Legal and Regulatory Framework for the Brazilian Energy Industry Industry Overview Expansion Planning and Auctions, Taxes and Levies, and MP 579 Claudio Sales Sep/28/2012 Industry Overview Industry Evolution Opportunities Challenges 2 Brazilian Energy Industry Timeline • Development of • Industry • Creation of • Interruption of • Foundation the new reforms Aneel the review, thermal regulatory begin (Regulatory privatization and natural gas Agency) program framework plants • Rationing 1993 1995 1996 1998 2000 2001 2003 2004 • Privatization • Creation of ONS • Approval of the new program launch (National System regulatory framework Operator) (Act No. 10.848) • First energy auction under the new rules: Existing Energy • Creation of EPE (Energy Research Company) 3 Brazilian Energy Industry Timeline (cont.) 2005 2007 2008 2010 2011 2012 • First “New Energy” Auction • 3rd Periodical Distributor Charges Review Cycle • Congressional Probe for • 2nd “Structural Site” Privatizations Auction: Jirau HP • Shortage of Natural Gas for Auction Thermal Plants on Auction (Petrobras Case) • High Risk of Rationing > New Short-Term • 1st “Alternative Sources” Operations Procedure Auction (PCHs and • Definitions for Concession Biomass) Renewals • 1st “Structural Site” • Paradigm Change?: Reduced Auction: Santo Antônio Industry Tax Burden HP Auction • 3rd “Structural Site”: Belo Monte HP Auction • TJLP (Long-Term Interest • 2nd Distributor Charges Rate) at a level under 6% Cycle • Institutional Attacks on the Regulatory Agency 4 Brazilian Energy Industry Value Chain • Low imminent risk of • Delayed transmission • 3rd Cycle of Charge rationing: supply- projects affect Reviews (EBITA and demand balance generation projects EVA reduction) • Socio-environmental • Socio-environmental • Permanent risk of challenges to capacity challenges to capacity political use expansion expansion • Possible consolidation • Movement for auction • First Cycle of Charge and/or restructuring rule changes (regional, Reviews begins in 2013 moves involving by source) embattled distribution companies Concession Renewals 5 EVA and other performance indicators EVA® is an appropriate indicator to evaluate the performance of infrastructure projects beccause it takes account of the opportunity cost of all production factors Source: Stern Stewart Co. / Instituto Acende Brasil. Sample: Coelce, Cosern, CFLCL, Coelba-Neoenergia, Celpe, Caiua-Rede, CPFL Paulista, CPFL RGE, CPFL Piratininga, Ampla, Enersul, Escelsa, Bandeirante, CPEE-CMS (until 2000), Eletropaulo, AES Tietê, AES Sul, Light, Cemar, Elektro, Tractebel and Duke. 6 ...but prospects pose a challenge ANEEL's chose methodology for the Third Charge Reviews Cycle reduces distribution companies' margins and assumes high productivity gains, which translates into a more challenging environment for distribution companies in the coming years. The terms and conditions of renewal -particularly as concerns the definition of the reversal worth of non-amortized assets – threatens the return on past investments. 7 The Brazilian Economy Brazil vis-à-vis Other Economies Predicted Growth, G6 and BRICs Investment Risk Index - BRICs In less than 40 years, the BRICs’ economy will GDP overtake G6’s Brazil (US$ BN Brazil 29 2003) 2040: the Russia 40 2050: the BRICs BRICs’ should economy will overtake G6 equal half of India 38 G6’s China 42 best Kurtzman Opacity Index worst The Kurtzman Opacity Index measures the investment risk associated with lack of transparency, corruption, legal framework, economic policy, governmental and accounting Source: Goldman Sachs, 2003 practices and regulatory framework. Source: Goldman Sachs, IMF, May 2007 8 Opportunity Predicted average consumption growth for electricity is at around 4% annually for the next 20 years. By 2030, the electrical system will have to more than double. 140.000 Predicted electricity consumption 119.521 120.000 * avg) avg) 100.000 - 83.345 80.000 64,840 MW-avg 66.347 60.000 54.680 Consumption(MW 40.000 20.000 0 2011 2015 2020 2030 Source: EPE – 2011-202 Ten-year Energy Plan and 2030 National Energy Plan. *Scenario B1 – “surfing the wavelet” of PEN 2030 9 Predicted Energy Matrix The contribution from the various sources to the electricity generated will undergo the following changes: . The share of hydro plants should drop; . The share of thermal plants in generation should increase; . The share of renewable sources (such as biomass and wind farms) should also increase by 2020. Energy Matrix 2009 (MW-avg) Energy Matrix 2020 (MW-avg) Hydro 84% Thermal 7% Wind 0% Biomass Nuclear 3% 5% Other 1% Source: EPE – 2010 National Energy Balance-sheet, 2011-2020 Ten-year Energy Plan. 10 Environmental and social issues Hydro potential from the various basins (MW) A large portion of the economically viable hydro potential lies distant from the load centers Native Reservations and Conservation Areas Source: Aneel (2002) Atlas de Energia Elétrica do Brasil. Source: MMA (2005) 11 Socio-environmental Challenges • There have been gains in some processes on the Federal level, but... Environmental Licensing • Delays and difficulties persist, particularly on the State level. • The socio-economic data bank has been regulated, but... Environmental Costs • “Social offsets” for municipalities and abusive conditions in the licensing process persist • The industry is still frequently affected by actions from the Public Prosecution, mainly in connection with new generation developments Pressure Groups Interference • Invasions led by “social movements” • The Native Peoples issue becomes increasingly relevant 12 GHG Emissions in the Brazilian Energy Industry In recent years, more than half the added capacity came from thermal Greenhouse Gases (GHG)- emitting plants. New plant capacity contracted in the latest energy auctions 3.500 3.000 2.500 2.000 [MW] 1.500 0% 0% 95% 1.000 66% 69% 500 100% 100% 0 34% 43% Auction I Auction II Auction III Auction IV Auction V Sto. Jirau Auction VI Auction VII Antonio Auction Auction Oil/Diesel Natural Gas Coal Sugar-cane Bagasse PCH Hydro Source: MME, CCEE, 2007 13 GHG Emissions by Industry Notwithstanding... GHG emissions should not hamper the installation of new thermal plants, as their share of Brazilian emissions is small. CO2 emissions by industry (%) Electricity generation . Represents a mere 1.2% of emissions in Brazil and . Emissions are just 94 tCO2e/GWh, against a world average of 580 tCO2e/GWh. Deforestation answers for 79.6% of GHG emissions Source: MCT (2004) National Inventory of GHG Emissions. McKinsey (2009). Pathways to a Low-Carbon Economy. 14 Expansion Planning and Auctions Challenge Diagnosis Improvements 15 Planning Challenges Required Periods Inventory Identifying the available energy resources 2 years Studies Resources inventory Defining optimum use Feasibility 1,5 year Ascertaining economic, social and environmental feasibility Study To illustrate, the inclusion of hydro plants requires a planning Pre-licensing 1 year horizon of at least ten years to enable timely entry. Bidding 0,5 year Process Basic Design 0,7 year Installation 0,2 year License Construction 4 years Operating 0,1 year License Total: 10 years 16 Planning Challenges Sizing Expansion Planning Estimating future demand for energy and power risk of risk of Defining investments to be made idleness shortage Expansion Decision Expansion planning dilemmas DECISION DEMAND OUTCOME If the system is oversized, unnecessary costs with high appropriate service idle capacity will be incurred invest If the system is undersized, rationing costs will ensue low idleness high rationing hold low appropriate service 17 Planning Challenges Operational Procedures Reliability Criterion Setting criteria for defining the Physical Assurance of better use of mitigated risk of energy assigned to each site, which, in turn, depends resources shortage on operational procedures Operational Procedure: Security Criterion Operation planning dilemmas DECISION AFFLUENCE OUTCOME If the system is operated in a bolder manner, with humid appropriate service greater use of the more economical energy assets, the risk of shortage increases deplete If the system is operated more conservatively, dry rationing preserving energy assets for future use, the cost of generation rises humid outflow Currently, the security criteria used for planning differ do not deplete from those used in operations, which distorts dry appropriate service planning. 18 Planning Challenges Configuration Identifying system issues that must be addressed, such as reserve capacity, modulation, seasonality, operational flexibility, structural imbalances among Sub-markets Determining the expansion of interconnections among Basic Transmission Network sub-systems Structural imbalance between supply and demand in each Sub-market The Brazilian Electrical System has growing needs that reduce reliability and hamper minimizing the operational cost. The auctions system must be improved to take account of such additional important attributes (i.e. location, operational flexibility, modulation capacity, etc). Source: CCEE. Prepared by: Instituto Acende Brasil. 19 Energy Industry Taxes and Levies Charge evolution Charge composition Implemented reductions Proposals 20 Electricity burden composition Taxes and levies already represent 45% of power bills Source: Aneel, PricewaterhouseCoopers and Instituto Acende Brasil(2010) 21 The power industry as a source of tax revenues In recent decades, the tax burden on the power industry has increased continuously, whether as a result of rising tax