Challenges Facing Uruguay's Electricity Sector

This broad-based, multiparty political-institutional agreement provides stability and reduces uncertainty for investments in the energy sector, where the national electricity system—operating within the framework of a stable energy policy—faces new challenges arising from changes in the market, such as growing demand, the gradual entry of private actors into electricity generation from renewable sources, and the future installation of a regasification plant in Montevideo.

Uruguay’s electricity sector, which has been established for over a century, plays a significant role in the national economy. In 2012, the system had an installed capacity of 3,049 MW, based primarily on generation from hydroelectric plants (1,538 MW) and fossil fuel-fired thermal plants (1,223 MW), with the process of incorporating and developing non-conventional sources still in its early stages, particularly biomass (236 MW) and wind power (52 MW). The country has very high coverage for the region, with an electrification rate of 98.7% as a result of the construction of rural grids in recent decades. However, the electricity system suffers significant losses totaling 19%, of which 3% are attributable to transmission and 16% to distribution, with a large portion attributable to non-technical factors. With demand growing steadily at a rate of between 3% and 4% annually, and the potential for large-scale hydroelectric power development virtually exhausted, dependence on oil and imports will continue to rise if other energy sources are not developed.

This summary is based on the Report on Uruguay’s Electricity Sector presented by Mario Vignolo, an electrical engineer and Ph.D. in electrical engineering who serves as head of the Power Engineering Department at the Institute of Electrical Engineering within the Faculty of Engineering at the University of the Republic (UdelaR), during the first session of the Public Policy Discussion Series organized by Universidad ORT Uruguay CAF—the Development Bank of Latin America. The theme of that session, held on May 28, 2013, was “The Electricity Sector in Uruguay: Current Situation and Outlook.”

Engineer Vignolo’s work was discussed by three Uruguayan panelists: Beno Ruchansky, a mechanical industrial engineer with a master’s degree in energy economics and former president of UTE; Alejandro Perroni, a certified public accountant, former General Manager of UTE, and current Chairman of the Board of Gasur; and Juan José Carrasco, an industrial engineer specializing in electrical engineering, former Manager of the Distribution Division at UTE, and current Executive Director of the Regional Energy Integration Commission (CIER). The role of moderator was filled by engineer Mauricio Garrón, a senior energy specialist at CAF-Development Bank of Latin America.

With the aim of assessing the current state and future prospects of Uruguay’s electricity sector, the panelists sought to identify opportunities and obstacles to the sector’s development,  assessing, among other factors, the regulatory framework, the government’s energy policy, the governance and management of state-owned enterprises, the diversification of energy sources, origins, and suppliers, electricity integration and interconnections with neighboring countries, and the possibility of Uruguay becoming a country with energy surpluses. Below is a summary of the main topics discussed by the experts.

The regulatory framework should be revised to reflect the experience gained in recent years

The Report on Uruguay’s Electricity Sector presented by Mario Vignolo states: “The 1997 Regulatory Framework Act (…) establishes a separation of roles within the government in the electricity sector, distinguishing between the business operations managed by UTE (National Administration of Power Plants and Electric Transmission) and the regulatory functions carried out by (…) URSEA (Regulatory Authority for Energy and Water Services). It also establishes free competition in the generation and sale of energy, creating a Wholesale Electricity Market (MMEE) and an administrator for that market, ADME (Electricity Market Administration). However, as established by the National Electricity Law of 1977, the public service regime for the transmission and distribution of electricity remains in place, operating as natural monopolies, with UTE serving as the provider of these services. For both the transmission and distribution of electricity, rates are regulated, as is the quality of service, under the principle of open access to the networks, which allows for competition among generators within the market.”

One of the panelists, Beno Ruchansky, began by asking whether the current regulatory framework is adequate to support sustained growth in the electricity sector. He noted that, in order to answer this question, the issue must be analyzed, on the one hand, from the perspective of energy policy and, on the other, from the perspective of institutional and regulatory architecture, in order to assess whether it facilitates the implementation of new projects.

Energy Policy. Mr. Ruchansky highlighted Mr. Vignolo’s comment during the presentation of his work, noting the importance of the government’s energy policy because the market alone may not lead to adequate results.

The former president of UTE explained that growth in the electricity sector has come from thermal generation, as large-scale development of hydroelectric dams in Uruguay has practically reached its limit. This situation poses a problem for us because it leads to a significant increase in energy costs. The lack of new power capacity added to the electricity system over the past 15 years led to cost overruns when increased demand had to be met with power generation from petroleum-based fuels, or when it was necessary to rely on energy from neighboring countries—which has not always been available and is, moreover, expensive. Given this assessment, he argued that countries need to have energy policies, as had been stated by Hamilton Moss, Vice President of Energy at CAF-Development Bank of Latin America, when he opened the Public Policy Discussion Series.

In Uruguay, the energy policy (Editor’s note: Approved by the Executive Branch in 2008 and ratified by the Parliament’s Multiparty Energy Commission in 2010) aims to achieve a more secure energy supply and provide cheaper energy that is less dependent on oil and imports, thereby increasing the country’s energy independence. For Ruchansky, this policy—which has adopted a strategy of diversifying sources and promoting indigenous and renewable energy—has an added advantage in that it is the result of multiparty agreements in various areas, including the energy sector, making it a state policy. This provides sustainability and reduces uncertainty for investments, as the energy sector is the only one that has not been called into question in any public forum.

In turn, Councilman Alejandro Perroni noted that the energy policy had been endorsed by a broad-based political and institutional agreement. However, he pointed out that such agreements must be reviewed and re-examined after a certain period of time in light of changing market conditions. Otherwise, policy discontinuities arise. He cited as an example that, since the Multiparty Commission’s agreements with short-, medium-, and long-term goals were approved, shale gas reserves have been discovered, the Fukushima nuclear plant accident occurred, and the price of photovoltaic panels plummeted.

Institutional and Regulatory Framework. Generally speaking, this framework has been consolidated through the separation of roles, with the Executive Branch defining energy policies, URSEA serving as the regulator, ADME acting as the market administrator, and UTE fulfilling the business role. The 1997 Regulatory Framework Law, currently in force, enshrines free competition, with transmission and distribution being natural monopolies and UTE serving as the service provider.

Although UTE maintains regulatory accounting by keeping its business activities separate on the books, Mr. Ruchansky pointed out that the company remains vertically integrated. If the separation had been carried out in such a way that each segment constituted a separate legal entity, this would have generated entirely unnecessary transaction costs given the small size of the local market.

When we look at the regional and global context, it becomes clear that countries that took a different path in this area are now changing course. Within the region, there is a growing trend toward creating vertically and horizontally integrated energy companies in order to compete in an increasingly globalized world. “Competing” often becomes a matter of “survival.” In this regard, Ancap (National Administration of Fuels, Alcohol, and Portland Cement) has implemented a policy to strengthen the distribution link and has sought to establish key partnerships that allow it to integrate both vertically—to secure oil—and horizontally—to enter the natural gas business. According to Ruchansky, “UTE’s vertical integration is a significant asset for the country and for the electricity sector itself.”

To elaborate on this point, Mr. Perroni noted that Uruguay needs to overhaul its regulatory framework to continue growing in the electricity sector. “We need to implement a reform that allows us to adapt our current reality to a future-oriented one. It should be a change that leads us to recognize how we have managed to develop this system and how to continue moving forward,” he said. He added that the rules governing a system generate significant value in the long term, and when they are not addressed in a timely manner, they generate “negative value” in the long term—meaning that doing nothing can end up being very costly.

The Role of Macroeconomic Factors in Setting Electricity Rates

The Report on Uruguay’s Electricity Sector states: “Electricity rates in Uruguay are set by the Executive Branch, taking into account proposals from UTE. The criterion used to determine rates is that UTE’s revenue must be sufficient to cover operating costs, depreciation of assets used in providing the service, and a reasonable profit. In practice, other macroeconomic considerations are added to these objectives, such as the impact on the government’s financial balance and inflation.”

 For Mr. Ruchansky, the first part of that paragraph is good news, both for investors and for the development bank that lends to investors and to the joint venture itself. However, the panelist raised a question regarding how “other macroeconomic considerations” affect electricity rates and, consequently, the company’s financial situation.

“There are specific factors—such as macroeconomic needs, anti-inflationary policies, or other considerations—that may have temporarily influenced certain rate adjustments. However, when looking at longer time frames, it becomes clear that these adjustments are corrected over the long term and that UTE has not been underfunded, which is no small matter,” Ruchansky noted. He added that when looking at the history of electric utilities in the region, the practice of using their rates as an anti-inflationary anchor or as a political tool in pre-election years has led to their underfunding and a decline in their management. “It is important to note that, in recent decades, this has not happened in the case of UTE, which is why it is in good economic and financial shape today,” he said.

Governance: Who owns UTE?

“Public enterprises play a central role in the economy,” stated Juan José Carrasco. Indeed, a state-owned enterprise like UTE, which generates more than US$2 billion in annual profits, is no small matter. Public entities are complex because their stakeholders sometimes act as customers when using their services, at other times as citizens, and in certain cases as shareholders. Something similar happens with their owners. Sometimes they act as owners because they want money, and at other times they work to leverage various types of social policies, thus operating between the political and ownership spheres. “That is why it is necessary to clarify the roles of who makes policy, who regulates, and who carries out business activities,” Carrasco stated.

One of UTE’s main problems is determining who owns it. Is it the Ministry of Industry, Energy, and Mining (MIEM), the Ministry of Economy and Finance (MEF), the Office of Planning and Budget, or another entity? This uncertainty, the CIER executive director continued, imposes restrictions on UTE’s business operations; however, those restrictions should be limited only to those necessary to comply with established energy policy and existing regulations governing companies.

Management. “How can we work together to ensure that public enterprises are effective and efficient?” asked Mr. Carrasco. His answer was that the operating costs of these entities must be as low as possible and their profitability as high as possible. That is the message that must be conveyed to those who manage them. The right to administer these revenues belongs to the people elected by the citizens, but they are not the ones who should manage the public enterprises. These relationships in which the State acts as owner must be made explicit and set forth in writing. There are examples of this around the world, such as the management contract held by Copel, which remains publicly owned but operates under stock market rules. There are also other public companies that have a minimal public float on the stock market, which introduces a series of controls and management practices that ensure transparency and build trust.

Mr. Carrasco noted that a generational gap has emerged in the human resources of public companies in Uruguay. This follows the staff reductions implemented since the 1990s, driven by both efficiency considerations and legal requirements. Therefore, efforts must be made to pass on experience and build capacity so that younger employees can manage these companies in the future. This means that these individuals must be able to acquire the most advanced knowledge available globally and also develop their own expertise. “Qualified human resources are essential for public companies to be effective and efficient,” he said.

Diversification of energy sources, origins, and suppliers

All the panelists agreed that the diversification strategy outlined in the sector’s policy is concretely reflected in the promotion of non-conventional energy sources and the integration of natural gas into the energy mix.

Mr. Perroni argued that the decision to build a regasification plant in Uruguay is a highly valuable strategic move because we are talking about a fuel that is used worldwide, for which new reserves are being discovered, a spot market is developing, and which produces low levels of pollutant emissions. According to most experts, natural gas is the bridge fuel between a world that currently relies more on hydrocarbons and a world moving toward a greater share of renewables.

According to the Chairman of Gasur’s Board of Directors, it is important for Uruguay to take advantage of this strategic moment—marked by the availability of equipment, international interest rates at their lowest levels, and very low country risk rates—because we know this situation will not last forever. This observation applies to the regasification plant as well as to other infrastructure projects. He added that the introduction of natural gas in Uruguay brings with it another set of externalities that are highly valuable. For example, all that can be done in the transportation sector, in the fleet, in industrial development, etc., will allow us to make significant progress.

On the subject of renewable energy, Perroni called for moving forward with the wind power plan. “We need to constantly monitor the balance between reliable power and the lower costs that may result from the introduction of domestic sources, and start looking at solar power, which will gradually become a viable alternative,” he said

Contracts. Mr. Ruchansky emphasized the importance of UTE not relying on large import contracts and of extending this approach to power purchase agreements in the local electricity market, which does not mean ceasing to take advantage of the benefits of electricity trade while continuing to strive for greater levels of integration.

He explained that it is not the same for UTE to negotiate with a supplier providing 400 MW as it is to deal with one that only has 50 MW. The goal is to prevent market concentrations that could ultimately limit its bargaining power. Our system is still in its infancy, and consequently, it would be beneficial to draw on the experiences of other countries that have delved deeper into this area and assess their successes and failures. He added that it would be interesting to establish a regulatory framework for public companies, as suggested by some statements from the President of URSEA, because these regulatory frameworks were established with the assumption that they would only apply to private companies. He concluded by stating that it would be beneficial to “update” this framework and tailor it specifically to current practices.

Integration and interconnections will move forward with the construction of a regasification plant

Mr. Carrasco stated that Uruguay urgently needs more baseload power and that one way to achieve this is through regional integration, given that it borders two large markets. He noted that, starting in the 1990s, the Uruguayan government relied on Argentina for baseload power, and, at the same time, there was significant delay in awarding a contract for a combined-cycle power plant as an alternative. “As a result, we became hostage to negotiating electricity through interconnections, whose prices were always higher for us. Integration efforts have not always been positive for countries, due to issues inherent to the markets of exporting nations, leading to a trend across Latin America toward seeking self-sufficiency in power generation to mitigate risks—but that policy entails much higher costs,” he said.

The introduction of natural gas is a key issue, as the eventual profitability of the Gas Sayago regasification plant will contribute to integration and interconnections.