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Over the last decade or so, electricity supply in Chile has lurched from crisis to crisis. The trouble started in the late 1990s when, in the face of one of the worst droughts in a century, staggered blackouts had to be imposed as hydroelectricity ran short.

Then, in the mid-2000s, it deepened further when Argentina, struggling with its own energy crisis, introduced ever deeper restrictions on exports of the natural gas used by many of Chile’s thermal generators. When that emergency was also compounded by yet another drought, the country faced what Marcelo Tokman, then energy minister, termed a “perfect storm”.

Rationing was avoided that time but only narrowly. And, this year, power is yet again in tight supply, also due to a drought. Add to that high electricity prices - twice those of Chile’s neighbors and almost 50 percent higher than in industrialized countries, according to the government - and it is little wonder that questions are being asked about the country’s electricity regulation. 

Improvements to regulation - but not a change in its essence - were, indeed, one of the election promises of Sebastián Piñera, Chile’s president since March 2010. Like businesses, his government sees a reduction in electricity prices as key for increasing the productivity and competitiveness of the country’s small export-driven economy. 

Chile’s present electricity regulation dates back to the early 1980s when, in a move considered revolutionary at the time, it unbundled its state-owned, vertically-integrated and price-fixed electricity system into three distinct segments - generation, transmission and distribution - each with its own regulation. In addition, it decided that generation - unlike distribution and, to a lesser extent, transmission - was not a natural monopoly and competition, rather than central planning, could be allowed to drive its development.

This was before the subsequent privatizations had even been thought of, recalls Sebastián Bernstein, a consultant who then headed the electricity division of the National Energy Commission. The idea, he says, was simply to break the hold of the state monopoly and make it feasible for private companies to enter the market.

But breaking up the state monopoly also posed another challenge - how to decide which power plants should be supplying the system at any given time. And, there, the 1982 Electricity Law took another pioneering step by introducing marginal-cost dispatch, the system under which plants are called into operation in ascending order of their cost of producing the next (marginal) kilowatt-hour of electricity.

This was a method that Bernstein had seen in France, although in the different context of an integrated system. Subsequently adopted by a number of other Latin American countries, including Peru and Bolivia, it is an alternative to the more usual system of tenders and bids and, in conditions of competition, should produce the same results, says Bernstein.

Price drivers

Some changes to this basic framework have been made since the late 1990s, mostly as regards transmission and, in the case of generation, to foster the development of alternative renewable sources, but the 1982 law remains the backbone of Chile’s electricity regulation. In general, although severely stressed by the droughts and, particularly, the withdrawal of Argentine gas, it is also seen as having performed reasonably well. “It’s a highly efficient system,” says Jorge Rodríguez, who served as economy minister with responsibility for energy during most of the 2000-2006 Lagos government and is now dean of the Economics Faculty at Alberto Hurtado University. “Marginal-cost dispatch means the system is always producing at the lowest possible cost whether or not there’s competition.”

It is, in fact, pretty clear that the lack of Argentine gas, rather than a failure of the regulatory framework, is at the root of today’s high electricity prices. The quickest fix for the absence of gas was diesel-fired generation - some of it still in use - which has a marginal cost of over US$200/MWh as compared to around US$80/MWh for coal-fired generation or US$40/MWh for hydroelectricity.

Prices should, however, drop as more efficient capacity, principally new coal plants, is brought on line in response to the incentive of attractive prices. This has, in fact, already occurred in the Northern Interconnected System (SING), the grid that supplies the mining north of country. In the Central Interconnected System (SIC), which supplies central and most of southern Chile, this process has, however, been slower, fuelling suspicion that a perverse incentive could be at work.

The system’s marginal cost or, in other words, that of the most expensive plant in operation is an important factor in determining the revenues that all the other generators receive for their output. In other words, lower-cost generators can, on paper at least, maximize their profits by adjusting their output to a level at which less efficient capacity is still needed.

It is not, in practice, quite that simple. For a hydroelectric generator, selling power on the spot market at diesel-determined prices is a gift but if, instead, it runs short of water and has to buy power on the spot market to fulfill contracts fixed at hydroelectric prices, it is in trouble.

Still, generators are rumored to pressure their grid’s operator, the Dispatch Center (CDEC), to keep expensive plants in operation. The usual trick, according to these rumors, is to take a lower-cost plant out of operation for maintenance just when a particularly inefficient plant would otherwise no longer be needed.

“The opportunities for that sort of gaming certainly exist,” admits Hugh Rudnick, a professor at the Catholic University’s Engineering School, “but there is no convincing evidence it actually happens.” 

Others are more skeptical. “The CDECs are underfunded, undermanned and, in practice, governed by the generators they are supposed to govern,” says Patricia Garip, bureau chief for Latin America at Argus Media, a UK-based publisher of energy prices and analysis.

The CDECs, in fact, may emerge as a key target of the recommendations of the 15-member Advisory Commission on Electricity Development, convened by the government in May to review the sector’s regulation and future growth options. Rudnick, a member of the Commission, suggests that, in his personal opinion, a more independent grid operator, perhaps with a charter similar to that of Chile’s autonomous Central Bank, could be an alternative.

Entry barriers

The underlying issue, however, is the dominance of the ‘big three’ generators - Endesa Chile, AES Gener and Colbún. Controlled, respectively, by Italy’s Enel, US-based AES Corp. and the local Matte business group, they account for around a combined 90 percent of the SIC’s installed capacity and, in the case of Endesa and AES Gener, also operate in the SING.

“Chile’s generating market is not really competitive,” says Rudnick. “I’m not saying the big three have colluded but they have benefitted from the absence of other players.”

There were hopes that French-Belgian GDF Suez would increase competition by emerging as a fourth large player. Its wings were, however, clipped by President Piñera last year when he decided to ask it to back down on its proposed Barrancones three-unit thermal complex in the SIC which, although close to a protected marine area, had received environmental approval. 

According to Ricardo Raineri, Piñera’s energy minister until January and now a professor at the Catholic University’s Engineering School, competition in the system is not, however, so much about the number or relative size of the players but about new projects. “It’s a matter of who is going to put in the next better-technology unit,” he says.

The catch is entry barriers. One problem, in the case of hydro projects, is water rights - there are few good ones left on the market, points out Garip - and, with hindsight, there is criticism of the decision to allow Endesa keep its stock of water rights when it was privatized in the late 1980s.

But entry barriers have also increased in recent years and that has nothing to do with the ‘big three’. It is the result of delays in obtaining official permits and, increasingly, their challenge by neighboring communities or environmental groups in the courts.

This problem is particularly apparent in transmission. Apart from having to obtain approval for its environmental impact study, new transmission infrastructure requires a concession from the Electricity and Fuels Superintendency (SEC) before the company can start to negotiate rights of way with landowners. In recent years, applications for concessions have increased exponentially and this has become an important bottleneck, says Raineri.  

A bill presented to Congress last year would help by making it more difficult for landowners simply to stall on granting rights of way and by improving the system for arbitrating disputes between landowners and transmission companies. It is “fundamental for Chile’s future electricity development,” says Raineri, but has yet to become law. 

Generation companies also face similar difficulties. In February, the Castilla thermoelectric complex that Brazil’s MPX Energia is proposing to build in the northern part of the SIC, at an estimated cost of US$4.4 billion, obtained approval of its environmental impact study, but has had at least one court case filed against it.

According to Garip, the Barrancones incident also strengthened entry barriers. “By tossing institutionality to the winds, it increased the costs for potential investors in terms of due diligence and building political support,” she argues.

 Public opinion

A country needs not only to produce energy at the lowest price but also to do so in a way that is environmentally and socially acceptable to its citizens. Otherwise, opposition to new projects - like the recent street marches against the HidroAysén hydroelectric project - risks slowing investment to an extent that will endanger supply security. 

The problem, according to Laurence Golborne, Chile’s energy minister until July, is that people now attach ever greater importance to the environmental and social implications of new projects. “They fear that our electricity development system doesn’t reflect their needs or expectations and see it as simply minimizing investment costs,” he said in a radio interview in May.

Over the next ten to 15 years, Chile will almost certainly need to double its generating capacity. And that won’t happen, or will be very costly, if each individual project becomes a battleground.

The most serious problem, according to Jorge Rodríguez, is a lack of zoning to earmark areas for different activities. “There are plenty of people who want to invest but, in this field, the rules of the game aren’t what they need,” he says.

“It’s not an environmental issue,” he argues, “but about not-in-my-backyard, with the aggravation that power plants create few jobs and so don’t have much to offer communities.” 

Zoning would, of course, increase land prices. It would, however, be a more rational way of incorporating a project’s externalities into its costs, suggests Rodríguez.

Bernstein, who used to oppose zoning, says he has now come round to the idea. “We’re seeing opposition to any sort of project, even small ones using alternative renewable sources,” he points out.

In a bid to avoid a repetition of the Barrancones conflict, the Ministry of Public Lands is preparing a “map of zones” that would identify areas considered suitable for high-impact projects like power plants, taking into account factors that include biodiversity, population centers and, for example, indigenous communities. According to Minister Catalina Parot, this map is a factor that would be taken into account when evaluating a project’s environmental impact study.

Other measures have been taken such as the introduction of emissions norms for thermoelectric plants. But they seem to have done little to placate public opinion.

The underlying problem, according to Rudnick, is that, when it comes to electricity, Chileans today are “just opposing, not talking”. Much of the debate - for example, the view of alternative renewable energy as a panacea - is, moreover, often stronger on emotion than hard facts.

Even among experts, adds Rudnick, there are widely diverging opinions about the way the system should be developing. In that context, the Advisory Commission which, as of early August, had already held 15 meetings has reportedly served as a useful forum for thrashing out different positions.

Initially regarded as a government ploy to gain time in the face of the protests against HidroAysén, it could, in fact, prove valuable if its report, due to be published in late September, serves as a basis for informed debate about the different options available to Chile, their respective costs and how to manage their inevitable externalities.

Ruth Bradley is a freelance journalist based in Santiago and a former editor of bUSiness CHILE.