Renewable and Sustainable Energy Reviews 56 (2016) 563–571

Contents lists available at ScienceDirect

Renewable and Sustainable Energy Reviews

journal homepage: www.elsevier.com/locate/rser

How capacity mechanisms drive technology choice in power

generation: The case of Colombia
Yris Olaya a, Santiago Arango-Aramburo a, Erik R. Larsen b,n
a
Decision Science Group, Universidad Nacional de Colombia, Colombia
b
Università della Svizzera italiana, Switzerland

art ic l e i nf o a b s t r a c t

Article history: Colombia enacted its first legal framework for promoting alternative energies in 2001 and a second
Received 12 May 2015 framework in 2014. Since the generation technology mix has not changed since 2000, there is a need to
Received in revised form understand how regulation and market structure affect the adoption of technologies. In this paper we
30 October 2015
address the question of what has been the impact of the capacity mechanisms adopted during the 2000s
Accepted 22 November 2015
on technology choices for power generation in Colombia. Our approach is to analyze the evolution of
Available online 17 December 2015
market structure and regulation. We found that regulatory uncertainty and low prices drove a surge of
Keywords: small hydro plants during the 2000s. During the 2010s, the new regulatory focus on reliability of supply
Power generation mix has resulted in increased coal-fueled generation and large hydro. This increased reliance on hydro power
Capacity mechanisms
can further delay the entry of renewable technologies and the diversification of the Colombian portfolio.
Renewable energy
& 2015 Elsevier Ltd. All rights reserved.
Colombia

Contents

1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 563
2. Overview of the Colombian power system. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 564
2.1. From central planning to deregulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 565
3. Effect of capacity mechanisms in the Colombian power sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 565
3.1. Before deregulation (Before 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 565
3.2. Market system and capacity charge (1994–2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 566
3.3. Reliability charge or forward firm energy market (After 2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 567
4. From big to small hydro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 568
4.1. Role of (other) renewables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 568
5. Discussion and conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 570

1. Introduction countries a desire to move away from nuclear generation [1–3].

Some of these changes are motivated by environmental concerns,
Technology choices for power generation determine to a large by technological uncertainty, economic changes, and perceived risk
extent the structure of energy supply and have lasting impacts on of nuclear power as well as ideological views, all of which play a
the environment. During the last three decades, we have witnessed role in establishing policy priorities.
a shift away from coal to gas-fueled power generation, the intro- The creation of power markets worldwide is the result of a
duction of renewable energy technologies, and recently in many broader energy policy aimed at increasing efficiency and attracting
private investments – with the goal of satisfying a growing
n
demand for electricity, particularly in the developing world [4]. In
Correspondence to: Via Buffi 13, CH-6904 Lugano, Switzerland.
E-mail addresses: yolayam@unal.edu.co (Y. Olaya), the early years of market reforms, increasing competition and
saarango@unal.edu.co (S. Arango-Aramburo), erik.larsen@usi.ch (E.R. Larsen). efficiency in generation were the main issues by regulators and

http://dx.doi.org/10.1016/j.rser.2015.11.065
1364-0321/& 2015 Elsevier Ltd. All rights reserved.
564 Y. Olaya et al. / Renewable and Sustainable Energy Reviews 56 (2016) 563–571

researchers. Bringing competition to the power market meant compared to other industries, making it more difficult to ensure
often unbundling utilities, breaking monopolies up, and creating that the right incentives are in place to achieve the right mix of
commodity-like markets for electricity. Two decades later, future technologies.
reliability is one of the main concerns in liberalized markets [5–9]. The aim of this paper is to illustrate how different regulatory
In fact, the International Energy Agency (IEA) and European Union regimes affect technology choices, using Colombia as a case study.
(EU) estimate that EU countries need to invest Euro 1 trillion from Colombia is an interesting case as the incentives for adding
2012 to 2020 and a further Euro 3 trillion to 2050 to ensure ade- capacity have been modified twice since deregulation, in an effort
quate electricity capacity [8], despite some disagreements with to adapt the regulation to shifting economic and market condi-
these estimates [10]. Ensuring that such new investments are tions. The first incentives (1996–2006) aimed at reducing the
made in a timely manner is a challenge for power markets and it electricity system's vulnerability during dry periods. These
might be an opportunity for introducing alternative generation incentives were modified in 2006 in order to provide signals for
technologies. expansions of the system. While regulation has succeeded in
In theory, a competitive market setting should give the right securing supply during dry periods, the technology mix has
signals at the right time for investors to choose the best technology remained basically unchanged since 2000. Furthermore, with the
for expanding generating capacity. Power markets, however, are not exception of small hydro plants, penetration of other renewable
perfectly competitive [11], future returns are highly uncertain [12] technologies is almost zero. In the next sections we examine how
and investment decisions are constrained by environmental con- capacity mechanisms and the structure of the market have influ-
cerns, availability of appropriate generation technologies and the enced technology choices for power generation in Colombia.
general future economic outlook [13]. As a result of the high This paper is organized as follows: Section 2 makes a brief
uncertainty and the long lead times for new projects, it is common description of the Colombian power system, including the capacity
for power markets to observe cycles of over- and under-capacity before deregulation and explains the events that led to deregula-
margin [14]. Such fluctuations increase supply risk, and thus the tion. Section 3 describes and discusses the resource adequacy
objective of regulation is to reduce them. Achieving a long-term mechanisms used in Colombia, and their impact on the generation
security of supply (resource adequacy) at a low cost is particularly mix, including capacity mechanisms’ implications for renewable
challenging for developing countries that face increasing demand energy. Section 4 presents the main insights and conclusions from
and need to expand access to energy [5–9,15]. the previous analysis.
While markets in different jurisdictions have different price-
setting mechanisms, the most common mechanism is prices based
on marginal costs. Marginal cost-pricing, however, does not offer 2. Overview of the Colombian power system
sufficient incentives for adding new capacity and increasing long-
term security of supply [16], a phenomenon known as the “miss- Seasonal variations of power demand in Colombia are relatively
ing money problem” [17]. Most markets solve it by using a sepa- small, and high capacity margins are maintained as a reliability
rate, often complex, set of rules for calculating and allocating strategy. Because the share of hydro generating capacity is larger
payments for capacity availability – known as capacity payments. than 65%, the Colombian power system is vulnerable to weather
The idea behind capacity payments is to recover capital costs that changes such as the prolonged and intense droughts caused by the
are not part of the market price, thus keeping enough capacity to macroclimatic phenomena of “El Niño South Oscillation” (ENSO).
satisfy demand at a given reliability level. Nowadays, there is a The interconnected power system provides electricity to 94.6% of
debate on whether capacity payments are needed, instead of the population [19], with high quality standards. Table 1 sum-
relying on an energy-only market that rewards generating plants marizes the main indicators of Colombia's macroeconomic con-
with scarcity rents [15,17,18]. Suppliers in an energy-only market dition and power system. Hydro power dominates the technology
bid prices instead of bidding their marginal cost. Price bids should
include the capacity cost and they also increase during peak Table 1
demand periods, when capacity is scarce. Many electricity markets Macro-economic and electricity industry indicators in Colombia.
use capacity payments or a related mechanism to increase the
Demographic and economic indicators Electricity prices ($US/kW h)
revenues of the generators and to incentivize their investment in
2012a
new capacity. That is the case of Argentina, Brazil, Chile, Colombia, Population (est. Jan. 2015)b 47,965,803 Residential 0.2
Perú, Spain, and the UK [15]. Alternatively, Australia, Alberta, GDP (ppp) Billions US$ 526.5 Industrial 0.22
ERCOT, and New Zealand have complete commodities markets for (est. 2013)c
electricity and have implemented energy-only markets that have GDP per capita (ppp) 2013 11,100 Commercial 0.16
est.c
been successful so far [17].
Market structure Bid based
The contribution of new capacity to the system's reliability
Installed generation capacity (MW), Dec. Electricity demand profile
depends on the size and timing of investments and varies widely
31 2013d (2012)e
across technologies. Wind technologies, for instance, have name- Hydro 9875 Industry 31%
plate capacities that are between 60 and 70 percent higher than Thermal 4598 Transport 0%
their annual output, and they only increase capacity margins when Wind 20 Residential 41%
wind is available. In fact, a proper mix of technologies increases Co-generation 66 Commerce and public 24%
Total 14559 Agricultural/Forestry/ 4%
the reliability of supply. Therefore, regulators need to understand
fishing
the logic of investment decisions and tailor the resource-adequacy
Energy intensitye Electricity demand growthe
mechanisms to each particular case.
TPES/pop (toe/capita) 0.66 Average 2004–2008 3.0%
To a great extent, the incentives and rules set by regulators TPES/GDP (toe/000 2005 0.16 Average 2008–2012 4.5%
drive technology choices by investors in a particular area, and the USD)
pace of the investment. The consequences of investment decisions
a
are complex as new capacity takes from some months (e.g. Photo [24].
b
[22].
Voltaic (PV)), several years (e.g. Combined Cycle Gas Turbines c
[21].
(CCGT)) to a decade (e.g. big hydro) to come on-stream. Moreover, d
[20].
capacity is often added in large chunks and has a long life-time e
[23].
 Y. Olaya et al. / Renewable and Sustainable Energy Reviews 56 (2016) 563–571
Fig. 1. Contribution of public utilities (electricity, gas, and water) to the Colombian
external debt between 1970 and 1998, [28].
mix for generation, as it represents 65% of the 8525 MW of
installed capacity [20].
Since the reforms of the power sector in 1994, Colombia has
had a market-oriented system, including regulatory and oversight
bodies [25]. Following deregulation, the power market has sup-
plied energy with virtually no interruptions; power companies are
today in a good financial position, as evidenced by their ability to
enter new markets in Chile, Brazil, Perú, and Guatemala, among
others [26]. Nevertheless, as we discuss next, the process to
improve the system's performance was not smooth and it has
required major structural and regulatory challenges.
The issues before the reforms are illustrated by the fact that
public utilities were responsible for more than 35% of the
Colombian external debt (see Fig. 1). Some companies had diffi-
culties financing expansions and mismanagement was widespread
[27], which led to a series of costly blackouts in the early nineties.
These major blackouts made reforms easier to pass because they
exposed the weaknesses of the existing monopolistic system.
The Colombian power sector has gone through several struc-
tural reforms, in which the regulator has adapted the strategy to
achieve resource adequacy, as we show in the following sections.
These changes provide us with valuable data and insights on the
impact of regulation on technology choices, as well as on the
effects of the initial technology mix on regulatory decisions. We
discuss these issues in further detail in the following section, in
which we give a short account of the events that shaped the
present power system in Colombia.
2.1. From central planning to deregulation
In the early 1960s, the Colombian government began planning
for the interconnection of the largest regional, vertically-
integrated public utilities. ISA, the national grid company, was
created in 1967 and was responsible for the system operation and
expansion planning. Between 1970 and 1980 the public utilities,
along with ISA, installed more than 1200 MW of generating
capacity,1 to satisfy the growing demand. Because of this expan-
sion, utilities (including ISA) were having trouble financing pro-
jects and there were problems with completing projects on
schedule; such delays led to power cuts in 1981 [27]. To avoid
power shortages, the government focused on financing new gen-
erating plants which led to a 28% increase in Colombia's external
debt between 1970 and 1980. By 1985, the external debt origi-
nating from public utilities was 35% [28]. At this point, nearly 40%
1
ISA informes de operación 1970–1998.
565
of the electricity sector's budget was allocated to pay back the
loans, and to cover past deficits [29].
During the 1980s, GDP grew on average less than 4% annually
[30]. The low economic growth continued through the 1990s, and
between 1985 and 1996 per capita electricity consumption in
Colombia was one of the lowest in Latin America [31]. Never-
theless, construction delays in new power plants and a strong El
Niño in 1991–992, led to major blackouts from March of 1992 to
April of 1993 [32]. The severe financial problems of the utilities,
their lack of efficiency and inability to make timely investments
explain why, by the end of the 1980s, there was a general agree-
ment on the need for a reform of the power sector, to improve its
technical and administrative efficiency.
The power industry's reform began with the new constitution
in 1991, and was completed in 1994 by laws 142 [33] and 143 [34].
Law 143 (Electricity Law) aims at increasing the efficiency and
quality of the electricity supply through market mechanisms,
whereas Law 142 establishes the role of the government as a
regulator. Enactment of these laws was the first step towards
deregulation. Law 142 created regulatory, planning, and oversight
bodies for electricity and gas. To foster competition, reforms
separated transmission from distribution and generation, and
achieved partial unbundling of generation and distribution. An
independent system operator in charge of coordinating transmis-
sion and dispatch was created, and open access to the grid was
guaranteed. Monopolies in transmission and distribution were
regulated, while generation and the unregulated retail market
were opened for competition.
A pool-based market was created to increase competition in
power generation. In this market, price is set in a day-ahead
market in which all generators must participate, regardless of their
contracts. Bids are freely placed in the market. Thermal generators'
bids are to be based on variable operating costs (fuel) while hydro
generators' bids represent the value of water. One of the main
motivations for the reform was the need to attract investment in
the generation needed to keep pace with the (forecasted) growth
in demand, [4,25,35]. For this reason, from the beginning, there
were separate payments for energy and for capacity. Capacity
payments have been modified three times since 1994, reflecting
policy shifts, and these changes have produced distinct responses
in capacity expansion that we examine next.
3. Effect of capacity mechanisms in the Colombian power
sector
In this section we discuss the effect of capacity mechanisms on
generation-technology choices in Colombia. Fig. 2 shows the
additions of generating capacity to the Colombian system from
1960 to 2010 and the approved additions to enter between 2011
and 2019. As discussed above, between 1960 and 2014 the elec-
tricity sector went through major structural changes. We divide
our analysis into three periods: the period before the sector reform
in 1994, the first regulatory period focusing on resource adequacy
where the mechanism was capacity payments, and a second reg-
ulatory period beginning in 2006, corresponding to reliability
payments (see Fig. 2).
3.1. Before deregulation (Before 1994)
Before 1994, ISA, the national transmission company, coordi-
nated the expansion of generating capacity. Expansion projects
were selected using an optimization program that minimized
capital and operating costs while satisfying expected demand and
transmission constraints, among other conditions. During this
period, hydro power was the preferred technology for expanding
566 Y. Olaya et al. / Renewable and Sustainable Energy Reviews 56 (2016) 563–571
Fig. 2. Annual additions to generating capacity in Colombia from 1960 to 2010 and approved additions from 2011 to 2019. Data from ISA's annual operation reports 1980–
2005, and from UPME, [36].
power generating capacity at low cost. In fact, 86% of the 1240 MW
added during the 1960s was hydro.
In the 1970s, new generating capacity doubled the previous
decade's capacity and the share of thermal generating capacity
increased to 40% of the total, as more than 5 GW were added.
Despite this surge in capacity, power generation could not keep up
with increases in demand as some projects were delayed, which
led to a blackout in 1983. By 1990, total generating capacity was
8312 MW with 78% hydro and 22% thermal. Capacity, however,
continued to grow at a slower pace than demand, creating the
conditions for the pivotal 1992 blackouts.
The year of 1991 had the lowest rainfall recorded to date and
water reservoir levels dropped from 57% in September of 1991 to
17% in March of 1992 [37]. Furthermore, thermal plants had been
poorly maintained, and of the 2100 MW of installed thermal
capacity, only 1137 MW (62%) were operating [38,32]. Power
shortages began in March of 1992 and lasted over a year. More
than 2400 GW h were rationed and it is estimated that these
programmed power cuts cost about one percentage point of the
GDP over the period [38].
During the blackouts, the government invested in refurbishing
generating units and accelerated the construction of backup
plants, adding 400 MW of capacity. When the blackouts ended, an
investment strategy was devised to accelerate capacity expansion,
thereby improving the power system's robustness by adding
1950 MW of generating capacity between 1995 and 1999 [32].
Thermal plants accounted for more than 60% of the new capacity,
comprising: 750 MW of gas fired plants, 450 MW of coal-fired
plants, and 750 MW of new hydro capacity.
In 1993, estimated costs for the 1995–2000 expansion strategy
were 1.88 billion US dollars [32]. The hydropower projects had
already been financed by multilateral bank credits and the public
utilities' own resources. However, there was particular interest in
securing financing for thermal projects that would decrease the
vulnerability of the system to extremely dry seasons. The scheme
proposed to finance the thermal projects consisted of long-term
power purchase agreements (PPA), guaranteed by the government.
This scheme pays for the energy from, as well as for capacity of,
the new plants. The same long-term PPA-with-guarantees scheme
was suggested for promoting private investment [32].
3.2. Market system and capacity charge (1994–2006)
The blackouts of 1992 led to the construction of thermal
capacity, and the pressure for increasing reliability provided by
thermal generation continued after the power sector was
reformed in 1994. However, while thermal plants provide relia-
bility, their operating costs are higher than hydro under normal
weather conditions, making them less competitive. The electricity
market began operating in 1995, and it became clear that thermal
output sold at peak prices during dry seasons would not generate
enough revenue to justify investments in thermal capacity. The
response from regulators was to create a capacity charge [39,40],
which rewarded the contribution of each generator to securing
supply during dry periods, in particular for an extreme El Niño
event. Such charges had previously been applied in the UK, Chile,
and Argentina [15].
Capacity payments were proportional to the fixed costs of a
thermal generation plant (capacity charge). The reference value for
estimating capacity charges was the cost of installing 1 kW of an
open-cycle gas generator (5.25 US$/kW). Charges were collected
from the energy pool and were a lower cap for the electricity price
[4]. Each month, the capacity payments for each plant were cal-
culated as the product of the capacity charge multiplied by the
fraction of demand that each plant could supply in a critical
hydrology scenario. To calculate the availability of plants in a dry
year, the regulator used cost and critical hydrology data to run a
model of the market [41].
After some adjustments, capacity payments were applied from
1996 to 2005. As shown in Fig. 3, the average share of capacity
payments awarded to thermal and hydro technologies is similar to
the thermal/hydro share of the system (approximately 30%/70%).
The thermal capacity expansion from 1996 to 2000 can be
explained, at least partially, by the capacity payments mechanism
and to a less degree by the government's push for a higher share of
thermal generation. The investments of this period changed the
technology mix from 87% hydro in 1995 to below 70% in 2000,
which corresponds to an increase in thermal capacity of 2514 MW.
The new thermal capacity included 1230 MW from the govern-
ment's emergency plan of 1993; the only hydro plant to come on
stream in this period (340 MW) was also initiated by the emer-
gency plan. The increase in thermal generating capacity achieved
its purpose as it made the system more reliable. In fact, the 97–98
El Niño, which was stronger than the 91–92 El Niño, caused no
blackouts, although spot prices were about four times higher than
in previous dry seasons.
By the late 1990s, Colombia faced an economic crisis with GDP
falling by 4.2% in 1999, and growing at rates below 5% until 2003
[30]. The economic recovery was slow, electricity demand growth
stalled, and capacity margins increased to above 50%, which kept
prices low making the return on investments less attractive. As a
result, only 1050 MW were added to generating capacity between
2000 and 2005, of which 95% was hydro. This included about
200 MW of small hydro, and a 400 MW hydro plant commissioned
before 1994 (see Fig. 2). Another factor contributing to the delay of
 Y. Olaya et al. / Renewable and Sustainable Energy Reviews 56 (2016) 563–571 567

100%
90%
CC Thermo CC Hydro
80%
70%

60%
50%

40%

30%
20%
10%

0%
Apr-97

Apr-98

Apr-99

Apr-00

Apr-01

Apr-02

Apr-03
Jul-97

Jul-98

Jul-99

Jul-00

Jul-01

Jul-02

Jul-03
Jan-97

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-04
Oct-97

Oct-98

Oct-99

Oct-00

Oct-01

Oct-02

Oct-03
Fig. 3. Share of capacity payments awarded to thermal and hydro technologies in Colombia between 1997 and 2004. Data from NEON (www.xm.com.co).

investment decisions was general economic uncertainty, as well as because less energy is traded at volatile spot prices [47]. The
the expectation for a new regulation period beginning in 2005 [25]. downside for the buyers is that they will have to pay more for the
By the year 2000, capacity payments were contested by both energy during periods where prices otherwise would have been
thermal and hydro generators. In fact, the regulatory commission low. To some extent, this mechanism shares some of the char-
was studying alternatives for increasing capacity adequacy. It was acteristics of mothballing, a controversial practice in which buyers
argued that these payments did not send clear signals for expan- also pay for having less volatility [48].
sion, that they favored hydro generators, and that the technology The period 2006–2009 was designated as a transition period by
used as a reference (GT) had low capital costs [42]. Most of the the regulator [45]. During this period, a centralized mechanism
critiques from generators were about the model's validity and was used for assigning and pricing capacity. A total of 138 MW of
assumptions. In particular, generators argued that the optimization new generation capacity was added during this period. The
model used by the regulatory commission was not adequate for the expansion consisted of 57 MW of thermal and the rest of small
reformed market because its parameters did not represent the hydro-power plants. The first auction took place in 2008, awarded
system's characteristics. It was also argued that capacity charges contracts for 3420.8 MW of new generating capacity that will
were only a source of revenue and that reliability was not guaran- come on stream between 2013 and 2019, where about 90% of this
teed [43,4]. These problems led the regulator to introduce the capacity is hydro.
reliability payments, which we discuss in the following section. The large share of hydro generation is explained by the
mechanism for estimating contributions to firm energy. For hydro-
3.3. Reliability charge or forward firm energy market (After 2006) power plants, the estimation of firm energy is based on an opti-
mization model that considers critical hydrology. By contrast, firm
In 2006, the regulator changed the mechanism for securing energy offered by thermal power plants must be backed by a long-
generation adequacy in the Colombian system. The previous term fuel contract [49]. Such long-term fuel contracts are not
scheme (capacity charge) had worked well on thermal-based available at competitive prices, in particular for natural gas con-
systems, such as the UK, but as discussed above, it was argued tracts. Before markets for natural gas were established around the
that paying for firm energy instead of capacity would be more world, the typical gas contract was a 20-year take-or-pay contract.
appropriate for a hydro-based system such as the Colombian Although take-or-pay contracts help to pay for dedicated
system [44]. The new mechanism is called the reliability charge, assets, during the 2000s, concerns about security of gas supply,
and it is based on a forward market for firm energy, where firm changes in natural gas regulation, and noncompetitive behavior
energy is the capacity to deliver energy in a dry year. The regulator from sellers have resulted in a lower offer of firm gas contracts in
auctions off sufficient obligations to supply firm energy (OEFs) to Colombia [50]. As a result, gas-fired power generators have been
satisfy the system's forecasted demand, three years ahead. OEFs required to have other fuel backups. Since fuel prices and supply
can be seen as a call option, backed by physical capacity. A gen- are highly uncertain, we argue that the mechanism for estimating
erator receiving an OEF must supply a given quantity of energy if firm energy favors hydro power. This is indeed supported by the
the spot price is above a previously defined scarcity price [45]. A choice of generation technology observed in the past firm-energy
generator that supplies more than its share during scarcity periods auctions. It also provides another example of how gas and elec-
receives the spot price, while a generator that supplies less is tricity markets are becoming increasingly interdependent and, in
penalized. Therefore, there is an incentive for the generator to be this case, what is “bad” for gas would be “good” for electricity.
able to deliver the agreed quantity as long as the penalty for not For the last 20 years, power demand in Colombia grew at a
being able to deliver is severe enough [44]. Contract length for yearly average rate above 2%. This, along with the potential for
new plants is currently 20 years. Simulation analysis indicates that hydro power, made mid- to large-size hydro plants the most effi-
the reliability mechanisms attract investment [46], lower market cient option to satisfy a growing demand, both under central
risk, and improve coordination in investment [47]. This latter planning and market rules (see [51]). Thermal plants are built to run
feature is desirable, since lack of coordination in investment has during dry seasons or to supply zones that have transmission
been related to undesired long-term cycles of over- and under- constraints. However, given the “bias” in the firm energy mechan-
capacity [14]. ism, there might not be enough thermal capacity available for a dry
Similar auction schemes are being used in Brazil, Chile, Peru, season. Other technologies, in particular renewables, have capital
and Panama [15]. The auctions of long-term supply contracts costs higher than hydro and there have been few opportunities to
provide stable revenue and more certainty for the investors in new develop them. As we discuss next, small hydro (less than 20 MW) is
generation capacity so that adequate resources are provided when the only renewable technology that has a noticeable share of
they are needed. Moreover, forward markets lower risk for buyers capacity and that is profitable in the market.
568 Y. Olaya et al. / Renewable and Sustainable Energy Reviews 56 (2016) 563–571

80 compared to conventional technologies [60]. As summarized in

70 Table 2, the provisions for RETs in Colombia's interconnected
system are limited to tax exemptions and other alternatives used
Capacity additions, MW

60
Small Hydro Plants

in other countries, such as feed-in-tariffs, and obligations [61] are

50 not considered [62]. The consequence of this structure is that
renewables other than small hydro play a minor role in the
40
Colombian electricity supply.
30 The institutional design has not taken RETs into account, which
20 means they must compete against conventional generation tech-
nologies whose environmental and social costs are not fully
10
internalized [63,64]. In general, the mechanisms for integrating
0 RETs with the interconnected system are not clearly defined. This
1971

1995
1960
1963
1966
1968

1973
1975
1977
1979
1981
1983
1985
1987
1991
1993

1997
1999
2001
2003
2005
2007
2009
2011
2013
Fig. 4. Small-hydro generating plants built between 1960 and 2011 and connected
to the power grid. Additions in 2000 include previously built plants that were
rehabilitated.
Source www.xm.com.co.
4. From big to small hydro
Large hydro-power plants are frequently perceived as envir-
onmentally unfriendly because they disrupt ecosystems and live-
lihoods of communities [52–54], even though they have low
emissions. Furthermore, mid to large-sized hydro plants have
higher capital requirements and longer lead times than thermal
plants, which increases uncertainty for the investors. In Colombia,
they attracted no private investment during the first years of
deregulation; in fact, no private firm was willing to make the
necessary financial commitment over the long time horizon in a
system where nobody knew how the market might evolve.
Instead, a surge in small hydro-power projects was observed
during the 2000s, as shown in Fig. 4. The large base of hydro
capacity means that electricity prices in Colombia are low for most
of the year, i.e. outside the dry seasons, and competitive genera-
tion technologies must have low operating costs. In Colombia,
hydropower plants with less than 20 MW capacity are classified as
small hydro, and under the current regulation, these plants are
always scheduled for dispatch at the spot price.
Colombia's potential for generating power with small hydro
centrals is estimated to be between 8000 and 25000 MW [55].
There are currently 95 small hydro plants in the interconnected
system, with a combined capacity of 643 MW [20]. More than 50%
of this capacity (387 MW) came on stream between 2001 and
2010 (Fig. 2).
The reforms to the power sector have had a positive effect on
small hydro deployment; this can be inferred not only for the new
capacity being installed but also from the rehabilitation of more
than 20 MW of small hydro plants installed before 1960. Since
small hydro plants have low operating costs and their capital costs
are lower than solar and wind, they are profitable at the Colom-
bian spot market price, while solar and wind plants are not
[51,56]. We turn now to discuss renewables, in particular solar
and wind.
4.1. Role of (other) renewables
Currently, the Colombian generation technology mix relies
almost exclusively on hydro resources and thermal power. Since
hydro plants generate most of the electricity in Colombia, power
generation contributes only 8.5% of the total CO2 emissions in
Colombia [57], a low value compared to the 2012 world average of
42% emissions from power generation and heating [58]. Colombia
has focused its incentives for renewables on the electrification of
rural off-grid zones, as emissions from the power sector are low
[59], and the costs of renewable technologies (RETs) are high
is a problem for wind and other power sources, because the lack of
a methodology and rules for calculating their contribution to firm
energy means that these sources cannot compete for reliability
payments in the firm energy auctions [65]. As discussed, high
investment costs are one of the barriers for large scale generation
with RETs. While costs of wind and PV have decreased in recent
years [61], their decrease has not yet facilitated their adoption in
Colombia, as, e.g. in the residential sector, the benefits of PV do not
outweigh their costs [66]. The outlook for the future of renewables
in Colombia is uncertain, but several steps have been taken that
could influence the future adoption of RETs making them more
attractive as a generation technology.
In May 13th, 2014, a new Law (1715/2014) was issued in order
to integrate non-conventional energy into the national power
system. This law provides a new legal framework to promote
investment, research, development, and use of non-conventional
energy sources including: wind, geothermal, PV, and biomass. The
law creates tax incentives for developing renewable generation
projects beyond the reliability framework of the OEF. The exact
mechanism is still not fully agreed, so currently we cannot foresee
the effect it will have on the future generation mix. Considering
this uncertainty, the best signal is given by the Colombian Energy
and Planning Unit, (UPME) in its 2015 generation and expansion
plan. The plan is not mandatory, and thus provides only an indi-
cation of possible future scenarios. According to the scenarios,
RETs' share in the 2028 generation matrix might be between 6%
and 15% of installed capacity [36]. As Fig. 5 shows, proposed wind
projects (scenarios 9 and 10) could substitute between 24% and
86% of the 1050 MW of coal capacity required in the base high-
demand scenario (5).
The results in Fig. 5 are consistent with previous research on
the competitiveness of wind power in the Colombian wholesale
market [64,65]. From a reliability point of view, increasing the
share of renewable technologies that do not depend on water
might help during dry seasons [51,59,67]. Furthermore, develop-
ing wind resources in the Guajira region could relieve some of the
current transmission constraints [67]. Generation from sugar cane
and African palm biomass is currently competitive [64,36], and
further developing this technology would diversify energy supply,
although at a smaller scale than wind power.
Spot prices are expected to decrease with a higher share of
renewables, which would particularly affect thermal generation,
implying that an increase in renewables will make future thermal
expansions harder. Finally, expansion of renewables is expected to
be facilitated by the development of smart grid technologies.
Smart grids in Colombia are envisioned as support for energizing
isolated rural areas using renewable generation [68], for inte-
grating renewables to the national energy system [69], and for
developing an electric car sector [67]. The challenge for regulators
is to integrate smart grids with the wholesale market. To date,
most smart grid projects have been demonstration projects.
InterAmerican Development Bank, IADB, is developing a roadmap
for the promotion of smart grids but results are not yet available.
 Y. Olaya et al. / Renewable and Sustainable Energy Reviews 56 (2016) 563–571
Table 2
State and incentives for renewables in Colombia until 2014.
2014 installed capacity (MW) FIT
Wind 20a No
Biomass – Cogeneration 206a No
Biomass – Other 26b No
Geothermal 0 No
PV 9–11c No
a
Interconnected capacity.
b
Data for 2010 [55].
c
Isolated capacity. Sources: [55,36].
Fig. 5. Alternatives for capacity expansions 2019–2028 in a high-demand scenario. RETs: geothermal, solar (PV) and Wind.
Source: elaborated from [36].
5. Discussion and conclusion
Large hydropower plants dominate the portfolio for power
generation in Colombia. The expansion in thermal capacity
observed between 1995 and 1999 resulted from government plan-
ning and market intervention rather than from market rationality.
With the advantage of hindsight, the need for thermal power was
overestimated, as evidenced by the low share of production by
thermal plants, and by the number of units retired during the 2000s
(more than 400 MW). Electricity demand is expected to continue
growing as the country develops, and adding hydropower capacity
keeps carbon emissions and electricity prices low – provided that
the market behaves competitively. The hydropower plants expected
to enter between 2014 and 2019 are supported by the new capacity
mechanism, known as reliability charge or firm energy. Although
the mechanism allows the installation of any technology that
increases resource adequacy, the conditions in Colombia: uncer-
tainty in gas markets and a large base of hydro, favor large hydro-
power plants. Along with the new large hydropower plants, a boom
of small hydro plants has been observed during the 2000s. These
small plants take advantage of their low capital cost, low environ-
mental impacts and the fact that all power plants under 20 MW are
always dispatched in the market (guarantee of generation).
The additions of hydro power that were awarded long-term
capacity contracts in 2008 displace thermal generation to the right
of the supply curve, increase resource adequacy, and make eco-
nomic sense. However, hydropower has environmental costs that
are not fully accounted for, such as the impacts on communities
and the local environment, and it is also vulnerable to weather
changes. A more diverse mix of generation technologies could
make the power system more reliable, for example, by using the
increase of winds during dry seasons to offset the decrease in
hydro power [70]. Adding intermittent technologies such as wind
or solar power to the interconnected system is one of the chal-
lenges for the next regulation periods. The experiences in other
569
Electric utility quota/obligation Tax exemptions Surplus energy and energy sales
No Yes
No Yes At market price
No Yes At market price
No Yes At market price
No Yes Regulated prices
countries suggest that renewable technologies require non-market
incentives such as feed-in-tariffs, but there are proposals for
supporting these technologies with capacity payments similar to
the reliability charges [65,70].
The power market created in the 1990s has greatly improved
the financial position of companies in the Colombian power sector.
There is evidence of the ability of the power system to satisfy
demand with efficiency. Capacity payments, such as the ones
applied in Colombia, have been effective in the sense that they
have added generating capacity, thereby avoiding black outs.
The goal of diversifying the technology mix for generation in
order to make the Colombian power system less vulnerable to
changing weather has not been achieved by the process of dereg-
ulation. Although technology diversification can be attained in
competitive markets, the high uncertainty in costs, demand and
technologies, and the imperfections of power markets may cause
actual choices to differ from optimal choices. Regulators are
expected to set up clear and stable rules for investing in new gen-
eration capacity. Regulators often intervene in the market with
incentives that are intended to move the system towards what is, at
that moment, seen as the desirable state. Many interventions,
however, lead to unintended consequences [71] as the market
might not always respond in the foreseen way, e.g. in the case of
Colombia, we can actually observe that twenty years after dereg-
ulation the system has less thermal generation than in the initial
period. It is also important that the regulator does not constantly
intervene in the system as this creates additional uncertainty and
risk for long-term investments. This is important because, as the
Colombian case evidences, investors respond to regulatory uncer-
tainty by delaying decisions until new information is available.
The impact of the different periods of regulation in Colombia
shows that the power system has improved, the debt levels are far
from what we observed before the deregulation, the companies are
relatively healthy today and, so far, there is enough capacity to satisfy
demand. From this point of view we conclude that the changes in
570 Y. Olaya et al. / Renewable and Sustainable Energy Reviews 56 (2016) 563–571
regulatory regimes have had at least some desirable effects, in that
the last change prompted a further round of investments. However,
from the reliability perspective there might still be a number of
uncertainties, as the change in regulation has not created the desired
change in the capacity mix. There is always a tradeoff between the
reserve margin, cost, and reliability, e.g. if Colombia has a significant
reserve margin mainly based on hydro then reliability might not be
an issue; however, the consumers will have to pay for this excessive
reserve margin. On the other hand, if the regulator manages to
increase the thermal generation capacity through capacity or relia-
bility payments, this might also increase the cost. The tradeoff
between these two options has to be carefully weighed to decide
which is the most cost-efficient for the same reliability.
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