Spotlight: Chile’s electricity subsidy bill sets sector alarm bells ringing

Chile’s biggest electric power industry associations have jointly sounded alarm bells over the government’s end-user subsidy bill, which contains measures that would impact around half the population.

While backing the need for mechanisms to support the country’s most vulnerable, the sector is concerned the draft legislation erodes legal certainty and confidence in policymaking and establishes tax levies on an ad-hoc basis.

Concern is voiced particularly over a funding pillar proposal that involves amending remuneration agreements on the transitional stabilized price paid for output from the country’s distributed generation plants (PMGDs), namely those up to 9MW in capacity and connected chiefly to the distribution network. 

While the stabilized price is itself considered by some a de facto subsidy, changing established rules of the game unilaterally is frowned upon and seen as potentially damaging to the wider economy.

The government bill was unveiled following political pressure on the executive after regulated end-user electricity rates were finally unfrozen after around four years of being held virtually steady, much longer than originally planned and resulting in sharp rate increases for homes and businesses. Rates were originally frozen in response to the social protests of late 2019.

According to the latest legislative proposal, subsidies would be in place until 2027 and cost more than US$1bn.

The energy sector joint statement – issued by renewables and storage chamber Acera, solar power association Acesol, generator association Generadoras de Chile and the country’s association of small and medium-sized generators GPM – comes after rating agency S&P Global said the changes could hit creditworthiness of some projects and create wider fallout.

“Discussions over the proposal should occur in the next several months in congress, where the administration does not have a majority. And given that there are no similar precedents in Chile of discretionary and arbitrary decisions that could hamper the electricity market's predictability without compensation mechanisms, we will closely monitor the developments to see if modifications to the proposal will be made,” S&P wrote.

“Overall, if approved, we'll perceive such changes as weakening the regulatory framework that could hamper the electricity sector's performance, and that similar changes could eventually expand to other industries.”

To get a helicopter view of the situation, BNamericas spoke with local expert Daniela González, who is director of Chilean regulation consultancy Domo Legal.

BNamericas conducted this interview prior to the sector associations issuing the joint statement.

BNamericas: In general, what is the electricity generation sector’s opinion of the bill?

González: I believe that, in general, the opinion of the proposal is negative, possibly for different reasons and concerning different elements of the bill. However, I would say there is broad agreement on two main points.

First, the subsidy coverage goal is very ambitious and diverges from what would be considered a targeted policy. We’re talking about a subsidy aimed at reaching all households in the top 40% of the social household registry, which comprises 4.7mn families, roughly equivalent to about 10mn people in a country with a population of around 20mn. This subsidy is much broader than the water subsidy used as a reference, which focuses on families that spend more than a certain percentage of their income on sanitation services. In 2023, the water subsidy targeted 1.35mn families, with about 1mn beneficiaries, which is significantly less than the proposed coverage for the electricity subsidy, and one might question why.

Second, to achieve this goal, “self-contained” solutions need to be developed in the electricity sector. We must remember that the rate increases sought to be mitigated result from the need to normalize rates paid by regulated customers and start repaying a debt of over US$7bn owed to generating companies that had their contract prices frozen. 

While the reasons for this freeze might have been understandable initially, there is a strong consensus that it lasted beyond what was reasonable and, as the finance minister said, it was like shooting oneself in the foot. 

Successive stabilization laws were motivated by political and social considerations, and their funding should come from fiscal resources. In this context, the design of the subsidy should align with the capabilities of the fiscal coffers and existing priorities for public resource allocation, rather than debating which industry players should contribute more or less to the subsidy’s funding.

BNamericas: Which articles or measures are most controversial or relevant for the generators?

González: The most controversial measure is the so-called FET charge, which, although it falls on trader agents or [grid] “withdrawals” that are both nonregulated and regulated, it is ultimately borne by the owners of PMGDs under the stabilized price regime contained in the repealed [decree] DS 244.

There has also been considerable discussion about the additional green tax surcharge due to its purely revenue-raising nature, which differs from the more or less broad proposals from the sector that an increase in this tax should be accompanied by a review of its exclusion from variable costs considered for system economic dispatch. Corrective taxes, including emissions taxes, are part of the government's tax reform agenda, and this measure raises uncertainty about whether the tax’s design will indeed be discussed in line with expert recommendations.

The measure for SMEs is also controversial because, although the volume of electricity covered by this mechanism is limited, it forces PMGDs to supply energy to distributors, impacting the electricity volume allocated to companies with existing contracts, particularly those with contracts where the average gross price is higher than the stabilized price. This is in a scenario where regulated supply tenders have become less attractive for leveraging investments in renewable energy, as demonstrated by the latest process.

BNamericas: We have read that the proposal regarding PMGDs has caused concern among investors. Why?

González: Because it directly affects the revenues of those projects, altering the projections they had in relation to the financial sector.

Remember that some industry players advocate revising or even repealing the transitional stabilized price regime to which hundreds of projects subscribed under a transitional article of supreme decree 88, regulation of small-scale generating units, for which they had to comply with specific requirements established by that regulation. This article allowed them to opt for this stabilized price mechanism for 15 years. This is because remuneration for the difference between the marginal cost and the stabilized price has increased considerably in the last two years, significantly impacting some generators.

In response to this controversy, many investors and banks sought a signal from the authorities to make decisions, for example, to close financing for other PMGDs still in development or to invest in storage systems. The authorities indicated several times that reviewing the transitional stabilized price regime was not on their agenda, and there was an expectation that the rules would remain as they were.

However, while this regulatory stability signal was given, this mechanism [proposed FET charge] was introduced, which in practice impacts revenue from the stabilized price, meaning that, in practice, the owners of these units will not receive the full stabilized price, and this “practical” effect is what ultimately matters for investment decisions and risk assessment by financial entities.

This measure, therefore, does not satisfy either those calling for a review of the stabilized price mechanism, as it relies on maintaining the price as it is and producing the same remunerations that currently exist, or the owners of PMGDs who will, in practice, see a lower stabilized price.

BNamericas: Based on your experience as a local consultant, do you think the bill will progress without major changes or amendments? Or is it uncertain at this moment?

González: It is becoming increasingly difficult to forecast what will ultimately happen in congress. However, in response to the question, I believe the bill will progress, as there is significant agreement in the political world regarding the need to expand the coverage of the subsidy and extend it over time.

However, I do not rule out that some aspects of the financing might be modified. For example, it should be noted that during the discussion of the last stabilization law, there was a proposal to increase the green tax on the same terms as those currently established by the bill, and that didn’t succeed. So it’s unclear whether there is broad consensus on this measure.

Now, it is very difficult for substantial changes to occur in the lower house since it has been agreed to discuss it in the mining and energy committee over five sessions, which is a very short time to generate consensus on alternative measures or a redesign. If there are changes, they will be minor or aimed at clarifying doubts about the implementation of what is currently proposed.

In the senate, however, the discussion may open up more, or at least it will be clearer which measures have more agreement and which may lack the majority for approval as proposed.