Rich in Renewables

Chile, Brazil and Mexico are countries rich in renewable resources, and are leaders in the Latin American region due to their governments’ position on renewable energy generation with adoption of innovative and aggressive policies. Investors lured by these enthusiastic policies in Latin American countries should nonetheless be aware of their long-term sustainability.

Chile, Mexico and Brazil are turning to renewable energy to build a more sustainable future. But the policies that support renewable energy must themselves be sustainable. 

Chile needs power – its electricity consumption is forecasted to grow at a rate of 7 percent through 2020. But the country is a net importer of electricity and does not have the native facilities to meet this demand. To close the gap, Chile, like other Latin American countries, is looking to its vast and largely untapped renewable resources. Chile is home to several solar-rich regions, including part of the Atacama Desert, the driest desert in the world with some of the world’s best solar radiation. Mexico also has significant stores of renewable resources: deserts that offer solar and wind possibilities, as well as thousands of miles of coastline that hold potential for marine energy. Brazil has a high solar incidence and a wind resource potential that is estimated to be approximately 140 gigawatts.

Facilities powered by renewable energy resources account for only a small percentage of Latin America’s generation. Generation fueled by renewable resources accounts for only 3 percent of Chile’s generation. Solar facilities in Brazil contribute only a miniscule amount to the country’s generation mix, as do wind facilities in Mexico. Many factors have contributed to the dampened growth in the renewable sector: the high cost of initial investment, difficulties in finding financing and outdated transmission infrastructure incapable of bringing energy from where it is generated to where is consumed. Moreover, without subsidies or incentives, energy generated from renewable resources is generally more expensive than that generated from traditional resources. 

Nevertheless, a flood of recent activity shows that developers are increasingly finding ways to cross barriers and invest in renewable resources in Chile, Mexico and Brazil. 

In January 2013, Arizona-based First Solar announced the acquisition of Solar Chile, a Santiago-based solar developer with 1,500 megawatts of projects in northern Chile in its pipeline. First Solar CEO Jim Hughes predicted that the combination of Solar Chile’s “market knowledge and promising project portfolio” with his company’s “resources, technology and strong execution track record” would bring the rapid development of significant solar generation capacity in the country. Also that month, Mitsui & Co., a Japanese investment group, announced plans to acquire a 50 percent ownership stake in a wind power generation facility under construction in Mexico. In Brazil, developers responded to the Brazilian legislature’s Program of Incentives for Alternative Electricity Sources (PROINFA) with 119 renewable generation projects implemented by the end of 2011. 

The success of these and future investments will rely as much on the regulatory framework established by legislators and policymakers as they will on access to the renewable resources. An enthusiastic government that creates a clear regulatory framework with indications of stability is a priority for investors.

It is indisputable that renewable energy was the success story of 2012 in the United States – almost half of new generating capacity installed last year was fueled by renewable energy sources – and it is reasonable to trace much of that success to supportive policies adopted by state and federal governments. But as any one-hit wonder can tell you, success now does not equal sustainability in the long run. So as countries in Latin America implement policies designed to incentivize the construction of an energy future based on renewable resources, investors that are lured by the enthusiastic policies into these countries should be aware of their sustainability. These policies and programs must be built on sound legal frameworks and foundations.

The Renewable Standard

As in the United States and Europe, the energy industry in Latin America generally is heavily regulated and the government can exercise that regulatory control to encourage and incentivize the development of renewable energy. The Brazilian government has made a number of changes to its policies to encourage the development of renewable energy. Likewise, Chile’s National Energy Strategy, released in 2012, prioritizes “the need to increasingly incorporate non-conventional renewable energy sources into the Chilean electricity matrix.” And Mexico, where the constitution requires the federal government to provide electric service to the public, has been active in enacting legislation to fight climate change for the past several years, including 2008’s Law for the Use of Renewable Energies and for the Finance of the Energy Transition (LAERFTE), which establishes mechanisms to promote the development of renewable power. 

One of the most common tools used by governments to jumpstart development of renewable generation is the imposition of a renewable energy standard (RES). An RES orders electric utilities to increase the percentage of renewable generation in their generation mix. The establishment of an RES sends a strong signal to investors and developers by instantly creating customers for their renewable generation facilities.

Twenty-nine states in the United States and the District of Columbia have RES requirements or goals. The Mexican legislature set an RES goal of decreasing the maximum share of the country’s fossil fueled power generation to 50 percent by 2050. Chile set an RES target of 20 percent by 2020, and Brazil is aiming to source 10 percent of its energy consumption in 20 years from renewable resources. 

RES policies require no financial outlay from the government, and are credited in a study published by global economics consulting firm NERA – Impacts of Renewable Energy Subsidies/Incentives on Costs of Achieving Renewables Goals – as being the most market-based incentives of renewable energy because they do not choose a winner within the renewables category in general. 

Nevertheless, customers fund the incremental costs of RES policies because renewable energy is invariably more expensive than fossil fuel fire generation. And in times of economic distress, those incremental costs are an easy target. As the United States economy still struggles to recover, RES policies across the country are coming under attack. In 2013, for instance, Virginia dropped the bonus that had been awarded to its electric utilities for meeting that state’s RES goals.

The most sustainable RES policies are those that are gradual and realistic and that place a cap on the amount of costs that utilities incur to meet the RES goals that can be passed along to customers.

Net Metering is Key

A policy that requires utilities to offer net metering is an unmistakable signal that the government is serious about encouraging the widespread installation of renewable generating units. Through net metering, the utility permits its customers to install a small generation facility, typically solar and sized no greater than the customer’s average annual consumption. The amount of energy generated by the facility is measured against the amount the customer buys from the utility. If the amount that is generated is more than the amount used, the utility has agreed in advance to buy back the excess. 

Net metering motivates customers to invest in small renewable generating facilities by guaranteeing that the customer will be able to buy power when the sun is not shining and by providing a financial incentive, all without requiring any direct government subsidy.

The cost of solar panels, although decreasing, still remains prohibitively expensive for many customers. Ideally, the law that requires utilities to offer net metering should also order the utilities to provide net metering in instances where a third party maintains ownership and operation of the facility. Permitting third parties to maintain ownership of the solar panels and sell the output to the residential customers explains why net metering is so immensely popular in sunny California, where the arrangement is permitted, and such a rarity in sunny Florida, where it is not.

In 2012, Brazil and Chile introduced net metering policies, following the lead of Mexico a few years earlier. Analysts expect net metering to kick-start the nascent solar industries in those countries, with some Brazilian PV distributors expecting a 50 percent jump in sales due to the policy changes.

Although net metering policies can lure investors, their success can be their undoing. Utilities are, generally speaking, reluctant to encourage their customers to buy less of the product they sell and can pressure the government to rescind or lessen net metering requirements. And net metering can shift costs to customers that do not net meter. Utilities recover their fixed costs associated with, for example, the distribution system that delivers energy to residential customers, through each unit of energy sold. Selling fewer units to customers that net meter forces utilities to pass more of those costs on to customers that do not net meter. 

In California, consumer advocates have raised the alarm that the state’s enthusiastic and ever-growing net metering program ultimately does more harm than good by unfairly shifting costs to non-net metering customers – typically lower-income customers – prompting an investigation by government regulators and possible suspension of the net metering programs. 

Similarly, Idaho Power recently proposed to impose a higher flat fixed charge to customers that net meter to help recoup its costs to maintain the distribution system – a move criticized by environmentalists for making net metering less attractive but that might make the program more sustainable in the long run. 

Incentivizing Growth 

One of the most successful policies for encouraging the growth of larger renewable projects in the United States over the past years has been the federal production tax credit (PTC), which provides a 2.2-cent-per kilowatt-hour benefit to project investors for the first 10 years of a facility’s operation. Similar laws have been enacted in Latin America: Chile grants tax credits to construction companies that use solar systems in new housing developments of up to 100 percent of the cost of the solar systems. Brazil also incentivizes solar through its tax system by offering to projects up to 30 megawatts in size an 80 percent discount off the taxes associated with the use of the distribution and transmission systems. And Mexico’s Accelerated Depreciation for Investments with Environmental Benefits allows investors in renewable energy to deduct 100 percent of their investment from tax liability during the first year of the facility’s operation. 

Special tax treatment encourages entities other than traditional developers to invest in renewable generation, which broadens the potential pool of capital. In the United States, a broad range of investors has been attracted by the PTC – spurring developments that might otherwise have taken longer to come about. 

Special tax treatment for the entities that invest, build and operate renewable projects has not been immune from attack, however. Last year’s battle over the PTC in the U.S. Congress demonstrates some of the issues. Furthermore, the economists at NERA warn that credit on capital may lead to a mismatch between the generation that is built – units with higher capital costs – and the generation that is needed – units that are less expensive but more efficient. 

Nevertheless, granting investors special tax treatment might be preferable to levying taxes directly on customers. Such taxes, like the one imposed on the majority of customers that use Brazil’s National Interconnected System to fund the PROINFA, can be easy targets as the electric rates rise. Germany also levies a tax directly on customers’ electric bills to fund renewable energy development that, according to the Wall Street Journal, accounts for 14 percent of the overall bill. Because of aggressive policies like this one, Germany has seen huge growth in its renewable industry, but is of late seeing a change in the political winds. Facing her re-election, German Chancellor Angela Merkel recently proposed putting a cap on the green energy tax through the end of 2014 and thereafter restricting its growth. This, developers and green energy advocates argue, will stymie the development of renewable generation by shifting costs back to developers. 

Using the tax system to encourage renewable energy development works best when the costs are diffused.

the Future of Incentives

The next generation of renewable energy policies is being designed with their sustainability in mind. Connecticut’s Clean Energy Finance and Investment Authority (CEFIA) was created in 2011 to transition the state’s clean energy programs away from grants, rebates and other subsidies toward low-cost financing of energy efficiency and renewable energy. CEFIA was established to attract private capital to partner with the public programs with the ultimate goal of lowering the price consumers pay for their government’s policies. Public-private partnerships (PPPs) like those encouraged by CEFIA lower the risks associated with renewable generation, thereby lowering the overall lifecycle costs of the facilities. Moreover, with the money of private investors come management practices that prioritize efficiency.

PPPs have great potential for the development of renewable energy, especially in Chile and Brazil, and to a lesser extent in Mexico. A 2010 report of the Inter-American Development Bank deemed Chile and Brazil two of the three countries in the region with the most potential to carry out sustainable PPPs. Chile was commended for its strong regulatory and institutional conditions and for laws that allow private generation companies to invest in and sell energy at wholesale as well as directly to retail customers. Brazil was also lauded for a political and regulatory environment that encouraged private participation in transportation infrastructure, but the study noted the dominance of state-owned enterprises in the electricity sector. But recent changes in Brazil indicate a willingness to open the industry to more private participation.

In Mexico, the study found that the “overwhelming power” of the Federal Energy Regulatory Commission (FERC) “undermines the attempts to introduce market-driven criteria in the project bidding and awards process.” FERC’s share of the country’s electric generation has fallen from 98 percent in 1996 to 60 percent in 2011, due in large part to the initiatives from LAERFTE.

Encouraging the development of renewable energy generation requires a balance between myriad factors: the costs passed on to customers, adequate incentives to lure investors, clear and stable regulations, access to resources and infrastructure, and innovation without losing sight of tradition. As the policies of Chile, Mexico and Brazil evolve, they will benefit both from the experience of the countries that have gone before them and from the circumstances that make the development of renewable energy generation uniquely possible in their own countries.

Fernando Alonso is a partner and  Noelle Coates is an associate at the law firm Hunton & Williams. They can be reached at 305-810-2500.

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