Chile has a long track record of honoring business contractual agreements, underscoring the opinion among investors and sponsors that the country is one of the most attractive jurisdictions in Latin America to operate. This has been the case also for domestic and international infrastructure players, which sought stability and predictability in business conditions due to the long-term nature of investments in this industry.
To offset the recently sharp rise in Chile's electricity rates, the government has proposed several changes to power industry regulations. Here S&P Global Ratings presents frequently asked questions from investors how these proposals could affect the regulatory framework for the electricity industry, and consequently, the credit quality of projects.
Frequently Asked Questions
Why does S&P Global believe the proposal could be harmful for Small Distributed Generation Means (or Pequeños Medios de Generación Distribuida [PMGD]) projects?
If Congress approves the recently proposed changes without modifications, cash flow available for debt service of all PMGD projects will temporarily drop. This is because instead of receiving the stabilized price--stipulated in the existing law that's currently in the $65 per MWh area--it will fall. We will monitor the discussions in Congress that should help us to quantify the volume of the stabilized-price haircut, which based on preliminary details could reach 30% (to around $20 per MWh). At the same time, under this scenario, we believe that most of these projects will struggle to service their debts, particularly considering that their financing structures have only a 20%-30% cushion to absorb any unpredictable events. Moreover, most of these financing structures are restrictive, given that additional debt is not permitted, and liquidity is limited to a six-month debt service reserve account (DSRA). In addition, some of these projects may face mandatory repayments, given that debt covenants that could be triggered by a regulatory change. Consequently, debt restructurings among PGMD projects are highly likely, setting a troubling precedent for the industry.
What comes next?
Discussions over the proposal should occur in the next several months in Congress, where the administration does not have a majority. And given that there are no similar precedents in Chile of discretionary and arbitrary decisions that could hamper the electricity market's predictability without compensation mechanisms, we will closely monitor the developments to see if modifications to the proposal will be made. Overall, if approved, we'll perceive such changes as weakening the regulatory framework that could hamper the electricity sector's performance, and that similar changes could eventually expand to other industries.
What has happened with electricity rates in Chile recently?
On April 30, 2024, the government published the Law No. 21,667, which aims at the gradual normalization of electricity rates, given that the compensation mechanism for the past five-year power-rate freeze started to weigh on the sovereign's fiscal accounts. This will result in an estimated rate increase of 20% for residential customers (defined as those with monthly energy consumption below 350 kilowatt hours [kWh]) and about 5% for small and mid-size enterprises (SMEs; with monthly consumption of 350-5,000 kWh) starting in October 2024, absent any modification to the proposals recently presented. These electricity rate increases will be in addition to those already implemented in July 2024 (approximately 20% for residential clients and 50% for SMEs), related to the accumulated adjustments between January 2022 and January 2024.
How has the government responded to the power-price hike?
To offset the unpopular measure and mindful of the social unrest in 2019 (sparked by a small increase in the Santiago metro fare), the Ministry of Energy presented on Aug. 26, 2024, a proposal to Congress to:
- Expand electricity subsidies;
- Reduce rates applicable for SMEs and rural sanitary services; and
- Expand oversight powers of the national agency for the regulation of electrical products (Superintendencia de Electricidad y Combustibles).
Under the proposal, the Ministry of Energy intends to triple the amount of energy subsidies, reaching 4.7 million households (and about 10 million residents), which would require more than $900 million, in comparison to $120 million allocated for 2024-2026 annually. In order to fund this amount, the proposal incorporates the following:
- The establishment of a surcharge on the carbon dioxide emission tax (from $5 to $10 per ton of CO2 equivalent);
- The allocation of the collection of the net value-added tax (VAT) revenue stemming from higher electricity rates; and
- The establishment of a charge (FET Charge) on the withdrawal of energy from the electricity system.
The FET Charge is a transitional charge that will be applicable during 2025-2027 to all energy withdrawals from the national electricity system. The charge will work as a type of retention applicable to the stabilized price among PMGD projects. This in practice would result in lower energy rate attributable to the companies operating under the PMGD framework.
What are the potential effects from the recently proposed changes?
We view the proposed absence of a compensation mechanism for PMGD assets--if approved--as the first instance of the government's harmful intervention in the electricity market. As a result, this would most likely change our perception of the regulatory framework in Chile. Still, Congress and Senate will need to review the Ministry of Energy's proposal prior to its implementation.
Have there been other regulatory changes in the infrastructure industry in the recent past?
Yes, there have been some in the past five years. For example, in 2019, the Ministry of Public Works eliminated the 3.5% annual adjustment above the inflation for the rates across all domestic urban toll roads starting in January 2020. In addition, the government froze energy rates between November 2019 and mid-2024.
Nevertheless those cases did not alter our view of a stable and robust framework, because profitability and cash flow generation for industry players has been preserved through compensation mechanisms. For the urban toll roads, this took the form of concession extension. The power-rate freeze also incorporated the creation of the Price Stabilization Mechanism (Mecanismo de Protección al Cliente) that provided, among other aspects, liquidity to power generation companies in the absence of rate increases, allowing for normal operations.
What are the PMGD assets?
The Chilean government established the PMGD framework in 2006 for projects generating up to 9 megawatts (MW). Distributed energy generation is decentralized in form and performed by small grid-connected or distribution system-connected generators. The projects that operate under this framework are self-dispatched, receive transmission toll reductions, and have access to a stabilized price regime for the duration of their asset life. The stabilized price tracks the average price of all active power purchase agreements in the Chilean electricity system, and adjusted to the regulatory projection of the system's marginal cost for the 48 months from the date of its computation amid average hydrological conditions. The stabilized price is reset every six months (January and July). As a result, such a price is much more stable than the one on the spot market. Therefore, the PMGD framework allowed smaller players to participate in the energy market, while helping to diversify the pool of generators in the system and to expedite the energy transition process.
The number of assets operating under the PMGD framework has jumped at an average compound annual growth rate of 33% in 2016-2023, reaching close to 3 gigawatts (GW) as of June 2024. Such assets accounted for around 17% of the non-conventional renewable projects in Chile (chart 1). Multilateral lending agencies and commercial banks have been financing the construction of most of these assets, setting a precedent in the country's energy market, and making PMGD projects a viable option for developers and investors.
Chart 1
Currently, S&P Global Ratings rates privately several entities operating under this framework, all of which are solar power plants with investment-grade ratings. The debt of these entities has been structured on a project finance basis, given that it was issued by limited purpose entities, all assets and contracts were pledged to bondholders, there are strict covenants that limit the projects' activities (including the ability to issue new debt), and there is a cash flow waterfall that determines money flow. According to our base-case scenarios, the minimum and median debt service coverage ratios of all these projects are in the 1.2x-1.4x and 1.35x-1.7x ranges, respectively. And these entities benefit from six-month DSRAs.
Related Research
- Your Three Minutes In Chilean Solar PMGD Projects: Capacity Boom Confronts Challenges, April 4, 2024
This report does not constitute a rating action.
| Primary Credit Analyst: | Candela Macchi, Buenos Aires + 54 11 4891 2110; candela.macchi@spglobal.com |
| Secondary Contacts: | Julyana Yokota, Sao Paulo + 55 11 3039 9731; julyana.yokota@spglobal.com |
| Pablo F Lutereau, Madrid + 34 (914) 233204; pablo.lutereau@spglobal.com |
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