Energy Policy in Brazil Perspectives for the medium and long term

Background report to PM 2014:05

Dnr: 2013/164 Swedish Agency For Growth Policy Analysis Studentplan 3, SE-831 40 Östersund, Sweden Telephone: +46 (0)10 447 44 00 Fax: +46 (0)10 447 44 01 E-mail: [email protected] www.growthanalysis.se

For further information, please contact Mikael Román Telephone: +55 613 442 5211 E-mail: [email protected] ENERGY POLICY IN BRAZIL

Table of Contents

Summary ...... 5 1 The Brazilian Energy Sector* ...... 6 1.1 Energy Supply ...... 6 1.2 Energy Consumption ...... 8 1.3 Institutional Framework and Policy Instruments ...... 9 2 Brazilian Energy Strategies in the medium and long term ...... 12 3 Energy Sources and Priorities ...... 15 3.1 Non-Renewables ...... 15 3.1.1 Oil and Gas ...... 16 3.1.2 Coal ...... 18 3.2 Renewables ...... 19 3.2.1 Hydropower ...... 19 3.2.2 Wind power ...... 21 3.2.3 Bioenergy ...... 21 4 Carbon Capture and Storage ...... 24 5 Energy Efficiency...... 25 6 Sustainability ...... 27 7 Challenges and Choices ...... 29 8 References ...... 35

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ENERGY POLICY IN BRAZIL

Summary

Brazil is endowed with abundant energy resources and is well known for its unusually clean energy matrix. But with recent discoveries of large oil reserves, the long term demand for oil is expected to increase. Other challenges to the current development model include growing internal energy demands, ageing infrastructure, and the emerging impacts of climate change. The renewable sector is expected to continue to grow and play a vital role in the county’s energy mix. Currently hydropower is well developed, but faces challenges regarding its expansion. Onshore wind power capacity is expanding rapidly, particularly in the Northeast, and the plants are operating at high capacity levels. Bioenergy is already used extensively in the transport (ethanol and biodiesel) and industrial (sugarcane bagasse) sectors, and the country has developed advanced technologies and policies to incentivise the use of bioenergy. In addition, an increase in the use of biofuels for electricity generation (thermo power) could be expected for the medium/long term. But investment in R&D for second generation biofuels is lagging behind, even though there are recent government and industry efforts to reverse this trend. Large investment in the oil and gas sector is planned, as Brazil seeks to become one of the largest oil producers in the world by 2021. Demand for fossil fuels is also expected to increase, not least because historically, part of the profit margin of state controlled Petrobrás (the national oil company) has been used to keep petrol prices in the domestic market low. Demand is then fuelled by the price incentive. The importance of natural gas in the country's overall energy mix is also growing, and there are signs of renewed interest in exploring Brazil’s gas potential, including its unconventional gas resources. Besides the use in industry, and because of shortages in rainfall, gas has increasingly been used to fire thermoelectric power plants – this trend is expected to continue. Sustainability has been part of the government’s rhetoric as one of the key priorities for the Brazilian energy sector, alongside security of supply and affordability. There are a number of positive developments with regards to reducing environmental impacts and CO2 emissions. An example is the large investments in CCS technologies being made by Petrobrás, as part of its EOR in offshore fields. In addition, Brazil’s energy sector has large potential for energy efficiency gains (savings of 40 TW per year have been estimated), but one of the key challenges has been the lack of a strong institutional framework to ensure the delivery of planned goals. In the industrial sector most of the opportunities lay in the less energy-intensive sectors such as food processing, whilst investment in public transport options could provide an opportunity for wider energy efficiency gains. However, the structural issue of changing consumption patterns more generally seems to be given very little attention. The Brazilian energy sector faces a strategic moment, with a number of challenges and opportunities being presented to policy and decision-makers. In the long run, a critical issue relates to the implementation of policies and strategies. Brazil has a well-developed regulatory and policy framework in place, however growing political interference to achieve short term goals, lack of strong implementation mechanisms and other structural problems may hamper the implementation of such plans.

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1 The Brazilian Energy Sector*

Brazil occupies a privileged position in the global energy system. It is blessed with abundant energy resources, and the recent government program “Luz para Todos” (Light for All) has enabled nearly all households to have access to electricity1. The country generates over 75 per cent of its electricity from hydro-power and is also well known for its extensive use of biofuels, mainly in the form of ethanol, in the transportation and industry sectors2. In addition, extensive deepwater oil and gas reserves were found in early 2000 outside the coast of Rio de Janeiro.3 The country is the largest energy consumer in Latin America, with a final energy 4 consumption of 253,422,000 toe . Yet, it is also an anomaly in the global energy context, mainly because of its relatively clean energy mix. In 2012, non-renewable energy constituted 57.6 per cent of Brazil’s Total Primary Energy Supply (see Figure 1), while renewable energy, including sugarcane products (15.4%) and hydropower (13.8%), made 5 up for a remarkable 42.4 per cent. This strong emphasis on renewables, which compares with a corresponding 8 per cent for the OECD, makes the Brazilian energy system one of 6 the least carbon-intensive in the world. Despite generous conditions, the energy situation in the country is increasingly complex. Growing internal energy demands, ageing infrastructure, and the emerging impacts of climate change are a few challenges that recently came to question the present development model.

1.1 Energy Supply In spite of its high share of renewable sources, Brazil relies on a higher share of fossil fuels in its total energy supply (39.2%) than both the global average in 2010 (32.4%), and the OECD mean in 2011 (36.3%). 7 In the medium to long term the demand for oil is projected to increase at a rate well above world average mainly due to: 1) an expected expansion of the transport sector; and 2) the ongoing exploration of the deepwater oil and gas reserves (pre-salt). While the latter should in principle affect primarily the global supply of oil, there is a reasonable possibility that it will also boost demand. The reason is that, historically, part of the profit margin of state controlled Petrobrás (the national oil

* For more detailed background information about the current Brazilian Energy sector, please refer to the report: Energy in Brazil – resources, trade-off and strategies for the future. http://www.growthanalysis.se/sv/publikationer/svar-direkt/svar-direkt/2013-10-31-energy-in-brazil---r- esources-trade-off-and-strategies-for-the-future.html (Accessed 2013-11-17) 1 Ministério de Minas e Energia. Programa Luz para Todos. https://www.mme.gov.br/luzparatodos/asp/default.asp?id=1 (Accessed 2013-11-17) 2 Ministério de Minas e Energia (2013) Balanço Energético Nacional: Ano base 2012. MME, Brasília, DF 3 Brasil garante um terço da expansão de óleo até 2035. Valor Econômico 13 November. http://www.valor.com.br/empresas/3336930/brasil-garante-um-terco-da-expansao-de-oleo-ate-2035 (Accessed 2013-11-13) 4 Ibid 2 5 In the Brazilian Energy Balance, the TPES is referred as Domestic Energy Supply (DES) but, as we compare the Portuguese and English versions, the two concepts are the same. For the data, see ibid 2. 6 Climate Policy Initiative (2013.) The Policy Climate. CPI, San Francisco 7 United Nations Development Programme (2004) World Energy Assessment: Overview 2004 Update. UNDP, New York, NY. pp. 28f. (http://www.iea.org/publications/freepublications/publication/kwes.pdf)

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company) has been used to keep petrol prices in the domestic market low. Demand is then fuelled by the price incentive.

Figure 1 Primary Energy Supply. Source: EPE (2013) Balanço Energético Nacional 2013: Ano base 2012

The discovery of oil reserves in the offshore pre-salt area has generated major investments and the ambition to turn Brazil into a major oil exporter over the next decade. Petroleum is thereby likely to remain a key fuel in the Brazilian energy mix for the foreseeable future (see Figure 2). Hydro-power makes up for nearly 80 per cent of total installed electrical capacity. This is the result advantageous conditions and deliberate government strategies. However this dependency on hydro energy is increasingly questioned, not least in light of environmental challenges and perceived climate changes. Over the next decades, a diversification in the Brazilian energy mix is to be expected, albeit this may be easier said than done. With regards to the use of bioenergy (nearly 30 per cent of the Brazilian primary energy supply), one should note that the country has developed advanced technologies and policies that allow the industry and the transport sector to make extensive use of biomass. The National Alcohol Fuel Program (ProÁlcool), intended to stimulate the use of ethanol in light vehicles, is well known, and similar attempts are being made to promote biodiesel through the so-called National Biodiesel Production and Use Program (PNPB). Biofuels should continue to play an important role in the energy mix, but the investment in new technologies in recent years has been minimal and the sector is suffering from recent government policies that kept gasoline and diesel prices artificially low.

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Figure 2 Oil Production and Electricity mix forecasts. Source: EIA World Energy Outlook 2013

Another renewable that has seen considerable progress in recent years is wind power. Most investment is happening in the Northeast, where natural conditions are highly advantageous. Electricity production from wind grew by 86.7 per cent between 2011 and 2012, so as to generate 5.050 GWh per year.8 Biogas is also getting increasing attention, not only for its energy generation capacity, but also as a means to solve waste and sewage challenges. At this stage, however, it has not advanced as much as wind power.

1.2 Energy Consumption The pace of growth in both economic activity and energy demand in Brazil has picked up noticeably since the turn of the century: from 2000-2011, average annual GDP growth was a full percentage point higher than in the previous decade (3.5% versus 2.5%). Oil and renewables (mainly bioenergy and hydropower) have remained dominant in the primary energy mix, and the only significant change over the last two decades was the growth in demand for natural gas, which increased its share from 2 per cent in 1990 to over 10 per cent today. In 2012, the manufacturing sector accounted for 35.1 per cent of total energy consumption in Brazil, followed closely by the transport sector at 31.3 per cent. One interesting trait is the comparatively high use of biomass in both the transportation and industry sectors. In the former, ethanol (referred to as alcohol in Figure 3) accounted for 12.5 per cent of total energy, while the use of sugarcane bagasse in the industry reached 20.1 per cent. However, the transportation sector is still the largest consumer of fossil fuels in the Brazilian energy sector and the fleet of personal vehicles has grown at a faster pace than the economy in the last decade. As for secondary energy, electricity demand continues to outstrip economic growth and overall energy consumption. 9 The trend of growing electricity demand is expected

8 Ministério de Minas e Energia (2013) Balanço Energético Nacional: Ano base 2012. MME, Brasília, DF 9 Ministério de Minas e Energia (2013) Balanço Energético Nacional: Ano base 2012. MME, Brasília, DF

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to continue, not least because of the increased residential and commercial demands. This should also open up opportunities for efficiency gains, through policies in building regulations and appliance standards. Energy consumption in general is set to continue on an upward trend. The International Energy Agency estimates that primary energy demand will rise by 80 per cent between 2012 and 2035.10 But these numbers should be considered with caution. This energy consumption scenario considers a steady and continuous economic growth of approximately 3.6 per cent per year. Given recent performance, this long-term growth forecast may appear optimistic. While Brazil indeed grew at an average rate of 4.1 per cent between 2003 and 2010, a number of factors suggest that this performance is unlikely to be sustained over long periods of time. Economic officials have already acknowledged a reduction in the potential growth rate of the country, and the projected average growth rate for the 2011-2014 period is a rather modest 2.1 per cent. 11

Figure 3 Primary Energy Supply. Source: Balanco Energetico Nacional 2013: Ano base 2012

1.3 Institutional Framework and Policy Instruments Brazil has a well-developed institutional and policy framework for the energy sector (Figure 4), as well as a system of detailed operational planning for its expansion, based on Brazil’s expected energy needs and consideration of social and environmental aspects.12 In the early 1990s the Brazilian energy sector underwent considerable restructuring, including the privatization of the electricity sector. In 1997 the Petroleum Law was approved, and it also had repercussions in the biofuel sector. The privatization efforts

10 International Energy Agency (2013), World Energy Outlook 2013, OECD/IEA, Paris. 11 This figure is based on the actual economic growth rates reported for 2011 and 2012, and the median growth forecast for 2013 and 2014 according to the market survey conducted by the Brazilian Central Bank (Focus – Market Readout of November 22nd, 2013) http://www.bcb.gov.br/?MARKETREADOUT 12 Plano Expansão de Energia 2021, Plano Nacional de Energia 2030, Balanço Energético Nacional 2013.

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intended to spur innovation in the energy sector more generally, by creating market incentives in all parts of the value-chain. The results so far have been mixed and it is fair to say that some sectors are still trying to find the optimal balance between market incentives and government control (which is, de facto, increasing). Moreover, it is not always clear whether existent problems in the implementation of policies are a function of institutional arrangements, administrative features, or political intervention. From a policy perspective the energy issues are primarily in the hands of the Ministry of Mines and Energy. The Brazilian National Council of Energy Policy (CNPE) was set up to advise the President of the Republic on energy issues in general and policies for the electric sector in particular. At the regulatory level, there are two agencies, one for electricity (Agência Nacional de Energia Elétrica) and another for petroleum and biofuels (Agência Nacional do Petróleo e Biocombustíveis).

Figure 4 Brazil’s energy policy and regulatory institutions Source: WEO 2013 p. 322

Brazil uses a number of policy instruments in its energy sector, which are briefly explained below. There has also been increasing political interference with stated market policies, such as keeping oil and electricity prices artificially low, in order to achieve short term economic performance goals. Currently, changes to domestic oil prices are decided by the Federal Government on a mostly ad-hoc basis. The key question which has not yet been answered by the government is how the extra resources from pre-salt reservoirs will ultimately affect the future domestic pricing policy of Petrobrás. There has been a recurrent debate over an automatic

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pricing formula for oil products – that would keep domestic prices more in line with global oil prices and exchange rate developments.13 Some market analysts have argued that the domestic pricing policy of Petrobrás makes it one of the few publicly listed companies in the world whose share price may actually drop when the price of its main output increases in global markets. This currently occurs because the company has to import fuel at higher prices to supply it at a price that is fixed in the domestic market.

Fuel Blending The large use of biofuels in Brazil is, in part, due to a government policy that mandates fuel blending. Since the Pró-alcohol era (1970s), it is mandatory for gasoline to contain a proportion of ethanol. This proportion varied along the years, and is currently set between 20 and 25 per cent (depending on the sugarcane harvest). In more recent years, diesel is also mandatorily being blended with biodiesel, at a 5 per cent rate.

Fiscal incentives These incentives take the form of tax reductions related to sales, purchase and import. One interesting example is the tax specific regime, Fontes Alternativas de Energia (REINFA), set up to stimulate the production and consumption of alternative energy. In adition there have been tax breaks for goods, such as cars and white goods, in particular those that are more energy efficient.

Public Financing Public financing is the predominant policy instrument. One central actor in this context is the Brazilian Development Bank (BNDES), which currently holds about 35 per cent of the total stock of corporate bank credits in the country. BNDES loans typically carry subsidized rates.

Energy Auction System A system of contract auctions held at regular basis has been used to foster other sources of renewable energy. The total long-term demand from the various distribution companies is matched, in a bidding process, to different combinations of potential supply, with the most competitive bids receiving long-term power supply contracts. Auctions for new power generation can be organized by technology, (e.g. renewables-only, or exclusively wind power), and in this way the auction system provides a mechanism for the authorities to exert a degree of control over the evolution of the power mix. An auction system is also used in the oil and gas sector, with bidding for the right to explore certain fields happening at regular intervals.

13 Petrobras busca mecanismo de reajuste depois de trimestre ruim. Valor Economico 28 October 2013. http://www.valor.com.br/empresas/3318172/petrobras-busca-mecanismo-de-reajuste-depois-de-trimestre- ruim#ixzz2kuI0rdIK (Accessed 2013-11-17)

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2 Brazilian Energy Strategies in the medium and long term

The future of the energy sector is one of the most important policy questions that the country currently faces. It includes not only questions of energy sources, but also challenges related to distribution, consumption, efficient use of resources, sustainability and climate change. The Brazilian energy sector is set to expand considerably in the next decades, not least because of the expected increase in oil products from the pre-salt reserves. By 2035 it is estimated that Brazil should be the sixth largest oil producer in the world.14 On the other hand, the renewable energy sector is also expected to grow significantly, especially biofuels, hydro- and wind-power sources. Internal energy supply assurance (“Garantia de Abastecimento”), at a relatively low-cost, continues to be the main overarching government goal for its energy strategies. Energy security or energy supply assurance, preferably from internal sources (so as to limit the effects of international supply shortages), has been a long-standing goal of the Brazilian government. The successful National Alcohol Fuel Program (ProÁlcool), launched following the 1970’s oil crisis, is one example of how past government actions were geared towards assuring internal supply of energy. An analysis of the large investments expected to take place in the country in the coming years (Figure 5) shows that about 54 per cent of the expected investment is to be directed towards the energy sector, with oil and gas being the sector that benefits most. In addition, the expected investments in the transport and industry sectors will certainly also have indirect impacts on the energy sector. Besides the focus on energy supply, there is some effort being made to improve the efficiency of the energy sector. Investments in better technologies and R&D to improve the high voltage transmission lines and the integrated electricity grids are some examples. From a sustainable development perspective, and considering Brazil’s discourse with regards to its sustainability credentials in the energy sector, one would expect some attention to be given to the issue of changing consumption patterns in the country’s strategic planning. However this is not the case. While analysing the government plans for the medium and long term, there is barely any attention given to the need to change current consumption patterns. On the contrary, it seems that more of the same is what is being pushed for. For instance, the large importance of the automobile sector within Brazilian industry and the national economic structure, as well as the increasing focus on short-term economic performance makes it unlikely that the federal government would make a big push for changes that would affect car sales in a negative way. 15 The development of alternative, more energy efficient means of transportation, has in general been sluggish. There are

14International Energy Agency (2013), World Energy Outlook 2013, OECD/IEA, Paris. 15 Figures suggest that, since 2010, Brazil possesses the fourth largest car market in the world, after China, the United States and Japan. (http://www.cnbc.com/id/44481705/page/11 and http://en.wikipedia.org/wiki/List_of_countries_by_largest_auto_markets. (Accessed 2013-12-01)

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localized exceptions at times. One such change - that was induced by street protests that erupted in several major cities in June and July 2013 - is an increased effort to finance the construction of subway systems in heavily congested urban centres.16 Another noteworthy initiative was the change in the environmental standards of trucks produced in the country from Euro 3 to Euro 5 in the beginning of 2012.17

Figure 5 Expected State and Private Investments until 2017(in Billion R$). Source: Valor Setorial: Infra-estrutura. June 2013.

A game-changer in the Brazilian energy sector and its future strategies was the discovery, in 2000, of large oil reserves in the offshore pre-salt layer. Whereas previously the energy mix was clearly geared towards investment in renewable resources, the current situation points towards growing investment in oil. This raises questions about the role that biofuels will play in country’s the future energy mix. Petrobrás is responsible for investments in both, oil and biofuels, and its recent commitment to large investments in the oil industry may restrict its ability to invest in other areas. One particular and challenging trait of Brazil more generally, is that the policies may be in place, and the rhetoric about long term strategies is well developed, however the realization and implementation of such plans is not something that can be taken for granted. A mix of factors can be responsible for the difficulties: bureaucracy, ineffective

16 Governo está investindo R$ 50 bi em linhas metrô nas capitais. Portal Brasil. 30 October 2013. http://www.brasil.gov.br/governo/2013/10/governo-esta-investindo-r-50-bilhoes-em-linhas-metro-nas-capitais (Accessed 2013-12-03) 17 In accordance with Phase 7 of the “Programa de Controle da Poluição do Ar por Veículos Automotores”. http://www.ibama.gov.br/areas-tematicas-qa/programa-proconve (Accessed 2013-11-30)

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institutions, weak regulations, political interference, and lack of clear control mechanisms, among others. Another noteworthy growing trend in Brazil seems to be the increased government interference in existing strategies to help achieve short term goals. In the case of energy, recent political interference to improve the short term economic performance of the country include reducing electricity tariffs and keep fossil fuel prices below market prices. In recent years the central government has forced gasoline and diesel prices to stay below their international value, to help keep inflation in check. This practice has artificially increased demand for fossil fuels, at the expense of biofuels – eroding the financial resources of Petrobrás (as it imports fuels at international prices) and limiting its future investment options. If this trend continues, it may create additional challenges for policies implementation in the long run.

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3 Energy Sources and Priorities

Brazil’s resources are abundant and diverse and the country’s ambition is to develop its natural resources over the coming decades so as to become one of the global major energy producers. Fossil fuels, in form of deepwater oil production leads the way, bringing with it large volumes of associated gas. On the renewable front, Brazil is expected to see an increase in output from hydropower, bioenergy and wind energy.18

Oil Gas Coal Nuclear Hydropower and electricity Biomass Sugarcane bagass Other renewable

Figure 6 Changes in sources of Energy Supply in medium term. Source: MME, Plano de Expansão de Energia 2012.

Figure 6 shows what the Brazilian energy supply may look like in the medium term. Oil, gas, biofuels and hydropower are currently the largest sources of energy, and are expected to continue to be so in the future. Other sources are complementary, but being a country of continental proportions, regionally some sources of energy are more abundant then others, and will therefore be more or less important in the regional energy supply. It is estimated that the energy mix by 2021 will show a slight decrease in oil and gas, compensated by an increase in biofuels and other renewable sources. However, a larger share of fossil fuels may be expected in the mix depending on climate conditions, as hydropower production is largely dependent on rainfall, and thus there may be a growing need for gas-fired power generation.

3.1 Non-Renewables Non-renewable resources in the Brazilian energy mix rely heavily on fossil fuels: oil, gas and coal are the biggest players. The generation of power from nuclear reactors is very limited (currently at 2.007 GW, produced by two reactors located in Rio de Janeiro), and amount to about three per cent of total electricity generation. Despite Brazil’s significant uranium resources (estimated at 277 thousand tonnes)19, the role of nuclear energy is likely to remain limited in the future. A new reactor is expected to start operating in 2018, but further expansion of nuclear power is limited by the availability of other low carbon

18 For a more detailed analysis of Brazil’s energy sources and priorities, refer to the International Energy Agency’s “World Energy Outlook 2013”, chapters 9 and 10. 19 NEA/IAEA (Nuclear Energy Agency/International Atomic Energy Agency) (2012), Uranium OECD/IEA, Paris.

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technologies at lower costs (e.g. hydro and wind power), long project lead times, public opposition and difficulties in the financing of new projects. 20

3.1.1 Oil and Gas In 2012, Brazil produced 2.7 million barrels per day (bbl/d) of liquid fuels, of which 78 per cent was crude oil. In early 2013, Brazil launched a 10-year energy plan that aims to expand oil production to over 5 million bbl/d by 2021. The plan also sets targets for oil exports of over 2.25 million bbl/d by 2021. 21 The Brazilian oil and gas industry is undergoing a period of great challenges and transformation. The country has for many years had a robust infrastructure for oil and gas exploration and production, but only more recently Brazil is being considered an emerging leading force in the world’s oil sector. A radical change occurred when Petrobrás made a number of large deepwater offshore pre-salt22 oil and gas field discoveries. These discoveries have mostly occurred in the Campos and Santos basins, situated 200-300 km outside the coast of São Paulo, Espírito Santo and Rio de Janeiro (Figure 7).

Figure 7 Main oil and gas fields in the Camps and Santos Basins Source: World Energy Outlook 2013 p. 375

As of 2012, Brazil’s proven oil and gas reserves amount to 18.2 billion barrels of oil equivalent (boe)23, but as exploration of the pre-salt progress, this reserves are expected to grow. The country aims at being self-sufficient (and export) oil in the medium term. Even though production from the pre-salt fields in the Santos basin has recently started, the oil output has levelled out at just above 2 mbd since 2010 (Figure 8). This is due to the declining output from more mature fields elsewhere in the country, and the fact that fields in the Santos basin still need to gain momentum.

20 Eletronuclear. Angra 3: energia para o crescimento do país. http://www.eletronuclear.gov.br/AEmpresa/CentralNuclear/Angra3.aspx#Titulo (Accessed 2013-11-18) 21 Plano Decenal de Expansão de Energia 2021 (2012). Ministério de Minas e Energia/ Empresa de Pesquisa Energética. Brasília: MME/EPE 22 These resources are called “pre-salt” because they predate the formation of a thick salt layer, which reaches up to 2.000 metres and overlays the hydrocarbons. 23 Agencia Nacional de Petroleo (ANP) Anuario Estatistico 2013. http://www.anp.gov.br/?pg=66833#Se__o_2 (Accessed 2013-11-29)

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Figure 8 Brazil oil production and domestic demand. Source: World Energy Outlook p. 316

Drilling into, and producing from, pre-salt reservoirs will require the industry to overcome several technical and environmental challenges. The ocean at the location of the pre-salt fields is often more than 2000 metres deep, followed by 5000 metres of rock (including 2000 metres of salt layer) – and wells need to extend through those layers before reaching the oil reserves. Production has already started (in mid-2013), indicating that technical and geological challenges are being overcome, but scaling up production remains a massive task, and will call for step-changes in investment levels in the years to come. As part of a government strategy to stimulate local industrial development, the development of new oil fields is linked to a “local content requirement”, which stipulates that part of the services and materials for all the wells, facilities and infrastructure is to be sourced locally within Brazil. This could potentially add important strain to the supply chain in the coming years, as workforce, technological development and supply of materials from local sources may prove difficult. Natural gas contributes to a growing proportion of the country's overall energy mix. Currently it provides about 10 per cent of total energy supply, however, the pre-salt fields are estimated to have large volumes of associated gas reserves, and this is creating pressure to develop new outlets for gas consumption (for example attracting energy-intensive industries). At the same time, the recent increased use of gas to fire thermoelectric power plants may be a sign that the importance of natural gas in the energy mix may change in the future. Besides the offshore fields, future gas production growth could also come from onshore, where there are signs of renewed interest in exploring and developing Brazil’s gas potential, including its unconventional gas resources (mostly shale gas). But there is great uncertainty related to shale gas production, as environmental concerns and lack of

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legislation and infrastructure has resulted in virtually no company showing interest for exploring such fields in recent government auctions.24 On a long-term basis, a potential use for shale gas in Brazil could be the production of fertilizers. Brazil has considerable reserves of shale gas in the states of Paraná and Mato Grosso, two large producers of soya beans. The production of fertilizers “in loco” could provide an opportunity for developing this industry close to its end users, and at the same time promote some energy efficiency gains in terms of transport (currently most fertilizers are produced in the Southeast region, and need to be transported inland). Gas consumption in Brazil is low by international standards, suggesting there is room for improvement. But the evolution of demand for natural gas in Brazil over the coming years is subject to multiple uncertainties and the speed at which this may happen will depend to a significant extent on what happens upstream and on how the market develops, i.e. whether gas enjoys advantages in terms of availability and affordability, compared with other fuels. Another key challenge for the natural gas sector will be to manage uncertainty over demand from gas-fired power plants. Those plants are used as back-up systems to the power sector, and their demand varies depending on hydrological conditions.

3.1.2 Coal Brazil’s coal reserves and resources are estimated to be of the order of 23.8 billion tonnes, but proven reserves amount to 6.6 billion tonnes. Around 75 per cent of this coal is low- grade lignite and the rest is hard coal.25 In addition, coal is regionally confined to the Paraná Basin, which extends mostly across the southern states of Santa Catarina and Rio Grande do Sul. The main demand for coal in Brazil comes from the iron and steel industry, but the high ash yield and sulphur values of Brazilian coal make it unsuitable for such use. Therefore the country relies heavily on import. 26 Coal production has been declining since the mid- 1980s, and was particularly hard-hit in 1990, when a long-standing law which stipulated that 10 of coal used in the Brazilian industrial production must be mined locally was revoked. Coal-fired electricity generation plays a small role in the Brazilian power mix (about 2 per cent), and most of its current coal-fired generation was built between 1960s and early 1970s.27 Although a power auction in August 2013 called for new coal-fired projects, none of the proposed projects won any capacity contracts. The increased availability of natural gas and the competitiveness of non-hydro renewable resource create even more challenges for coal. In addition, there is an ongoing debate about lifting tax incentives that have been in place for imported coal used in power generation.28 These issues suggest that the role of coal for power generation in the longer term is unlikely to change.

24 Leilão da ANP é marcado por falta de disputa. Valor Economico. 29 November 2013. http://www.valor.com.br/empresas/3356852/leilao-da-anp-e-marcado-por-falta-de-disputa#ixzz2mGZueiBY (Accessed 2013-12-01) 25 BGR (German Federal Institute for Geosciences and Natural Resources) (2012). Energy Resources 2012, Reserves, Resources, Availability, Tables. Hannover, Germany. 26 MME Plano Nacional de Energia 2030 – 6. Geracao Termeletrica, Carvao Mineral. 27 International Energy Agency (2013), World Energy Outlook 2013, OECD/IEA, Paris. 28 Comissão aprova fim de incentivos concedidos ao carvão mineral importado. Câmara Noticias, 23 October 2013.

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In a long term horizon it is reasonable to expect a modest growth in the Brazilian coal-fired generation capacity, in particular in the southern region, close to the Brazilian coal reserves. There are also studies indicating that, from a cost-effectiveness perspective, the development of new thermoelectric plants located near ports, and run with imported coal may be an interesting alternative for electricity generation in the longer run.29 However this development would demand considerable investment in infrastructure and tech- nological development to reduce emissions, and currently there are few signs of any move in this direction.

3.2 Renewables The International Energy Agency has estimated that consumption of renewable energy in Brazil, excluding hydropower, is to rise by 90 per cent between 2013 and 2035. Although hydropower is set to continue to be responsible for a considerable share of the energy mix, other sources of renewable energy are expected to shift somewhat, from declining use in traditional biomass, charcoal and harvested wood and a growing contribution from wind, solar, biofuels and bagasse (used for heat and power generation). This increase, though guided by policy, is driven in most cases by the strong competitive position of renewable energy within Brazil.

3.2.1 Hydropower Currently hydropower accounts for around 80 per cent of domestic electricity generation. In the long term it should continue to retain its primary position in the power mix, as the current hydropower facilities explore only approximately one-third (83 GW) of the country estimated hydropower potential (245 GW). Thus, in theory, there should be large room for growth in this sector. But as shown in Figure 9, continued expansion of hydropower is increasingly constrained by the remoteness (40% of the total capacity is located in the Amazon region) and environmental and social sensitivities of the new projects. Nonetheless, 20 GW of hydropower capacity is currently under construction in the Amazon region. In contrast to traditional hydropower development which relied on large reservoirs, most of the additional hydropower plants being either planned or developed in Brazil are “run-of- river” type. However there is an ongoing discussing between different parties considering the implications of this shift. On the one hand run-of-river plants avoid flooding of very extensive areas (thus reducing social and environmental impacts), but have very little water storage capacity, and therefore their power output is subject to seasonal variation in rainfall and river flows over the course of the year. To a degree, the seasonal variations introduced by run-of-river hydropower could be absorbed by existing hydro reservoirs, which can be replenished during periods when runoff-river output is at its highest. But coal and gas-fired power have increasingly been used to supply power during the dry season, and questions related to CO2 emissions and other environmental impacts of such plants are being raised.30 31

http://www2.camara.leg.br/camaranoticias/noticias/ECONOMIA/455388-COMISSAO-APROVA-FIM-DE- INCENTIVOS-CONCEDIDOS-AO-CARVAO-MINERAL-IMPORTADO.html (Accessed 2013-11-19) 29 Interview Prof. Roberto Schaeffer, COPPE/Rio (13 November 2013) 30 O Globo (2012), Polêmica envolve a volta das hidrelétricas com reservatórios (12 August 2012). 31 Faria, I.D. (2013). Hidrelétricas no Brasil e a vitória do obscurantismo. Valor Economico 11 November.

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Figure 9 Brazil hydropower potential by river basin. Source WEO 2013.

The run-of-river projects also have lower capacity than the ones with reservoir. Belo Monte plant, currently under construction in the Amazon area, is a good example: the natural water inflow to the plant (as opposed to the regulated inflow which would be possible with a reservoir) varies by a factor of twenty between the greatest and lowest monthly values (EPE, 2010). It is also expected to have a lower capacity factor than hydropower with large reservoirs; generating, on average, less electricity per unit of installed capacity over the year. Belo Monte will have a capacity factor of about 40 per cent, compared with an average capacity factor of 77 per cent from 2000-2012 for the massive Itaipú hydropower plant, which is located in the Southern state of Paraná. The seasonal variation introduced by the run-of-river hydropower will have significant impacts on the evolution of the country’s power system. The shift towards more run-of- river capacity is also expected to result in wider variations in transmission needs throughout the year, reducing average line-utilisation rates and potentially placing greater stress on the (already rather fragile) system. The need of alternative power supplies during the dry season is another challenge that will need to be addressed. Given the very contentious and long project development time scales - which is typical for hydropower - a question to ponder is “what if” the planned hydropower expansion in the long term fails to materialize, or is considerably delayed? In that case it is reasonable to expect that other sources of renewable energy, such and wind power, biomass and solar energy might increase their share in the electricity generation. At the same time, the use of fossil fuels may also step up, and as a result CO2 emissions could rise considerably. Also, if (mostly due to environmental reasons), the Amazon area is considered “off limits” for future development of hydropower, less than 70 GW of the country’s potential remain http://www.valor.com.br/opiniao/3334086/hidreletricas-no-brasil-e-vitoria-do-obscurantismo#ixzz2lNdqj8eb (Accessed 2013-11-22)

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untapped. In this case, the focus for hydropower expansion may fall in regions such as the Paraná River basin (which already supplies the Itaipú hydropower project), whose large resource is made more attractive by its relative proximity to Brazil’s largest consuming area, the Southeast.

3.2.2 Wind power Wind power still plays only a small role in the Brazilian energy mix. But it has shown considerable growth in recent years. Favourable climatic conditions have resulted in most investments in wind power plants to be located onshore in the Northeast region, but future development will see growth in investment the Southern region. The potential for offshore generation is also large, but it is considerably more expensive to develop, and is therefore not expected to be explored until it becomes more competitive. Since the electricity crisis in early 2000s, the government has been pursuing an increase in power generation by alternative renewable sources, and wind power projects have been competing successfully against other sources in the medium and long term market development prospects. From the installed plants, early indications show that wind power plants are operating at capacity factors in excess of 50 per cent, which are high levels by international standards. In a recent government led energy auction for supply from 2016, wind power competed with thermal, small hydro and solar power projects, and won all the bids. The preference for wind energy is related to the relatively low cost of wind power generation in Brazil, and strengthens the growth trend for this source of electricity in the medium term (just in 2013 new contracted projects added up to an increased capacity of 2.372 GW).32 The success of wind power when competing with thermal plants in Brazil’s power supply auctions has received a lot of attention, but this success poses both an opportunity and threats. The opportunity lies in proving that wind power is an economically viable option for meeting rising demand from the power sector, while holding down CO2 emissions. The challenge lies in building the contracted wind projects on time and delivering the promised performance. Another important challenge that has hampered wind power are the delays in the building of transmission lines that connect the power plants to the national grid. Bureaucracy alongside difficulties in obtaining environmental licenses has created delays in the development of several transmission lines in the Northeast region.33

3.2.3 Bioenergy The use of bioenergy in Brazil is widely associated with ethanol consumption in the transport sector. But Brazil’s climate, size and large agriculture industry contribute to the productions of a variety of biofuels. Four main categories of biofuels have strong presence in the country: firewood and charcoal, agricultural residue, ethanol and biodiesel.

32 Calmon, P. (2013) Vai se abrindo, no Brasil, o leque de fontes de energia. Estado de São Paulo. 20 Novembro. http://www.estadao.com.br/noticias/impresso,vai-se-abrindo-no-brasil-o-leque-de-fontes-de- energia-,1098553,0.htm (Accessed 2013-11-24) 33 Borges, A. (2013). Chesf admite erro em obras de linhas de transmissão. Valor Econômico 19 November. http://www.valor.com.br/empresas/3342700/chesf-admite-erro-em-obras-de-linhas-de- transmissao#ixzz2lNqkx2kS (Accessed 2013-11-22)

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The share of wood in the Brazilian energy balance has been declining in the last decade, but it still accounted for 9.1 percent of primary energy demand in 2012.34Iron and steel industry are the chief users of charcoal, with household users accounting for 35 per cent of wood consumption, mostly for cooking. Projections suggest that national charcoal production should steady or decrease in the medium and long run, being substituted by imported coal. Agricultural residue, mostly bagasse from sugarcane processing, is widely used in industrial processes with steam turbine generation systems. In the coming years, an expected growth in sugarcane harvests alongside moves to reduce the unproductive burning of residues and an increase in the mechanisation of harvesting are expected to boost the availability of bagasse. As a result, there should be an increase in the production of electricity from biofuels. The use of ethanol in transport, particularly in cars, is widespread. It currently meets around 15 per cent of demand in the Brazilian transport sector, where flex-fuel technologies account for around 90 per cent of new passenger vehicle sales. However, the country has recently seen a sharp decline in production as well as investments in the ethanol sector. A number of factors have contributed to this trend: high sugar prices on the international market, poor sugarcane harvests, rising operational costs, underinvestment and government interventions. The biodiesel production (primarily from soybean oil) has grown rapidly since 2003, when the state-supported National Biodiesel Production & Use Program (PNPB) was launched, with the ambition to gradually substitute petro-diesel with biodiesel. In addition, and similar to the ethanol experience, there is also a mandatory blending of biodiesel in the petrol-diesel, which in 2012 reached 5 per cent. Since 2009, in an effort to fight inflation, the ethanol sector (and in a smaller scale also the biodiesel sector) has had to compete with artificially low gasoline (diesel) prices.35 The consequences have been severe. One area of particular concern is the lack of investments 36 37 in research and innovation. This may ultimately threaten Brazil’s position as a technology leader in the field and, hence, the industry’s competitiveness also in the longer perspective. Instead of advancing in the area of second-generation biofuels, in which Brazil has an enormous potential, the industry is gradually falling behind. There have however been signs that the government is increasingly aware of this situation, and current market conditions look more promising, as a new regulatory regime, involving tax incentives and extended funding to the bioenergy sector is being created. 38 One major challenge that remains is how to stimulate investments in bioenergy sector in the shadow of the expanding oil and gas industry.

34 Ministério de Minas e Energia (2013) Balanço Energético Nacional: Ano base 2012. MME, Brasília, DF 35 International Monetary Fund (2013) Case studies on energy subsidy reform: Lessons and implications. IMF, Washington, DC. 36 Pereira, R. (2011) Falta de investimento ameaça etanol. O Estado de São Paulo 22 May. http://economia.estadao.com.br/noticias/economia%20brasil,falta-de-investimento-ameaca-etanol,68072,0.htm, (Accessed 2012-06-03). 37 Santos, G. R. (2013) Pesquisa em Biomassa Energ[etica no Brasil: Apontamentos para Politicas Publicas. Ipea. Radar 06/2013. 38 Bitencourt, R., Borges, A. (2013) Governo traça novo 'regime' para o etanol. Valor Econômico 7 February. http://www.valor.com.br/empresas/2998710/governo-traca-novo-regime-para-o-etanol (Accessed 2013-11-20).

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4 Carbon Capture and Storage

The Brazilian government is not showing great efforts with regards to developing CCS technology, but the oil and gas sector is making considerable investments. In particular Petrobrás is investing in CCS technology. This results largely from a market-driven effort, as CCS could provide additional benefits for an increase in production via Enhanced Oil Recovery (EOR) or Enhanced Gas Recovery (EGR) in its deepwater reserves. Under the right conditions, CO2 dissolves in crude oil, increasing the mobility of the oil and thus the use of CCS could be an interesting solution. Because CCS also serves the Brazilian government’s aims regarding energy supply and national competitiveness, the government is now giving full support to Petrobrás’ investment in CCS. In terms of R&D, Petrobrás’ reseach center CENPES coordinates a network of 11 research institutes at universities throughout Brazil, with the aim of stimulating the technological development of CCS. Since June 2013 Petrobrás and partners, have commenced the commercial phase of

CO2 injection for EOR into the Lula field (in the Santos Basin), located approximately 300 kilometres off the coast of Rio de Janeiro. In addition, Petrobrás is is also conducting a pilot experimental site in an existing CO2-EOR facility on the Miranga field. The pilot project is for CO2 to be separated from natural gas, and then injected into a depleted oil reservoir.39

In part due to the relatively clean energy mix, and comparatively low CO2 emissions (if compared with OECD countries for instance), at this point in time Carbon Capture and Storage is not a priority in the Brazilian case. However with the expected increase in the role of fossil fuels in the medium to long term this situation could change. Commercial uses of CCS in combination with the production of bioenergy (BECCS) are alternatives that have yet to be explored in Brazil. Given the large share of biofuels in its primary energy supply, Brazil shows potential for using BECCS technologies in combination with production of ethanol.

39 Global CCS Institute. http://www.globalccsinstitute.com/location/brazil (Accessed 2013-12-01)

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5 Energy Efficiency

It is generally agreed that there is large potential for energy efficiency gains in the Brazilian energy sector. The PROCEL (National Program for the conservation of Electricity) estimates that a total of 40 TW per year could be saved. The industrial, commercial and residential sectors could save about 22 TW, while 18 TW are lost in the electricity sector with distribution and other technical losses.40 The IEA estimates that final consumption by 2035 could be reduced by 43Mtoe, without any major technological breakthroughs, by the implementation of energy efficiency measures and technologies that exist today and are economically viable. In 2011 the Ministry of Mines and Energy launched a report that explores Energy Efficiency challenges, and proposes actions41. A number of institutions have been involved in preparing this report, and although there is an ongoing debate about the issue, very little is happening on the ground. There are a few punctual projects (i.e. Hydrogen Bus, National Program for Public Lighting and Efficient Traffic Lights – Reluz), but their impact is very limited. Discourse and reality seem to be diverging. One of the challenges is the lack of a strong institutional framework. A number of government institutions claim to be handling energy efficiency matters (including PROCEL, ANEEL, MME, EPE, CONPET), however there seems to be lack of leadership and decision-making is not effective. Nonetheless, there are some noteworthy efforts in this field. The Inovar-Auto program is one such example. It provides tax incentives for a limited period (5 years) for the automobile industry, and encourages automakers to produce more efficient, safer, and technology-advanced vehicles while investing in the national automotive industry. Assuming the program is well implemented, and that enforcement and compliance are effective, there is potential for energy efficiency improvements of the order of 12 per cent in light-duty vehicles between 2012 and 2017.42 However positive and necessary these efficiency gains for cars are, they do continue to create incentives to a mobility model that is energy intensive. One interesting question is related to how the government will pursue public transport options as a wider energy efficiency policy. Following the mass protests in mid-2013,43 there has been an awakening in the government towards the need to improve public transport services in the country. There is a large opportunity window not only for much needed improvements in infrastructure and services, but also for energy efficiency gains. Still in the transport sector, there is a largely untapped potential for efficiency improvements related to moving freight transport off the roads, onto rail and waterways.

40 Ministério do Meio Ambiente (MMA). Eficiencia Energetica e Conservação de Energia. http://www.mma.gov.br/clima/energia/eficiencia-energetica (Accessed 2013-11-14) 41 Ministério de Minas e Energia, Plano Nacional de Eficiencia Energetica (2011). 42 Olivon, B. (2012). O que o Inovar-Auto quer das empresas. Revista Exame 04 Outubro. http://exame.abril.com.br/economia/noticias/o-que-o-inovar-auto-quer-das-empresas (Accessed 2013-11-20) 43 Passarinho, N. (2013) Após protestos, Câmara anuncia debate sobre transporte público. 18 June. G1 noticias. http://g1.globo.com/politica/noticia/2013/06/apos-protestos-camara-anuncia-debate-sobre-transporte- publico.html (Accessed 2013-11-21)

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This would require large infrastructure investments in the country, and although there are plans in the medium and long term to invest in such infrastructure, the realization of such plans is not guaranteed. In the buildings sector the policy of phasing out incandescent light bulbs is another example of the sort of efficiency gains that policies can help deliver. By mid-2014, bulbs above 60 Watts that do not meet a performance standard can no longer be sold in Brazil. This is possibly the policy with highest impact on efficiency in buildings in the country, and it could save up to 11TWh per year by 2035. In contrast to the trend in many other countries, the program Procel Edifica (which encourages energy efficient concepts in building design) is not binding, and has only a voluntary system of energy performance ratings for buildings. Regionally adapted (due to climatic conditions) mandatory labelling for buildings and implementation of stricter building codes is another opportunity to facilitate more energy efficient buildings. One missed opportunity in the building sector was the chance to link the large ongoing low-cost housing program “Minha casa, Minha vida” (My house, my life), financed by the central government, to energy efficiency gains. On the other hand, in recent years higher tax-incentives have been given to household appliances that are rated “A” in the labelling standards.44 In the industry sector, the energy-intensive industries have already invested in energy efficiency gains, and most of the new opportunities may lay in the less energy-intensive sectors such as food processing through improvements in steam systems and electricity motors. This sector might benefit from increased awareness and know-how, as well as targeted financing opportunities. The BNDS, through its Climate Fund and PROESCO Projects is an important instrument in fostering industrial energy efficiency gains. New regulation on solid waste management,45 although not directly related to energy issues, could have an impact on energy use and efficiency gains: more recycling leads to a reduction in transport to landfill sites, while the development of incineration plants could open up energy recovery possibilities. As noted, the opportunities are plentiful, and so are the challenges with regards to energy efficiency. Government policies will play a critical role in achieving efficiency gains as they can help lower market barriers and minimise transaction costs, unlocking the necessary investments.

44 Bruno Federowski (2013). IPI da linha branca sobe em outubro, mas não volta a níveis originais. Reuters Brazil 30 de setembro de 2013. http://br.reuters.com/article/domesticNews/idBRSPE98Q09A20130930 (Accessed 2013-11-21) 45 Ministério do Meio Ambiente (2010) Politica Nacional de Residuos Solidos). http://www.mma.gov.br/pol%C3%ADtica-de-res%C3%ADduos-s%C3%B3lidos (Acessed 2013-11-21)

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6 Sustainability

Sustainability has been part of the government’s rhetoric as one of the key priorities for the energy sector, alongside security of supply and affordability. However discourse and practice do not always walk hand in hand, and some challenges related to the questions of a sustainable energy system are raised below. As shown, a unique trait of the Brazilian case is the availability of hydropower and extensive use of bioenergy sources in its primary energy mix. These factors have enabled the country to achieve significant development while keeping its CO2 emissions related to the energy-sector at relatively low levels. A key policy challenge however is how the country is to maintain its low-carbon profile, as domestic energy demands are predicted to continue to grow rapidly and oil and gas availability are also projected to grow in the near future. The combination of growing demand, and availability of abundant fossil fuels may lead the Brazilian policy makers to consider anew the trade-offs between economic, environmental, social and energy security objectives. The social and environmental dimensions of energy development, including water and land-use issues, particularly for projects that have direct or indirect impacts on the Amazon region, are gaining in importance in the public debate. As a result, the prospects for the development of the country’s remaining hydropower potential are being questioned. With the expected growth in the offshore oil and gas developments, challenges related to possible accidents and spills (similar to the Macondo episode in the Gulf of Mexico in 2010) create reasons for concern. Brazil has seen its own share of incidents in offshore operations, the most dramatic being the sinking of the Sao-36 floating production semi- submersible rig in 2001. From a regulatory perspective, the Agência Nacional do Petróleo, Gas Natural e Biocombustível (ANP) is responsible for operational safety on offshore installations, while regulatory authorities at state level are responsible for environmental protection. In addition, the Brazilian Environmental Agency (IBAMA), has tightened its scrutiny of contingency measures and increased its requirement for operators to maintain dedicated spill-response vessels offshore at all times. Upon reviewing the risks from recent oil spillage accidents across the world, the Brazilian government decided to implement a national contingency plan to deal with emergencies. Work on the plan started in 2010, and it has recently been finalised. However, as is often the case with environmental regulation in Brazil, it has been criticized for being a list of “good intentions”, which leaves many unanswered questions with regards to implementation and operationalization of effective measures in the event of an accident. 46 With regards to biofuels, there have been concerns over the way that increased biofuels production could displace other agricultural activities and contribute to deforestation in the country. As a response, the government’s “ZAE Cana” programme has mapped suitable zones for the expansion of sugarcane in Brazil establishing that, under its guiding criteria, 7.5 per cent of Brazil’s national territory could be suitable for sugarcane production.47

46 Nada além de uma carta de intenções. Valor Econômico. 31 October 2013. http://www.valor.com.br/opiniao/3323038/nada-alem-de-uma-carta-de-intencoes (Accessed 2013-11-25) 47Zoneamento Aagroecológico da Cana de Açucar.(2009) Ministério da Agricultura, Pecuéria e Abastecimento. http://www.cnps.embrapa.br/zoneamento_cana_de_acucar/ZonCana.pdf (Accessed 2013-12-01)

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There are, however, a number of positive developments in the country as it seeks to reduce its environmental impacts and CO2 emissions. One of such examples is the Program for Low-Carbon Agriculture (Plano ABC) that seeks to reduce CO2 emissions in the agriculture sector. The program administered by the Ministry of Agriculture and established for the period 2010–2020, holds seven focus areas, including: recovery of degraded land, biological fixation of nitrogen, and climate change adaptation.48 This program has particular relevance to the biofuels sector.

48 Ministério da Agricultura, P.e.A. (2013) Plano ABC. Mapa. http://www.agricultura.gov.br/desenvolvimento- sustentavel/plano-abc, (Accessed 17 June, 2013, 2013).

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7 Challenges and Choices

The large proportion of renewable energy sources in the Brazilian energy mix is something that, despite government plans and rhetoric, may be difficult to maintain or increase in the long run. Although renewable resources are plentiful in Brazil, there are potential constraints to their growth, such as those arising from the low investment in R&D for biofuels, variability of rainfall patterns and hydropower inflows, exacerbated by changes to the climate, etcetera. Efforts to conserve Brazil’s biodiversity, policies on land use and water-resource management are also all closely intertwined with the outlook for the energy sector. And changes in those policies, in particular the ones related to transport and infrastructure systems, will have direct implications for future development of the energy policies. Some more specific challenges are highlighted below:

Energy cost and Industry Despite its abundant energy resources, final consumers in Brazil pay a generally high price for energy services (with exception of bioenergy), if compared with most other countries. Although prices paid by various end-users vary in different parts of Brazil, the average price of natural gas to industry is higher than in Europe and about four times higher than in North America. In terms of electricity, despite reduction in prices in early 2013 and the large share of low-cost hydropower, the average price paid by the Brazilian industry is comparable to European prices, and twice the level in the United States. As indicated in Figure 10, the critical energy cost component for the end-users in Brazil is related to heavy taxation. The Brazilian tax rate on gas (22%) is very high if compared to the United States (zero) and Japan (5%).

Figure 10 Average natural gas and electricity prices to industry by component Source: World Energy Outlook 2013 p. 347

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Alongside the country’s generally complex business environment, high energy costs have had an impact on company strategies and investment decisions, in particular in the energy- intensive industries (iron and steel, chemical, glass, aluminium, pulp and paper, etc.). Until 2006 Brazil was a net exporter of energy-intensive products, but since 2007 the trade balance in these sectors has reversed. There are a number of factors that may have influenced this change, but electricity prices are a key issue. Increased industrial competitiveness has recently been targeted by a number of policies, including the government intervention to lower electricity prices in early 2013 and some tax reductions. Considering that gas is a growing source of energy for electricity production (thermo power), in the long term, a key challenge for Brazil may be related to the developments in the gas sector: the availability of new supply (offshore and onshore), volume available, suppliers and most important, its price.

Transmission and Distribution challenges Timely expansion of the transmission and distribution network in Brazil is critical to meet the continued growth in the power demand and to ensure the reliability of power supply. The Brazilian National Interconnected System (SIN) is a transmission and distribution system that integrates the various components of the power system transports energy generated in the power plants to the demand centres. The interconnected nature of the Brazilian grid allows supply and demand to be balanced over a very large area (by 2015 all states and capitals will be connected to the grid) through multiple transmission corridors – which improves reliability. The SIN also connects several hydrological basins, enabling operators to control hydropower reservoir levels and optimise generation in hydro and thermal power plants. In addition to the expansion of the transmission and distribution systems within its borders, Brazil is also seeking to increase interconnection with its neighbouring countries, including Venezuela, Argentina, Bolivia, Paraguay, Peru and Uruguay. The most recent power interruptions in Brazil, contrary to what happened in the early 2000’s, have not been caused by shortage in generation capacity, but have been related to problems in its transmission and distribution systems. An example of this occurred in 2009, when a short circuit in transmission lines, caused by heavy rains, resulted in the shutdown of the Itaipú hydropower plant. The resulting power-cut affected around 90 million people across the country. Similar problems have occurred fairly frequently in recent years. To address these issues and meet growing power demand, over 47 000 km of new transmission lines and related equipment are planned for the period 2013–2021.49 But the challenge to deliver on those plans in a timely manner, avoiding problems in the distribution system, remains. In an effort to spur innovation in the sector, and at the same time lower Brazil’s comparatively energy prices, President Rousseff decided in September 2012 to press some of the energy companies, by preceding negotiations on their terminating concessions.

49 Ministério de Minas e Energia. Plano de Expansão de Energia 2021 (2013).

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Parallel with this, the government is also putting considerable resources into research on 50 smart grids.

Fragility in Electricity sector In the last years there have been several incidents, related to both production and transmission of electricity, with systemic impacts all over the country. This led to directed initiatives from the government and a general call to diversify the country’s energy portfolio. Besides the electricity distribution and transmission issues outlined above, another critical issue concerns the reliance on hydro energy. Here, there are a set of issues that jointly come to question the government’s plan for building new dams, mainly in the Amazon area. One concerns the arduously slow processes for acquiring all necessary environmental permits. The recurrent protests and problems related to environmental permits at the Belo Monte dam construction are an illustration of the challenges that companies are facing. A second issue relates to the limited efficiency of the new generation of dams built with a limited reservoir (run-of-river). Finally, there is the emerging effect of climate change that is now threatening the very access to water. In 2013 reservoirs have been at the lowest levels since 2001 due to the 51 lack of rain. As a result, many of the back-up energy systems (mostly gas and coal fired thermo plants) are now running on a permanent basis – and there are clear signs that they will continue to do so. This raises some important questions regarding transitionary energy sources in general. At what point, and for what reason, could they effectively become permanent solutions?

R&D and Innovation Brazil ranks comparatively low on R&D investments, and there is a widespread understanding of innovation as technology development (invention/patents) plain and simple. More broadly, problems include: comparatively low investments in research, development and innovation (both from public and private sectors); a high regional concentration of research and development, as well as strong concentration of research to public federal universities; and very little collaboration between academia and the private sector (Santos 2013). However, there are sectors in which Brazil is highly innovative and competitive, i.e. agriculture as well as oil and gas.52 While these structural problems constitute major impediments to Brazil’s competitiveness, the government has in recent years made considerable efforts to stimulate innovation. This

50 Villaverde, J. (2012) Concessionária de energia só terá contrato renovado se aceitar investir mais de R$ 20 bi. O Estado de São Paulo 10 September. http://economia.estadao.com.br/noticias/economia,concessionaria-de- energia-so-tera-contrato-renovado-se-aceitar-investir-mais-de-r-20-bi,126138,0.htm (Accessed 2013-12-01). And Polito, R. (2013) Inova Energia recebe R$ 12,3 bi em projetos. Valor Econômico 8 May. http://www.valor.com.br/brasil/3115096/inova-energia-recebe-r-123-bi-em-projetos, (accessed 2013- 12-01) 51 Taufer, P. (2013) Reservatórios das hidrelétricas estão no nível mais baixo desde 2001. Ibid.3 May. http://g1.globo.com/jornal-da-globo/noticia/2013/05/reservatorios-das-hidreletricas-estao-no-nivel-mais-baixo- desde-2001.html, (Accessed 4 June, 2013). 52 Cruz, C.H.d.B., Chaimovich, H. (2010) Brazil, UNESCO Science Report 2010: The Current Status of Science around the World. UNESCO, Paris, pp. 103-121.

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is reflected in both increased financial investments as well as considerable institutional changes in the Brazilian innovation system. One institutional change has been the creation of an umbrella program called Inovar Empresa, which is intended to unify and coordinate different innovation initiatives. Under this umbrella the program Inovar Energia provides a total financing of 9.6 billion SEK (BRL 3 billion) in three different areas: smart grids and ultra-high-voltage electricity 53 transmission; alternative energy; and hybrid and energy efficient vehicles. Funding for R&D is also heavily incentivised by the Brazilian Development Bank (BNDES) - the largest credit provider in Brazil and also the direct arm of the federal government. BNDES has launched several funding programmes to incentivise technological development in the energy sector over the last years. In addition, there are funding mechanisms at the state level, and although their influence varies, they are central actors in São Paulo (FAPESP), Rio de Janeiro (FAPRJ) and Minas Gerais (FAPEMIG). Corporate actors play an important role in the energy research scenario. Petrobrás is currently investing heavily not only in oil and gas technology – but also in renewable energy. In 2012, the company invested more than 7 billion SEK (BRL 2.2 billion) into research and development, with a powerful research cluster emerging around the company’s research centre (CENPES) in Rio de Janeiro.54 A similar role can be ascribed to the former electricity monopoly, Eletrobrás, which has also established major research centres, as for example the one in conjunction with the Itaipú dam. Brazil has a history of leading development in the first generation of biofuels. In recent years, however, the country has lagged behind in R&D investments for development of second generation biofuels. But BNDES and FINEP (the federal government’s research and development funding agency) have recently launched the PAISS programme, and allocated $733 intended to provide supportive investment to the development of an advanced ethanol sector in Brazil, together with complementary sectors such as biochemical and bio-refineries.55

Regional Differences Brazil covers an area of 8 514 million square kilometres. Its size, geography, climate, and natural resources make Brazil a diverse country, and this has implications for the energy sector and its policies. In terms of energy resources, the Southeast coast is endowed with most of the country’s oil and gas reserves. Shale gas has been found in various parts of the country, but usually in overlaying large aquifers – which creates additional environmental challenges. The country’s largest coal reserves are located in the Southern region, while climatic and topographical conditions for wind power generation are best in the Northeast and Southern states. Hydropower potential is distributed throughout the country, but the Amazon area has most of the untapped resources. In terms of biofuel, the states of Rio Grande do Sul,

53 Polito, R. (2013) Inova Energia recebe R$ 12,3 bi em projetos. Valor Econômico 8 May. http://www.valor.com.br/brasil/3115096/inova-energia-recebe-r-123-bi-em-projetos, (accessed 20 May, 2013). 54 Soares, P. (2010) Espaço para centros de pesquisa do pré-sal se esgota no Rio. Folha de São Paulo 14 June. http://www1.folha.uol.com.br/mercado/929930-espaco-para-centros-de-pesquisa-do-pre-sal-se-esgota-no- rio.shtml, (accessed 18 July, 2011). 55 BNDES (The Brazilian Development Bank) (2013), The BNDES and the Sugar-Ethanol Industry in 2012: Innovation as a Priority, Sectorial Report, BNDES, Rio de Janeiro.

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Goiás, Mato Grosso and São Paulo are responsible for about 82 per cent of total biodiesel production.56 The state of São Paulo is also the largest producer of ethanol. Energy consumption is highest in the industrialized South and Southeast regions, with the state of São Paulo alone accounting for 30 per cent of total demand. Similarly, there are considerable differences between the regions in the use of and access to different energy sources.57 At the same time, Brazil’s interconnected national grid (SIN) covers 95–97 per cent of the population, and allows for a more flexible electricity system. Given the regional differences outlined above, it is not surprising that, although most energy policies are set by central government, the role of different energy sources across the country will vary, depending on their availability, as well as consumption patterns.

Energy Efficiency As mentioned earlier, Brazil has a large potential for energy efficiency gains. There is significant scope for savings within the energy sector itself (particularly with regards to transmission and distribution losses), but also within the building, residential and most importantly in the transport sector. The possibilities for improving efficiency have already been identified by both the industry and the government. However the challenge lies in coordinating efforts and creating an institutional framework that will facilitate and enforce implementation of much-needed change. The current system does not clearly assign responsibilities, and good practice examples tend to be the result of intermittent efforts.

Brazil Cost “Custo Brasil” (Brazil cost) is a term often used to refer to structural problems that lead to increased operational costs associated with doing business in the country, making Brazilian goods and services more expensive compared to other countries. Among the factors that contribute to this increased cost are: high tax burden (tax revenues equivalent to 36 per cent of GDP), excessive bureaucracy, inefficiency in public services, corruption, high interest rates, expensive labour costs, scarcity of well-educated workers, which is also linked to low productivity, high electricity cost and an underdeveloped infrastructure, including a deteriorated network for domestic shipping by rail, highway and navigation.58 59 The Brazil Cost has implications for the energy sector, and is one of the reasons for recent difficulties in attracting external investors, not least in the development of new energy related infrastructure.

56 Mato Grosso e outros três estados concentram produção de biodiesel. O Globo. 9 Abril 2012. http://g1.globo.com/mato-grosso/noticia/2012/04/mato-grosso-e-outros-tres-estados-concentram-producao-de- biodiesel.html (Accessed 2013-12-01) 57 Empresa de Pesquisa Energetica (2012) Anuario Estatistico de Energia Eletrica 2012. EPE/MME, Rio de Janeiro 58 Sobral L (2013). Custo Brasil encarece em até 30% produtos no país. Revista Exame 11 June 2013. http://exame.abril.com.br/economia/noticias/custo-brasil-encarece-em-ate-30-produtos-no-pais (Accessed 2013-11-28) 59 The Economist (September 2013) The price is wrong: Why Brazil offers appalling value for money. http://www.economist.com/news/special-report/21586678-why-brazil-offers-appalling-value-money-price- wrong (Accessed 2012-11-24)

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The Energy Sector in Brazil is facing interesting crossroads, with many challenges and opportunities opening up. Decision-makers seem to be aware of the important decisions that need to be taken to promote a more sustainable, affordable and secure energy system, but only time will tell if the rhetoric and implementation walk hand in hand to deliver on the proposed goals.

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8 References

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http://www.growthanalysis.se/sv/publikationer/svar-direkt/svar-direkt/2013-10-31- energy-in-brazil---r-esources-trade-off-and-strategies-for-the-future.html (accessed 2013-11-17) Taufer, P (2013) Reservatórios das hidrelétricas estão no nível mais baixo desde 2001. O Globo 3 May. http://g1.globo.com/jornal-da-globo/noticia/2013/05/reservatorios- das-hidreletricas-estao-no-nivel-mais-baixo-desde-2001.html, (Accessed 4 June, 2013). The Economist (2013). The price is wrong: Why Brazil offers appalling value for money. 28 September . http://www.economist.com/news/special-report/21586678-why- brazil-offers-appalling-value-money-price-wrong (Accessed 2012-11-24) The Economist (September 2013) The price is wrong: Why Brazil offers appalling value for money. http://www.economist.com/news/special-report/21586678-why-brazil- offers-appalling-value-money-price-wrong (Accessed 2012-11-24) United Nations Development Programme (2004) World Energy Assessment: Overview 2004 Update. UNDP, New York, NY. pp. 28f. Valor Setorial (2013) Intra-estrutura Urbana (June 2013). http://www.revistavalor.com.br/home.aspx?pub=6&edicao=5 (Accessed 2013-11- 15) Villaverde, J (2012) Concessionária de energia só terá contrato renovado se aceitar investir mais de R$ 20 bi. O Estado de São Paulo 10 September. http://economia.estadao.com.br/noticias/economia,concessionaria-de-energia-so- tera-contrato-renovado-se-aceitar-investir-mais-de-r-20-bi,126138,0.htm (Accessed 2013-12-01).

Interviewees

Roberto Schaeffer - Professor in energy planning at COPPE-UFRJ. (13 November 2013) Gesmar Rosa dos Santos – IPEA: Técnico de Planejamento e Pesquisa da Diretoria de Estudos e Políticas Setoriais de Inovação, Regulação e Infraestrutura (Diset). (11 November 2013)

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