Brazil’s bid for energy: Implications and challenges for DG

The introduction of new statutory electricity sales arrangements in 2004 are addressing the competitiveness of distributed generation projects in Brazil. Here, Antonio Carlos Pereira Maia discusses some of the latest developments and the outlook for DG there.

In a COSPP article last year (July-August 2005), I suggested that 2004 could come to be seen as a turning point for distributed generation (DG) in Brazil. For in 2004 a new electricity sector model was launched – notably Law 10,848/04 and its accompanying executive decree 5163/04. This new legal framework for the electricity sector provided significant opportunities for distributed generation in Brazil.

The new institutional model for the electricity sector created an alternative for distributed generation in the domestic power generation market by introducing the possibility of selling surplus energy to electricity distribution concessionaires. However, one year on, this contracting option has not yet spawned results. Conditions have still not been satisfied for new distributed generation projects – especially cogeneration plants designed to generate energy surpluses for sale to the distributors to meet total market requirements. The cogeneration projects installed so far do not incorporate the generation of electricity surpluses for trading. Nevertheless, the regulated contracting environment (see below) created space for distributed generation in the Brazilian power generation portfolio.

A biomass cogeneration plant in Brazil. Conditions have not been great for DG in Brazil in the past few years, but recent energy auctions are beginning to raise the competitiveness of the technology (UNICA)
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This article examines some possible regulatory changes for increasing the competitiveness of energy production – reducing restrictions and stimulating the uptake of distributed generation. A review of the current regulations will be necessary to recognize the cost savings accruing from distributed generation as a result of lower transportation overheads and reduced operating losses from electricity transmission and distribution.

An overview of the new model for the electricity sector

The new legal provisions came into force in the first half of 2004. The new model for the Brazilian electricity sector is designed to guarantee supply and promote modest tariff charges. It requires distributors to guarantee energy to 100% of their markets through regulated contracting, while generators must provide evidence of underlying energy sources – either their own or based upon third-party contracts.

Under the new model, the sale of electricity will occur through two different so-called environments:

  • Regulated Contracting Environment (ACR) – via auctions
  • Free Contracting Environment (ACL) – under which sale prices among market agents will be freely negotiated and governed by bilateral purchase and sale contracts.

Electricity distributors may only contract in the regulated environment. In the free environment, contracts are freely negotiated among market players (i.e. those that are not distributors). Concessionaires that provide public service and independent producers/self-producers with a surplus can sell their energy in both environments.

Brazil is seeing a trend towards the modernization of cogen plants fired with sugar cane bagasse (UNICA)
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Within the new model, distribution utilities can contract through energy auctions from new or existing generation projects (contracts need to be firmed up 1, 3 and 5 years in advance) or through public invitation from distributed generation projects. The latter option is limited to 10% of the distributor’s load requirements.

Electricity contracted in the new model

Some electrical energy auctions have already been held in the transition process to the new model. The first auctions (December 2004 and April 2005) tendered energy from existing power plants. The last one, held in December 2005, offered energy to be delivered from power plants that are yet to be built.

At the first auction, 16,000 ‘average’ MW (average demand in MW is the amount of required power in MWh divided by the duration of operation in hours) were sold, of which:

  • 9000 average MW were for the supply period 2005-2012
  • 5800 average MW were for the supply period 2006-2013
  • 1200 average MW were for the supply period 2007-2014.

The start dates have a major impact on the offer versus demand balance.

At the second auction, 1300 average MW were sold for the period 2008-2015 at an average price of R$83.13/MWh (US$35.6/MWh). (All figures use an exchange rate of US$1.00 = R$ 2.3352 [average value between buying and selling on 16 December 2005].

The first auction of electricity generated from new plants was held on 16 December 2005 and followed the new system whereby electricity distributors can only contract power in a regulated framework through auctions. The results of the auction amounted to R$68.4 billion (US$29.28 billion), equivalent to 3286 average MW of energy from various sources (a total of 51 plants). Demand for 2008 and 2009 was almost totally taken up and, for 2010, was 0.2% over-contracted. Figure 1 shows the results of the auction by product.

Figure 1. Demand taken up by successfully tendered contracts at auction in December 2005
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The majority of energy sold at the auction originated from centralized energy projects (Figure 2). These accounted for 89% of energy successfully tendered from a total of 28 hydro, natural gas and coal-fired plants. Although accounting only for a small share of 11% of energy contracted, decentralized energy represented a significant number of power plants – 23 of the total 51 plants (45% of the total).

Figure 2. Results of the auction considering all products successfully tendered: centralized compared with decentralized energy
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Sponsoring the debut of natural gas in energy auctions, Petrobras (the Brazilian National Oil Company) tendered successfully for contracts for energy from five thermoelectric plants. Four of these plants are in the south-east/mid-west regions of Brazil and amount to 1250 average MW. The other (141 average MW) is in the north-east. The total of 1391 average MW is equivalent to 43% of the total energy and 61% of the thermoelectric energy contracted at the auction including coal, biomass and fuel oil-fired plants. Generation of this energy will begin in 2008, with a forecast 352 average MW. In 2009, a further 469 average MW will become available and, in the following year, the remaining 570 average MW. The average price achieved in the case of the natural-gas-fired thermo-electric plants was R$125/MWh (US$53.53/MWh).

With respect to the fuel oil-fired thermoelectric plants, 263 average MW was contracted, corresponding to 11.5% of 2270 average MW of thermoelectric power. Figure 3 shows the fuel split for the decentralized energy projects.

Figure 3. Results of the auction considering all products successfully tendered: decentralized energy by source
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A further 700 MW was contracted from two coal-fired plants (Candiota III and Jacuàƒ­). The construction of these power plants means that total Brazilian energy generated from this source will ramp up from an existing 1400 MW to 2300 MW.

Bioelectricity (generation of electricity from biomass) also featured at the auction, with seven projects raising the curtains on the biomass era – particularly sugar cane bagasse in the regulated market. An average of 31 MW was contracted for supply from 2008 and a further 66 average MW in 2009 – all with a 15-year supply period. The best prices attained for sugar cane bagasse were R$138.99/MWh (US$59.52/MWh) for 2008 contracts (supply start year) and R$137.17/MWh (US$58.74/MWh) for 2009 contracts respectively. Auction prices proved more attractive than those under PROINFA, the federal government programme for alternative energy sources, which fixes a price of R$103/MWh (US$44.11/MWh) for power generated from sugar cane bagasse. In three of these projects, complementary energy sources are planned: two with wood chips and a third with fuel oil.

2005 saw the end of the first phase of the cycle for implementing the new electricity sector model. This process, which began in 2003, has surmounted the first major obstacle. The greater degree of uncertainty that dominated 2005 has receded, though there are still variables that warrant close monitoring. The Brazilian thermal system does not operate in terms of baseload. On the contrary, natural-gas-fired power plants are switched on and off according to hydrological conditions and expectations. This is mainly because the Brazilian electricity system is able to store energy in the form of water accumulated in huge reservoirs and thus take advantage of different hydrological cycles, transferring electricity from one region to the other and significantly optimizing the system’s operations. During 2006 and the next few years, there is also the issue of the slow pace of environmental licensing approval.

Further auctions in 2006 will to complement demand in 2009 and to satisfy distributor consumption forecasts for 2011. The first auction, which took place on 29 June 2006, sold energy generated from new generation plants for supply periods starting in 2009. About 1800 average MW will be tendered, equivalent to the energy volume not contracted in December 2005, and represents the shortfall from expected demand in 2009. Another auction is scheduled for 5 September 2006 for supply periods starting in 2011.

DG contracting: early outcomes

The presence of biomass-generated electricity at the auction of electricity generated from new plants held on 16 December 2005 can be regarded as an opening impact of the new regulatory framework for distributed generation.

Increasing domestic and overseas demand for sugar and ethanol, associated with the additional incentive of electricity auction sales, is provoking a trend towards the modernization of cogeneration plants fired with sugar cane bagasse – notably in the form of the substitution of low- for high-pressure boilers. This momentum for modernization is particularly important since many Brazilian sugar mills date from the implementation of incentive programmes for the use of ethanol as a vehicle fuel in the 1970s, and are characterized by low operating boiler pressure and energy generation equipment nearing the end of its useful life. The result of modernization is an increase in plant efficiency and greater generation of energy surpluses.

Brazil has a thriving ethanol industry, producing automotive fuel from sugar cane (Julije Domac)
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The cost of expanding the electricity system based on medium to large hydro units is expected to increase in light of the need to install even more complex systems. This is in addition to the already highly complex integrated national network, with an accompanying expansion in transmission infrastructure for harnessing hydro resources that are more and more distant from the main centres of demand.

The prospect of an increase in electricity consumption in a scenario of sustained economic growth in Brazil against an expansion in generation capacity suggests no restriction on supplies over the next 3-4 years. Nevertheless, this situation could be reversed due to:

  • environmental limitations on the installation of new hydroelectric investments
  • higher economic growth rates with a reflection on electricity consumption
  • unfavourable delays on the construction of the plants that tendered contracts for energy at the auction of electricity generated from new operations.

This would create the need to obtain additional supplies of energy.

Based on a combination of these factors, together with the new electricity sector legal framework (notably the flexibility to sell electricity from DG projects in the regulated environment), the scenario is still positive for the entry into the market of distributed generation with an emphasis on projects beginning operations in the medium term.

Adjustments for DG regulation

The results of the electricity power auction in December 2005 demonstrate that space has been created for the insertion of distributed generation as part of the Brazilian power generation portfolio. This has arisen through the regulated contracting environment, with the inclusion of distributed generation as a source of complementary electric power generation to meet market demand. However, there has been no noticeable market impact where expectations have been highest, i.e. in the acquisition of electric energy from distributed generation to meet the total market needs of distributors. The cogeneration projects being installed so far do not contemplate the generation of surpluses of electricity for trading.

This section looks at some of the regulatory issues that are blocking investment and suggests some proposals for change. These possible adjustments in distributed generation regulation would allow the possibility of selling surplus energy from distributed generation projects introduced under the new electricity sector legal framework to be fully explored.

The first question relates to the classification of what is ‘distributed generation’ for the purposes of acquisition by the distributors to meet the full needs of their markets (limited to 10% of the load). Distributed generation is the production of electric energy from plants connected directly to the purchaser’s electricity distribution system. Put another way, the distribution company may only acquire electricity from distributed generation plants located within its operating concession area. (Of the DG plants, hydroelectric plants with an installed capacity > 30 MW and thermoelectric plants [including cogeneration projects] with an energy efficiency of < 75% are excluded. Minimum efficiency percentages are not required for thermoelectric plants that use biomass or process waste as fuel.)

The second question relates to the pass-through of the costs of acquisition of electricity from distributed generation to tariffs. This pass-through is limited to a reference value of the regulated market – the Annual Reference Value or RV. The aim of this limitation is the promotion of modest supply tariff charges. The RV is calculated as a function of the average weighted costs of energy purchases for all distributors in the auctions over the past five years according to the following formula:

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where VL5 and VL3 are the average values of acquisition of electric energy from new generation projects in auctions held respectively five and three years previously, weighted according to the respective quantities acquired (Q5 and Q3).

Since the legal structure was established only in 2004, specific procedures were defined for the period 2005-2008. For example, the RV for 2006 will be calculated on the basis of the results of the auction for 2004.

The RV for 2005 was set slightly below R$70 (US$30) – much lower than the values obtained by the various generating plants in the December 2005 auction. This price parameter has a doubly negative effect. By making the sale of energy surpluses from cogeneration projects to distributors uneconomic, it inhibits investment. In addition, any contracting of electricity from distributed generation above the RV implies additional non-reimbursable costs. Consequently, the expected incentive of attracting investment for expanding distributed generation is rendered innocuous.

One possibility would be to revise the current criteria and conditions for the pass-through of the values for contracting distributed generation by adopting as a reference – particularly in the case of cogeneration projects – the average purchase prices successfully tendered for thermal energy sources at the electricity auctions. Such a measure will enhance the competitiveness of cogeneration in sales via the free contracting environment, creating effective conditions for the direct trading of surpluses to the distributors. These trading conditions would be particularly critical for small cogeneration units in urban regions located in the principal centres of demand and supplied by natural gas distribution networks.

Final remarks

Distributed generation operates on a complementary basis to centralized generation:

  • adding value to the electricity system
  • reducing and postponing investments in transmission and distribution
  • allowing the reduction of operating losses from these systems, increased energy efficiency and greater reliability in electricity supply.

Although these traditional drivers are increasingly attracting end consumers in Brazil interested in opting to produce and consume their own energy, they have been insufficient to transform this interest into plants on the ground.

The new institutional model for the electricity sector has created an alternative for including distributed generation in the power generation portfolio through the regulated contracting environment. However, the conditions have not been satisfied for new distributed generation projects – especially cogeneration plants that are designed to generate energy surpluses for sale to the distributors to meet total market requirements.

In this article, I have put forward some possible regulatory changes aimed at increasing the competitiveness of energy production, reducing restrictions and stimulating the offer of distributed generation. However, these proposals are not exhaustive. I have not touched upon many other factors such as:

  • abolition of some regulatory charges
  • concession of benefits for reducing tariffs for using the distribution system
  • complementary supply of electricity from solar, wind and biomass.

Whatever the factors involved, a review of the current regulations remains necessary.

Antonio Carlos Pereira Maia is Cogeneration and Distributed Generation Manager at Petrobras, Rio de Janeiro, Brazil. Fax: +55 21 3212 2850 E-mail:

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