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Recent changes and new opportunities in the Brazilian electricity sector

Important regulatory changes and subsequent challenges have dominated the headlines in the Brazilian electricity sector news in recent years.

A series of measures adopted by the Government to renew power generation and transmission concessions and to reduce energy prices in 2013, cumulated with the severe drought affecting the hydrology levels on Brazilian rivers in 2014. This led to significant rises in energy prices and to an unprecedented cash flow shortfall affecting the vast majority of sector companies.

But equally or even more relevant are the innumerous opportunities that arise from this scenario. After the energy spot market prices reached an historical target of approximately US$315/MW in 2014, and as the Government continues to dismiss any rumours of rationing programs, the power production and trade sectors continue to be attractive to investors. Indeed, despite slow economic growth, energy demand in Brazil grows firmly at a 4% annual rate, showing that high demand for energy is likely to increase even further as the industry recovers.

The country's strong reliance on hydro energy sources, which currently represent 68% of the Brazilian electricity matrix, needs to be reviewed. Consequently other renewable and thermal sources are on the rise as promising alternatives to investors.

The Brazilian Government Ten-Year Energy Plan launched in December 2014, for instance, foresees the growth of wind energy supply in the national electricity matrix from 1.1% in 2013 to 8.1% in 2023, representing approximately additional 20GW worth of new wind power capacity.

The newly appointed Minister of Mines and Energy has also recently promised to simplify environmental licensing procedures, which could boost thermal and small hydropower projects in the next few years, and could also allow several interrupted projects to be resumed.

Three new energy auctions have been announced for 2015. The "Renewable Energy Auction", to be held on April 27 2015, has already received 530 wind power project proposals, totaling 12,865MW, and 40 biomass projects, amounting to 2,067MW. An "A-3 Energy Auction" will also take place July 24, 2015, welcoming the submission of proposals for new hydroelectric, thermoelectric, biomass and wind energy enterprises by February. Finally, there will be an "A-5 Energy Auction" for hydroelectric and thermoelectric energy projects to be held on April 30, 2015. Proposals were due by the end of January.

The solar energy market is taking its first steps towards becoming an economically viable renewable source in Brazil. The sector has been developing as more energy auctions provide opportunities for investment in future solar projects, and micro and mini generation projects are stimulated by the Government. In addition, the Brazilian Development Bank (BNDES) offers a credit line specifically for solar projects.

In parallel, distribution may also provide new investment opportunities, considering that there are 33 concession agreements about to expire in 2015, representing approximately 4GW of contracted energy. As the rules for renewal or auctioning of such concessions are yet to be announced, it is still uncertain whether current concessionaires will be able to maintain their agreements or whether such distribution concessions will be auctioned to new interested parties.

Meanwhile, opportunities for mergers and acquisitions in the power sector are presenting themselves, especially in light of the current financial situation of the distribution companies, which have already contracted loans in excess of USD 6.5 billion in order to secure the settlement of their energy purchases until October 2014 and are now seeking additional USD 960 million to settle the accounts of November and December 2014.

A recent governmental announcement stating that energy tariffs from now on should reflect "real tariffs", meaning that increases in energy prices for distributors would be immediately passed through to consumer tariffs, alleviating the cash flow issue aggravated in 2014 by the Government's political decision to hold off increases to consumer electricity tariffs may also come as a further incentive to investments in the distribution area, and should be very well-received by financial institutions interested in financing this sector.

Finally, in view of high energy prices, independent energy production has also become an attractive alternative for large corporations wishing to produce their own energy instead of purchasing from other producers. Under these regimes, a company may consume the energy it generates (securing their demand and benefiting from certain tax incentives), and selling the excess to the market. Likewise, unused energy arranged in long-term contracts may now be re-sold in the spot market, as allowed by recent regulation to incentivize large consumers to negotiate their excess energy.

As the demand for electricity continues to rise, so will investment opportunities in the Brazilian electricity sector, ranging from renewable and thermal energy projects to distribution and transmission concession agreements, and including energy trades in the spot market creating a favourable market for mergers and acquisitions.