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Brazilian Electricity Sector | Notes on MP 579

Provisional Measure 579, announced by the federal government in September, proposes a drastic reduction in the taxes and fees that contribute to Brazil’s energy costs, considered among the highest in the world.

The consulting firm Hiria recently held a conference on Brazilian government initiatives to remake the rate-setting model and reduce electricity costs to industry and consumers..

For months, electricity market players have awaited definite answers regarding electricity concessions. On September 17, the government published MP 579 and extended the term of current electricity concessions. The news put pressure on the shares of publicly traded companies in the sector and left numerous uncertainties unresolved. This panel will discuss these changes and the consequences of 579 for energy prices.

The discussion over the effects on profitability were a bit hard to understand, on first glance, in light of Cemig’s posting of a third-quarter profit of nearly R$ 1 billion, up 43%, YoY. 

But as a quick Google Finance consult shows, the state-owned electrical utility of Minas Gerais has not yet overcome the post hoc.

Or perhaps these results remain at risk pending the negotiation of concession reviewals. If I knew better, I would be running hedge funds. At any rate, I am taking some notes, followed by an interesting interview on the subject from CartaCapital magazine, based on an interview with an expert less than bullish.

A morning session at the Hiria conference dealt with Minister of Mines and Energy Executive Order 455.

Market Making

In August, Mining and Energy published Order 455, which sets forth directives for the registration of buy and sell contracts signed on the open electricity market.

The order surprised the market mainly because it eliminates the registration of ex-post contracts, the loss of which which could result in higher costs to industrial consumers on the free market.

Jornal da Energia explains, in a report that deserves a translation of its own.

Currently the Brazilian energy market. BBCE, and the Brix deal mainly with so-called short-erm “spot” contracts in which the client seeks an «ex-post» contract to satisfy a past demand.

This method of buying energy after consuming it using contracts based on the PLD — the Price of Liquidation of Differences — has been widely used and has its own nickname. Traders say they are “surfing the PLD” and are thereby able to take advantage of lower prices when surprised by a sudden price hike, since the short-term indicator takes into account such variables as rain, and so on.

Price Structures

An mid-afternoon panel dealt with a pricing structure adjusted for the time frame of energy use.

In November 2011 ANEEL defined a new rate structure for high-tension customers with rates differentiated according to the hour of consumption. The rule changes standards in force since the 1980s and is designed to create new pricing tables by 2014.

Amended Tax Schedules

A late afternoon session dealt with the tax incentives offered to take the sting out of bringing their prices in line with consumer purchashing power.

MP 579, announced by the government in September, proposes a drastic reduction in taxes and tariffs on electrical energy in Brazil, considered among the highest in the world. This panel will gather experts to discuss these changes and the viability of the government’s measure, as well as the new pricing structure envisaged for the coming years.

Carta Capital | Interview with Roberto Pereira D’Araujo

On November 11, president Dilma Rousseff announced a program to reduce energy rates for industrial customers by up to 28%. Since then, Provisional Measure 579, drafted by the president, has been targeted for criticism by industrial firms and unions. Energy companies are complaining of the conditions placed on concession renewals and say that the indemnification offered in exchange is insufficient. Union are afraid that job cuts may result from the conditions imposed on management. Roberto Pereira D’Araujo, director of the NGO Ilumina –Institute for the Strategic Development of the Electricity Sector — says the issue was not taken seriously enough early on and argues that the government has made bad decisions. Below, an e-mail interview with Pereira with CartaCapital magazine.

Carta Capital: How do you view the federal government’s MP 579?

Roberto Pereira D’Araujo: It demonstrates a certain desesperation on the part of the federal government.The issue could have been dealt with four years ago, but nothing has been done to date. The most surprising aspect of the provisional measure is a brutal government intervention in the sector not based on a thorough analysis of why electricity prices have grown in an explosive manner. MP 579 is a medicine prescribed without any diagnosis at all.

Perhaps this is because a thorough analysis would reveal the terrible decisions the government has made in the past that resulted in rate hikes. The fact that such measures have never been implemented in any other country in the world should be sufficient to demonstrate that MP 579 is completely inadequate.

CC: Electricity companies have said that conditions placed on concession renewals by the government will be “devastating.” Is the government being too rigid?

RPA: It’s not a matter of inflexibility. What’s devastating is that it will be implemented on the basis of erroneous reasoning, especially as regards state-owned electricity companies. Nowhere in the world are generation facilities responsible for rate-setting. Setting rates in the job of the concession-holder. If MP 579 becomes law, the concessionaires will be transformed into mere contractors.

As an example,take Furnas, which charges, on average, R$ 80/MWh, cheaper than many new generation plants, but will now receive R$ 5/MWh from 45% of the generation plants it owns. I will say it again: Is there any place in the world that imposes energy pricing on this model?

CC: Will companies in the sector suffer from loss of profitability and market value?

RPA: Of course. Revenues at FURNAS are down 60%. At CHESF, they are down 76%. And so I say it again: have you ever seen anything like it in all the world?

CC: Is there a better alternative to the president’s plan to reduce energy prices to industry and the consumer?

RPA: The market model, introduced in Brazil during the Cardoso years and continued under Lula, is not the favorite of of hydroelectric companies. Canada and the U.S., which have physicial similarities with the Brazilian system, never adopted this market-based experiment. Contrary to what you read in the press, the market model creates costs that were not present before.

Futher, the government has not made a single adjustment in the tax burden on electricity. The Brazilian electricity sector, unique in all the world, is fragmenting into a variety of groups with serious methodological differences. All of these increases costs! The electricity sector needs a reform negotiated with civil society.

CC: Dilma Rousseff has been dealing with the sector since the first Lula administration, when she served as minister of mining and energy. Could this debate have taken place earlier? Is this the proper moment to renew concessions?

RPA: You must recall the document “Directives and Lines of Action for the Brazilian Electricity Sector,” published in 2002 by the Instituto Cidadania, and signed by Lula, Dilma, Mantega, Sauer, Pinguelli, Tolmasquim, Kirchner, Agenor de Oliveira, Roberto Schaeffer and myself.

That document contained diagnoses pointing in the opposite direction to what was adopted starting in 2003. First of all, we advised against not renewing with state-owned energy, which at the time was the cheapest available. And what did the government do? It continued to allow contracts to lapse and created a climate encouraging the “self-dealing” exchange of cheap hydoelectrics for expensive thermo plants.

In Ceará, for example, this meant swapping energy at R$ 53 for energy costing R$ 153/MWh. The energy produced by state-owned companies served to “irrigate” the free market with energy at R$4/MWh — a veritable birthday present. The free market as envisioned by Cidadania was meant to be a mariginal force and not this black box in which no one knows who is buying what from whom, for how much and within what time frame.

CC: Will MP 579 cause a retraction in the electricity sector?

RPA: It certainly will. Electricity companies will be fundamentally transformed, shedding their contingents of engineers. They will become mere service contractors or limited liability holding companies. This will be some sort of a “privatization from the inside out”?

CC: Brazil has had problems with electricity delivery in recent months. Was this a accident? Or does it reflect the breakdown of the current model?

RPA: It is no accidental. The weakness of the transmission system shows that it is time to invest more in monitoring. With the revenues anticipated in MP 579, however, this lack of investment tends to get worse.

CC: Does Brazil run the risk of a crisis in energy delivery in the near future? What effect might MP 579 have on this scenario?

RPA: Brazil runs the risk of returning to energy rationing. But even if it avoids this fate, Brazilian society will pay a higher fuel bill for thermoelectric plants that came online this year. This is a symptom of the fact that we are approaching a precipice. There are differences in methodology between ONS and EPE that serve as structural defects of the model adopted by 579.