MINISTER ROUSSEFF EXPLAINS NEW ENERGY MODEL

UNCLAS SECTION 01 OF 04 BRASILIA 002859

SIPDIS

SENSITIVE

PLEASE PASS DOE FOR GWARD

E.O. 12958: N/A
TAGS: ENRG EINV EFIN PGOV ECON BR
SUBJECT: MINISTER ROUSSEFF EXPLAINS NEW ENERGY MODEL

REF: BRASILIA 00835


1. (SBU) SUMMARY. Mines and Energy Minister Rousseff and
Vice Minister Tolmasquim have provided EmbOffs a two-hour
presentation of Brazil's new energy model. The Minister
summed up the new model as re-establishing the concept of
public service as the sector's prevalent principle. It
aspires to better segregate GoB energy planning, regulation,
and policy, while providing moderate prices to consumers,
reasonable compensation to generators and distributors, and
decreased risks in energy generation. The vigor and
resolution of this special presentation was impressive, but
it seemed to leave many practical core issues unresolved, as
our sampling of private-sector contacts has subsequently
confirmed. A common industry view, in fact, is that the
GoB,s design to date does not yet merit the appellation of a
full model. That it will be ready for initial implementation
in January 2004, as the Minister insists, seems unlikely.
END SUMMARY.

Work In Progress
--------------

2. (U) The GoB,s new model was first presented to the
National Electrical Power Policy Council on July 21.
Honoring a promise that Minister of Mines and Energy (MME)
Rousseff had made to Ambassador at a previous one-on-one
lunch, the Minister and Vice Minister Tolmasquim dedicated
two and a half hours to a special meeting with Ambassador and
six embassy officers to explain the plan.


3. (U) The Minister prefaced her presentation by asserting
that Brazil's existing energy model, launched in the early
1990s, had proved a fourfold failure. It had not resulted in
moderate prices; it had not stimulated expansion; it had not
brought investors needed assurances; and it had contributed
to Brazil's financial crisis, she said. The new GoB,s model
was aimed to put &the concept of public service8 back into
the sector's management as its prevailing principle. At the
same time, it is designed to respect existing contracts,
minimize transaction costs, preclude tariff pressures
resulting in higher consumer costs, ensure transparency, and
create a favorable environment for long-term investment.
Implementation is to begin Jan. 2004, with a transition
period of two to three years, the Minister said. Little
concrete would change in 2004, she noted, since most of
Brazil's energy delivery for that year is already under
existing contracts.

Main New Elements
--------------

4. (U) In particular, the new model aims to: define rules
that limit the National Agency for Electrical Energy's
(ANEEL) role to regulation without policy consequences or
implications; solidify policy control in the ministry; and
create The Energy Studies and Planning Foundation (FEPE),an
independent GoB planning body akin to the U.S. Energy
Information Administration (EIA),to forecast supply and
demand. The FEPE is to review energy production, monitor
climate conditions, and track consumer demand to project
future generation needs. The long-term plan of twenty years
is to be reviewed every four years and revised as required.
Long and mid-term planning will be submitted to public
hearings. (NOTE: The Minister reiterated her eagerness,
expressed at her meeting with Secretary Abraham during the
June presidential summit, for EIA technical assistance for
FEPE. A team will be coming to Brasilia the week of Sept.

15. END NOTE)


5. (U) At the core of the new model is a total re-design of
the way electricity is sold. Sales are to take place within
two contractual environments overseen by the Electric Energy
Contracts Administration Authority (ACEE),which is to
replace the never-functional Wholesale Electricity Market
(MAE). ACEE will be linked to the Ministry of Mines and
Energy (MME) and will take over the relevant organizational
and operational structures of MAE. ACEE will calculate
tariffs based on a yet-to-be-determined index. The largest
volume of energy will be through a pool which will blend
prices between Brazil's lower-priced hydro energy and more
expensive thermal energy. This is a critical change, since
the generators will now be regulated regarding to whom and at
what terms they sell their energy. All distributors will buy
energy at a set price from the mix of generators supplying
power to the pool, with all contracts being administered by
ACEE. Currently, there are sixty-four distributors that will
be mandated to contract through this pool.


6. (U) The balance of energy supply will be allowed to be
contracted through bilateral agreements between Independent
Power Producers (IPP) and "free" consumers. Free consumers
are entities with energy needs above 3000 megawatts (e.g.,
shopping malls). They may become captive with a five-year
notice. The new model also allows captive consumers to
become free with the same notice. Captive consumers may
become free with just a two-year notice if they are going to
be supplied by a renewable energy source. This is the new
model's incentive (the only one, so far) to create demand for
renewable energy sources, yet its long-term goal is to have
10% of consumption come from such sources. New thermal power
plants will only be authorized to generate as IPPs, and must
have a Power Purchase Agreement (PPA) before construction
begins. An energy reserve will be maintained as cushion
against shortages. The cost will be passed on to all
customers through tariffs.


7. (U) The new Energy Sector Monitoring Committee (CMSE) is
to be coordinated by the MME and aided by FEPE, ACEE, ANEEL,
and the administrator of contracting transmission facilities,
the National Electrical System Operator (ONS). This entity
will be responsible for oversight and assure the consistency
of supply. CMSE will monitor projected demands, and ACEE
will collect penalties for any deviations from a
distributor's forecast of more than five percent either way
at the end of the five-year contract period. Fines will be
imposed for both negative and positive deviations, with the
former being more severe.


8. (U) The new model expressly forbids &self-dealing8.
For example, CEMIG (Brazil's largest generator, which has
Southern Electric as its strategic U.S. partner),both
generates and distributes electricity. Under the new model,
such companies will have to split up. The newly formed
generation company will have to sell its energy to the
national pool, and the new distributor will buy it at a set
price from a part of their old company and old competitors.
For the same reason, the state of Parana's Governor Requiao
has declared that he will refuse to have COPEL (Parana,s
state electricity company) participate in the pool. He
asserts that the state will continue to be supplied directly
by COPEL's low cost hydro energy and only put up surplus
energy to the pool.

Private-Sector Industry Reactions
--------------

9. (SBU) Since the Minister's private brief, we have met
with Sao Paulo State's Secretary of Energy, three association
leaders, the president of a power producer, and the CFO of a
power distributor to gauge reactions to the new model.
Uncertainty was palpable in all of the meetings. All our
interlocutors were particularly concerned that the cost
index, which is to be the future basis for revising the
tariff, has not been formulated. There was resentment at
this model having been allegedly created in a vacuum without
input from stakeholders in industry and associations.
(COMMENT: In contrast, Rousseff prides herself on the
transparent, inclusive consultations she believes the
Ministry has conducted. END COMMENT)


10. (SBU) Beyond these common initial reactions, we have
heard individual concerns and observations. Sao Paulo
State's Energy Secretary Mauro Jardim Arce was the only one
who expressed the need to get the model hammered out as soon
as possible to stabilize the sector. He commented that
monthly consumption is down 40% compared to pre-rationing
levels. The current over-capacity and dollar-denominated
debt of companies in the sector is not addressed in the plan,
Arce also pointed out.


11. (SBU) Silvia Calou, the Executive Director of ABCE (a
67 year old association with 70 member companies involved in
generation, transmission, and distribution),said ABCE's
primary concern is that the model is built on flawed GDP
forecasting with exaggerated optimistic projections which
will result in over-investment and excess capacity. She
expects this scenario eventually to result in large tariff
increases which will induce lower consumption. The five-year
planning cycle makes the distributors vulnerable to market
forecast risk. While the "transparency" portion of the new
model allows bids to be contested, it is unclear how this
will be done, and the association's members fear some may
have more information than others, which will impact bidding.



12. (SBU) Most negative has been Claudio Sales, president of
CBIEE, an association of the 15 largest private investors in
the energy sector, including U.S., Brazilian, French,
Spanish, Portuguese, and Belgian companies. He was vocal
about his distaste for the plan, forged, in Sales,s words,
by "politically biased scholars". It addresses the future,
he said, but doesn't address the "present, reality, and
survival". But Sales also predicted that the model's
"craziness" will be trumped, asserting that his association
has the ear and support of Finance Minister Palocci, to whom
CBIEE is apparently putting forth counter-proposals for
fixing the present tariff structure and the tracking
accounts.


13. (SBU) AES Tiete President Mark Green, on the other
hand, was surprisingly serene about the new energy model. He
expressed confidence that it will leave AES Tiete,s
generation contract unaffected until its scheduled expiration
in 2015. He was more concerned with the bidding process,
however, in which consumers will only be looking at price.
He believes if bidding rules aren't more tightly defined that
producers will cut necessary operational redundancies to
reduce costs in order to secure bids in that competitive
environment. Green noted that AES has a poor relationship
with ANEEL, and liked the fact that the new model diminishes
ANEEL,s authority. AES Eletropaulo CFO Jeff Safford said
his company was still formulating its opinion of the model,
but initially believes it is too vague to attract new
investment. He concurred that AES feels itself ahead of the
game since its generating (Tiete) and distribution
(Eletropaulo) companies are already bifurcated. Safford
likewise expressed confidence that AES,s Tiete-Eletropaulo
ANEEL-approved contracts would stand up through the life of
their 15-year term.


14. (SBU) Finally, Sao Paulo Econoff received additional
input from an August 26-27 FIESP energy seminar in Sao Paulo.
Players on the generation and transmission side expressed
relative contentment with the new model, which they feel
insulates them from most market risk. However, other agents
in the production chain (e.g., distributors and free
consumers) continue to express deep concern that the model as
it stands will not promote private investment or remove risk
of future shortages. In addition, private investors won't be
interested in considering new activity until after
legislative passage of the bill in its final form, when they
know all of the rules and ramifications. MME Vice Minister
Tolmasquim attended this FIESP seminar, listened to concerns,
and invited participants to provide input into the final
model.


15. (SBU) COMMENT: In our private briefing, Minister
Rousseff was adamant that the bill enshrining the new model
would be passed in time for implementation to begin by Jan.
1, 2004. This looks unrealistic, given stake-holders'
abiding uncertainties and the fact that the necessary rules
and regulations underpinning the model have not been defined,
plus the scant prospect of legislative action in this time
frame, considering President Lula's time-consuming priorities
of pension and tax reform. The long-awaited new energy model
has already slipped well behind the ambitious original
timeframe for its introduction. That said, most in industry
and the government alike would concur that it is more crucial
to do this change well than to do it rapidly. And on the
positive side, it does appear that private-sector actors are
being consulted and given the chance to make their points
adequately at this stage of the model's refinement. END
COMMENT.


16. (U) This cable was coordinated with Consulate Sao
Paulo.
HRINAK