The case against regional power grid integration in Latin America

Summary: Latin American governments and development banks continue to think in black-and-white 20th century mindsets and thus propose similarly outdated solutions. This includes the largely erroneous idea that international electric grid integration will result in lower energy costs and give access to more people, when in reality there are solutions that are a better fit for the region, more cost-effective, and will better serve us.

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.
LAC-CORE Finance Summit

 He was recently named Summit Chairman of the upcoming LAC-CORE Finance Summit held at the Ritz Carlton in Miami, Florida this October 3-5, and will also be speaking at renewable energy conferences in Argentina and Chile in the coming months.

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When discussing energy in Latin America, two important themes come up repeatedly: that there are still too many without access to electricity, and that economies of scale are the best way to address that while ensuring that electricity costs go down.

Six percent of Latin America’s population — some 30 million people — still lack access to electricity, while another 14% (65 million people) depend on traditional biomass for heating and cooking. And while electricity prices vary dramatically from country to country (ignoring for the moment the matter of individual government energy subsidization policies), studies typically conclude that larger generation plants and longer transmission lines will result in overall lower costs to all — and is the best way to reach these almost 100 million people.

But these two issues are not as inter-related as analyses suggest. In a 2010 study completed by the World Bank it was estimated that of the then 34 million without access to electricity in the region, more than half were in just four countries (Peru, Haiti, Brazil and Colombia). See the chart below; click to enlarge. Is internationalization of the electric grid the best solution to this problem?

Latin America Electricity Access Rates, 2008
Latin America Electricity Access Rates by Country, 2008. Source: Meeting the Electricity Supply/Demand Balance in Latin America and the Caribbean, World Bank, September 2010

It is becoming increasingly clear that we are still thinking with 20th century mindsets using 20th century models: that bigger is always better and more efficient. Yet this no longer necessarily holds true. As a matter of fact, the trend we are all struggling to get our heads around is that the solution does not lie in larger centralized models but rather decentralized distributed renewable energy, where decision-making is at the local community level and not by regional organizations.

The analyses for regional electric integration, for example, always focus on two primary benefits: that greater openness and international electricity trade will lead to lower energy costs for all parties concerned, and that it will facilitate access to those who still don’t have it. Sounds very reasonable, no?

Yet it does not play out that way. We are misallocating capital and focusing on the wrong solution. Let me use as an example the one truly international grid that is actually operating in our region.

The Central American Electrical Interconnection System (SIEPAC, in Spanish) transmission line is almost 1800 kilometers (1100 miles) long, crossing six Central American countries. It was initially budgeted to cost $405 million after including the 15 substations and 28 access bays when construction began in 2006. But by the time it was completed in 2014 – much later than anticipated — costs had ballooned 25% to $505 million. The final tab is a very expensive $280,000 per kilometer ($450,000/mile) of transmission.

The Inter-American Development Bank (IADB) put up about 60% of this total with 40-year loans. The Corporacion Andina de Fomento (CAF) and Banco de Integracion Economica (BCIE), two more development banks, another 28% of debt, leaving the equity providers (the six countries plus Italy’s ENEL) to put up only 12% of the cost.

But not only is it too expensive, it doesn’t even serve its purpose. Few participating countries seem happy with the results and SIEPAC is severely underutilized.

So what happened? Unsurprisingly, each country has taken a mercantilist position, seeking to export electricity while not importing. In 2015, the first full year the grid was operational, Guatemala (with the greatest installed capacity in Central America), exported 387 thousand megawatt-hours (MWh) but bought none. Meanwhile, Honduras and Nicaragua essentially didn’t participate at all, neither importing nor exporting. (To learn more about the state of renewable energy in Central America, see this previous analysis.)

SIEPAC Transmission Grid through Central America
SIEPAC Transmission Grid. Source: Nuevas oportunidades de interconexión eléctrica en Latinoamerica. CAF/CIER, July 2012

Inter-country tolls have not been agreed upon yet so true cost of electricity is still unknown. Long term contracts are not allowed — even though that is the only way the economics of SIEPAC will make sense. Each country wants to have its own installed capacity and not depend — long term – on energy imports.

Additionally, technical issues abound and haven’t been addressed. Costa Rica, typically with surplus hydroenergy, recently sought to export electricity to its neighbors but was severely restricted in its ability to do so because while the SIEPAC line has the capacity to transmit 300 megawatts (MW), its neighbor’s domestic grids could only handle between 120 and 160 MW.

The weighted average interest rate on the SIEPAC loans is about 5% p.a. The equity investors had targeted an internal rate of return (IRR) of 11-12% but, given the cost overruns and lack of usage, are unlikely to see dividends anytime soon. The banks will be collecting interest for a very long time on this project, ultimately borne by taxpayers.

“If Chile, perhaps the most pragmatic country in the region, cannot get its own transmission grids interconnected, can we reasonably expect it to happen between multiple countries?”

But perhaps worse of all is that the next round of solutions being put forth reveal more of the same mindset: new studies are suggesting adding additional capacity to this very grid (to be known as SIEPAC II).

SIEPAC II would reinforce the initial grid at a cost of another $500 million. However, even advocacy groups such as the Regional Energy Integration Commission (CIER, in Spanish) out of Uruguay have come to the conclusion that the expansion would have a “marginal” cost-benefit return (even before any possible cost overruns), in large part because each country has considerable new capacity coming online in the coming years — mostly renewable — in line with their individual energy independence and security policies.

Another regional integration project is the Andean Electrical Interconnection System (SINEA, in Spanish), which would interconnect Chile, Peru, Ecuador and Colombia and has Bolivia as observer. The IADB has provided money for technical assistance studies.

This grid would run for some 6300 kms (4000 miles). If we assume it comparable to SIEPAC, it will cost about $1.4 billion — before any possible overruns and any delays.

If Chile, perhaps the most pragmatic country in the region, cannot get its two main transmission grids (the SING and SIC) interconnected, can we reasonably expect it to happen between five countries at a final cost and with conditions that leave consumers better off?

At the same time, other studies such as those by the Northeast Group indicate that Latin America will invest about $50 billion in smart grid infrastructure by 2025. As indicated in a previous study (see here), there is a case to be made that Latin America can leapfrog mature economies as they already have done in the past — this time by embracing distributed energy solutions. (The previous case is what happened with mobile phone market penetration. Briefly put, the outdated and expensive telephone landlines created an incentive to go with an entirely new solution.) Distributed energy solutions would truly give our region an economic advantage and better place the region to compete globally — just like it did by embracing mobile phone technology.

And by the way, Latin America is today the fastest growing smartphone market in the world, beating out even Asia. The population of Latin America is young and gets it. Those in charge are not and don’t.

In the end, Latin American international power grid integration will prove valuable to many consultants, engineering firms and technology vendors, and allow for much chest-pounding by silver-haired politicians and development banks. Some jobs will be created and there is value in that. But far better would be to see the signs of a new world emerging and adapting it to our needs. That would be a better use of capital for the entire region.

 

© Latin American Energy Review 2016

About the Author:

Carlos St. James is the Managing Director of Santiago & Sinclair, LLC, a financial advisory firm focused on renewables in emerging markets. Carlos co-founded 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.

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2 thoughts on “The case against regional power grid integration in Latin America”

  1. Very interesting article. I just have two questions:
    1) In a previous article (Making sense of Central America’s Renewable Energy Sector) you seem to celebrate that “.. perhaps the important issue is that Central America is making headway towards setting itself up as a single energy market. The region has a unifying electric grid known as SIEPAC (Sistema de Interconexion Electrica de los Paises de America Central)”. Now in this new article you accuse “Electric Regional Integration” of being an outdated idea of old fashioned politicians and policy makers. What did make you change opinion?

    2) If Regional Integration is such a bad idea, why do development banks continue spending so much of their political and financial capital on these projects, instead of financing the type of local initiatives that you seem to propose? Any hypothesis?

    1. Hello Stefano, forgive my delay. I did indeed change my mind on this topic; it is actually the reason I write: to get clarity for myself on where I stand on any given issue in Latin America. I think development banks love giant projects like these because it helps justify their existence. Big, bold dreams are exactly the kind of think they’re supposed to helping make a reality in Latin America, so you can always count on them to finance giant dams, infrastructure, etc. And there is of course the possibility that I’m wrong about regional transmission grids…

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