Chile’s creativity comes to the fore in its 2017 energy auctions

Summary: Chile’s energy sector continues its positive evolution. The upcoming auctions have a number of creative features that allow renewable energy technologies to maximize their potential while minimizing the drawback that is their intermittency. New record low prices are likely to be seen — although there is one glaring risk that could harm progress.

About the publisherCarlos St. James is a leading advisor to energy investors, bankers and developers in emerging markets at Wood Group. He is also a board member of the Latin American & Caribbean Council on Renewable Energy (LAC-CORE) and publishes the Latin American Energy Review to help generate debate on the industry’s issues.

He will next be speaking at the 8th Annual World Infrastructure & Energy Summit in Barcelona on September 27 on Managing Latin America’s renewable energy targets set out by the Paris Agreement and its implications for clean energy investment.


Following Chile’s very successful electricity auctions last year, another one is already well underway for 2017: bids are due mid-October with winners to be announced early November. The clock on the twenty year power purchase agreements (PPAs) will not begin ticking until 2024, giving winners ample time – perhaps too much — to price technology and structure their projects. The auctions have a number of new and very creative twists that benefit intermittent sources and should further lower a rapidly dropping average energy price.

Chile initially planned to auction off 4200 gigawatt-hours (GWh), but later lowered the figure to 2500 GWh. A couple months ago it made the further decision to auction only 2000 GWh this year, which after adding a 10% allowance, made it a total 2200 GWh.

So why does the Chilean government keep reducing the size of this auction?

For two primary reasons. The less significant is that projections for economic growth are getting revised downwards: whereas last year Chilean growth was projected at between 1.5-2.5% p.a., it has since been pulled back to between 1-2%. But given the significant delay until required commercial operation dates (COD) on these projects, this is insignificant.

The more noteworthy reason may have greater repercussions for the energy sector as a whole: there is a somewhat unexpected migration of electricity customers shifting from the regulated sector to the unregulated, where lower prices can be had.

Graph: Average winning prices of last three electricity auctions in Chile. Source: Chilean ministry of energy

Chile is in effect becoming a victim of its own success in energy prices, as can be seen in the downward trend in prices starting with the average $130.40 per megawatt-hour (MWh) achieved in the 2013 auctions (all contracts are in USD) to the $47.60/MWh achieved last year — which included the much-discussed $29.10/MWh winning bid from Spain’s Solarpack. (Click on graphs and images to enlarge.)

Commercial electricity users whose consumption ranges between 500kw-5MW (supermarkets and light manufacturing are the usual examples) can choose to operate in either the regulated or unregulated market. Given the clear downward trend in prices, it is an easy bet to assume they can get lower prices in the unregulated market — albeit for shorter terms. This is in effect what has happened, resulting in a massive shift of consumers away from the regulated, forcing the government to downsize the upcoming auction.

The auction’s structure

This auction is a marvel of creativity. One of the new features of the Chilean auctions is that there are two separate blocks defined by time: hourly and quarterly. Bidders can make offers in any number of combinations, and the auction’s software is set to use heuristics (a decision-making concept developed by economics Nobel laureate Herbert Simon) to find the optimum prices from the complex offers they’ll receive.

While the auction is officially technology agnostic, it is set up in ways that favor certain technologies, notably solar (in the hourly-segmented 24-hour block) as well as hydro and wind (in the seasonally-adjusted quarterly blocks). It allows intermittent technologies to maximize their potential without having to incorporate a still-expensive storage component.

The hourly blocks (officially called Bloque de Suministro No.1, or Supply Block #1) are comprised of three unequal segments covering a 24-hour period and totaling 1700 GWh. The quarterly blocks (Supply Block #2) are comprised of four equal segments of three months each covering a year and totaling 500 GWh. There’s your 2200 GWh auction total.

Picture: Hourly Block #1 of the 2017 Chilean electricity auctions covering a 24 hours period. Source: Comision Nacional de Energia de Chile’s tender documentation

The first block’s goal is to get the lowest price for every 24 hour period possible. While Block #1-B (see picture) will be favored by most of the solar bidders since it represents daylight (a ten hour period from 8 am to 6 pm), the goal is of course to fill up all three blocks totaling 24 hours. Bidders can make offers in all kinds of combinations in these three blocks, or bid in only one. If in the first round total offers do not beat the (secret) ceiling price, they will flow into a second round. Common sense suggests that if that happens it’ll likely be for Blocks #1-A and #1-C.

Failing this, it will flow into a third round called the Base Case in which the 24 hours are bundled. Final winners will be the lowest price derived from adding up offers from Rounds 1 + 2, contrasted to those in Round 3/Base Case.

Picture: Quarterly Block #2 of the 2017 Chilean electricity auctions covering a 24 hours period. Source: Comision Nacional de Energia de Chile’s tender documentation

The results of this will spill over into the second block (Bloque de Suministro #2), comprised of four equal calendar quarters (January through March, April through June, etc), whose goal is to lower annual prices. In this instance seasonal renewables may have an advantage. Hydro energy – first from rain and later from melting ice and snow — is more readily available in winter: the second and third quarters of the year. Similarly, Patagonian wind tends to peak in summer (fourth and first quarters). Thus a mini-hydro project, for example, might bid only in the one or two quarters where it has the highest certainty of having abundant resources, allowing it to bid very aggressively.

Given the specificity of the auction’s structure, we are likely to see new world-record low pricing in the Block #1-B of the Hourly segment: it is tailor-made for solar PV and strips away the intermittency risk. And while the government is seeking to attract as many investors as possible to this auction, the fact remains there is already a lot of excess and a number of large players with capacity to offload; one possible scenario is that a handful of large players bid very aggressively for large blocks and walk away with the lion’s share of the two time pies that are up for grabs.

Either way, Chile’s citizens will win as prices continue to drop, while doing so specifically because of the creativity of the government officials who put this together. A well deserved tip of the hat to them.

So what could possibly go wrong?

The auction’s structure appears to have one risk disguised as an opportunity: the start date of the 20-year PPAs. Initially set to begin in January 2023 (more than five years from the date each bidder needs to commit to a price), this past June it was extended yet another year to January 2024. Thus, projects that are getting priced in October 2017 will not have to have a COD until more than six years later.

This certainly seems like an opportunity for bidders to, for example, wait for the price of solar panels to drop further. But it could easily backfire. On the one hand, panel cost declines are starting to flatten out, so the likelihood of continued significant price drops decrease. But more importantly, this extended start date acts kind of like an extension of the construction period, that “Neverland place” where risks are high while commitments have been made. (Note: there is money to be made by hedging or insuring that risk.)

We are living in a geopolitical world with heightening risk, and with no view of it declining in the foreseeable future. Interest rates are low now and international trade agreements firmly in place, but that may not be the case in a few years when you are looking to lock in financing and trade terms for your winning project. This beautifully-designed auction could lose some of its luster if any of these variables changes, and the longer COD lengthens and magnifies that risk without a sufficiently comparable upside. It would have been wiser to pressure bidders to reach COD sooner rather than later.


© Latin American Energy Review 2017


This report has been prepared by Carlos St. James for The Latin American Energy Review. The views expressed on this site are his own and do not reflect the views of Wood Group, its affiliates or business partners. This report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The report is based on information obtained from sources believed to be reliable but is not guaranteed as being accurate, nor is it a complete statement or summary of the securities, markets or developments referred to in the report. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Any opinions expressed herewith are subject to change without notice and The Latin American Energy Review is not under any obligation to update or keep current the information contained herein. The Latin American Energy Review accepts no liability whatsoever for any loss or damage of any kind arising out of the use of all or any part of this report. Additional information will be made available upon request.


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