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DISCUSSION DOCUMENT. IMPACT OF RATIONING AND MAE INTERVENTION ON ENRON LINES OF BUSINESSES São Paulo, May 10, 2001 For internal use only. OBJECTIVES OF THIS DOCUMENT. I - Present what is happening in the energy sector in Brazil Energy Rationing MAE Intervention
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DISCUSSION DOCUMENT IMPACT OF RATIONING AND MAE INTERVENTION ON ENRON LINES OF BUSINESSES São Paulo, May 10, 2001 For internal use only
OBJECTIVES OF THIS DOCUMENT • I - Present what is happening in the energy sector in Brazil • Energy Rationing • MAE Intervention • II - Discuss Enron’s views and expected impact on our businesses • III - Agree on next steps
I. WHAT IS HAPPENING IN THE ENERGY SECTOR IN BRAZIL?
ENERGY RATIONING • Government has [finally] accepted the need to implement an urgent energy rationing plan • Encompassing 80% of Brazilian market, in the industrial heart of the country • Expected cut: +20% of the load, from June till November; the end of dry season • So far, government has underestimated crisis and adopted cosmetic measures • Experts anticipated the crisis in late 1999 - reservoirs being depleted at fast pace • Government did not address new generators’ concerns on regulatory risks • Finance Ministry officials - we “would rather have rationing than to allow the pass-through of dollar denominated generation costs” • How to implement the 20% cut? Still being debated. Initial idea was to establish quotas per customer groups, with penalties for non-compliance • Serious doubts have been cast on the feasibility of the quota system • Legal basis for the penalties • No time for D/Rs to get prepared - systems, quota setting, customer handling • Very likely, a rolling black-out system ala California • Final decisions to be made on May 23; to be effective June 01 !
MAE INTERVENTION • ANEEL has recently issued a series of Resolution significantly changing the governance and structure of MAE, the Wholesale Market • Eliminated COEX - replaced by COMAE, a 6 member independent Board • Established a solid hierarchical relationship between ASMAE and ANEEL • Set penalties and guarantees [yet limited] • A 60 day transitional period - in the meantime, ANEEL in the driver’s seat • Within 30 days, ANEEL to publish new guidelines for the Market Agreement • Actions perceived as a “coup-de-etat”, by most stakeholders • An “intervention”, defeating the purpose of a free wholesale market • Several agents challenging the legality of the intervention • Enron’s view • Badly needed, MAE never worked - but weak on legal grounds • We have publicly raised concerns about MAE governance system
II - ENRON’S VIEWS AND EXPECTED IMPACT ON OUR BUSINESSES
IN A NUTSHELL • Energy rationing and MAE intervention are bringing a lot of anxiety • Uncertainties on the direction of change • How will it impact our businesses? • In the medium run, will it kill the market? • We have been very attentive to those changes - and lobbying to preserve some key institutions such as MAE, contracts, free spot prices, competition, etc. • Elektro and Eletrobolt are the ones which entail more risks and opportunities • Elektro • Lost sales and revenues; also liability issues before the final customer • On the other hand, great opportunity to sell our long positions on the spot • Eletrobolt • Risk of a non-functioning market or intervention in the spot prices • On the other hand, a significant upside with spot prices skyrocketing • A relatively comfortable position given agreement with Petrobrás THE FOLLOWING PAGE SUMMARIZES THE EXPECTED IMPACT ON EACH ONE OF OUR BUSINESSES
WHAT ARE WE DOING ABOUT IT? • Enron has been active and outspoken • Crisis should not be an excuse for challenging contract sanctity (including pass-through issues) and for delaying competition • A well functioning MAE is key to to bring more capacity on line and mitigate the impact of rationing • So far, ANEEL/MME have not violated any of the basic market principles • We have supported ANEEL in the “intervention” of the MAE • Aknowledging that it was badly necessary • Providing valuable technical and legal inputs to ANEEL on how to get a good new Market Agreement in place • Leading coalition groups to support the overall effort and not challenge ANEEL on legal grounds • We have been active in helping the government in the design of the rationing process • Finding the best trade-off between the technical and the operational aspects • To mitigate potential exposures on Elektro
FOLLOW UP ISSUES • On Rationing • Following up the subject closely • Getting Elektro prepared for either scenario - quotas or black-outs • Keeping a close eye on Elektro’s financials - knowing exactly what we should lobby for • So far, a functioning market and maintaining Initial Contracts is key • The distribution coalition group has advocated for a rolling black-out - no more time to implement quotas as originally designed • On MAE intervention • Continued support to ANEEL - contingent upon the fact that intervention was meant to help, not to destroy the market • Drafting a new MAE agreement and leading this discussion among our coalition groups • Approach ANEEL on an individual basis to provide our detailed contributions WE WILL KEEP YOU POSTED AS THOSE PROCESSES EVOLVE
I - ENERGY RATIONING - What is the situation? - What are we doing about it? - Follow up issues
WHAT IS THE SITUATION? • Government publicly admitted that “Rationalization Plan” has not worked, and the situation is now serious (“like a war”) • Good response on supply side (several incremental MW) • But no response at all from demand • More drastic [tentative] plan jointly announced by ANEEL/MME • At least 20% D reduction, by quotas by customer group • Huge penalties for customer’s not achieving their individual quotas • Effective June 01 - quotas to be reviewed quarterly • Immediate Reactions • On legal grounds - no basis for penalizing customers • ABRADEE, CBIEE - too complex a system, no time; start with rolling black-outs • ABRACEEL - attach to MAE price (cost, not penalty) and give proceeds to D/Cs • A lot of confusion • Quotas, rolling black-outs? • Penalties, incentives, both? • To be decided by the National Council of Energy Policy on May 23
WHAT ARE WE DOING ABOUT IT? • Enron/Elektro - the first ones to express our views • Contract sanctity (including pass-through), a functioning MAE • Right economic signals to bring more capacity • “Rationalization” plan will not suffice • So far, ANEEL/MME not violating any of the basic market principles • Divergent views in the market • ABRADEE - quotas will not work, go straight to rolling black-outs • ABRACEEL - quotas fine, but MAE signals • In parallel, we are finalizing Enron’s views on Public Hearing 02/2001 - “Cost of Deficit • Praise for the goal - it does need to be increased • Go straight to R$ +2300/MWh (instead of R$ 684/MWh) • It will set a cap on spot price during rationing
FOLLOW UP ISSUES • Follow up decisions by CNPE on May 23 • In the meantime, a flexible plan for Elektro • Be prepared either to rationing or quotas • War strategy - plan & resource requirements to handle either (or both) situations • Continually examine our financials; in particular how the bonus and penalty systems are supposed to be implemented • Act promptly if bonus/penalty system impair our financials • Keep on lobbying for contract sanctity (Annex V) and a functioning MAE, where we can sell our long positions
I - MAE INTERVENTION - What is the situation? - Potential impact our businesses - What are we doing about it? - Follow up issues
WHAT IS THE SITUATION? • ANEEL has recently issued a series of Resolution significantly changing the governance and structure of MAE • Eliminated COEX - replaced by COMAE, a 6 member professional Board • Solid hierarchical relationship with ASMAE • Established penalties and guarantees [still limited] • A 60 day transitional period - in the meantime, ANEEL in the driver’s seat • Within 30 days - ANEEL to publish new guidelines for the Market Agreement • Actions perceived as a “coup-de-etat”, by most stakeholders • An “intervention”, defeating the purpose of a wholesale market • Initial adverse reactions from COEX and General Assembly • Several agents challenging the legality of the intervention • Part of the anxiety mitigated after ANEEL invited all CEOs to explain rationale
POTENTIAL IMPACT ON OUR BUSINESSES DURING RATIONING (DIRECTIONALLY) • The Wholesale Energy Market has never functioned properly • Delays and procrastination in implementation • Partial, discriminatory rules (e.g. loss sharing) • Delinquency, aggravated by the Angra II case • A flawed governance system, based on a stakeholder board • The intervention brought new expectations to have a real, functioning market • Where one can register contracts, buy and sell energy • Where Eletrobolt may sell on a merchant basis (and collect money) • In a broad sense, the actions were positive to all of our businesses - particularly due to Enron’s long position
DESPITE THE PROS, ANEEL MEASURES ENTAIL SOME RISKS • An intervention is always an intervention, not a good precedent • ANEEL is now in the driver’s seat • Via ASMAE • Appointing 2 of the 6 voting members of COMAE • Is ANEEL going to use its power for further interfering in the market? Or being forced by a Law or Decree to violate its principles? • Setting caps on spot or any action to limit costs to consumers? • Vehicle to implement a political agenda? • Fragile from a legal standpoint - it may be challenged by one or more stakeholder on those ground (until MAE agreement is signed) • Given adverse reaction, are stakeholder going to subscribe to a new Market Agreement within the expected timeframe? • Given those uncertainties, will the intervention defeat its own merits? That is, to expedite the implementation of the MAE
WHAT ARE WE DOING ABOUT IT? • In general terms, we are supporting the idea • In the past, Enron has expressed its view about the poor governance of COEX and the urgent need to have penalties/guarantees (Informativo Regulatorio #3) • We have disseminated the idea that the intervention was indeed a “necessary evil” • In a recent meeting with ANEEL, involving all CEO’s, we proposed (and it was accepted) the idea of “negotiating” a new MAE Agreement • We are now selling the idea, among our coalition peers, that we should move to the next step, that is: • Proposing something that really works. Deadline = May 15 • And negotiating some relevant points with ANEEL • We have examined the Resolution in detail and shared thoughts with our peer companies • But mindset is still confrontational • Not too much effort in getting things done • In the worse case scenario, the current Resolutions as they stand now are still better than the previous status quo
FOLLOW UP ISSUES • Continued discussion with coalition groups - a few important meetings to follow this week • To change the confrontational mindset • To propose sound recommendations to ANEEL • Further thinking on how to make the new governance/structure work - still many lose strings • Should we have/express our own view on the subject? • Assuming coalition groups do not reach an agreement until May 15 • Or, if agreed points or level of detail do not satisfy our needs
III - INTERACTIONS BETWEEN THE TWO ISSUES - RATIONING AND THE MAE • In principle, those are separate issues • But they share some synergies - good and bad ones • Good ones - the need to attract additional capacity has forced ANEEL to intervene in the MAE trying to make it work • Bad ones - rationing may create significant exposures in the MAE - which in turn may encourage regulators to modify rules, set caps on spot, limit pass-through and other political actions, harmful to competition and to our long positions • So far, ANEEL has been quite consistent with our “principles”, or respecting contracts, making MAE work, let spot prices move freely • However, no one knows for how long • Lobby from agents with short positions is already a reality • Temptation and lobby to interfere in the spot price is ever present • Buzzword - “during rationing there should not be big winners or losers” always has political appeal