AMBASSADOR AND MINISTER OF MINES AND ENERGY

UNCLAS SECTION 01 OF 03 BRASILIA 002834 SIPDIS SENSITIVE NSC FOR MIKE DEMPSEY STATE PLEASE PASS TO USTR FOR SCRONIN DEPT OF TREASURY FOR FPARODI USDOC FOR 4332/ITA/MAC/WH/OLAC/SHIELDS USDOC ALSO FOR 3134/ITA/USCS/OIO/WH/RD/CREATORE USDA FOR FAS/ITP AND FAS/FAA/WH DOE FOR SARAH MARQUIS STATE PASS OPIC FOR MORONESE, RIVERA, MERVENNE STATE PASS EXIM FOR NATALIE WEISS, COCONNER STATE PASS USTDA FOR AMCKINNEY E.O. 12958: N/A TAGS: ENRG EINV BEXP PGOV ETRD BR SUBJECT: AMBASSADOR AND MINISTER OF MINES AND ENERGY DISCUSS GOB'S NEW ENERGY MODEL/NRG INVESTMENT DISPUTE REF: A) BRASILIA 528, B) RIO DE JANEIRO 518 ¶1. (SBU) SUMMARY AND INTRODUCTION. ON NOVEMBER 8, AMBASSADOR PAID A COURTESY CALL UPON MINISTER OF MINES AND ENERGY DILMA ROUSSEFF. THE MINISTER EXPLAINED TO THE AMBASSADOR THE THINKING BEHIND THE GOB'S NEW ENERGY MODEL, WHICH MINISTRY OFFICIALS CHARACTERIZE AS A "HYBRID" AIMED AT PROMOTING COMPETITION IN THE MARKET WHILE STRENGTHENING STATE CONTROL. THE AMBASSADOR MADE THE POINT THAT MAJOR U.S. INVESTORS (INTER ALIA, DUKE POWER) CURRENTLY OPERATING IN THE ELECTRICITY GENERATION MARKET FELT THAT THE NEW MODEL RETROACTIVELY CHANGED THE RULES OF THE GAME TO THEIR DETRIMENT. (A DIRECTOR OF THE ELECTRICITY SECTOR REGULATORY AGENCY SEPARATELY EXPRESSED SKEPTICISM OF THE NEW MODEL AND POINTED TO THE GOB'S DECEMBER AUCTION TO SUPPLY POWER AS THE NEW MODEL'S FIRST MAJOR TEST.) AMBASSADOR ALSO URGED MINISTER ROUSSEFF TO MOVE QUICKLY TO HELP ENSURE THAT PETROBRAS PAID AN USD 83 MILLION ARBITRAL AWARD DUE THE U.S. FIRM NRG. ROUSSEFF PLEDGED TO FACILITATE DISCUSSION BETWEEN NRG AND PETROBRAS ON THE MODALITIES FOR PROCEEDING WITH THE PAYMENT. IN CLOSING, MINISTER ROUSSEFF EXPRESSED APPRECIATION FOR ALL THE HELP THAT DOE - AND IN PARTICULAR, SECRETARY ABRAHAM - HAS BEEN ABLE TO PROVIDE IN TERMS OF SUPPORT ON ISSUES SUCH AS ALTERNATIVE ENERGY SOURCES. END SUMMARY AND INTRODUCTION. NRG ADVOCACY -------------- ¶2. (SBU) IN A NOVEMBER 8 COURTESY CALL UPON MINISTER ROUSSEFF AND HER CHIEF OF STATE (NELSON JOSE HUBNER MOREIRA),AMBASSADOR, (ACCOMPANIED BY ECONCOUNS, DEPUTY SENIOR COMMERCIAL OFFICER, AND SPECASST) URGED THE GOB TO QUICKLY COME TO AN UNDERSTANDING WITH THE US FIRM NRG ENERGY, INC. REGARDING THE TIMING/METHOD FOR PAYMENT OF AN USD 83 MILLION ARBITRAL AWARD DUE THE COMPANY. ALTHOUGH NRG PREVAILED AGAINST PETROBRAS IN ARBITRATION REGARDING THE LATTER'S MOVE TO ASSUME OPERATIONAL CONTROL OVER THE TERMO RIO PROJECT, TO DATE PETROBRAS HAS NOT COMPENSATED NRG AS REQUIRED BY THE ARBITRAL AWARD. ¶3. (SBU) MINISTER ROUSSEFF EXPRESSED SURPRISE THAT THIS ISSUE WAS OUTSTANDING, NOTING THAT THE PETROBRAS BOARD HAD DECIDED TO MOVE FORWARD WITH THE PAYMENT OVER TWO MONTHS AGO. SHE EXPLAINED THAT THERE WERE THREE POSSIBLE MECHANISMS FOR EFFECTING PAYMENT: A) NRG COULD SET UP A COMPANY IN BRAZIL AND RECEIVE IN REAIS, B) PETROBRAS COULD REMIT DOLLARS TO NRG (WHICH WOULD REQUIRE CENTRAL BANK APPROVAL),AND C) PETROBRAS COULD PAY NRG FROM ITS OVERSEAS DOLLAR ACCOUNTS. MINISTER ROUSSEFF PLEDGED TO IMMEDIATELY PHONE PETROBRAS FINANCIAL DIRECTOR GABRIEL TO REQUEST THAT HE ENTER INTO CONTACT WITH NRG TO ASSURE THEM THAT PAYMENT WOULD BE FORTHCOMING. NOTE: PER NOV. 10 DISCUSSIONS BETWEEN FCS AND PETROBRAS, IT APPEARS THAT NRG AND PETROBRAS WILL SOON RESUME DIRECT TALKS. PETROBRAS WAS UPSET THAT THE USG DID NOT FEEL THAT IT WAS NOT COMMUNICATING OPENLY WITH NRG OR THE USG. HOWEVER AFTER MANY UNSUCCESSFUL ATTEMPTS TO SCHEDULE AN APPOINTMENT WITH PRESIDENT DUTRA, PETROBRAS DID APPEAR TO BE AVOIDING THE SUBJECT. NEW ENERGY MODEL -------------- ¶4. (SBU) AMBASSADOR THEN QUERIED ROUSSEFF ABOUT HER PLANS FOR RESTRUCTURING THE ENERGY SECTOR. ROUSSEFF NOTED THAT UPON ENTERING THE MINISTRY IN 2003, SHE FOUND THAT THE SECTOR WAS IN A PRECARIOUS STATE. ASSETS PRICES HAD DROPPED WORLDWIDE, AND BRAZIL FACED A DOUBLE WHAMMY AS ITS ECONOMY WAS IN CRISIS. HOWEVER, SINCE THEN, SHE SAID, THE HEALTH OF THE COMPANIES (BOTH PUBLIC AND PRIVATE) IN THE SECTOR HAS BEEN RESTORED, EVEN THOUGH THE GOB NEEDS TO DO MORE IN TERMS OF STREAMLINING OF LICENSE/ENVIRONMENTAL REQUIREMENTS, ESPECIALLY FOR HYDRO GENERATION PLANTS. ¶5. (SBU) THE AMBASSADOR POINTED OUT THAT US INVESTORS (INCLUDING DUKE ENERGY) WERE UNHAPPY WITH THE MINISTER'S PLAN TO SUB-DIVIDE THE ENERGY GENERATION MARKET INTO "OLD ENERGY," I.E. ESTABLISHED PRIOR TO JANUARY 1, 2000, AND "NEW ENERGY," POST JANUARY 1, 2000. OLD ENERGY WOULD BE SUBJECT TO LONG-TERM CONTRACTS AND LESS PRICE VARIATION; NEW ENERGY WOULD BE FREE TO FLUCTUATE WITH THE MARKET. AS DUKE ENTERED THE MARKET PRE JANUARY 1, 2000, ITS PLANTS WOULD BE CONSIDERED OLD ENERGY AND WOULD HAVE TO COMPETE PRINCIPALLY WITH FULLY-DEPRECIATED STATE-OWNED PLANTS. THE MINISTER REPLIED THAT SHE UNDERSTOOD DUKE'S COMPLAINTS, BUT THAT WHAT THEY WANTED WAS SOMETHING SHE COULD NOT PROVIDE. BECAUSE NEW INVESTORS FACED HIGHER RISKS - AS THEIR FACILITIES WERE NOT IN PLACE - IT WAS ONLY LOGICAL TO REWARD THEM WITH THE OPPORTUNITY TO EARN HIGHER RETURNS. REGULATORY AGENCY SKEPTICAL OF NEW MODEL -------------- ¶6. (SBU) IN A SEPARATE MEETING WITH PAULO PEDROSA, ONE OF THE DIRECTORS OF THE ENERGY REGULATOR (ANEEL) AND HIS ADVISOR, RULEMAR PESSOA, ECONOFFS HEARD ANEEL'S CONCERNS WITH THE MINISTRY'S HYBRID MODEL. PEDROSA, WHO WAS APPOINTED BY PREVIOUS PRESIDENT CARDOSO, CHARACTERIZED THE MINISTRY'S NEW HYBRID MODEL AS A PARADIGM SHIFT. HE STATED THAT BRAZIL IS MOVING FROM FDI-CENTRIC MODEL, BASED ON A FIXED LEGISLATIVE FRAMEWORK AND INDEPENDENT REGULATORY REGIME, TO A MODEL THAT SEEKS TO LEVERAGE INFRASTRUCTURE DEVELOPMENT WITH MONEY FROM THE NATIONAL DEVELOPMENT BANK (BNDES) AND PENSION FUNDS. THE ERA OF FREE COMMERCIALIZATION OF ENERGY WAS "ABORTED," PEDROSA SAID, WITH THE HYBRID MODEL NOW GIVING THE STATE A LEADING ROLE. FOR EXAMPLE, IN THE FUTURE THE STATE WILL DETERMINE HOW MUCH NEW CAPACITY IS NEEDED, BASED ON FORECASTS FROM A NEWLY-CREATED AND PURPORTEDLY- INDEPENDENT ENERGY RESEARCH INSTITUTE (IPE). (NOTE: WITH THE ECONOMY EXPANDING BRISKLY, SOME INDUSTRY FORECASTERS ARE ALREADY PREDICTING ELECTRICITY SHORTAGES BY 2008 UNLESS SUBSTANTIAL INVESTMENT IS MADE TO KEEP PACE WITH THE BURGEONING DEMAND. THE MINISTER HERSELF HAS PUBLICLY STATED THAT THE COUNTRY NEEDS INVESTMENT OF USD 2.9 BILLION IN GENERATING CAPACITY, USD 1 BILLION IN TRANSMISSION, AND USD 2 BILLION IN DISTRIBUTION.) ¶7. (U) IN MOVING TO THE NEW MODEL, HOWEVER, THE MINISTRY OF MINES AND ENERGY (MME) HAD TO ACCOUNT FOR EXISTING GENERATORS AND INVESTMENT IN A MODEL DESIGNED WITH NEW POWER IN MIND. THIS WAS THE ORIGIN OF THE MME'S AWKWARD DUAL POOL MODEL: THE FIRST A POOL OF "OLD ENERGY," PRODUCED BY PLANTS THAT CAME ON LINE BEFORE THE CUTOFF DATE, AND A SECOND OF "NEW ENERGY," PRODUCED BY NEW PLANTS THAT CAME ON LINE AFTER THE CUTOFF (REFTELS). THIS DIVIDES INTO TWO SEPARATE COMPETITION GROUPS POWER GENERATORS THAT HAD NOT YET AMORTIZED THEIR INVESTMENTS (NEW ENERGY) AND THOSE THAT HAVE (OLD ENERGY). THE GOB IS FORGING AHEAD WITH PLANS TO IMPLEMENT THE MODEL, BEGINNING WITH AN EARLY DECEMBER "MEGA-AUCTION" FOR 55 MW OF OLD ENERGY, TO BE SOLD TO MEET EXISTING, PRIMARILY RESIDENTIAL AND SMALL BUSINESS, POWER DEMAND. ¶8. (U) PEDROSA EXPLAINED TO ECONOFFS THAT POWER SOLD INTO THE OLD ENERGY POOL WILL BE BOUGHT BY DISTRIBUTORS AND RESOLD TO "CAPTIVE" CONSUMERS, PRIMARILY RESIDENTIAL CUSTOMERS AND SMALL BUSINESSES. GENERATORS THAT DO NOT SELL INTO THE POOL MAY COMPETE FOR LARGE COMMERCIAL OR INDUSTRIAL CUSTOMERS, KNOWN AS "FREE" CUSTOMERS, WHO RETAIN THE RIGHT TO CONTRACT DIRECTLY FOR POWER SUPPLIERS. THE POOL IS OBLIGATED TO PURCHASE MORE EXPENSIVE POWER (3000 MW WORTH) FROM SMALL HYDROELECTRIC PLANTS, WIND PLANTS AND SOME THERMAL POWER GENERATION PLANTS. ISOLATED POWER GRIDS IN THE AMAZON, PRIMARILY RELIANT ON DIESEL FUEL-BASED GENERATION, RECEIVE A SUBSIDY. ¶9. (U) IN EARLY 2005, ACCORDING TO PEDROSA, THE GOB PLANS TO AUCTION OFF AUTHORIZATIONS TO BUILD NEW POWER PLANTS. THE AMOUNT TO BE AUCTIONED WILL BE BASED ON DEMAND PROJECTIONS DRAFTED BY THE IPE. THESE NEW PLANTS WOULD BE REQUIRED TO SELL INTO A "NEW ENERGY" POWER POOL, WHICH WOULD BE USED MEET THE IPE-FORECASTED EXPANSION OF DEMAND. THE AUTHORIZATIONS TO BUILD NEW PLANTS WILL BE AWARDED TO THOSE WHO OFFER THE LOWEST FINAL ENERGY PRICE. OLD ENERGY, GIVEN ITS ALREADY-AMORTIZED INVESTMENT, WOULD BE ABLE TO UNDERCUT THE PRICES CHARGED BY NEW PLANTS AND WOULD THEREFORE NOT BE GIVEN ACCESS TO THE NEW ENERGY MARKET. ¶10. (SBU) PEDROSA BELIEVES THAT THE RESULTS OF THE DECEMBER AUCTION WILL BE INDICATIVE OF HOW THE POWER SECTOR VIEWS THE NEW MODEL. FOR EXAMPLE, IF FEW LONG-TERM CONTRACTS FOR SALES TO THE POOL ARE OFFERED, IT WOULD INDICATE POWER GENERATORS ARE BETTING ON RISING POWER PRICES AND UNWILLING TO TIE UP THEIR CAPACITY FOR LONG WITH SALES TO THE POOL. THIS WOULD BE AN IMPLICIT CALCULATION THERE WOULD NOT BE SUFFICIENT CAPACITY IN THE FUTURE, AND TO SOME DEGREE AN INDICTMENT OF THE MODEL ITSELF. LIKEWISE, OLD ENERGY PRODUCERS COULD DELIBERATELY BID HIGH SO AS TO LOSE OUT ON SALES TO THE POOL BUT THEREBY RESERVE THEIR CAPACITY TO COMPETE FOR THE LARGER INDUSTRIAL AND COMMERCIAL CUSTOMERS ("FREE CUSTOMERS") THAT ARE ALLOWED TO CONTRACT DIRECTLY FOR THEIR POWER SUPPLIES. COMMENT -------------- ¶11. (SBU) WITH RESPECT TO THE NEW ENERGY MODEL, ROUSSEFF AND THE MINISTRY REPEATEDLY HAVE RESPONDED TO CRITICISM FROM BOTH INDUSTRY AND ANEEL WITH THE SAME STOCK ANSWERS THAT SHE GAVE THE AMBASSADOR. ROUSSEFF BELIEVES STRONGLY THAT THE STATE MUST PLAY A FAIRLY CENTRAL ROLE IN ORGANIZING MARKETS. THE MARKET, HOWEVER, WILL SOON HAVE ITS OWN SAY; THE DECEMBER OLD ENERGY AUCTION WILL, AS PEDROSA POINTED OUT, SPEAK VOLUMES ABOUT INDUSTRY EXPECTATIONS. EXISTING GENERATORS, HOWEVER, ARE STUCK, AND MUST TO SOME DEGREE MAKE PEACE WITH THE NEW MODEL. THE EARLY-2005 NEW ENERGY AUCTION WILL PROVIDE A MORE DEFINITIVE ANSWER, BECAUSE NEW-TO-MARKET INVESTORS WILL BE FREE TO AVOID IT ALTOGETHER. CHICOLA