Brazil's Electricity Market: A Successful Journey And An Interesting Destination

The beginning of the journey

Brazil is the third largest energy market in the Americas, after the United States and Canada, and its growing power sector is the largest in Latin America. Electricity consumption growth rates fluctuate at around 5% per year, demanding the entrance of an average of 3GW every year. The entire electricity sector was overhauled in the late 1990s, the aftermath of which continues to drive reform, innovation and opportunity in the market. Brazil has made significant progress on its transformational journey away from having an inefficient and underinvested state-owned electricity sector on the brink of collapse, and can today celebrate its achievements in having introduced unprecedented levels of competition in its electricity sector. That all of this has come about in so short a period of time is impressive: today the electricity sector offers investors an exciting and dynamic market which would have been a closed shop a little over a decade ago. However, there are still issues and weaknesses in the system: now may be a good time to consider where Brazil's ongoing journey may lead to next.

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The beginning of the journey

Brazil is the third largest energy market in the Americas, after the United States and Canada, and its growing power sector is the largest in Latin America. Electricity consumption growth rates fluctuate at around 5% per year, demanding the entrance of an average of 3GW every year. The entire electricity sector was overhauled in the late 1990s, the aftermath of which continues to drive reform, innovation and opportunity in the market. Brazil has made significant progress on its transformational journey away from having an inefficient and underinvested state-owned electricity sector on the brink of collapse, and can today celebrate its achievements in having introduced unprecedented levels of competition in its electricity sector. That all of this has come about in so short a period of time is impressive: today the electricity sector offers investors an exciting and dynamic market which would have been a closed shop a little over a decade ago. However, there are still issues and weaknesses in the system: now may be a good time to consider where Brazil's ongoing journey may lead to next.

Development and deterioration: 1970-1990

After a period of rapid development in the 1970s, by the late 1980s the largely state-owned power sector in Brazil was on the verge of collapse. The sector had deteriorated as a result of heavily subsidised tariffs and a large shortfall in revenue, which in turn led to underinvestment in the sector as a whole, and delays in the construction of new plants to increase generation capacity.

1990s Reform and investment

In 1996, the government led by President Cardoso, which had pledged to implement radical reforms in the electricity sector as part of its election manifesto, initiated the Project for Restructuring the Brazilian Electric Sector ("RE-SEB"). The objective of RE-SEB was to establish a competitive power sector by allowing for the participation of capital from the private sector, and to privatise many of the state-owned utilities and assets (excluding transmission assets). As a result of these reforms, private investors spent approximately US$10 billion in buying out 85 per cent of the country's existing distribution in the form of government-granted concessions with price cap regulation. Any increases in future demand would be met by freely negotiated new energy contracts, which would be less prescriptive in terms of price cap regulation, but would set out limits on pass-through energy costs.

The initial reforms also led to the creation of the Agência Nacional de Energia Elétrica ("ANEEL"), a quasi-independent industry regulator. Further reforms followed in 1998 with the creation of independent operators of the national transmission system (the "ONS") and the commercial market (the Mercado Atacadista de Energia Electrica ("MAE")).

Following the reforms of 1996-8, new capital was attracted from the private sector, with foreign investors such as Tractebel, AES, Prisma Energy, El Paso and Duke acquiring state-owned assets and becoming significant producers. In addition, local investors invested heavily in the national generation sector. Other newcomers to the Brazilian electricity market included EDF, Endesa and Chilectra, who focused their investment on the distribution segment, where privatization brought improved quality of service and a reduction of theft, non-payments and technical losses.

The energy crisis of 2001-2

Whilst the reforms of the late 1990s were a bold attempt to overhaul the failing system which preceded it, serious issues remained in the sector which the initial reforms failed to address. Growth in capacity continued to lag far behind growth in demand, and the country relied heavily on hydroelectric generation for 80 per cent of its electricity. Delays continued in the expansion of the sector due in part to the uncertainty in the definition of pass-through prices which complicated pricing mechanisms.

After a few years in which average rainfall had been significantly lower than expected, reservoirs were depleted, and strict demand reduction programmes had to be implemented by the Crisis Management Board, established and led by President Cardoso in June 2001. The Board had powers to implement emergency measures such as special tariffs, compulsory rationing and blackouts. Additionally, the government established a quota system based on historical and target consumption levels, and a corresponding bonus and penalty scheme whereby consumers were...