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Change in Chile

With Argentina suffering a natural gas crisis, Chile has been forced to reevaluate and diversify its energy planning in order to maintain its growing reputation as the place to do business.

Peter Howard Wertheim and Dayse Abrantes,

The World Bank reports that Chile's conditions are good enough to rank it as the best country to do business in Latin America, and second best among economies in a similar state of development worldwide, only outperformed by Malaysia.

However, Argentina's energy crisis is threatening to destabilise Chile's energy balance, and therefore, its economic stability. Since last May, Argentina has cut back its natural gas exports to Chile, which has caused Chile to reevaluate proposed natural gas projects and the way in which it plans its power system.

New rules will change the calculation of prices that generators charge to distributors, based on measurements of their guaranteed supply. The pricing scheme will punish natural gas plants built without backup plans, and will favour using liquid natural gas, coal or other fuels that are always available in the market.

The need for change comes after Chile realised how vulnerable its power supply was when Argentina cut part of its natural gas export to Chile earlier this year. Some 25 per cent of Chile's power comes from natural gas fired plants that totally depend on imports from Argentina. "The system must adapt to a new reality – the unexpected natural gas drought," said energy minister Jorge Rodriguez.

The impact on Chile of Argentina's gas export cutbacks has varied. For example, Chile's northern grid (SING), has been most impacted by the natural gas restrictions, as 58 per cent of power generation capacity in that region is gas fired, while central and southern regions have been relatively immune to the cuts. Gas fired power plants in northern Chile, particularly those that are unable to switch fuels, have been forced to purchase electricity from third parties in order to meet contractual obligations. Even those power plants which have fuel switching capabilities have been affected by the restrictions, due to the higher cost of purchasing other fuels.

Hydropower dominates

Hydropower has historically been Chile's single largest power source, at times comprising over half of the country's installed electric generation capacity and production. In 2002, for example, hydropower supplied 72 per cent of Chile's power and accounted for 59 per cent of installed electric capacity. Droughts, however, have periodically curtailed hydropower production.

The Argentine gas crisis has revitalised Chilean hydropower projects, while also encouraging the development of coal and oil fired power plants. One new hydropower project is the 155 MW La Higuera plant on the Tinguiririca River. Construction is expected to begin in late 2004, with completion due January 2008.

Development of a second phase project, La Confluencia, with a capacity of 145 MW, is expected to begin in the next two to three years. Australia's Pacific Hydro Limited and Norway's Statkraft Norfund Power Invest will own and operate La Higuera. Other hydropower plants under consideration are the Coya-Pangal (25 MW) and an unnamed 65 MW plant.

Chile's biggest power generator Endesa is mostly hydroelectric, while the second largest generator is largely a thermoelectric company with a high proportion of coal fired plants. Colbun, the country's third biggest power generator, is about half hydroelectric and half natural gas.

Expansion plan rules

"In Chile there is full freedom for investment in the electrical sector, the basic objective has been to minimize barriers of entry to new investors. Nevertheless, the National Energy Commission (CNE) elaborates an indicative expansion plan for the country's two electrical systems," said Hugh Rudnick, IEEE Fellow and a Professor of electrical engineering at the Catholic University of Chile.

The criteria used in the indicative planning consists of determining those options and project sequences, proposed by private investors or defined by the regulator, that minimize the costs of investment, operation and non served energy over a time horizon. The solutions obtained around the optimum are then analysed with minimizing risk criteria, considering future demand growth and evolution of fuel prices. It is important to emphasize the indicative character of this planning since it does not compel the private sector to accomplish the determined investments, explained Professor Rudnick.

The indicative plan had more strength in the generation environment than in the transmission one. Transmission investments were often linked to new generation plants being developed, and thus were included as part of those actions.

From a private point of view, the investment decision will be to develop those projects that, with the tariffs and costs perceived by the private investors, produce desired return rates and/or respond to their strategic interests. In terms of the authority, the indicative plans are defined based on a social appraisal of fuel costs, investments and return rates dictated by the National Planning Ministry. The objective is to supply demand by minimizing the cost to society.


Of Chile's four interconnected grids, SING has been hit the hardest by Argentina's natural gas crisis
Click here to enlarge image

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The optimum expansion of the electrical system as determined by CNE, directly impacts the regulated tariff levels determined by the authority. The law indicates that every six months, the National Energy Commission (CNE) must determine 'nodal prices' for energy and capacity. This is done in agreement with a regular update of the indicative plan. The nodal prices represent the generation transmission component of the final price to consumers smaller than 2 MW. It corresponds to a four year projection of the generation-transmission marginal costs and is obtained through simulations of the stochastic hydrothermal operation of each system, considering the optimal system expansion as defined by the indicative plan.

As competition increased in the Chilean power sector and the introduction of natural gas combined cycle plants reduced energy prices, a growing divergence arose between the CNE indicative plan and the investments accomplished by the private sector. Differences arose in the incorporation dates of new plants and/or in generation technologies used for the expansion. The differences are so large at present that there are CNE plans for a series of new combined cycle plants that nobody is planning to build.

Expansion needed

A worse situation has developed in relation to transmission expansion. A long awaited separation of the transmission company Transelec from the main generator company took place in October 2000. Hydro-Québec International acquired the transmission assets of Endesa, Chile's largest generating company. Endesa was forced to divest itself of its transmission business following requests from the Antimonopoly Commission, which questioned interests of power producers in transmission concerns. While this awaited development was welcomed in the country, it was a major test of transmission regulation. It exposed the weakness of the tariff system in financing existing installations, the result being less expansion.

The transmission tariffs are based on a usage scheme, where generators claiming open access negotiate with the transmission owner on their transmission payments. These payments are allocated among all users on a strictly prorate base of their usage. These negotiations are done on a one at a time two side basis (one generator with the transmitter), so that they do not assure the financing (or over financing) of all investments.

Transelec has complained about these conditions and has minimized its new investments. This has been aggravated by an incomplete tariff scheme, where there are no ways to finance the transmission expansions needed by consumers.

The southern part of the main electrical system is in need of urgent expansion, conditioned by load growth in the area. While there is no way to transfer these new costs to consumers to enable this expansion, blackouts have already taken place because of congestion. This has driven all parties involved to look for solutions.

A new electricity law (Ley Corta) was approved in March 2004 with the aim of increasing electricity generating capacity and improving transmission systems. The law promotes the interconnection of existing networks and changes the fees paid by generation and distribution companies to transmission companies. In an effort to end disputes between companies, transmission fees are no longer to be negotiated between the transmission and the generation companies in contracts.

The law also aims at stabilizing node prices by allowing a fluctuation of up to five per cent from the market price negotiated in private contracts (down from ten per cent previously). An 80 per cent generators to 20 per cent consumers with an improved centralized process for the allocation of payments was established for Chile's main transmission corridor.

Professer Rudnick argues that the change of the electricity law in March 2004 was seen as the only approach, as bylaw modifications could not go into the root of the problem. The main items of the new law are: explicit separation between transmission and other agents; transmission values to be set by a regulator and tariffs set by a system operator; remuneration of all transmission assets; payment based on a use of system approach, but incorporating demand; payment rates published every year; and an expert council to solve conflicts among agents.

The new law is expected to boost investment in electricity generation by reducing regulatory uncertainty.

Seeking alternatives

Analysts believe the new rules could affect power companies that produce a larger portion of their power from natural gas, since it will force them to provide alternatives or be punished in the price calculations.

In coming years, it remains unclear when Argentina will be able to meet its supply obligations with Chile. Although Argentina has sufficient natural gas reserves (663 billion m3 as of January 2004) to supply both its domestic market and Chile, the current natural gas supply problem stems mainly from booming demand for natural gas in Argentina, after the government froze gas prices at artificially low levels in January 2002.

Click here to enlarge image

The low gas prices have also discouraged natural gas producers in Argentina from increasing their output more than contractually necessary, as well as from investing in new exploration and production activities. While the Argentine government pledged to increase investment in the country's natural gas sector to boost production and transport capacity, analysts question whether the country can raise, as well as attract, the financing that is needed.

Source: Balance de Energía, Comisión Nacional de Energía in Chile

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