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Brazil Energy Market: Investor Boost From Reforms?
New legislation, privatizations will unlock investment opportunities.
BY ARTHUR DEAKIN
Although it is the largest and one of the most developed energy sectors in the region, Brazil still requires important regulatory changes to improve the competitiveness and openness of its sector. Despite having access to cheap generation sources, the cost of electricity for both small and large consumers are disproportionately high. In fact, 48 percent of consumer’s electricity bills are composed of taxes, fees and subsidies used to fund an Energy Development Account (CDE) and incentivize specific generation schemes. Brazil’s heavy dependance on hydropower has also forced the country to turn on expensive thermal plants during periods of insufficient rain and low water supplies, leading to historic surges in energy costs.
As it stands, Brazil’s energy market remains highly fragmented due to its unique set of rules for its different types of consumers. Depending on the amount, the type of energy, and the setting in which they consume electricity, consumers can fall into the following five categories: free, special, distributed, self-generating and regulated. A more unified set of rules for consumers would encourage price transparency and grid predictability in Brazil.
Despite the challenges, there are unique pockets of opportunity within Brazil’s energy sector that remain highly attractive and lucrative. A key prospect is the Distributed Generation subsegment, where companies and homes use solar panels to generate decentralized power of up to 5 MW. Following the approval of a net-metering bill in 2012, the segment has attracted $3.5 billion in investments. By 2030, if subsidies are maintained, Brazil’s distributed generation capacity will increase six-fold and will attract an additional $13.5 billion in capital investments.
The growth in distribution generation can be largely attributed to two factors: first, the current regulatory framework exempts companies and individuals from paying distribution fees while generating this type of power. This creates lofty returns as solar technology becomes increasingly cheaper. Second, any distributed energy that is generated, but is not consumed, can be used as a credit to discount future bills.
There is one bill currently being discussed in congress that can drastically change the direction of this segment. PL 5829/2019, which is supported by the government in behind-the-scenes negotiations, recently “entered” the House of Representatives’ agenda and seeks to preserve the subsidies granted to users of distributed generation. The mere fact that the bill is part of the legislative agenda and supported by the government, is by no means a guarantee that the bill will be voted on, much less approved. Brazil’s horse-trading politics can lead to months, even years of voting delays as congressman holdout their votes in exchange for specific concessions.
Critics of the bill claim that keeping the subsides will be an unfair burden carried by all consumers, especially those that don’t have the means to install distributed generation. They project that subsidies will cost consumers $25 billion over the next 30 years. Proponents, on the other hand, calculate that the law will create cost-savings and energy efficiencies that will lead to $9 billion in net savings by 2035.
Natural gas law and the modernization of the electricity sector – the government’s gradual opening of the energy market
In addition to creating a regulatory framework for the distributed generation sector, the government also took a large step towards improving the energy market in April of 2021. After seven years of debate, Brazil's congress approved a bill (law 4476/2020) to further open the natural gas market to private competition and break the monopoly held by state-owned Petrobras. The bill aims to promote fair competition in the distribution of piped gas, allowing private market players to access existing pipeline infrastructure. The construction of new pipelines will now be conducted via a simple authorization model, rather than the long-standing concession structure.
Although the federal law seeks to prevent vertical monopolies by prohibiting local gas producers from distributing gas, the Brazilian constitution grants a monopoly to states over the distribution of piped gas. For the federal law to be fully implemented, it will require each state to pass their own compliant regulations, which they purposefully may delay or even challenge. Nevertheless, four states have already passed laws, and more are likely to follow.
In the meantime, the new gas bill has already begun to attract private capital. Soon after the Senate first approved the bill in December 2020, Brazil’s largest Liquified Petroleum Gas distributor, Ultragaz, said it would invest $43 million in expanding its infrastructure to handle the country's opening refining market. Since Brazil's gas infrastructure is underdeveloped, especially when it comes to pipelines, the government expects the bill to unlock $10.6 billion in private investment by 2026. Currently, the United States’ pipeline system is 50 times the size of Brazil’s.
Another bill floating in congress is PL 414/2021 (formerly PLS 232/2018), which seeks to structurally reform, open and modernize the electricity sector. Initially, the bill would allow all consumers with a demand greater than 500 KW to buy energy from any generation source. 42 months later, this option would be opened to all consumers—regardless of their demand. The bill also seeks to end a compulsory quota regime to buy hydroelectricity and separates the supply and commercialization of energy. In simpler terms, it aims to change how energy is bought and sold in the country. Many proponents believe the bill will fundamentally improve the country’s much-needed energy efficiency, as Brazil is the only country in the G20 whose energy consumption grows faster than its economic production.
Generation-related subsidies to promote alternative energies have also been the subject of intense discussions in the government. A provisional measure in September 2020 declared a 12-month phase out period for the 50 percent network tariff discount provided for renewable plants to connect to the transmission and distribution networks. The Ministry of Energy argues that these subsidies, which are often given to large consumers, increase costs for retail consumers by $775 million per year. In line with some of the more developed markets, the Ministry argues that incentives for renewables were suitable 15 to 20 years ago—not today, when renewable energy is advanced and competitive. The elimination of the tariff discount is also aimed at alleviating losses experienced by distributors, who are paid the discounted fees. Many of these distributors come from the northeastern region of the country—home to several congressmen in the influential "Centrão" coalition formed by the Bolsonaro government.
In a rush to take advantage of the expiring subsidy, solar and wind developers have doubled their efforts to build new renewable projects. In some cases, developers seek project authorizations from Brazil’s Electricity Regulatory Agency (Aneel) before they have even secured a deal with a distributor to buy the energy generated. This pre-approval is especially common among solar PV plants, which don't require a deposit when seeking authorization from Aneel. Without this requirement, developers limit their potential losses if the project never becomes operational. The elimination of this subsidy will increase solar pricing by $3.50 USD/MWh, according to Greener, a Brazilian consultancy. Such a price move will help usher in more solar capacity investment.
ELETROBRAS
Another fundamental aspect in the opening and improvement of the Brazilian electric sector is the privatization of the largest power utility in the region, Eletrobras. Eletrobras once held a vertically integrated monopoly over Brazil’s electricity sector and its privatization is a major policy objective for President Bolsonaro’s administration. Eletrobras still owns 31 percent of Brazil’s installed generation capacity and 47 percent of the country transmission lines. Currently, the federal government holds 51 percent of the company’s ordinary shares, which includes voting rights.
Following a 21-day blackout period in the Northern State of Amapá, where a private company’s transformer suffered a defect and exploded, many anti-privatization politicians reinforced their calls to prevent any further privatizations. In Amapá, the partial privatization of the state’s electric grid began in 2008, where the concessions for the transmission and distribution of energy were awarded to the private Spanish company, Isolux. During the recent blackouts, which left more than 700,000 people without power, Eletrobras successfully took over the grid and contracted supply from thermal-electric plants nearby.
Using the “success” of the publicly owned Eletrobras and the “failure” of the privately-owned Spanish Company in Amapá, many old-school politicians, part of Brazil’s traditional horse-trading politics, reiterated their refusal to support a privatization bill that did not preserve the government’s “golden share” in Eletrobras. This golden share would allow the government to continue to have veto power over strategic decisions made by the company.
Despite congressional resistance, mostly from leftist parties, the house of representatives approved the Eletrobras privatization bill on June 21, one day before the bill expired. The following day, Bolsonaro turned it into law with no further changes. The bill will allow the government to issue more Eletrobras common stock, diluting its stake to 45 percent. However, the bill will also grant the government its “golden share” while allowing it to keep control of the Itaipu and Electronuclear power plants. Moreover, it mandated the purchase of an additional 2 GW of gas-fired thermal power in pre-defined regions, helping win support of certain lawmakers from those states. Many of these regions lack access to gas and will require the construction of pipelines, raising concerns over the feasibility of that provision.
Another important aspect of the bill is the 20-year extension of Proinfa, the Incentive Program for Alternative Sources, that aims to subsidize small hydro plants, and a select few solar and wind projects. Through Proinfa, Eletrobras buys energy at pre-set preferential prices to incentivize the use of renewable sources that were not competitive at the time the energy was contracted. In 2020, Proinfa spent $670 million to support 131 projects, where the average tariff rate was $58 to $124 per MWh. In contrast, in the 2019 auctions, wind power was negotiated under $19 per MWh. The privatization bill also excluded the establishment of a transition period, from January 2023 to July 2026, for all power consumers to choose their suppliers of electricity. This issue will be dealt with the previously mentioned PL 414/2021, the law that seeks to modernize the electricity sector.
Including the primary share offering, concession fees and the potential sale of remaining shares, the economy ministry said they could raise $17.7 billion (100 billion reais) in the entire privatization process. Those funds will be used to lower consumer energy bills and renew concessions for Eletrobras’ hydro plants and transmission lines. Critics call it a capitalization bill, intended to raise funds for the company while retaining government control, rather than a privatization law. They also said it will raise electricity prices for consumers.
Even as this privatization legislation unfolded, a June 2019 decision from the Supreme Court allowed both Petrobras and Eletrobras to proceed with selling their shares in regional energy subsidiaries. Eletrobras, for example, began privatizing utilities such as the CEEE-D in Rio Grande do Sul, the distribution company of the southernmost state. Petrobras also sought to slash $30 billion in debt by selling its downstream refineries and gas distribution assets. With growing demand from China, Petrobras is focusing on oil exports and upstream development of its pre-salt basins. In 2019, in asset sales alone, it raised $16 billion.
Conclusion – Navigating a tough investment climate to get a piece of the pie
Foreign investors looking to purchase assets at a discounted price should look closely at the divestment of state-owned assets. A key policy driver in the Bolsonaro administration, Economic Minister Paulo Guedes, has remained steadfast on his goal to sell state-owned companies to compensate for Brazil’s growing fiscal deficit. Brazil’s Covid-19 stimulus, one of the largest and most effective in the world, has the country’s debt-to-GDP ratio nearing the ominous 100 percent threshold. Guedes understands that Brazil’s spending cap must not be modified, as this would hurt the country’s fiscal credibility, raise borrowing costs, and frighten investors. To compensate for Brazil’s increased spending, Guedes has reemphasized his team’s efforts to move forward with divesting state assets—including those owned by both Eletrobras and Petrobras.
Outside of the opportunities in Petrobras and Eletrobras, smaller segments, such as distributed generation, are more profitable and less competitive. In fact, distributed generation in Brazil generates 30 percent annual returns. These opportunities are surging across the region and will attract the main global energy players and investors. Navigating the challenging investment climate that awaits these projects, requires careful ESG due diligence, risk monitoring and a precise reading of the new political alignments forming in key jurisdictions.
Arthur Deakin is Co-Director of the energy practice at Americas Market Intelligence, where he oversees projects in oil & gas, solar, wind and hydrogen power, as well as battery storage and electric vehicles.
This article was originally published by AMI. Updated by the author and republished with permission.
