Expansion of the Brazilian power trade market – impacts and opportunities for foreign investment

April 2023  |  SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2023 Issue

The Brazilian power sector is divided into four segments – generation, transmission, distribution and commercialisation. Power systems are structured in a unidirectional model, beginning with the generation of electricity by power plants usually located far from consumer loads, which is then transported by high-voltage transmission lines (some extending over 2000km) to the concession area of distribution companies. Distribution companies then supply electricity to consumers.

Transmission and distribution services are granted and operated under a natural monopoly via federal concessions with an average term of 30 to 35 years, whereas generation (except for nuclear, thermal and large hydroelectric plants) and commercialisation are usually operated in a competitive environment by independent agents authorised by Agência Nacional de Energia Elétrica (ANEEL), the Brazilian national power regulatory agency. Transmission concessionaires receive a fixed revenue (except for adjustments for inflation) for the operation of the grid, making this a very stable business for investors (transmission concessions are essentially fixed-income assets). Distribution services, on the other hand, are remunerated by end-consumers within the concession area and are therefore subject to financial impacts resulting from payment default due to economic crisis, such as the coronavirus (COVID-19) pandemic, for example, migration of consumers to the free market for the trading of electricity, and other market factors. Therefore, as a rule, the power distribution business tends to be a more volatile investment.

The four segments of the Brazilian power industry are centrally planned and regulated by the federal government, which ultimately means that the government and regulators exert great influence on how the market develops.

The power trade market is currently based on bilateral power purchase agreements (PPAs) that can be entered into in two environments, namely the Regulated Contracting Environment (ACR) and the Free Contracting Environment (ACL). PPAs in the ACR are executed between power distribution concessionaires and power purchase auction winners and are usually long-term contracts in order to allow power generators to finance projects by means of assignment of receivables from such PPAs. In the ACL, PPAs result from bilateral negotiations or private power auctions, negotiated freely between the parties.

Currently, most consumers with a load equal to or greater than 500kW are considered free consumers and can purchase power from any concessionaire or authorised power generator or energy trader, regardless of the source. The Brazilian ministry of mines and energy (MME) has progressively reduced this limit since 2018, when the minimum load to access the ACL was 3000kW.

Consumers with a load lower than 500kW, including residential consumers, are generally considered ‘captive consumers’, and have their energy supply compulsorily serviced by the power distribution concessionaires or permissionaires to which they are connected. For these consumers, the only other option is to participate in the net metering system called ‘distributed generation’, which benefits from certain tariff exemptions that have recently been reduced by Federal Law 14,300/2022, after years-long, strenuous discussions between ANEEL, industry participants and the Brazilian congress.

Due to its structured and capital-intensive character, the electricity sector requires sources of long-term financing to make investments viable. For this reason, the Brazilian national development bank (BNDES) and regional development banks have historically played important roles in financing all segments of the Brazilian power industry. Notwithstanding this, capital markets have developed consistently in recent years to become an important source of funds for the electricity sector. The issuance of infrastructure debentures (similar to project bonds) in capital markets have become common in recent years and are currently a reliable supplemental source of funds for the implementation of energy projects, as tax exemptions, especially for foreign investors, make the investment attractive.

BNDES’ participation in financing the electricity sector has been decreasing alongside the development of Brazilian capital markets, mostly as a result of project bonds, and the bank has purposefully sought to act in a complementary way to private markets and to promote the entry of new sources of funds that make sustainable investments possible in the Brazilian economy.

Modernisation of the Brazilian power sector

Since 2018, the minimum load requirement for accessing the ACL has been progressively reduced by the MME. In 2022, an ordinance published by the MME established that the ACL shall become accessible to all consumers connected to high voltage as of 2024, regardless of the load. However, this process will not happen overnight. Migration to the ACL demands adaptations, takes time, and requires intermediation to adjust and manage consumption.

The expansion of the ACL is also accompanied by a series of other changes aimed at modernising the Brazilian power sector.

In 2021, the federal government issued Law No. 14,120/2021, which abolished, for new projects, the transmission and distribution tariff discounts to which renewable generation projects were entitled. This subsidy, which is funded by means of sectoral charges paid by all power consumers, was preserved for existing projects until the end of their grant term. This measure was intended to provide legal certainty to investors already active in the power sector.

Similarly, in 2022, the federal government issued Law No. 14,300/2022, which also abolished the distribution tariff exemption for net metering (distributed generation) consumers, creating a transition to the collection of such tariffs until 2031 for new projects, but safeguarding exemptions for existing distributed generators until 2045.

Further to these recently implemented changes, Bill No. 414/2021 proposes to open the power market to all consumers, including low-voltage residential consumers. Already approved in the senate, the text is being discussed in the chamber of deputies.

According to the Bill, the possibility of migrating from the ACR to the ACL for all consumers should be put in place within 42 months from its approval. Consumers with a load of less than 500kW would purchase power from retail trade agents (comercializadores varejistas), who will represent them in dealings with the CCEE, the entity that centralises power purchase and sale contracts in Brazil.

The Bill also consolidates the regulation of self-producers, those consumers who receive authorisation from ANEEL to produce their own energy at their own expense and risk. They are exempt from certain sectoral charges applied to self-produced power, with criteria for calculating charges.

These measures aim to provide greater robustness to the power market. Notwithstanding, one of the difficulties in expanding the ACL is that it may lead to further ‘over-contracting’ distribution companies. The mass migration of consumers could cause an imbalance in the concessionaires’ portfolios, greatly burdening the remaining consumers.

Impacts and opportunities for investment

The electric energy sector has undergone a series of profound transformations around the world in recent years, and Brazil is no exception. Brazil is in a privileged position, both for the high level of renewable sources in its matrix (roughly, 85 percent of total installed capacity in February 2023) and for the great potential of energy resources available in its territory. The robust interconnection infrastructure (approximately 198,000km of high-voltage lines in 2023) and the storage capacity of hydroelectric reservoirs facilitate the use and integration of variable renewable sources, such as wind and utility-scale or distributed solar power projects.

Opening the ACL will further promote expansion of generation sources, with more investments, possibilities of high returns to generators and decentralisation of energy sources.

In this context, the consolidation of the legal framework applicable to net metering and self-production can have a positive effect on investments, providing legal certainty which in turn results in broader financing possibilities, be it via capital markets or more traditional project finance structures.

On the other hand, opening the ACL to captive consumers might impact the future of the net metering system, as consumers would no longer be bound to their local concessionaire. Furthermore, it may worsen the ‘over-contracting’ of distribution companies. We see this as a market disruption opportunity for new players and for consolidation through M&A transactions in the various segments affected.

Self-production projects and trading structures help reduce the cost of energy in Brazil and thus should continue to attract investments (with the expansion of the eligible consumer demographic). This is further facilitated by PPAs denominated in foreign currencies (according to Law No 14,286/2021) for offtakers that export goods. This creates a natural hedge when financing power generation projects in hard currency, especially for the typically large consumers that export commodities.

The current scenario in the Brazilian power industry is conducive to further foreign investment activity, be it from an M&A, financing or investment perspective, including ESG investing, especially in public stock.

Conclusion

The government and the major power sector incumbents have actively pushed for the ACL to expand and open to more consumers in a secure and sustainable manner. Proof of this is the recent elimination of subsidies and exemptions, which has been done in a responsible manner that protects existing projects and their investors, along with allowing PPAs to be denominated in foreign currencies.

The newly elected government also has a plan to reduce carbon emissions and increase renewables in the Brazilian generation matrix.

A lot remains to be defined, but Brazil has been taking steps toward expanding its power market and modernising applicable regulations, which creates multifaceted opportunities for investors in the country.

 

Daniel Engel and Alberto Büll are partners and Luisa Tortolano Barreto is an associate at Veirano Advogados. Mr Engle can be contacted on +55 11 2313 5945 or by email: daniel.engel@veirano.com.br. Mr Büll can be contacted on +55 11 2313 5871 or by email: alberto.bull@veirano.com.br. Ms Tortolano can be contacted on +55 11 2313 5719 or by email: luisa.barreto@veirano.com.br.

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BY

Daniel Engel, Alberto Büll and Luisa Tortolano Barreto

Veirano Advogados

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