For long term security of electricity supply, Chilean energy policy must "go public"

In the early eighties, Chile was a world leader in modernizing its electricity sector by privatizing state assets and creating a competitive environment.  Now, it has the chance to be a leader again in the “green power” revolution if it modernizes its electricity sector to fix the places where it is not working.  To do this, Chile first needs to take the planning of the sector public.  

Chile was a world leader in 1982 with its successful privatization of its energy sector.  Many places followed, including European countries and U.S. states.  What few countries or states have emulated, however, is Chile’s near complete privatization of energy policy in addition to the standard package of privatizing generation, transmission and distribution assets. 

Much of the thinking about electricity policy in Chile is constrained by the “natural” fact that it does not have significant domestic hydrocarbon supplies and the legal and political fact that decisions regarding the direction of the sector have effectively been privatized.  The lack of hydrocarbons makes the country dependent on foreign sources of coal, oil and natural gas.  The lack of public policy makes Chileans dependent on the judgment of the major generation companies for the cost effective and secure evolution of their electricity supply.  There is ample reason to doubt the companies’ wisdom.

One domestic energy source that Chile does have is hydropower.  Historically, its abundance resulted in an electricity generation portfolio heavily weighted towards hydroelectric power and therefore vulnerable to periodic droughts.  You can read a recent English-language summary of the history of the sector in a recent academic article.

In the mid 1990’s, because of the droughts, continued rapid growth in consumption and the completion of a large hydro build out, the companies sought to diversify by entering into contracts with Argentinean gas suppliers for the supply of low cost natural gas and began to invest heavily in gas infrastructure.  The low-cost of imported natural gas made gas generation attractive relative to new large hydro plants and coal.  As a consequence, gas began to eclipse new hydro in terms of generation growth to claim an increasing share of the national capacity mix as seen in Annex D2 of the “National Energy Balance” spreadsheet complied by the Chilean National Energy Commission.  Soon after these major investments in the late 1990s, the short-sightedness of the gas-hydro portfolio play became clear. 

First, in spite of the increasing diversification into gas, a major drought in the period 1998-1999 caused blackouts and rationing in Chile.  A couple of years later in 2002, Argentina decided during its economic crisis to restrict gas exports to Chile in order to ensure sufficient cheap supplies at home.  This instigated another energy crisis in Chile as electricity prices skyrocketed when Chilean generators were forced to import expensive diesel to burn in modified gas-fired plants.  Since then, the talk in Chile has returned to building new large hydro in Patagonia (as discussed by my colleagues Amanda Maxwell and Susan Casey-Lefkowitz) as the backbone of the system with diversification into LNG, coal and even nuclear.  

Given that much of the impetus for this plan is coming from the big private energy companies with their own interests in mind, it should be scrutinized.  Private companies must play a significant role in the orientation of the sector, but to arrive at a sustainable result, they must act within a long term framework set out by public policy.  Left to their own devices, the companies will steer the market to dysfunction again and again.  Dysfunction is the necessary result of substituting the economic interests of shareholders (many of whom are not Chilean, by the way) for the Chilean public interest, with no guiding policies to require stability, efficiency or sustainability. 

This point was recently made by the International Energy Agency in its 2009 Chile Policy Review when it noted of Chile’s current system:

“While investment decisions should continue to be made by the private sector, the government needs to take a more proactive position with regard to monitoring energy developments and systematic risk assessment.”

 In the same document, the IEA recommended that the government should: 

“[s]end clear investment signals to the private sector and create a framework to ensure that long-term investment decisions will be based on long-term cost/benefit analysis, including environmental externalities and the downward cost curve of certain technologies.”

Lack of coherent policy guidance for electricity generation – an essential public good – leads to sub optimal societal outcomes, as the IEA recommendations imply.  The premise of the Chilean system is that the public’s only interest is in having a sufficient supply of electricity at the lowest possible price, as determined by the market mechanism, but even by this standard, the system is not working.  Chile has all the symptoms of a poorly managed energy system:  high energy prices, blackouts and the kind of vulnerability to drought and the loss of gas supplies that result from misguided investment.

In the U.S. we don’t have a coherent national energy policy (as evidenced by the near-term death of the climate and energy bill last week), but at the state level there are institutions, such as public utilities commissions, that make decisions on new electricity investment, system cost, security of fuel supply and system reliability with the interests of the ratepayer as a fundamental consideration. Not all of these commissions adequately balance public concerns, environmental sustainability and the need for reliable and affordable energy services, but several states (some with populations and economies larger than Chile’s) have well developed polices.    

In Chile by contrast, the generation business is dominated by three large players who make investment decisions without any public input.  The companies are not required to show that a given asset is necessary or that alternatives have been considered or to demonstrate any other kind systemic or public benefit.   Unsurprisingly, the only factor the companies will consider is their own bottom line.  But what is surprising is that it is very difficult under current law for a Chilean government institution to reject a project because it is inefficient, unnecessary or not in the public interest for other reasons, like air pollution.    

Chile could reprise its history of leadership in energy policy, but only if it develops a detailed understanding and vision of the public interest rather than allowing its energy policy to be set by the narrow interests of a select group of companies.  It pioneered competition in the electricity sector and now it needs to level the playing the field again through long term policies and regulations that sufficiently incentivize efficiency and renewable energy and account for the true costs of dirty and destructive sources of generation. 

About the Authors

Douglass Sims

Director of Strategy and Finance, Center for Market Innovation

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