Looking Beyond the Energy Crisis: Scenarios for a Renewed Brazilian Electric Power Sector Washington, March 2002 Pedro Parente Minister of the Presidency Acting Minister of Mines and Energy Head of the Energy Crisis Committee

OUTLINE  The Brazilian electric sector  Introduction  The electric sector model  2001 crisis - Origins and management  Revitalization of the model for the electric sector  Crucial questions  Were the lessons learned?

Introduction to the Brazilian Electric Sector

 Large capacity dams, in 7 basins with different hydrologic regimes different hydrologic regimes  Generations in the different basins are linked through huge basins are linked through huge transmission lines, in some transmission lines, in some cases longer than 1,000 km cases longer than 1,000 km  There are 91 hydroelectric plants and more than 69,000 Km of transmission more than 69,000 Km of transmission lines lines  One of the world’s largest inter-linked systems systems Electric sector characteristics I N T E R L I G A Ç Ã O N O R T E - S U L HIGH DEPENDENCE ON HYDROLOGY Assured Energy (2001)*: 364,000,000 MWh

Current total generation capacity of the inter-linked system is 74,000 MW, for an demand at the peaks of: before during after rationing rationing rationing 56,000 MW 44,000 MW 48,000 MW Total Generation Capacity

Hydroelectric Conventional thermal Nuclear thermal Wind/Small hydros Total Capacity Itaipu (Paraguay) Imports Total Supply Inter-linked system - Installed capacity (MW) 61,555 6,944 1,966 2,345 72,810 5,500 1,150 79, ,448 17,024* 1,966 5,645 94,083 6,200 3, , (%) 2004(e) (%) * Including emergency thermals (e)=estimate

69,510 67,048 63,971 63,110 61,571 62, % 4.59% 1.47% 1.35% 0.99% 56,000 58,000 60,000 62,000 64,000 66,000 68,000 70,000 72, YEAR TRANSMISSION SYSTEM EXTENSION (Km) ENERGY TRANSMISSION SYSTEM Total extension (Km) and annual increase (%)

AVERAGE TARIFFS Generation Distribution R$/MWh US$/MWh

Brazilian Electric Sector Model

BRAZILIAN ELECTRIC SECTOR MODEL BEFORE 1996 Totally public owned Generators owned by the Federal Government Distributors owned by State Governments Model failed in the beginning of the 90’s

BRAZILIAN ELECTRIC SECTOR MODEL THE NEW MODEL Competition in Generation and retailing Regulation in transmission and distribution Based on Private investments Independent regulatory body to ensure adequate balance between utilities and consumers and high quality of services

  Prices in the spot market are based on a computational model: agents don’t make price offers   Prices in the spot market are very volatile   There is almost no free consumers   No external price references for price caps for captive consumers BRAZILIAN ELECTRIC SECTOR MODEL CURRENT INADEQUACIES (1 OF 2)

  Wholesale market not working properly   Calculation of assured energy needs to be revised   Implicit subsidies   Public utilities still account for a large portion of the market BRAZILIAN ELECTRIC SECTOR MODEL CURRENT INADEQUACIES (2 OF 2)

Evolution of the wholesale market prices Southeast/South system 66 Marginal Operation Costs in the SE/S system from January 1993 to August 1997 US$/MWh.

In Brazil, prices in the spot market are not the driver for new supply Long term contracts (PPA’s) are the driver for new supply AS A RESULT: BRAZILIAN ELECTRIC SECTOR MODEL

Origins and management of 2001 crisis

Below average hydrology Delays in investments in plants and transmission lines The model inadequacies Delays in the implementation of the model An ill-suited administrative structure within the government to manage the new model in a totally different environment 2001 CRISIS ORIGINS

Federal Government took immediate responsibility for the crisis. There was no finger pointing within levels of government and/or agencies A “crisis cabinet” was created at the highest government level, with powers commensurate to the task 2001 CRISIS MANAGEMENT

Decisions taken in this cabinet were, in general, final, i.e., did not depend upon other government instances All the lines in the plan of action were implemented. Two out of five were concluded, and the remaining are fully under way 2001 CRISIS MANAGEMENT

1) Program for the reduction of demand 2) Structural program to increase the energy supply 3) Emergency program to increase the energy supply 4) Conservation 5) Revitalization of the model for the electric sector PLAN OF ACTION

Total demand reduction (Rationing period= Jun/2001 to Feb/2002) * For the Northern region, the basis period was not May/Jun/Jul 2000

North: 782,000 MWh (equivalent to Pará (*) state) Northeast: 4,700,000 MWh (equivalent to Bahia state) Southeast and Mid-west: 20,500,000 MWh (equivalent to Minas Gerais state) The load reduction in households was on average 24.4% during the rationing period (*) except electrointensive industry Total energy saved : 26,000,000 MWh Total Saved Energy During Rationing

Load Evolution ( ) ,198 25,848 25,560 23,961 23,112 22,086 21,252 20,096 Southeast/Mid-West averageMW In 2001, the load equalled that of Cumulative GDP growth from 1997 to 2001 was 11.2%. Still, GDP grew 1.5% in 2001.

1) Program for the reduction of demand 2) Program to increase the energy supply 3) Emergency program to increase the energy supply 4) Conservation 5) Revitalization of the model for the electric sector PLAN OF ACTION

POWER PLANTS IN THE STRUCTURAL PROGRAM (MW) 2001* Total HYDROELECTRIC (24)1,3973,0502,4219,990 THERMAL (38)**1,3542,5303,928 11,434 COGENERATION WIND ,050 IMPORTS (5)981, ,386 TOTAL (MW)3,0429,2997,76228,040 TRANSMISSION LINES (18) - Km 5051,3714,3509,250 SUBSTATIONS (8) - MVA 4,347 6,297 INCREASE IN SUPPLY TYPE OF INVESTMENT SMALL HYDROELECTRIC (SHPs) * Actual. ** Considering a non-performance of 20% in the program ,122 3, ,937 3, ,050 EMERGENCY THERMAL (58)-2,153- -

ESTIMATED INVESTMENTS ( ) PrivatePublic Total HYDROELECTRIC (24) 7,8833,35611,239 THERMAL (38)12,3954,371 (*)16,776 IMPORTS (5) 1,317- TRANSMISSION LINES 3,7701,1674,937 OTHER SOURCES (**) 5, ,195 TOTAL % 34,054 78,4 9,374 21,6 43, TYPE OF INVESTMENT (R$ Million) (*) Mostly PETROBRAS in association with private firms. EMERGENCY THERMAL (58)2,974 - (**) Other sources: Cogeneration, eolic, photoelectric and SHPs.

Scheduled bids (2002/2003)*  Transmission lines: 6,250 Km  Feb. through Dec  Estimated investments: R$ 2.8 billion  Hydroelectric Power Plants: 10,978 MW  Estimated investments: R$ 16.5 billion * Source: ANEEL

28 Source: IIRSA SOUTH AMERICA Infrastructure Interconnections BRAZIL Highways Navigation Power: Itaipu Guri (Venezuela) Bolivia-Brazil pipeline Argentina

1) Program for the reduction of demand 2) Program to increase the energy supply 3) Emergency program to increase the energy supply 4) Conservation 5) Revitalization of the model for the electric sector PLAN OF ACTION

DEFINITION OF THE ELECTRIC ENERGY EMERGENCY SUPPLY FOR Estimated demand for 2002/03 Structural Supply Program 2001/03 Assumptions for hydrology Emergency Supply Needs 2002/03

EMERGENCY SUPPLY Guidelines  Additional energy supply, on a temporary basis, to work as an “insurance” for the consumer  A public energy trader (SPC) was set up to buy energy from independent producers

Contracting Emergency Generation: Results  117 proposals (> 4,000 MW)  2,100 MW selected  1,500 MW  NE  600 MW  SE  average price: 290 R$/MWh  100 R$/MWh fixed price  190 R$/MWh variable price

1) Program for the reduction of demand 2) Program to increase the energy supply 3) Emergency program to increase the energy supply 4) Conservation 5) Revitalization of the model for the electric sector PLAN OF ACTION

 Approval of Law Nº 10,295, on the National Policy for Rational Energy Use and Conservation  Assistance Program for Micro-, Small and Medium Companies  Regulatory Decree: Creation of Managing Committee for Indicators and Levels of Energy Efficiency (CGIEE) Conservation

1) Program for the reduction of demand 2) Program to increase the energy supply 3) Emergency program to increase the energy supply 4) Conservation 5) Revitalization of the model for the electric sector PLAN OF ACTION

Revitalization of the model for the electric sector

 Created within the Crisis Cabinet  Mission:  To correct inadequacies and propose improvements to the power sector model.  To preserve the model’s fundamentals Revitalization Committee

General Agreement of the Sector Implementation of measures from 33 proposed themes Resumption of private investments. Free competition in the sector (generation and retail). Proper market functioning. Assurance of reliable energy supply, with mitigated tariff impact Revitalization Committee

  Solved deadlock and avoided paralyzation of announced investments   Avoided financial hardship for generators and distributors alike   Solved controversies related to non-manageable costs (e.g. price of gas)   Mitigated impact on tariffs   Contributed to prevent repetition of events in the future General Agreement (Dec.2001)

Schedule for implementation of measures from the 33 proposed themes  Report with details on the 33 themes released February 1st, 2002  Discussion with agents (1-2 months)  Releasing of each detailed measure for final public discussion (1 month)  Implementation (1-2 months) Total time frame: February to July 2002

A. Resume market operation B. Reinforce market-based mechanisms C. Ensure adequate expansion of supply D. Monitor supply reliability E. Improve interface between market and regulated segments F. Stimulate fair competition G. Realistic tariffs and consumer benefits H. Improve functioning of institutional agents 33 themes divided in 8 areas

Some of the priority measures   Assess the possibility of introducing price offers by agents in the spot market   Improve the price cap (VN) system   Regulate the government-owned generation trading   Establish a system to review the assured energy granted to each hydro plant   Stimulate consumers to become free

Some of the priority measures   Review the distributors limits to self-generation   Proceed with unbundling   Introduce a system of early warnings   Increase the minimum level of long-term contracts by distributors   Improve the economic signals embedded in the tariff structure

Safety Curve ( ): Southeast/Mid-West Average hydrology for the 4th worst two-year periods of the historical time series, equivalent to 68% MLT in 2002 and 67% MLT in 2003 Deliver 100% of demand in two years

Proposal for Government-owned generation  All energy belonging to these companies will be traded through public auctions  Additional dividends earned by the Federal Government will be used to finance emergency plants, natural gas subsidy, etc.  Transparency  Interests of shareholders (both Government and minority shareholders) and consumers are protected

General Consequences of the Proposed Measures  Reinforcement of the model’s fundamentals and market mechanisms  Higher government intervention at the regulatory level, not as entrepreneur  Rights of private investors preserved Stability, transparency and predictability of rules

CRUCIAL QUESTIONS

  Given the special properties of electricity, how to ensure in the long term the right balance between supply and demand? Would a full free market be able to do so?   Will it be possible for Brazil to fully eliminate the bottlenecks in the transmission system? Will it be worthwhile?

CRUCIAL QUESTIONS   Will it be possible in Brazil to introduce a system of price offers by market agents, keeping at the same time the centralized dispatch system?   What is the right balance between market freedom and regulation?   Regardless of the freedom enjoyed by the sector, what level of direct or indirect intervention power should be granted to the government?

WERE THE LESSONS LEARNED?

In a special report as of Sept. 17, 2001, the Wall Street Journal stated that the Californian Crisis “has taught a lot about the do’s and don’ts of deregulation”. Let’s use it to compare to what we have been doing in Brazil. Here the lessons by the WSJ:   “Electricity is no ordinary commodity”   “Don’t leave utilities hanging on in the spot market” WERE THE LESSONS LEARNED?

  “Let consumers feel the pain - or pleasure”   “Be ready for surprises”   “Make sure consumers have choices”   “Have enough generating capacity...”   “... But not too much capacity”   “You have to deliver” (it refers to the need of having a good transmission grid)   “Regulators have to keep up” Wall Street Journal WERE THE LESSONS LEARNED?

Washington, March 2002 Pedro Parente Minister of the Presidency Acting Minister of Mines and Energy Head of the Energy Crisis Committee Looking Beyond the Energy Crisis: Scenarios for a Renewed Brazilian Electric Power Sector