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 Date:10/6/2009

 

World News
Renewed Energy
Jose L. Valera explains LNG in Chile: A tale of quick thinking and course correction.

Chile inaugurated its first Liquefied Natural Gas terminal in early September of 2009. It is located in the bay of Quintero, close to the capital city of Santiago. The $1.1 billion project, under active development since 2005, is designed to satisfy all the gas demand for residential, commercial, industrial and electric generation purposes in the central part of Chile. This amounts to about 40 percent of the nation’s demand. The project owners and primary gas off-takers are ENAP, Metrogas, BG Group and Endesa Chile.

A second LNG terminal is currently under construction in the bay of Mejillones, in northern Chile. Developed by GDF Suez and Codelco since 2007, this project is designed to provide natural gas for electric generation, primarily in support of the massive mining industry in that part of the nation. The first phase is expected to come into operation in 2010.

Ironically, Chile was not supposed to need these projects.

Back in 1995 Chile was facing major economic and environmental challenges in determining how to meet rapidly increasing energy needs while lacking domestic and competitive sources of energy. Energy consumption was growing at high annual rates and new energy needs were being met primarily by importing more oil and coal. There were increasing economic and environmental constraints in expanding hydroelectric capacity.

To solve its energy needs, Chile turned to its neighbor Argentina, which at the time was benefiting from government policies begun in 1989 that broke up and privatized state-owned monopolist enterprises, deregulated wholesale prices, brought market-based regulation to retail prices, and encouraged investment in the exploration and production of hydrocarbons. Based on the success of these policies, Argentina was turning itself into an exporter of oil, gas and electricity.

Between 1996 and 2000, five natural gas pipelines were built to transport Argentine gas into Chile. One was built in the Magallanes region in the far south, another (Gasoducto del Pacifico) to the industrial region of Concepcion and a third (GasAndes) to the Santiago metropolitan area. Two more pipelines (Gas Atacama and Nor Andino) were built in the north of the country for residential purposes and to support the mining industry. Overall investment in international pipeline projects between Chile and Argentina in the 1996-2000 period was more than $1.5 billion. Together with the gas pipeline from Bolivia to Brazil which was built around the same time, these were the largest energy integration projects in Latin America.

Chile now could add natural gas to its fuel mix and mitigate economic costs and adverse environmental impact. Billions of dollars were also invested in domestic gas transportation and distribution networks and gas-fueled power plants.

Unfortunately for Chile, Argentina did not live up to the bargain for too long. As a result of serious macroeconomic blunders and monetary dislocations, Argentina began experiencing an economic crisis in 1998 which reached its boiling point in early 2002. Argentina ceased to be a reliable supplier and Chile’s continued long term economic growth couldn’t wait for Argentina to get it affairs back in order. The policies in Argentina in response to the economic crisis are the direct cause of Chile having had to develop the LNG terminals.

In response to its economic crisis, among other things the Argentine government stopped supporting its currency, which devalued from a fixed one-to-one exchange with the U.S. dollar to almost four-to-one. The government then decreed that gas tariffs for end users would remain denominated in the local currency at nominal value, without adjustment on account of the devaluation. As an example, this means that one day consumers were paying 10 pesos for residential gas, which represented $10 in revenue to the gas supplier at the one-to-one exchange rate, but the next day the same consumer paid the same 10 pesos for the same volumes of gas, which represented $2.50 to the gas supplier. The same was done with the electricity rates. Suppliers were also hit by the fact that they remained obligated to service foreign debt denominated in U.S. dollars.

Regulators froze the tariffs at those levels and, by and large, still remain there. Gas producers and electric generators in Argentina were not compensated for the reduction in their real revenue. The effects of these policies started showing in 2004: due to the low prices and lack of conservation measures, gas demand shot up. Gas producers which had the export contracts with Chilean buyers were ordered to curtail export sales in order to satisfy all domestic demand. With gas net back prices at the wellhead being one of the lowest in the world, E&P companies had no economic incentive whatsoever to risk new capital in exploration. Between 2004 and 2009 Argentine gas exports have declined consistently to a small fraction of the originally contracted volumes. Argentina is now estimated to have gas reserves left for less than 10 years.

Chile reacted quickly to the supply destruction in Argentina after having had to import diesel to run power plants to mitigate the cuts in gas exports. The problems clearly were not going to be fixed in short order. Argentina and Chile are interconnected with gas transportation infrastructure, but there is no longer energy integration. Integration requires policy coordination, political commitment to maintain agreed upon rules, and trust. Chile had to turn elsewhere to obtain secure supply.

In an interesting twist, it is not inconceivable that the flow of the pipelines may be reversed and Chile may export gas to Argentina in the future.

Jose L. Valera, of the Houston office of Thompson & Knight LLP, focuses his practice on domestic and international energy transactions. Valera has more than 25 years of legal experience representing oil, gas, and electric energy companies throughout the United States, Central America, South America, Africa, Asia, and the Caribbean. Reach him at jose.valera@tklaw.com.