Brazil’s electricity & gas markets
CEMIG CFO on "the development of the emerging Brazilian power and gas markets, and his company’s future plans" Original headline: Ripe for change
Source: Energy Risk
Author: Gillian Carr
Source: Energy Risk | 09 Jul 2012
Categories: Energy Risk Management
Topics: Brazil, Electricity, Gas
In this exclusive interview, the chief finance officer of Brazilian utility Cemig, Luiz Fernando Rolla, speaks with Gillian Carr about the development of the emerging Brazilian power and gas markets, and his company’s future plans
While Europe and the US continue to endure an economic downturn, in contrast the Brazilian economy is forecast to grow 3% in 2012 and 4.1% in 2013, according to the International Monetary Fund’s country outlook. And with its industries continuing to expand, demand for electricity is expected to increase 52% to 633 terawatt hours (TWh) from 415 TWh by 2022. As Brazil currently has the third-highest electricity prices in the world, there is a pressing need for more infrastructure and better management of hydroelectric volatility.
Cemig is the largest vertically integrated utility in Brazil, with operations in 23 states, which span the entire electricity sector from power generation to transmission and distribution. The majority of its distribution is in the consumption-heavy southeastern states of Minas Gerais, Rio de Janeiro, São Paulo and Espírito Santo. Within the states Cemig operates in, its energy mix is 98% hydro, and across the entire country it owns hydro power plants and wind farms and is beginning to build a natural gas distribution business as well. It has 7,000 megawatts (MW) of capacity, 10,000km of transmission lines and 500,000km of distribution lines. Cemig has 7% of the total Brazilian electricity market with 25% market share in the unregulated market, which is where energy-intensive users are able to buy electricity from any supplier.
Q. How do you conduct most of your electricity trading in the wholesale market?
A. We are possibly the largest trader of power in Brazil. We have a very large client base and those clients are long-term focused industries – we are talking about steel mills, aluminium smelters, chemical companies – energy-intensive companies and, of course, they grow their business over time. We sign contracts with those clients for the long run and commit ourselves to provide more power to them as long as they need it. Usually those contracts are for 10 years but some are 20 years long. But that depends on the client. The contracts are tailor-made and bilateral.
Q. How is the pricing determined for Brazilian power?
A. The Brazilian market is very specific because 80% of the power is hydro and the price is regulated in a different way [from other types of generation]. In Brazil we have a national operator of the systems, in the same way as the UK has National Grid, which dispatches the power through the transmission grid. This transmission grid is accessible to any large client. They can buy electricity from, for instance, power plants that are built in the northern area and [power producers] bring the power to the consumption centre in the southeast. So it is a very competitive environment. Today 100% of our 7,000MW of capacity is sold out, and we buy around 1,000–1,500MW of additional capacity to supply those clients.
Q. What are your strategies for purchasing that additional power?
A. In general we go to traders and project developers. For instance, when we have a wind farm project that comes online, these kind of energy resources are subsidised so the final price is very competitive, so we buy electricity from those suppliers or generators, which we then sell to our clients. There is no big difficulty in doing that because currently we have excess capacity so that drives down the price and makes it easy to supply the clients.
Q. Because there’s excess capacity at the moment, do you ever use hedging programmes for any of your generation or supply needs? Do you lock in prices?
A. Our prices are negotiated bilaterally on that basis and we adjust the price sometimes. We have many kinds of contracts but the most usual is to set the price at the moment you sign the contract and establish the means to adjust the price against inflation using an indicator – usually an inflation indicator – but that will depend on the client. Some clients peg the energy contract to other commodity prices.
Energy trading is not really that risky in Brazil because we have a centralised operation, with the dispatch of the power plants done by the national operator and it provides a kind of hydrological risk management. But hydro power plants’ output is very volatile, depending on the time of the year – reservoirs provide some stability to the output but the fact is, given the big impact on the environment, new reservoirs have not been built and so volatility of the output has been high and then you have to provide some compensation for that.
Q. What kind of risk management is done for hydro volatility in the market? Do prices shift a lot because of this?
A. This year was very volatile. We started with $16 per megawatt hour (MWh) and today it is an average of $180 per MWh, a jump of more than 10 times. The reason for that is, as I mentioned, we are not building reservoirs, so existing reservoirs, which in the past were able to supply the market for five years, today are able to supply for only two years. This increases the volatility, which will become even more intense because next year it will be just one year’s supply due to growing demand.
So we need more diversity and the national operator is therefore targeting thermal generation. As Brazil has only recently found gas and oil deposits, we do not have a high percentage coming from the thermal power plants. We have to increase this percentage and there is a plan for the next 10 years to build those thermal power plants in order to achieve a level that will provide reliability to the hydro output.
Today, water accumulates in the reservoirs, but the power produced is a random output because you cannot control the flow of water to the reservoir. But if you replace reservoirs with thermal plants you can control the output.
And we are investing as well in wind farms, which are very complementary to the hydro output because the wind comes in the dry season, exactly when we need more supply.
Q. Will there be another attempt made to put contracts on an exchange or is it not likely to happen?
A. We’d have to change the regulation in order to have some contracts trading because power-purchase contracts are very specific, with certain contracts based on consumption. Sometimes they consume more electricity, sometimes they consume less, and these variable consumption levels prevent us from establishing a standard contract.
Q. Does this make the market more difficult to trade in? Is it relatively transparent and is it easy to find counterparties?
A. The power contracts should be very simple to negotiate but because we are hydro based, it brings a lot of difficulties to the negotiation because the regulation is a lot more complex. Generation throughout the year looks like a parabola. Technically you are allowed to sell to clients only a certain amount of power throughout the year, because during the dry season you have only so much to sell. However, in other times during the year, you have excess capacity and this drives down the price, which only starts growing again when you have the dry season.
Q. How are Cemig’s plans to develop its natural gas business coming along?
A. The consumption of power in Brazil is concentrated in the southeast region but the potential for hydro [generation] is in the north region so you’d have to build transmission lines to reach this region. Of course to build these transmission lines, we are talking 2,000km or 3,000km of lines and that’s pretty high, so the thermal power plants became a little bit more competitive.
At the moment, it’s not that competitive because the natural gas price in Brazil is pretty high. We just have one government player – Petrobras – which establishes the price. The reliability of the supply is very controversial as well because Petrobras uses the gas for its own projects and sometimes it needs to pump the gas to get more oil and then it suspends the supply of natural gas to the industry and companies.
So it is very unpredictable, and that prevents the development of these industries. But recently we’ve had some onshore natural gas findings in the southeast, which is a lot more beneficial because that is exactly in the consumption centre.
We believe that the natural gas industry in Brazil is going to develop quickly and strongly and then, of course, the price will become more competitive because we are talking about a supply that will already be in the region where consumption is. It’s shale gas and we have great hopes because we are looking at the US’s example. In 10 years they developed a huge deposit of shale gas and drew down the price very sharply. I was watching the prices there and natural gas was about $2.50 per 1,000 cubic feet. In Brazil it’s $12 now. So at that price, electricity could be produced at $100 per MWh, approximately the cost of producing through hydro power plants or wind farms, so it would be very competitive for the Brazilian economy and that of course will foster additional economic growth.
Q. How do you see these markets developing over the next couple of years as more natural gas comes into the market?
A. Brazil needs 5,000MW of new capacity every year and the vast majority today comes from hydro. But with the additional natural gas supply, we believe the percentage can change to a 50–50 split and for sure it will be a lot more efficient for Brazil.
Q. Do you see a futures or derivatives market developing as well?
A. It’s a baby industry here, we have to design everything, we have to create the mechanisms, the instruments, the tools in order to have the mature market that you have in Europe or the US. We are in the very early stages here. |
