The Brazilian government announced in early January that it plans to modify the regulatory scheme for the power sector in an effort to revitalize the domestic power industry.

A number of regulatory changes will be instituted in the next few weeks. Other measures are expected to be implemented over the next several months.

The measures were announced by the Câmara de Gestão da Crise Energética, or CGE, which was established last year in the wake of a severe power shortage nationwide. They follow recommendations by the Comitê de Revitalização do Sector Elétrico — a power industry restructuring committee that is composed of senior officers and technicians from BNDES, ANEEL, CGE and representatives of affected government ministries.

Immediate Changes

The CGE announced the following new measures on January 9.

First, there will be changes in the calculation of firm power provided by the system and the operation safety margin of the system, under rules established by the country’s independent system operator, known as the ONS. ONS is a non-governmental organization in charge of managing the system’s technical operations. These changes will also apply to new thermal and hydro plants that are to come into operation. In addition, the firm energy values of each hydroelectric plant will be recalculated, leading to the reconsideration of the power reallocation system — called the MRE or Mecanismo de Realocação de Energia — procedures, established in 1998.

Second, the wholesale energy market — called the MAE or Mercado Atacadista de Energia — will be eliminated and be replaced by something called the Brazilian energy market— a new entity called MBE or Mercado Brasileiro de Energia. Since it first came into force in September 2000, the MAE was never able to settle financial transactions, and it was always a major obstacle for companies operating in the industry. The main difference between MAE and the new MBE is that the new market will be entirely regulated by ANEEL, as opposed to the self-regulating model under the MAE. This change of control will lead to revised mechanisms for establishing prices in the spot market for energy.

Third, there will be a mandatory “deverticalization” of utilities by separating generation, transmission and distribution functions, with a fixed deadline for accomplishing this. The federal government has already started the process of reorganizing state-owned companies under its control (FURNAS, CHESF and ELETRONORTE), and is expected to have completed that process by the end of May this year.

Proposals Still Under Discussion

The other measures that the government intends to implement will require more discussion among consumers, private companies and public entities with an interest in the process.

These include a proposal for so-called “old energy,” generated by older, state-owned hydroelectric plants at a very low cost under initial contracts with distribution companies, to be fully regulated as the generator of the energy is gradually released from its supply commitment under such a contract. The release from the supply commitments is at the rate of 25% a year from 2003 through 2005. The purpose of this measure is to prevent cheaper energy produced by state-owned companies from undercutting electricity from private suppliers and to avoid rate shock since there will be a large amount of uncontracted energy in the system by 2003. It is unclear whether this measure will affect only the federal companies or both federal and state companies (like COPEL, CESP and CEMIG).

Also under discussion is a proposal to end ratepayer cross-subsidies by reducing residential rates and raising tariffs to the industrial sector.

Electric distribution companies will have to increase from 85% to 95% the volume of energy contracted under long-term agreements. The goal is to lock in power supplies under bilateral contracts, thereby reducing the exposure to the new wholesale market.

Distribution companies will then be required to meet standard conditions for services rendered for all customers, including services to rural and low-income consumers. There will be an increase in the number of consumers considered “free” because they have an option to bypass the local distribution company and buy their electricity from any generation company, other distributors or traders.

The government also proposes to establish guidelines under which the “system” will contract for thermal plant power. The thermal supply will operate as a type of safety net against energy shortages. All consumers will bear the cost of the safety margin in supply.

In addition, the government has proposed measures designed to increase investment in thermal generation. These include subsidies for natural gas transportation from the Bolivia-to-Brazil gas pipeline to the PPT group plants and changes in the “normative value amount,” or the ceiling price below which a distributor can pass through the cost of its power purchases to retail customers. According to the new model, the normative value will vary by region and time of use of the power produced, but will no longer vary by energy source.

Alternative sources of energy and cogeneration projects will also receive incentives such as access to special credit facilities, higher purchase prices to cover their investments and reduced transmission and distribution tariffs.

Conclusion

The new framework points to a less competitive market with government participation and an increase in tariffs charged to end consumers in order to support the expansion of the system.

Since not all measures have been fully disclosed by the federal government and the formal regulations to implement the new scheme have not yet been issued, the full impact of the changes remains still to be seen. In the meantime, market participants have suggested that investor appetite for the upcoming privatizations will probably be less intense than the government hopes. On the other hand, some market participants may be able to foresee more accurately income and expenditures if there is a reduction in regulatory risk.

If thermal plants become a backup for the system and their capacity generation cost is actually recovered from all consumers, then they will become a good choice for developers.