Ecuador’s thirst for power

Like Brazil, Ecuador has been in the headlines of late as a result of power shortages. IFandP takes a look at the bigger picture, together with the country’s controversial decision to invest further in hydropower.

Ecuador was spared the worst of the global financial crisis and the following recession. Although one would think that given the country’s heavy focus on its oil industry, the rapid drop in oil-based revenues would have acted as a brake on growth, the country’s economy shrank by just 1.4 per cent in 2009. Current projections are for a mild return to growth this year, with the IMF predicting an increase in GDP of 1.5 per cent. The fact that oil prices have recovered substantially since early 2009 is encouraging, particularly given the increased need for state intervention in order to create lasting growth. A real issue has and will continue to be the country’s exposure to the US economy, which is currently home to over 1m expatriates and is one of Ecuador’s largest trading partners.

Ecuador’s power utilities are starting to feel the strain, thanks to a combination of high level of debt and the fact that electricity demand grew at a CAGR of around six per cent over the 2002-2008 period primarily spurred on by rocketing residential demand. Some breathing space was gained as a result of the recession, with demand dropping in 2009. In addition, it is now projected that the pace of future growth in electricity consumption will be lower at around 3.8 per cent per annum for the 2010-14 period. The main drivers behind past and future growth appear to be a buoyant construction sector, coupled with a continuing shift towards greater urbanisation.

The structure of the market

Ecuador’s electricity sector is predominantly state controlled. At present it consists of the regulator Conelec, which was set up in 1999, the Centro Nacional de Control de Energía (the national centre for the control of energy), together with 13 power companies, one transmission company and 20 distribution companies. The country’s total generating capacity in 2008 stood at 4307MW, relatively unchanged from that seen in 2007. Grid management relies extensively on electricity imports, particularly from Colombia. Typically total imports account for around 15 per cent of demand.

Ecuador’s buoyant construction sector and rising urbanisation are pushing electricity demand upwards

The high level of state involvement is something of a weakness, in the context of the current political situation. President Rafael Correa’s party, the Alianza País (AP) lacks a legislative majority and this combined with political pressure from the conservative opposition and the damage done to the government’s fiscal standing by the recent recession will make it hard for the state to deliver lasting improvements in this area. The need to continue operating at a fiscal deficit for 2010 in order to prop up the economy also restricts room to manoeuvre and while as mentioned earlier the rebound in oil prices will help Ecuador’s economy, the low levels of investment in the energy sector, resulting from the financial crisis will mean that oil output is unlikely to rise over the course of this year. Private companies involved in the country’s power sector such as Odevrecht and EDC have found themselves locked in lengthy contract disputes and payment delays. This poor commercial environment is effectively forcing the government to finance the majority of all infrastructure projects in the power sector.

A real issue, as is the case for many countries in Latin America is the reliance on hydropower, in the context of frequent dry spells that can result in significantly reduced power output. Utilities have taken a number of measures designed to reduce the impact of this such as building back up reservoirs and adding additional capacity. However, the situation is still one of the major drivers behind the country’s need to import electricity, especially from Colombia. The country’s reliance on hydropower led to power rationing being introduced in September 2009, thanks to one of the worst droughts in 45 years. This severely impacted on the 1075MW Paute dam, which is the largest of its kind in the country. By November, the situation was such only two of its 10 turbines could function, reducing its output from 20,000MWh to just 4000-5000MWh. The power rationing was eventually stopped on January 20th 2010 and since then reservoirs have returned to normal levels thanks to high levels of rainfall. The combination of reduced supply and power rationing reduced electricity consumption by four per cent during the November to January period and is estimated to have cost the commercial sector US$250m in lost business. Around the same figure according to President Correa was invested to help resolve the crisis.

The power crisis may owe its roots to more than just a lack of rainfall. Ecuador suffered from a severe economic crisis back in 1999/2000, which triggered a six per cent decline in GDP and forced the country to default on its external debt. Investment rapidly dropped off as a result and a lingering aftershock from the crisis was a massive increase in the poverty rate and this led to the imposition of a windfall tax on foreign oil companies in 2006, which led to reduced oil production in 2007. President Correa also threatened to default again on the country’s debt in December 2008 and levied a further windfall tax on the oil companies. As a result, private investment declined significantly in 2009. In addition, the political environment, along with unstable regulations and corruption has lead to Business Monitor International labelling it the most risky country in the region from the perspective of investors. In such a context, it is clear that Ecuador’s power sector has struggled to obtain the levels of investment needed for modern equipment and the capacity additions necessary to support further economic growth. Indeed, during the height of the crisis, President Correa took pains to cast previous governments as the cause, saying that it was the consequence of twenty years of not investing in electricity.

Interestingly in October 2009, Luis Castelo, a senior official at the country’s ministry of electricity and renewable energy (MER) said that the government was looking to boost the proportion of hydropower in its generating mix to 80 per cent by 2020, up from the current 43 per cent, despite “a lot of resistance from the indigenous communities.” A further 10 per cent would come from renewables, so that if the plan comes to fruition, the country would only look to fossil fuels to supply 10 per cent of its electricity. Part of the rationale behind this goal is the need to reduce Ecuador’s reliance on diesel imports, as despite being a major oil producer, the country lacks refining capacity needed to meet current demand. MER has also made the point that a switch to greater use of renewables would free up more oil for export. Its figures include that the program would allow Ecuador to export around 86Mta of oil, raising over US$5bn in revenue for the country.

The new drive to boost the country’s hydropower capacity is the rationale behind the Zamora hydropower project, which was announced by Ecuador’s Minister for Coordination of Strategic Industries Galo Borja in February 2010. The US$6bn, four dam project, with a combined generating capacity of 4000MW is expected to be complete by 2016 and will be funded by state-run companies. However, the hefty price tag, together with the difficulty of raising finance, raises serious question marks as to whether it will ever materialise.

However, Ecuador may not be entirely committed to hydropower, as its government signed a memorandum of understanding with Russia on civilian nuclear power in August 2009. This included a measure affirming cooperation in terms of geological research, the development of uranium fields and also for the production of nuclear fuel and for the creation of a legal framework for Ecuador’s yet to be developed nuclear sector. Around the time of the MoU signing, President Correa commented that Russia might provide US$2.5bn in financing “for our strategic sectors,” without elaborating further. The government has also been discussing the possibility of new nuclear build with South Korea.

A clear signal that the sector is in real need of renewal is the fact that transmission and distribution losses are in the order of 21 per cent. In actual fact, several distribution companies have reported losses in excess of this, with Emelmanabí and Sucumbíos declaring losses of 36 and 35 per cent, respectively. The decision to split the national state utility network into many smaller companies has failed to result in higher levels of investment and it is thought that high level of government subsidy in the sector is compounding the issue. The high level of transmission losses was behind President Correa’s recent decision to put forward a law that would make power theft a crime.

There has been some recent progress on this front, with CNEL reporting that total electricity losses due to unpaid bills, theft and technical problems dropped in 2009 to 25.99 per cent, compared to the 30.16 per cent recorded in 2008. In order to try to reduce this figure further, it is planning to invest US$60.5m in the installation of 250,000 remotely controlled meters for residential consumers.

Current projects

President Rafael Correa has already signed a US$2bn contract with China’s Sinohydro, resurrecting the Coca Codo Sinclair 1500MW hydroelectric dam project along the Amazon River. 85 per cent of the finance will come from a Chinese bank and the remainder will come from sales of oil to China. Although Sinohydro’s expertise in large scale hydropower is well known, its participation does fit into China’s pattern of investing heavily in oil rich developing nations, as has been seen in Venezuela and Africa. Ecuador’s government was originally going to provide 70 per cent of the funding for the project with Argentina providing the remaining 30 per cent. However, the project collapsed due to an inability to raise the necessary finance and therefore Ecuador was forced to pay US$5.5m to acquire the Argentine stake from its state power utility, on September 14, 2009.

Other recent investments include the purchase of two power turbines from the US for a total of US$14m, using state funds. They are to be installed at the Alvaro Tinajero and Abibal Santos thermoelectric plants and will generate 42MW and 20MW, respectively. Alstom Hydro is supplying two generators to the US$400m 162.6MW Mazar hydropower project that is expected to come online this month (March 2010).

In October 2009, power utility Hidropaute floated a tender for the pre-construction study and design of the 327MW Cardenillo hydropower plant. The design is expected to be finalised in 2011. There is also the Topo hydropower project which has recently had its designed capacity increased slightly to 22.7MW, by Conelec. Proyectos Energía y Medio Ambiente is developing the plant, which is expected to be up and running by May 2012. However hydrological studies conducted in the mid 2000s, indicated that it could only produce 6-10MW throughout most of the year. The project is also controversial, given the high level of biodiversity in the affected area.

In related news, Ecuadorian and Mexican companies have signed a US$2m two year design contract for two hydropower plants on the river Guayllabamba with Russia’s Gidroproekt Institute, which has designed over 150 such plants. Meanwhile, power utilities Hidrotoapi and Energyhdine are currently looking into the possibility of tapping into national social security institute (IESS) funds to help finance their Toachi-Pilaton and Rio Luis hydropower plants.

In terms of fossil fuel-fired generation, there have been relatively few developments, which is unsurprising, given the country’s attempts to move away from it on strategic grounds. That said, a 90MW complex was launched in January 2010, in the western canton of Quevedo. Its capacity was expected to have been increased to 120MW by February, according to the local daily El Comercio. The generating units had been hired from a local firm, Procapet, by the government, under a six-month contract. The fuel costs expected to be incurred over this period are estimated at US$25m.

Building more hydropower dams could free up additional crude oil for export. The country’s oil wealth is also sparking interest from Chinese investors.

Will the water be there?

While Ecuador’s current hydropower resources are impressive, the recent events coupled with long-term concerns regarding the region’s climate in the context of global warming and further deforestation raises serious questions regarding the wisdom of dramatically expanding the country’s reliance on hydropower. While there is clearly a compelling economic case for freeing up more oil for export, relying on any one source of electricity to the extent the government is proposing has been shown to create major issues for the power sector. A good example is France, where around 80 per cent of the nation’s electricity comes from nuclear plants. Their inability to rapidly adjust to fluctuations in demand mean that the country is forced to often export electricity at very low prices and import it during times of peak demand.

In Ecuador’s case, while building much more hydropower capacity than the country currently needs could limit the downside of drought-induced declines in the load factors of individual plants, it is doubtful whether such an approach would be economic in the long run, even accounting for the potential to export electricity to its neighbours and the potential boost to oil export volumes. There is also the question as to where the necessary finance will come from, given the state of the country’s finances. However, China’s thirst for oil clearly represents a major opportunity, especially in the light of its growing reluctance to keep so much of its new found wealth in the form of US bonds. From Ecuador’s perspective, much would rest on whether what it receives from a such a deal will be fair value in the future, in the context of dwindling global oil resources and what would happen to overseas investment if China’s nascent property boom were to implode.