Impediments to Investment in Latin America Power Sector

1. Impediment to Investment in the Latin America Power SectorJaime Millan Inter American Development BankCLAI – OAS Energy ConferenceMarch 19th, 2002

2. Presentation • Power sector reforms • What investors want • Investment drivers change with time • Technical & institutional constraints to power sector reform • Conclusions

3. Reform has produced substantial benefits • Private sector has taken the investment burden while the lights are still on. • Substantial improvements in efficiency • Many sectors have profited from lower prices and higher quality • Large industrial and commercial consumers • State coffers drain has been reversed

4. Latin America is world leader in private investment in electricity Private investment 1990-99 Chile Argentina Brasil Panama Colombia Trinidad y Tobago El Salvador Desinversión Republica Dominicana Jamaica Nueva inversión Perú Operación y manejo privado con inversión mayoritaria privada Bolivia Costa Rica Guatemala Nicaragua Honduras Venezuela México Ecuador 0 50 100 150 200 250 300 350 400 450 Dólares per cápita Fuente: PPI Project Database, Banco Mundial

5. Reform elements • Attracting private sector investors, mainly foreign • Enlisting market forces to attain efficiency in the competitive segments of the market, thus minimizing regulatory burden • Establishing a new regulatory framework and regulatory institutions that foster competition, attain efficiency in the monopoly segments and protect the consumer • Using non-distortion, well targeted instruments to address social considerations

6. But Recently... • Little appetite for investment • Few bidders for distribution, Ecuador, Colombia • Investment in generation in Chile • Brazil: Reluctance to invest in thermal generation • AES and ENRON • Wholesale Market interventions in Colombia, Brazil • Regulators independence and competence is questioned :Colombia; Brazil

7. What investors want and some ways to get it • Low risk • Commercial PPA • Regulatory good connections • Country insurance, IFIs loans • High profit • Low cost IDB loans, tax holidays, subsidies • High prices avoid competition, seek vertical integration • Improve efficiency • The strategies to attract investors have evolved over time

8. The Pioneer: The text book sequence to reform • Attracting private investors was a major concern of Chile’s Reform • Corporatization of SOEs • Regulatory framework Little regulatory discretion • Limited scope for competition • Finally privatization with plenty of incentives for local investors

9. The second wave: Argentina had to rush but learned from others experiences • Privatize SEGBA without having in place the regulatory framework and the market • Need to grant initial contracts for SEGBA thermal plants and attractive conditions for distributors • Later on investors were eager to participate in a competitive generation market driven by abundance of natural gas and a sound investment climate • But, market mechanisms for transmission expansion have not been successful

10. The second wave:Privatizing distribution a critical step • Capitalization: a success story • Made Bolivia’s reform possible • Bogota’s successful experience was key to Colombia’s reform but has not been replicated • Sequence in privatization is important but not sufficient as the Brazilian case shows • And some privatized companies were slow in making efficiency improvements

11. But generation faced bigger challenges • The establishment of a competitive wholesale market in Colombia and Brazil: Work in progress • Matching long-term and short-term price signals • Price volatility in a hydro dominated system • The problems of the transition and the threats of government intervention

12. Not enough incentives for investments The changing rules of the game Broken promises And we need a better world Vertical integration Talk to the circus owner and seek special treatment Ask their government intervention Seek only PPAs Today’s investors Complains Strategies

13. Changing rules of the game • Wholesale Markets are work in progress and must be adjusted • Handling market power and capacity charges in Colombia • Brazilian MAE Reform • Chile’s change in Law • A sword of two edges: The Colombian distribution charges review

14. Workable competition • Concentration of ownership. Several countries that had unbundled prior to privatization have relapse. • Limitations in the number of players due to small market sizes and strategic behavior of multinationals • Perfect competition is not possible and some degree of workable competition is the only competition we may still hope for. • There is a trade-off between the short-term needs for regulation and the danger of foreclosing future opportunities for competition

15. Questions: Workable Competition in Small Markets • Is market concentration inevitable? • The Global strategies of multinationals • The difficulties in integrating regional energy markets in the short-term • If the markets are not workably competitive then some sort of regulation is inevitable • what kind of market power mitigation mechanisms should be used • Contracts, Caps, cost based pools • Regulated of vertically integrated monopoly • how best could they be enforced in weak institutional contexts • Trade-offs

16. The world’s largest utilities, 2000Source : Goldman Sachs

17. Who is to blame? • Lack of coherence between the reforms and institutional endowments and lack of time consistency in incentives have made them vulnerable to external shocks • economic downturn • weather • strategies of the multinationals • For that reason it is necessary to search for the original sin

18. Institutional constraints • The critical role of institutions was seriously underestimated • Consultants lacked expertise in institutional issues • Regulation is a foreign concept in French Law, therefore the lack of regulatory culture • Institutional endowment is a limiting factor • Antitrust institutions are weak or nonexistent • Property rights are often not clearly defined and control is not always exercised by the owner • Unpredictable and prone to capture Judiciary • Weak financial institutions and lack of hedging instruments

19. Institutional Constraints... • Regulatory capacity is also limited • Regulatory bodies and governance of the pool lack independence, human and financial resources, and expertise • Lack of coherence between regulatory and oversight functions, and the adequacy of the institutions • These and the asymmetric relation with the private foreign investors make regulators easy to capture

20. Conclusions • Investors have participation constraints that must be met • There is not easy answer because building credibility in regulatory institutions takes time and solutions in the interim may foreclose the scope of a future competitive market • Tradeoffs must be

21. Impediment to Investment in the Latin America Power SectorJaime Millan Inter American Development BankCLAI – OAS Energy ConferenceMarch 19th, 2002