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Shock of The Revewal | Bill 579

Electricity-sector stocks on the Bovespa, and state-owned Eletrobras in particular, have been pummeled lately as a Provisional Measure sent down to Congress from the Presidency seeks to reorganize the process of pricing energy.

Rumor is that Eletrobras will post EBIDTA-zero this year.

Industrial consumers seem glad. Should they be?

Source: Valor, via Portal ClippingMP.

Despite mixed signals, the federal government is convinced that electricity transmission company Cteep and the state-owned generator  Cesp will in the final analysis suspend concession contracts currently maturing between 2015 and 2017, according to interim Mining and Energy minister Márcio Zimmermann. “Come December 4, you will see surprises,” Zimmermann, said in an interview with Valor on Friday.

Zimmermann attributed the threats, according to which the companies would not agree to an earlier date for renewal of the contracts, to “the hope by lobbyists” of influencing the content of Provisional Measure 579 — currently under debate in Congress, the bill reduces energy prices and allows concessions to be suspended.

As to when the contractual extension would be signed, the minister said he was «almost certain» that  Cteep and Cesp will adhere to the plan.

Last week, CTEEP’s board voted not to accept the plan to defer the concessions offered by the government. The company has 96% of its assets in concessions ending in 2015, a figure which represents 18,000 km of transmission lines.

As to Cesp, state energy secretary José Anibal, believes it will be “very difficult” for the company’s three generators — Ilha Solteira, Jupiá and Três Irmãos — to adhere to the plan.

As to state-owned  Cemig, Zimmermann says he is “confident” that the federal ministry will win the court battle if Cemig sues for the tights of three of its generation plants –São Simão, Miranda and Jaguara — under the terms of legislation predating MP 579.

Zimmermann, says there are companies out there — foreign multinationals, even — that are interested in hydoelectric plants and transmission lines that will be auctioned early than expected. This situation should motivates current concession-

Valor offers a more detailed sidebar on the issue, to come. The difficulties with the bill, basically, is that it is structured as a zero-sum game.

Before analyzing MP 579, let’s take a moment for a conceptual overview.

When a company acquires a capital asset, it does so in exchange for a liquid asset, such as cash, that will generate value for a number of years, during which it will under physical amortization. Amortization is related to the decreasing value of assets which, by law or by the terms of a private contract, should revert to the concession grantor when the concession runs its course, without inemnification. Depending on the regulatory structure, amortization may be accelerated in order to reduce taxes paid on corporate profits.

As to corporate profits part should be set aside and another saved in a depreciation account to offset losses from physical wear and tear. At the same time, capital must be amortized but also generating valor at the same time. This happens when the amortization rate — set by regulators — changes more rapidly that does the useful life of installations and equipment.

In this context, it is clear that fully amortized assets are perfectly suited to contributing to the manufacturing process and still generate to profits. This entire process takes place regardless of whether or the regulator demands that a portion of electrical energy revenue be accounted for as amortization.

All productive labor — capital and labor — has to be paid for based on the value created, or on productivity, as the economists say. If capital is amortized but continues to be productive, it satisfies this need in the form of profit margins.

In the Brazilian electrical sector, capital set a side for amortization she be repaid by the concession-granting autority. (Law 8 987/1995). Investors have known about this role since their initial bids and therefore have no credible reasoning for questioning it now.

MP 579, however, is innovative in they way it repeals revenue from amortized capital. In practice, the concession dries up, capital assets are returned to the concession-granding authority, which no longer makes a claim on capital returns. If no returns are necessary — and, of course, if no corporate savings exist in the form of a depreciation fund — then prices to the consumer can be lowered. As these prices fall, energy sales tend to rise. The erosion of working capital increases, as does the need for new investments. In a December 2009 report, the Agência Nacional de Energia Elétrica (Aneel) estimated that R$17 billion in new investment would be required

With prices dow and costs standing firm, return on capital diminishes, as do the company’s savings. MP 579 reduces profit margins of energy companies, but is not nationalizing the risk and responsiblity for new investments, which remain in the hands of the private sector.

One model of investment based on a pricing table was that attempted by the late Soviet Union — the results are well known. Industry may be delighted with lower prices now, but in the future may well suffer energy outages caused by lack of investment.