It is well known that Brazil’s power market is about to undergo reform, but the real talking point is exactly how the needed changes will be achieved.

Peter Howard Wertheim and Dayse Abrantes
Rio de Janeiro, Brazil

Brazil’s Mines and Energy Minister Dilma Rousseff unveiled a proposal aimed at eliminating risks of future blackouts and attracting fresh investments to the country’s electricity sector. The government plans to split power markets between small retail consumers and key industrial power users by using long-term contracts.

The government has also proposed to suspend auctions of so-called “old energy” to distributors and distribute the energy through an equally-divided pool. According to Rousseff, this measure would reduce costs for all participants in the sector because contracts for old energy are cheaper.

Figueiredo: Foreign investments are and will continue to be sorely needed
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Rousseff added that the government plans to replace Brazil’s existing wholesale energy auction market, known as MAE, with a new regulatory body called ACEE. In addition, new licenses would be directly granted by the Mines and Energy Ministry (MME) and no longer by Aneel, the country’s power sector regulator.

New model

The new model will be presented to Congress and political analysts expect it to be voted by December 2003. Under the proposed schedule, the new measures would be fully implemented by 2009 after a transition period of five years.

President Luiz Inácio Lula da Silva has implemented orthodox economic policies

President Luiz Inácio Lula da Silva has implemented orthodox economic policies
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The power sector’s inefficient regulatory structure and a lack of forward-planning led to a power crisis in 2001, during the previous government, which culminated in a nine-month rationing plan of 20 per cent. The power crunch not only stalled economic growth in Brazil but it also led to a dramatic drop in power consumption, which lingers to this day. With their cash-flow severely affected by the fall in revenue, distributors such as Light Servicos de Eletricidade, controlled by France’s Electricité de France and Companhia Energetica de São Paulo, or Cesp, have had to ask creditors for more time to pay their debts.

“The target of the new model is to establish general guidelines to renew investments in generation and reduce distribution risks, but, at the same time, it reduces the competitiveness of the power sector,” said Eduardo José Bernini, vice-president of the Brazilian Association of Basic Industries (Abdib).

Investment in the Brazilian power sector has been falling
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According to Bernini, to evaluate the concrete effects of the proposal, the MME needs to present details involved in the implementation of the model and the government and Congress must define the legal framework that will become the basis for the model, with stable rules, and concise and balanced legislation avoiding conflicts for all segments of the production chain.

The executive called upon the government to define the sources and financing conditions, since the government is cash-strapped and the private sector only has as an alternative the banking institutions, to which it must offer guarantees. These guarantees that will allow the sector to obtain interest rates and deadlines compatible with the characteristics and with financial return forecasted for the projects.

To demonstrate the seriousness of the problems faced by the power system, Abdib conducted a nationwide research, which concluded that around $68 billion in investments is needed for an additional 85 000 MW by 2020 and the system reach a capacity of 163 300 MW. By comparison, power installed in Brazil between 1995 and 2002 was of 21 447 MW.

International consultancy

Eduardo José Bernini is the vice president of Abdib and president of Eletropaulo
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Luiz Figueiredo, a power analyst with Rio de Janeiro-based Tauil & Chequer associated with US-based Thompson & Knight LLP, one of the largest energy consultancies in the world, points to the exchange volatility as another factor responsible for the instability in the regulations of Brazil’s power sector. “Exchange volatility directly affects new and needed investments since Brazil does not have domestic savings in Brazilian Real, sufficient to invest in power installations. Thus, foreign investments are and will continue to be sorely needed,” added Figueiredo.

The analyst points to the fact that the present model was only implemented partially, since the state-owned power holding Eletrobras, was not privatized as planned by the previous government. Other analysts say that despite the fact that President Luiz Inácio Lula da Silva (Lula) a former left wing union leader, surprised his allies (unpleasantly) and the international financial community (pleasantly) by implementing orthodox monetarist economic policies since he took office last January, it is highly unlikely that the new government would privatize Eletrobras.

Figueiredo advocates that the new regulatory model includes fiscal incentives for new investments. “While demand for new energy comes onstream, which should happen sooner or later, the incentives could be proportionally reduced and the investment risks transferred back to the market,” argues Figueiredo.

“At present the main questions of the agents of the power sector and of consumers which were being answered slowly by the previous government, are not receiving clear answers from the new government’s authorities. Clear and firm answers as to which model for the power sector we want for the country, how to create this model in a more efficient and less burdensome way for society, and definitions of the origins of the financial resources to implement the new model are fundamental for planning and implementing MME’s proposal,” concluded Figueiredo.


“Our opinion is that despite the MME’s positive speech towards private investments and risk reduction in the sector, the current proposal for the electricity sector restructuring shows many pitfalls that may cause private investors to remain cautious on further investments,” said Rodrigo Barros, an analyst at the Pactual Bank in Rio de Janeiro.

“Among our main concerns are the political consequences of a national energy pool, as well as the different treatment for current and future investors in the sector,” stated a report by the bank. Pactual’s simulation shows that consumers in Minas Gerais, Parana, and other states in the North/Northeast, would face tariff increases of seven, one, and six per cent (after all current energy sold through initial contracts is contracted through the pool), respectively, without any additional benefit. And the tariff increase would be entirely used to lower tariffs in other states and regions.

“This opens room for probable legal and political disputes. We believe that the government can make up for these problems by creating some compensation funds. Our understanding, however, is that if for each problem a new fund is created, the cost of the implementation of the model would be high and the pool would lose most of its strength,” added Barros.

The economic benefit of this pool mechanism would be rather small – tariff reduction in the south/southeast/midwest regions would correspond to a very modest one per cent, which would certainly not compensate for the political cost of higher energy tariffs in several states, added the Pactual bank report.

Probably, the most important risk perceived by the sector agents is that the MME seems to treat current and future investors in the electricity sector differently. Because of the consciousness that private investors’ participation is mandatory, government is unable to fully fund the sector’s expansion. The new model is shifting risks from generators to consumers, in order to increase their appetite for new investments. At the same time, the government seems to believe that a large portion of investments made by existing investors are already sunk and, therefore, they deserve a different treatment compared to new investors.

It is important to remember that the most likely sponsors of new investments (both equity and debt) in the sector are the companies already present in Brazil. An increase in their risk perception would not only decrease their investments, but also contribute to increase the required rate of return on projects of new investors as well.

Risk perception

A study by Standard & Poor’s states that the process may take longer than expected, while the ministry tries to accommodate demand from various industry segments. Regulatory risk is derived from the lack of a transparent and stable regulatory environment and the absence of clear definitions for issues such as the operation of the wholesale market, energy supply procurement, remuneration of regulated companies, increases in generation capacity and the incorporation of thermoelectric power in Brazil’s energy matrix.

The current ratings assigned to the electricity companies reflect, in general, their very limited financial flexibility, which in many ways is primarily a consequence of the industry risk perception. Until this is changed, it is likely that companies will continue to struggle to perform well and obtain financing with reasonable conditions.

Standard & Poor’s expects that a task force headed by the MME, which is also composed of industry players and regulators, will diagnose and then outline solutions for the sector’s problems. At present, oversupply stands at 7500 MW average. As a consequence, generators cannot entirely replace their initial contracts, spot markets prices have plummeted, and investments have been suspended, added Standard & Poor’s.