Brussels / Du sseldorf / Hamburg / London / Manchester / Munich / Paris / Shanghai / Silicon Valley / fieldfisher.com THE BRAZILIAN POWER MARKET: An Interesting Investment Regime for Onshore Wind and Solar Power? April 2016 1 The Brazilian Power Market 1. Introduction Power generation from renewable sources has always played an important role in the Brazilian electricity matrix, which has been until now, mainly reliant on hydro power generated by large-scale hydroelectric plants. Following a power supply crisis due to prolonged dry seasons that affected water basins, the Brazilian electricity market was redesigned by a legal reform in 2004. With this, a regulated market was created in which distribution utilities contract their demand at power auctions based on long-term power purchase agreements (herein "PPAs") awarded to generators on a lowest price basis. The PPA secures the sale of energy generated over a certain period for a fixed price adjusted annually to the inflation rate, thereby ensuring a steady income flow for power projects. This auction-based mechanism is the main instrument to promote investments in onshore wind and solar power generation in Brazil today. The regulatory framework allows the federal government to strategically indicate the kind of renewable sources eligible to participate in auctions taking into consideration the national renewable expansion targets. Power auctions may take place both at federal and state level. Along with the auction-based scheme, there is also a feed-in-tariff scheme (herein "FIT scheme"), recently introduced to incentivize distributed power generation from solar plants with up to 30 MW installed capacity. 2. Some background information In Brazil's electricity matrix, power generation from renewable sources has a predominant share of 74.6% today. The bulk of it, 65.2%, is accounted to hydro power generation.1 However, the integration of further renewable sources such as wind and solar energy in the Brazilian power system is most sensible not least because of their great ability to contribute to supply security.2 These sources are able to complement hydro power generation by compensating for lower hydropower generation during the prolonged dry seasons that may occur. Conversely, hydroelectric power plants can be flexibly operated so as to back up solar and wind power generation tackling a recurrent intermittency issue around it.3 3. The positive impact of the auction-based system on onshore wind and solar power development Since the 2004 electricity market reform, the auction-based scheme has led to more investments in renewable sources other than hydro power and, as a consequence, to greater diversification of the electricity matrix. 72 GW of new generation capacity, including 46% from hydropower and 29% from other renewable sources, were built in the country over the period between 2005 and 2013.4 The first successful onshore wind-exclusive auction took place in 2009, in which 1,805.7 MW in PPAs were awarded to investors.5 Nowadays, onshore wind power total installed capacity amounts to 8,486 MW, what makes up a 5.97% share in the electricity matrix.6 In contrast, solar power total installed capacity corresponds to 22.9 MW, representing a share of still only 0.02% in the matrix.7 Currently, there are 3,113 MW of onshore wind projects under construction and further 6,220 MW of onshore wind capacity allocated in auctions to be built. As for solar power, 1,851 MW of utility-scale solar PV projects which have been awarded PPAs in recent auctions will come online in the near future.8 Thus, the Brazilian energy auction system has proven effective to attract investments in the renewable energy sector. Only in 2014, the Brazilian onshore wind power market grew 72% as compared to the previous year, thereby elevating Brazil into the top-10 countries with the most total installed capacity of wind power. 9 Despite the considerable development in onshore wind and solar power generation, the full potential of wind and solar resources remains untapped. This scenario is bound to improve as the national expansion targets for onshore wind and solar have constantly risen over the past decade. According to the Brazil 10-year energy expansion plans (herein "PDEE") in its latest edition, PDEE 2024, which is developed by the Brazilian Energy 1 EPE, National Energy Balance (Balanço Energético Nacional) 2015, available at https://ben.epe.gov.br/BENRelatorioSintese.aspx?anoColeta=2015&anoFimColeta=2014. 2 World Bank Group, 'Performance of Renewable Energy Auctions – Experience in Brazil, China and India', October 2014, available at http://documents.worldbank.org/ curated/en/2014/10/20291035/performance-renewable-energy-auctions-experience-brazil-china-india. 3 Gabriel Cunha, Luiz Barroso, Bernardo Bezerra, 'Lessons learned from the auction-based approach to integrate wind generation in the Brazilian electricity market', (2014) available at www.cigre.org. 4 Ibid. 5 Germany IRENA, 'Renewable Energy Policy Brief', (2015) available at www.irena.org. 6 ANEEL, Banco de Informações de Geração (Generation Information Database), available at http://www.aneel.gov.br/aplicacoes/capacidadebrasil/capacidadebrasil.cfm accessed 30 March 2016. 7 Ibid. 8 Ibid. 9 World Wind Energy Association, 'WWEA Bulletin Special Issue 2015', (2015) available at http://www.wwindea.org/wwea-bulletin-special-issue-2015/. 2 Research Company (herein "EPE"), a public entity subordinated to the Brazilian Ministry of Mines and Energy, renewable sources will represent 86% of the electricity matrix by 2024, a 15% increase from the share of 74.6% registered in 2014. Onshore wind power generation is anticipated to have an 11.6% share in it and expand up to 24 GW of installed capacity in the same period, a plus of 207% as compared to the current installation figures. PDEE 2024 includes also a very ambitious objective of 7 GW of solar PV installations by 2024, which doubles the value of 3.5 GW stipulated in the previous PDEE.10 3.1 The auction-based scheme – how it works 3.1.1 Common features of all auction types According to Law no. 10.848/2004, the Brazilian framework law for the power sector, and to Decree no. 5163/2004, which stipulates specific rules for the power market, the power auctions are relevant solely for the so called regulated market, where the legal relationship between the participants is fully regulated by the Brazilian Electricity Regulatory Agency (herein "ANEEL").11 There, distribution utilities are obliged to contract their projected power demand at power auctions.12 These utilities are in turn entitled to charge consumers for power supply with a tariff set by ANEEL that shall, amongst others, cover the bid price for the energy purchased at the auction.13 There are different types of power auctions, each pursuing different goals. The main types are the regular energy auctions, which may contract energy from existing plants, new plants or renewable energy plants only, and the reserve energy auction to contract surplus energy. Both the regular auction to buy capacity from new plants (herein "regular auction for new capacity") and the reserve auction type (herein "reserve auction") have been widely used mechanisms to promote renewable energy projects. In the Brazilian auction mechanism, the price per MWh for the power to be sold by generators is the bidding criterion, i.e. the bidding participants offer to sell energy at the lowest, most viable price, which shall, respect a ceiling price per MWh established beforehand in the tender rules. The capacity to be awarded and the types of energy sources to be promoted at the auctions are defined by the Ministry of Mines and Energy (herein "MME") taking into consideration studies delivered by EPE for this purpose.14 After consideration of MME's definitions in this regard, ANEEL stipulates the tender rules and contract models for every auction.15 Moreover, ANEEL sets forth the criteria for technical and financial qualification of the bidding candidates. Projects are eligible to participate in an auction after registration before ANEEL and technical accreditation by EPE.16 For technical accreditation purposes, bidders have to demonstrate environmental licencing, wind certification for wind projects, land lease agreements, grid access statement, etc.17 All types of auctions are conducted by the Electric Power Commercialisation Chamber (herein "CCEE"),18 a regulated nonprofit entity formed by agents from the power market, on behalf of ANEEL. 3.1.2 Regular auction for new capacity Regular auctions are in general intended to ensure adequate system expansion, as it takes place to cover the expected load growth reported by distribution utilities.19 Here the winning bidder signs a PPA with multiple distribution utilities.20 The term of duration of the awarded PPAs at such auctions fall under one of these three categories: A1, A3 and A5, which means that a project shall start delivering power respectively 1, 3 or 5 years after contracted. The term of a PPA awarded for A1 projects ranges between 1 and 15 years and for A3 and A5 projects between 15 and 30 years.21 When renewable energy is contracted, the term ranges between 10 and 30 years.22 According to Decree no. 6049/2007, at renewable-exclusive auctions, categories A1 to A5 may be awarded. Other than that, the A1 category is intended for use only at regular auctions for existing capacity, while the A3 and A5 categories are directed at contracting new capacity. In previous regular auctions, PPAs for onshore wind and solar power projects have been regularly awarded for a period of 20 years. 3.1.3 Reserve auction The reserve auction, regulated by Brazilian Law no. 10,848/2004 and Decree no. 6353/2008, is a mechanism aimed to contract surplus energy to ensure supply security and is carried out at the 10 EPE, PDEE 2023 and PDEE 2024, available at http://www.epe.gov.br/pdee/forms/epeestudo.aspx. 11 ANEEL, www.aneel.gov.br. 12 Art. 11 Decree 5163/2004. 13 Art. 34 – 46 Decree 5163/2004. 14 Art. 12 Decree 5163/2004; Art. 6 decree 6353/2008. 15 Art. 20 Decree 5163/2004. 16 Ministry of Mines and Energy, Ordinance No. 21 of 18 January 2008. 17 Ibid. 18 CCEE, www.ccee.org.br. 19 Art. 17 Decree 5163/2004. 20 Art. 2 § 2 Law no. 10,848/2004, Art. 27 to 33 Decree 5163/2004. 21 Art 27 Decree 5163/2004. 22 Art. 27 Decree 5163/2004. 3 government's discretion.23 The PPA term shall extend over a period of up to 35 years.24 The counterparty to the PPA awarded at a reserve auction is CCEE. CCEE acts, however, only as the agent of the consumers of reserve energy, i.e. distribution utilities, free consumers25 and self-producers, which are in turn obliged to enter into a contract with CCEE to purchase reserve energy.26 The role of CCEE is, in principle, to centralise the payments made by these consumers and set up a guarantee fund to ensure payment to the generator in case of default.27 All costs arising from contracting reserve energy shall be borne by all consumers through a tariff surcharge.28 3.1.4 Regional incentives for renewable energy projects Federal states are also entitled to promote renewable generation within their territory. The Federal State of Pernambuco in NorthEastern Brazil, for instance, conducted in late 2013 the country's first solar-exclusive auction, which awarded 122.8 MW in projects for an average price of BRL 228.63 (USD 55.89) per MWh and PPAs with a 20-year term.29 These projects are to come online this year thereby increasing the total installed capacity of solar power in Brazil six-fold. 3.2 FiT-scheme for distributed solar power generation Further to the auction-based scheme, a FIT-scheme has been introduced by the Brazilian government to promote distributed power generation from renewable sources by consumers, in particular those from the industry, retail and agriculture sector.30 The incentive programme with the acronym "ProGD" launched in December 2015 has a special focus on solar installations and sets up a compensation scheme based on a reference price per MWh, which is adjusted annually to the inflation rate. For the sale of electricity from PV installations a reference price of BRL 454 (USD 111) per MWh is to be paid by distributors to the producing consumers. Solar installations with an installed capacity greater than 1 MW and up to 30 MW are eligible to be subsidised under the reference price compensation scheme. ProGD complements other incentives for distributed generation already in place, such as (i) an energy credit compensation programme for small distributed generation plants with up to 1 MW installed capacity,31 (ii) reduction of import taxes from 14% to 2% on capital goods used for PV equipment manufacturing, and (iii) tax exemptions for the electricity delivered to distributors by the producing consumers.32 Under the ProGD programme, an investment volume of USD 24 billion and the installation of 23.5 GW by 2030 are projected.33 4. Overview of recent national-level tenders involving onshore wind and solar projects at national level The last regular auction procedure in the category A-3 (projects delivering energy three years after contracting), auction no. 004/2015,34 involving onshore wind projects amongst other sources such as hydro and thermal (natural gas and biomass) took place on 21 August 2015. The auction rules provided for a price cap for wind power set at BRL 184 (USD 44.85) per MWh. The average price for this source reached BRL 180 (USD 44.05) per MWh, thus, only slightly lower than the cap price, and a total wind capacity of 538.8 MW was contracted for a 20-year period. As for reserve auctions, the most recent one contracting power exclusively from onshore wind and solar projects, reserve auction no. 009/2015,35 took place on 31 November 2015. A total capacity of 1,477 MW was awarded in 20-year term contracts to both technologies, 548.20 MW of it for onshore wind and 929.34 MW for solar. Power delivery shall commence in November 2018. The average price reached at the auction was BRL 201.86 (USD 49.58) per MWh for onshore wind and BRL 297.24 (USD 73.01) per MWh for solar projects. Another reserve auction, tender no. 008/2015,36 aiming exclusively to award contracts to solar projects took place on 28 August 2015. 382 projects with a total installed capacity of 10,500 MW were accredited to participate, of which 30 with a total The Brazilian Power Market 23 Art. 3 § 3 Law 10,848/2004. 24 Art. 2 Decree 6353/2008. 25 Those with a peak load equal or greater than 3 MW according to Art. 15 § 2 Law 9074/1995. 26 Art. 2 and Art. 3 Decree 6353/2008. 27 Art 5 § 1 Decree 6353/2008. 28 Art. 4 Decree 6353/2008. 29 Government of Pernambuco, http://www.srhe.pe.gov.br/index.php?option=com_content&view=article&id=519:pernambuco-promove-primeiro-leilao-de-energia-solar-dopais&catid=40:newsflash&Itemid=72 accessed 25 January 2015. 30 Ministry of Mines and Energy, Executive Order No. 538/2015, available at www.aneel.gov.br; Ministry of Mines and Energy, http://www.mme.gov.br/web/guest/paginainicial/outras-noticas/-/asset_publisher/32hLrOzMKwWb/content/programa-de-geracao-distribuida-preve-movimentar-r-100-bi-em-investimentos-ate-2030 accessed 27 January 2016. 31 ANEEL Ordinance 482/2012: generators receive so called energy credits if their production exceeds consumption, which can be set off against their electricity bill within a 60-month period. 32 Ministry of Mines and Energy, http://www.mme.gov.br/web/guest/pagina-inicial/outras-noticas/-/asset_publisher/32hLrOzMKwWb/content/programa-de-geracaodistribuida-preve-movimentar-r-100-bi-em-investimentos-ate-2030 accessed 27 January 2016. 33 Ibid. 34 ANEEL, overview of regular auction no. 004/2015 available at http://www.aneel.gov.br/aplicacoes/editais_geracao/documentos_editais.cfm?IdProgramaEdital=144. 35 ANEEL, overview of reserve auction 009/2015, available at http://www.aneel.gov.br/aplicacoes/editais_geracao/documentos_editais.cfm?IdProgramaEdital=150. 36 ANEEL, overview of reserve auction 008/2015 available at http://www.aneel.gov.br/aplicacoes/editais_geracao/documentos_editais.cfm?IdProgramaEdital=145. 4 capacity of 833.8 MW were successfully awarded a PPA in the end. The term of the PPAs was set at 20 years and energy delivery shall begin in August 2017. The biggest winner of the tender was the Italian investor Enel Green Energy, awarded 553 MW of capacity, which has now become the leading solar power player in Brazil as for both installed capacity and project portfolio size.37 The average bid price reached the amount of BRL 301.79 (USD 72.43) per MWh, thus approximately 14% lower than the initially set cap price of BRL 349 (USD 83.77) per MWh.38 Compared to the first auction in which solar projects were successfully contracted at national level, reserve auction 008/2014 directed at solar, onshore wind and biomass projects,39 solar prices per MWh increased in the 008/2015 considerably by almost 30%. The lower average MWh price of BRL 214.58 (USD 52.51) per MWh reached at the 008/2014 auction is due to a lower cap price set at BRL 262 (USD 64.12) per MWh. By setting a higher cap price at the 008/2015 auction, the efforts of the Brazilian government to attract more investments in this area are apparent. 5. Outlook For this year, a regular auction for new capacity in the category A- 5 (energy delivery commences five years after contracting) has been announced through order MME no. 382 of 12 August 2015, which is planned to take place on 29 April 2016 and provides energy delivery from 2021. The following technologies will be tendered: hydro power, coal and biomass, natural gas and onshore wind. 1,055 projects have been registered before the EPE for technical qualification for the tender. 81% of the registered projects are accounted to onshore wind projects representing 21,232 MW of capacity.40 Although the outcome of the accreditation process at EPE is not yet known, EPE's chairman, Mr. Mauricio Tolmasquim, has noted that the number of already registered projects is a Brazilian record and that the tender is bound to be the largest power auction in the world ever.41 Moreover, two reserve auctions have been announced through order MME no. 104 of 23 March 2016, which are scheduled for 29 July 2016 (so called "first reserve auction") and 28 October 2016 (so called "second reserve auction") respectively. In the first reserve auction small hydro power projects and solar projects are eligible to participate. As for solar projects, energy delivery shall commence in 2018. At the second reserve auction onshore wind and solar power will be contracted. Energy delivery for both technologies shall commence in 2019. The term of the PPAs to be awarded to both onshore wind and solar projects at these auctions will be 20 years in accordance with the usual practice. 6. Conclusion The bottom line is that Brazil is a fast growing market for renewable energy projects and therefore interesting for investors seeking such projects. Besides the fact that wind and solar resources are available in abundance in the country, the Brazilian legal framework for renewable energy provides a stable and predictable basis due to the regulator's long-term planning.42 Not least the high project registration rate pertaining to the upcoming regular auction for new capacity to produce energy in five years time (A-5) is a fairly good indication of the attractiveness of the Brazilian investment regime for the renewable power sector. 37 http://www.enelgreenpower.com/en-GB/media_investor/press_releases/release.aspx?iddoc=1665222 accessed 21 January 2016. 38 http://www.aneel.gov.br/aplicacoes/noticias/Output_Noticias.cfm?Identidade=9037&id_area=90. 39 ANEEL, overview of reserve auction 008/2014 available at http://www.aneel.gov.br/aplicacoes/editais_geracao/documentos_editais.cfm?IdProgramaEdital=133. 40 ANNEL, Technical Note no. 47/2015-CEL/ANEEL of 7 December 2015 available at www.aneel.gov.br. 41 http://www.brasil.gov.br/economia-e-emprego/2015/10/leilao-de-geracao-de-energia-tem-1055-projetos-cadastrados accessed 27 January 2016. 42 International Energy Initiative, 'Report of the Workshop Germany-Brazil: Comparing the Brazilian and German Public Policies Experiences on Renewable Energy. Sources and Energy Efficiency', (2014) available at http://iei-la.org/report-of-the-workshop-germany-brazil-comparing-the-brazilian-and-german-public-policiesexperiences-on-renewable-energy-sources-and-energy-efficiency/ accessed 21 January 2015. Brussels / Du sseldorf / Hamburg / London / Manchester / Munich / Paris / Shanghai / Silicon Valley / fieldfisher.com This publication is not a substitute for detailed advice on specific transactions and should not be taken as providing legal advice on any of the topics discussed. © Copyright Fieldfisher LLP 2016. All rights reserved. Fieldfisher LLP is a limited liability partnership registered in England and Wales with registered number OC318472, which is regulated by the Solicitors Regulation Authority. A list of members and their professional qualifications is available for inspection at its registered office, Riverbank House, 2 Swan Lane, London, EC4R 3TT. 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