Chile: A Role Model for a Smooth Transition to Renewable Energy

Chile: A Role Model for a Smooth Transition to Renewable Energy

Chile is undergoing a remarkable energy transformation. Renewable energy in the country is expanding quickly, exceeding annual quota obligations required by the national Renewable Law. Chile expects to meet its 2025 target of generating 20 percent of its electricity from renewable energy sources well ahead of schedule. Per World Bank estimates, Chile’s renewable energy sector is the second largest renewables market in South America behind Brazil. Despite a relatively small energy market, in 2015 Chile ranked tenth in renewable energy investments worldwide. Several of the key drivers of this energy transition include the impacts of droughts caused by climate change on hydropower energy, a heavy dependence on volatilely priced fossil energy imports, and environmental and social concerns about mega-energy projects. Favorable market conditions and successful policy reforms also offered an attractive investment climate and guided renewables to self‐sustainability on the market. Chile was one of the first subsidy-free markets in the world in which renewable projects competed directly with conventional energy sources. Despite Chile’s achievements, the continued development of Chile’s renewable sector hinges on overcoming obstacles, particularly transmission-related ones, while simultaneously creating further incentives necessary for the development of a major renewable energy sector in Chile.

Chile’s growing energy needs and dependence on external energy sources, such as on natural gas, coal, and diesel, are also driving Chile’s energy transition. Over the past decade, economic growth significantly boosted both Chile’s demand for energy demand and need for energy infrastructure. Until the 1990s, Chile produced more than 70 percent of its energy domestically, relying heavily upon hydro power to do so. Today, Chile is far less self-sufficient than in the past, importing 60-65 percent of its total energy need and falling behind its South American neighbors in this regard. Chile’s heavy dependence on energy imports makes the country susceptible to global market volatility, and its hydropower resources expose the country to the impacts of uncontrollable climate events.

Consequently, in 1998-1999 and in 2004, Chile experienced a number of energy shortages stemming from underinvestment in its energy sector. The electricity price spikes associated with these shortages negatively affected Chile’s economy. To reduce dependence on imported energy and to diversify energy its sources, Chile began to invest in renewable energy. At the same time, power shortages and high electricity prices made renewable energy projects more competitive in the market.

A favorable investment environment and a wealth of natural resources were keys to fostering renewable energy development. But the Chilean government’s leadership was also instrumental in growing renewable energy. In the past, Chile lacked a consistent long-term energy policy to attract investments in the energy sector in line with its national interests. Because the sector was dominated by a handful of conventional energy companies, commercial factors drove investment decisions. However, the landscape of the energy sector changed when the Chilean government invested considerable resources into an ambitious strategy to tackle energy concerns, creating the Ministry of Energy in 2010 as part of that plan. Through the Ministry of Energy, the Chilean government has enacted policy reforms that have increased competition in the energy sector and supported integration of renewables.

The Chilean Congress’ approval of the Renewable Energy Law, the Renewable Portfolio Standards (RPS) was the first important reform in the renewable energy sector. The RPS system supports renewable energy generation by setting the proportion of Chile’s electricity supply that must be produced by renewable energy sources. The law states that by 2025, 20 percent of Chile’s energy matrix must be composed of renewable energy. As of the second quarter of 2016, electricity generation from renewable sources reached sixteen percent of the system’s total power, making Chile likely to meet and even surpass the Renewable Law quota.

Another important reform was Chile’s restructuring of its “power auction” system, a mechanism widely used in Latin American countries to award energy projects based on competitive bids. Winning bids are awarded long-term contracts for their projects. Chile first improved renewable energy generators’ ability to compete in power auctions by opening bidding processes to any power source, increasing renewable generators’ prevalence in the energy market. More recently, Chile established specific time periods in the design of the system favoring renewable generators. In a 2016 power auction, Chile awarded wind and solar projects to about 40 percent of the country’s total auctioned energy—which effectively met 30 percent of Chile’s energy demand.

These auctions’ efficient and competitive nature has decreased energy costs and encouraged further investment in the sector. Moreover, this reform improved the commercialization of renewables, thereby allowing renewable energy projects to obtain needed commercial bank funding. Although power auctions demonstrate Chile’s potential for renewable energy investment growth, the fulfillment of investment pledges by some companies that have won contracts to supply electricity remains a serious challenge for the sector. Lower prices are not enough to entice business; rather, new projects must be commercially viable for companies to maintain momentum.

The Chilean parliament also recently passed a law concerning electricity transmission that aims to increase renewable energy project development. Today, Chile’s power transmission system has significant congestion issues, making it difficult for renewable projects to obtain reliable energy connection points. Many renewable projects were postponed due to delays in building new transmission lines. This 2016 transmission law allows specific regions and power providers to expand their electricity grids, facilitates the unification of Chile’s two largest power grids, guarantees open access to the grids, and makes transmission pricing more transparent. This law will consequently improve long-term energy planning and increase renewables investment, as the connection of the north and central grid systems will satisfy growing energy needs in many industries across the state.

Chile currently leads the market-driven transition to renewables in South America, but it must appropriately address several factors in its future shift to sustainable energy. An effective transition, as shown in the successful renewable energy experiences of Denmark, Ireland, Scotland, and Sweden, requires a combination of clear decision-making, consistency in government policy, long-term planning, and a commitment to tackling transmission challenges to accommodate renewable energy in the power system. In contrast, inconsistently implemented or enforced policies can create market boom-and-bust cycles, negatively impacting investment decisions.

Although consistent support is never easy, Chile must develop a policy portfolio, rather than rely on a single solution for the country’s power sector. Greater policy constancy indicates strong political will, which minimizes uncertainty and drives firms to confidently invest in renewable energy projects. Renewable energy support must be part of a broader policy package that can be implemented throughout the economy. Aligning long term renewable energy goals with energy efficiency and demand response strategies can effectively increase the share of renewables in Chile’s hydropower generation portfolio. In addition, successful transition to a larger share of renewable energy sources requires a modern and flexible transmission network infrastructure.

Substantial growth in renewable energy investment in relatively short periods of time in Chile is a remarkable shift to sustainable energy. However, this optimism should be met with caution. Removing transmission related obstacles and implementing further reforms remains a key question which will be critical to their success. The recently enacted transmission law is a significant step forward. A greater emphasis on clarity, consistency, and transparency in long-term transmission planning, as well as on creating a strategic vision with neighboring nations for market-driven transmission development investment, will benefit renewable energy development. In addition, recent reforms in auction system provided incentives for investors. However, implementation of auction mechanisms must be closely controlled for irrational bidding or market rigging to enable renewables to compete in the long term.