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ByMark Turner

Nansen, 8th century Chinese Zen master.

Note: Your author is the first to admit that this post is longer than the average, but it can be summed up in the following six points. If it is still interesting to you after reading these headers, then read on. You will find there are some charts along the way to lighten the load. A PDF version is available free of charge by sending me a mail (my address can be found by clicking my namehere). MT

Chile is facing an acute energy shortage for the next four months. A series of factors have combined to create a “perfect storm” in its energy generation sector.

Electricity generation costs will be substantially higher than in 2007 due to lack of hydroelectric generation supply and reduced natural gas deliveries from Argentina.

Thermal energy production is key in the next four months. Figures suggest that supply will be very tight, and there is a clear and present danger of supply failing to reach necessary levels. Even if Chile manages to supply higher cost fuel to all its thermal electric power stations and they run non-stop, it is likely supply will still not be enough to meet the demand required to sustain macroeconomic growth at forecast levels.

Chilean ministers describe the situation as ‘delicate’, but are currently telling its populace that there is ‘no cause for alarm’. However authorities quizzed by international media have been more candid, with admissions that the system “is close to breaking down”. We certainly agree. Chile is already affected by a significant outage in one of its main thermal generation plants throughout the period, and any further restrictions in any of its large generation plants will cause severe disruption.

We see three possible scenarios for the Chilean energy sector in the next four months. Even our ‘best case’ scenario is not optimistic. Our ‘realistic case’ scenario calls for substantially higher energy costs for the country that will eat into GDP growth and stoke inflation. Our ‘worst case’ scenario implies severe across-the-board disruptions that would markedly affect the economy and have substantial knock-on effects in world markets.

Chile’s key copper industry will feel the effects of this energy crisis. We forecast Chilean copper may fall short of expected production by at least 68,000MT in the next four months, thus restricting an already tight market. The price of copper will rise on the world market due to this shortage.

Unless otherwise stated, all figures for the Chilean energy sector used in this report come from official published reports and data from the CNE (national energy commission of Chile) and the SIC (national energy grid of Chile, Central region)

Macro Overview of Chilean Energy Sector

Chilean electricity is 99.9% generated either by hydroelectric or by thermal power stations run on natural gas or fuel oil/diesel. The country runs no nuclear power and very limited power comes from alternative sources such as geothermal or wind power. Since 1980 electricity generation has been 100% in the private sector, with 26 companies operating generating concessions and five companies operating transmission concessions.

Depending on annual precipitation levels in any given year, either thermal or hydro provides the lion’s share of electrical energy supply, but installed capacity is 60% thermal and 40% hydro. The hydro sector takes the lion’s share of the workload whenever possible as it generates at a significantly lower cost per KWh, but as the meteorological conditions in the most heavily populated central area of the country mean that rainfall is concentrated around the months of June and July (with very little precipitation in the first part of the year), inter-annual mix changes constantly.

As befits a country experiencing a prolonged period of economic growth, demand for electricity continues to rise. Fig. 1, taken from the SIC website, shows growth since 1985 and in that period demand has increased an impressive fourfold.

This growth is slated to continue at the same pace in 2008. Fig. 2 shows monthly demand for 2007 and the forecast monthly demand for 2008. The CNE predicts a YoY growth rate of 4.96% for total electricity demand in FY08.

It is worth mentioning in passing that the growth forecast in energy demand made by CNE is not just numbers plucked out of the air, but forms an integral part of GDP growth predictions for the year ahead.

We now turn our attention to the energy supply breakdown in the hydroelectric and thermal generation sectors in greater detail.

Hydroelectric Sector and Supply Problems

At present, hydroelectric power generation has been severely restricted by a lack of rainfall in preceding months. On February 1st Chilean energy minister Marcelo Tokman reported that 2007 had been the third driest year in the last 50 years and reservoir levels were on average 40% lower than expected (1). At the same press conference, Chile’s Interior Minister Edmundo Pérez Yoma said he expects 2008 to be equally as dry as in 2007 (though perhaps predicting the weather is a dangerous game to play). Adding to the problem was a recent period of cold weather that had stopped ice and snow in mountainous regions from melting as normal and supplying reservoirs.

Thermal Sector and Supply Problems

Thermal generators are traditionally supplied with natural gas from Argentina. In 1995 the two countries signed an accord to guarantee supply that means Argentine natural gas should cover all needs as well as covering domestic gas demand in urban areas. In practice Argentine gas supplies around 80% of the power needed to supply Chile’s thermal stations, this partly due to a Chilean law guaranteeing supply precedence to domestic users.

However, since 2004 this scenario has deteriorated. Argentina’s energy ministry passed resolution 659/2004 which took away the guaranteed nature of supplies to Chile. Once this law was passed, natural gas supplies were immediately affected (though for only a short period in 2004). However Argentina took further action in 2005, cutting gas supplies by around 60% for a period in August, and then cut gas supplies in 2007 by 64% in May 2007. The most recent restriction was in January 2008, when Argentina drastically cut gas supply to its neighbour. The 1.2 million cubic metres of gas delivered by Argentina to Chile last month compares to the near 16mm3 of January 2007.

All these restrictions force Chile to use fuel oil/diesel to power its combined cycle thermal power plants. As fig. 3 shows, the cost of producing thermal energy from fuel oil/diesel is substantially greater than that of natural gas. Although these figures pertain to the US energy sector, we can assume that the percentage differences are close enough to that of Chile to be a fair comparison. In fact, it is likely that the USA pays more than Chile for its natural gas due to the ongoing contracts Chile has with its neighbour, Argentina, but for the purposes of this analysis is we will assume ratios are similar. What is clear is that Chile has to pay substantially more to power its thermal generation plants with fuel oil or diesel than it would if natural gas is the sole source of energy.

Our best estimate is that the cost of powering thermal stations in Chile rises by 80% if fuel oil/diesel is the source fuel. There is also a significant increase in pollution levels when fuel oil/diesel is used to generate electricity.

Details of the Supply Mix 2007/2008

According to official forecasts from Chile’s energy commission (CNE), hydroelectric power generation will be significantly lower in 2008 than in 2007 due to the aforementioned dry weather period. The major share of the workload will therefore be taken up by the thermal generation sector.

Fig. 4 below shows Chile’s power generation mix for the period February 2007 to January 2008, and the predicted generation mix for 2008 going forward according to official CNE figures. The CNE makes three separate forecasts annually; one for wet conditions, one for ‘normal’ conditions and one for dry conditions. As this year will almost certainly fall into the ‘dry’ category, these are the figures used for our analysis. As we can see, thermal power generation will be used to a far greater extent in the first part of 2008 than it was in the corresponding period of 2007, with the equivalent reduction in hydro generation.

Therefore the problem for Chile in 2008 is that although electricity demand is forecast to grow by 4.96%, hydro power supply has been severely weakened by the lack of rainfall. In fact, thermal power supply under the dry period scenario will have to increase by 18.28% YoY to meet this increased demand, as fig. 5 illustrates:

Thermal Supply Disruption

The thermal generation sector is, therefore, critical for the short-term situation in Chile. This brings us to December 19th 2007, when Minister Tokman outlined the rainfall and Argentine gas supply problems up to then and remarked somewhat ironically, “It seems like a joke, but everything that could have gone wrong, did.” (3)

He was wrong. Last week, the minister was informed that the large ‘Nehuenco I’ thermal generator that has been offline for repairs since December 2007 would not be able to come back online in March 2008 as expected, but would be offline at least another 5 months to July 2008. We can only imagine the sinking feeling he must have felt when informed of this, because Nehuenco I is responsible for at least 11% of Chile’s thermal generation supply. The timing of this extended delay to recommencement could not have come at a worse time. Fig. 6 outlines the importance of Nehuenco I; when looking at the figures it should be remembered that the station was offline in July 2007, thus the 11% total load figure for the period is likely to be higher in any other year.

To summarize, there are three basic ingredients to the near-term problems facing Chile’s energy sector: 1) Weather conditions largely blamed on the “La Niña” effect have meant that precipitation has been at record lows, with resulting low water stock levels at reservoirs. 2) Natural gas supplies from Argentina have been dramatically cut. 3) Loss of supply at Chile’s Nehuenco I power station

Thermal Generation is Unlikely to Meet Demand

This next table is rather long, but we feel it is necessary to go into some detail about the key thermal power generation sector. Fig. 7 shows all the Chilean thermal generating power stations, and next to each name the amount of power in MWh produced by each station in its best single month during the 12 month period February 2007 to January 2008 according to the CNE. We have then added up all those top performing months at each station to give us an aggregate figure, and also a figure excluding Nehuenco I which is out of action.

Of course, no power station ever operates to the same level over a long period of time, but we have taken each station’s best month of twelve to show what each can achieve if asked to perform to the best of its abilities over an extended period.

If we now go back to the previous supply mix chart (fig. 4), the problem becomes evident. During the months of March, April, May and June 2008, the thermal generating plants will not be able to produce enough electricity to satisfy projected demand even if they operate at the maximum single-month output levels of 2007, non-stop over four months. Fig. 8 summarizes the figures:

To get all stations operating at optimum levels over the next four months can safely be described as “a big ask” by the Chilean government. We would expect that in reality production levels fall somewhat short of the figures we outline in fig. 8. Either way, supply restrictions are all but guaranteed. We would also point out a more ominous possibility; excluding the offline Nehuenco I, over 56% of remaining thermal power supply is concentrated in seven of the total 57 generation plants (namely Guacolda I, Guacolda II, Nehuenco II, San Isidro I, San Isidro II, Ventanas II and Nueva Renca). If just one of those larger stations suffered a problem at any time from now until July it would undoubtedly cause severe energy restrictions across the board and a full-blown crisis would ensue.

Recently Announced Restrictions

To its credit, the Chilean government has not shied away from the problem and has recently taken steps to combat the impending energy squeeze. It certainly has a more responsible attitude to its energy problem than that of Argentina. When asked last week about the gas supply shortages currently affecting Argentines, Argentine planning minister Julio De Vido (who can be characterized, shall we say diplomatically, as a ‘typical’ example of LatAm politician) brushed off any problem by saying, “This always happens at this time of year” and went on to say that the government would keep to “the same policies” as always in the energy sector (4). In our view, it would be unfair to call De Vido irresponsible, as the adjective is far too modest to describe his attitude.

Back to Chile. On February 8th, the Chilean government announced a series of measures designed to save energy in the period to come (5).The measures include:

a) A 10% reduction of voltage supplied to domestic users, implying that supply will be dropped from the normal 220v to 198v.

b) An extension of daylight-saving time to the last week in March

c) An enforced 5% cut in power consumption in government offices.

d) Distribution of energy-efficient lighting.

e) Pledges from industry to save electricity by turning off non-essential machinery.

Minister Tokman said these measures would help stave off more restrictive power rationing measures in the immediate term, but could make no guarantee for the rest of the year. He also pointed out to the public that the drop in voltage would not affect normal domestic apparatus. We believe that although Chile’s government is taking a responsible attitude to the impending crisis now, it is very much a case of ‘too little too late’. The voltage reduction may help somewhat but has the side-effect of reduction supply efficiency. The extension of daylight-saving time will only have a marginal effect, as it will only be of any significance in the southern regions where little energy is consumed compared to the populated Central and industrially rich Northern regions. The other measures also strike us as different sized drops in a very large bucket.

It is also telling that they have introduced these measures in the month of February, historically the month with the lowest energy demand of the year (see Fig. 2 above). The government has emphasized the heavy-use month of March as its main target, but has not explained to the Chilean public that the crisis will almost certainly continue until the rains (hopefully) arrive in June. There are surprises in store for Chilenos, and they are unlikely to be pleasant ones.


We have little doubt that Chile’s economy will be affected by the problems in its energy sector we have highlighted. The forecast figures made by CNE at the beginning of the year assumed that energy demand would grow by nearly 5% in order to fuel the expected GDP growth. It therefore stands to reason that less energy supplied means less growth. However we will stop short of making any firm predictions on the effects on macroeconomic figures as we feel it would be precipitate to do so at this time. There are too many variables in play to allow any firm predictions for Chile and its energy sector and events as they unfold would probably change any early-stage forecast that used a swathe of specific numbers. However it is prudent at this time to give a broad-stroke outline, and we currently foresee three general scenarios. At the moment we favour the ‘realistic scenario’ as the most likely to play out, but emphasize the changeable nature of the next few weeks and months. There is no doubt that events will have to be closely monitored.

In fact, early estimates from Chile’s economy ministry have said that the country will suffer a 0.5% to 1% hit on its GDP growth figures (6). It seems to us they are guilty of guesswork. We would add that our realistic case implies a greater loss to GDP that 1%. We think they are still looking at their own ‘best case’ scenario.

Effect on Chile’s Copper Industry

Special mention must be made of Chile’s copper industry and how it might be affected by the energy crisis. We have gone into detail about the Chilean copper industry and its importance on the local economy in previous reports (available on our website or on demand), but suffice to say here that copper is responsible for over 60% of Chile’s export revenue, is the major source of wealth creation in the country and has been the main motor of economic growth in the last five years.

The government is well-aware of the adverse effects the coming energy shortage will have on the copper industry. In a Bloomberg report dated February 6th (7) Senator Balde Prokurica of the government mining and energy committee admitted that the energy system “is close to breaking down” and that miners have to brace for further energy cuts. Union spokesperson Raimundo Espinoza was equally gloomy and said that the risk was not only for state mining company Codelco but would affect the whole country.

Companies are reportedly prepared to shut down non-essential machinery. This will unfortunately be just another drop in the bucket, as the vast majority of electrical power supplied to mining companies goes to running smelters and SX-EW plant. Many have their own sources of backup power generation that can cover most but not all local power shortfalls, but will certainly add significantly to production costs.

Although we preferred not to make any estimates on how the energy squeeze to come might translate into macroeconomic figures, we do feel in the position to make a more specific preliminary estimate on how the problem might affect Chile’s copper industry. Fig. 9 shows copper production figures for the years 2006-2008 as estimated by the Chilean government body Cochilco. We see that SX-EW production, directly reliant on large quantities of electricity supply to produce its copper, now makes up over one third of all copper produced in Chile, with that percentage set to rise in FY08.

It is admittedly difficult to make an accurate forecast as to how the impending energy supply squeeze will affect copper production in the months ahead. However, we are basing our preliminary estimates around the following assumptions:

a) The ‘realistic scenario’ outlined above.

b) Copper producers are able to keep up 100% of smelter production via on-site generators using more costly fuel oil/diesel as a power source. This will affect profitability but will not affect copper production per se.

c) 10% of SX-EW production is lost due to energy reductions and/or outages during the next four months. We feel this is a conservative estimate, but prefer to err on the side of caution at present.

In fig. 10 we estimate the amount of copper production lost during the four month period March-June 2008. We base the numbers on the Cochilco estimate of 2084MT of SX-EW production for 2008 as a whole divided by three. We have highlighted the “10%” line to emphasize our preliminary forecast, but other percentage figures are also included for reference.

The effect on world spot prices for copper of a 68.3KT supply shortfall is likely to be significant. Fig. 11 shows current inventory levels at the London Metal Exchange (LME), and shows the drop in inventory levels so far this year to around 170KT. The market for copper is already very tight, and a 68KT shortfall in such a market is likely to push the price of copper, seen in fig.12, to higher levels. But we stress that these figures are in our view conservative. It would not be a great shock to see production numbers in Chile over the next few months that are substantially lower than our initial estimate. We believe that any shortfall will result in investment opportunities in both the metal and in copper producing companies, particularly those with little or no Chile exposure.

Longer Term Considerations

Although a little outside of the scope of this report, it is worth examining the longer-term energy situation in Chile. The country has learned not to trust natural gas supplies from its neighbour Argentina and is currently working on several projects to improve generating capacity and cost-efficient fuel supply. In the hydro sector, there are currently five projects under construction that will supply 70MW, 19MW, 55MW, 32 MW and 155MW respectively, a total of 331MW which will come on line in stages beginning late 2008.

Three new gas-fired plants are also being built, with production capacities of 250MW, 370MW and 120MW respectively. Further down the line, plans are in place to begin construction of five more plants with a combined capacity of 1500MW.

Supply for the new thermal plants will become easier once the county’s first LNG (liquid natural gas) processing plant is commissioned in late 2008, with full capacity expected to be reached some time in 2009. This will remove its near total dependency from Argentine supply and allow shipments of LNG to arrive from other suppliers with relative ease. Another LNG terminal is also being built in the North of Chile in a joint venture between state copper company Codelco and Belgium’s Suez Energy that is expected online in 2015. Finally, Chile has been attempting to promote non-conventional energy projects (wind, solar, geothermal, etc), but with little near-term effect expected so far.

All this bodes well for the longer-term future of Chile’s energy supply and the country is obviously planning. However it is now playing catch-up against circumstances that have overtaken its longer-term plans. And as weather patterns change due to global warming, the country may not be able to rely on its hydroelectric sector as much as it has in previous years, with or without the new projects coming on line.


Chile is about to go through a serious energy shortage that may develop into a full-blown crunching crisis if events go against it. Whether it is victim of bad planning, bad luck or a combination of the two is a moot point, as although it has future plans in place to stabilize its energy supply present events have overtaken longer-term issues. 2008 GDP and growth figures are almost certain to be affected by events of the coming months, and the knock-on effects of copper production shortfalls into an already tight metals market are likely to be felt around the world. The only thing that remains to be seen is not whether the country goes through an energy crisis, but how deep that crisis will be.