Fitch: 2016 Chilean Regulated Electricity Auction May Pressure Generators’ Credit Metrics

Fitch Ratings expects this week's Chilean regulated electricity auction to pressure prices for contracts starting in 2021. The results of this 12,500 GWh/year auction will have a higher impact on those companies with a higher portion of their contracts expiring in the next five years. The companies with the highest re-contracting risk in 2021 are Colbun SA ('BBB', Outlook Stable), and AES Gener S.A. ('BBB-', Outlook Stable) with more than a quarter of its outstanding contracts expiring by 2022.

Fitch believes Colbun's imbalance in the company's long-term contracted position may affect its credit profile. This may be a result of the company's inability to re-contract a significant portion of its expiring contracts. Chile expects to have two additional smaller auctions for 3,000 GWh/year this year and 8,000 GWh/year in 2017, for contracts starting in 2023 and 2024, respectively. This may alleviate the pressure if the company is not able to re-contract the totality of its approximately 4,000 GWh expiring by 2021.

Fitch notes that thermo generator AES Gener has less flexibility to withstand lower margins resulting from potentially lower awarded prices given its higher generation cost. Additionally, AES Gener is still under a significant capex intensive phase, which coupled with a more aggressive capital structure reduce its tolerance to lower margins. Positively, the company's dominant position in the Chilean market, relatively manageable re-contracting exposure and proven track record of obtaining bilateral contracts partially mitigate this risk. A change in AES Gener's commercial policy that results in an imbalanced long-term contractual position would be viewed negatively by Fitch.

Finally, Fitch believes Engie Energia Chile S.A., formerly known as E.CL ('BBB', Outlook Stable) is the least exposed to re-contracting risk as the company had a healthy average remaining life of approximately 12 years as of March 2016 and no significant maturities until 2026. The company's participation in this auction is expected to be symbolic and the results of the auction will be credit neutral for the company.

--Fitch Expects the 2016 Auction to Result in Lower Contractual Prices

Fitch believes the participation of new players; coupled with the potential aggressive offers from the non-conventional renewables (NCREs) will likely pressure contractual prices downwards. This will be one of the most competitive auctions in Chile's history with bidders presenting offers almost seven times higher than the amount being auctioned. A significant portion of new projects, including NCREs, mainly solar and wind were among the bidders.

Fitch considers that the Chilean government will allocate the contracts not only based on pricing, but considering the stability of the country generation matrix for the future. Chile has historically benefited from one of the most balanced and reliable generation matrices in Latin America, which the government will likely preserve despite an increased participation of NCRE players. Additionally, Fitch expects the dominant players will continue having a key role in the country's power generation.

--Spot Prices Decline: Mixed Results for Fitch's Rated Generators

The decline in spot prices observed during the first half of 2016 had mixed results for Fitch's rated companies. In the short to medium term, Fitch expects those companies with higher exposure to spot prices and higher marginal costs to be the most affected. The impact on companies' cash flow generation will depend on their generation mix, contracted position and adequate indexation mechanisms. Fitch's rated power generators, Endesa Chile S.A. ('BBB+', Outlook Positive) and Colbun have a significant hydro component in their generation matrices with a favorable cost structure during average hydro conditions, allowing them to be better suited to withstand sporadic depressed spot prices.

In the case of Endesa Chile, Fitch believes the company's conservative business strategy, coupled with access to LNG from GNL Quintero, provides more flexibility to Endesa Chile to withstand more volatile scenarios. Meanwhile, Colbun is more exposed to spot price volatility due to a higher contractual position when compared with its firm generation capacity. Under a dry hydrology scenario, Colbun can meet its contractual obligations with its natural gas backup units or by purchases in the spot market, typically with a negative effect on margins. Positively, Colbun secured temporary provisions of natural gas for its thermal units through contracts with Metrogas S.A. and Empresa Nacional del Petroleo (ENAP) until 2019. Fitch views positively the 20-year contract with GNL Chile securing regasification capacity at the Quintero terminal starting in 2021.

--Challenges Ahead: Balanced Generation Mix Growth

Fitch believes the main challenges ahead in the Chilean electricity sector are related to the balance of the country's generation mix and balanced growth of its base load capacity complemented with an adequate transmission system. The TEN project will partially alleviate the transmission congestion to provide access to both systems to the more efficient terminals. The main concern related to new projects coming online, especially the green field NCREs, relates to the ability and experience of the sponsors to complete the projects and provide the energy during the committed periods at the offered prices. Many of these NCRE projects are bidding for the full day block, which in the long term may not be reliable if not complemented with a more consistent technology such as hydro or thermo generation.

Additional information is available on www.fitchratings.com

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