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Electricity price hikes are expected to be relevant.
2024/06/14 | Andrés Pérez M., Vittorio Peretti & Ignacio Martinez Labra

First, a little bit of history... In the context of the social crisis that began in Chile in October 2019, Congress approved the government’s bill that froze electricity tariffs (link) at the level of 1S19 through December 2020, and created a stabilization fund (or debt) with the local energy firms. The price freeze was then extended due to the pandemic. According to the Budget Office’s 2023 Annual Contingent Liability Report (available here), the price freeze led to a cumulative liability of 0.43% of GDP through the end of 2023. Recognizing the need to gradually adjust prices, normalize payments with electricity suppliers, pay the debt with suppliers, and provide targeted support to vulnerable households, Congress approved the Tariff Stabilization Law on April 10 (link).


Ok, so what does the new Law say? Electricity tariffs for consumption of up to 350 kWh (the segment measured by INE) will be readjusted in their generation (70% weight of the bill) and distribution (20%) components. The remaining component, transmission (10%), was not part of the law but should also increase this year (addressed later in the text).  


On generation, the increase considers two steps:


    1.      For 1H24 an adjustment using accumulated CPI;

    2.      For 2H24 a tariff that reflects the average node price (PNP).


Throughout the legislative discussion, the Government presented a “12%” increase, which likely reflects cumulative CPI from Apr-22 to Oct-23. We cannot rule out the use of a longer time horizon, even since tariffs were frozen, leading to an even higher cumulative CPI.Today, the economic ministry signaled a 15% average hike in July (link), with uncertainty over the medium-term adjustments.


On distribution, the law considers a phased-in adjustment in two steps; one third of the increase is penciled in during 2024 (exact timing to be determined), and the remainder in 1H25, but exact month is still unknown.


When will these increases occur? For the new regulatory framework to take effect, the government must publish the tariff decree for 1S24, which should take place at the latest by mid-June (up to 45 days since the publication of the law in the Official Gazette, April 30). The National Energy Commission published its preliminary reports (May 23, link), which will be subject to review by the companies, and then the final report this month. In the days/weeks ahead we should have some additional clarity on the timing and size of the expected price adjustments.


Now the hard question… what does this mean for inflation? For starters, electricity prices represent 2.2% of the CPI basket. Up until now, our 4.1% and 3.1% year-end inflation call for 2024 and 2025 only considered cumulative electricity price increases of roughly 20% this year (around 0.4pp contribution) and a further 20% next year (around 0.4pp contribution). In terms of the specific months, we penciled in the hikes in July (total CPI: 0.6%) for first generation adjustment;   August (CPI: 0.5%) for the second generation and first distribution adjustment; and then January 2025 (CPI: 0.8%) for second distribution adjustment and the beginning of the debt payment. These estimates only consider the direct effects of the electricity price increases on the basket; that is, they do not include the effects of indexation nor second round effects.


However, the size and timing of the price increases on CPI are still subject to a considerable degree of uncertainty. Indeed, risks lean heavily to the upside. Experts state that the size of price increases discussed during the legislative process were underestimated (more info here), with an accumulated increase during 2H24 potentially exceeding 40% (+1pp contribution). Furthermore, adjustments to the transmission component (10% weight of the total electricity cost) were not considered in the law (more info here) - could further increase inflation this year; the adjustment is to be determined by the regulator. Experts have estimated up to a 60% average increase in transmission costs in Santiago (10% weight: +6% and 13bps).


So, if all these risks materialize, how much could inflation increase? The materialization of all upside electricity price risks would lead us to raise our 2024 CPI call up by an additional 50-70bps to 4.6-4.8%. Greater indexation pressures and second round effects would pose upside risks to our 3.1% call for 2025 (by around 20-30bps). Partly offsetting the upside pressures will come from a firmer CLP path, but freight costs may not help. The gradual domestic demand recovery will likely prevent the full transferal of higher costs to final consumer prices, preventing greater spillover effects. While it is possible that additional subsidies materialize, they will likely be household focused and therefore not considered in INE’s price collection.

Finally, are these readjustments a game changer for the BCCh? A scenario of higher short-term inflationary pressures will add a layer of policy caution but not prevent a gradual easing cycle from continuing in the near term. In May, the 50bp cut to 6% led to an ex-ante one-year real rate of 2.8%. With the 25bp cut we expect for this month to 5.75%, the ex-ante one-year rate would drop to 2.55% (still well above the 1% neutral level). The rate cut cycle would total 550bps. In our view, the June IPoM should revise the BCCh’s 2024 yearend inflation forecast up materially from the current 3.8%, which did not consider any electricity price adjustments, its indexation risks and second round effects. Nevertheless, the supply-side inflation shock is unlikely to de-anchor medium-term inflation expectations. We expect the Board to slow the rate cut pace to 25bps in June and proceed at the same pace in the next few meetings. Developments on the global financial conditions will likely play a key role in determining the end point of the current cycle. The 1Q24 IPoM showed a corridor path (33% confidence interval) that averaged 5% in 4Q24 and 4% in 4Q25. Our current scenario sees rates pausing at 5.25% this year before resuming a downward trend to 4.5% during 2025. Both analysts and trader surveys see the rate cut path continuing at a 25bp pace ahead with respective yearend rates of 4.75% and 5.0%.