 and sold first to Spanish investors and, more recently, to Italian investors.

Chile’s first steps were to unbundle the generation, transmission, and distribution sectors and then privatize them. Currently, apart from the CNE ( Commission Nacional de Energia), which is responsible for central planning and tariff regulation, the whole sector is private. This model has been exported to other Latin American countries such as Argentina, Peru, and Columbia.

As Minister Marcelo Tokman explained in an interview (see sidebar), although Chile does have a minister for energy, it is just now in the process of putting together a Ministry of Energy. At the time of writing this report, important responsibilities were divided between the Ministry of Mining, the Ministry of Public Works, and the Ministry of Economy. For example, the DGA ( La Dirección General de Aguas), headed by Rodrigo Weisner, which grants the water permits needed for hydro plants, lies within the Ministry for Public Works. A bill currently going through parliament will attempt to centralize the majority, but not all of these responsibilities, within a unified Ministry of Energy.

Interview with Minister for Energy Marcelo Tokman

GBR: Chile hasn’t traditionally had a specific minister of energy. What impact has this change had on energy policy development and implementation in the country?

MT: When this government came to power, the Energy Ministry was combined with the Mining Ministry. There wasn’t a specific minister of energy. Whoever had been in charge of energy was also in charge of something else at the same time, and there was a tendency only to focus on energy when we had a crisis.

Once the crisis had passed, the minister started concentrating on other issues in one of their other areas of responsibility. At the moment I have political responsibility, but the tools necessary are in various departments. This change will help to unify the decision-making structure and concentrate power.

GBR: Does the current bill enjoy sufficient support and signify a change regardless of who wins the upcoming election?

MT: This bill [an ammendment to LEY No. 2224, which created the Ministry of Mines and Energy] has already gone though the House of Deputies without a single vote against it. In the Senate the progress has been slower than we had hoped. However, a large majority of the senators have expressed their support to the idea of creating a Ministry of Energy and to transfer some faculties which are currently spread through different ministries to the Energy Ministry.

GBR: How important is the role of renewable energy in Chile’s energy matrix?

MT: If you compare Chile to the rest of the world, using the broad definition, which includes hydro-power, we compare very well, with 40% of the electric mix being renewable. Renewables play a much stronger role in Chile than most other parts of the world. If you exclude conventional hydro though, nonconventional renewables had a very small participation (2.4%) at the beginning of this government three years ago.

We find this strange due to the enormous availability of natural resources which Chile has (small hydro, wind, solar radiation, biomass, and geothermal). Given our natural resources and the fact that technology has been improving rapidly, there seem to be restrictions that are not allowing these technologies to deploy as much as they could. We have been working very hard to find what are the barriers preventing higher penetration of the nonconventional renewables and designing and implementing policies to eliminate these barriers.

In just four years of our government the use of renewables will have more than doubled. There were certain types of renewables which weren’t present at all, such as wind and geothermal. Now we have geothermal exploration being carried out in several places of the country and by the end of this government’s current term, just taking into account wind parks in operation or under construction, we will have 200 MW of wind power. At the start we heard people saying that it was impossible to have wind farms constructed without government subsidies, but we were convinced that the problem was not the cost but the fact that our market wasn’t designed for these types of projects. What we see from this explosion in renewable projects, not only small hydro, is that we were right.

GBR: You talk about 200 MW in operation, and the figures that you mention aren’t really an explosion. It is only a small percentage of what Chile needs.

MT: We are talking only about wind power. We started with a 2-MW project, which wasn’t connected to the main grid, and we will have ended this period with 200 MW in just three years. So this is a 100-fold increase. If you take into account that we need at least one year to measure and design, to obtain a contract, and to purchase equipment, it has been a period of considerable growth. If you take into account all of the wind farms that have been presented for environmental approval in the last few years, you will find projects for more than 2,000 MW. In addition to that, you have more than 500 MW of other nonconventional renewables. The projects are there; you just need to give them the time that they require to be built.

GBR: When you say something has grown 100 times, that’s a strong level of growth, but in fact the sector has grown from a very, very small percentage to just a very small percentage of the power output Chile needs.

MT: When we started promoting nonconventional renewables there was very little support for the sector. We have implemented different policies to remove existing barriers. Among many we can mention are low-interest-rate credit lines and subsidies for pre-investment and engineering studies, solar radiation, and measurements and maps, and a guarantee fund and contingent subsidy for geothermal exploration. We have also created tax incentives and made it mandatory that a certain percentage of electricity has to be generated from nonconventional renewables. We have done all this in a very short period of time. We have evidence that the policy is right and that the projects are starting to appear. This is something we have been doing for three years. This shows that it doesn’t seem to be a problem from a policy point of view.

GBR: Do you foresee yourself making further changes to the regulatory environment?

MT: The fact that all of these projects are coming to the market is the best proof that the framework and the environment work for the deployment of these technologies is working. You don’t start with 1,000 MW right away, but the fact that these projects can start without a subsidy is a good signal.

Our expectation and our aim is for nonconventional renewables to reach a 10% target by 2020. We believe that this amount can be achieved without having to incur higher energy costs than conventional sources. We understand that there are some technologies which are not competitive. We want to ensure that we use first all of the potential that we have in competitive renewables before making further charges in the framework.

GBR: What advantages does Chile have over its neighbors as a destination for investment within the energy sector?

MT: We are not expecting firms to come to develop projects if they are not profitable. We are not competing with Spain or Germany in terms of our levels of subsidies. Chile is a developing country which has several needs which require fiscal resources. There are still a lot of people living in poverty in Chile. In our case it would be an irresponsible policy to force higher-cost technologies on our people and firms. We have allocated more than $500 million just for renewables, not to subsidize the final price, but to create information and reduce the barriers that these technologies face.

As for reasons to invest in Chile, you can look at rule of law, macroeconomic stability, low levels of corruption, and nondiscriminatory treatment of foreign investment. In terms of international comparisons, which are important for potential investors, risk premiums are low compared to our regional competitors. Chile stands out as a serious, responsible, and well-managed country.

In terms of electricity we were one of the first in the world to liberalize the energy sector, so we have plenty of experience. We have a good and stable regulatory framework; we have a history of large international players in the energy sector who have been here for several decades. After the uncertainty over our levels of gas imports from Argentina, we have made some changes to the regulatory framework which have helped to attract new investments. These changes were made on the basis that prices reflect costs. This is the foundation of our thinking on energy policy.

Forty-eight percent of total investment in the country is projected to be in the energy sector. In terms of electricity, the environmental evaluation system has approved more than 11,000 MW of projects, and we have the same amount again under evaluation. That implies that in terms of any estimates of what we may need for the next decade, there are companies who are willing to make the required investments.

GBR: How difficult is it to balance the need to increase power generation and the environmental concerns that may arise from this expansion?

MT: It is increasingly difficult to balance environmental concerns with power needs. There are two factors in this equation. First, the size of the country; it is hard to find a location of a project which doesn’t have alternative demands on its use. Secondly, and this isn’t necessarily a bad thing, we see more awareness and concern amongst the population about the environmental impacts of new developments. All projects have some kind of impact, so we have to expect opposition. What we have to do is guarantee that the projects that are constructed comply with all the norms and minimize their impacts.

Unlike some of its neighbors, Chile isn’t rich in traditional fossil fuel resources. This lack of fossil fuels, together with Chile’s unique topology, has resulted in a very strong hydro sector. Chilean engineering and expertise in this area are among the best in the world. This specific strength has enabled Chilean energy companies to offer services and develop the hydro sector throughout South America.

As Figure 2 shows, Chile is still at an emergent stage in terms of energy consumption. The country currently has 12,000 MW of capacity and intends to reach 25,000 MW by 2020.

2. GDP per capita vs energy consumption. As Chile’s economy grows, so will its energy consumption. Source: International Energy Agency, 2006

Chile faces a difficult challenge to both expand and diversify its power portfolio. During the 1990s and the start of this decade, the power industry as a whole shifted using imported natural gas. This led to overcapacity and a subsequent drop in prices. This movement to gas was to be short-lived, as political changes left Chile’s gas supplies hugely reduced. Imports currently stand at less than 10% of the 22 million cubic meters that were originally agreed upon with Argentina. Argentina’s withdrawal of natural gas in 2004 left a devastating scar on Chile’s power landscape and has pushed many opinion-makers toward the idea of energy independence.

Alfredo Zamorano, CEO of Proyersa Energy, an engineering and project management company, argues: "When the Argentineans stopped exporting gas, all development stopped and the industry was in a state of shock. Other projects were reactivated very speedily as the industry tried to look for an alternative to gas. The projects we have now are not enough to satisfy the level of demand for energy in Chile. We need to build more plants."

Chile’s challenge is to determine which route it will take to make up for its power deficit. Colbún and ENDESA, which jointly own HidroAysén, believe that this huge hydro project located in the south of the country is the answer. Other voices, such as Jaime Vela, executive vice-president of SW Consulting, argue for a return to fossil fuels: "We believe that coal is the future," he says, highlighting the competitiveness of this fuel source. Still others, including José Ignacio Escobar, general manager of the Chilean section of Irish renewables company Mainstream, believe that with certain regulatory adjustments, the renewable sector could play a significant role. Escobar says, "There are certainly improvements which we believe the government could implement which could really benefit the renewables sector."

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