Navigating the Brazilian Energy Market: Challenges and Opportunities

1. The Brazilian Energy Market Edvaldo A. Santana Superintendent of Market Studies USEA / USAID / ANEEL Energy Partnership Program ANEEL/FERC/MoPSC/UtahPSC Workshop Brasília, August 9th, 2005

2. Outline • The Brazilian Power Industry • The Energy Market • Regulatory Framework • Trading Arrangements • Expansion Planning and Energy Auctions • Emerging Challenges 2

3. The Brazilian Industry • Originally vertically integrated • Limited resources for expansion • Lack of incentives towards efficiency • Extra-large hydro units • Large thermal units • Small hydro units • Green energy • Long transmission links • Hydro domination • Plants in cascade • High demand growth rate • Long-term hydro regularization • Public utilities • Independent power producers • Self-producers • Co-generation • Merchants 3

4. Statistics Hydro 70,884 MW Small hydro (< 30 MW) 1,421MW Thermal 18,806 MW Nuclear 2,007 MW Wind 31 MW Partial 93,149 MW Import (excl. Itaipu) 8,170 MW Emergency thermal 2,050 MW TOTAL 103,369 MW Annual Consumption 350 TWh Consumers 51.2 millions Growth rate ~ 4.5% year Average tariff (2004) R$ 0.1975 / kWh Annual revenue ~ R$ 70 billions Transmission > 138 kV ~ 173,000 km Network > 230 kV ~ 70,000 km

5. The Brazilian Power Systems Isolated Systems installed capacity: 2,810 MW Interconnected System installed capacity: 92,389 MW Import 8,170 MW 5

6. The Brazilian Sub-systems North Cap: 6,466 MW Load: 3,131 MW avg Northeast Cap: 15,646 MW Load: 6,531 MW avg Southeast/ Midwest Cap: 53,163 MW Load: 28,502 MW avg South Cap: 17,144 MW Load: 7,465 MW avg 6

7. International Exchanges 200 MW Venezuela Paraguay 70 MW 2,200 MW • Unlike the NordPool the energy markets are not integrated Argentina Uruguay 72 MW 7

8. The Energy Market • Market of Differences • DISCOs have get into long-term PPAs for 100% of their demand requirements • GENCOs have to demonstrate “selling capacity” • PPAs are registered by the market operator (quantity only) • PPAs are cleared bilaterally @ contracted prices • System operator dispatches generation resources • Market operator calculates spot prices • Generation and consumption mismatches are cleared within the market operator environment @ spot prices 8

9. Regulation @ ANEEL Ruling Monitoring Mediation Inspection and Auditing Regulation Fundamentally a political-economic concept Why Regulate ? Prevent market failures (Monopoly power; Asymmetry of Information; Externalities) 9

10. Generation – SRG Optimisation models for dispatch and pricing; assured energy Regulation at ANEEL • Transmission – SRT • Transmission tariffs; transmission standards • Distribution – SRD • Network distribution tariffs; reliability and quality indexes • Market – SEM • Rules for spot transactions; auctions; market monitoring • Retail trade – SRC • Free consumers; captive x DISCOs affairs; universal access • Economic – SRE • Energy tariffs; system fees 10

11. Regulatory Framework • Market rules and procedures • Agents or CCEE can propose new rules and procedures • ANEEL approves and issues new rules • Transparency reached by public hearings • Arbitrate Chamber • Solves disputes between agents • ANEEL can mediate disputes 11

12. IPP IPP GENCO GENCO Regulated Pool Auctions Single-buyer model Free Market Traders DISCO DISCO Regulated Tariffs Market prices Free Consumers Captive Consumers Captive Consumers Free Consumers Trading Arrangements Long-term market 12

13. Trading Arrangements Spot Market • Bilateral contracts (PPAs) • DISCOs have to contract bilaterally for 100% of their market requirements • PPAs have to be registered/approved by ANEEL • PPAs are registered in CCEE (only quantity) • PPAs are cleared bilaterally • ANEEL oversees “selling capacity” • CAP value to pass on to regulated supply tariffs • Spot market • Energy mismatches (contracted vs. measured) are cleared in the spot market • GENCOs can sell up to 100% of their capacity (merchants) • Traders can buy or sell 13

14. Existing-energy Auctions December 2004 Results: • 1,325 blocks • 17,008 MW avg • Prices (R$/MWh): 57.51(2005) 67.33 (2006) 75.46 (2007) Products: • Blocks of 1 MW avg; • 8-year PPA (starting supply on 2005, 2006 and 2007) 17 GENCOs Selling to 34 DISCOs ~ 900 PPAs 14

15. Existing-energy Auctions April 2005 Results: 1,325 blocks 92,920 GWh R$ 88.13 / MWh R$ 7.7 Billions (8 years) Products: Blocks of 1 MW avg; 8-year PPA (starting supply on 2008) 34 DISCOs 0.43 – 57.24 MW avg 1 GENCO 450 MW avg 34 PPAs for each GENCO 15

16. Market operator: long period of mis-operation (no clearing) ANEEL initial operation Market Operator (self-regulated) Market Agreement 2002 1998 1999 1996 1997 2001 2000 J F M A M J J A S O N D J F M A M J J A S O N D D J F M A M J J A S O N D D J F M A M J J A S O N J F M A M J J A S O N D J F M Market Operator regulation ANEEL creation ANEEL regulation Market Rules Market Operator: monthly clearing – less then 1% defaults Market Operator (regulated by ANEEL) 2002 2003 2004 2005 J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D Partial (50%) clearing of 25 months Final (50%) clearing of 25 months New model for the energy sector Spot Market Evolution 16

17. Average Spot Prices Southeast / Midwest 17

18. Consumers Choice Free Consumers June 2003: 292 GWh per month June 2005: 6,935 GWh per month 18

19. Emerging Challenges • Government • Ensure generation and transmission expansion • Guarantee the reliability and quality of supply • Environmental licensing • ANEEL • Rules and regulations for new-energyauctions • Increase transparency and credibility to attract investments • Financial guarantees for project finance (investment in new capacity) • Market monitoring • Tariffs review 19

20. Generation Expansion Planning Supply adequacy in the long term Emerging Challenges (cont.) New-energy Auctions 20

21. New-Energy Auctions • Complimentary to the generation expansion planning • Single-buyer-like model • DISCOs inform demand requirements • System demand result from aggregating DISCOs´ needs • EPE propose list of candidate projects • Least-cost-based procurement • Winner of the auction will be awarded concessions (or authorization) and PPAs • Scheduled to happen late December 2005 21

22. http://www.aneel.gov.br Telefone: 0800 727 2010 Fax: (61) 3426 5705 institucional@aneel.gov.br 22