Burned in Chile: The folly of merchant solar power

Summary: Pro-market policies have led to over a gigawatt of solar photovoltaic parks now operating in Chile. But with few long term offtake agreements available, an alarmingly high percentage of these depend on the spot price to generate revenues – which regularly drops to $0/MWh in the afternoons.

Carlos St JamesAbout the AuthorCarlos St. James is an advisor to energy investors and developers in emerging markets. He co-founded the Argentine Renewable Energies Chamber in 2005; has been a board member of the Latin American & Caribbean Council on Renewable Energy since 2010; founded the Middle East-Americas Energy Council in 2014; and publishes the Latin American Energy Review in his free time to generate debate and educate on industry issues.

Layout 1He was recently named Summit Chairman of the upcoming LAC-CORE Finance Summit in Miami, Florida in October 2016.


This January Chile hit two significant milestones: installed capacity of solar energy passed the one gigawatt mark, and it surpassed wind. Surely a great omen for a country known for its solar resources and stable economy. Yet losses are mounting at some power plants, caused by weak planning on behalf of the public sector and an unwillingness from the private sector to acknowledge some real risks in the rush to invest – decisions that are now costing the industry millions and scarring Chile’s porcelain reputation.

Installed Capacity of Wind & Solar in Chile
Source: Centro para la Innovacion y Fomento de las Energias Sustentables (CIFES), Ministerio de Energia de Chile

The enthusiasm for solar makes sense. The Atacama Desert in the north has excellent radiation and is home to the world’s largest copper mining industry — big energy consumers. You’d think it would make for an ideal business opportunity.

(Click on the graphs to see them more clearly.)

But it hasn’t been that way. Simply put, miners will tell you that intermittent energy sources do not serve their purposes. By and large, they are uninterested in signing long term power purchase agreements (PPAs) with these renewable technologies.

So project developers began to promote merchant solar power plants. (By “merchant power”, I mean electricity generation plants that are built without having PPAs or any contracted revenue stream. In its simplest form, merchant plants sell their electricity on the spot market at whatever the price happens to be at that moment.)

[Recently] an industry magazine declared the country, “… a near perfect storm in which merchant solar can grow.” But the market was already changing and no one had noticed.

Soon everyone was gushing about the merits of going merchant in Chile: industry research analysts, law firms, the specialized press. Barely a year ago one industry magazine declared the country, “… a near perfect storm in which merchant solar can grow.” Spot prices were high and expected to remain that way.

But the market was already changing and no one had noticed.

Two Grids

The transmission grid in the northern part of the country (called “SING” — the NG part means Norte Grande) supplies 90% of Chile’s industrial electric demand, and they’ve managed to keep that cost pretty steady. See the red line on the graph.

Electricity Spot Price in Chile
Source: Centro para la Innovacion y Fomento de las Energias Sustentables (CIFES), Ministerio de Energia de Chile

The blue line represents the much larger but more volatile central transmission grid (“SIC”; the C stands for Central), where 90% of the country’s residential electricity demand is located — and where the merchant problem really lies (the two grids have yet to be interconnected). And because it includes a considerable amount of hydro power it is also affected by droughts.

Note the 50% drop in the spot price in mid-2015; the same thing happens almost every year, since it is winter and dams fill up from rain and snow. And it will happen again in mid-2016 especially after the abundant El Niño rainfall.

Chile's four separate transmissions grids
Chile’s four separate transmission grids

Why would merchant deals get done at all?

That they could get financed says a lot about the evolution of the renewable energy industry in Latin America and Chile’s special place in it.

Much of this merchant solar photovoltaic capacity has been installed to feed into the SIC grid. But because of Chile’s love of free markets, the government has not supported long term contracts such as PPAs in the same way that some other neighboring countries have with great success, notably Uruguay, Peru and Brazil. Herein lies the public sector’s principal fault in all this: nurturing and protecting what amounts to an infant industry should have been done to some degree.

But the bulk of the blame belongs to the private sector: over-enthusiasm blinded them.

The proponents for merchant made the case that the spot price was likely to remain high: because oil prices would continue to rise; because droughts would be the norm and keep competing hydro energy expensive; because Chinese demand for commodities like copper would remain high and keep the Chilean economy humming (copper provides about a fifth of government revenues and represent almost half of all exports).

In retrospect, none of these came to pass. That “near perfect storm” was badly mis-read:

  • The price of oil fell from a high of $108/barrel in 2013 to a recent $40/barrel;
  • The price of copper fell from a high of $4.50/lb. in 2011 to a current level of $2.30/lb.;
  • El Niño-driven rainfall has replenished many dams, and while they are still well below normal, experts predict continued abundant rainfall through April-May of this year, even before winter arrives;
  • Chile’s economy has gone limp and is struggling to find ways to grow.

And all this exacerbated by:

  • The drop in spot prices will affect larger investments more than smaller ones, because generation under 9 MW gets preferential treatment;
  • There are an additional 2082 MW of solar plants under construction which will only worsen the congestion problem, especially those feeding into overburdened nodes such as Cardones and Polpaico, both in the SIC;
  • In its hurry to get the renewable industry going, the government was too quick to allocate land for projects.

The result: free electricity

The end result is that at peak energy demand in the afternoons, the marginal price remains abysmally low and quite often goes down to $0/MWh.

Case in point: at the Cordones node, where a number of solar projects connect to the SIC, as early as November 2014 (check out the first graph again: there were less than 400 MW of solar installed at that point) there were 15 days in which the spot price fell to $0, often for many hours and invariably in the afternoon – peak solar time. In 2015 every single month had at least two days in which the marginal price fell to $0/MWh – and when it wasn’t free, the price was far below the necessary to provide adequate returns to the project as a whole.

Chile SIC Cardones node spot price Dec 23 2015
Source: Centro de Despacho Economico de Carga (CDEC) del Sistema Interconectado Central (SIC)

The month of December 2015, for example, had ten days in which the spot price fell to $0. This graph shows one of them, December 23. At no point did the price reach even $40/MWh, and during the seven sunniest hours between 12 noon and 7 pm the price fell to nil.

How will this play out?

There are no less than 350 MW of solar plants in operation that depend entirely or partially on the spot price: a third of all installed solar capacity in Chile. They are scrambling to sign PPAs but find no takers. Some will go bankrupt, with a resultant massive loss of asset valuation. Yet one group’s loss is another’s opportunity; you can expect to see some big players sweep in and buy perfectly good assets at a deep discount in the coming months.

This is not what the region wanted to see from its star country. And the ripple effects can be quite damaging. Something will have to be done about the additional 2082 MW under construction in ChileMexico has already toyed with merchant plants — with mixed results. Colombia‘s market is similar to Chile’s and they too are considering merchant solutions, as outlined here.  And Argentina isn’t even a candidate for PPAs let alone merchant right now (see here), but the last thing it needs are commercial and development banks retrenching from the southern cone after bad experiences in the neighborhood.

What Chile and its energy investors and lenders are feeling is the “invisible hand” of free markets slapping them across the face. Let’s make sure it doesn’t happen elsewhere.


© Latin American Energy Review 2016

About the Author:

Carlos St. James is the co-founder of the Argentine Renewable Energies Chamber (CADER, by its initials in Spanish) and was its first President until 2011; is a board member and was elected the first President of the Latin American & Caribbean Council on Renewable Energy (LAC-CORE); is the founder and chairman of the Middle East-Americas Energy Council (MEAMEC); and founder and publisher of The Latin American Energy Review. His private sector background is focused primarily on finance and bringing together stakeholders so that deals get done. He advises governments on renewable energy policy, counsels private equity firms seeking to enter the region; and brings together stakeholders, including investors, for new energy projects.

He obtained his undergraduate degree in international economics from DePaul University and his masters in international relations from the Fletcher School at Tufts University.


Please follow and like us:

Leave a Reply

Your email address will not be published. Required fields are marked *