The strong share of hydropower in Latin America and the policies to go beyond

As the global arena adamantly scours for new resources, methods and instrumental technologies to combat the energy demand crisis, renewable energy sources present themselves as a sustainable and increasingly attainable solution. Developing economies such as those located in Latin America are beginning to harness the economic and electric potential behind their rich topographical environment in order to fulfill their respective energy requirements.

Ever since the start of the 2000’s Latin America and the Caribbean has become a proactive promoter of renewable energy. In 2020 the renewable energy capacity for the region neared 280 gigawatts (GW) which represents a growth of more than 60% when compared to the start of the decade. Its wind capacity stands at 34 GW, while its solar photovoltaic capacity stands at 21 GW. In 2019 the installed power capacity in Latin America surpassed 400 GW, an increase of almost 50% in comparison to 2010. Nevertheless, it is crucial to denote that despite the geographical proclivity regarding the diversification of the renewable energy market, hydropower has seized the clear victory within the region. In 2020, alone the hydropower capacity in Latin America and the Caribbean amounted to around 200 GW, representing a 30% increase in comparison to 2010.

This analysis will primarily examine the proliferation of hydropower in the region, as well as the challenges it poses. Then, the text will proceed to detect the support policies introduced by Latin American nations in order to promote the diversification of the renewable energy market, as well as consolidate their hydropower capacity. Finally, it will reveal the tax legislation reforms concerning renewable energy in the area.

Hydropower, the main renewable source

Hydropower is the most widely utilized renewable power source in the world. The global hydroelectric installed capacity which exceeds 1,295 GW, accounting for more than 18% of the world’s total installed power generation capacity and more than 54% of the global renewable power generation capacity. Hydropower has as well a sheer dominance within the energy market of Latin America, representing 45% of the total electricity supply for the region, with an installed capacity of 196 GW in 2019.

South America, with an installed capacity of 176 GW, entailed the fastest hydropower growth rate after the East Asia and Pacific region in 2019; in 2020 Brazil surpassed China with 4,919 MW of added capacity. This impressive fact is attributable to the inauguration of the 11,233 MW Belo Monte hydropower plant, which will provide electricity to 60 million people, positioning itself as the fourth largest in the world. Nevertheless, Brazil’s hydropower superiority relies on the Itaipu hydroelectric dam, the largest hydroelectric asset in the world. On the other hand, Chile possesses almost 16 GW and Argentina almost 22 GW of hydropower potential. Additionally, in Colombia the Ituango hydropower plant is expected to start operating in 2021, as it is bound to support 17% of the country’s energy demand. Furthermore, within the scope of Peru’s plan to become energetically self-sufficient by 2040, a couple of power plants are expected to enter into operations within the next few years.

Crucially, it is imperative to denote that the successful dissemination of hydropower within Latin America is largely due to its geographical positioning and the fluvial availability offered by a plurality of rivers. The major basins are located east of the Andes, with the main rivers flowing towards the Atlantic Ocean. Additionally, the four largest drainage systems comprising the Amazon, La Plata, Orinoco, and Sao Francisco rivers, cover about two-thirds of the continent.

Nonetheless, hydropower does not constitute an infallible energy source, as climate change may generate negative repercussions for it, whilst creating a necessity for the diversification of the renewable energy market. Climate projections assign an escalation in the variability of extreme precipitation events, which translate into unpredictable floods, droughts, and heavy rainfall by the end of this century. The latter, presents itself as a paramount threat towards hydropower as the unpredictability of extreme precipitation events will “increase risks to hydropower generation by altering water availability, increasing sediments or causing physical damages to government subsidized assets”. In addition to the spatial variation in precipitation patterns, Central America, Mexico, Chile, and Argentina are forecasted to experience a concise reduction in precipitation in the coming century, which would inevitably be detrimental for hydropower.

Besides the imminent threat of climate change, the subject concerning aging hydro plants raises concerns about the viability of hydropower. The standard lifespan of a hydropower plant or dam is 30-80 years, a digit which has been already surpassed in some countries such as Mexico and Peru, where the average technical lifespan of a hydropower facility is estimated to be between 81-104 years for the latter. In fact, over 50% of the installed capacity within Latin America is stated to be over 30 years old (6). Hence, due to the limited availability of capital in the region, and the intensification of environmental constraints regarding construction permits, it is likely that lifespan expiration of hydropower facilities becomes a standard practice in Latin America.

Policies to boost renewable energy: auctions

The IEA World Energy Outlook projects that, due to the development of other renewable sources, the share of hydropower would stay globally at its current level. In the case of Latin America, as result of both climate change and aging hydropower facilities, hydropower capacity will most probably decrease within the next decade. Consequently, governments within the region will need to establish novel legislative proposals that promote the diversification of renewable energy sources and the conservation of hydropower against the adversities of climate change.

Ever since the usage of renewable resources became economically viable for Latin American countries, the implementation of support policies has become a common-place practice within the state agencies of the Latin American nations. According to a Pfeiffer and Mulder’s 2013 Study of 108 developing economies, the likelihood of investing in renewable energies is 30% higher in countries with support policies. Now, due to the cost gap between conventional sources (such as fossil fuels) and renewable energy, investments in the latter have relied on the implementation of price-based and quantity-based support policies.

Price-based initiatives consist of feed-in tariffs (FITS) that set a fixed price at which the renewable energy could be sold, ensuring a return on investment in a stable predictable framework. On the other hand, quantity-based policies rely on renewable energy auctions or ‘demand auctions’, whereby the government basically issues a call for ‘tenders to install a certain capacity of renewable energy-based electricity’. Within these types of auctions project developers will submit a bid with a price per unit of electricity at which they are able to realize the project, the government will then evaluate the offers and proceed to sign a purchasing agreement with the successful bidder. Upon this exposition, the Pfeiffer and Mulder study determined that since 2012 the auction system has consolidated itself as the main policy instrument characteristic of the region with generally positive results.

Actually, by 2017 10 countries in the region had implemented at least one type of renewable auction policy. The dominance of auctions in the region partially relies on the sub-performance of feed-in tariffs in Latin America, as the few countries that have applied such a policy have endured relatively poor results. For example, in 1998-2006 the public policy based on feed-in premium in Argentine failed to advocate for renewable energy sources which were affected by an ‘unfavorable macroeconomic and regulatory context’.

Moreover, the application of the auctions has propelled the renewable energy market within the region, providing sufficient intelligence to distinctly identify five advantages of the auction system. According to German Bersalli, Philippe Menanteau and Jonathan El-Methni the auction system i) provides a stable revenue system that facilitates project funding, ii) stimulates competition amongst producers in order to facilitate the externalization of the costs concerning renewable energy, iii) renders itself adaptable to technologies with varying degrees of techno-economic maturity, iv) allows the introduction of other selection criteria that may support national public policy such as job creation, v) finally and most importantly, the auction system ensues itself as a perfect fit with the institutional design of the electric system in most Latin American countries. Hence, due to the authoritative nature of the previously mentioned assertions, their legitimacy shall now be corroborated with concrete case study from various Latin American countries.

Brazil, a regional leader in renewable energy implementation, has had a successful experience with the application of energy auctions. Originally, the utilization of auctions was contingent on price disclosure and the reduction of asymmetric information between the energetic industry and the government. Within the socio-economic and political context of Brazil, the auction scheme is utilized to meet the growth in electricity demand within a regulated market and/or to affix a supplementary energy outlet in order to expand the electrical system’s reserve margin. As a result of their effective implementation, ever since 2008 auctions have been launched annually to contract renewable energy projects. Moreover, in 2005-2013 a total of 62 GW was contracted via 52 auctions for new energy capacity, including nine renewable energy power generation auctions. Additionally, the introduction of the auction scheme comprised an effective catalyst for renewable energy investment. For instance, once the first alternative energy auction to attract small hydropower and biomass projects was inaugurated in 2007, 143 companies progressively registered for pre-qualification.

Following the standardization of the auction scheme within the governmental energy policy, there has been a prolific promotion in wind energy, which in some regions is starting to crowd out biomass and small-hydro. Besides, technology specific auctions have generated support for the development of other types of renewable energy. Before 2010, all auctions involving renewable energy in Brazil were labeled as technology-specific (which solely focused on one typology of energy), whose execution led to a corresponding market development. Consequently, the price competitiveness that ensued, allowed all the renewable energy sources to compete directly with each other. Therefore, when one type of renewable energy is unable to compete with another (such as wind and solar energies), the tension generated by the auction regulated market scheme will propel the creation of alternative support schemes that introduce the unfavored renewable energy into the marketplace.

In the complementary ambit of the spectrum, Peru also provides a veritable exemplification of the correct application of the auction scheme into governmental policy. Subsequent to the restructuring of the power sector between 1991 and 1993 crystallized within the Electricity Concessions Law of 1992, the adoption of the auction scheme became the prevailing and fixed standard for energy commercialization. Following the application of the aforenamed law, the Peruvian auctions were prosperous in bringing prices down. For example, between their first auction in 2009/2010 and their second one in 2011, prices decreased by 14% for wind, 11% for small hydro and 46% for solar. In addition, Peru’s auctions have been instrumental in attracting RE project developers, as they have helped secure a minimum of $420 million in investments. The favorable ramifications of the auctions also manifested themselves by 2011, year in which the Ministry of Energy and Mines contracted a total of 639 MW of renewable energy across 26 projects with minimal additional institutional costs. Finally, the auction scheme was ultimately successful in the attraction of foreign company investments, which greatly benefited the overall economic growth of the nation.

While the promising by-products of the auction scheme have been manifested via the previous two case studies, it is of pivotal importance to denote that deficiencies within the system are a natural corollary of their implementation. Normally, a customary disadvantage attributed to the auction system relies on the favorability of ‘big’ existing competitors or actors, which translates into the arduousness of new and small producers to enter the pre-existing markets. Specifically, in the case of Brazil, the low prices set forth by the auction scheme during 2010-2011 raised concerns regarding the realization of allocated capacity. For instance, in a study conducted by Bloomberg New Energy Finance, it was estimated that 40% of the wind capacity incurred in 2012 would produce returns below 10%. In the Peruvian case, the targeted volumes (specifically for biomass and hydro) were not always met due to price ceilings being set too low, a procedure which mechanically disqualified bidders that offered higher prices. Therefore, in an attempt to circumvent the minor disadvantages within the auction system, Latin American nations have established a commonplace practice of encouraging renewable friendly tax reform legislation.

More policies: tax incentives

The previously mentioned uncovered vulnerability in hydroelectric sources accompanied by the slight deficiencies in the auction scheme have prompted legislators in the region to introduce regulatory tax reforms in order to diversify the renewable source’s economic viability. In other words, legislators employ taxes to foster investment and growth of renewable energies in order to reduce the regional dependency on both hydropower and auctions.

Argentina, for instance, as the second largest electric consumer of South America (after Brazil) has adopted a compilation of laws and regulations aimed at promoting renewable energy sources. Based upon these regulations, it is presently required that 20% of all the electricity consumed by the Argentine republic must be produced via renewable energy resources by 2025. Also, the Chilean tax reform has included the possibility of deducting expenses incurred due to demands or environmental conditions imposed for the execution of a project or activity, continued in the resolution issued by the competent authority that approves said project or activity in accordance with current environmental legislation”.

In another example, Colombian law detects three diverse forms of tax incentives introduced since 2014. The first taxation incentive is crystallized in the Act. 1715 of 2014 which was introduced to promote non-conventional sources of energy (NCSE) with a specific prominence on renewables. Secondly, by decree, “efficiency projects are allowed to claim up to 25% of the investment as a tax credit against income tax liabilities. Lastly, projects intended to (i) prevent the production of solid or liquid waste, (ii) the preservation of biodiversity and renewable natural resources are eligible for tax benefits.

Lastly, Uruguay, internationally recognized by the Renewable Energy Agency as one of the leading nations regarding the production of wind and solar power, has several tax incentives applicable to renewable energies. The Investments Promotion Regime (codified in Act. 16,906 and Decree #143/018), grants pertinent tax incentives to general investment projects advocated by the Executive Power. These tax benefits are subject to compliance with various indicators such as employment, increase of exports and indicators related to renewable energy investments typified by the usage of ‘clean technologies’. Likewise, the Power Generation Regime (Act 16,906 and Decree #543/009) establishes a specific regime of tax incentives for renewable energy regarding’ electricity generation from non-traditional renewable sources, energy resources production from renewable sources, conversion of solar power into thermal power, amongst others.

Thus, in light of the factual evidence portraying the regional tendency towards tax incentives regarding renewable energy it is prudent to state that the region is aiming towards the diversification of their renewable energy outlets.

A resolute bedrock

In essence, despite Latin America’s comparative tardiness with respect to the steadfast and consistent exploitation of renewable energy, throughout the last decade, the region has steadily adopted a fairly uniform legislative framework. The region’s geographical and topographical richness provides a resolute bedrock for the application of diverse support policies or techniques that adapt to the energy necessities of each country. Regardless of the statistical and material primacy of hydroelectric power in the region, the imminent threat posed by climate change has compelled legislators to expand their renewable energy arsenal.

Therefore, the progressive implementation of auction schemes and tax incentives are simply the organic methodology for the diversification of renewable energy sources within Latin America. Consequently, in spite of the geographical and socio-political differences within the heterogeneous nations of Latin America, their energy derived necessity acts as a legislative adhesive that creates a corresponding legislative framework regarding renewable energy sources. In other words, the amalgamation of legislative procedures in response to common needs.