Brazil´s difficulties in making decisions

Blackout in Energy Policy

Continued on page 3

Document of the Fernand Braudel Institute of World Economics Associated with the Fundação Armando Álvares Penteado N. 31 2002

We were lucky. The rains came. Thanksto heavy rainfall in early 2002, Brazildanced away from electricity shortagesthat last year threatened blackouts andforced rationing of 20% of what was thenconsidered normal consumption. Effec-tive rationing, managed by the govern-ment and supported by the population,revealed consumption economies thatheightened the impact of abundant newrains. The rains suddenly flowed into Brazil´sreservoirs, feeding one of the world´s larg-est hydropower systems, to raise water fromlevels of acute scarcity (18% of capacity indams supplying the populous Southeast) toan average approaching 70%. In the drierNortheast, reservoir levels had fallen to onlyfive percent.

Technicians now talk of an electricitysurplus over the next few years instead ofthe chronic shortages that were feared onlya few months ago. But they also say thatfaster economic growth and/or more yearsof low rainfall after 2003 would throw Brazilback into the desperation and confusionover failing electricity supplies that led torationing in 2001. The government´s Commit-tee for Revitalization of the Electricity Sectorwarned, as rationing ended earlier this year,that “a mistaken forecast of future abundancecould lead to an overuse of reservoirs and adeterrent for using electricity from thermalplants, leading to a supply crisis in case ofanother severe drought in the future.” Despiteheavy downpours in early 2002, rains for theyear as a whole remain 20% below long-termhistoric averages. Based on historic averages,Brazilian energy authorities predict rainfallshortages in 10% of all years on record,producing a worst-case scenario of a 20%shortfall between supply and demand. How-ever, recent irregularities in global rainfallpatterns have increased the uncertainty ofeven these predictions.

Last year’s energy rationing is a painfulreminder of how Brazil, in energy policy as inother areas, is suffering as a result of havingfailed to strengthen sufficiently its institu-tions, in this case those that manage andregulate the electricity system. This problemis not new. Because of disputes over electric-ity tariffs and the resulting failure to invest innew generating capacity, the drought of1952-54 continued to cause power shortagesfor the next decade. In the course of the 20thCentury, electricity was woven into the fabricof modern life throughout the world andcame to be regarded, along with air, waterand food, as one of the pillars of human

survival. The civilizational pillar of electricitybegan to totter during the surges of chronicinflation in the late 1980s and early 1990s.State power companies collapsed financiallyunder the burdens of swelling demand at lowreal prices, compounded by political interfer-ence that undermined their investment andoperational capacity. While the spread ofelectricity contributed spectacularly to itseconomic development, Brazil would havegrown faster, with more stability, withoutrecurrent uncertainties of power supplies.

Dancing Away

Brazil danced away from electricity ration-ing in 2001 into the electoral season of 2002,after which in 2003 newly elected politicianswill face problems not solved by their prede-cessors. The main goals of President FernandoHenrique Cardoso (1995-2003) were to (1)end chronic inflation; (2) achieve fiscal bal-ance, and (3) get Congress to amend the 1988Constitution to permit his reelection for asecond four-year term in 1998.

These achievements created a climate ofpolitical and price stability unseen in Brazilfor decades, with big gains in living stan-dards. However, each measure needed tostabilize public finances and open theeconomy to the outside world needed sup-port from a volatile coalition in Congress,whose members demanded and obtained

power over key ministries and state compa-nies, including those governing the electricitysector. State electricity companies were priva-tized, despite resistance from bureaucraciesand politicians, in return for federal restruc-turing of state debts that was managed by theNational Bank for Economic and Social De-velopment (BNDES).

Political resistance was revived in the con-fusion over recent power shortages.Privatization of electricity supply and distri-bution has been stalled for the past threeyears. Many unresolved issues plague thisvast system of 64 distribution firms (44 ofthem now in private hands), 20 transmissioncompanies and 15 generating corporations,all linked together by a transmission grid ofcontinental proportions, dependent on rain-fall to sustain fast-growing consumption.Privatized distribution companies now cover65% of the Brazilian market, but 80% ofgenerating capacity is owned by the State.Gas supplies, needed by private investorsfor rapid expansion of thermal generation,

Norman Gall is executive director of theFernand Braudel Institute of World Economicsand editor of Braudel Papers. This essay isbased in part on papers by Peter Greiner,Roberto Campos Research Fellow in EnergyPolicy at our Institute, whose work can be foundon our home page www.braudel.org.br.

Norman Gall

Untitled-3 30/9/2002, 10:261

2 BRAUDEL PAPERS

Fernand Braudel Institute ofWorld Economics

Associated with FundaçãoArmando Álvares Penteado

(FAAP)Rua Ceará, 2 - 01243-010 São Paulo, SP - Brazil

Tel: (55 11) 3824-9633 Fax: 3825-2637e-mail: ifbe@braudel.org.brwww.braudel.org.br

Honorary President: Rubens RicuperoBoard of Directors:Luís CarlosBresser Pereira (president), MarcelloResende Allain (vice-president),Roberto Campos Neto, RobertoTeixeira da Costa, Eduardo Giannettida Fonseca, Francisco Gros, AntônioCorrêa de Lacerda, Miguel Lafer, ArnimLore, Luiz Alberto Machado, IdelMetzger, Charles B. Neilson, Mailsonda Nóbrega, Antônio Carlos Barbosade Oliveira, Maridite Cristóvão Oliveira,John Schulz, Beno Suchodolski,Joaquim Elói Cirne de Toledo, DiegoTheumann, Rick Waddell and MaartenAlbert Waelkens.

Executive Diretor: Norman GallCoordinators: Nilson Oliveira andPatricia Mota Guedes

Sponsors

AESBanco Lloyds

BasfBoucinhas & Campos Auditores

BradescoBrascan Brasil

Brascan EnergiaBrasmotor

EDPEricsson

General Electric FundIcatu Holding

ItaúKlabinNatura

O Estado de S. PauloPhilipsPirelli

Safra - Projeto CulturalSiemens

Souza CruzVoith HydroVoith Paper

Votorantim (CBA)

Solutions Instead of More Confusion?Peter Greiner

Braudel PapersEditor: Norman GallDeputy Editors: Nilson Oliveiraand Marcones Macedo

Braudel Papers is published bythe Fernand Braudel Institute ofWorld Economics with specialsupport of The Tinker Foundation,KM Distribuidora and O Estado deS. Paulo.

Copyright 2002 Instituto FernandBraudel de Economia Mundial

I - Stalling a fairly well conceived reform strategy

Brazil´s electricity sector reform began in1995 without aclear market model, which was proposed by the 1997Coopers & Lybrand report drawn from the RESEB – ElctricSector Restructuring process which involved 200 Braziliantechnicians. A regulatory agency (ANEEL), a non-profitNational System Operator (ONS) and a Wholesale EnergyMarket (MAE) were created. Capacity expansion efforts installed projects were reactivated and enhanced throughpartnerships with private capital, and the Bolivia-Brazil gaspipe line was built to help to meet demand over thetransition period.

Successive economic crisis triggeredpolitical disputes andweakened the political basis for support to governmentreforms. After 1999 a new Minster of Mines and Energydecided to focus on a wide thermal-electric generationprogram, neglecting privatization and the development of acompetitive market Without firm steering, reform andderegulation went askew as illustrated by the followingfacts:1. The wholesale market (MAE) has not operated until now:- over R$ 13 billion of invoices are waiting to be cleared.2. Confusion over rules for new generating capacity enter-ing the electricity market, notably the uncertainties and risksfaced by thermal plants on how to compete with cheaphydropower and very strict take-or-pay gas supply condi-tions, under heavily dollar-related costs.3. When privatization was interrupted, 80% of generationwas still in government hands, 30% corresponding to the bi-national Itaipu hydropower and the Angra I and II nuclearplants, and the remaining 50% to amortized state controlledhydropower plants, operating at very cheap costs.4. New investments may be curtailed by the low prices ofthese amortized hy droelectric plants and a surplus on thesupply side due to rationing, markets contraction and sloweconomic growth.5. Natural gas market is still dominated by Petrobrás, whichmay be able to solve short-term investment problems butdrives away private capital in the long run.6. Uncertainties and institutional weaknesses drove awayexperts from the Energy Ministry and Eletrobrás, while theincreasingly powerful regulatory agency ANEELremainedlacking qualified and trained staff.

These deficiencies are being amplified in the absence ofa clear energy policy and balanced redefinition of the role,limitsand relations among state agencies.

II. The 2001 Electricity Crisis and additionalcomplications

By relying solely on the thermal program the governmentfailed to pay close attention to the timely conclusion ofimportant projects like Porto Primavera (1,800 MW),Angra II Nuclear Power Plant (1,360 MW), two additionalunits at Itaipu (1,500 MW) and key transmission intercon-nection lines to increase interchange capability.

Thanks to consumers’ extraordinary collaboration withrationing efforts, the government was able to avoid “rollingblackouts” as in California, by reaching a 20% saving on theprevious years consumption corresponding to a 24% re-duction of the projected income. By the end of the year andthe beginning of the rainy season, the crisis had already beenaverted. As early as March 2002, existing reservoir levelshad secured supply for 2002 and 2003, According toANEEL and ONS authorized ongoing projects meet thedemand until 2006. But the following factors continue togenerate confusion and uncertainties:1. Decrease in demand pushed the utilities into deepfinancial trouble. Recovery measures considered by theAdministration and Congress provoked controversy.2. Resistance to change increased. Opponents may not beable to revert privatization, but are tempted to promote amixed model of state and private enterprise. However, withstate corporations controlling 80% of electricity generation,competition and efficiency can be hardly achieved.

3. An electricity surplus in 2002, combined with regulatoryuncertainty, could discourage and delay investments inprojects already awarded by public bidding, thus exposingBrazil to future shortages.4. Brazil´s internal difficulties are being compounded bydistrust of foreign independent power producers, such asEnron and AES, lack of foreign investors’ confidence inemerging economies after Argentina´s collapse, and disap-pointing results in telecommunication and electric servicesectors around the world.

III. Guidelines to avoid more confusion, fail-ures, and a new, more serious supply crisis.

Biased diagnosis argue that the new market modelfailed and that investments were insufficient. But theyfail to acknowledge that the market model has not yetbeen duly implemented and tested , and that annualaverage capacity has actually tripled when compared tothe 1990-1995 period of state control. But, if noappropriate institutional and regulatory measures aretaken, current private capital commitments may be atrisk. At this very moment investors wonder what thenext Brazilian President’s policy for the electric sectorwill be.

Calls for a “hybrid” model of state and private capitaloften overlook the fact that state-owned corporationsmay hinder competition and manipulate prices speciallywhen controlling, as they do, amortized assets thatallow for dumping.

Given that all candidates are in favor of resumingeconomic growth, it is likely that any next president willbe tempted to ensure capacity expansion through stateinvestments that avoid more lengthy systemic reforms.An obvious temptation is to use the state controlledgenerators as cash cows by floating their amortizedenergy output, and maintain PETROBRAS’ leverageover the US$ 11/bbl national oil,representing 80% ofthe country’s total consumption.

This short lived strategy would endanger fiscal bal-ance, driving away private capital and posing the risk ofa even more dramatic energy crisis in the future. Underthese conditions any new government should considerthe following guidelines in setting responsible energypolicies:1. Establish a comprehensive energy policy in conjunc-tion with an economic development strategy focusedon securing supply, rationalizing consumption and es-tablishing a more credible financing model.2. Give energy policy a permanent place in the govern-ment economic agenda, enforcing a key role for theNational Council for Energy Policy.3. Create, within Eletrobrás, an Energy DevelopmentInstitute to : (a) manage remaining state assets andpromote strategic projects, and (b) advise the Ministryof Mines and Energy in managing energy programs.4. Maintain the role of Petrobrás in diversifying Brazil´saccess to primary sources of oil and gas at home andabroad, but under conditions of fair competition in thenational market, especially in natural gas, oil refining anddistribution.5. Diversify the energy matrix to emphasize security ofsupplies to minimize risks of instability and dependence,with stocks of strategic reserves and emergency plans.6. Promote energy exchanges within Latin America,assuring the greatest possible direct or indirect accessto primary energy sources, such as oil, gas, hydropowerand coal, to strengthen the regional market and pro-mote development of participating countries.

IV. Energy Policy and Institutional Efficiency

As indicated by the brief analysis and guidelines, theenergy sector demands not only good intentions andproposals but a stable, long-lasting and competentmanagement, as implied by the following proposals:

Untitled-3 30/9/2002, 10:262

BRAUDEL PAPERS 3

Peter Greiner is Roberto Campos ResearchFellow in Energy Policy, at the Fernand BraudelInstituto of World Economics. He served atNational Energy Secretary (1994-1999).

are in the hands of a state monopoly,Petrobrás,which for many years was reluc-tant to develop and market this new energysource. The basic issue raised by this essayis: How to establish a legal and politicalframeworkwith enough credibility to mobi-lize investment for meeting Brazil´s electric-ity needs in coming decades?

Harvesting the Streams

Brazil is a lucky country because of its threegreat river basins, the Paraná, the São Fran-cisco and the Amazon. In the second half ofthe 20th Century, big rivers were dammed atmany of their numerous waterfalls to flowthrough giant turbines, transforming Brazil´seconomy and society with cheap and abun-dant electricity transmitted from dams todistant cities. These hydropower stations wereaudacious undertakings of a backward na-tion, the largest and most complex projects inBrazil´s history, enabling it to quickly harvesttechnological progress that gathered speedaround the world over the previous century.

The ancient Greeks and Romans couldconvert the power of streams into the rotarymotion of stones to mill grain. The use ofrivers as a source of energy spread widely inmedieval Europe not only for milling grain,but also for sawing wood and making cloth,iron, paper, silk, copper pots and weapons.Towns and cities grew around these indus-tries and markets. But mobilizing the powerof rivers on a truly massive scale had to awaitmore recent discoveries and inventions.

The critical advance was the discovery in1831 by Michael Faraday that moving a con-ducting circuit in the presence of a magnetcan create an electric current. Before and afterFaraday´s discovery came sindependent ex-plorations by hundreds of men, almost noneof them scientific professionals in today´ssense. After one of the most celebrated ofthese early experiments, attracting lightningto a key hung from a kite in a storm, BenjaminFranklin announced in 1751: “That the Elec-tric Fire is a real Element, and different fromthose heretofore known and named….” Elec-tricity still was, according to the economichistorian David Landes, “a scientific curiosity,a plaything of the laboratory.”

In the decades after Faraday´s discovery,however, cascading inventions led to moreadvances: the first self-exciting electromag-netic generator; the ring dynamo to generatedirect current commercially; alternators andtransformers to produce and convert high-voltage alternating current, and advances inmaking armatures, cables and insulation. Jo-seph Swan (1828-1914), inventor of the in-candescent lamp, recalled:

The days of my youth extend back-wards to the dark ages, for I was bornwhen the rushlight, the tallow dip orsolitary blaze of the hearth were thecommon means of indoor lighting [when]the common people, wanting the in-ducement of indoor brightness such aswe enjoy, went to bed soon after sunset.

In 1900 Brazil was still in these “dark ages,”consuming almost no commercial energy. Itspopulation was only 18 million, compared

Electricity1. Instruct ANEEL to delegate to Eletrobrás all non-regulatory technical functions, such as inventories andresearch.2. Establish data banks with systematic and frequentlyupdated information, transparent and independentlyaudited, so the government, society and consumerscan have current, unbiased knowledge of the realityof the electricity industry.3. Resume long-term planning.4. Maintain the new model principles competition,free consumer choice, regulation seeking marketefficiency, clear and stable rules preserving theregulator’s independence and consistent with marketprinciples.5. Correct faults, omissions and uncertainties ofexisting legislation: clarifying concepts such as “publicservice,” “service by price,” “economic and financialbalance” and the public auction process.6. Organize a coherent new Energy Code.7. Uniform pricing of “old” electricity from amortizedplants in relation to new capacity being added to thesystem.8. Find a balance between the current economicfinancing criteria (10 –12 years amortization) andconcession terms (30 years) to avoid huge windfallprofits and discretionary regulatory intervention.9. Establish transmission tariffs providing better eco-nomic signals and guarantees of open access.10. Create a new hydroelectric inventory to identifypriorities, including long-term benefits not consideredtoday, such as useful life of facilities and avoidance offuel imports.11. Study the option of building the Angra III nuclear plantto maintain technological development in this area.

Oil and Natural Gas1. Create a competitive natural gas market by creatinga new gas transportation company, separate fromPetrobrás, eventually complemented by part ofPetrobrás’ gas and imports from Bolivia.2. Promote the partial privatization of Petrobrás’refinery system, in exchange for private commitmentsto increase refinery capacity. These measures woulddepend on international market conditions, todayallowing for imports of refined products below thecost of expanding Brazil´s refineries.3. Controlled deregulation of prices charged byPetrobrás.4. Ease imports of crude oil, refined products andnatural gas, emphasizing free access to transportationand storage facilities.5. Harmonize regulation of electricity and natural gasproduction and distribution to sustain thermal plants.6. Build pipelines in Amazônia to transport natural gasfrom the reserves of Urucú and Juruá to the cities ofManaus and Porto Velho. Produce diesel or methanolin Coari to supply liquid fuels for electrification ofcommunities on the Amazon river basin.

Alternative Energy Sources1. Revive the ethanol program in stable fashion tosustain employment, gaining greater efficiency withincreases in production scale and stabilizing the sugar-alcohol industry while enhancing fuel security.2. Stimulate co-generation with sugar cane bagasseand increase the use of multi-fuel vehicles to expandthe market for alcohol.3. Promote co-generation (electricity with processheat or refrigeration) with special financing.4. Rationalize subsidies linking them to amortizationof transparent investment credits for different alter-native energy sources and technologies, inhibitinglong-lasting subsidies of uncompetitive operationalcosts.

Continued from page 1

Untitled-3 30/9/2002, 10:273

4 BRAUDEL PAPERS

with 170 million today. Life expectancy at birthwas only 30 years in 1900, against 68 years in2000. But Brazil already had begun to capital-ize on technological advances elsewhere, en-abling this vast country, shackled by illiteracyand disease, to become one of the fastestgrowing economies of the 20th Century.

In 1881, the world´s first public powerstation was installed in England. As early as1883 Brazil´s first municipal power plant be-gan operating in the town of Campos in Rio deJaneiro State. A few years later the first hydro-electric plants started up in France and Swit-zerland with a technology that spread fast. In1889 Brazil´s first hydropower plant beganproviding electricity for a textile factory andpublic lighting in Juiz de Fora, Minas Gerais.

A German importing firm sent salesmen intothe interior of São Paulo State, offering easycredit to planters wanting to set up hydroelec-tric stations to supply plantations, factories andtowns. Foreign investors quickly installed thenew technologies throughout Latin America.In Brazil the main investors were the Toronto-based Brazilian Traction, Light and PowerCo. (at first called “Light” and later “Brascan”)and American and Foreign Power Co.(AMFORP).

Since 1899, Light provided and oper-ated public services in São Paulo andRio de Janeiro (trolley, gas and tele-phone companies), installing hydro-electric and thermal plants to powerthese operations and to meet fast-growing urban demand. AMFORPoperated utilities in the interior ofSão Paulo State and in several statecapitals.

Between 1913 and 1929, worldoutput of hydropower multiplied240-fold to produce 40% of allelectricity. Brazil accompanied thisworld trend, as increases in electric-ity demand far exceeded economicgrowth. In the early 20th Century,these developments were driven by foreigninvestment and technology. In 1928 Lightingeniously reversed the course of the TietêRiver at Cubatão, creating a 720-meter water-fall in the Serra do Mar near São Paulo that feda complex system of dams, canals, pumpingstations and surface and underground gener-ating plants, transforming a coastal mountainrange from an obstacle to inland developmentinto an abundant source of electricity throughthe 1930s and 1940s.

As recently as 1951, Brazil still had none ofthe 170 largest hydroelectric plants, above 75megawatts (MW) capacitys. But by 1997 Brazilhad become the world´s third-largest pro-ducer of hydropower (after Canada and theUnited States) and second in the world independence on hydropower (after Norway),relying on it for 92% of its electricity supplies.In 1950, the United States had the world´slargest concentration of big hydroelectric sta-tions. Soon after, Brazil absorbed this cultureof great dams, along rivers that cut into themassive shield of its Central Plateau.

The first of these big projects was PauloAffonso I on the São Francisco, finished in1962, followed by Furnas (1963), Jupiá (1969),Funil (1969), Ilha Solteira (1973) and manyothers. Most of the early projects were de-

signed and managed by foreign engineeringand construction firms while Brazilians gainedexperience with these technologies.

Brazilian engineers traveled to dam sites inthe United States, Scandinavia, Switzerland,France, Egypt, Russia and China to learn aboutorganizing these huge projects. Brazilian engi-neers were wary of doing big dam projects.But Sebastião Camargo, who began his careeras a contractor by moving earth on the backsof burros for building roads in the interior ofSão Paulo State, boldly submitted an alterna-tive design to build Jupiá on his way toestablishing what was Brazil´s biggest con-struction firm.

“We were a poor, vast, empty country andthere were no roads to the dam sites,” recalledJosé Gelásio da Rocha, who headed construc-tion of Jupiá. “We had to build the infrastruc-ture ourselves.” For the first time, great mobi-lizations of materials, machinery and workersconcentrated resources in Brazil´s immensebacklands. Rivers were diverted and millionsof tons of concrete, poured from giant mixing

plants, were carried byhuge cranes to coat

the rock coreof colos-

sal walls stretching across canyons and valleys.Temporary cities rose beside these rivers forworkers, technicians and their families whomigrated among dam sites over the next fewdecades. At the Jupiá and Ilha Solteira damsites, ice plants were built to keep the cementfrom cracking in the intense heat. Foreignmanufacturers, such as Voith, Siemens, Gen-eral Electric and what is now Asea BrownBoveri, began to build big generators, turbinesand transformers in Brazil to meet growingdemand from the state companies.

These technical achievements enabled Bra-zil to develop a hydroelectric monoculture thatnourished rapid urbanization and industrial-ization as well as improvements in communi-cations, distribution and information networksand in the processing of food and medicine.Since 1950 electricity output grew from only5.5 billion kilowatt-hours (KWh) to 332 billionKWh, a 20-fold increase in consumption percapita. Since 1970 the share of homes withelectricity soared from 35% to about 95%today, signifying a great leap in the moderniza-tion of Brazil´s society. The question posed byrecent electricity shortages is whether thismodernization can continue.

The Unnecessary Crisis

The promise of Brazil´s abundant naturalresources is undermined by institutional weak-nesses. The technical and economic issues ofelectricity supply and demand are lost amongdispersed and negligent centers of decision.Compounding the difficulties of planning andcoordination was the backlog of unfinishedprojects that would have added enough gen-eration and transmission capacity to compen-sate for the lack of rainfall in 2001. Brazil´sTribunal de Contas da União (TCU), equiva-lent to the General Accounting Office of theUnited States, reported that “delays and failureto implement planned projects contributed toan emptying of the reservoirs by some 41%and were identified as the main cause of theenergy crisis.” These public projects weredelayed by lack of funds, onerous bureau-cratic procedures, environmental disputes andpolitical manipulation, all causing huge costoverruns. Some examples:

·In 1980, São Paulo Governor Paulo Malufsigned contracts for the Porto Primavera damto generate 2,000 MW at where the mightyParana River forms the border between thestates of São Paulo and Mato Grosso do Sul.Porto Primavera was one of five hydroelectricprojects launched by Maluf at the request ofEconomics Minister Antonio Delfim Netto togenerate cash from foreign suppliers´ creditson the eve of the Latin American debt crisis ofthe 1980s.

Maluf happily complied, distributing con-tracts for the five projects among big construc-tion companies that normally contribute toelection campaigns. But managing five majorprojects at the same time overwhelmed CESP,the heavily indebted São Paulo state electricitycompany. CESP ran out of money, causingdelays and a pileup of interest charges asconstruction of Porto Primavera dragged onfor two decades before being inaugurated in2000, now renamed in memory of Communi-cations Minister Sérgio Mota Mello. But thedam´s reservoir could not be filled until 2001,on the eve of electricity rationing, because ofdisputes with the state government of MatoGrosso do Sul over environmental impactsand relocation of displaced population. Thestation is generating sat only two-thirds ofcapacity because its turbines are being in-stalled only now instead of during construc-tion. Originally budgeted at $2 billion, theproject´s final cost is estimated at $10 billion.

·Rationing also could have been avoided ifthe government had built transmission lines tobring surplus power to the cities of the South-east from southern Brazil and from the 12,600MW bi-national Itaipú dam, the world´s larg-est, on the Paraná River where it forms theborder with Paraguay. A third transmissionline from Itaipú was delayed until 2002 be-cause a supplier from the Ukraine offered thelowest price in international bids for trans-formers. The Ukrainian transformers burnedout upon being installed. New transformershad to be ordered. The government failed tobuild a relatively cheap transmission line be-tween Curitiba and São Paulo that could havepumped surplus power into the national gridfrom the hydroelectric stations of the South,which had heavy rains in 2001 while the

Untitled-3 30/9/2002, 10:274

BRAUDEL PAPERS 5

Southeast suffered drought.·The nuclear power station Angra II (1,360

MW), the first and only of eight plants thatwere to be built under the Brazil-Germannuclear deal of 1975, was under construc-tion for 25 years, accumulating interestcharges and cost overruns that fed into theenormous debts of the federal electricitysector. Even after completion in 2000, AngraII had to run the gauntlet of approvals byseveral government agencies before it couldstart producing electricity in 2001. The misseddeadlines of Angra II in starting generationled to default by Furnas, the federal powercompany, on its supply contracts to distribu-tors, undermining the government´s cred-ibility in dealing with private investors.

·As international financial markets wereexpressing concern over Brazil´s energyshortages and mounting public debt,Eletronorte, the federal power company forAmazônia, was completing the $1.5 billionsecond phase of the giant Tucuruí dam onthe Tocantins River, with 11 new turbines toadd 4,000 MW to the 4,000 MW alreadyinstalled. However, Tucuruí II will operate farbelow its designed capacity during the dryseason, since there is little upstream reservoirstorage to regulate river flow.

What Have We Learned?

In 2001-02, Brazil managed its shortagescreatively to avoid the kind of electricityblackouts that California suffered around thesame time. In Brazil, however, the blackoutwas in energy policy, in the inability of govern-ment to make decisions that would stabilizethe flow of resources into a critical and fast-changing industry. As rationing was windingdown late in 2001, two distinguished ex-Ministers of Mines and Energy and two ex-Presidents of Eletrobrás wrote in the newspa-per O Estado de São Paulo, that “our worriesincrease when we observe that the country stillhas not identified the way to assure success inimplementing the new model [because of]discord between the Ministries of Finance andEnergy, between Eletrobrás and BNDES overconflicting goals and over the privatization ofstate enterprises.” Earlier, Francisco Gros, formerpresident of the Fernand Braudel Institute ofWorld Economics, then president of the BNDESand now president of Petrobrás, told a profes-sional audience: “The confusion is so great thatit looks like it was designed by officials of theelectricity sector to guarantee their own jobsfor many, many years.”

Faced with the threat of recurrent shortages,Bazil´s government has launched major initiatiesto concentrate decisions in an Energy CrisisCommission; to raise electricity prices to levelsthat would sustain investment; grant conces-sions for new transmission lines; provide arealistic legal and economic framework forlong-term supply contracts; reorganize the newwholesale electricity market, and settle conflictsbetween public and private providers andbetween generators and distributors. But manypolicy decisions were bogged down in trenchwarfare between bureaucratic and commercialinterests, in contradictory laws and regulationsand seemingly endless judicial and regulatorydisputes. The government lacks the political

machinery to make decisions along economi-cally rational lines and to implement its decisions.

1. A vacuum in decision-makingNo institutional authority for setting priorities

and making policy has replaced the giantpublic corporations whose size and powerswere reduced by privatization. New laws werepassed in 1995-98 that ended public monopo-lies in electricity generation and authorizedprivate operation and ownership of the infra-structure. A basic strategy was drafted to (1)create the National Agency for Electrical En-ergy (ANEEL) as the main regulator; (2) breakup vertically integrated state companies intoindependent units for generation, transmis-sion and distribution; (3) set up competitivemarket mechanisms and institutions, grantingindependent producers free access to trans-mission and distribution networks; (4) gradu-ally phasing the transition from regulated tocompetitive pricing as the new electricitymarket went from 98% state ownership toprivate participation.

In its first four years the Cardoso Administra-tion more than doubled annual increases ingenerating capacity, built new transmissionlines and gas pipelines to link regions andreach remote areas, completed 23 paralyzedprojects and revoked concessions for manyprojects that never began construction. Never-theless, the legacy of neglect had taken its toll.

Nobody was able to implement the newstrategy effectively after a leadership change inthe Energy Ministry in 1995 under pressures ofcoalition politics. Public sector technicians andexecutives were recruited to regulate a newsystem for which they had little sympathy, whileothers took early retirement to join the privatesector, depriving the government of experienceand technical competence needed to operate ina new regulatory environment. The politicianswho made the laws and appointed theseofficials knew little of the organizational andtechnical complexity of the system. New regu-latory agencies and old state companies, suchas Eletrobrás and Petrobrás and their manysubsidiaries, operated in a floating world, withlittle policy direction or supervision.

The energy sector remained a field of patron-age and political rivalry, among Congressional

leaders, regional bosses and lords of bureau-cracy, even as average levels of Brazil´s mainreservoirs declined steadily during the 1990s.For decades, all political factions succumbedto the temptation to use the state electricitycompanies as cash cows to balance budgets,finance election campaigns or win votes bysubsidizing consumption with “social tariffs.”

The Ministry of Mines and Energy lost power,leaving a vacuum of responsibility for deci-sions. Unresolved disputes over rules andprices emerged between diametrically op-posed interests of generating and distributioncompanies, with 80% of electricity generationin the hands of state managers with littleinterest in restructuring the industry. To obtainsupport in Congress, Cardoso ceded control ofthe electricity sector to his main coalition allythen, the Liberal Front Party (PFL), in anindustry demanding high levels of capital andtechnical knowledge. Economic stabilizationprevented the government from using theinflation tax to finance public investment. Stateelectricity companies invested less so that thegovernment could keep within limits on in-creases in public debt.

Between May 1999 and January 2001, waterstorage in reservoirs of the Southeast, Brazil´smain electricity market, fell from 70% to 18% ofcapacity. Some technicians urged rationing of10% of consumption in early 2000 withoutwaiting for shortages to worsen, but they wereoverruled. “The occurrence of severe rationinga few months after officials said that there wouldbe no problems,” the Revitalization Committeeobserved, “means that risk aversion must beintroduced into the system´s operation.”

With the onset of 20% rationing in mid-2001,Cardoso named Pedro Parente, his trusted andwidely respected Superbureaucrat, to head atemporary Energy Crisis Commission, withCardoso claiming that the traditional electricitybureaucracy failed to warn him of impendingshortages. Since the new Energy Czar had noprior experience in the electricity sector, afrantic period of learning ensued in the secondhalf of 2001 until the rains came.

Brazil´s rationing, with general consump-tion economies and a secondary markettrading quotas among industrial users, wasmanaged more intelligently than California´s

South

Untitled-3 30/9/2002, 10:275

6 BRAUDEL PAPERS

panic-provoking “rolling blackouts.” The suc-cessful rationing effort then was suspended,with many institutional and regulatory uncer-tainties plaguing Brazil´s energy economy stillunresolved.

The Energy Crisis Commission organizedseveral working groups that labored furiouslybetween June 2001 and June 2002, publishing43 technical and economic “issues for perfec-tion of the sector model.” Few of the 43proposals were implemented until they werecut to six by a new Energy Minister, FranciscoGomide, in hope of getting something done inthe last few months of Cardoso´s administra-tion. Appointed in mid-2002, Gomide is the firstelectricity sector professional to become Minis-ter since Cardoso took office in 1995.

The next government will have to face issuessuch as the continuity of privatization; makingthe new wholesale energy market a commercialreality; ending vertical integration of Brazil´snew natural gas industry, now controlled byPetrobrás, opening the market to competition;compensating for price and exchange fluctua-tions, and clarifying the respective roles ofhydropower, thermal and nuclear generationand alternative energy sources.

The real electricity crisis is structural, aggra-vated by the paralysis of the reform process. TheEnergy Czar returned to his job at the Presiden-tial Palace. Gomide assumed command of theEnergy Crisis Commission, which was relegatedto an advisory role in July 2002. Several pendingmeasures await action by the new Administra-tion and Congress to be installed in 2003.2. Electricity prices: dialogue of the deaf

The story of Brazil´s electricity prices for mostof the 20th Century is linked to the long-termproblem of chronic inflation. Fiscal deficits weresustained by the government´s foreign anddomestic borrowing and by the erosion of thepurchasing power of successive Brazilian cur-rencies. Although Brazil was able to increaseelectricity consumption enormously in recentdecades, the moral of this story, in the end, isthat you get what you pay for. Even if prices forelectricity consumption are kept artificially low,higher costs, including debt service, eventuallywill be paid through taxes.

The political manipulation of electricity ratesbegan with the Water Code of 1934, decreed byPresident Getúlio Vargas (1930-45; 1950-54),empowering the federal government to settariffs. The Water Code limited utilities´ profitsto 10% of the nominal historic cost of theirassets, without adjustment for inflation thataveraged 18% yearly from 1946 to 1961, erodingthe real value of both assets and income.

The Water Code´s impact on electricity sup-plies was delayed because the foreign compa-nies´ generating capacity remained far abovepeak demand until after World War II. How-ever, as surging economic growth and electric-ity demand absorbed excess capacity, longperiods of rationing followed over the next twodecades, even in years of abundant rainfall.

In 1954, the Joint Brazil-United States Eco-nomic Development Commission observed:“At times of serious system overload the powercompany has no option but to disconnectcertain circuits…without warning the powerusers concerned….Tiremakers lose a day´sproduction when such a stoppage occurs, andanother day is required to clean out the machin-

ery. Stoppage of power to glass furnaces cuts offthe air circulation used to cool the walls of thefurnaces, endangering the life and strength ofthese walls.”

The foreign power providers received onlyone rate increase in the two decades afterpassage of the 1934 Water Code, but thegovernment contrived to keep them in thegame by granting preferential exchange ratesand allowing surcharges for specific cost in-creases. But this improvisation failed to per-suade them to invest in new generating capac-ity. Instead, they purchased electricity from thenew government power companies that werebuilding new dams.

Public investment in electricity generationwas so intense that, according to former EnergyMinister Antonio Dias Leite, in sthe ambitiousPlano de Metas of President Juscelino Kubitschek(1956-61) “the energy sector absorbed almosthalf the total budget of this plan, and electricityhalf of that half. In the plan´s execution, electric-ity had priority.”

A tug-of-war ensued between advocates ofpublic and private power. In 1960 John Cotrim,then head of Furnas and a leading advocate ofrate increases, issued this challenge: “Either wedecide once and for all to give to privateenterprise the conditions for survival and ex-pansion, or else the country has to face up to thetake-over of these services by the government.”

In 1962, Eletrobrás, the state holding com-pany, was incorporated, providing the legalstructure for government control of the industrywhile allowing the Light companies to retainelectricity distribution in Rio de Janeiro and SãoPaulo. In 1964, the Energy Minister of the newmilitary government, Mauro Thibau, persuadedthe Finance Minister, Octávio Bulhões, to issuedecrees providing automatic adjustment forinflation of electricity prices and of the value ofassets. “Bulhões was worried about the impactof electricity rates on inflation,” Thibau saidlater, “but I told him that things will be muchworse if we run out of electricity.”

In State Hands

Throughout the world, large hydroelectricprojects tend to be carried out by state enter-prises, producing sudden surges in capacity.There were exceptions, of course. The greatPacific Gas & Electric Co.(PG&E), which filedfor bankruptcy in the recent California crisis,was a pioneer of hydropower systems. How-ever, as recently as 1949, four-fifths of allhydropower capacity, installed and under con-struction in the United States was in governmenthands. During the Great Depression, privateinvestors attacked the dam-building projects ofthe New Deal, fearing that government intru-sion into the power-generating business wouldproduce unmanageable excess capacity. Yet bythe early postwar years there were widespreadfears of shortages. In an article on “The GreatPower Shortage,” Fortune magazine in 1948scolded Congress for cutting the budgets offederal dam projects.

By the 1970s, Brazil´s state companies werecarrying out one of the world’s most ambitioushydroelectric programs, supported by robusttariffs that assured financial viability. These ratesprovided the international credibility that en-abled Brazil to borrow heavily and invest

roughly $70 billion [2002 prices] in 1974-86 tobuild dams and nuclear power plants during theliquidity boom of the 1970s. From 1965 to 1979hydroelectric capacity multiplied five-fold, whileconsumption was growing by roughly 12%annually. However, in the mid-1970s the mili-tary government began manipulating electricityprices in a futile effort to control inflation. By1986, residential rates fell to 22% of their 1974level, from $120 per MW-hour to $26, whileindustrial rates, already heavily subsidized, shrankby 20%-30%. By 1999, residential electricityrates lost 90% of their 1975 value in dollar terms,while industrial tariffs fell by 75%.

The loss of real income, compounded by thesurge of international interest rates in the debtcrisis of the 1980s, led to financial collapse of thestate utilities and truncated their investmentcapacity. Yearly investment in the system fellfrom about US$15 billion in the mid-1980s toUS$4.5 billion in the mid-1990s. Aging equip-ment and installations deteriorated. This kind ofdeterioration in a substation of Baurú, in theinterior of São Paulo State, provoked a blackoutin 13 states in 1999.

A spiral of circular defaults ensued amonglarge electricity consumers, distributors andgenerating companies. The government finallyhad to compensate for mismanaging tariffs witha US$26 billion bailout in 1993 in which thefederal treasury absorbed their debts. After thebailout, state utilities began another cycle ofdefaults until they were privatized.

Brazil still is struggling with the consequencesof the financial collapse of the state system.Throughout the 1990s, Brazil´s overuse of itshydropower resources and its financial inabilityto invest in new generating capacity led to afrightening decline in the water levels of itsreservoirs. Successive governments ignored thewarnings of technicians. A decade ago theFernand Braudel Institute of World Economicspublished a major study, Electricity and ChronicInflation in Brazil, which argued:

The state electricity corporations in Bra-zil are decapitalized and incapable ofexpanding output to meet growing de-mand, which is artificially stimulatedby low tariffs. The deficits of these andother public service companies intensifychronic inflation, forcing the govern-ment to print money to keep them run-ning. Beginning in 1975, the govern-ment eroded the world’s highest electric-ity price structure, destroying its mainmethod of capital-formation and com-pelling it first to resort to foreign anddomestic borrowing and then to infla-tion. Meanwhile, a disincentive to cost-control was created once electricity tar-iffs, the main source of income for thesecompanies, became playing cards hid-den up the sleeve of a magician. But themagic is turning against the magician.Repression of tariffs, manipulated obsti-nately as a way of combating inflation,itself became a main source of inflationand today threatens collapse of Brazil´selectricity supply system.

A decade ago, when our report was written,new technologies were changing the econom-ics of electricity as a result of intensive develop-

Untitled-3 30/9/2002, 10:276

BRAUDEL PAPERS 7

ment of jet engines in the 1980s and the end ofpolitical restrictions on the use of natural gas toproduce electricity. The development of com-bined cycle gas turbines (CCGTs) were cuttingthe cost of thermal generation while low-cost,large-scale river sites to produce hydropowerwere becoming scarcer in Brazil and the rest ofthe world. The CCGTs add flexibility becausethey can be built near power markets, reducingthe need for investment in long-distance elec-tricity transmission.

The International Energy Agency (IEA) ex-pects gas-fired generation to grow, at continu-ously declining costs, to 350% of its currentlevels by 2020 and its share in electricity outputto double, with power demand growing fastest(by 4.6% yearly) in developing countries, mostdramatically for residential and commercialuses. In Brazil, the capital cost of installing akilowatt of gas turbine capacity already hasfallen to $600-$800, within the range projectedby the IEA for 2020 and also below thecapital costs ($1,000-$1,500) for new hy-dropower installations in Brazil. But invest-ment in these plants has been paralyzedbecause energy pricing policy has failed tobridge the gap between the extremely lowcost of electricity from old, amortized butstill highly productive hydro plants and themuch higher cost of fuel to generate powerfrom new gas-fired plants. These newthermal plants must earn faster returns torepay borrowed money and justify theopportunity cost of private investment.

In the words of the Revitalization Com-mittee: “With a mistaken prediction ofexcess supply, future price estimates wouldbe too low, leading to a decision bydistributors –also mistaken—against sign-ing future contracts for part of their de-mand. Thus there would be less incentiveto add new generating capacity, whichneeds long-term contracts to mobilizeproject finance.” At this writing, Brazil isdeadlocked on this issue, with both itsprivatization program and the building of ther-mal plants paralyzed as pressure on electricitysupplies has been relieved by the recent rains.

Brazil may be returning to something like thedestructive wrangling of the 1940s and 1950sover electricity prices between public and pri-vate suppliers. The old debate continues in thestyle of the sterile disputes of medieval theolo-gians and philosophers over the “just price,”without solving any of the institutional prob-lems of Brazil´s future electricity supplies.

The quandary of calculating the “just price” forelectricity has many facets. According to calcu-lations by Peter Greiner, low electricity pricesfor industry in recent years worsened incomeinequalities through irrational subsidies at a rateof US$10-$20 billion per year. Industrial subsi-dies apply to high-voltage consumers, using55% of Brazil´s electricity but paying only 37%of distributors´ revenues. Big consumers werepaying US$22 per megawatt-hour (MWh) whilehouseholds paid US$92. These subsidies forcedstate-owned electricity companies to make low-return investments to meet artificially increaseddemand while freeing private capital to investmore profitably.

The cost of underspricing electricity for bigconsumers has been compounded by the in-vestment inefficiency of state companies that

experience more project delays than privatecompanies and pay 30%-40% more for equip-ment, construction and services. Deficits bredby inefficient investments of state companiesalso contributed to Brazil´s fast-growing publicdebts.

Politicians have been distorting electricityprices by pursuing their own agendas. Congressamended a new law intended to compensateutilities for their revenue losses during rationingby adding a provision that households consum-ing up to 80 KWh per month would get theirelectricity very cheap under a “social tariff,” so70% of residential users in the Northeast payalmost nothing. The financial settlement withutilities is being held up pending litigationattempting to annul the new “social tariff.” Inthis labyrinthine pricing maze, knowing whopays what to support the system is not easy. Atthe retail level, taxes absorb 40% of all charges.

The profitability of Brazil´s retail electricity

network is limited by its low density, in both thenumber of paying consumers in an area and theintensity of consumption. Brazil´s per capitaelectricity consumption (2,000 KWh) is roughlyone-third that of Britain, France and Germanyand one-fifth that of the United States, withtransmission losses three times as high.

Given uncertain regulation and a distortedprice structure, Brazilian electricity distributorsearned net profits on assets of 0.7% in 2000,before suffering large operating losses in 2001because of rationing. This compares with 15%return on assets for Chile´s privatized Chilectraand 10% as the worldwide industry standard.More important, there seems to be little notionof the cash flow for the system as a whole. Is thesystem financially solvent? Who pays for what?Does the system earn enough to meet itsexpenses and invest to satisfy future demand?Or will an under-financed electricity systemfeed a relapse into blackouts, chronic inflationand spiraling public debt?

3. Transmission problems Brazil´s transmission grid is an intricate and

delicately balanced logistical enterprise operat-ing on a continental scale. One of the marvelsof electricity is that people can activate life-enhancing and life-enriching systems with the

flick of a switch, only faintly aware of thecomplex networks that sustain these systems.Many national grids grew spontaneously fromseparate and independent generation and dis-tribution utilities, achieving operational flexibil-ity by linking neighboring systems. Brazil gainedhuge economies by developing a vast transmis-sion network connecting distant points of hy-droelectric generation and consumption. Likegreat cities, national electricity grids may arisespontaneously, but they also demand carefulmanagement and investment to avoid degrada-tion. Professor Paul Joskow of MIT explainedthe challenge for both the continental UnitedStates and Brazil´s system:

The transmission system is not simply atransportation network that moves powerfrom individual generating stations todemand centers, but a complex “coor-dination” system that integrates a large

number of generating facilities dispersedover wide geographic areas to provide areliable flow of electricity to disperseddemand nodes while adhering to tightphysical requirements to maintain net-work frequency, voltage and stability…Afailure of a major piece of equipment inone part of the network can affect thestability of the entire system. Efficientand effective remedial responses to equip-ment failures can involve coordinatedreactions of multiple generators locatedfar from the site of the failure. Finally,there is generally no meaningful directphysical relation between the electricpower produced by a specific generatorconnected to the network and a specificcustomer taking energy from thenetwork….[Within regions] there mustbe a single network operator responsiblefor controlling the physical operation of acontrol area, coordinating generatorschedules, balancing demand for andsupply of generation services flowing overthe network in real time and coordinat-ing with neighboring control areas.

Brazil has taken steps to fill the gaps in itstransmission network that aggravated the

Untitled-3 30/9/2002, 10:277

8 BRAUDEL PAPERS

electricity shortages in 2000-01. However, somekey problems remain unsolved. Under theoriginal restructuring proposal drafted in 1994,transmission on the huge national grid was tobe a natural regulated monopoly, controlledfor the time being by state-owned utilitiesproviding open access to other providers andbuyers, while generation and distribution werebeing privatized. A National System Operator(ONS), a regulated private non-profit corpora-tion, dispatches power between points on thegrid, its decisions based on real time informationflows processed by central computers to coordi-nate hydropower output throughout the grid.

However, the Concession Law passed byCongress in 1995 mandated piecemeal con-cession of additions to the transmission net-work to private bidders, thus tending toBalkanize the system and depriving it ofstandardized management and equipment thatwould make it easier to detect the causes ofpower failures. The recent transmission con-cessions have fallen behind their constructionschedule, largely because of financial difficul-ties. This balkanization was intensified byANEEL´s auction in August 2002, financed byBNDES, of 11 more sections of the transmis-sion grid. The U.S. Federal Energy RegulatoryCommission is moving in the opposite direc-tion in its new Standard Market Design, apply-ing lessons learned in the recent California andEast Coast electricity shortages, to avoid con-gestion and traffic surges by streamlining andfurther integrating transmission between re-gional operators of the national grid.

Under the regime of fixed prices per kilome-ter to pay for transmission services, privateconcessionaires may be tempted to increaseprofits by using lower-grade materials andequipment to lay new lines. ANEEL let bids forprivate concessions for 5,700 kilometers oftransmission lines to interconnect differentregions of this vast country with differentrainfall regimes, claiming that an integratedgrid would enable utilities to save 20% on newinvestments. But the Revitalization Committeenoted “the great difficulties of [obtaining] ana-lytical and computational information for effi-cient planning of transmission and, especially,interconnections between regions in a com-petitive environment.”

Traditionally, the planning group at Eletrobrásdid this job. The group was moved to theEnergy Ministry when its boss, Benedito Carraro,briefly became Energy Secretary in 1999, butwas allowed to disintegrate after Carraro quit

in a dispute with the minister of the day,Rodolfo Tourinho. In early 1999, Tourinhorejected a $500 million World Bank loan thatwould have supported the expansion of trans-mission lines and development of the ONS andthe new Wholesale Energy Market (MAE) as wellas strengthening the ministry´s technical staff.

Since 1999, all three Energy Secretariesstayed in office for less than a year, under thefour Ministers of Mines and Energy whosucceeded each other so far during Cardoso´ssecond administration. The ONS was blamedfor failing to use power from thermal plants onthe national grid in order to stem the drainingof hydroelectric reservoirs during the recentdrought. ONS used calculations based on theoperating costs of hydropower instead of theeconomic costs of electricity shortages.

4. Confused and arbitrary regulationUnder the old system, the state-owned elec-

tricity companies were regulated by the Na-tional Department of Water and ElectricalEnergy (DNAEE), a federal agency of theMinistry of Mines and Energy that set tariffs,authorized use of water resources and grantedand supervised concessions under perfor-mance standards that it established. In prac-tice, the DNAEE could do little to influencestate governors, many of whom siphonedaway funds from the state utilities as “taxadvances,” since the governors controlled thestate Congressional delegations on which fed-eral authorities depended for legislative sup-port. In effect, Brazil had little experience inelectricity regulation when new demands onthe system were created as privatization inten-sified after 1995.

After many months of bureaucratic andCongressional debate, ANEEL was created in1997, two years after privatization was launched,incorporating most functions of DNAEE andthe Ministry of Mines and Energy. The staff ofANEEL, an acronym sometimes ironically iden-tified as the “Association of Employees ofEletronorte,” was drawn heavily from theBrasília headquarters of Eletronorte, the leastefficient of the state companies, under theinfluence of political bosses of Amazônia andthe Northeast.

The ANEEL staff also included lawyers andeconomists without prior experience in theelectricity sector. Members of Congress haveno technical support and show little interest inthe economic implications of their legislativeactions. The federal government delegated to

ANEEL, beyond its role as regulator and super-visor, special powers to “organize public bid-ding and contract concessions for generation,transmission and distribution of electricity….regulate tariffs and establish conditions foraccess to transmission and distribution sys-tems.” Among ANEEL´s many tasks was tosupervise and authorize the activities of theONS and to approve rules for the new whole-sale energy market.

With appointments of senior officials serv-ing fixed terms approved by the Senate, sub-ject to political bargaining, ANEEL accumu-lated 43 different functions. Despite the threatof rationing and blackouts, ANEEL delayedapproval of production of electricity from newprivately owned thermal plants to avoid higherfuel costs, which would have forced rateincreases but would have conserved reservoirsin the face of imminent water shortages. Thisunderscored the Revitalization Committee´swarning: “Since state companies control alarge share of the market for generation, newprivate investments could be inhibited by thefear that public enterprises would adopt a mixof `old´ and `new´ electricity to be sold atlower prices than the marginal cost of outputfrom new plants.”

Of 287 new power plants authorized byANEEL, 179 have fallen behind in their con-struction schedules. Work never started onmost thermal plants. The TCU attributed “thescarcity of new private investment in newgeneration projects” to “vagaries in the regula-tory framework, as well as its lack of consoli-dation and stability.”

5. Privatization stalledAccording to the IEA, most of the three million

MW of new generating capacity to be installedworldwide over the next two decades wouldmeet the needs of poorer countries, whereinvestments in new plant would total $1.7trillion. Over the past two decades, despite bothchronic inflation and the debt crisis, Brazil wasable spectacularly to double its generating capac-ity to roughly 80,000 MW today, with dams onmore than 140 river sites. But now the govern-ment clearly has neither the credit nor the savingsto continue these investments, which grow inscale as the system becomes larger.

Public debate fails to focus on how thefuture expansion of electricity supplies canbe supported financially. Institutional weak-nesses, aggravated by ideological disputes,increase the danger of market failure and

Untitled-3 30/9/2002, 10:278

regulatory failure as well as the cost andperceived risk of private investment.

As Brazil developed a hydroelectric monoc-ulture, it failed to diversify its power supplyrisks. As demand grows, this monoculturetends to limit supplies, especially in droughtsand consumption peaks, intensifying the risksof rationing and violent price fluctuations. TheInter-American Development Bank warns:

A growing market and reliance on hy-droelectric resources makes an energyconstrained system more of a norm thanan exception, exacerbating price vola-tility. The lack of human resources, theweakness or lack of institutions to over-see and regulate competition, and theambiguous role for the judiciary makedifficult the oversight of competition andthe enforcing of other regulatory measures.

These risks of hydroelectric monoculture canbe reduced by creating sufficient reserve capac-ity in the system, drawing partially on thermalgeneration, with clear rules to avoid suddenprice fluctuations. On the other hand, invest-ments in renewable hydropower offer hugeadvantages because of their longer useful lifeand lower operating costs, without the airpollution caused by oil, coal and gas.

Over the past decade, Latin America led theworld in privatization of its power systems. Inthe 1990s, Latin America absorbed 40% of the$193 billion invested in private electricity projectsin developing countries. Privatization in Brazilwas concentrated in distribution companies.Key buyers paid very high prices during thefinancial boom of the 1990s, justified by the highprofit margins embedded in the distributiontariffs. However, they now are having troubleservicing the loans that financed these pur-chases.

According to Abradee, the distributors’ as-sociation, regulated electricity rates rose by141% between May 1994 and May 2002, whileprices of telephone service and bottled gasincreased respectively by 445% and 400% andBrazil’s currency depreciated by 242%. OnSeptember 3, ANEEL shocked the industry bydecreeing that scheduled tariff reviews fordistributors will be guided by the depreciated

BRAUDEL PAPERS 9

stock market value of assets instead of theirminimum price at privatization auctions, hand-ing investors a capital loss of some $5 billion aswell as erosion of current revenues.

Meanwhile, prices for electricity generation($25-$28/MWh) remained far below the costs ofexpanding capacity, offering little profit forprospective buyers to privatize sstate generat-ing companies. Most potential buyers of thesestate companies now are heavily subsidizedhigh-voltage consumers, in industries such asaluminum and heavy chemicals. Under presentprograms, these large consumers will graduallylose their subsidies beginning in 2003, as con-tracted generation will be freed yearly for publicbidding in increments of 25% through 2006.

The Brazilian privatization program now hasstalled, along with the privatization wave thatswept through Europe and Latin America in the1990s. The debate on public vs. private owner-

ship of electricity production and distributionwhich began in the 1950s, remains unsettled. Itsubsided in the decades of state control (roughly,1965-95) only to be revived during privatization.. There is consensus on the need for privatecapital because the government lacks the finan-cial capacity to invest in large-scale electricityprojects to meet future demand. But privatepower companies are unwilling to invest in theabsence of electricity prices that provide anadequate return on capital employed and ofclear legal and regulatory rules providing stablebusiness conditions.

Under the privatization program, governmentgeneration and distribution companies weresold to private investors to raise US$21 billionmainly to service public debt, of which US$17.5billion came from sale of state utilities and onlyUS$3.5 billion from sale of federal companies.Privatization began even before a regulatorystructure was established by law and organized.While some 65% of the distribution networkwas privatized, the main exceptions being thestate companies of Minas Gerais, Paraná andSanta Catarina, only about 15% of generatingcapacity was sold.

Since 1999, little or no progress was made indefining the new role of Eletrobrás and indrafting and applying regulations for the newmarket-oriented model. In the panic and confu-

sion of electricity shortages, aggravated by aseries of contract defaults by major public sectorsuppliers, distributors were paying spot pricesin the wholesale energy market that fluctuatedwildly, from R$5 to R$684 per megawatt-hour,before spot trading collapsed during rationing.

The confusion in the electricity market wascompounded by sudden depreciation of Brazil’scurrency during the pre-election financial panicof July 2002, reducing it to 30% of its 1998 dollarvalue. A cheaper real made imported electricity,priced in dollars, much more expensive. Utili-ties lost money on power from the bi-nationalItaipú dam and previously contracted “take-or-pay” imports from Argentina, for which a newtransmission line recently was built.

Foreign investors have curtailed capital spend-ing. Some are trying to withdraw from Brazilbecause of low return on their assets and theconfusion in Brazil´s decision-making process.

Privatized distributors suffered big foreign ex-change losses because of three surges of cur-rency devaluation since 1999 and big revenuelosses during rationing in 2001 and as demandstayed at historically low levels in 2002. BothEnron and AES paid very high prices forBrazilian distribution companies, but now mustexpect much lower prices from their efforts, sofar unsuccessful, to sell these assets. Enron wastrying to unload its Brazil properties early in2000, nearly two years before its scandalousbankruptcy. Enron´s collapse, involving ac-counting and trading fraud, shook world finan-cial markets and especially the electricity sector.It came only weeks before the political andeconomic failure of Argentina, also impactinginvestors in Brazil.

Among the casualties of these crashes wasAES, with power plants and distribution com-panies in 33 countries, owner of Eletropaulo,the huge São Paulo distributor, and othermajor Brazilian utilities. Burdened by debtsincurred in dollars to finance its aggressiveacquisitions that concentrated half of its world-wide assets in Latin America, with severecurrency devaluations cutting returns on thoseassets, AES saw its stock price fall from $70 inOctober 2000 to $1.77 in July 2002 and itsbonds downgraded to junk status. Comment-ing on AES efforts to get out of Latin America,

Untitled-3 30/9/2002, 10:279

10 BRAUDEL PAPERS

Bear Stearns, an investment bank, observedthat “there are no buyers for most of thecompany´s high risk/underperforming assets”in Argentina, Brazil, Venezuela and Colombia,adding that “possible AES asset sales imply aworsening supply glut that could undermineprivatizations in 2003 and beyond.” Eletropaulo/AES was saved from default on $120 millionin foreign bonds, which would have plungedBrazil deeper into financial crisis, by a last-minute payment by BNDES in long-delayedcompensation for revenue losses during ra-tioning. Eletropaulo´s debt to its pre-privatization retirement fund, Fundação CESP,is R$3 billion, or twice its market capitalization.

Eight privatized utilities, with debts totaling$4 billion and annual revenues of $5.9 billion,are now for sale. Brazilian power companieslost $800 million in the first half of 2002, withtwo-thirds of these losses incurred by CESP,the São Paulo state utility that now owes $1.8billion. Electricité de France (EDF), unable tocollect $200 million in unpaid consumer bills,is trying to sell its giant Light distributor in Riode Janeiro. Pennsylvania Power & Light (PPL),which bought a utility in the Northeast state ofMaranhão, is walking away from a $300 mil-lion investment with half of its monthly billingsunpaid and an 83% customer delinquencyrate. The Companhia Energética de Maranhão(CEMAR) is being run by a receiver named byANEEL. With so many privatized utilities forsale, representing foreign investment of morethan $12 billion, opportunists are fishing forbottom-of-the-barrel prices. Mighty Petrobrásis now a scavenger of wrecked foreign invest-ments and ambitions in Brazil, Argentina andBolivia, including most of Enron´s properties.Other privatized utilities may fall into thehands of the BNDES or private Brazilianinvestors.

The newsletter Global Power Report ob-served in May 2002 that “the stream of compa-nies retreating from overseas markets hasturned into a stampede.” Robert J. Munczinski

dustry always depended on international fi-nance to expand and diversify capacity toensure security of supplies. Market failure andregulatory failure are forcing Brazil to strugglewith institutional weaknesses that limit theviability of investment. Under both private andpublic ownership of utilities, Brazil needs astable and effective legal framework and astructure of electricity prices that create condi-tions for markets to work and for levels ofinvestment to produce future supplies. Elec-tricity is so critical to civilization as we know itthat the price of adequate supply is muchcheaper than the disruption and confusionproduced by chronic shortages.

Under the new government that takes officein January 2003, political time and space willhave to be allotted for regulatory and institu-tional stabilization that would create condi-tions for more private and public investment.Private investors have been discouraged byarbitrary breaches of contract by the stategovernments of Minas Gerais, Pernambucoand Bahia after receiving privatization pay-ments. In coming years, state corporations willplay a key role in expansion of capacity, rasiingprices for low-cost generation to finance in-vestment.

Federal and state electricity companies em-brace a wide range of corporate behavior. Theprofessional excellence of CEMIG in MinasGerais, COPEL in Paraná and the federal utilityFurnas contrasts with the overstaffing andinefficiency of state distribution companies inSão Paulo, Rio Grande do Sul, Mato Grossoand the Northeast, undermining the financialstructure of the electricity sector by chronicdefaults on payments to generating compa-nies. Many state utilities, together with state-owned banks, formed a nexus of corruptionand illicit funding of political campaigns thatcontributed to fiscal deficits and public debt.State banks and utilities were privatized inwhat was essentially a bankruptcy proceduremanaged by the Finance Ministry and theBNDES under the Cardoso Administration torefinance state debts. A danger of moreprivatization failures, akin to that of CEMAR inMaranhão, would be a relapse into the oldways of running state companies.

6. Petrobrás and the natural gas economyIn the disorder of Brazil´s energy policy, the

skilled and focused bureaucracy of Petrobrás,with its historic legal monopoly, usually couldget its way with politicians. An example of thisinfluence is the ability of Petrobrás to turn to itsown advantage its failure to modernize itsrefineries, part of its investment program sincethe 1970s.

In 1985, as two decades of military rule wereending, the Association of Petrobrás Engineersreported to the incoming civilian government:“Our refineries are aging and in many cases areobsolete. At times their maintenance is precari-ous…. With greater use of natural gas, largequantities of [heavy] fuel oil would becomeunusable surplus that cannot always be soldabroad because the world market is gluttedwith this product, almost always sold at de-based prices.”

In May 2002, the head of the NationalPetroleum Industry Organization (ONIP)warned of a “refinery blackout” in four or five

of BNP Paribas said that“it is very difficult tofinance on a hard cur-rency basis transactionsthat generate a local cur-rency cash flow.” CarolMates, counsel for theInterrnational FinanceCorporation, a branchof the World Bank,added: “Only in the last10 years have we as acommunity been fi-nancing private projectsin emerging markets.One thing we all areappreciating now is thatwhen you have a pri-vate provision of a pub-lic service, you cannever get out of thatcountry. The end usersare paying you in localcurrency, and you havethe macroeconomic riskof the whole countryand the whole system.To a certain extent, youare really stuck. Can this

country support its currency? That´s a differentissue than one faces in a domestic deal.”

The confusion in Brazil finds a parallel in theUnited States. In both countries, power short-ages in 2001 became surpluses in 2002. Therecent uncertainties in the United States, dra-matized by the California emergency, showshow sudden disruptions and changes of direc-tion can appear. With generating capacity(700,000 million MW) roughly 10 times biggerthan Brazil´s, the United States added 100,000MW of new capacity since 1997, but another125,000 MW of announced projects werecancelled or delayed indefinitely as financingwas shut down because of the end of the stockmarket bubble and the scandals surroundingEnron and other energy companies.

Many companies are selling assets. Regula-tors are considering a freeze on further deregu-lation. The federal government is investigatingelectricity-trading practices. California is tryingto break long-term contracts signed underduress in 2001 to secure electricity at very highprices. According to Vincent Duane of Mirant,“electricity is a volatile commodity. If it is to betraded in the wholesale market, there is atremendous need for risk management. Theelectricity market is not as liquid and efficienta market as the market in other commoditiesbecause of the physical dimensions to it….The political climate at the moment favorsthose forces that have not traditionally sup-ported change and innovation. You are evenseeing a renaissance of public power andmunicipalization in some areas –places likeNew York—that we have not seen for sometime.”

Living with Instability

So Brazil is going to have to live with thisinstability and to manage its consequences.There may be tradeoffs between energysecurity and efficiency. Under both privateand public ownership, Brazil’s electricity in-

Untitled-3 30/9/2002, 10:2710

BRAUDEL PAPERS 11

years, forcing Brazil to import petroleumproducts worth $4-$5 billion annually, if atleast two new refineries are not built at acost of $2 billion each. Yet a worldwideglut of refinery capacity, with low valueadded, led Petrobrás and many othercompanies to prefer trading in oil prod-ucts to investing in new refineries.

The government´s 43 pro-posals for reform failedto mention the Petrobrásmonopoly over gas sup-plies, which are neededif generation is tocomplement hydro-electric monocul-ture. Petrobrásgained a large shareof Bolivia´s gas re-sources by buying intoproducing fields and build-ing the $2 billion pipeline from Corumbá, onthe Bolivian border, to São Paulo and PortoAlegre. The pipeline operates at only 40% ofcapacity because of high transport charges,lower electricity demand and failure to de-velop the Brazilian gas market. Petrobrásblocked open access to the Bolivia pipeline forother gas producers, violating a provision ofthe World Bank loan contract to finance theproject.

Natural gas in Brazil, although expensive forthermal electricity generation, could competeagainst fuel oil for furnaces and large heatingand refrigeration installations, in ovens formaking steel and glass in industry and inhomes for air conditioning and bathroomshowers. This potential market for gas hasbeen undermined by the cheapness of low-grade fuel oil from obsolete Petrobrás refiner-ies, discouraging investment in local gas distri-bution networks and in more efficient indus-trial equipment using gas.

Since Petrobrás itself became a major sup-plier of natural gas, it has been modernizing itsrefineries to reduce its production of heavyfuel oils in recent years. But the market forelectricity from gas-powered thermal plantssuddenly shrank in the new surfeit of hydro-power created by the rains that followed thedrought of 2000-01, leading Petrobrás andprivate investors to curtail their programs ofbuilding thermal plants.

A stable institutional environment is neededto provide secure, long-term electricity sup-plies from different energy sources, overcom-ing today’s investment risks. Under presentconditions, nobody knows how future invest-ments in generation, transmission and distri-bution capacity will be made.

A False and Needless Dispute

A false and needless dispute persists betweenthose who believe that either public or privatepower must prevail. Both are needed. We alsoneed clearer operating rules, better regulationand a market that works, independently ofideological constraints.

Brazil lacks the savings needed to financeby itself the growth of electricity suppliesneeded for the coming decades. Its publicsector lacks the financial capacity to makethese investments. Also, state power compa-

nies havebeen payingmuch more thanthe private sector forequipment, construc-tion and support ser-vices.

These inflated invest-ments shrank Brazil’scapital stockand increasedpublic debt.Gene rou sp e n s i o n sand subsidies madepublic power even morecostly. Yet political andbureaucratic resistance and uncertainties infinancial markets make total privatization ofthe state electricity sector unlikely for the timebeing. Meanwhile, the government’s target ofincreasing generating capacity by 26,000 MWby 2004 has been cut in half.

Brazil needs foreign investment, but it can-not depend wholly on foreign investors todevelop and manage secure electricity sup-plies. With its weak regulatory structure,Brazil would be an easy victim of the kind ofmarket manipulation and accounting fraudsby private energy companies such as Enron,Reliant, El Paso, CMS and Dynegy discoveredrecently in the California electricity shortages,despite several decades of industrial regula-tion in the United States.

According to a Wall Street Journal sur-vey: “Energy companies seized on loop-holes and local shortages to charge priceshundreds of times higher than normal.Suppliers withheld power from the state´sprimary market, and sometimes idledpower plants to induce shortages andboost power prices. Gas companies ma-nipulated supplies and prices, driving upthe cost of a main ingredient of electricity.Enron played a much bigger role thanpreviously believed in California´s energymarket. Its trading strategies overwhelmedregulators and drove up prices" Reformulation of energy policy in Brazilcomes during retrenchment of privatizationworldwide, especially in the electricity andtelecom sectors, with project cutbacks, bank-

r u p t -c i e sa n dconsoli-dation by

mergers be-coming common.

So foreign investors are tryingto sell their Brazilian holdings, be-cause of regulatory/political prob-lems and market failure in Brazil or

financial pressures at home. Brazil needs a balanced policy of well-regulated electricity companies under bothprivate and public ownership. Efficient statecompanies could still absorb 20%-30% of themarket, in both generation and distribution,avoiding regional monopolies. State compa-nies should be organized as competitive andprofessional organizations, protected frompolitical manipulation. Competing in a freemarket would help these state utilities togain efficiency.

Brazil must learn to live with the uncertain-ties of both public and private ownership ofits electricity complex while guaranteeingsecurity of supplies. Progress can be madeonly by keeping the goal of security in mind,by developing clear and enforceable rulesand by creating adequate incentives forinvestment and production.

Energy security comes at a price. But thecost of not paying the price could be muchgreater, in the form of chronic power short-ages and degradation of the fabric of Brazil´seconomy. The real causes of the blackout inenergy policy lie not in rainfall or reservoirs,but in the weakness of Brazil’s public insti-tutions, incapable of making effective strate-gic decisions on the future of a complex andfast-changing society. In all countries and atall times, institutions tend to lag behindtechnological development.Brazil gained sta-bility and progress over the past decade bystopping chronic inflation. In coming yearswe must build on this progress by investingmore and strengthening public institutions,especially in the critical areas of education,public security and electricity.

Untitled-3 30/9/2002, 10:2711

Here are some ideas for discussion on how to strengthen publicinstitutions for achieving more security of electricity supplies:

1. Energy policy is ultimately a Presidential responsibility. The decision-making process should be strengthened by increasing the powers of theEnergy Ministry, under Presidential supervision, and by removing it fromcoalition politics. The goals can be achieved by only appointing qualifiedprofessionals to top positions, including that of Minister.

2. The National Council for Energy Policy (CNPE) was established by thePetroleum Law of 1997 and lapsed into inactivity shortly after its regulationswere approved in 2000. Recently revived by the new Energy Minister, theCouncil should be supported by a qualified staff to plan for contingenciesand to produce an overall flow-of-funds analysis of the electricity sectorevery two years for submission to Congress and the President. The Councilshould have powers to subpoena information from market participants,including ANEEL.

3. With information provided by the Ministry and the National EnergyCouncil, the government should publish a 10-year energy plan in the secondyear of each administration, to be approved or rejected without amend-ment by Congress. The plan should state invest-ment needs, identify prospective sources of fundingand outline a set of economic signals and incentivesneeded to attract investment.

4. The administration that takes office in 2003should propose to Congress a new Energy Code toreplace the Water Code decreed by Getúlio Vargasin 1934. The new Energy Code should be drafted bya commission of five leading specialists in energypolicy, supported by a small staff with expertise ineconomic and legal aspects of electricity, who wouldconsult extensively with producers, distributors andconsumers. The new Code should authorize con-tracts in foreign currencies, with electricity prices andasset values to be readjusted for inflation. The newcode should provide a sound legal framework forcompetitive pricing and clarify basic concepts ofexisting legislation on public service, financial ac-counting and profitability. The new code also shouldbetter define the roles and responsibilities of publicagencies such as the Energy Ministry, ANEEL, Na-tional Council for Energy Policy (CNPE), NationalPetroleum Agency (ANP), Eletrobrás and Petrobrás.

5. The professional staff of the electricity industry and its regulatoryagencies badly needs renewal. An Institute for Higher Energy Studies shouldbe established, with curricula in specific areas of engineering and economics.Directors and senior technical staff of regulatory agencies and stateenterprises should be required to pass rigorous competitive examinationsadministered by the Institute. This system of advanced study and examina-tion would qualify professionals for salary supplements to guaranteeincomes competitive with equivalent jobs in the private sector. Also, theseprofessionals would participate in exchange programs with regulatoryagencies and utilities in other countries, involving periods of residenceabroad.

Congress should create a Joint Committee on Energy Policy, supportedby a permanent staff of graduates of the Institute for Higher Energy Studies,to review new legislative proposals and monitor developments in planning,finance and supply in energy industries.

Further privatization of generating companies should reduce their marketpower to create effective competition, with state utilities keeping assetsneeded for water flow regulation as instruments of public policy.

6. Distribution companies should increase their long-term supply con-tracts from 85% to 95% of estimate needs, as proposed by the RevitalizationCommittee, with standby reserve capacity of 12% contracted mainly withthermal plants. Long-term contracts are needed because financial marketsrequire firm commitments to support project finance.

7. Instead of open bidding for each new project on the interconnectednational grid, there should be at most one transmission company, public orprivate, for each geographic region. Transmission companies should becarefully regulated, within international standards of employment ratios fortheir workloads, under a rate structure sufficient to support financiallyinvestment and maintenance responsibilities in their areas.

8. In 1995 all electricity concessions were renewed for 30 years, withpossible extension in 2025 for another 20 years. The government will beexposed to intense political pressure in 2025 to renew all concessions atonce, incurring huge economic losses while concessionaires reap windfallprofits after a short payback period for project finance over 10-15 years. Themaximum term of future concessions should be 25 years, renewable at 10-year intervals subject to pre-established performance criteria and increasedroyalties upon renewal.

9. Tariffs for generating electricity should be raised to compensate for thebig fall in the share of generating companies in revenues of the system duringdecades of chronic inflation. This increase would make thermal plantsfinancially viable, facilitating further privatization, and would remove exces-sive subsidies to large industrial consumers.

10. To avoid windfall profits to older hydroelec-tric producers, the large gap between generationcosts of amortized hydropower stations and newthermal plants would be breached by an equaliza-tion tax, to be revised every 10 years in line withevolution in costs and technologies, on electricitygenerated by hydro plants more than 10 years old.In addition to making new thermal plants morecompetitive, the equalization tax would raise gov-ernment revenues, permitting tax reductions inother areas, and would help to rationalize con-sumption patterns.

11. A competitive gas market is needed foreffective competition in electricity generation. Fora competitive gas industry to develop in Brazil, thevertically integrated Petrobrás monopoly of pro-duction, transport and distribution of gas resourcesof Brazil and Bolivia must end. Under presentcontracts, Petrobrás forbids distributors from re-sale of gas, thus blocking development of a second-ary market. To allow competition, Petrobrás mustdivest itself of majority ownership of the Brazil-

Bolivia gas pipeline and, in two or three tranches, eventually auction off 60%to 70% of its intake from the Bolivian gas fields that it owns wholly or partially.The World Bank loan that financed the project requires this divestiture.Instead, a new independent company should be formed to transport gaswith open access to all producers and consumers, including Petrobrás. Theprice of gas is inflated by the cost of financing the politically-inspired anduneconomic decision of the government in the mid-1990s to extend theBolivia-Brazil pipeline to Porto Alegre in the far south of Brazil. The federalTreasury could reduce the price of gas by assuming part of this debt service.Reducing this debt burden also would enable Petrobrás or any future ownerof the pipeline to lower the gas price by modifying “ship or pay” contractswith distributors and thermal plants, lowering compulsory transportationpayments from the 95% of contracted gas nearer to the 75% in current“take or pay” deals.

12. Distributors must contract for additional power supplies toprovide a margin of security above projected peak demand, with someof these marginal supplies purchased from thermal plants. Long-termcontracts are needed because it takes at least two or three years tofinance, develop and build a thermal plant, with costs recovered overroughly 15 years.

13. Electricity conservation in Brazil is still in its infancy and should beintensified. Rationing in 2001-2, cutting demand by 20%, suddenly demon-strated the huge economies to be harvested from reducing waste.

Brazil can do better

BRAUDEL PAPERS 12

Untitled-3 30/9/2002, 10:2712