S&P Global Ratings views the electric utilities' regulatory framework in Latin America as supportive, overall. Regulations in most of countries allow for timely recovery of operating costs and capital. We consider such frameworks as predictable and transparent, which we view as credit supportive. During the short and medium term, we believe regulators will focus on raising the share of non-conventional renewable energy in the electricity matrix; improving the transmission systems and connectivity to new industrial and/or urban areas; and using additional investments and digitalization efforts in order to improve efficiency.

Table 1

In our analysis of a regulated utility's business risk, an important factor is regulatory risk. Regulation, no matter where in the spectrum of our assessments, generally strengthens the business risk profile and credit quality of an entity, because it points to stability and predictability of operations, and to financial continuity. During the past three to five years and despite the regulators' autonomous operations, we note several common trends emerging throughout the region: the expansion of renewable energy; the enlargement of the transmission facilities to handle new capacity; efforts to incorporate intermittent energy sources; expansion of the distribution lines through significant investments, and the greater use of digital technology.

Sorting Through Regulatory Jurisdictions In Latin America

Below, we summarize our views of the following electric regulatory jurisdictions in Latin America: Argentina, Brazil, Chile, Colombia, and Mexico. We assess the jurisdictions based on four indicators (see the heat map below) that help determine regulatory risk, and according to our analysis of more than 80 utilities we rate in the region.

Although we consider some jurisdictions to be "very credit supportive," such a descriptor doesn't necessarily indicate that the regulatory bodies support the credit quality of market participants, nor does it necessarily endorse a view that regulation in the jurisdiction is effective. We assess jurisdictions in the five countries as "credit supportive" and the designations only differ in degree rather than in kind. Finally, we designed the assessments to portray utility regulation in terms of its effect on credit quality (see table below).

Table 2

Table 3

Jurisdiction Highlights

Argentina

Regulatory stability.  Despite the Macri administration's radical overhaul of electricity regulation starting in 2016, the sector has experienced more than a decade of regulations that lacked transparency, predictability, and consistency. Given these factors and the short track record of the current regulatory framework, we view regulatory stability as less credit supportive than those in other countries in the region.

Regulatory independence.  Law No. 24,065 established ENRE as an autonomous entity within the former Secretariat of Energy (now known as the Ministry of Energy and Mines). ENRE's main responsibilities are:

• Enforcing the regulatory framework and controlling the rendering of public services and the performance of the obligations set forth in the concession contracts at a national level;
• Issuing the regulations applicable to the Wholesale Electricity Market (WEM) members;
• Setting the calculation of rates and approving their schedules for transmission and distribution companies (discos) holding national concessions;
• Authorizing electrical conduit easements; and
• Authorizing the construction of new facilities.

The government owns 20% of CAMMESA's capital stock. In addition, each of the four associations that represent the generation, transmission, and distribution companies, and large users owns 20% of CAMMESA. This entity is in charge of dispatching electricity into the system, planning energy capacity needs and optimizing energy use, monitoring the operation of the term market, billing and collecting payments for transactions among WEM agents, purchasing and/or selling electric power from other countries. CAMMESA's operating costs are financed through WEM agents' mandatory contributions.

Rate-setting: Credit supportive.  During the 2001-2002 economic crisis, Argentina's Congress enacted the Public Emergency Law, which restructured the electricity regulatory framework substantially. The Law aimed to reduce power prices in the post-dollarization era and to avoid steep price hikes. Among the main changes were the pesification of rates (conversion to Argentine pesos from dollars), the cancelation of inflation and indexation adjustments, and the introduction of new adjustments to determine prices in the WEM. For more than a decade, electricity prices have been adjusted on a discretionary basis and timing, impairing the utilities' profitability.

Since President Macri took office in December 2015, his administration implemented several measures aimed at removing supply bottlenecks and eliminating recurrent power blackouts. In 2016, the government enacted a decree that declared an "electricity emergency" until the end of 2017. It also instructed the Ministry of Energy (MEM) to enforce and implement a program for the generation, transportation, and distribution of electrical energy. As a result, MEM issued Resolution No. 6/16 in January 2016, which approved a quarterly reprogramming for the system that raised power prices for the generators and reduced government subsidies to the sector. Resolution SE 7/2016 reflected increases in the seasonal price of electric energy, instructing ENRE to fix the rates of the two major distributors for the city of Buenos Aires and its metropolitan area. Subsequently, ENRE followed the steps and published the new rate tables applicable to these distributors. Finally, through Resolution SE 19/2017, the government set the new remuneration scheme in dollars for power availability offers. In addition, ENRE implemented the so called Integral Tariff Review that established a final rate adjustment mechanism (as opposed to temporary measures through the abovementioned Resolutions) and an investment plan for transmission and distribution companies for 2017-2021. The new regulatory framework had eliminated the companies' dependence on discretionary disbursements from the government, improving their cash flow predictability in the short to medium term, as well as their liquidity and capital structure. Still, there is a very short track record.

As a result of the abovementioned changes, electricity rates increased to around $20.5 per megawatt hour (MWh) in 2018 from $10.5 per MWh in 2016. Electricity generators receive payments from CAMMESA, which in turn receives payments from other members of the WEM, and in the past two years, we haven't seen delays in CAMMESA's payments to generators. Nevertheless, we continue to monitor timeliness of such payments, particularly because the electricity rates are denominated in dollars, while Argentina's peso lost more than half of its value in 2018, the impact of which hasn't fully been passed to final consumers.

Future developments: Less credit supportive.  We expect 2019 to be very challenging for Argentine utilities, mostly because of increasing uncertainties over companies' financial profiles and regulations amid the country's volatile macroeconomic conditions and upcoming presidential election. In order for Argentina to have a thriving electricity sector that attracts private investment, the government will have to fully update the regulations to establish predictable rate adjustments and allow unimpeded relationships between market participants in order to improve service levels and raise capital expenditures.

Although the regulation has improved in the past few years, we still believe there's a long way to the full stabilization of the sector. We believe the main aspects of the utilities' financial profiles to monitor are the impact of the currency's sharp fall, given that prices for natural gas, which account for around 50% of the country's energy matrix, are denominated in dollars. In addition, many Argentine utilities have dollar-denominated debts. So far, most of the cost increases haven't yet been fully passed through to the final customers, and it's still uncertain who will bear in the medium and long term these costs (i.e. the government, the gas producers, the consumers, or certain utilities), particularly in light of October's presidential election.

Brazil

Regulatory stability.  We view the regulatory framework in Brazil as credit supportive, with a track record of fully respected contracts among industry players. Nonetheless, regulatory independence is still rebounding after political interference earlier in the decade temporarily weakened the financial stability of the players especially in the electricity distribution segment.

Since 2004, the electric regulatory framework has been organized according to the flow chart below, based on the Laws 10,847 and 10,848, and National Decree 5,163.

Below, we provide a brief explanation of the various regulatory bodies:

• CNPE is an inter-ministerial advisory board to the president on energy policy to optimize the use of energy resources and assure power supplies in the country.
• MME is responsible for formulating and implementing power-related policies, which the CNPE defines. MME grants energy concessions and establishes main policies, guidelines, and regulations. MME delegates the regulation and inspection of the electricity sector to the ANEEL (see below).
• EPE is a state-owned company that develops studies and research to help plan the Brazilian energy industry, including oil and gas, electricity, natural gas, etc. EPE revises the 10-year energy plan on an annual basis, which outlines the investments needed to meet the growing demand. MME uses this plan to prepare an investment plan for the sector's expansion.
• ONS coordinates and controls generation and transmission activities. The ONS is also responsible for submitting plans for expansion of the electric grid, the National Interconnected System (Sistema Interligado Nacional in Portuguese) to MME.
• CCEE carries out wholesale transactions and commercialization of electric power in the regulated, free, and spot markets.
• CMSE is an advisory board that monitors and evaluates power supply continuity and safety, and develops proposals for the proper and safe implementation of projects, such as construction of new plants and transmission lines.

In addition, ANEEL regulates and supervises the generation, transmission, and distribution segments through the following activities:

• Establishing sector-wide regulations;
• Holding auctions for new concessions;
• Supervising and inspecting the concessionaires' service quality and applying penalties when needed;
• Defining criteria for calculation of distribution and transmission rates, including for generation plants that renewed their concessions under the Law 12,783; and
• Resolving any administrative litigations between electric power generators and buyers.

Regulatory independence.  We consider the regulatory bodies as independent from the government, with rates accurately reflecting energy costs, although the government interfered in the segment in the past decade in order to reduce electricity prices. With the enactment of the Provisional Measure 579/2012, which subsequently became the Law 12,783/2013, the government promoted an about 20% reduction in rates. It did so by offering generators and transmitters the early renewal of their concessions that were ending in 2015-2017 in exchange for lower rates/prices, and the reduction of the companies' contribution to the sector-specific funds that were embedded into rates. Nevertheless, some generators refused to renew their concession under these terms, and the government didn't retaliate.

A severe drought in Brazil during 2013-2017 caused the cost of energy to spike, because the bulk of the country's energy is hydro based. The government was unwilling to allow the hikes in rates after it worked hard to reduce them. Therefore, the government opted to support the sector's companies directly and indirectly during this period. Given the high cost of support to the sector--R$11.4 billion in 2013 and R$23.4 billion in 2014—and as the cooling economy began to squeeze the federal budget, ANEEL approved a 25% rate increase in early 2015 to the final consumers. Since then, a series of initiatives were taken in order for rates to better reflect energy costs. More specifically, in order to reduce working capital needs because rates are adjusted annually, ANEEL established the rate flags mechanism, which is defined monthly and triggers rate increases depending on the spot prices' level.

Rate-setting: Very credit supportive.  ANEEL is responsible for setting the rates for distribution and transmission companies. Rates are set in order to remunerate the investments made in the concession area. Rate setting for transmitters is simpler, because these companies receive revenues according to their availability to the system. In that sense, the transmitting companies' concessions can be categorized up as:

• The concessions renewed under the Law 12,783— O&M fees are annually adjusted to inflation, and the remuneration for potential new investments made in the transmission lines.
• Concessions for those that don't have a periodic rate reset. Their revenues are annually adjusted to inflation, and in the 16th year of the 30-year concession, revenues drop by 50%.
• The newer contracts, in which revenues are annually adjusted to inflation, and every five years the regulator makes a reset in order to remunerate the investments through a regulatory weighted average cost of capital (WACC) set for each reset cycle.

Given that the distribution companies currently operate under a model of pass-through costs, along with the remuneration of their investments, they have annual rate readjustments every three to five years (depending on the concession contract). Rate readjustments allow the companies to pass through the electricity costs incurred and G&A-related expenses, which are pegged to inflation, to the clients. Rate reviews incorporate efficiency gains during the cycle, which are shared with the customers. In each cycle, the regulator sets a new WACC to remunerate the investments during the concession. Distribution companies also have the right to request an extraordinary rate review, in order to recover the financial and economic rebalancing of the concession contract. MME assures the rights of the companies to receive, until the end of the concession contract, the whole remuneration for the investments made in the concession area and any costs not fully recovered through rates.

Future developments: Very credit supportive.  The next few months will indicate the new government's stance on key factors for the sector such as hydrology risk and the potential privatization of Centrais Elétricas Brasileiras S.A. – Eletrobras, the country's largest electric utility. Given Brazil's rising electricity demand, we expect the new government to continue encouraging the increase of non-conventional renewable generation--especially solar and wind power--which should raise their share of the country's electricity matrix.

We expect Brazil and Paraguay to discuss the terms for Itaipu Binacional's electricity sales after April 2023, because debt related to the hydro plant's construction will be fully amortized on that date. The payment of this debt represents a significant portion of Itaipu's current sales price. In addition, although each country receives 50% of the output, Brazil ends up consuming 90% of Itaipu's production, because Paraguay sells its surplus to Brazil. Therefore, it will be important that both governments reach an agreement about this matter as soon as possible in order to plan ahead Brazil's electricity needs, because Itaipu is responsible for about 15% of the country's electricity supply.

Chile

Regulatory stability.  In our view, the Chilean regulatory framework is stable and transparent, and there's a low probability for adverse changes to the pricing regimes or contracts. The system has operated well under expansionary and recession cycles and during several administrations of opposing political leanings, and we haven't seen modifications that could put at risk the country's reputation, highlighting our view of the framework as the strongest in the region.

Regulatory independence.  CNE was set up through the Law No. 2,224 of 1978, which was modified by the Law 20,402, which set up the Ministry of Mining and Energy. Its functions are as follows:

• To analyze the structure and level of the prices and rates of energy goods and services.
• To fix the technical and quality norms necessary for the functioning and operation of energy installations.
• To monitor the current, and project the anticipated, functioning of the energy sector and propose to the Ministry of Mining and Energy the legal and regulatory norms required.
• To advise the Ministry of Mining and Energy on all matters related to the energy sector to foster its development.
• The administration of the Commission falls to the Secretary-in-chief, who is the Service`s Chief Secretary and its legal, judicial and extra-judicial representative.

Rate-setting: Very credit supportive.  CNE is responsible for carrying out the balances of the electric system, determining the corresponding transfers between generators and calculating the marginal cost schedule, price at which energy transfers are valued. By definition, Chile's electric system is a marginal cost one, denominated in dollars. Generators receive capacity payments for contributing to the system's sufficiency to meet peak demand. These payments are added to the final electricity price for unregulated and regulated customers. In addition, capacity can be contracted or left uncommitted to be sold at spot prices. Most of the generators that we rate have contracted capacity of at least 75%, which provides a very high level of predictability, which we view as credit strengths. Transmission and distribution businesses are by nature stable and profitable.

Future developments: Very credit supportive.  The need to mitigate the environmental impact and adapt to climate change has facilitated the entrance of new solar and wind energy facilities in the past few years. In the same vein, the government passed a law setting the requirement to have 20% of energy generated by renewable technologies by 2025. Additionally, the current government created a working group to develop an energy roadmap for 2014-2050, with the goal of renewable projects generating 70% of total electricity, including large hydro projects.

The main risk to Chilean generators participating in the auction for concessions is the regulatory provision that exposes them to lower-than-contracted energy sales volumes, which may mean that actual demand is less than the demand projections used in the execution of the supply contracts. In the auction mechanism, discos make projections for regulated demand, on which PPA supply contracts are based. To reduce risks and uncertainty associated with the demand projections, the forecasts are updated twice a year.

Despite these updates, the possibility still exists, particularly in the near term, for actual energy demand to deviate from the forecasts. In the case that actual demand is below the contracted energy at a particular time (i.e. the distribution companies are overcontracted), the actual demand will be covered by all generators in proportion to their contracted energy.

In the event of lower-than-projected demand, a generator could be exposed to reduced revenues under the PPAs, and consequently in an extreme may be unable to service its debt. Nevertheless, the Chilean energy regulator assumes a 3.6% compounded annual growth rate for demand in the system of around 3.5% between 2017 and 2027, compared with the previous forecast of 4.0% and 4.7%, respectively. As such, we don't expect the risk of over contracting for the near term.

Colombia

Regulatory stability.  Colombia's robust structure of regulatory agencies oversees market participants at every stage (generation, transmission, distribution, and commercialization), which was established through Laws 142 (the Public Utility Services Law) and 143 in 1994. In addition, the framework clearly defines segment separation and forbids vertical integration within the electricity industry. Below, we summarize briefly the regulatory agencies' responsibilities:

• The Ministry of Mines and Energy (MME) is responsible for defining and implementing the sector policies. While it delegates the expansion plans to the Mining and Energy Planning Unit (UPME), the Energy and Gas Regulatory Commission (CREG) is responsible for the regulations and inspection.
• The National Dispatch Center (CND) controls the generation and transmission activities, for which XM S.A. E.S.P., a subsidiary of Interconexion Electrica S.A. E.S.P, is responsible.
• The Commercial Exchange System (SIC) carries out wholesale transactions and commercialization of electric power, the spot market transactions, and maintains the information for the Wholesale Electricity Market.
• The Superintendence of Domiciliary Public Services (SSPD) supervises the sector, including the energy users. SSPD determines if any entity in the sector isn't complying with the regulations and can subsequently levy fines.

In 2014, the Colombian government passed the Renewable Law (Law 1,715), aiming to promote the development of non-conventional renewable projects in the country through tax breaks and subsidies. The main goal is to reduce the country's dependence on thermal generation during the dry seasons. Recently, the government has awarded a contract to build projects that would generate 1,398 MW of non-conventional renewable energy by 2022, consisting of six wind power projects totaling 1,160 MW and two solar projects totaling 238 MW. This would enable the government to meet its goal of adding 1,500 MW of non-conventional renewable energy to the electricity matrix, helping to diversify it.

Regulatory independence.

We believe the regulatory framework in Colombia enjoys autonomy from the government, with rates in all segments fully covering the cost incurred and adequately remunerating the investments made, which guarantees the long-term finances of the electric sector players. Currently, the regulatory framework allows the companies to generate stable and predictable earnings, even under stressful periods

Rate-setting: Very credit supportive.   CREG determines the rates for the electric power generation, transmission, distribution, and trading companies. Overall, the regulator aims to assure that all players have their costs fully covered, and at a margin that either remunerates the investments or the risks involved in the activity.

Transmission.  It's based on the availability to the system, the transmission rate includes a connection charge, which covers the cost of operating the facilities, and a usage charge, which applies only to traders. Currently, the regulator is finalizing changes to the remuneration mechanism (please see below).

Distribution.  It follows a model of cost pass-through and investment remuneration. Rates allow distribution companies to recover the operating, maintenance, and capital costs, while the remuneration of the investments is based on the replacement cost of the assets, and a regulatory WACC 11.9% before taxes between 2019 and 2023.

Future developments: Credit supportive.   We will monitor the following factors in 2019, which could have an impact on the Colombian electric utilities:

• Hidroituango's start up: given the delays in the power plant's construction (2,400 MW of installed capacity that will represent about 17% of the country's total), there are still uncertainties when the plant will start operating, which could cause spot market prices to rise in the short to medium term. In addition, to mitigate a potential electricity shortage, the government has implemented energy auctions to guarantee a higher electricity supply in 2022 and 2023.
• Transmission remuneration scheme changes: CREG and market participants have been discussing the new remuneration scheme for several years. It's likely that the regulator will publish the new methodology this year, which will replace the current one that's based on net replacement value to that of depreciated value. Basically, in order to maintain the same revenue level, companies will have to have a minimum maintenance level that at least equalizes its depreciation level. We don't expect these changes to influence the cash flows of Grupo Energia Bogota S.A. E.S.P. (BBB-/Stable/--) and Interconexion Electrica S.A. E.S.P. (BBB-/Stable/--).
• 'El Niño' phenomenon: The phenomenon is relevant for the domestic electricity sector, given that hydropower plants account for about 70% of the country's electricity matrix, while majority of the reservoirs are relatively small, with less than a three-month storage capacity. For 2019, the phenomenon is unlikely to cause spot prices to spike or trigger a high thermal dispatch, because the hydro plants' reservoirs in Colombia are at high levels--60.1% of capacity as of Jan. 31, 2019.

Mexico

Regulatory stability.  The regulatory framework in Mexico has a track record of contracts being respected. Nevertheless, it's currently unclear if the new administration is planning to introduce significant long-term changes in the energy sector. However, in the near term, we believe the new government will have incentives to take advantage of the flexibility from the 2013 energy reform to continue to attract private investment to the sector. In particular, we think the new government will be inclined to attract investment in thermal, wind, and solar power plants, whose output would support the new administration's GDP growth target.

Regulatory independence.  According to Mexico's Constitution, the Ministry of Energy is in charge of the developing the national electric system. This includes the indicative program of installation and retirement of electric facilities, development and modernization of the transmission and distribution networks. Such a program is prepared annually and has a 15-year projection.

CENACE is a decentralized public agency in charge of the national electric system and the wholesale electric market, and grants impartial access to the electric system.

CRE is the independent regulator of the energy sector. It has the obligation to enforce the Electric Industry Law, which sets the sector's framework.

According to the 2014 Electric Industry Law, generation is dispatched based on the minimum cost, in order to benefit the end users. In addition, the wholesale market was created for the generation segment to lay bases to obtain better electric tariffs.

Rate-setting: Credit supportive.  In 2017, CRE established the formula for the electricity rates in the country, which have two main components. The first one is a fixed component, which incorporates every segment of the value chain in the electric industry, such as distribution, maintenance, and operation. Moreover, this component varies depending on the geographic area and consumption trends. The second component is a variable element, which depends on the cost of electricity generation, which strongly correlates with the cost of fuel used for the generation of electricity. CRE publishes rates on a monthly basis. Mexico's generation companies receive a marginal cost, given that variable costs are pass-through to the offtaker.

Future developments: Less credit supportive.   In the next few months, we will have a clearer view where the new administration stands on the key factors in sector, especially on the participation of the private sector to increase the total energy generation, particularly renewables. Moreover, we're waiting more clarity for the administration's view on the natural gas supply for the pipeline network for electric generation, and the subsequent decommission of oil-fired power plants. Finally, the participation of private sector in bidding processes to build, manage, and operate transmission lines in the country.

Mexico's additional capacity requirement for 2018-2032 is about 66,912 MW, of which around 40% is intended to be from renewable energy (mostly wind). The government's target is to increase the share of renewables to 35% of energy matrix by 2024.

Related Criteria and Research

Related Criteria

• Criteria - Corporates - General: Corporate Methodology, Nov. 19, 2013
• Criteria - Corporates - Utilities: Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013

Related Research

• Credit Conditions Latin America: Tough Fixtures Home And Away, Nov. 29, 2018
• S&P Global Ratings Raises Brent Oil Price Assumptions For 2018 Through 2020; WTI Assumptions For 2018 And 2019; Natural Gas Price Deck Unchanged, Sept. 17, 2018