BARRIERS THAT AFFECT THE DEVELOPMENT OF ENERGY MARKETS IN THE SOUTHERN CONE OF LATIN AMERICA

Adrin Peres, Pan American Energy LLC, Argentina; Amanda Pereira, ARPEL, Uruguay Abstract
Gas and electricity are key driving forces for regional integration in Latin America, but the physical barriers and the differing pace of the deregulation and re-regulation process for both sources of energy in the different countries, complicates the adequate operation of energy markets. This paper analyzes the barriers that affect the development of energy markets and establishes the importance of eliminating these barriers to allow economic growth and a better standard of living for the region. Scenarios faced by the Latin American energy sector are strongly impacted by globalization, political and economical instability, technological development, stricter environmental standards and the need to supply markets at competitive prices. Market competition and energy integration allow for a more efficient allocation of resources, and contributes to regional optimization, but this process needs clear, transparent and harmonized regulations in order to be successful. The importance of natural gas as a source of power generation and industrial applications has increased significantly for technological and environmental reasons. However to ensure reasonable market prices and a stable supply of the resource physical and regulatory barriers must be removed. The process needs to facilitate the improvement of natural gas pipeline and power transmission infrastructure and to develop a framework of clear transparent and harmonized regulations. In particular the differences between natural gas market regulations and power regulations constitute significant barriers to the development of efficient markets. This process of removing physical and regulatory barriers will promote economic development and a better standard of living for countries in the region.

Background
Regional integration in the Southern Cone is a reality in a global world today. Fifteen years ago Brazil and Argentina began a process of integration based on the strategic idea of improving the conditions of their participation in the world economy, envisaging coordination among countries as a central instrument in the process. During the 90s, changes in the world affected conditions of the integration process. The worldwide consensus based on the idea that the elimination of frontiers and economic controls would impel general prosperity, promoted a very important opening of the economies of developing countries. The idea of changing the rules that govern international economic flows was abandoned in favor of the need to adapt national policy strategies to existing rules. The end of traditional funding sources of infrastructure industries in the regional countries together with the need for a fast expansion of services to attend increasing economic and social development led to a deep institutional and organizational reform of these activities. An important opening took place with the implementation of privatization governmental programs. The opening of the energy industry in the Southern Cone countries was seen as a great opportunity to strengthen synergies in the regional energy integration. Meanwhile the alignment of national policy strategies with the rules of the global environment and the opening of energy markets deeply altered the institutional and organizational context of the energy industry in the region. On one hand the role of governments in the control of energy policy was reduced and on the other hand a broad restructuring from the economic side increased the presence of international and regional players in the energy industry.

This has resulted in the entrance of new players in the regulatory frameworks of Southern Cone countries which are still fragile to face the challenges brought by the integration of energy markets. Therefore the elimination of barriers to energy market integration is extremely important. During recent years those players have identified a number of physical and regulatory barriers which were delaying the integration of the energy industry and various proposals designed to overcome those barriers have been promoted. In this environment it is necessary to diversify efforts, and while actions to surmount known barriers must be maintained, a new focus has to be developed to minimize the effects of the Argentine crisis on Southern Cone integration.

Physical Barriers
In recent years existing infrastructure has begun to expand via natural gas pipelines, oil pipelines and electricity transmission lines, crossing international borders to link previously separate sectors of energy supply and demand in the region. For example, the Bolivia-Brazil pipeline linked significant natural gas reserves in Bolivia to growing Brazilian demand bringing increased access to natural gas to the economically powerful states of Central, Southeast and Southern Brazil. Additional pipelines connected the well developed Argentine natural gas transportation system to three distinct regions of Chile: (1) the northern mining region; (2) the central portion of the country to serve the markets in and around Santiago and Concepcin; and (3) the far south to serve as a feedstock for world scale methanol production. Several projects are also competing to bring Argentine reserves to Southern Brazil. This regional integration is continuing to progress with the connection of the Argentine system to Uruguay (figure 1). By 2010, the ring connecting the most developed regions of the Southern Cone with all gas producing basins will be linked into an integrated network (figure2).

Gas Infrastructure 2000

Cuiab Sta. Cruz Belo Horizonte Ro de Janeiro San Pablo

Porto Alegre Santiago Concepcin Montevideo Buenos Aires

Capacity MMcfd

Argentine System 3835 BTB N. Chile C. Chile S. Chile Uruguaiana GCDS 1050 600 635 177 100 215 6612

P. Arenas

R. Grande

Total

Figure 1 Southern Cone gas infrastructure 2000

Possible Gas Infrastructure 2010

LNG
GTL
Cuiab Brasilia Espiritu Santo Belo Horizonte Ro de Janeiro San Pablo

Porto Alegre Santiago Concepcin Montevideo Buenos Aires BBP Loop Transiguaz TGN Loop GCDS + Gaucho C. Chile TGS Loop GTL P. Arenas R. Grande

GTL

LNG

Figure 2 Southern Cone gas infrastructure 2010 Similar development is expected to happen in the electricity sector. There is already an interconnection between Brazil and Argentina, which allows the interchange of 1000 MW of power, and a new interconnection of 1000 MW, is being constructed. Besides the interconnection with Argentina, a thermal generation plant is being constructed in Puerto Suarez in Bolivia to export 80 MW of energy to Brazil. The regional electric interconnection network includes the interconnection between Argentina and Chile incrementing in more than 700 MW of power the energy inter-regional trade (figures 3 and 4).

Power Infrastructure 2000

Sta. Cruz Ro de Janeiro San Pablo Curitiba Mendoza Santiago Concepcin Porto Alegre Endesa Termoandes 1000 MW 632 MW

Buenos Aires Baha Blanca

C. Rivadavia

P. Arenas

R. Grande

Figure 3 Southern Cone power infrastructure 2000

Power Infrastructure 2010

Sta. Cruz

Ro de Janeiro San Pablo Curitiba Porto Alegre Santiago Concepcin Buenos Aires Mar del Plata Endesa 2* 1000 MW Chile North- Center Argentina Expansion Brazil Expansion

Figure 4 Southern Cone power infrastructure 2010

Institutional and Regulatory Obstacles

Historically, resistance to the integration of the Southern Cone natural gas and other energy markets has been caused primarily by the existence of some political issues and the commercial interests of certain industrial sectors seeking to protect their entrenched positions in the industry. The unfortunate result of such efforts to restrict free trade is that competition is stifled, consumers are denied choices and obliged to pay prices which are unnecessarily higher than they would be otherwise, slowing economic growth. The local industrial sector in producing countries, which relies on natural gas as a source of energy or raw material, has opposed integration out of fear of losing a perceived competitive advantage to industrial competitors in non energy self sufficient countries by allowing them access to lower priced natural gas. The political support of this group against integration is based on the argument that it would be unwise to allow the exportation of raw materials without adding value through additional processing and that increased production would jeopardize natural resources, the legacy of future generations. In practice, the combined effect of these attitudes impedes the development of projects to add value to the raw material on either side of the border, and constitutes an obstacle to investments in exploration and production which would improve the well-being of said future generations by guaranteeing adequate natural gas reserves for both domestic and export markets. Similarly, natural gas importing countries contain industry players who are not in favor of the arrival of a more cost-efficient fuel source. These market actors generally control higher cost fuel options (liquid fuels, LPG in cylinders, etc.) or generating facilities that cannot convert to natural gas and may not be dispatched under more open market conditions (for example, coal or pet coke burning plants). These sectors not surprisingly, resist losing their dominant market position to a more economic fuel source. The 90s brought very important structural changes in Southern Cone energy industry. New institutional and regulatory guidance promoted changes in industrial organizations and opened an important space to private capital. In the case of electricity in the majority of regional countries this industry did not achieve its maturity with the exception of Argentina, and in the case of natural gas the process started to develop. The financial restrictions enhanced the role of multilateral institutions, particularly the World Bank to lead structural reforms in energy industry, which included the following:

The creation of regulatory agencies, independent from governments and state companies A new price structure based in the long-term marginal cost and the end of subsidies The prioritization of investments to reduce technical and commercial losses And the increase of private sector participation The countries of the Southern Cone have been implementing reforms of the energy sector that follow in general terms the recommendations of the World Bank. When examining those reforms, differing stages of implementation can be observed, showing different regulation models and markets structuring, and determining the existence of asymmetries which constitute barriers to energy markets development. Argentina is the country that has made the most significant progress in structural reform in the energy industry, through the privatization and structural separation of the oil, natural gas and electric chains. The natural gas and electricity sectors were structured as competitive activities creating a wholesale market for transactions, and in which large consumers and traders have open access to transport and distribution infrastructure at a regulated price. The Argentine experience was very successful in the expansion of electricity supply and the increase of electricity and natural gas exports to countries of the South Cone. Notwithstanding when this paper was prepared (March 2002) the process, which was moving slowly but in positive direction, suffered the impact of the Argentine financial crisis, the consequences of which are unknown and unpredictable. On the one hand the devaluation of the Argentine peso will lower domestic costs and could foster exports (including energy products such as natural gas, liquefied gas, oil and electricity). However, on the other hand, the imposition of export taxes establishing an artificially low export parity could neutralize the gains caused by devaluation. In addition, the risk of hyperinflation, the distortion of domestic prices and the lack of access to normal financing, have created a critical economic situation for a number of Argentine energy players, including oil and gas producers, power generators and transport and distribution companies. Domestic prices have been compulsively converted to local currency and restrictions to transfer the money abroad are in place. The terms of the licenses of the distribution and transportation companies have been suspended and a forced re-negotiation of the contracts is underway. Further, crude oil and other hydrocarbon exports could also be taxed. This situation could result in serious disruptions in business and will produce a substantial reduction in the investment programs of various companies, which, sooner or later, will have an impact on the volumes of oil, gas and power to be produced and the expansion of transport systems, negatively affecting the integration process. The regulatory changes implemented in Argentina did not occur in other countries of the region, resulting in regulatory asymmetries among the countries of the region. Brazil, in spite of having implemented a legal framework for the participation of the private sector, the pace, and results of the structural reform process have been very different. In the electric sector, the figure of Independent Power Producers was created and open access to transmission and distribution systems for big consumers was established, together with the creation of a regulatory agency (ANEEL). Despite the political decision to create a Wholesale Market of Energy, some difficulties delayed its implementation until 2003. Privatization conceived as the first step in the strategy of sector reform came to a standstill after the privatization of 70% of the distribution sector. Transmission continued to be state owned except for 20%, and in the case of generation the process stagnated because of a lack of regulations for water usage, blocking the implementation of the Wholesale Market of Energy and worsening the unfavorable economic environment. This situation affected private investment in thermoelectric plants. With regard to natural gas the established framework also had regulatory conflicts between federal and state regulations. The federal agency (ANP) implemented guidelines for competition of the production and transportation of natural gas and the state regulatory commissions defined a monopoly in distribution and commercialization of natural gas.

Another important obstacle has been the high interdependence of imported natural gas for the thermoelectric program because of the uncertainty of the exchange rate. The evolution of this process in Brazil has a serious impact on the development of integrated markets in the South Cone because of the size of its market. Bolivia in spite of its small domestic market, has become a key player in the dynamic of future integrated energy markets as a potential supplier of natural gas for the expansion of the electricity sector in Brazil. The process of reform took place in all energy industries and began with the Privatization Law and the Capitalization Law, which allowed the transfer of state companies to workers and private companies. In the natural gas industry competition was introduced in production through the concession of exploration areas to private companies and the privatization of the assets of the State Company YPFB. Incentives to private investment were also established in the transport sector. The most important achievement of this policy was the construction of the Bolivia-Brazil gas pipeline. After the starting of activities of this pipeline companies increased their efforts to add new reserves, multiplying six times the proven and probable reserves of the country. In the electricity sector different segments were separated in production, transmission and distribution with the participation of several private companies. Chile pioneered the introduction of liberal economic reforms and was the first country to reform the energy sector. It began with the electricity sector where generation was decentralized and separated from transmission and distribution. To supply the increasing demand of electricity generation government policy promoted thermal generation with natural gas imported from Argentina. After rationing of energy consumption in 1998-1999 the policy of increasing thermal generation was strengthened. However conflicts and legal disputes among generators caused by management of rationing demonstrated the fragility of the new regulatory framework, affecting the positive impression of Chilean reform. In the hydrocarbon sector, where more than 90 % of the internal supply depends on imports, the National Oil Company maintained its monopoly on exploration, production and refining but with great flexibility in management, promoting the diversification and internationalization through joint ventures. Paraguay is an example of the traditional organization of the energy sector with a public structure of monopoly in which the companies work as operators and regulators of the State in the sector. The institutional configuration of the energy sector in Paraguay is very different from that of other countries of the South Cone. Uruguay has initiated a reform of the energy sector, but its general configuration, maintains a traditional structure. A state-owned vertically integrated company operates the electric sector. The reform of the regulatory framework creating a Wholesale Market of Electricity has been approved but the law has not yet been regulated. The natural gas industry is starting to develop thermal generation supply, the industrial sector and home consumers. The introduction of natural gas through two gas pipelines from Argentina takes place under a regulatory framework that allows private participation and competition. After a decade of reforms of the energy sectors in the region, there are significant institutional and regulatory asymmetries, which are seen, in the differing pace of restructuring of regional energy industries. In Paraguay and Uruguay the reforms have not yet been implemented for political reasons. In the case of Brazil reform has stagnated with changes in the international economic situation after the financial crisis and the progressive devaluation of its currency. The evolution of Brazil as the major market to drive forward the dynamic of energy integration will assume significant implications for the energy markets convergence, redefining the institutional and regulatory barriers with other regional countries, especially with regard to Argentina. In spite of these significant obstacles, the natural gas infrastructure for interconnection among countries has made important progress during the last decade, which contrasts with electric infrastructure that has stagnated. At present projects developed in this area, seek the commercialization of electricity in great wholesale blocks among companies bilaterally positioned between the borders of the region. Existing and in-construction infrastructure is still far from the potential for interconnection of the region. The basic reason is the huge technical and economic complexity of electricity transactions, which demand a reasonable harmonization of the regulatory frameworks of the countries involved and competent technical coordination of the organizations that

manage the electricity systems. This institutional and technical-economic requirement has still to be achieved in the South Cone. For example the interconnection between Brazil and the border countries requires the investment in stations of frequency conversion because power in Brazil is generated at 60 Hertz while in the other countries it is generated at 50 Hertz. On the other hand simulation studies developed by CIER (Regional Energy Integration Commission) have demonstrated that interconnections that produce global benefits can be unilaterally prejudicial for market actors or countries, which makes it extremely important to pay attention to the mechanisms of allocation of benefits. If countries or actors are not negatively affected resistance to the integration process may arise due to the irrational distribution o the benefits derived from the integrated sector. Even though private operators are very active in detecting business opportunities, sometimes they do not have a systemic vision of two aspects: The detection of benefits of more complex quantification and their sustainability in the long term The needs of all actors as well as the community. Consequently it is important to design national policies, market mechanisms and governmental measures that promote the private operators initiatives on energy integration projects, and take into account equitable distribution of costs.

Integration: The Future of the Regional Market

The central aspect that characterizes initiatives of regional energy integration up to date, has been the execution of isolated projects that respond to the individual strategic vision of big international and regional players, especially regarding investments in natural gas. But the integration process needs a referential framework to be established through national policy, which may allow the development of harmonious regulatory frameworks. National governments and regulatory authorities have begun to take steps to eliminate such barriers through a more effective application of the principles fostering more complete energy integration. Such changes to the regulatory structure serve to level the playing field for those companies seeking to enter the market against dominant market players. Several examples of new rules and regulations implemented to foster an open energy trade could be mentioned: (1) the enactment by the Argentine government of an automatic system of authorization for natural gas exports (Resolution Nr. 131, Secretariat of Energy and Mining, dated February 2, 2001); (2) the elimination of tolls paid to and the significant reduction of the monopoly rights of the state owned company (Article IX, Law 17.292, dated January 29, 2001); (3) the attempts by the Brazilian government to increase flexibility on the natural gas transportation system in Brazil (Revision to Portaria Nr. 169/98, currently under debate). All of these represent important inroads towards a more open regional energy market. The experience of the natural gas industry in country after country has been that a system where open access, non-discrimination rules exist stimulates a cycle in which: 1) 2) 3) 4) Access to new markets is achieved by new industry players which; Creates a need for increased gas reserves / supplies Creates a need for infrastructure expansion; and Stimulates investment, continuing the cycle.

The end result of this process is a more secure and abundant supply of natural gas at market competitive prices, which fosters economic development and therefore a better quality of life for the entire region.

Conclusions

Regional energy integration in the South Cone represents an opportunity for sustainable development in the context of a global economy. The South Cone is an advocate for an integration process with growing risks and difficulties taking into account the situation of regional countries specially Argentina. But the benefits of integration are significant. The creation of a cycle among the regional national markets through economies of scale, the efficiency of national energy systems and consequently better served markets, requires an agenda to be developed by governments. This agenda should include the definition of an institutional process for the harmonization of regulatory frameworks and the progressive opening of national energy markets. There are still several institutional and regulatory asymmetries that have to be eliminated in order to obtain the potential benefits of the hydrologic resources, hydrocarbon reserves, and demand structure. But efforts to progress on markets integration needs to be focused on the coordination of government energy policies to advance energy reform. The definition of a precise agenda to deepen the integration process must involve all market actors, including governments and companies. International projects require the authorization of the governments involved and regional integration demands a joint action of regional governments together with companies to coordinate activities. This will allow institutional and regulatory barriers to be overcome; establishing formal processes and instruments of relationship among the agencies involved for implementing agreed joint decisions under the framework of a regional energy policy. It is the time for governments to assume their role in energy integration leaving the stage of agreements on generic principles, and focusing their efforts in the negotiation and coordination of specific actions and the management of natural conflicts that arise from cooperative relationships in a process of integration. This would lead to an active convergence that will level out the barriers that hamper the development of regionally integrated energy markets.