By Roshan Madawela
Brazil’s power crisis is having a severe impact on the country’s economy, bringing downward revisions in growth forecasts. But the crisis could be good news for investors with numerous opportunities for generation and transmission capacity opening up. Resource enriched Brazil has enjoyed growth in its oil, natural gas and electricity markets in recent years. Around 92 per cent of the country’s installed electricity capacity of 65 GW is generated from hydropower, and the remainder from a mix of coal, natural gas and renewable sources. Along with Paraguay, Brazil operates the world’s largest hydropower complex at the Itaipu facility on the Parana River which has a capacity of 12 600 MW. Brazil also has two operational nuclear plants, Angra 1 and 2, and another one is currently under construction.
However, with electricity demand rising at around twice the rate of economic growth, a serious imbalance in the electricity market became evident this year. The gravity of the electricity deficiency was illustrated on June 4 when the government announced its rationing plan, calling for a 20 per cent reduction in electricity consumption from both domestic and industrial consumers.
The immediate cause of the scarcity of power is two consecutive years of inadequate rainfall that has left reservoirs at record low levels in the southeast, central west and northeast regions of the country. However, analysts had warned the government against the dangers of over reliance on hydropower, and predicted the current scenario in the absence of investment to diversify the sector.
A number of regulatory flaws have also been blamed for the current situation. Until recently, most of the natural gas imported for thermal power plants was paid for in dollars but the generators had to sell their power in Brazilian Reals. This exposed the generators to currency fluctuations without any protection.
Power generation in Brazil is dominated by hydropower.
Additionally, the distributors have been paying rising prices to the transmission firms throughout 2001 without having the freedom to pass on the extra cost to their consumers. The enforced 20 per cent reduction was the last straw for distributors Enron and AES who announced that they are putting “a brake on investment” in Brazil.
Cambridge Energy Research Associates (CERA) highlighted a number of ‘California-like’ flaws in Brazil’s market that discourage investors. These include delayed development of wholesale market deregulation, delays in privatizing Petrobras, residual monopolies in the natural gas supply chain and disparate spot market prices across regions.
Electricity demand grew by 55 per cent between 1990 and 1999 while installed generation only rose by 25 per cent during the same period. As a result, the system has been operating below the security margin since 1997. Aware of the possible dangers, the government orchestrated a $26 billion investment programme in 2000 to install 25 000 MW of power, but the shortage in rainfall outpaced the investors.
Privatization in the power sector has been part of government policy for a number of years. In 1998, the electricity generating company Centrais Eletricas Geradoras do Sul S.A was sold for $800 million. During that year, Enron International purchased shares worth $215 million in Eletricidada e Servicos, AES acquired Cia. De Geracao de Energia Eletrica Tiete, while Duke Energy Corp. acquired Cia de Geracao de Energia Eletrica Paranapanema. In addition, EDP of Portugal, Iberdrola of Spain and EDF of France are also active in the sector. By 2001, around 75 per cent of distribution and 25 per cent of generation was transferred to private hands, predominantly controlled by foreign companies.
The currency devaluation in 1999 and strong political opposition halted the privatization programme and all of Brazil’s electric transmission utilities still remain in public hands. Congress has recently considered legislation to prohibit the sale of the three main utilities including Electrobras, which controls around half of the nation’s installed capacity and most of the main transmission lines.
The current situation has undoubtedly checked the progress of economic growth, which was projected at 4.2 per cent prior to the emergence of this crisis. Analysts at the National Electricity Management Association (NEMA) have re-projected the rate to 2.3 per cent. Similarly, the rate of inflation has also been revised from 4.3 per cent to 5.8 per cent despite concerns that real wages could fall.
Similarly, the US dollar/Real exchange rate has now been estimated at 2.3 instead of 2.05 and foreign investment has been revised downwards to $19 billion from last year’s $31 billion, which made Brazil third in global investor popularity after the US and China.
Nevertheless, it is clear that not everyone is a loser. With a few exceptions in distribution, players in the energy sector are managing to capitalize on fresh opportunities that have sprung up in the rush to install new capacity. Firms involved in lighting controls and energy conservation have already seen a boom in sales and been hard pushed to match supply to demand. Sergio Parada of Siemens said that the combination of the Brazilian crisis and the US rush to increase capacity has resulted in his firm falling three years behind in the supply of gas turbines.
Well-placed domestic firms are also cashing in. Generator manufacturer Weg, which produces units of 2000 kVA is reported to be expanding its factory in Jaragua do Sul, Santa Catrina state. Production is already up from 400 units over the first quarter of 2000 to 490 units in 2001. Weg expects a further rise to 1000 by mid-2001.
Brazil’s neighbouring economies are also likely to feel a boost to their foreign reserves as Brazil imports natural gas via newly constructed pipelines. Brazil’s President Henrique Cardoso has already cancelled a trip to Russia so that he could meet the Bolivian President, Hugo Banzer, and negotiate an increase in natural gas contracts. The current situation could lead to the first steps in the establishment of a Latin American power grid.
Industrial end-users have been hit hard by the crisis, however. A 4.9 per cent increase in industrial activities expected for December 2001 has now been revised down to -0.6 per cent. Most recently, Aluminium producers Alcoa, Billiton and Alcan have announced production cuts of 25 per cent.
With the electricity rationing plan likely to be in effect until the end of 2001, there are additional headaches for manufacturers who fail to cut electricity consumption by 20 per cent. One-off failures to comply are to be levied with surcharges while persistent offenders could be cut-off from supplies.
The problem is expected to be less acute for the service sector, but still significant as growth is forecasted to fall from 3.1 to 2.5 per cent.
It is evident that a return to regular rainfall and billions of dollars of investment will be needed for Brazil to emerge from the current crisis within the next three years. While the government has no control over the former, its ability to direct the latter is also restricted. Due to agreements with the IMF, the government is not permitted to spend all the money required by the energy sector and therefore the funds will need to be drawn from the private sector.
In this regard, the government has encouraged foreign direct investment (FDI) inflows by providing a ‘level playing field’ with clear rules for the sector. Overseas investors are not subject to special terms as they are in other markets and can expect to receive the same treatment as domestic companies. There is also access to a government run credit line for investments, which offers low interest rates through the Brazilian Bank of Social Development (BNDES) that can be used to build new power plants, transmission and distribution lines.
The crisis has also given rise to additional measures in the form of tax incentives for products related to generation, transmission, distribution and electrical conservation equipment and devices. For large generators, embarked thermal power plants and other products, the import tax has been reduced to zero until December 31, 2001.
In June, the government also set up a task force to work out a strategy to import energy from the neighbouring countries of Bolivia, Peru and Paraguay who have large quantities of natural gas. The authorities have also announced a plan to build 49 natural gas-fired thermal power stations based on Bolivian gas reserves. If the plans are executed, Bolivia’s annual sales of gas to Brazil will increase from $150 million to $500 million.
With so many rumours circulating about Brazil being overrun by recession, investors should be warned against believing the hype. As CERA’s analysts point out: “The sheer size of Brazil’s market, which is equal to all the South American power markets combined, and an intense need for capacity and ample supplies of natural resources, make it one of the most dynamic and highly attractive energy markets in the world and an immense opportunity for investment and expansion.”
In addition, there is a good chance that the country can ride out 2001 without having to resort to a cut in working hours, a prospect that the business community dreads. The energy conservation figures for June showed that the country was adapting well to the rationing with the southwest region exceeding expectations, reducing electricity consumption by 24 per cent.
The government’s latest plans, announced on 5 July, gave further notice to foreign investors that opportunity is knocking on the door of Brazil’s energy sector. An emergency plan for 2001-03 includes the construction/retrofit of 21 hydropower plants, 15 thermal power plants (natural gas and coal) and 644 km of new transmission lines. The plans are expected to inject 17.5 GW into the system, and will require around $15 billion in investment. The government is also expected to acquire mobile thermal power plants to serve areas with a high risk of blackouts.
Electrobras and federal oil giant Petrobras also announced plans to expand five fuel oil and diesel oil thermoelectric plants and convert them to use natural gas. Foreign groups which have partnerships with Petrobras in the construction of thermoelectric plants have been invited to participate in the ventures.
In June, the Brazilian power agency Aneel appointed 34 from 55 local and foreign firms interested in taking part in the auction for construction and operation of eight hydroelectric power facilities expected to create 16 000 jobs. Meanwhile, Europe’s Alstom, Spain’s Iberdrola and VA Tech of Austria have also clinched new deals or intensified operations in Brazil.
BNDES is set to inject R$7 billion ($2.8 billion) to finance 50 power projects, while metal giants Alocoa Inc., Billiton and Companhia Vale do Rio Doce SA are also set to fast-track planned power facilities to secure uninterrupted production.
Hilton Moreno of NEMA believes that new investment opportunities in Brazil will arise as the country embarks upon the construction of a nuclear plant (Angra 3) within a few months and builds at least one more over the next few years. The government has recently announced that Brazil is ready to become a more active member of the International Nuclear Energy Agency. Moreno added that “fantastic” opportunities exist in cogeneration projects where the government is using financial incentives to stimulate the use of alternative sources for electricity generation like solar, wind and fuel cells. An investment of $632 million could result in biogas generation of 1522 MW as early as next year.
Brazil is already a pioneer in the use of ethanol, first developed during the oil shock in the 1970s as an effective substitute for petrol and diesel.
Most commentators take the view that riding out this year will see an end to the critical phase of the crisis with increasing energy imports and a number of thermal plants coming into play in 2002. Aneel projects that Brazil’s power generation capacity will increase by 3000 MW in 2001, 5200 MW in 2002 and another 8800 MW in 2003. Assuming that rainfall returns to normal by 2002, the energy market can be expected to return to equilibrium and the economy should bounce back to regain its economic growth momentum.
Moreno says that medium term investments are already established with a planned $15-20 billion to be spent over the next five years, mostly on generation. He adds that around $30-35 billion will be needed to solve the crisis within a five year period.
In the worst case scenario, rainfall might continue to evade Brazil and forthcoming elections could let in a political leadership that reverts to old style populist policies. In this case, investors will be driven away by fears of low returns, and a vicious circle of stifled economic growth and low investment could trigger a recession.
It is still worth noting that Brazil remains the main source of profits for many of its foreign players. This may be a result of the peculiar imbalance created by partial privatization, the regulatory structure and the government’s commitment to IMF arrangements that restrict use of public funds for the sector. Most commentators expect Brazil to pull through with a stronger power sector and realize its true potential.
In terms of future opportunities, the smart investor will cash in by navigating strategy to match an evolving power sector.