Spotlight: the energy markets in Brazil

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Energy markets

The 2004 restructuring process that resulted in the current regulatory framework for the Brazilian power sector envisaged two markets in which participants are able to sell power: the regulated market and the free market.

Within the regulated market, generation companies sell power to distribution companies, which participate as buyers in public auctions conducted by the government. Generation companies compete against each other according to the rules of each auction by the lowest bid price⁷ to sell power to the distribution companies. As mentioned above, new-energy auctions also involve the granting of concessions or authorisations to enable the winning bidders to operate new power plants.

The regulated market serves the captive consumers. In other words, the power bought by distribution companies in the auctions is purchased by captive consumers (those defined as not having any choice in selecting their power supplier) or potentially free consumers (those that have not yet migrated to the free market even though they meet the criteria). As a rule, distribution companies are obliged to buy power on the regulated market (apart from a few legal exceptions) and to ensure that 100 per cent of their consumers' demand is met.

There are three main types of auctions within the regulated market:

1. new energy auctions, conducted to promote power generation expansion sufficiently in advance to enable plant construction, to meet growth in market consumption;
2. existing energy auctions, conducted to contract power produced by existing projects, to reduce the financial risks for distribution companies in their demand projections; and
3. backup-energy auctions, conducted to increase security of power supply.

The auctions are known as 'A minus N', where A is the year in which the plant must enter operation and start delivering power to the grid. Auctions for new energy may include HPPs designated by the government, but companies usually also participate in their own projects (SHPPs, thermal, wind, biomass and solar projects, depending on the auction rules). Prior technical qualification, recognised by the EPE, is required for participation in the auctions. In auctions for existing energy, generation companies with projects in operation, as well as trading companies, may sell power within the regulated market. Finally, backup-energy auctions exist to ensure security of supply to the electricity system, and this energy is usually contracted from SHPPs, wind and biomass plants.

Within the free market, power is freely traded between those parties entitled to participate in it: generation and trading companies, and free and special consumers. As mentioned, free consumers are those whose demand is currently greater than 1MW and who may choose their power generation supplier. Pusuant to Article 160 of ANEEL Resolution No. 1,000/2021, this load requirement has been reduced and will continue to be reduced until 2023. The first reduction occurred in July 2019, when free consumers were required to have demand greater than 2.5MW then, in January 2020, this dropped to 2MW, then to 1.5MW in January 2021 and, finally, to 1MW in January 2022. The demand requirement will be further reduced to 500kW in January 2023.

Special consumers, which may be a single consumer or a group of consumers that share the same interests, are required to have a demand greater than 500kW and may only choose their supplier when buying from specific renewable sources.

Sector participants that carry out power trading transactions are obliged to comply with the sector's rules and regulations. As a result of the 2004 regulatory reform, participants must prove that 100 per cent of the power sold under PPAs is associated with their own generation plants or those belonging to third parties (by means of purchases from them through PPAs), according to the terms set by Decree No. 5,163/2004. Distribution companies have to serve 100 per cent of their market's demand; sellers have to produce or purchase the same amount as is sold under PPAs; and consumers have to purchase the same amount as the amount consumed.

If they are not able to produce or purchase the total amount of power traded or consumed, participants will be subject to exposure on the spot market to cover their original PPAs, in proportion to the amount not produced or purchased. Financially exposed participants are:

1. obliged to pay the amount equivalent to the difference between the power contracted and the power delivered or consumed (not covered in additional PPAs), multiplied by the difference settlement price (PLD), which is defined weekly by the CCEE;⁸ and
2. may be subject to penalties imposed by the CCEE.⁹

The amount of power allocated to each generation plant is determined by its assured capacity, defined as the maximum amount of power that the plant is allowed to sell and is committed to deliver under PPAs.¹⁰ This calculation is very important as it sets the limit on the power available for sale (originating from the plants' own power generation).¹¹

The operation of the Brazilian interconnected system may cause a dissociation of the participants' contractual commitments from the actual physical delivery of the power traded. Power production mainly depends on operational decisions made by the ONS, since several power plants are subject to centralised dispatch, which reduces the control that companies have over their own plants' output. A few regulatory mechanisms have been established to mitigate this risk and avoid these participants facing financial exposure for reasons they cannot manage, such as the energy reallocation mechanism applicable to hydropower plants.

Within the regulated market, because of the auction process, long-term PPAs are executed between the generation companies that have won the bid and the distribution companies buying at the auction. Similarly, in backup energy auctions, a backup energy agreement is executed between the sellers and the CCEE, as the representative of all consumers. All contractual conditions are defined within the bid process and are not subject to negotiation, including supply period, rates (set by the lowest-bid award criterion) and amounts.

The contracts' effective terms depend on each type of auction and power source and may vary from 15 years to 35 years for new energy auctions, from one year to 15 years for existing energy auctions, and for up to 35 years for backup-energy auctions. The PPAs may be executed under one of two modalities: quantity or availability. Under quantity contracts, sellers assume hydrological risks (variations between the amounts contracted and effectively produced) and deliver the power sold at the submarket where the plant is located. Under availability contracts, buyers assume the risks deriving from the plant's unavailability resulting in lower production than the amount contracted.¹²

It has become increasingly common to have long-term PPAs in the free market, which makes the construction of new plants financially feasible. There is even a specific practice whereby a producer who is also the consumer can be exempt from certain sector-specific charges (self generation). Within the free market, participants execute PPAs in which they freely establish the conditions, supply period (short, medium or long term), price and amounts, provided that the contractual terms comply with sector rules and regulations, particularly the CCEE's trading rules and procedures.

Law No. 14,120 of 1 March 2021 stated that the government will cease to grant grid discounts for new renewable projects requesting power generation authorisation 12 months after 2 March 2022, the date the Law was enacted, or entering into operation 48 months after the date of issue of the authorisation (assuming an authorisation request before 2 March 2022). Once a discount has been granted, the project concerned remains entitled to the benefits until the relevant licence expires (usually a period of 35 years). The Law also provides for the creation of a new incentive for sources with low carbon emissions, although details of this mechanism have yet to be specified.

In addition, distributed generation is now subject to a brand new regulatory regime, introduced by Law No. 14,300 of 6 January 2022, which sets out changes to credit compensation, in particular regarding the payment of 'Wire B' and 'Wire A' distribution system use tariffs. Plants already connected to the system or that connect within 12 months of publication of Law No. 14,300 will continue to benefit from the terms of ANEEL Resolution No. 482/2012 until 31 December 2045. Law No. 14,300 sets out different transition periods for plants that connect to the system between months 13 and 18, and those that connect after month 18, following publication of the Law, according to the category, source and capacity of the plant. After the transition period, plants will have to pay all the tariff components, minus the applicable discounts determined by ANEEL for each particular electrical system project.

There has also been a discernible trend towards both long-term renewable PPAs, for which renewable energy certificates can be obtained, and self-generation projects, which are entitled to exemptions from certain sectoral charges.