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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Brazil Aims To Privatize State-Owned Utility Company

Brazil

Imagine the setting. A conference room full of senior politicians. "The tapes are bad",
one says. “A lot of stuff about bribes”. Another adds, "Yeah, and we're polling in the single digits. Any lower and we'll resemble Japanese interest rates". A conference room deep in the bowels of the White House in Washington, DC? Nope. Brasilia, Brazil.

The scope of the Brazilian scandal, called locally “Lava Jato” (Car Wash), is truly impressive. It may encompass two former presidents, the sitting president, the heads of both houses of Congress, ninety lawmakers and one third of President Temer’s cabinet. Twenty different political parties implicated in this scandal in which bribes paid allegedly amount to two billion dollars.

But, despite the disorder caused by the corruption charges, President Temer is desperately trying to stabilize the wobbly Brazilian economy and get the government’s finances in order. One key measure: privatize a vast swath of the Brazilian economy now held by the government, selling off the mint, the state bank’s lottery unit, the federal savings and, most significantly to us, the government's interest in the country's largest electric utility, Electrobras.

In response to this news, the shares of Electrobras responded "modestly" with a 50 percent intra-day gain. A gain that a typical utility investor might expect over 15 or more years. If nothing else we suspect the Temer administration just picked up a few friends in the investment community.

The government hopes to realize twenty billion reais or $6.4 billion from the Electrobras stake alone. Aside from raising desperately needed funds, the government hopes to free the economy from government interference.

As part of another announcement, the government wants to require that the state development bank, BNDES, base its standard lending rate on the government Treasury five-year bond rates starting in January, thereby reducing BNDES’ freedom to hand out subsidized loans.

The government of Michel Temer, deeply unpopular, has little time to get these measures accomplished. The presidential election next year will end Temer’s tenure.

The next administration and Congress may have less sympathy for this proposed "reform" package. And former President, Lula, who impeded privatization efforts 12 years ago has just begun campaigning again for a return to power.

Regardless of eventual ownership, Eletrobras controls transmission lines and electric generating plant throughout Brazil, as well as owning power distribution companies which are now being sold. Eletrobras accounts for almost one third of Brazil's power generating capacity and almost one half of the nation's high voltage transmission network.

Those percentages include Brazil's share of the Itaipu hydroelectric project which is owned by the government. Power output for a nation this size is surprisingly low in CO2 production due to the predominance of hydro, some nuclear and renewables. Fossil fuels account for roughly 10 percent of total Brazilian electricity output. Related: Russia’s Comeback In The LNG Race

We should add that the government's official announcement regarding the impending sale of Eletrobras made clear that “there is no definite model of how the [privatization] will take place.” And we would add there may not be for quite some time. But we can speculate given previous experience with privatizations both in Brazil and elsewhere:

First, there are too many legal obstacles to removing Itaipu or the nuclear plants from government ownership although Eletrobras may continue to operate them. So, the government will not get out of the power business.

You can find Leonard Hyman's lastest book ‘Electricity Acts’ on Amazon

Cost of capital for transmission and generation will rise because the privatized Eletrobras will move out from under the government's low-cost debt umbrella. BNDES would not subsidize this former government entity as before, either. And for this soon to be privatized utility, more competition increases risk and, in turn, adversely influences the cost of capital.

Cost of capital may make up 40 percent or more of the costs of hydroelectric power generation, renewables and nuclear generation and of transmission. The bottom line? Higher electricity prices for the nation over time. Not necessarily immediately, though.

Neither British nor American advocates of privatization and deregulation devoted much in the way of thought to cost of capital. This still surprises us given that it is such a large part of the electric utility cost structure. But anyway, the British pretty much concentrated on getting the money from the sale of its utilities, not costs to consumers afterwards. Why should the Brazilians be different?

Presently Brazil holds auctions to determine who builds and owns power generation and transmission assets. Lowest cost bidders receive contracts to supply wholesale power. Higher capital costs will disadvantage local, Brazilian bidders on power and transmission projects. State owned utilities backed by national treasuries, on the other hand, may put national interests over cost of capital. Chinese state companies, for example, already have beaten local firms by bidding low on transmission and bidding high to buy private assets. They own the largest investor owned utility in Brazil and transmission assets. They gain competitive advantage when their competitors’ capital costs rise.

Unless Eletrobras is truly broken up, the Brazilian power generation and transmission sector remains relatively concentrated. This is not a good omen for competition. (São Paulo state, in fact, was considering stripping some dam concession away before selling its electric generating company.) Privatizing the market for electric power generation with too few competing generating companies was one of the biggest mistakes made by Thatcherites in the UK. That near monopolistic market with just two or three players hobbled the development of real competition for years.

Despite having enormous wind, solar and biomass resources, Brazil uses far less renewable energy (excluding hydro), proportionately, to produce electricity than fog-bound, England. Renewable growth in Brazil, mind you, has been rapid. But renewables still amount to a small fraction of output and far less than other similarly advantaged countries. That picture could change however.

For the first time, newly liberated power generators will face real, unsubsidized capital market conditions. This may alter views of huge dam projects that engender opposition from indigenous groups and environmental activists. With respect to adding generating capacity, smaller, quicker and "greener" and may become the new management mantra.

To some extent, Brazil’s slow embrace of renewables (relatively speaking) may prove an advantage. The newest technologies are more efficient than their immediate predecessors. Related: Looming Gas Shortage: “Imports Can’t Make Up For This”

Renewables need energy storage to complement them. And Brazil has the perfect "storage battery" complement for its new renewables. Its vast hydro system. A hydroelectric system, with its rapid dispatch capability is really one big, water powered storage battery. As long as there's no drought you're in business.

Eletrobras’ management has indicated that its strength lies in power generation, both big hydroelectric and nuclear operations. Conceivably it might even cede the renewable field to others in order to reduce its dominance in the market place.

We would not be surprised if the Brazilian market for renewables, given the uniquely positioned hydro assets, becomes one of the most important in the world.

You can find Leonard Hyman's lastest book ‘Electricity Acts’ on Amazon

By Leonard Hyman and Bill Tilles for Oilprice.com

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