Chile – a clean energy powerhouse

The authors advise
on energy projects at the Chilean law firm Larraín Rencoret Urzúa.  In September 2018 it was announced that,
following a vote by the partners of Dentons, it was expected that Larraín
Rencoret Urzúa would shortly be combining with Dentons.

In the 1980s, Chile was one of the pioneers of electricity
market liberalization. More recently, benefiting from both the strength of its
regulatory culture and its exceptional renewable energy resources, its
non-hydro renewables sector has enjoyed spectacular growth, particularly in the
form of solar projects – and there is more to come.

1.         Policy and law

Chile was the first country to privatize its formerly
state-owned electricity industry. Through Decree-Law (DFL) No. 1, enacted in
1982 (the General Law of Electricity Services or LGSE), Chile introduced a deep
reform to the electricity sector, obliging vertical and horizontal unbundling
of generation, transmission and distribution. This led to large-scale private
investment, and introduced competition into the generation sector. A minimum
global cost operation model was established, and generation companies were
encouraged to enter freely into supply contracts with non-regulated customers
and distribution companies (regulated customers).

In recent years, Chile has aggressively pursued an
ambitious program to move the country’s energy matrix towards non-conventional
renewable resources (NCRE: i.e. renewable electricity generation technologies
other than large-scale hydropower). The government’s energy policy encourages
supply, security, efficiency and sustainability.

As a first step, in 2004, and as a result of its
successful economic development, Chile introduced several legal changes in the
industry, which have brought new investment in the electricity generation field
and major possibilities for the transmission sector, especially in the
interconnection of the two major electricity transmission systems (Central
Interconnected System “SIC” and Norte Grande Interconnected System “SING”). As
a first critical step, changes to the LGSE, made official in March 2004 through
Law No. 19,940, modified several aspects of the market affecting all generators
by introducing new elements, especially those applicable to NCRE. In
particular, small-scale NCRE generators can now participate more aggressively
in the electricity market, as they are partially or totally exempt from
transmission charges.

Likewise, Law No. 20,257, better known as the
Non-Conventional Renewable Energy Law, which came into force on April 1, 2008,
introduced a requirement on all electricity companies selling electricity to final
customers to ensure that a certain proportion of the electricity they sell
comes from NCRE. A power company unable to comply with this obligation must pay
a penalty for each MWh short of this requirement. As of 2013, with the
enactment of Law No. 20,698, known as the 20/25 Law, which amended Law No.
20,257, Chile’s objective is that, by 2025, 20 percent of the electricity
produced in Chile will come from NCRE sources.

On October 14, 2013, Law No. 20,701 was published in the
Official Gazette, amending the LGSE, simplifying the procedure for obtaining an
electricity concession (a key step in the development of new substations,
electricity network infrastructure and hydroelectric plants: see section 3
below). This new framework was a response to the need for speeding up the
procedure and timeframe necessary to obtain an electricity concession,
providing more certainty to the system. In summary:

• the process to obtain a provisional electricity concession has been simplified and the timeframe adjusted;

• there is more clarity as to the observations and challenges that those against the project can make;

• the notification process was amended; a simplified and faster judicial procedure has been introduced;

• the process of valuing land or real estate has been amended; and

• potential conflicts between different concessions have been amended.

On February 7, 2014 Law No. 20,726 amended the LGSE, in
order to study and promote the interconnection of the SIC and the SING systems.
The government stated that this interconnection between SING and SIC would
allow the transfer of surpluses produced in the northern part of Chile to its
central zones. That interconnection, which was successfully carried out at the
end of 2017, should reduce electricity system costs by US$1.1 billion. The
interconnection of the two systems is also expected to boost the development of
renewable energies and to reduce uncertainty for operators while increasing
competition.

ln 2016, Law No. 20,936 (the Transmission Law) redefined
the constituent parts of the national transmission system and created the
Independent Coordinator of the National Electricity System (the CISEN). Under
this law, which was published on July 20, 2016, the Chilean government aims to
contribute to the timely expansion of the electricity transmission network. The
Transmission Law heightens the role of the government in the electricity
sector, granting it greater capacity to execute electricity infrastructure
planning, expand the system and determine and manage the creation of land
strips for the installation of new structures related to transmission lines.
Regarding the CISEN, it has among its duties the coordination of operations,
determination of the marginal costs of electricity, to assure open access to
the transmission systems, to maintain global safety, and to coordinate economic
transactions between agents, determining the marginal cost of electricity and
economic transfers among the organizations that it coordinates.

Finally, it is important to mention the project to reform
the Water Code that could affect any new hydroelectric project in Chile. The
aim of the pending bill would be to reduce water shortages, proposing a series
of regulatory changes. Specifically, it proposes an increase in state control,
which could affect the legal certainty necessary for the development of
economic activities, and would seek to change the legal nature of existing
water rights, undermining property rights. This reform aims to change the
perpetuity of water rights (DAA). The reform provides that the use of the DAA
will have a maximum duration of 30 years, transforming the DAA into a simple
administrative concession. In addition, the reform aims to create grounds for
revocation, which could affect existing DAAs.

2.         Organization of the market

The electricity market in Chile has been designed in such
a way that investment and operation of the electricity infrastructure is
carried out by private operators, promoting economic efficiency through
competitive markets, in all non-monopolistic segments. Thus, generation,
transmission and distribution activities have been separated in the electricity
market, each having a different regulatory environment.

The distribution and the transmission segments are both
regulated and have service obligations and prices fixed in accordance with
efficient cost standards. In the generation sector, a competitive system has
been established based on marginal cost pricing (peak load pricing), whereby
consumers pay one price for energy and one price for capacity (power)
associated with peak demand hours.

According to the National Commission of Energy (CNE),
Chile’s power generation for September 2018 was 5,972GWh, comprised of:
thermoelectric 57 percent, conventional hydroelectric 23 percent and NCRE 20
percent. It is the fifth-largest consumer of energy in South America.

The wholesale electricity market comprises generation
companies that trade energy and capacity between them, depending on the supply
contracts they have entered into. Companies capable of generating more than the
amount they have committed in contracts sell to companies with a generation
capacity below what they have contracted with their customers. The CISEN
determines physical and economic transfers (sales and purchases) and – in the
case of energy – valued on an hourly basis at the marginal cost resulting from
the operation of the system during that hour.

3.         Authorization to construct and operate
generation facilities

While no governmental authorization has to be obtained in
order to construct and operate generation facilities, power utilities usually
obtain electricity concessions to acquire fundamental rights to protect their
investment. A classic key right is the imposition of a right of way over the
land whose owners are reluctant to grant rights of way through voluntary
agreements. These electric concessions, however, are only available for the
construction and development of hydropower plants, substations and transmission
lines. These rights of way are fundamental to allow the power company to secure
the transport of electricity to the national grid. Notwithstanding the above,
authorizations under the Environmental Law, the Land Use Planning Law and the
Municipality Law may be required when building a power plant or generation
facility.

The Environmental Law (Law No. 19,300, as amended by Law
No. 20,417, enforceable since January 26, 2010) establishes a regulatory
framework applicable to projects with an environmental impact (article 10 of
the Environmental Law and article 3 of its regulation determines the projects
that must be submitted to the environmental impact assessment process, among
which are power plants with output capacity in excess of 3MW). These projects
may force the developer to request and obtain an environmental approval
resolution (RCA). In the event of infringement of the obligations established
in the RCAs, the Environmental Superintendence may impose the following
sanctions: verbal warning, fines of up to US$10 million, revocation of the
approval or closure of the facilities.

We do not refer to other permits that must be obtained in
advance of developing a generation facility project, such as land use planning
permits, water rights or geothermal exploration or exploitation concessions.

According to information provided by the CNE, by October
2018, 56 power generation projects were under construction. Together they
represent a capacity of 2,838MW and are expected to start operation between
July 2017 and October 2022.

4.         Alternative energy sources

According to the CNE, in September 2018, 20 percent of
Chile’s power generation came from NCRE. In this respect, Chilean law contains
incentives as well as obligations to foster the use of renewable energies. Law
No. 19,940, Law No. 20,257 and the regulations contained in Supreme Decree No.
244 (which regulates the NCRE based in small generation units of up to 9MW,
known as “PMG” or “PMGD” depending on the type of network to which they are
connected) create the conditions necessary for the development of NCRE,
encouraging power generation based on alternative energy sources.

Incentives

NCRE power facilities with less than 20MW may sell their
output capacity to the spot market without having to pay (totally or partially)
tolls to transmission companies (with differentiated treatment for units of up
to 9MW and those between 9MW and 20MW). As regards PMG (only if classified as
NCRE) and PMGD, Chilean law incentivizes the development of this kind of energy
source, granting them the possibility to decide whether to sell energy at the
spot market price (marginal cost) or at a fixed price. Another incentive to
this kind of projects is that all PMG and PMGD will operate with auto dispatch,
meaning that the owner or operator of the respective PMG or PMGD will be
responsible for determining the power and energy to be injected into the
distribution network to which it is connected (coordinated with the CISEN).

Obligations

As noted above, by Law No. 20,257, all electricity
companies selling energy to final customers must ensure that a given percentage
(20 percent) of the energy they sell comes from an NCRE source. In fact, this
target was met some seven years ahead of schedule, because, in 2018, 20 percent
of the withdrawals of the power companies will have been injected into the
system from NCRE sources. However, already in 2015, the government had
published a long-term energy policy (to 2050), which aims, amongst other
things, to reach renewables (NCRE + conventional hydropower) shares of
electricity generation of 60 percent by 2035 and at least 70 percent by 2050.

New and exclusive bidding process for NCRE

Since 2015, the Ministry of Energy has been obliged to
carry out a public bidding process every year for energy coming from NCRE
sources, which will help to reach the quotas of NCRE required by law. This
competitive mechanism aims to improve the financing conditions of NCRE, and has
the followings characteristics:

• the public bidding process can be implemented separately for each transmission system in up to two bidding periods per year. The amount of energy will depend on the projections for the fulfillment of NCRE quotas for the next three years;

• each participant in the bidding process shall submit an offer including the amount of energy (GWh) and a price (US$/MWh); and

• the project will be awarded to the cheapest bid until the necessary amount of energy is reached, considering a maximum price equal to the average cost of the most efficient generation technology of the electric system that can be installed in the long term.

5.         Other incentives

Two major undertakings have been launched for the purpose
of introducing incentives on NCRE: improvement of the regulatory framework of
the electricity market and the implementation of direct support mechanisms for
investment initiatives in NCRE:

a. The proposed changes to the regulatory framework
intend, among other things, to create the conditions to implement a portfolio
of NCRE projects to accelerate the development of the market; to eliminate the
barriers that frequently impede innovation; and to generate confidence in the
electricity market regarding this type of technology. This is partially
achieved by the government enacting the law for the development of NCRE (Law
No. 20,257 amended by Law No. 20,698).

b. On the other hand, as declared by the current
Environment Minister, since the ratifying of the United Nations Framework
Convention on Climate Change (UNFCCC) in 1994 and the signature of the Kyoto
Protocol in 2002, Chile has actively engaged in the establishment of national
policies in response to climate change. In this regard, it is important to
mention Law No. 20,780, which established a new annual tax on emissions from
CO2, SO2, NOx and particulate matter (PM) sources. It is aimed at facilities
with boilers or turbines that, together, add up to a heat output of at least 50
megawatts thermal (MWth). This tax is called a “green tax” since it
would be an incentive for the growth of NCRE projects. Specifically, Chile’s
green tax targets large factories and the electricity sector, covering an
important percentage of the nation’s carbon emissions. In the case of PM, NOx
and SO2 emissions into the air, the taxes will be the equivalent of US$0.1 per
ton produced or the corresponding proportion of said pollutants, increasing the
result by applying a formula that takes into account the social cost of
pollution such as costs associated with the health of the population. In the
case of CO2 emissions, the tax is equivalent to US$5 for each ton emitted. In
order to determine the tax burden, the Chilean Environmental Superintendency
will certify in March of each year a number of emissions by each taxpayer or
contributor during the previous calendar year. Each taxpayer or contributor who
uses any source that results in emissions, for any reason, shall install and
obtain certification for a continuous emissions monitoring system for PM, CO2,
SO2, and NOx. This tax will be assessed and paid on an annual basis for the
emissions of the prior year, beginning in 2018 for the 2017 emissions.

6.         Energy Goals

One remarkable aim in the energy sector, which was
included in Law No. 20,936 mentioned in section 1 above, is to define and
incorporate electricity storage systems along with generation and transmission
facilities, and to organize all the electricity system (including storage)
under the CISEN. The Chilean regulatory framework does not currently support
electricity storage in a particular way but grants the CISEN broad powers and the
ability to allocate permanent funds for research, development and innovation in
energy storage. In the coming months, the Chilean authorities must publish the
special regulations for the functioning of the CISEN and particularly on how it
will use the available funds. In this regard, a new regulatory decree
(“Reglamento de Coordinación y Operación”) is already under discussion between
the Ministry of Energy and key private players.

The vision of Chile’s energy sector is reflected by its
whole legal framework and regulatory system. That vision is also reflected by
Chile’s Energy Agenda to 2050. By the year 2050, the vision is to have a
reliable, inclusive, competitive and sustainable energy sector. Chile’s
development must be respectful of people, of the environment and of
productivity, and must ensure continuous improvement of living conditions. The
aim is to evolve towards sustainable energy in all its dimensions, on the basis
of the attributes of reliability, inclusiveness, competitiveness and environmental
sustainability.

Chile’s
energy infrastructure shall cause low environmental impact. Such impact should
be avoided or, if not, then mitigated and compensated. The energy system must
stand out as an example of low greenhouse gases emissions and as an instrument
to promote and comply with international climate-related agreements.