1. Regulatory challenges for Smart Grid developments in Brazil Rafael Ferreira 1 ISGT 2012 Washington DC January 2012 Contact : ferreira@psr-inc.com ferreira@psr-inc.com www.psr-inc.com

2. The Brazilian power system Clean electricity matrix. 2 Fast growing total consumption (app. 5%/year); comparably low per capita consumption, also growing. Dimensions: 116 GW (installed), 68.7∙10 6 consumers.

3. Main drivers for Smart Grid in Brazil 3 Reduction of non-technical losses: – Currently ranges from 2% to 30% of total consumption, depending on distco. Improvements in service quality and reliability: – SAIDI ranges from 0.6 h/year to >28h/year, depending on distco and region. Reduction of electricity costs to end-consumers.

4. Smart Grids and Brazilian Legislation 4 Possible supporting points for Smart Grid development in Brazilian legislation: – Law #8,987/1995 (Concessions for Public Services): Adequate service is that in accordance with: “regularity, continuity, efficiency, safety, modernity, generality, courtesy in service supply, tariff moderateness”. – Law #9,984/1994 (Energy Policy): Among the general, fundamental objectives of the Brazilian Energy Policy, there are: ▪ Protection of consumers’ interests with respect to price, quality and amount of supplied products; ▪ Protection of the environment; energy conservation.

5. Smart Grids and Brazilian Regulation 5 ANEEL, the Brazilian Electricity Regulatory Agency, has been active in supporting the development of the Smart Grid: – Public Hearings and/or Regulatory Impact Studies on: Smart Metering (technical specifications); Time of Use Tariffs (both inter-monthly and intra-weekly price signals); Mechanisms for facilitating the penetration of Distributed Generation at the end-consumer’s side (including net metering). – Regulation on Power Line Communication has been issued (REN 275/2009). – ToU Tariffs have been recently approved and were incorporated to the new distribution system tariff structure. – ANEEL has been active in supporting Smart Grid-related R&D and pilot projects.

6. Smart Grids and Brazilian Regulation 6 Yet, making the Brazilian regulatory environment compatible with Smart Grid-related technologies and products is far from being a simple task. The regulation is characterized by a legacy of specific mechanisms that we designed taking into account that: – Due to the high penetration of hydro plants and the adaptability of short-term operation (because of large reservoirs), the bulk of measurements aiming at ensuring system security focused in long-term decisions and in the supply-side of electricity markets; – Naturally monopolistic power distribution activity: no competitors when it came to supplying capacity; assumption of full capability of distribution companies to predicting load behavior – tight regulation aims at emulating competition, ensuring tariff moderateness.

7. Smart Grids and Brazilian Regulation 7 In the following, we present three examples of mechanisms permeated by the principles mentioned above, and discuss possible barriers to the implementation of Smart Grids: – Incentives for distribution companies to accurately predict peak demand in the long-term, in order to support long-term contraction of transmission system usage; – Incentives for distribution companies to accurately predict peak demand in the medium-term, in order to support distribution network capacity expansion (and remuneration); – Incentives for distribution companies to accurately predict energy consumption in the long-term, in order to support long-term energy contracts (if we have time).

8. Distco’s are currently required to project the maximum instant power demand in every interface between the distribution network and the bulk transmission system, for a 4-year horizon. The projections serve as inputs for transmission system expansion. Long-term projections of transmission system usage 8 Transmission expansion

9. The distribution companies are subjected to penalties in case the maximum loading of tie-lines between the distribution system and the transmission network deviates from the projections by more than a pre-defined tolerance band (± 10% ). The projections serve as inputs for transmission system expansion: – Transmission reinforcements that meet these projections are planned and auctioned (Dutch auctions). The auction winner receives a fixed remuneration for the transmission reinforcement (regardless of actual system loading and usage). – The investment risk of the transmission owner is transferred and becomes an operational risk of the distribution company. – The premise that the distribution company is the sole responsible for managing the provision of capacity to its costumers underlies this risk-transfer mechanism. Long-term projections of transmission system usage 9

10. It is generally felt that the width of the tolerance band is ± 10% is too tight, specially in networks with (investor-owned) distributed generation. This situation could be aggravated with a higher penetration of: – Consumer-owned, intermittent generation; – Demand response. The revision of penalties designed taking into account that the distribution company is the exclusively responsible for providing capacity to end-users may be adequate. Long-term projections of transmission system usage 10 σ/μ = 14.8%

11. The inclusion of certain types of distribution system reinforcements to a distco’s regulatory remuneration basis (RRB) currently depends on equipment loading: – On regular time intervals (at the occasion of the multi-annual tariff revisions), the distco’s RRB can be expanded, with the inclusion of new assets to the gross remuneration basis. – The distco’s remuneration for the wires service (availability of power transportation infrastructure) is limited to the assets that are included in the RRB. Only prudent investments result in expansions of the remuneration basis – E.g., the parcel of the investment of a distribution company on a new substation that is included in the RRB is proportional to the substation loading, as measured right before the (multi-annual) tariff revision process. Medium-term projections of peak demand and distribution system loading 11

12. This mechanism aims at incentivizing prudence (efficiency) in investments in new capacity. Higher levels of end-consumer-owned distributed generation may be beneficial to distcos due to opportunities to defer investments in network reinforcements: – New substations built closer to the revision of the RRB generally result in better cash-flows. However, the higher uncertainty in substation loading results in a higher uncertainty in investment remuneration, increasing the investment risk experienced by the distribution company. – There is currently no regulatory mechanism that allows the distribution companies to manage the additional investment risk due to consumer-owned distributed generation. Medium-term projections of peak demand and distribution system loading 12

13. Medium-term projections of peak demand and distribution system loading 13 20% PV penetration 10% PV penetration

14. Long-term projections of energy consumption 14 Bulk of energy consumption of regulated market: contracted via long-term contracts in new energy auctions, held 5 or 3 years before the delivery of energy (A-5 and A-3 auction, respectively). There are strong regulatory incentives for distcos to contract in A-5 auctions. As regulated market accounts for most of the load, generation system expansion is driven by new energy contracts.

15. 15 Distcos have regulatory incentives for efficient contracting and accurate demand forecasts for energy auctions: – E.g., limits for costs of over- and under-contracting passed- through to retail consumers (tolerance band is [100%;103%] of actual energy demand). The 3% tolerance band for passing-through costs of over- contracting energy was calculated without taking into account effects of DR programs. Maintaining the same tolerance band after DR is in force could expose distcos to commercial risks not anticipated during the design of the sectorial model. Long-term projections of energy consumption

16. 16 Long-term projections of energy consumption

17. Conclusions 17 The fundamentals of the Brazilian legislation are compatible with the development of the Smart Grid, and the Brazilian regulator (ANEEL) has been active in supporting this development. Yet, the current regulation has a legacy of specific mechanisms that were designed taking into account some principles that may be altered by Smart Grid-technologies. The effectiveness of broader initiatives that aim at Smart Grid development will be influenced by the ability of different agents of the Brazilian sector to identify and discuss such mechanisms.

18. Conclusions 18 It is imperative that focus is given to: 1.Design of new regulatory solutions to foster the development of new, Smart Grid-related technologies and products, while taking into account specific characteristics of the Brazilian system; 2.Attention to adaptations in legacy regulatory mechanisms, in order to reflect eventual modifications that new, Smart Grid- related technologies might bring to system planning, operating, risk-managing and remuneration processes. Thank you! Any doubts? ferreira@psr-inc.comferreira@psr-inc.com ; priscila@psr-inc.com ; luiz@psr-inc.compriscila@psr-inc.comluiz@psr-inc.com