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NEWS & COMMENTARY 2008 SPEAKERS 2007 2006 2005

Saturday, March 11, 2006

Chile economy: Heading for an energy crisis?

FROM THE ECONOMIST INTELLIGENCE UNIT

On March 21st, only ten days after taking over from her fellow Socialist, Ricardo Lagos, as Chile's president, Michelle Bachelet will fly to Argentina to try to secure from that nation's government assurances on natural-gas supplies. She will also discuss a possible "strategic alliance". The trip underscores concerns in Chile about energy security, an issue that will be at the top of the new president's agenda. The risk of energy rationing is growing, even as more companies make commitments to invest in electricity generation.

Chile has been living dangerously in terms of usable generating capacity since March 2004, when Argentina's government began to impose severe restrictions on natural-gas exports to Chile in violation of supply guarantees contained in both long-term supply contracts signed in 1996 and in a bilateral gas integration treaty of 1995. These gas supplies are likely to be reduced further in the coming years given the paralysis in Argentina's gas output capacity and the rapid rise in its domestic consumption.

Within this context, the chances that energy rationing will have to be imposed in Chile in 2007-08 have risen sharply following the recent confirmation by the US National Weather Service that the La Niña climatic phenomenon is again in operation. In Chile La Niña is synonymous with drought.

The supply of energy from Chile's hydroelectric plants will remain relatively secure this year because, after two consecutive years of abundant rainfall in 2004-05, Chile began 2006 with 8,186 GWh of dammed energy in the reservoirs of the central grid, Sistema Interconectado Central (SIC). This is their highest level since 1997.

However, these reserves will be exhausted in 2006 if the drought is severe. If the drought continues into 2007-repeating the two-year pattern of previous La Niña appearances in 1968, 1988 and 1999-and Argentina deepens its gas cuts as it is widely expected, Chile is likely to face an energy crisis.
Chile’s generating capacity by the end of 2005
By grid, MW
Type SING SIC Aysen Magallanes Total
Hydroelectric 12.8 4,695.3 17.6 0.0 4,725.7
Thermoelectric 3,583.0 3,593.0 13.9 64.7 7,254.6
Natural gas 2,111.7 1,749.4 0.0 54.9 3,916.0
Natural gas or diesel 660.0 660 0.0 0.0 1,320.0
Eolic 0.0 0.0 2.0 0.0 2.0
Total 3,595.8 8,288.3 33.5 64.7 11,982.3
Source: Comisión Nacional de Energía (CNE).

Of Chile's generating capacity of 11,982 MW at the end of 2005, 43.2%, or 5,181 MW, was fuelled by Argentinian natural gas. Out of this amount, plants with a capacity of 1,320 MW were able to run also on other fuels, mostly diesel. Chile's nominal hydroelectric capacity stood at 4,726 MW, or 39.4% of total generation capacity. Peak demand for electricity was around 7,400 MW, and this is likely to reach 7,800 MW in 2006.

The roots of Chile's energy vulnerability are twofold. The first cause is government policies that combined reliance on Argentinian natural gas to the exclusion of all other energy sources between 1995 and 2004-which raised the generating capacity dependent on Argentinian natural gas from zero in 1997 to 43% at present. The second was a populist amendment to the electricity law (Article 99 bis), passed during the previous La Niña occurrence, just before the presidential and congressional elections of 1999.

Article 99 bis eliminated force majeure limits on contractual obligations for electricity supply without a compensating rise in electricity tariffs to pay for the additional generating capacity required to guarantee supply in all events. It was a popular measure and succeeded in its objective to secure Mr Lagos's election, but it put an end to the construction of new electricity generation projects for four years.

Although many of the ruling Concertación coalition's own experts urged Mr Lagos to revise Article 99 bis in 2001, the government merely allowed electricity tariffs to rise at a firm pace, hoping thereby to entice companies to invest. Only in the second quarter of 2004, following the panic caused by Argentina's gas cuts, did the government agree to a U- turn, hurriedly preparing a new regulatory regime that enables generators to limit their risks by passing increased costs to consumers.

Investment thrust

High and rising electricity tariffs-by the end of 2005 they were 75% above their 1998 level-coupled with the completion of this new regulatory regime through Law 20,018, which came into force in May 2005, have triggered a major investment drive by electricity generation companies, including several new market participants. However, most of their new capacity will come on stream only from the second half of 2008.

Among the old players, the Spanish-controlled market leader Endesa will bring on stream in late 2008 a 377-MW plant, San Isidro II, able to run on liquefied natural gas (LNG) or diesel. It is also building the 32-MW Palmucho hydroelectric plant scheduled for 2007. Endesa is preparing environmental impact studies for four controversial hydroelectric projects on the Pascua and Baker rivers in Aysén, in the extreme south, with a combined capacity of 2,430 MW that would come into operation between 2012 and 2018.

The second-largest generator, Colbún (a joint venture between the local Matte group and the Tractebel subsidiary of France's Suez), is building the 70-MW Quilleco and the 50-MW Hornitos hydroelectric plants, due to be completed in 2007, and will bring on stream an emergency diesel generator of 18 MW later this year.

AES Gener (US), the third-largest generating company in Chile, got permission to install a 136-MW diesel turbine in Las Vegas, which is due to be commissioned in the second half of 2006, and has presented an environmental impact study for a coal-fired 250-MW plant at Nueva Ventanas on the central coast.

Among the newcomers, British Gas (BG, UK) won the tender called by Chile's state oil company Enap in mid-February 2006 to build a US$350m, gas- natural-gas (LNG) regasification plant on the central Chilean coast. It is scheduled to be in operation from early 2009 at the latest, to enable imports of LNG that will be supplied by the same BG group.

Suez, which was defeated by BG in Enap's tender, is seeking the support of Colbún and AES Gener to launch an alternative LNG project.

The Latin American private equity fund Southern Cross acquired the Campanario project and is installing as a first step two diesel-fired turbines of 60 MW each that will be operational from August 2006. The overall project is meant to generate 260 MW with open-cycle turbines burning gas or diesel, and could eventually be transformed into a 360-MW combined-cycle generator by adding a 120-MW steam turbine.

The Australian generating company Pacific Hydro is due to complete in 2008 the 155-MW La Higuera hydroelectric plant on the Tinguiririca river in a partnership with Norway's SN Power. They also have three smaller hydro projects-Confluencia (145 MW), Las Damas (40 MW) and Portillo (55 MW)-for subsequent years.
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