Economy & Trade, Energy, Headlines, Labour, Latin America & the Caribbean
– Can the “energy transition” in Latin America help address the risks caused by greenhouse gases (GHG) on the climate, and the economic depression caused by the pandemic?
Energy transition refers to the shift from fossil-based systems of energy production and consumption — including oil, natural gas, and coal — to renewable energy (RE) sources like wind and solar, etc. Proponents of investments in RE highlight investments’ impacts on jobs and industrialization opportunities.
RE deployment implies a trade-off between the objectives of energy and industrial policies: The energy policy would seek the reliable supply of electricity at low cost while industrial policy would pursue an expansion and diversification of manufacturing capabilities impacting production costs.
Local Content Requirement Concept
Local content requirements (LCR) is a policy tool used to promote industrial development. The justification of LCR is based on the expectation that it increases economic linkages with local businesses resulting in more jobs locally. Any investment would have a “natural” level of local content, defined by the share of local procurement and jobs the investor would contract in the absence of LCR.
Latin America could achieve lower levels of GHG while also keeping electricity generation costs low by connecting regions with renewable energy surplus potential to demand nodes through transnational grids
That investment would generate a certain level of spillovers and learnings with the local businesses. Those spillovers can be expanded by requiring the initial level of investment to increase its local procurement level above its natural level.
However, there is an optimal level of LCR in which those linkages are maximized, beyond that point the costs of LCR would results in lower output or investment delays. If the gains from the linkages in terms of local procurement and job creation expected from LCR are higher thant the negative effects caused by their higher production costs, then LCR would be justifiable.
Most jobs in RE value chain are in the manufacturing of components. In the European Union, manufacturing accounts for 55% of all the jobs of the value chain. (Sooriyaarachchi, et al. 2015). Manufacturing of RE components requires the use of complex technologies and a skilled workforce.
Latin America’s experience.
Latin America’s GHG emissions from electricity generation are lower than world averages due to the reliance on hydroelectricity. But the region’s electricity generation matrix hides significant differences between countries.
Brazil, Colombia, or Costa Rica for example relied on hydroelectricity, while fossil fuels are the main source of electricity generation in the Caribbean, Chile, Argentina, Bolivia, or Mexico. However, Latin America’s supply of hydroelectricity is becoming less reliable due to changing weather patterns, requiring an increasing use of fossil fuels to meet growing demand.
Moreover, hydroelectric projects encounter increasing communities’ opposition and environmental challenges. RE expansion would then have to consider both levels of dependency (hydro and fossil fuels) while keeping prices low and ensuring that intermittence challenges from RE are addressed. Until recently most of the growth of RE was on biofuels, then wind power and more recently solar energy.
Latin America could achieve lower levels of GHG while also keeping electricity generation costs low by connecting regions with RE surplus potential to demand nodes through transnational grids. Regional integration is believed to lessen the need for national investments while reducing overall GHG and electricity generation costs (Guimaraes 2020).
However, efforts of regional electricity interconnection have not always provided the expected results. Large cost overruns, expensive cost of capital, construction delays, and the tendency for governments to protect their own markets makes regional electricity integration and unlikely alternative.
RE deployment in Latin America has prioritized the expansion of installed capacity at the lowest cost over local manufacturing development.
Market driven instruments such as auctions have been the preferred option for RE deployment since they tend to achieve lower prices by stimulating competition. Auctions have not included LCR clauses, but Mexico and Brazil adopted other mechanism promoting LCR in their RE deployment efforts.
Brazil’s LCR operated indirectly by offering companies that complied with the stringent local content access to preferential loans from Brazil’s National Development Bank (BNDES). Securing low cost of capital was an important competitive advantage during the auction process, encouraging companies to comply with the LCR.
The measurement of LCR was based on weight. Since a tower represents approximately 80% of the total weight of a wind turbine, it implied that developers would have to build in Brazil or acquire the towers from a local manufacturer the towers.
Manufacturing towers locally increased production costs since Brazilian steel was about 70% more expensive than imported one (Kuntze and Moerenhout 2012). The use of weight as a measurement for LCR helped to expand the manufacturing base, but it benefitted mostly a well-established industry (steel) as opposed to the development of new and more complex activities.
Mexico RE policy objectives were multiple but emphasis was given on capacity expansion and low cost of supply (Tyeler and Schmidt 2019). The government also opted for the use of auctions, but the development of a local value chain was not explicitly included in the design of the auctions.
Auctions attracted strong interest from large foreign RE firms. Smaller local developers struggled competing with foreign firms which had access to lower cost of finances from their home countries. Local manufacturers also had difficulty adapting to the discipline foreign buyers brought in terms of market competition and due diligence skills.
Many companies grew used to work through non-competitive procurement processes with CFE. Wary of the risks of entering a new market, foreign power generators opted to reduce risks by controlling what they could control such as their own supply chain.
Mexico meets several conditions for the expansion of solar power generation and the use of LCR to expand its manufacturing activities: The country’s photovoltaic and solar thermal resources are among the world’s best, it has a large market potential, and a strong industrial base. Since 2013 it developed a regulatory framework that, based on market response, was successful at attracting investments.
Even more, Mexico is well positioned to benefit from US re-localization of value chains. However, following the election of President Andres Manuel Lopez Obrador (2018-2024) the outlook for RE expansion looks uncertain. The elected president preferred to support oil and gas activities, and protect the commercial interest of Pemex, even if that implied selling fuel oil to CFE although the power utility had already started to use RE sources as a viable source of energy. (Grustein 2020).
The government’s decision creates significant regulatory uncertainty, questioning the future of the entire RE deployment strategy, and the expansion of a local value chain.
Contrary to electricity generation, the main source of GHG emission in Latin Americas are from agriculture, forestry, and land use (AFOLU). This is where the region should focus its efforts (Guimaraes 2020).
The use of LCR in RE to expand manufacturing jobs of RE components has been modest. Most of the job opportunities from RE expansion would be on construction, operation, and maintenance.
As such, Latin America’s energy transition in electricity generation is unlikely to be the main solution to reduce GHG, nor will it be a significant source of jobs in the manufacturing of components if the priority is – as it should be- to ensure a supply of electricity at competitive prices.
This, however, does not mean RE deployment should be ignored. On the contrary, efforts should be on strengthening the stability of the regulatory environment on RE electricity generation to reduce dependency on hydroelectricity and fossil fuels.
To capture more jobs, focus should be on improving and expanding workforce’s technical skills on RE activities. As such, universities, and technical centers working in coordination with RE power generators and EPC companies should develop proper certification programs according to the expected market potential of each country.
Rene Roger Tissot, Energy Fellow Institute of the Americas, PhD Student University of British Columbia Okanagan, expert on energy economics and local content development programs. M.A. Economics, MBA, CMA.