Volume 4, Number 32, Page 3

Guatemala: Opportunities in the Electric Power Market

by Juan Carlos Castillo

part 2 of 2

Part 1 examined Guatemala's new General Electricity Law, including the following features:

Normative and Regulatory Bodies, the Ministry of Energy and Mines, and the National Electric Energy Commission.

-Editor

The Wholesale Market Administrator

The Wholesale Market Administrator is unique among the regulatory bodies in the sense that it is a private, non-commercial entity with public functions. The law requires the Administrator to coordinate the operation of generators, international interco nnection points and transport lines at a minimum cost. As such, the Administrator controls the dispatch of the system and, even though it cannot impose penalties, has the power to disconnect an agent (generator, transmitter, or broker, including importers , exporters, and distributors) from the national power system.

Because the Administrator is a private entity, all market agents and large users (those with a maximum power demand of more than 100 kW) have the right to belong to it. However, even if they decide not to participate, all agents must comply with the co ordination rules issued by the Administrator.

The law also renders the Administrator responsible for running the spot market by granting it the power to establish spot prices. Even though that power is unclear, it must be interpreted as establishing a system in which spot prices can be determined by supply and demand. The rules currently being drafted should clarify this important issue.

Corporate Separation of Activities

The introduction, generation, transmission and distribution of electricity must be performed by separate legal entities. However, there is no prohibition of one company having an interest, even a controlling interest, in another company that performs a different activity.

The law allows generators and distributors to own secondary lines to connect to the primary transmission system. Distributors may own generating assets of up to 5 MW. This provision also applies to state-owned entities such as EEGSA and INDE, which mus t comply with the law and divest their activities within a one-year period from the enactment of the law. That period ends in November and is the force behind the current process of privatizing EEGSA’s generating assets.

The following analysis of generation, transmission and distribution divides each activity into two components: installation and operation.

Installation of Generating Plants

Generation of electric power is probably less regulated than either transmission or distribution. It requires no concession, license or permit (except for hydroelectric and geothermal generation, which require authorization if the installed capacity is more than 5 MW). Here the law departs from the traditional system of concessions by choosing the monetary amount for an authorization, which is governed by a contract signed by the government and the investor. This scheme applies to all cases in which an authorization is needed and granted. These authorizations are not exclusive, cannot exceed 50 years, and follow a bid process to maximize the benefits for the system.

Installation of Transmission Systems

No monopoly is allowed in the transmission system, and anyone can enter the business. The only requirement is that use of public lands and easements on private lands must be authorized by the Ministry of Energy and Mines (MEM).

Installation of Distribution Networks

Two kinds of distribution networks are covered by the law: Private Distribution Networks and Final Distribution Service Networks. The former are those networks for which no public lands or easements on private land are needed. These networks do not req uire any authorization or permit. Final Distribution Service Networks, on the other hand, use public lands or require easement on private lands, or both. These networks require authorization from the MEM.

Authorization is granted after a bid process is completed, and a bid is granted for a specific geographic area. This authorization, however, does not grant any kind of exclusivity for the area.

Operation of Generating Plants

The operation of generation assets is not heavily regulated. The operation is subject only to the dispatch and coordination rules issued by the administrator and by the technical rules issued by the commission.

Operation and Use of Transmission Lines

Transmitters are required by law to allow access to third parties for their residual capacity. In exchange, they receive a toll agreed upon by the parties, or fixed by the commission in cases where no agreement is possible. Tolls are currently expresse d in US$/kW/month and are based on the principle that payment of the toll is made in exchange for the right to withdraw the transported energy at any point within the primary transmission system.

Operation of Final Distribution Service

As with transmission lines, the Final Distribution Service is subject to strict regulations; quality of service is enforced through a series of penalties. Distributors must indemnify their customers for every kW they have failed to supply and in cur an additional penalty. The rules, however, allow for a transitory period to enable distribution companies to adjust to the new regulations.

Distributors must also allow third-party access by large users to their distribution capacity so they can arrange direct supply from generators. In return, distributors receive a toll, which cannot exceed the Value Added for Distribution (VAD) for that particular company. In these cases, distributors are not considered transmitters.

Tariffs

The entire scheme described above allows for a system in which tariffs for all users, except for those known as "regulated users," are determined by market forces. Regulated users are those whose maximum capacity demand does not exceed 100 kW . For those users, tariffs are fixed by the commission and are determined by the sum of the average acquisition price (contracts and spot) plus the VAD.

Tariffs must be fixed on the basis of consumption patterns and the system of measurement. This is a departure from Guatemala’s traditional system, which is based on the final use of energy. The system also departs from the past in the sense that t ariffs are published upon approval and become binding. The new system attempts to undo an unfortunate tradition of politics mixing with tariffs — a tradition that has left a legacy of financial chaos among distribution companies.

The Electric Power Wholesale Market

The wholesale market, run by the Wholesale Market Administrator, is one of the most innovative concepts contained in the law. Although the law regarding this market is still largely undeveloped, the following points can be made:

1. The wholesale market is the sum total of operations involving the purchase and sale of blocks of power or energy.

2. It contains two kinds of markets: a long-term contract market and a short-term spot market. Both are based on supply and demand. There is still discussion about whether a contract market for energy should exist or if only spot market purchases shoul d be allowed.

3. Under the law, agents of the wholesale market are defined as generators, transmitters, distributors, brokers, exporters and importers. However, the law may be seriously flawed as a result of excluding large users, which have considerable impact on t he market. This flaw could be remedied in the Administrator’s rule drafting process.

The market is based on the following basic criteria: total access to the system by all market participants; minimum operation cost through an economic dispatch; and market prices in both the contract and spot markets.

Current Privatization Process

In response to last November’s law, the largest market participants in Guatemala —EEGSA and INDE —are spinning off their activities into separate legal entities. INDE appears to be doing this primarily through internal reorganization. EE GSA, on the other hand, has embarked upon a gradual privatization process, beginning with its generation assets (considered its most inefficient).

EEGSA remains the largest distributor in Guatemala, with half a million customers, energy sales totaling 2,437 GWH, a maximum demand of 476 MW (66% of the total National Interconnected System), and a very low level of distribution losses (10.5%). It is a particularly interesting case because it was and, technically speaking, still is a private company. EEGSA was founded in the 1800s and was owned by an American company up until some 20 years ago, at which time the government purchased more than 90 perc ent of the shares. Since then, the government has come to realize that its unsatisfactory performance has deprived most of the population of the benefits of electricity.

EEGSA is selling its generating assets by transferring them to NEWCO and then selling its shares. The assets are old, low-efficiency, high-cost plants with little commercial value. The sale is attached to an 18-year, 150 MW Power Purchase Agreement (PP A) with EEGSA. Rather than seeking the maximum possible price for the assets, EEGSA opted for a lower energy price. The price of the assets was set at US$ 30 million for 90% of the shares. The remaining 10% will be offered to the employees, at the same pr ice paid by the investors, as a right of first refusal. If they do not exercise their right to purchase those shares, the shares will be sold to the highest bidder.

The 150 MW PPA would be Guatemala’s largest. It represents a very attractive opportunity for foreign investors and a strong incentive to buy the plants.

The bid will be awarded on the basis of a mathematical formula that has been provided to the investors; no discretionary authority will be invoked. EEGSA is committed to an untainted and transparent process.

Problems Encountered

Some interesting problems have already been encountered since the privatization process began last year.

1. Lack of experience. Considerable changes have transpired in an extremely short period of time as the new law and privatization have taken Guatemala into previously uncharted territory. While multiple processes are moving forward simultaneously, EEGS A’s is the one with the greatest chance for success and is likely to be the first to conclude.

2. Lack of regulation. Because the system is so new, not all of the rules are in place. Consequently, legal gaps have been filled by contracts, but some degree of uncertainty remains for investors.

3. Past experience. At the beginning of this decade, Guatemala faced extremely serious energy problems that forced the government to restrict supply. The end results were catastrophic. The government then decided to enter into PPAs with international I PPs. Unfortunately, Guatemala lacked experience and sophistication with respect to the PPA process at that time, and it is commonly perceived among Guatemalans that international companies exploited this situation, imposing high prices and one-sided contr acts. This has remained a significant problem during the drafting of the privatization documents.

4. Commercial guarantees. The tariff problem combined with guarantees asked by previous IPPs has left the company with very little to offer as a guarantee for the PPA. Consequently, the investors were permitted to ask for a guarantee in the form of a l etter of credit; exercising that right, however, would negatively affect the bid.

5. Environmental problems. Even though Guatemala’s environmental regulation is almost non-existent, investors and bankers are acutely sensitive to environmental issues and liabilities. The uncertainty regarding the plants’ environmental liabi lities under future legislation is of major concern to investors.

6. U.S. tax laws. U.S. investors represent the bulk of prequalified bidders so far. These investors have raised the issue that NEWCO should take the form of a partnership so they can take advantage of U.S. tax benefits. Consequently, Guatemala finds it self in a situation where it must choose between favoring U.S. investors versus non-U.S. investors. This is a problem that has not been solved yet. However, EEGSA has expressed its willingness to accommodate various possible alternatives as long as they d o not interfere with its main objectives.

The law firm of Castillo Love is located in Guatemala, Guatemala. Practice areas include mercantile, finance, intellectual property, foreign investment and energy law.

See Energy: Guatemala, on p. 983 for related summary.