OVERVIEW Emerging Disruptions and the Next Frontier OVERVIEW Energy Markets in Latin America Emerging Disruptions and the Next Frontier Overview Latin America and the Caribbean are uniquely positioned to take advantage of the ongoing, global revolution in clean-energy and digital technologies, which are disrupting the status quo and transforming energy markets. The region has abundant renewable energy resources and significant experience with sophisticated energy-market structures. A new wave of ambitious policies and regulations is laying the groundwork for a clean-energy economy. At the same time, the energy sector’s infrastructure and output are increasingly challenged by climatic variability and shocks, as well as by increasing urbanization. And there remains a pressing need to improve the technical and economic performance of energy systems and services. Efforts to ensure affordable, secure, and sustainable energy for all will depend critically on the capacity to introduce the technologies and practices necessary to harness clean- energy resources on both the supply and demand sides, and, in so doing, to approach higher efficiency frontiers. Moreover, drawing full benefits from disruptive clean-energy and digital technologies will require a new approach to planning, regulating, pricing, operating, and financing—and, more importantly, the capacity to foresee and adapt to emerging innovations. Energy systems are on the cusp of a radical transformation Change is nothing new where energy markets are concerned. In the world’s oil and natural gas markets technological innovation, geopolitical pressures, and shifts in regional dynamics have brought waves of structural change. Electricity systems, too, have experienced significant change, notably through new market structures to stimulate competition and increasingly efficient generation technologies. Perhaps most notable in the natural gas sector are technological advances that allow the production of shale gas and the transportation of liquefied natural gas (LNG). The shale boom has increased reserves and reduced gas prices worldwide. “Floating” facilities for the liquefaction and regasification of LNG are increasing access to the resource worldwide. But until now the traditional energy supply chain has remained almost unchanged. In the power sector, for example, electricity is still delivered through transmission and distribution networks to relatively passive consumers. This will change. Global trends— rapid urbanization, the looming threat of climate change, the emergence of disruptive 4 • 2017 REPORT FIGURE 0.1 New Business and Investment Opportunities Closer to Customers CURRENT MODEL GENERATION TRANSMISSION DISTRIBUTION RETAIL AND FUELS Meter CUSTOMER Passive FUTURE MODEL GENERATION TRANSMISSION UTILITY DISTRIBUTION RETAILING PROSUMER AND FUELS SCALE Meter Proactive consumer BATTERY STORAGE Electric vehicle Distributed Storage generation Energy efficiency Source: Adapted from World Economic Forum 2015 ENERGY MARKETS IN LAC • 5 technologies, and persistent financial constraints—are converging to disrupt the status quo. At the same time, powerful new technologies—such as solar photovoltaic (PV) generation, electricity storage, smart grids, blockchain-enabled instant payment, and electric vehicles—are accelerating the once-gradual transformation of traditional energy systems, promising new benefits to consumers. As industry stakeholders examine how these technologies might disrupt traditional electricity systems, utilities, and markets, it appears that a new market architecture is beginning to form, one in which clean energy and digital technologies will expand the use of distributed resources, harness demand-side resources more effectively, and develop vibrant retail markets where the consumer could play a more active role, notably by producing and storing energy as a so-called prosumer) (Figure O.1). How this expected disruption will affect different types of systems is still unknown. The transformation is already under way in markets where competition is well established and the pricing of energy, capacity, and ancillary services varies by location and time (e.g., intraday or sub-hourly). But preparing for disruption is necessary for two reasons. First, new technologies and business models that support the development of retail or demand-side markets could significantly contribute to reducing the investments needed for large-scale generation and transmission. And, second, renewable energy and energy efficiency will help counter the growing threat of global climate change, even as they reduce pressure on local environments. Energy systems in LAC are relatively clean, and the region’s energy intensity is low by global standards—but much of the potential of clean energy remains untapped Compared with other regions of the world, LAC has a relatively clean energy matrix. The region still relies heavily on fossil fuels (73 percent of primary energy supply), but the contribution of hydropower to final consumption and electricity is large. Primary energy sources have undergone a gradual and significant decarbonization, shifting from oil to natural gas over the past two to three decades. LAC has also been the world’s least-energy-intensive region since the early 1990s—with energy intensity at 4.0 megajoules (MJ)/$ (purchasing power parity of the 2011 U.S. dollar) in 2014, against 5.4 MJ/$ globally. Most recent analyses show that the decoupling of energy consumption from economic growth has accelerated in recent years. At the same time, LAC has been slow to diversify its energy matrix with nonconventional renewable energy. Wind, solar, and geothermal energy together represent less than 1 percent of total final consumption despite abundant resource endowments. 6 • 2017 REPORT The generating potential of the region’s renewable energy resources is estimated at 93 petawatt-hours (PWh)—enough to power the region into the next century. Chile’s Atacama Desert alone—the driest non-polar desert of the world—could become a regional hub for solar power. There is also huge potential for increased energy efficiency in the region’s transport, industrial, and buildings sectors, notably in the large economies of Brazil and Mexico, but also in Bolivia, Ecuador, Guatemala, Haiti, Trinidad and Tobago, and Uruguay, where energy intensities have risen. Efforts to secure the region’s energy supply while also decarbonizing will depend critically on the development of clean energy LAC is starting to see the limits of its longstanding oil-to-gas decarbonization trend and of its reliance on hydropower. The region has substantial natural gas reserves (about 4 percent of the world’s total proven reserves and 28 percent of the world’s technically recoverable shale gas reserves), but exploitation of those reserves has been relatively stagnant—notably so in Mexico and Argentina, with the result that few countries remain self-sufficient. The widening gap between supply and demand has prompted rapid growth of LNG imports. Growth in the supply of gas has been constrained by several factors—among them (i) difficult geography (gas fields located in remote or environmentally sensitive sites, complicating efforts to develop a pipeline network to connect the region’s demand centers), (ii) insufficient progress in creating functional competitive markets; (iii) lack of technological know-how; and (iv) a weak investment climate (incomplete legal and regulatory frameworks, lack of solid development plans, and overly complex or absent schemes for licensing and reducing uncertainty). The region’s natural gas industry has not been particularly successful in attracting private investment for infrastructure development. Only 13 percent of total private investment in the energy sector during 1990–2015 supported projects in natural gas infrastructure—and that was mainly devoted to gas distribution networks in Argentina, Brazil, and Mexico. Meanwhile, demand for natural gas has grown not only in response to economic expansion, but also because of artificially low end-user prices in some countries. Investment in natural gas infrastructure would have to double if demand for gas grows as forecasted by global and regional energy models under business-as-usual scenarios. Natural gas is expected to continue to play a transitional role in the energy matrix, primarily in supporting the integration of variable renewable energy (VRE) sources in combination with all forms of storage, and in the decarbonization of the transport and industrial sectors. But a need to lower and manage import dependence while also weaning the region from fossil fuels, underlies the urgency of charting a path toward a clean-energy economy in the region. ENERGY MARKETS IN LAC • 7 Hydropower faces its own constraints in LAC, given its vulnerability to weather and climatic variability. Climatic shocks, such as the El Niño–Southern Oscillation, can dramatically reduce the output of hydropower facilities. In Colombia, the last occurrence of El Niño was particularly intense and prolonged—lasting from September 2015 to March 2016—and had an economic cost of $5.8 billion. In Brazil, the long drought of 2013–14 resulted in an overall revenue shortfall of $25 billion, which the customer base is still absorbing. Large hydroelectric dams also pose significant social and environmental risks that slow their planning and implementation. For these reasons, hydropower’s share of generation has declined consistently since 1990 (Figures O.2 and O.3). FIGURE 0.2 Composition of Hydropower and Fossil-Fuel-based Generation in LAC (with and without Brazil), 1990–2014 65% 60% 55% 50% 45% 40% 35% 30% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Fossil Fuel Share (LAC excl Brazil) Fossil Fuel Share (All LAC) Hydropower Share (LAC excl Brazil) Hydropower Share (All LAC) Source: Prepared by authors based on data from IEA Energy Statistics and Balances (database) 2017. FIGURE 0.3 Shifts in Fuel Sources Used for Generation, 1990–2014 (%) 80% 60% 40% 20% 0% -20% -40% -60% -80% Colombia Peru Venezuela, RB Bolivia Brazil D.R. Trinidad and Tobago Jamaica Cuba El Salvador Panama Nicaragua Costa Rica Honduras Guatemala Haiti Mexico Paraguay Argentina Uruguay Chile Ecuador Andean Zone Caribbean Central America Southern Cone Coal Oil Natural gas Nuclear Hydro Renewables (without Hydro) Source: Prepared by authors based on data from IEA Statistics and Balances (database) 2017. 8 • 2017 REPORT The region has made great strides in reforming power sectors, developing market structures, and delivering better-quality service, but even the best performers could aim for greater efficiency Many countries in LAC have introduced power sector reforms and developed sophisticated legal, regulatory, and market structures. The wave of reform began in Chile in 1982 and continued in the 1990s in Argentina, Peru, Bolivia, Colombia, Brazil, and most of Central America. In a few cases there were parallel reforms in the oil and gas sectors (Argentina in 1991, Colombia in 1994, and Mexico in 2013). Many Caribbean Islands also made structural changes, led by the Dominican Republic in 2001. Today, market structures, incentives, and regulatory practices vary widely from country to country. Over the past three decades, adjustments to internal and external market dynamics have come in distinct waves. The first wave, beginning in the early 1980s, involved market restructuring and liberalization, accompanied by institutional reorganization in the form of independent regulators, system operators, and administrators. Markets were changed through vertical and horizontal unbundling, divestment, privatization, and the creation of spot and contract markets. The second wave (2000s) was triggered by a realization that private companies would not invest in reserve capacity without incentives. In response, competitive tenders and auctions were introduced, complementing competition in the market with competition for the market. In the third wave (since 2009), countries have introduced measures to develop nonconventional renewable energy, increase energy efficiency, and, more recently, test new market designs and regulations to increase retail competition and foster distributed generation. The implementation of reforms has not been without obstacles. Reversals have occurred in Argentina, Bolivia, the Dominican Republic, and Ecuador. Yet, in the process, many countries have also pioneered innovations to increase supply security and raise economic efficiency. These include the auctioning of reliability payments in Colombia, of renewable energy in Brazil, and of transmission concessions in Brazil, Colombia, and Peru. The design of the first auction of renewable energy in Brazil in 2007 was widely replicated around the region and the world, and the capacity payment introduced in Colombia inspired similar designs in the United Kingdom and Italy. Private investment in energy infrastructure has flowed mainly to Brazil, Argentina, Chile, and Mexico. Reformed markets in LAC attracted a total of $331 billion in private investment over the 1990–2015 period. Four countries—Argentina, Brazil, Chile, and Mexico—captured most of that volume, likely because they have medium- to high-grade credit risk ratings (Table O.1) and a strong ability to mobilize private investment via public-private partnerships. Uruguay, Peru, Panama, Nicaragua, and Guatemala also attracted relatively high volumes of private investment to develop generation assets. ENERGY MARKETS IN LAC • 9 Remarkably, generation projects in renewable energy, including hydropower, attracted 63 percent of the total private investment over the period.1 Distribution drew 16 percent, transmission 8 percent, and diversified projects 14 percent. Private participation in transmission assets took off after 2000. The reforms often strengthened the performance of utilities, helping propel a few to multinational status. Publicly traded utilities sold shares on domestic stock markets and raised cash to finance investment and other expenses that allowed further gains in service quality. Chile is a prime example. Its energy company, ENERSIS, reached out across borders to take part in the privatization of distribution companies in several countries in the region. ENERSIS acquired distribution companies in Argentina (EDESUR), Peru (EDELNOR), Brazil (AMPLA and COELCE), and Colombia (CODENSA) and helped them adopt the new efficiencies from which it had already benefited. In some of these companies, distribution losses dropped from 18–24 percent to 6–11 percent over the ten years from 1997 to 2007. Other examples in the region are the Colombian companies EPM (Empresas Públicas de Medellín), which expanded to the water and natural gas sectors, and ISA (Interconexión Eléctrica S.A.), which expanded operations to Peru, Bolivia, and Brazil. FIGURE 0.1 Risk Rating and Market Structure of Selected Countries in LAC Moody’s Risk Rating Vertically Single Buyer Plus Plus Large Plus Full Retail New Virtual Rating Integrated with IPPs Wholesale Customers Competition Utility Monopolies Competition Choice Minimum Aaa Denmark USA-California Credit Rating High Grade Aa1, Aa2, Aa3 Chile Upper-Medium A1, A2, A3 Bahamas Peru Mexico Grade Medium Baa1, Baa2, Barbados Uruguay, Panama Brazil Colombia Grade Baa3 Trinidad & Tobago Speculative Ba1, Ba2, Ba3 Paraguay Costa Rica Guatemala, El Salvador Elements Bolivia Subject to B1, B2, B3 Suriname, Honduras, Nicaragua, High Credit St. Vincent Belize, Ecuador Dominican Risk Republic Bonds of poor Caa1, Caa2, Venezuela Cuba, Jamaica Argentina standing Caa3 Source: Prepared by authors using Moody’s Risk Rating 2016. 10 • 2017 REPORT But in many countries in LAC, the performance of large electric utilities has not approached high efficiency. While utilities have evolved alongside the growing sophistication and maturity of electricity wholesale markets and performance-based tariff regulations, a gap persists between them and the best global performers. For example, available data on the frequency and duration of interruptions and transmission and distribution losses suggest that while some of the region’s utilities (notably in Brazil and Chile) are approaching the best global performers, others are far from even the global median and performing poorly (as in the Dominican Republic, Guyana, Honduras, and Nicaragua).2 Large utilities in Chile, Mexico, Peru, and Colombia—though financially sustainable and delivering service of relatively good quality—have not reached the service levels found in the United States or Europe. Mature markets in LAC have electricity tariffs comparable to those in member countries of the Organisation for Economic Co-operation and Development (OECD). Yet energy market structures and pricing policies differ considerably across LAC, and, on average, electricity prices in the region are among the highest in the world, notably for commercial and industrial consumers (Figure O.4). Electricity prices are particularly high in the Caribbean owing to a significant dependence on imported fuel and lack of diversity in the energy mix. Central American countries—Belize, El Salvador, Honduras, Nicaragua, and Panama—have prices well above the regional average and global benchmarks. And in Brazil and Colombia—despite their reliance on low-cost hydropower—tariffs are slightly above the OECD average. Those in Mexico and some Andean countries approach the OECD benchmark. FIGURE 0.4 Electricity Tariffs in Selected LAC Countries, 2015 (USD/kWh) 0,5 0,4 USD/kWh 0,3 0,2 0,1 0 Venezuela Bolivia Ecuador Peru Colombia Brazil Trinidad and Tobago Suriname Belize Guyana Haiti Barbados Grenada Jamaica Dominican Republic Honduras Costa Rica Panama Nicaragua Guatemala El Salvador Mexico Argentina Paraguay Chile Uruguay USA OCDE Itally Germany Andean Zone Caribbean Central America Southern Cone Commercial and public services Residential Industry Source: Prepared by authors based on data from the Latin American Energy Organization’s Energy-Economic Information System (OLADE-SIER); IEA Electricity Supply (database); utility data. ENERGY MARKETS IN LAC • 11 Electricity consumption is still subsidized throughout much of the region, particularly in Venezuela (where subsidies represented 5.4 percent of GDP in 2016), Argentina (5 percent in 2016), Mexico (2.8 percent in 2013), Brazil (1.84 percent in 2016), and the Dominican Republic (1.26 percent in 2015). The region’s very limited cross-border trade in electricity is likely to constrain the economic gains of future clean-energy development LAC has developed four clusters of cross-border power integration with a transfer capacity of about 62 gigawatts. The four are Mexico–United States, the Central American Regional Electric Market (MER/SIEPAC); the Andean Community (CAN), and the Southern Cone (MERCOSUR). The only substantial trade in the MER/SIEPAC cluster is of exports from Mexico to Belize and Guatemala, and between Guatemala and El Salvador. In CAN, trade occurs only between Colombia and Ecuador and involves less than 20 percent of capacity. Power exchanges within MERCOSUR have declined to a near absence of trade in recent years, except for that associated with binational hydropower plants. Augmenting cross-border energy trade will require that all countries in the region work to lower geopolitical and regulatory barriers. This is particularly important for Central America, where the scale-up of VRE has grown in recent years, and in the MERCOSUR area, where complementary resources—large solar projects in Chile and hydropower in Brazil, Paraguay, and Uruguay—could help increase economic efficiency. Flexible power exchanges among countries could facilitate the use of VRE and deliver substantial economic gains, particularly in areas where the seasonal variability of renewable energy resources might be complementary. Recent analysis of South America by the Swedish Royal Institute of Technology (KTH) using the OSeMOSYS-SAMBA model shows that international interconnections (with active cooperation among countries) play a key role in optimizing resources, enhancing system resilience, and “greening” the grid. As VRE penetrates power systems, therefore, the value of regional trade will increase exponentially. Although it is difficult to draw comparisons among power pool structures, the Nord Pool—which connects 19 European countries—has often served as a global benchmark for international trading and as an exemplar of how to create a single electricity market. In the Nord Pool, trading uses about 40 percent of available transmission capacity, a high-efficiency frontier. To facilitate trade, countries will need to create the conditions for increased private investment in regional transmission infrastructure, which has been low in the past. 12 • 2017 REPORT The region is gradually progressing toward sustainable energy, although challenges remain, particularly to create the investment climate necessary to attract private sector participation Because they have the potential to strengthen resilience to climatic variability, improve security of supply, lower investment requirements, and increase the economic efficiency of energy systems, renewable energy and energy efficiency are of strategic importance to the region. Many countries in LAC have introduced policies to promote these goals, but there is still much to do in most countries. The region’s countries are increasingly introducing policy, legal, regulatory, and procurement frameworks to scale up grid-connected nonconventional renewable energy and distributed generation. The use of auctions to promote wind and solar generation has been quite successful recently in Argentina, Brazil, Chile, Mexico, and Peru. Other countries will soon follow, including El Salvador, Colombia, Guatemala, and Jamaica. Many countries have already opened the way to allow transactions via net metering schemes at the distributed level, so rooftop solar and other forms of distributed generation are now possible on the consumer side (although in most cases only for very small capacities or loads). And many countries, like Mexico, are starting to consider amendments to their existing regulation of ancillary services to accommodate and properly reward storage schemes. However, attracting private investment in clean energy will require additional regulatory measures and market rules to address risks related to access to transmission infrastructure; interconnection and pricing rules; provisions for the dispatching and integration of variable and flexible resources; long-term contractual agreements; and administration of licensing and permitting. In many cases, adequate measures in these areas are still not in place. On the RISE (Regulatory Indicators for Sustainable Energy) Index for renewable energy, LAC scores 52 out of 100, against the 83 scored by OECD’s high-income economies. That means that in the menu of regulations and measures necessary to attract private investment to nonconventional renewable energy projects, there is still much to do. With respect to energy efficiency, few countries in the region have developed comprehensive policy frameworks. Mexico has made great strides in developing a robust framework of incentives—including appropriate electricity rate structures—and in creating solid institutions to promote energy efficiency. Brazil, Chile, and Colombia also have begun to assemble a solid institutional and legal platform. Other countries have general policies and targets in place, but implementation is inconsistent and must be prioritized. In the RISE Index for energy efficiency, LAC scores 41 out of 100, against 70 scored by OECD’s high-income economies (Figure O.5). Except for Mexico, which scores very high (80), most countries of the region need to considerably revamp their efforts toward frameworks that support energy efficiency. ENERGY MARKETS IN LAC • 13 In terms of energy access, the region has achieved high levels of access to electricity and modern non-solid fuels, but in some countries energy poverty is still pervasive among low- income and rural populations Ninety-seven percent of the region’s people have access to electricity and 86.5 percent to clean non-solid fuels used primarily for cooking. These rates stand well above global averages and are consistent with LAC’s high degree of urbanization. However, there remain 18.5 million people without access to electricity, and about 84 million people with no access to modern non-solid fuels. Most live in Haiti and rural areas of Bolivia, Brazil, Colombia, Guatemala, Honduras, Nicaragua, Mexico, and Peru. These countries have not developed systematic interventions to encourage efficient and clean cooking in millions of wood-burning households. The lack of access to modern fuels in rural areas undermines the health of the population. A recent study finds that the cost of health problems resulting from indoor air pollution in Guatemala, Haiti, Honduras, and Nicaragua was in the range of 2.3–4.5 percent of GDP in 2015, and in Bolivia, Colombia, Mexico, and Peru in the range of 0.7–1.8 percent of GDP (World Bank 2017). Affordability remains a barrier to universal energy access in a few countries. An examination of social tariffs and income suggests that, even if connections are available, the poor in a few countries of the region—notably Guatemala and Honduras—often cannot afford minimum levels of electricity. Despite large intraregional variations in performance and progress toward best practices, LAC is well positioned to take advantage of the ongoing revolution in digital and clean-energy technologies As noted at the outset of this summary, many countries in the region have developed sophisticated energy-market structures, and a new wave of policies and regulations is laying the groundwork for a clean-energy economy based on advances in digital technology. Argentina, Chile, Colombia, Costa Rica, and Mexico have introduced aggressive goals for renewable energy and energy efficiency, and many other countries are starting to focus efforts on promoting electricity storage and distributed generation. Recent auctions for renewable energy development in Argentina, Chile, Mexico, and Peru—notably in wind and solar generation—have delivered extremely competitive prices. Technology-neutral auctions in Mexico and Chile conducted in November 2017 delivered prices for solar energy as low as 1.8–2.2 U.S. cents per kilowatt-hour. 14 • 2017 REPORT FIGURE 0.5 RISE Index of Energy Efficiency—A Comparison of Selected Countries and Subregions in LAC with Best- Practice Frontiers Brazil Mexico National energy National energy efficiency efficiency planning planning Types of Energy Brazil Types of Energy Mexico 90 90 electricity rate efficiency electricity rate efficiency structures entities Comparators1 structures entities Comparators1 OECD Frontier2 OECD Frontier2 0 0 Information United States Information United States Financing Frontier Financing Frontier provided to provided to mechanisms for mechanisms for consumers about consumers about energy efficiency EAP Tiger energy efficiency EAP Tiger electricity usage electricity usage Frontier3 Frontier3 Incentives & mandates: utilities, public sector, Incentives & mandates: utilities, public sector, karge consumers, energy efficiency standards, karge consumers, energy efficiency standards, energy labeling systems energy labeling systems 1: “Comparators” average: includes China, Malaysia, Turkey, Romania and Poland 1: “Comparators” average: China, Malaysia, Turkey, Romania and Thailand 2: “OECD” average Australia, Canada, Chile, France, Italy, Korea, Rep., Poland, Turkey, United Kingdom 2: “OECD” average: Australia, Canada, Chile, France, Italy, Korea, Rep., Mexico, Poland, Turkey, United Kingdom 3: “EAP Tigers” average: China, Korea 3: “EAP Tigers” average : China, Korea and Singapore South America 1 South America 2 National energy National energy efficiency efficiency planning planning Types of 90 Energy Types of 90 Energy South America 2 South America 1 electricity rate efficiency electricity rate efficiency structures entities structures entities Comparators Comparators1 (Algeria) 0 OECD Frontier2 0 OECD Frontier2 Information China Information Financing Financing China Frontier provided to Frontier provided to mechanisms for mechanisms for consumers about consumers about energy efficiency energy efficiency EAP MIC Frontier3 electricity usage EAP MIC Frontier3 electricity usage Incentives & mandates: utilities, public sector, Incentives & mandates: utilities, public sector, karge consumers, energy efficiency standards, karge consumers, energy efficiency standards, energy labeling systems energy labeling systems 1: “Comparators” average: Romenia, Poland, Turkey 1: “Comparators” average: Algeria 2: “OECD” average: Australia, Canada, Chile, France, Italy, Korea, Rep., Poland, Turkey, United Kingdom 2: “OECD” average: Australia, Canada, Chile, France, Italy, Korea, Rep., Poland, Portugal, Turkey, United Kingdom 3: “EAP MIC” average: Indonesia, Malaysia, the Philippines, and Thailand 3: “EAP MIC” average: Indonesia, Malaysia, Philippines, and Thailand Central America Caribbean National energy National energy efficiency efficiency planning planning Types of 90 Energy Types of 90 Energy electricity rate efficiency Central America1 electricity rate efficiency structures entities structures entities Comparators2 Caribbean1 OECD Frontier3 Comparators: 0 0 Maldives2 Information China Frontier Information Financing Financing Frontier - Greece3 provided to provided to mechanisms for EAP Tiger mechanisms for consumers about consumers about energy efficiency Frontier4 energy efficiency electricity usage electricity usage Incentives & mandates: utilities, public sector, Incentives & mandates: utilities, public sector, karge consumers, energy efficiency standards, karge consumers, energy efficiency standards, energy labeling systems energy labeling systems 1. Central America: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Panama 2. Comparators: Armenia, Mongolia, and Kazakhstan 1: “Caribbean” average: Dominican Republic 3. OECD: Australia, Chile, Mexico, Japan, Korea, Rep., United Kingdom 2: “Comparators” average: Maldives 4. EAP MIC’s: Indonesia, Malaysia, Philippines, and Thailand 3. Frontier average: Greece ENERGY MARKETS IN LAC • 15 But further changes in market structures and institutions will have to be made to make the most of new technologies on the demand side. This is an area that requires immediate attention in order to increase economic efficiency and reduce investment needs. Compared with more-advanced power markets such as those found in Texas and California, the region still lacks the full retail competition, intraday markets, nodal pricing, and intense participation necessary to promote vibrant competition on the demand side (Table O.2). These elements can be gradually introduced in many of the well-functioning electricity markets in LAC, if appropriate to their scales and specific conditions. Harnessing demand- side resources (and dispatching VRE on the supply side) requires an efficient system of prices and charges, one that is precise in terms of time and location. On this front, a few markets in LAC are already operating with nodal pricing, and some (such as Mexico and Colombia) are starting to consider intraday pricing. TABLE 0.2 Features of Electricity Market Design in Selected Countries of LAC TRADITIONAL EMERGING APPROACHING FRONTIER NIC SALV PAN PER CHI ARG GUA BRA CO MX California Texas MARKET COMPETITION Centralized economic dispatch via price bids x x x Demand side bidding allowed x x x x x PRICING IN TIME Intraday Markets x x LOCATIONAL PRICING One single pool price x x x x Zonal pricing x Nodal pricing x x x x x(2) x x CUSTOMER CHOICE Medium/high (voltage or load) thresholds x x x x x x x x x x x Low (voltage or load) Thresholds x x x x x(2) Full retail competition (open to all customers, including x residential) Active non-franchised market (1) x x Participation of independent traders/marketers/retailers) x x x x x x(2) x x Emerging competition via self-generation (e.g. PV x x x rooftop) HEDGING PRICE VOLATILITY Competition for Transmission Concessions or BOT/BOOT x x x x x x Contracts Organized market of financial derivatices x x x Financial Transmission Rights (FTRs) x(2) x x Competition for Long-term Energy Contracts for x x x x x x x x x(2) x x franchised market (1) High rates of opting out for eligible customers (2) Included in the current market reform, under implementation Source: Prepared by authors. 16 • 2017 REPORT Some degree of retail competition has been relatively functional in Brazil and Colombia, and recently Mexico introduced a sophisticated regulatory framework that includes provisions for competition on the demand side as well as nodal pricing. Yet although retail competition is allowed at some level in most countries of the region, the number of customers switching suppliers is still small. Most countries do not allow demand-side participation; in those that do, the option is seldom utilized. Net metering policies—which promote development of power supplied from distributed generators—have started to emerge in the region, although maximum threshold levels are low (0.5 megawatts in Mexico and Brazil vs. 20 in California). With conducive regulations and pricing, however, subsidies would not be necessary to support rooftop solar panels and the development of other distributed resources. Smart grids and advanced metering infrastructure (AMI) are essential to improve performance and unleash clean-energy markets. Policy makers in the region are increasingly aware of the importance of developing a strong digital backbone and the Internet of Things (that is, internet connectivity among equipment and devices). Already Chile, Colombia, Mexico, and other countries in the region are crafting strategies and policies to develop the information and communication technology necessary for greater efficiency in the sector. Disruptive technologies interacting in the urban ecosystem could trigger a paradigm shift Electricity as a commodity assumes a different role in a “disrupted” ecosystem, because new technologies and practices make it possible for distributed generators, traders, and consumers to deploy multiple new services—among them low-cost electricity generation, saved energy, reliability services, lower carbon emissions, and collection and processing of data on consumer behavior. These new services will create a more decentralized market with more stakeholders. The new ecosystem of business models and stakeholders will require profound adjustments to legal and regulatory frameworks to address new concepts of ownership rights and obligations, civil liberties with respect to use of private consumer information, operational and market rules, and competition regulation (Table O.3). The new services can have a further impact if deployed through a smart-city platform, where governments, service providers, and consumers interact. Argentina, Brazil, Colombia, and Mexico are starting to introduce platforms that raise the efficiency of resource use efficiency, reduce local pollution, and strengthen resilience to weather-related disasters. Cities and states can reduce emissions in many ways—for example, contracts with local utilities to supply greater amounts of renewable energy (including through distributed generation), electric transport infrastructure, and energy efficiency in buildings. Corporations can take measures such as buying renewable energy for their offices and factories, or making sure their supply chains are climate friendly. And consumers can respond to market signals or incentives for charging electric vehicles during off-peak electricity hours, saving energy, and installing rooftop solar photovoltaic systems coupled with batteries. ENERGY MARKETS IN LAC • 17 TABLE 0.3 Traditional and Emerging Market Architectures Current Structure New Architecture Market Structure Energy services: supplied to inelastic regulated and In addition to existing network services: non-regulated consumers, clustered-class consumers, bus-bar demand aggregation Demand-side distributed services and prosumers: re-balancing of the supply-demand equilibrium One-direction business: traditional horizontal supply chain Multi-directional trading: demand-side bidding, trading among consumers (e.g.; facilitated by blockchain technology) Market design: limited granularity (day-ahead, single pool price, limited retail competition, limited financial Market design: increasingly granular and more accurate price signals hedge) (intraday, multiple spot prices or nodal/locational pricing, time-of-use tariff, vibrant retail competition, sophisticated financial hedge) Trading platform: energy and reserve, capacity, clean energy certificates, long-term contracts, Trading in retail markets (behind the meter): distributed energy financial transmission rights resources (generation, storage, demand-side response, energy efficiency), consumer data New competition dynamics, new players in retail (demand side) markets, consumers as suppliers of capacity, energy, ancillary services, and data Business models Across traditional segments: generation, New ecosystem of multiple business models: aggregators, shared- transmission, distribution and retailing asset usage, value-added enablers (digital infrastructure and services, big data platform host), virtual utility Customer side business model: more active management of customer interface Customer choice: data ownership and leasing, choice of services (bundled) Regulatory Regulation based on cost of service and allowed Need for new policy and regulatory frameworks that sets clear revenues, regulatory levies, fees, and taxes guidance (co-existence of business models), embraces emerging businesses, aligns cost-recovery mechanisms of electric distribution Business models thriving on asset returns and fuel/ utilities, and provides incentives for integration of demand side supply management mark-ups, tariff-based resources Networks: concessions (rent seeking), guaranteed Competition and new players in retail revenues Adequate remuneration and incentives mechanisms: access to Commodities: energy, capacity, ancillary (rent markets, compensation (comparable opportunity) seeking), guaranteed entry barriers More accurate price signals: trade-off will be higher complexity and Trading and retail: energy volume management transaction costs, but increased system’s efficiency mark-ups, supplier and customer capture Privacy and security issues: data and information and information Net metering: important step, but economic flows efficiency issues Financial Public and concessional funding, commercial Participation of new actors in the financing behind-the-meter financing, mortgage-based, concession-based PPP installations structures Services platform: market-driven fees Energy chain supplier (regulated asset rent seeker): authorized revenues (RoE, equity/debt costs, asset- Specialized vehicles such as Yield-Cos (retailer, trader), blended yields base) Concessional finance and grants for load aggregators Millennium investor approach New sources of risk: requires innovative risk mitigation instruments Governance Focus on managerial efficiency (utilities), regulatory New emphasis on capacity to embrace change (flexible mindset), autonomy, transparency, and accountability leadership and agility of decision making, consultation and adjustment, facilitating active engagement of multiple stakeholders, interagency dialogue Source: FGV-CERI for World Bank (2017); authors. 18 • 2017 REPORT A smart-city platform can encourage technology change and responsible practices. These include modern digital infrastructure, smart grids, energy efficiency and distributed generation in public buildings, and centers to coordinate multi-sector information and emergency response. Policy makers, regulators, and utilities across the region are preparing for a clean-energy and digital economy. The entrepreneurial spirit of those countries in LAC that have pioneered power sector reform and systematic innovations on the regulatory side is expected to continue to deliver the changes necessary to develop demand-side markets. Systems characterized by poor service quality can learn from the experiences of mature markets in the region and leapfrog to embrace innovative technologies and reach higher levels of efficiency faster. A disruption of the traditional supply chain in electricity is thus not unlikely in LAC; however, it will unfold in different ways across the region, depending on the conditions of domestic markets, regulations, pricing structures, and incumbent utilities’ expectations and behaviors. It is difficult to predict the time span of the paradigm shift. Previous market transformations, such as from coal to oil to gas, have spanned several decades, while others have played out more rapidly, such as the development of nuclear energy. In LAC, changes will probably happen gradually and lag behind those observed in more-developed economies. Central to developing new energy infrastructure are understanding and facilitating the uptake of the technologies that will address the big challenges of the region: poverty, shared prosperity, climate change, and (growing) megacities. However, technology alone will not produce a paradigm shift. Moving closer to efficiency frontiers will also require political commitment, strong governance, capable institutions, a new way of planning, and appropriate legal and regulatory frameworks. Embracing the clean-energy and digital revolution would help the region close its yawning investment gap. LAC will need substantial investment to develop its energy infrastructure. The International Energy Agency’s New Policies Scenario,3 which assumes the effects of existing and announced energy policies, forecasts a cumulative investment of $3.8 trillion by 2030 to develop the sectors devoted to oil (54 percent), gas (12 percent), and electricity (22 percent). The rest would support the coal industry (less than 1 percent), biofuels (2.3 percent), and energy efficiency (6.4 percent). Considering previous investment patterns, the estimated annual investment gap is $122 billion in overall energy infrastructure, and $22 billion in electricity, of which $7 billion is in generation and $15 billion in transmission and distribution. The estimated gap in generation represents only 39 percent of what was invested annually between 2000 and 2013, whereas in transmission and distribution it amounts to 2.4 times the levels invested. Investment to develop the natural gas industry would need to almost double: The estimated investment gap in that sector is $14 billion annually till 2030, about two times historical levels. ENERGY MARKETS IN LAC • 19 Unlocking the potential of clean energy and demand-side initiatives could significantly lower investment needs. In the IEA’s 450 scenario, which assumes a low-carbon future, cumulative investment for the region would be $3.7 trillion by 2030, roughly the same as the New Policies Scenario but with much-reduced carbon emissions. In the case of electricity, a recent analysis conducted by the Swedish Royal Institute of Technology (KTH) suggests that South America—excluding Mexico and Central America— would need $23 billion per year if it were to follow the business-as-usual approach to infrastructure expansion i. Yet costs would at least halve under an approach that favors demand-side management and renewable energy solutions. This exercise illustrates the powerful contribution of clean energy and strengthens the rationale for fast adoption of emerging and disruptive technologies. At the same time, long-term financing continues to be a significant challenge Many countries in the region face persistent and often sizable fiscal deficits that are bound to impact their ability to undertake much-needed public investments in infrastructure. Such countries need to direct public resources to appropriate projects with a goal of mobilizing private financing. As noted, private financing has been concentrated in just a few countries, mostly large economies with deep financial sectors, such as Brazil, Chile, and Mexico, as well as those that have reformed their power and gas sectors. Several barriers continue to prevent private investment in energy infrastructure in LAC. Lowering those barriers will require comprehensive change on five fronts: • Reinforcing ongoing reforms in public-private partnership legislation and institutions to ensure a pipeline of bankable and fiscally sustainable projects • Leveraging project finance from domestic and global banks • Developing a flexible and suitable menu of capital market vehicles and instruments adjusted to the varied risk-return profiles of domestic and global institutional investors • Ensuring that domestic pension fund regulations encourage investments with distant horizons, complemented by a broad-based annuity industry • Shifting the mandate of development finance institutions away from direct investments toward catalytic interventions addressing market failures (credit enhancements and vehicles to coinvest alongside the private sector). 20 • 2017 REPORT LAC countries can be clustered in groups depending on their current conditions and performance; the groupings illuminate their paths toward a more efficient and clean energy future One set of countries in LAC has shown it can attract private sector participation and innovate in policy and regulation, and adopt emerging technologies. These countries are ready to introduce transformative solutions (cluster 3, Figure O.6). A second set is working to develop stronger institutions and markets, and has made significant progress on some of the vectors and indicators discussed here (cluster 2). A third set will need to revamp efforts toward better operational and financial performance if they are to deliver sound services and attract long-term financing (cluster 1). Indicative actions for these three sets of countries are presented in Table O.4. FIGURE0.6 Energy Use vs. Economic Output: A Path Toward a More Efficient and Clean Energy Future SATISFICING OPTIMIZING TRANSFORMING Resource Use / Energy / Emissions Countries Business as in Cluster 1 usual innovation “Overhaul” Efficient Frontier Countries in Accelerated low Cluster 2 carbon innovation “Catch-Up” Countries in Countries in Carbon price Cluster 3 Cluster 4 driver innovation “Transform” “Efficient” Economic Output / Consumption Sources: Adapted from Grubb 2015. ENERGY MARKETS IN LAC • 21 TABLE 0.4 Path to Transformation: Indicative Actions for Three Country Groupings Step 1. Overhaul Step 2. Catch Up Step 3. Transform Country Readiness Countries with heavy energy Countries with cost-reflective tariffs countries with aggressive clean subsidies, oil dependent (1) that need to increase efficiency (2) energy DG agendas (3) Governance Incentive regulation and subsidy Regulatory streamlining Regulation favoring innovation reform Market architecture Accountable, conventional supply Intraday, zonal and dynamic Transactive model, Smart City pricing, innovation pilots platform Technology and Climate Move to natural gas generation Smart metering and grids, Full digitalization, storage and renewable move to renewable and natural Demand side management / gas generation, demand side energy efficiency management / energy efficiency Financial Markets Guarantee products Innovative risk mitigating structures Innovative risk mitigating structures New energy asset classes New energy asset classes (1) Haiti, Honduras, Nicaragua, Guatemala, Dominican Republic, Ecuador, Bolivia, Venezuela (2) Argentina, Peru, Panama, Colombia, Paraguay (3) Mexico, Brazil, Chile, and centralized systems with aggressive clean energy agendas (Costa Rica, Uruguay) Source: Prepared by authors. Note: DG = distributed generation. The report concludes with five strategic recommendations. Recommendation 1. Plan strategically for climate resilience, increased efficiency, and sustainable cities Energy systems are increasingly complex, constantly developing, and periodically unstable. Today, policy makers and investors face huge uncertainty. A new approach to planning and decision making can significantly reduce public expenditures and avoid stranded assets and inefficiency across the value chain. Factoring in new sources of risk, especially those associated with climate change, is vital for energy infrastructure to be sustainable and resilient. One of the most important constraints of traditional least-cost investment modeling is that they are based solely on the optimization of supply-side interventions. Policy makers have lacked planning tools or algorithms that simulate demand-side and 22 • 2017 REPORT consumer behavior—that is, elastic or more responsive demand. Today new modeling tools integrate demand-side resources and allow better long-term planning for resilient infrastructure, such as integrated resource planning, system dynamics, and methodologies based on nonprobabilistic decision-making under uncertainty. Using these tools to coordinate planning among sectors, and to factor in market dynamics and increased uncertainty, is becoming crucial to the design of long-term strategy. Recommendation 2. Transform markets to embrace emerging technologies and practices Governments would do well to systematically adopt the policies, regulations, market design, and organizational processes necessary to embrace innovation and support the entrance of smart solutions. Functional markets will be key to the transformation. For instance, countries could introduce time-of-use tariffs and nodal pricing—when applicable to the scale and specific conditions of a system—to allow the development of dynamic retail markets, which require a much more refined level of disaggregation of time and location. This transformation requires interventions that go beyond repairing market failures to promoting smart innovation and actively shaping and creating the markets of the future. Regarding technology absorption, two priorities must be considered. The first is that countries need to have some sort of clear technology path (based on an understanding of the technologies of today and the future). The second is that in some instances it is possible—and desirable—to leapfrog to new business models and technological solutions. Recommendation 3. Strengthen governance at the sector and corporate levels While specifics vary considerably, enhancing governance is a challenge that all countries share. The task is to develop energy sectors where the roles of all public and private actors are clearly defined and mutually complementary, institutions are held accountable for performance, and a solid enabling environment attracts long-term financing and private investment. Concerning state enterprises, good governance entails a clear role for the state as owner, regulator, and policy formulator; a level playing field for public and private agents to avoid distortions and inefficiencies; explicit legal mandates that regulate the provision of public service obligations; clear and equitable rules for all stakeholders (including small investors); and corporate autonomy and accountability. One aspect of good governance that requires special emphasis in the midst of rapid change is “institutional agility.” For now, the utility industry has a base of heavy assets that amplify the forces of inertia. Policy makers and regulators are often slow in adjusting to technology change and innovation on the business side, thus delaying efficiency gains. But new emerging players—such as digital and distributed generation companies— are agile by nature. The efficiency frontier moves fast. ENERGY MARKETS IN LAC • 23 This means that policy makers and regulators must become more attuned to technology changes and foreseeable disruptions. They can gather information, allow experimentation and pilots, and reallocate resources. They can promote analysis and collaboration, create networks for the sharing of knowledge and skills, better understand consumer behavior, and foster partnerships. All of these actions add up to institutional agility. It is not enough for a country just to keep up with the demand for energy exerted by a growing economy. Instead, governments must move toward an efficient or best-practice frontier. This entails using less energy for the same or higher economic output. Approaching a best-practice frontier also requires a deep understanding of behavioral and organizational economics, and an emphasis on efficiency across all segments of the supply chain. Today, agile institutions are those that know what kind of transformation they want to pursue and what route, policy tools, and strategic investment will take them there. Recommendation 4. Create smart energy cities Transforming cities so as to provide citizens with high-quality services and clean ecosystems is one of the biggest challenges facing the region. This will require multi- sector collaboration on integrated solutions to reducing pollution; improving mobility; ensuring access to affordable, reliable water and energy; increasing wastewater treatment; maximizing recycling and appropriate disposal of waste; and preparing for emergencies. Meeting these challenges will entail institutional coordination, collaboration among multiple stakeholders, and the proactive engagement of citizens. Multiple new technologies can be deployed to support the ongoing urban transformation and the more efficient use of fiscal resources. The emergence of distributed energy markets will change the city ecosystem, and city governments will need to understand and facilitate the transition as well as interlinkages with other sectors, notably water and transport. Energy is needed to pump water, for example, and electricity to power the increasing numbers of electric vehicles. Recommendation 5. Spend better and leverage public resources to mobilize private financing Attracting different types of investors will entail turning energy infrastructure investments into asset classes, strengthening regulation and business environments, strengthening the capacity to develop public-private partnerships, introducing innovative financial products and facilities to support long-term financing, and allocating and managing risk more effectively. 24 • 2017 REPORT Notes 1. Private investment in wind projects took off in 2008, and in solar projects in 2011. 2. Based on data reported in Doing Business, which follows a specific methodology to ensure a degree of consistency and comparability, and considers only the largest utility in each country. 3. Every year the IEA’s World Energy Outlook presents an analysis of the global energy system, with regional disaggregation. Three main scenarios are produced each year: (i) the Current Policies Scenario (CPS), based on policies that are being implemented; (ii) the New Policies Scenario (NPS), which also includes policies that have been officially announced; and (iii) the 450 Scenario, which includes new policies put in place to keep GHG emissions to levels necessary to limit the long-term rise of global temperatures to 2 degrees centigrade. In the NPS, 42 percent of investments in electricity would go to renewable energy. ENERGY MARKETS IN LAC • 25