The Energy Transition in Latin America: a Multidimensional Analysis of a Strategic Opportunity

  Focus - Allegati
  15 dicembre 2022
  23 minuti, 24 secondi

The Energy Transition in Latin America: a Multidimensional Analysis of a Strategic Opportunity

Authors:

Annagrazia Caricato - Junior Researcher, Mondo Internazionale G.E.O. - Economics


Abstract

Whilst it is widely acknowledged that there is an urgent need to reduce CO2 emissions associated with energy, the exact paths toward a just and sustainable transition from fossil-based to low-carbon energy systems are difficult to define, as they involve a number of social, technological, economic, and environmental factors that are relevant to specific realities. Moving from this observation, the present paper explores the intricacies of the energy transition in Latin America, a region that finds itself at a crossroads: how can this region, which is rich in renewable energy resources but dependent on fossil fuels and extractives for economic growth and energy security, decarbonise in a way that addresses the aforementioned drivers? Reflecting on this issue, the research first reviews the concept of the energy transition, as a prelude to the economic and socio-environmental analysis that will follow, aiming to offer a multidimensional insight into the Latin American case and to stimulate thought on the challenges and opportunities that lie ahead.

Introduction

From Mexico to Tierra del Fuego, Latin America is a region of extremes: the vast South American geography hosts more than 40% of the Earth’s biodiversity, more than one-quarter of its forests and is the single most biologically diverse area in the world; around 60% of global terrestrial life, diverse freshwater, and marine species can be found in the entire region, earning it the title of “biodiversity superpower” (Bovarnick et al, 2010; UNEP, 2016). Furthermore, Latin America is well-endowed in renewable energy sources, but it is also historically and currently dependent on fossil fuels and extractives for energy security and economic growth. The transition to a low-carbon energy system, thus, may represent a strategic opportunity for the region, but insofar as it is placed in a strategically complex situation, both economic-productive and ecosystem-wise, perspectives of effective capitalisation remain shrouded in uncertainty (Estenssoro, 2020). Most countries in Latin America, indeed, hold a natural competitive advantage due to their abundant wind and solar energy sources, but a wide range of opportunities is yet to be explored. Based on the 2022 Latin America Energy Transition Readiness Index, the accelerated expansion of renewable energy tops the list of energy priorities in the region, and the policy area shows a high level of priority of action needed to enable Latin America to act as a third party for the US and China, and to develop into a reliable exporter of green energy and hydrogen. However, the energy transition is a process of structural change with significant effects on the economy entailing socio-environmental, as well as distributional factors that affect people’s livelihood, and ultimately shaping the prospects of a just energy transition. Under such circumstances, Latin American countries are faced with a question that the present research aims to reflect on, that is, “how to decarbonise in a way to address the drivers of energy security, economic competitiveness, and environmental sustainability?” (Wood, 2022).

Conceptualising the Energy Transition

As public understanding of climate change's effects grows globally, the energy system needs to change from relying on fossil fuels to being carbon-free by the second half of this century. The necessity of reducing CO2 emissions associated with energy is more than ever a pressing need. This necessity is strictly linked with the urge to shift the global energy sector from fossil-based energy production and consumption systems to renewable energy sources. According to Smil (2016), an energy transition is “the change in the composition (structure) of primary energy supply, the progressive transition from a certain pattern of energy provision to a new condition of an energy system.”

Energy sector decarbonisation is urgent, and a worldwide response is needed to address the issue. Energy efficiency and renewable energy solutions might help reduce carbon emissions by 90% (IRENA, 2019). However, energy transitions are intricate, including social, technological, and economic elements (Montero et al., 2020). Moreover, many academics and analysts see energy transitions as uncommon and drawn-long processes. Thus, it is crucial to look at past examples for guidance on how they could play out in the future. For example, there have been and are now occurring several significant energy transitions since the start of the Industrial Revolution (Fouquet, 2016). However, how we obtain energy also saw significant developments before the Industrial Revolution, when individuals ground their grains using hand mills, water, wind, and muscular power while heating their dwellings and cooking with wood and dried dung (World Economic Forum, 2022). Due to shortages, the cost of firewood and charcoal increased throughout the 16th and 17th centuries. Therefore, ​​industrialising countries like the UK required a new, less expensive energy source. They switched to coal, signalling the start of the first meaningful energy change (World Economic Forum, 2022). Edwin L. Drake drilled Pennsylvania's first commercial oil well in 1859, but it was not until over a century later that oil became a significant energy source. When assembly lines were invented, oil consumption from internal combustion engine cars began to rise, and after World War II, as vehicle sales rose, it took off (World Economic Forum, 2022). The continuing energy transformation is centred on renewable energy sources. Global solar and wind energy capacities are growing as states increase their efforts to reduce emissions. The need for innovation is at the heart of the transitions mentioned above. The current transition, instead, is driven by the knowledge that a reduction in greenhouse gas emissions is necessary to prevent the catastrophic impacts of climate change. These changes are part of longer-term secular trends towards cleaner and more efficient energy supply and end-use, which will continue to materialise, albeit at varying speeds depending on the location.

Finally, recent academic and policy work presents a new level of knowledge about the possible adverse effects of the energy transition for specific communities and socio-economic groups on the front of the shift (Carley & Konisky, 2020). Nowadays, new insights are required to comprehend the transition's justice and equitable elements and guarantee that no one is left behind.

The Energy Transition in Latin America: A Regional Snapshot

In Latin America, the incorporation of renewables into national energy mixes emerged as a prelude to the transition from fossil-based to low-carbon models of energy supply already in the 1970s. The establishment of the Brazilian National Alcohol Program (Proálcool)[1] by Federal Government Decree No. 76,593 in 1975, indeed, represented a pioneering step in the process of advancing the energy transition, albeit initially driven by energy security and trade deficit-related concerns arousing from the 1973 oil shock (Serrate & Weber, 2021). The same decade witnessed the deployment of similar initiatives across the region, such as the geothermal program in Costa Rica and Nicaragua and hydropower projects in Paraguay and Brazil, where earlier attempts also materialised in the 1940s and 1950s – particularly through former President Juscelino Kubitschek’s Plano de Metas – and culminated in the construction of the co-owned binational Itaipu dam (Ebeling, 2020; Koengkan & Fuinhas, 2022).

As the region embarked on a distinctive trajectory of hydropower and recently biofuels development, its shares of renewables significantly expanded, thus favouring gradual diversification into other sources that eventually shaped some of the most dynamic renewable energy markets worldwide, including Chile and Mexico, along with Brazil (Wood, 2022). Whilst Latin America is home to several success stories – the most illustrative case being Costa Rica’s generation of more than 99% of its electricity from renewables, with hydro, wind, and geothermal being the three leading sources (IEA, 2020) – no regional coordination endeavours to promote a transformation beyond Nationally Determined Contributions (NDC) were hitherto made, except the SIEPAC project[2] and political efforts in regional fora (Tornel Curzio et al., 2022; Guimarães, 2022).

​​Although the regional energy snapshot points, prima facie, to the growing role of renewables, phenomena of considerable variation occur both at the sub-regional and national levels[3], hence the need to intend general trends as a starting point to further contextual analysis.


Figure 1. Total Energy Supply (TES) by source and Total Final Consumption (TFC) by sector in Central & South America, 2019.

Source: own elaboration on data from International Energy Agency (IEA).

In this regard, Tornel Curzio et al. (2022) detect the main dynamics currently underway in the Latin American energy transition, namely (a) the use of gas as a transition fuel and (b) of coal, (c) dependency on and subsidies to hydrocarbons, (d) the role of extractives and critical minerals, (v) social impacts and conflicts associated with the development of infrastructural and renewable energy projects, and (f) vulnerability and climate injustices. Furthermore, it is worth noticing that additional factors influence the rise of renewables in the region: besides the prominent role of fossil fuels and extractives in national energy mixes, linkages with one of the region’s main exports, i.e., commodities, deserve equal attention (Wood, 2022). Under such circumstances, the diversity encountered in the region has the potential to foster synergies between, for instance, large hydropower and other intermittent energy resources, but it also constitutes a challenge for a just energy transition whose economic and socio-environmental ramifications will be explored in the following paragraphs.

2.1 Economic Drivers and Challenges

The energy transition can be defined as a structural economic change whereby deliberate policy, changing preferences, and technological change determine the rise of some parts of the economy, and as a consequence the decline in relative importance of others (Semieniuk et al., 2020). Thus, transition risk drivers stemming from the growth of low-carbon sunrise industries and the waning of high-carbon sunset industries may impose economic costs, with considerable financial and macroeconomic impacts at different levels.

For the purpose of assessing developing countries’ macroeconomic exposure and systemic vulnerability to the low-carbon transition, the French Development Agency detected three risk dimensions, that is (a) external, (b) fiscal, and (c) socio-economic exposure, respectively measured as dependency on sunset industries to raise (a) foreign currency and (b) government revenues, and (c) to generate employment and wages. Moreover, the study found that Trinidad and Tobago, Bolivia, and Venezuela present high dependence on sunset industries in all the three dimensions considered, whereas Paraguay and Ecuador display lower external dependence, but exposure in the fiscal and socio-economic realms (Espagne et al., 2021).

The abovesaid analysis offers a key to interpreting the underlying drivers and challenges of the Latin American energy transition. As claimed by Stanley (2020), indeed, when countries’ global insertion relates to the exploitation of non-renewable resources, their economies are exposed to, simultaneously, saving and fiscal external gaps impinging on the capacity, policy space, and funds available to diversify the economy. Although both individual and concerted efforts toward a green fiscal reform to tax CO2 emissions have been documented, for instance, in Chile, Colombia, and Mexico, the implementation of such adjustments nonetheless requires favourable political conditions, as well as adequate sequencing and compensation schemes that may vary substantially throughout the region (Jakob et al., 2019). This especially applies to economies that depend on extractive industries for exports and fiscal revenues, with significant implications beyond energy policy targets: the employment of fiscal resources to support said sectors can erode a government’s ability to generate the requisite revenue to fund other public services and investments, thereby exerting a distortive effect in the direction of fossil-fuel energy sources locking in carbon-intensive assets, ultimately limiting prospects of rapid uptake of less carbon-intensive technologies (Elgouacem et al., 2019).

Figure 2. Oil rents as a percentage of GDP, selected Latin American economies, 2000-2020.

*The most recent figure available for Venezuela is from 2014.

Source: own elaboration on data from World Bank.

At the same time, these economies are exposed to the risk of stranded assets or the problem of premature abandonment (Semieniuk et al., 2020). Regulatory, technological, and societal changes linked with the energy transition may determine an abrupt loss of competitiveness of high-carbon industries, hence hindering these assets’ ability to earn an economic return before the end of their economic life. Stranded assets in the oil and gas industry include, amongst others, resources, exploration and development assets, production and processing facilities, and distribution infrastructure (Carbon Tracker Initiative, 2017). According to Solano-Rodríguez et. al (2019), “66-81% of 3P oil reserves in Latin America will remain unused by 2035, and stringent global climate action could reduce fiscal revenues to $1.3-2.6 trillion compared to $2.7-6.8 trillion if reserves were strongly exploited.” This phenomenon is of the utmost importance not only for leading oil-producing countries like Brazil, Mexico, and Venezuela but also for those that rely on energy-intensive industries, particularly mining. For example, in 2020, electrical energy consumption in copper mining in Chile amounted to 24.960 GWh or 35% of the total national electricity consumption (Consejo Minero, 2022). The availability of cheap energy is thus essential for the mining industry to remain competitive which, considering that Chile is a net importer of hydrocarbons, represents a major driver of power matrix diversification through electrical projects based on Non-Conventional Renewable Energies and the strengthening of traditional sources such as hydro and biomass to guarantee the security of the energy supply (Zamorano, 2022).

To complete the picture, a reference to National Oil Companies’ role in the energy transition should be made: Brazil’s Petrobras and Colombia’s Ecopetrol are the only companies in the region to pledge net zero by 2050, whereas doubts persist over Argentina’s YPF as the high share of natural gas in its portfolio may constitute an advantage in the decarbonisation strategy; the outlook for Venezuela’s PDVSA and to a certain extent Mexico’s PEMEX, instead, appears grimmer (Palacios & Monaldi, 2021; World Benchmarking Alliance, 2021).

Furthermore, Latin American countries also face barriers to the development of renewable energy, one of the most cited being the need to mobilise finance into the region’s untapped potential in solar and wind energy, green hydrogen production, and its abundant reserves of strategic minerals crucial to supporting the energy transition (Koopa, 2022). In this regard, the high cost of capital is deemed as a major constraining factor in the deployment of clean energy investment in many emerging and developing economies, driven not only by higher country risk but also by higher sectoral risks comprising regulatory, off-taker, and land acquisition risks. An analysis carried out by the International Energy Agency (IEA) found that the cost of capital for a typical solar PV plant in 2021 was between two- and three-times higher in these markets than in advanced economies and China, with Brazil and Mexico’s weighted average cost of capital measured respectively at 12.5%-13.5% and 9.5%-10.0% (World Energy Outlook, 2022). This notwithstanding, wind and solar expansion in 2021 delivered outstanding results partly stemming from the completion of delayed projects spearheaded by Brazil and Chile (BloombergNEF, 2021). Interestingly, both countries appear among the top recipients of public investments in renewables in South America between 2010 and 2020, with Brazil holding the lion’s share of investments, valued at $36,7 billion, more than 60% of the cumulative transactions registered in South America in the same time span (IRENA, 2020).

De León (2021) maintains that the general trend in the region is an increase in financing for renewable projects, supported by the Export-Import Bank of China, the China Development Bank, the Inter-American Development Bank, the Development Bank of Latin America, and the US Agency for International Development, in that order. Most of the region sees China as the leading financier: between 2000 and 2019, the Asian country dedicated $58,4 billion to the Latin American energy sector, respectively allocated in oil and natural gas projects (83%), hydroelectric energy (12,8%) and solar energy (2,2%); expenses incurred under the Belt and Road Initiative (BRI), instead, were destined to oil and gas (56%) and renewable energies (39%) (Instituto de las Américas, 2021). Whilst an investigation into China’s multifaceted role in the Latin American energy industry is not the object of the present research, it is necessary to acknowledge that its approach is progressively experiencing a qualitative transformation that pundits advocate for the entire region: an increase in funds, indeed, must be accompanied by a redirection from fossil fuels to renewables (Koop, 2022). Moreover, public investment constraints point to the potentialities of the private sector, which is expected to be a considerable source of financing. Ultimately, if rent-extracting fiscal dependency needs to give way to pro-growth fiscal strategies, the financial toolkit for a just and orderly transition in Latin America will require the integration of existing and novel mechanisms, including but not limited to, the effective deployment of international development finance, local development banks’ mobilisation and de-risking instruments, alongside greater local and international green and ESG bonds development (Palacios & Cárdenas, 2022).

2.2 Social and Environmental Considerations for a Just Transition

“Just transitions” concentrate on the changeover from high-carbon production to the green economy, attempting to minimise the adverse effects of this process while minimising harm to workers, communities, nations, and regions. Just transition is an emerging idea endorsed globally in the 2015 Paris Agreement and received significant momentum at the Glasgow UN Climate Conference in 2021 (IHBR, 2022).

The transition to new sustainable energy sources could have a huge impact on people and communities along the entire value chain, from the risks faced by those involved in mining minerals for renewable energy sources to the possibility of violations of the rights of those living close to the land needed for quickly expanding green infrastructure (IHBR, 2022). The concept of just transition has, over time, come to imply something far broader: a conscious effort to plan for and invest in a transition to ecologically and socially sustainable employment, sectors, and economies (Smith, 2017). However, the just transition will not take place on its own: plans and policies are needed, and it will take time for communities and workers who depend on fossil fuels to find alternate sources of income and funding. On this subject, it is pertinent to note that besides the already-mentioned conundrum of external and fiscal exposure, the low-carbon transition also presents Latin American countries with significant socio-economic risks. Sunset industries account directly and indirectly for about 4% of employment in Brazil, Argentina, Peru, Ecuador, and Colombia. The high socio-economic exposure found in these countries, however, does not necessarily entail high vulnerability, which materialises in countries that also present high inequality, a large share of the population below the poverty line, and low levels of social protection, the latter being the case of Peru, Bolivia, and Ecuador (Espagne et al., 2021; Magacho et al., 2022). This is precisely why transformation involves more than just phasing out polluting businesses; it also involves the creation of new jobs, industries, skills, investments, and opportunities for a more equitable and resilient economy (Smith, 2017). The key to achieving these positive outcomes is social dialogue. Indeed, the policy consistency required for climate action to result in job creation and community rejuvenation will be provided via social dialogue between the government, industry, labour unions, and civil society organisations. The 2021 UN Climate Conference (COP26) in Glasgow was a crucial opportunity to assess the status of global climate action while also stepping up pledges and developing a clear plan of action for achieving climate action objectives. It particularly “urged” countries to submit long-term strategies to the UN before COP27 “towards just transitions to net-zero emissions by or around mid-century” (UNFCCC, 2021). The long-sought agreement to create a fund to pay “loss and damage” from climate change-related catastrophes in developing countries was eventually reached in COP27. The summit also offered an occasion for Latin American countries to call for greater regional alignment on climate policy, as the Joint Declaration presented by the Community of Latin American and Caribbean States (CELAC) restated the importance of “unity and collaboration to address the climate crisis and promote comprehensive and sustainable development under a just transition framework in the region,” hence signalling a potential departure from the fragmentation that characterised previous climate negotiations (CELAC Declaration, 2022; Koopb, 2022).

Moreover, it created a work program on just transition, which was warmly welcomed by the trade union movements. According to the Sharm el-Sheikh Implementation Plan, social dialogue is the basis for just transition. Furthermore, in the final decision, the parties affirm that genuine and effective social dialogue and the involvement of all stakeholders are necessary to develop sustainable and just solutions to the climate crisis. It was also acknowledged that the transition to low emissions globally presents both opportunities and challenges for eradicating poverty and sustainable economic development (UNFCCC, 2022). Finally, it was stressed that a just and equitable transition must consider pathways for the energy, socio-economic, workforce, and other aspects of the transition, emphasising the critical role that social solidarity and protection instruments play in reducing the harmful effects of implemented measures.

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[1] The program’s strategic rationale was based on (a) the reduction of external dependence on fuel and (b) saving foreign currency by replacing petroleum-based fuels with ethanol derived from sugarcane when the crop’s production was at its highest. As the policy produced achievements and failures, its focus progressively changed throughout the years by including social and political aspects such as employment and energy matrix diversification, amongst others (Stolf & Rodrigues de Oliveira, 2020).

[2] The Central American Electrical Interconnection System (SIEPAC) was set out by Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica, and Panama, and formalised in the Central America Electric Market Treaty Frame (1996) to favour electric integration among the parties.

[3] The Renewable Energy Market Analysis: Latin America (2016) produced by the International Renewable Energy Agency (IRENA) distinguishes between Central America, Andean States, Southern Cone, Mexico, and Brazil. Generally speaking, the main source of primary energy supply in 2013 was represented by oil; bioenergy and waste were a leading source in Central America (39%) and Brazil (28%), while a high share of natural gas was reported in the Southern Cone (35%), Mexico (32%), and Andean States (27%).

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