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Cablegate: Brazil: Latest Energy Auction Further Reduces

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 BRASILIA 001239

SIPDIS

SENSITIVE

NSC FOR RENIGAR, BREIER
TREASURY FOR OASIA - DAS LEE AND FPARODI
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/DDEVITO/DANDERSON/EOL SON
DOE FOR SLADISLAW

E.O. 12958: N/A
TAGS: ENRG EINV ECON PGOV BR
SUBJECT: BRAZIL: LATEST ENERGY AUCTION FURTHER REDUCES
CREDIBILITY OF NEW MODEL

REFS: A) BRASILIA 0040

B) SAO PAULO 0134
C) 03 BRASILIA 3942

1. (SBU) SUMMARY. On April 2, Brazil held its second auction of
long-term contracts to supply electric energy under its new
energy model. The Minister of Mines and Energy once again
hailed the auction of energy to be delivered beginning in 2008
and 2009 as a success because the prices represented what it
believes to be a fair value for the energy, but were still low
for consumers. However, contracts representing only 42% of the
energy demand offered in this round were auctioned, and no
energy contracts beginning in 2009 were signed, although some of
the demand for these years had already been met with contracts
sold in the December 2004 auction. Many industry analysts and
energy producers consider the auction a failure and complained
about the lack of transparency of the process and rules which
appear to artificially depress prices. Although the upcoming
auction for "new" energy projects is considered to be the real
test of the Lula administration's energy model, unless the GOB
reconsiders its auction rules and objectives, the April 2 event
will cast a cloud over the investment climate in the electricity
sector. END SUMMARY.

AUCTION RESULTS
---------------

2. (U) The new energy model was one of the Lula administration's
early priorities (Ref C), and the April 2 auction constituted
the second round of electric energy auctioned under this new
model. (Ref A reports on the first auction.) The April 2
auction included two "products," each of which was an eight-year
contract to supply electric energy beginning in 2008 and 2009.
In total, only 42% of the energy demand placed up for auction
was sold (1,325 megawatts) for R$7.7 billion (US$3.1 billion).
(Note: Because the contracts are for eight years, some of the
contracts signed during the previous auction will meet demand
anticipated for these same years. End Note.) The average price
for contracts beginning in 2008 was R$83.13 MWh (US$33.25), and
no energy for contracts beginning in 2009 was sold.

3. (SBU) Mauricio Tolmasquim, then Executive Secretary (vice-
minister) of the Ministry of Mines and Energy (MME), told
Brasilia EconOffs on April 13 that the goal of the auction was
to achieve "adequate prices." (On April 29, Tolmasquim became
the President of the GOB Energy Research Enterprise (EPE). The
new Executive Secretary is Nelson Huber.) Tolmasquim considered
the results "good" because the prices matched econometric
expectations of a reasonable rate of price increases. In terms
of contracted energy, Tolmasquim said the glass should be seen
as half-full, and claimed that Peru and Chile were interested in
Brazil's energy model. In those terms, the auction was the
success that the MME has claimed: prices across the two auctions
were R$57.71 MWh for 2005, R$67.33 MWh for 2006, R$75.46 MWh for
2007, and R$83.13 MWh for 2008 -- a smooth curve when graphed.
Given the limited amounts sold in this round, however, the
auction itself just barely avoided a total collapse and the
president of the Brazilian Chamber of Electric Energy Investors
(CBIEE) is quoted in the press as calling the auction results
"disastrous."

4. (SBU) Tolmasquim told Emboffs that the GoB would have to hold
new auctions for the unmet 2008 and 2009 demand. Implicitly
acknowledging that the auction rules and structures had been
complex, Tomasquim said that a new auction would be simple,
focused on meeting demand beginning in a single year. He also
noted that the "new" energy auction, planned for June or July,
would likely have to be postponed until these additional "old"
energy auctions could be completed. (Note: the MME distinguishes
between "old" energy -- from generators that came on-line before
January 1, 2000 --, and "new" energy -- from future generators
and those that came on-line after January 1, 2000. End Note.)

AUCTION RULES: THROUGH A GLASS DARKLY...
----------------------------------------

5. (SBU) According to several of our interlocutors, aspects of
the auction have lead to suspicions of excessive government
intervention in the process. For instance, the MME made last
minute changes to the auction rules, including a decision to
decrease the demand to be sold by the 700 MW that had not been
purchased in the December 2004 auction and was held over for the
April 2 event. Executive Director Regis Martins of the
Brazilian Association of Independent Electric Energy Producers
(APINE) said that this last minute change provoked such an
outcry by producers and distributors that on April 1, the MME
reinserted the 700 MW into the demand to be auctioned.

MANIPULATION OF DEMAND
----------------------

6. (SBU) Echoing concerns first voiced following the December
2004 auction, personnel in the National Electric Energy
Regulatory Agency (ANEEL), APINE, representatives of large
energy generation companies, and energy analysts all told us
that the auction rules artificially cut the demand during the
bidding process. This has the effect of forcing prices down.
Christiano Vieira da Silva, an advisor in ANEEL's Economic
Market Studies division, told Brasilia EconOff that a slice of
the demand was "cut" off the top so that the auction would not
be aborted because of insufficient supply. With the demand set
as lower than the supply, the auction system continued to drop
the price. In the end, however, the auction prices were
considered too low by so many suppliers that they withdrew their
offers, forcing MME to remove the 2009 contracts from the
auction altogether. A JP Morgan analyst reported that the
decision to cancel the offer for contracts beginning in 2009
"underscored the complexity of the auction rules, and the
[energy] pool's vulnerability to alleged government interference
over prices."

INDUSTRY GRADE? "F" FOR FAILURE
--------------------------------

7. (SBU) The industry response to the first auction in December
2004 was mixed, but with some significant positive sentiment
(Refs A and B); however, the reaction to this second round
auction was generally negative. APINE considers the auction a
failure. On the Sao Paulo stock market (BOVEPSA) the Monday
following the auction, 6 of the 10 stocks with greatest loss of
value on were in the electric energy sector. In a meeting with
Brasilia and Rio EconOffs, Pactual Investment Analyst Pedro
Batista said he had expected to see more "rational" results in
the second auction because of tighter supply/demand, more
involvement of non-state producers, less concern by the GOB
about the impact on inflation in 2008-09, and significantly less
pressure for the producers to get cash. (Note: during the
December 17 auction, the contracts beginning in 2005 were
effective January 1, meaning a near immediate cash-inflow. End
Note.) Putting a positive, but ironic, spin on the auction's
near-collapse, Batista argued it meant that the energy producers
were not yet willing to accept "unrealistically low" prices.

8. (SBU) Sao Paulo EconOff spoke with a senior executive of an
international energy generating firm, who said many energy-
generating companies, including his own, were unwilling to sell
at the artificially depressed price the GOB had set. The
executive said his firm has been telling the GOB for years that
the GOB's attempt to manage the market by segregating energy
into old, interim, and new, is a "disastrous" approach. He
lamented the auction's lack of transparency. While suggesting
"it's anybody's guess" as to how the GOB should proceed, the
source said that for the energy sector, which requires long-term
investment, the lack of transparency and GOB interference in the
market sends "the worst kind of signal." In his opinion,
considering the current environment, no private energy company
will wish to make new investments in Brazil. He surmised the
GOB may soon have to depend on its own funds to finance energy
supply and related infrastructure projects. Another executive
expressed concern about the GOB or parastatals leading
investment into new energy projects because of their
fundamentally different perspectives about business operations;
he also considered additional investments into the country less
likely if the GOB continues to diminish the value of the
product.

FEAR AND LOATHING
-----------------

9. (SBU) In particular, private generators and industry analysts
object to the differentiation between "old" and "new" energy as
creating artificial price differences for the same product. An
executive of a private energy generation company told Brasilia
EconOff that with multiple rounds of auctions for the same
product, the GOB may be setting itself up for potential lawsuits
by companies who sold energy at one (lower) price during an
early auction, while another company is selling at another
(higher) price at a subsequent auction. Eric Westberg, a former
president of APINE who now represents a private investment firm,
expressed surprise to Brasilia and Rio EconOffs that the energy
model had not generated any lawsuits yet, but assumed this was
because the state-owned generators dominated the first auction
and were less likely to sue the GOB.

COMMENT: "NEW" WINE IN "OLD" BOTTLES?
-------------------------------------

10. (SBU) Although the Lula administration generally has pursued
market-oriented and orthodox macroeconomic policies, its energy
model creates a system in which the State plays a leading role
in a mixed private-public energy sector. The lack of
transparency and apparent GOB manipulation of the auction rules
to achieve stable, incremental growth in electric energy prices,
however, has added to widespread doubts about the system and is
having a negative impact on the investment climate. The likely
delay of the new energy auction until the November time-frame is
bad news, as the GOB needs to get licensing and construction of
new hydroelectric plants started as soon as possible in order to
meet expected energy capacity needs beginning in 2009. And,
while the GOB model arguably will provide more stability for new
concession holders than they have chosen to give to existing
energy producers, the desire by GOB policymakers to reject what
they view as "unbridled" market forces is clear. As many
details of the auctions for new energy remain to be worked out,
there is still time for the GOB to adjust to a more open, market
approach. If this is to indeed happen, pressure from private
power producers will be key.

11. (U) This cable reflects input from Consulates General
Sao Paulo and Rio de Janeiro.

CHICOLA

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