On 11 September, Brazil’s President Dilma Rousseff announced major tax cuts in the electricity sector in order to lower prices, keep inflation at bay and hopefully reinvigorate Brazil’s stagnant economic performance. According to President Rousseff “The reduction of energy costs generates a systemic effect which will impact the economy as a whole… It will promote Brazil’s international competitiveness, reduce inflation and stimulate investment… Businesses and consumers will benefit”.

The measures will come into effect in 2013 and consist of the abolition of the general reserve reversion tax (reserva global de reversão or RGR) and the fuel consumption account tax (conta de consume de combustiveis or CCC), as well as a 25% reduction in the energy development tax (conta de desenvolvimento energetico or CDE). These taxes were enacted during previous governments to subsidise investments in the electricity sector and help fund improvements to Brazil’s vast electricity grid. Although they were initially intended to be temporary measures, they have persisted and increased over the years, resulting in Brazil having one of the highest electricity costs in the world. According to a 2011 study based on data from the International Energy Agency, Brazil’s electricity costs an average of US$180 per megawatt hour (MWh); the third most expensive of the countries studied.

President Rousseff’s announcement also confirmed that the government will renew a number of electricity concessions due to expire between 2015 and 2017. Pursuant to Brazil’s electricity regulatory regime, concessions are granted for periods up to 30 years and at the end of the concession period the government acquires ownership of all assets and infrastructure, it is then free to either auction them off in another concession round or operate them directly. The Brazilian government has indicated that it is willing to extend existing concessions on revised terms, which may require additional investments in electricity infrastructure and efficiency measures. Only if utility companies do not accept the revised concession terms on offer, will the government auction the relevant concessions to other bidders.

Energy Minister Edison Lobão announced that the relevant electricity concessions comprise 20 in generation (comprising 18% of the total), 9 in transmission (67% of the total) and 44 distribution contracts (35% of the total). The company that will be most widely affected is Centrais Elétricas Brasileiras S.A., more commonly known as Eletrobras. Eletrobras is the ex Brazilian State monopoly, which still controls a large part of the Brazilian electricity market. It is listed on the São Paulo and New York stock exchanges (BOVESPA and NYSE), but still controlled by the Brazilian Federal Government.

With regard to electricity concessions expiring after 2017 and whose initial capital investments will not be amortised by the time the reduction in public subsidies comes into effect, the government plans to compensate them by utilising the reserve funds raised by the RGR, which currently amount to circa R$ 20 billion (US$ 9.94 billion).

The big winners from current reforms may be Brazilian electricity consumers. The government estimates that industrial electricity rates will fall by up to 28% and residential rates by 16%. Although it still needs to be seen whether all of the savings will be passed on to consumers, the reform has been welcomed by Brazil’s business leaders. Despite Brazil’s strong economic performance in the last decade, its economy has been largely stagnant since mid-2011 as local businesses struggle to remain competitive due to high taxes, a strong local currency and inflation above the government’s 4.5% official target.

The current reforms demonstrate that the Rousseff administration is moving away from policies aimed solely at stimulating consumer demand, by focusing on the high cost of business that has deterred international investors and reduced Brazil’s competitiveness abroad. Brazil’s high electricity prices are a major factor in the so-called “Brazil Cost”, i.e. the combination of excessive bureaucracy, taxes, high interest rates, labour costs and infrastructure bottlenecks which have caused the Brazilian economy to become less competitive in the past years.

Energy intensive industries stand to benefit the most, including mining, steel works, petrochemical and aluminium producers. It is estimated that electricity accounts for 35% of production costs in the aluminium industry. Major aluminium producers have been in talks with the Brazilian government regarding reductions in electricity prices and it is hoped that the reforms may stimulate investment in the sector, which has been negligible over the past decades, notwithstanding Brazil’s bauxite reserves and abundance of hydroelectric power.

In addition to industrial users, the greater Brazilian economy will benefit from the current reforms. Brazil’s Finance Minister, Guido Mantega announced that the tax cuts alone will help reduce inflation by 0.5% to 1% from next year. Brazilian consumers will have lower energy bills and consequently see a rise in their disposable income. Moreover, provided that reductions in the “Brazil Cost” are passed on to the ultimate consumer, the price of Brazilian-made goods should become more competitive.

These energy market reforms are part of President Rousseff’s “new phase” of industrial policy, which include last month’s infrastructure initiatives and payroll tax cuts for selected industries. All of these initiatives seek to reduce the “Brazil cost” and could result in a leap in the international competitiveness of Brazilian industry over coming years.