Electric Industry Privatization and Restructuring: Lessons from Brazil

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1 Electric Industry Privatization and Restructuring: Lessons from Brazil New England Chapter International Association for Energy Economics Massachusetts Institute of Technology Cambridge, MA March 27, 2002 Ashley C. Brown Executive Director, Harvard Electricity Policy Group John F. Kennedy School of Government, Harvard University Of Counsel, LeBoeuf, Lamb, Greene & MacRae, LLP 1

2 Overview of Power Sector 65,134 MW Installed Capacity (1998) 95%+ Hydro Need for Thermal Expansion National Ownership of generation and transmission State owns distribution companies Nationalization completed in 1970 s 5% Demand Growth (1999) 2

3 Overview, con t Three Systems: South / South-Central Northeast Isolated Systems Heaviest Load in South / South-Central region Hydro facilities located on only a few rivers 3

4 Overview, con t Many hydro plants are multiple use: Electricity Water / irrigation Navigation Generating resources far from load centers Procel Efficiency Program 4

5 Overview, con t Generating and Transmission Sectors well planned and operated Deteriorated distribution networks High non-technical losses Some vertical integration at State levels 45% Rural Electrification 1 Nuclear unit; 2 others planned 1 Huge Bi-national plant 5

6 Socio/Economic Context Massive Government Debt Real Plan Inflation declining Pressing social needs Skewed demographic and geographic distribution of wealth Partly first world / partly third world 6

7 Motivation For Privatization Macro-Economic Considerations - Primary Government Debt Recover Debts Owed by States to National Government Pressing Social Needs Satisfy Loan Conditions Micro-Economic Considerations - Secondary Improve Performance of Distribution Sector Inability to Raise Capital Needed to Meet Growing Demand 7

8 Goals of Privatization Primary Objective: Maximize Revenues from Sale of Assets Part of Overall Economic liberalization Finance System Expansion 8

9 Sector Considerations Secondary or Tertiary Delayed Creation of Regulatory Structure Delayed Consideration of Market Structure and Rules Inadequate Attention to Need for Promoting Thermal Development 9

10 The Plans Distribution Sector Entirely Privatized (Where BNDES Controlled) Generating Sector Privatized (Where BNDES Controlled) State retention of Transmission + Itaipu and Angra 10

11 Flaws in the Plans Complexity of Unbundling and Privatizing Hydro Generation Water Rights and Priorities of use Upstream/Downstream Issues Asymmetry in Hydro-Thermal Competition High Productivity of the Generation and Transmission Sector Privatization Before Creation of Regulatory and Market Institutions 11

12 Flaws in the Plans, Con t Lack of Balance Between Micro and Macro Economic Considerations Underestimate of Currency Risks Asymmetry Between Fuel Market and Electric Sector Needs Emphasis on Short Term Results Inadequate Consideration of Transition Problems 12

13 Institutional Responsibility For Privatization BNDES Given Main Responsibility Ministry of Mines and Energy Only to Coordinate Sector State Owned Companies Precluded from Obtaining Independent Advice Role of State Governments 13

14 Incentives for Investors Price Caps Without Productivity Expectations General Absence of Social Expectations Mandate Pre-existing Contracts for Generators with Distributors Annex V Throughput Assurances for Distributors 14

15 Course of Privatization Revenues from Sale of Distribution Companies Generally Exceeded Minimum Average Premium over Minimum = 45% Sale of Generators Generally Required Long Term Sales Contracts to Attract Investors State Financing Central to Many Transactions (26% from BNDES alone) Most of Distribution Sector Privatized (17 companies) 15

16 Course of Privatization, Con t Generation Largely Not Privatized (4 companies) Inability to Privatize FURNAS, CHESF, and Eletronorte Inability to Attract Significant Thermal Investment CEMIG Controversy Current Inability to Attract Private Investors (e.g. COPEL, CELG) Increasing Concentration of Private Investors 16

17 Results from Consumer Perspective Shortage of Supply and Rationing Service Quality Problems Prospect of Huge Increases in Rates (33-50% over Next Few Years) No Appreciable Expansion of Service 17

18 Reasons for Consumer Disappointments Drought Failure to Diversify Resource Portfolio Disincentives for Private Investment Perversity of Incentives Lack of Productivity Expectation Inability to Distinguish Between Cost Cutting and Productivity Gains Ex Post Creation of Regulatory Regime Lack of Coherent Market Structure 18

19 Results from Investor Perspective Substantial Financial Losses Assumption of Uncontrollable Risks Fuel Market Currency Fluctuation Artificial Price Constraints (Unlinked to costs) Inability to Enforce Contracts e.g. Annex V 19

20 Results from Investor Perspective, Con t Asymmetrical Market Privatization before Regulation Skewed and Uncertain Market Rules and Conditions Distributors Unwilling to take Long Term Contract Risks in Face of Uncertainty Generators Unwilling to Risk Capital in Absence of Contracts or Market Rules 20

21 Reasons for Investor Disappointment Unreal Expectations Created by Initial Incentives Decline in Value of Real Drought Macro-Economic and Political Concerns Trump Micro-Economic Considerations Inflation Fears Opposition to Any Form of Indexing Unwillingness to Impose New Obligations on State-Owned Companies (e.g. Annex V) Lack of Regulatory Independence Mismatch Between Gas and Electric Markets 21

22 Reasons for Investor Disappointment, Con t Failure to Break Monopoly in Natural Gas Market Imbalance Between Incentives and Regulatory Rules (e.g. Rio Light) Legal Uncertainties Regarding Contracts (e.g. CEMIG) Uncertain Relationship Between License Conditions and Subsequent Regulations Service Quality Standards Expansion of Service Availability Technology Transfer Affiliate Transactions Unknown Market Rules With Full Market Opening in

23 Government Responses to Problems Ad Hoc Socialization of Risks, Not Clarification of Market Socialization of Annex V and Angra II Liabilities (BNDES + Tariff Increases) State Owned Generators Relieved of Obligation Socialization of Fuel Risks Petrobras Assumption of Risk for 12 Month Periods Socialization of Thermal Investment Petrobras as Strategic Investor in Sector 23

24 Government Response to Problems Creation of Crisis Management Chamber (CGC) Mandatory 20% Curtailment of Use & Rationing Disbanding of MAE Strengthen ANEEL s Jurisdiction over Market Design Mandate that 95% of all Generation Output be Sold Long Term Segregation of Old Energy from Thermal Energy Make Dispatch Protocols more Thermal Friendly 24

25 Government Responses to Problems, con t Dispatch Regime changed from Cost Based to Bid Based Reinforce Independence of ONS Subsidize Gas Imports from Bolivia Implementation of LMP Transmission Pricing New Incentive to Promote Use of Renewables Promotion of Rural Electrification 25

Brazilian Power Sector: Lessons from the Past, Challenges Going Forward

Brazilian Power Sector: Lessons from the Past, Challenges Going Forward Johns Hopkins University School of Advanced International Studies Washington, D.C. October 5, 2011 Ashley C. Brown Executive Director,