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CONFIDENTIAL
Gas Sector in Brazil:
Liberalisation and Pricing Policy
Cairo, May 9th 2004
Future Planning for Egypt's Gas Industry
Luiz Nelson Porto Araujo
This report is confidential. It may contain confidential, proprietary or legally privileged information. No confidentiality or privilege is waived or
lost by any access to it. You must not, directly or indirectly, use, disclose, distribute, print, or copy any part of this report without the written
consent of Delta economics & finance.
2
Agenda
• Reform of the Economy and the Energy Sector
• Market Structure and Regulation
• Gas Sector - Fundamentals
• Tariff Review
• Annex
3
Reform of the economy – an ongoing process
• Stabilization of the inflation rate at low levels
• Redefinition of the role of the State in the economy
• Liberalisation and concession of public services
• Comercial and financial liberalization (kick off)
• Fiscal Responsibility Law
• Central Bank Independence
• Social Security Reform
• Tax Reform
• Comercial and financial liberalisation (conclusion)
• Income distribution
• Social policies (education, security, food)
Source: Delta analysis
Adjustments Implemented Adjustments to be Implemented
Within the context of the economic and social reforms it is relevant to notice that:
• the institutional, legal and regulatory framework for the energy sector are strongly related
• the regulatory environment is still under construction
• the stability of the regulatory rules is still a major problem
The reform of the economy has implied an entirely new approach to
government production of goods and services
The choice between a public or private solution to the energy sector is one of
the main issues for its development
4
Key issues in rebuilding the energy sector
• Brasil has had a long tradition
for subsidies in the economy.
Began a phasing-out in the late
1980´s
• Subsidies for energy sector were
widespread, at a time when the
country was heavily importing oil
• Most of the energy business was
conducted by state owned
companies
• Energy conservation and
efficiency were not seen as
incentive mechanisms
Tariff Policy Private Sector Participation Regulatory Policy
Source: Delta analysis
• The fiscal distress in the late
1980´s implied that a new
source to finance the necessary
investments was to be sought
• International experience had
already demonstrated the
benefits of private sector
participation in infrastructure
• Private sector involvement
called for a new regulatory policy
and agencies
• Until the early 1990´s regulatory
policy was non-existent – except
for tariff control
• International experience had
already demonstrated the
benefits of credible regulatory
policy and agencies
• Government believed that the
introduction of a new regulatory
policy should be associated with
a change in the market structure
These issues were deeply and jointly analysed by the government and the
private sector as the reform of the economy proceeded
5
Guiding principles for the energy sector – 1993
promote
competition
stimulate
efficiency and
quality of
service
stimulate
private
investment
consumer
protection
Guiding
Principles
• competitiveness and efficiency
• stability of regulatory rules
• optimization of supply and demand
• fulfillment of market demand
• investment capacity
• environmental conservation
• improvement of role of State as
regulator
• private sector involvement
• quality of service
• fairness of tariffs
Source: Delta analysis
The guiding principles for the energy sector are an important reference for
any discussion concerning its improvement. It reflects the vision for that
sector. They are fundamental in a regulated business
6
Congress
Regulatory State
Agencies
Consumer
Protection
Consumers
Councils
Competion Law
Agencies
President
Consumers
Ministry of Mining
and Energy
ANP
(oil and gas)
ANEEL
(electricity)
Development Bank Planning
Policy
Regulation
Market
Institutional
Agents
Institutional framework of the energy sector – regulated business
Production Importation
Transportation
Distribution
G
T
D
C
Source: MME, Aneel, ANP; Delta analysis
7
Agenda
• Reform of the Economy and the Energy Sector
• Market Structure and Regulation
• Gas Sector - Fundamentals
• Tariff Review
• Annex
8
Framework for private sector participation
Assumptions for private sector involvement (1997)
Opportunities for private sector involvement
• Government does not have resources to
invest in generation, transmission, and
distribution of electricity. The same applies
for the exploration of natural gas at the local
level
• Macroeconomic conditions (exchange rates,
growth, interest rates) favorable to
investment by residentes and non-residents
• Expectation of tariffs adjustments and
economic growth
• Regulatory framework which guarantees the
passthrough of costs together with a price
cap model which gave incentives to
productivity gains
• Franchising of electricity distributors (state
and federally owned). Franchising of gas
distributors in São Paulo and Rio de Janeiro
• Trading of energy for free consumers
• Franchising of electricity generators (state
and federally owned)
• Expansion of generation through new
auctions for hydro and licenseing of thermal
plants
• Auctions for construction of new
transmission lines
• Trading of new energy/reduction of volumes
of initial contracts
Source: Delta analysis
The privatization program (1990), the concession law (1995), and
amendments to the constitution (1995) were an important reference for
private sector involvement in the energy sector
9
The dynamics of the regulatory agencies
Source: Aneel, Anatel, ANP; Delta analysis
electricity
ANEEL
Eletrobrás: state owned
Local utilities: private owned
Competition: expected
telecom
ANATEL
Telebras: franchise
Competition: earlier
ANP
Petrobras: state owned
Private companies
Competition: expected
oil and gas
The government adopted a framework in which regulatory agencies were
assigned responsabilities for different sector. The dynamics of agencies has
turned out to be very different
10
Regulation of the energy sector in practice
• Regulatory framework approved by a
law passed by Congress
• Relatively high public image of the gas
sector and the regulator (vis-à-vis other
public services)
• Interaction between regulatory and
competition laws predicted
• Rights and obligations of service
providers and consumers defined before
privatization (as part of concession law
and concession contract)
• Lack of long-term government
infrastructure policies
• Possibility of lock-up by regulators
• Very strict service obligations, even
under extreme situations
• No independent administrative or
judiciary appeal instances
Strengths Weakness
There are many challenges faced by regulators, among them lack of
experience in the regulation of public services; integration of regulation and
competition law; and utility integration (energy, telecom, water & sewerage)
Source: Delta analysis
11
Agenda
• Reform of the Economy and the Energy Sector
• Market Structure and Regulation
• Gas Sector - Fundamentals
• Tariff Review
• Annex
12
Agents
• Supply contracts at freely
agreed prices
Producers Transporters Distributors
Source: ANP; Delta analysis
• Regulated tariffs
• Long term transport contracts
• Tariff adjustments predicted in
contract
• Embryonic capacity resale
market
• Regulated distribution service,
with exclusive rights within the
area (concession contract
anticipates free consumers after
a period of time
• Ceiling prices with pass-through
adjustment mechanism for gas
price and transportation tariff
variations
• 5-year Tariff Review. Adjustment
by and X Factor (expected
efficiency gains)
The market structure of the gas sector is clearly defined. Nevertheless some
adjustments are called for to improve total welfare
13
Demand for natural gas
47
29 28
2421
15
6
0
5
10
15
20
25
30
35
40
45
50
Argentine Italy Mexico USA Germany France Brazil
Demand for natural gas
% - 2003
Argentine Italy Mexico USA Germany France Brazil
Comments
• Consuption growth has been increasing in
most regions of the country and market
segments
• Network expansion is a major challenge
• The recent results of a tariff review in São
Paulo – for Comgas, the gas company – are
expected to be very relevant as a signal for
private investors
• New model for electricty sector is expected
to increase the demand for gas, through the
dispatch of thermal plants
Source: MME, Petrobras; Delta analysis
Total demand for natural gas in Brazil is behind that observed in other
countries. Nevethelss, growth potential is very high
14
Comgás – the most important gas company in Brazil
Consumers (in thousands)
329 345378
416
2000 2001 2002 2003
Volume (in MM m3)
(except for thermal generation)
1,68
2,24
2,953,30
2000 2001 2002 2003
Investments (in R$ MM)
103
229201
242
2000 2001 2002 2003
Network (in km)
27162965
32003600
2000 2001 2002 2003
Source: Comgás, Delta analysis
Company growth depends on good regulation and market potential. Growth
has implied consumer access, network expansion, and new investments. All
contribute to more jobs, tax collection, and better service quality
15
Benefits of regulatory stability and credibility
Higher consumer
access
• significant growth in number of consumers – in all segments – with access to gas
supply. Improvement in population welfare
Increased
network
expansion
• significant growth in size of netwok, besides substituion of old pipes. Externalities in
other economic activities (production, employment, tax, etc)
Better and higher
investments
• private investor was able to invest the amounts necessary to fufill requirements of
service quality and market demand. Externalities in other economic activities
More
employment
• increase em jobs, both direct and indirect. Also, increase in quality of manpower.
Improvement in population welfare (income, schooling)
Better
service quality
• better perfornance, lower waste of time and cost of quality. Higher efficiency and
lower service cost
Increase in tax
collection
• increase in tax revenues. Reduction in fiscal deficits and possibility of higher
transfers to poorer sectors
Source: Comgás, Delta analysis
16
Challenges for natural gas growth
NGV
• Tarrifs
• Access – availability and security of supply
• Involvement of auto makers
• Tax incentives for gas powered vehicles
Residential and
comercial
• Pricing of LPG – butagas (subsidized)
• Access – availability and security of supply
• Development and introduction of new products and services
Industrial
• Expansion of distribution network
• Pricing of fuel oil (subsidized)
• Availability and security of supply; contracts (take or pay clause, interruptable etc)
Co-generation
• Joint use with industries and large commerce
• Investiments in techonology and non-interruptible supply
• Feasibility of distribution projects
• Tax incentives
Source: Delta analysis
17
Agenda
• Reform of the Economy and the Energy Sector
• Market Structure and Regulation
• Gas Sector - Fundamentals
• Tariff Review
• Annex
18
Key dimensions of a tariff review
Legal
EconomicSocial
Political
Nature of
Business
• Market growth potential
• Competition of
alternative fuels
• Regulation of tariffs
and market access
• Stakeholders interests
Nature of
Regulation
• Framework and
Agenda
• Accountability and
Independence
• Forecastibility of Rules
• Enforceability of
Contracts
• Conflict Resolution
• Energy policy
• Fundamentals of
energy – ang gas in
particular – regulation
• Petrobras strategic
plan
Source: Delta analysis
A successful tariff review should take into account the interests of the major
stakeholders involved with the business
19
Final Tariff to
Consumer
Operacional
Expenses
Capital
Remuneration
InvestimentsMaximum
Margin
Gas Cost +
Transportation
Tariff review – implications
Source: Delta analysis
Tariff reductions in general imply lower return to investment which impacts
the incentives for firm growth, investment, employment, tax collection, and
the expansion of the network
20
Limitation supply growth
Deterioration of credit rating and increase in
the cost of capital
Worsening of social involvement
Worsening of the economic-financial desequilibrium of
contract
Limitation investments
Risk of deterioration of the quality of
services
Consequences of loss in cash flow in
tariff reviews
Tariff review – implications (cont.)
Source: Delta analysis
The overall limitations imposed by a badly conducted tariff review are very
significant, and not only at the firm level
21
Agenda
• Reform of the Economy and the Energy Sector
• Market Structure and Regulation
• Gas Sector - Fundamentals
• Tariff Review
• Annex
22
Restructuring the energy sector – main issues
Historical development
and diagnostic
• state private
• planning
• franchising and concession
• investiments
• regulatory framework and tariff policy
Characteristics
of sector
• economics of networks
• hydro base and oil import
• distance between generation and consumption
• energy sources
New investment
decisions
• regulation, risk and return
• new markets
• competition and liberalization
• consolidation
Restrucuturing and
regulatory framework
• state reform
• institutional model
• regulatory framework and tariff policy
• transition phases
• strategic positioning of utility companies
Source: Delta analysis
23
The gas sector – development and diagnostic
• Between 1953 and 1995 Petrobras monopoly
(extraction and production; transportation; and
trading)
• Natural gas was not a priority
• Until 1988 distribution activities (industrial consumers)
were performed by Petrobras in all States except in
São Paulo and Rio de Janeiro
• Starting in 1988 (with the new Constitution) the
granting of distribution concessions was given to local
(State) governments
• The Constitutional Amendment n° 9, of 1995, redefine
the State Monopoly in oil and gas
• Insufficient investment to increase supply
• Insufficient network (extension of pipeline grid)
• Need of a new tariff policy with incentive-based
mechanism
• Petrobras monopoly was a significant constraint in
private sector participation
Source: Delta analysis
Historical Development Diagnostic in 1997
The development of the gas sector openned new business opportunities for
private investors. Legal and regulatory framework have changed drastically
24
Franchise Restructuring Regulation
Electricity, Water & Sewerage, and Transportation
Franchise
(conception)
Restructuring Regulation
Telecommunications, Oil & Gas
Franchise
(operation)
Source: Delta analysis
Privatization and regulation
The government has approached franchising and regulation for
infrastructure differently, depending on the sector
25
Investment and return in a regulated business
Legal Stability
Fundamentals
of Regulation
Existence of
Legal Framework
Institutional Stability
Existence of
Institutional
Framework
Fiscal Stability
Stabilization and
Growth
State Reform
Investments
and Returns
Tariff Model
Market
Oganization
Regulation
Source: Delta analysis
In Brazil, investments and returns are conditioned by Legal, Institutional and
Fiscal Stability, which have to do with the state of the economy
26
Main markets and power connections
transmission lines
pipelinesArgentina
Bolivian
Gas
Venezuela
Itaipu
Source: MME, Delta analysis
Integration of the energy
infrastrucuture in Latin
America will increase in the
coming years
27
Natural gas in the southern cone
Source: Delta analysis
• High potential for growth in gas demand in Brazil:
• gas represents only 6% of the energy sources
• 80% of total power generation is hidro
• residential, industrial and thermal consumption
are likely to increase
• south/southeast have best potential market
• Chile, Paraguai, and Uruguai: other potential markets
• Argentina: export potencial
• Future supply is expected from Bolívia (Argentina?
Peru?) to Brasil
• Petrobras supply position:
• significantreserves in Southern Cone
• controls Brazil –Bolivia pipeline
• controls transportation infrastructure
• Petrobras currently has an average stake of 40% in
the develpment of 16 thermal plants, with eight plants
in operation, or in testing, and three under
construction
Peru
Bolivia
Argentina
Brazil
28
Natural gas – Brazil-Bolivia pipeline
Source: ANP; Delta analysis
Brazilian Gas Chain
transfer pipes
UPGN
transportation pipelines distribution pipelines
consumptionproduction city gate
Bolivian Gas Chain
production
Transierra/
Transredes
compression
GTB
city gate consumption
TBG
TBG
Transpetro distribution pipelines
The current infrastructure for the exploration of natural gas through the
Brazil-Bolivia pipeline is clearly defined
29
Energy sources and penetration of natural gas
hydro
7%
30%
11%
10%
6%
36%
oil
sugar cane
coal
natural gas
others
Energy sources Reasons for low penetration of gas
• Significant hydro generation
• Focus on exploration and production
of oil
• Limits on the domestic supply of gas
• High cosf for the expansion of
transportation and distribution
networks
• Supply of competitive fuels – sugar
cane, coal and fuel oil
Source: MME; Delta analysis
Mostly because of geographic location and lack of incentives for natual gas
the energy sources in Brazil are concentrated in hydroelectricity and oil
30
Supply of natural gas and infrastructure
• Recent discoveries
have tripled the total
reserves of natural
gas
• Investments in
pipelines now allows
Brazil to import gas
from Bolivia
• Production has
grown very rapidly
– 9,8%a.a. since
1980 e 9,0%a.a.
(between 1998-
2003)
• Since jul/99 Brazil
has been importing
gas from Bolivia –
nearly 14 MM m3/
day
• “Cabiúnas Project”
intends to reduce
the burning of gas
in flares by 5,2 MM
m3/day
• Construction of
Gasbol is a major
landmark
• Additions to the initial
pipeline allows the
gas to reach the
south region of the
contry
• New “Network
Project” intends to
consolidate the north
and south networks
• Pivate sector
participation in
distribution
companies has
made a major
difference in
investment, service
quality, employment
and security of
supply to
consumers
Source: Delta analysis
ReservesProduction and
ImportsTransportation Distribution
The supply of natural gas has increased sharply as a result of major
decisions taken by the government. More recently, private sector
participation has also been very relevant
31
Challenges for natural gas growth
Regulation and
transportation
• Conflicts among regulatory agencies
• Unbundling of networks
Pricing the
Bolivian gas• The contract needs revision to take into account developments in both countries
Thermal power
development
• Most power generation is still hydro based; there is insecurity as to the usage of
thermal plants
Price of fuel oil in
domestic market
• Relative price of fuel oil and natural gas is distorted by all sort of subsidies in the
former
Environmental
Policy• Lack of clear cut policy for the emission of gas by vehicles
Source: Delta analysis
The challenges cover a wide range of issues. The government and the private
sector are involved in exploring new opportunities to increase the usage of
gas in all segments of the economy
32
Tariff policy – price adjustments and reviews
Tariff
Adjustment
(X =0)
0 Year
IGPM
IGPM - X
EFE
IGPM
IGPM
IGPM
Review
(X >0)
EFE
Tariff
Adjustment
Tariff
Review
Tariff
Adjustment
Source: Delta analysis
The regulatory framework for tariffs – price cap model – takes into account
the economic-financial equilibrium of the concession contract
33
Tariff review – managing regulation, risk and return
Regulatory
Framework
Tariff
Policy
Equilibrium of
the Contract
Risk and Return
of the Investiment
• X Factor
• Cost of capital
• Regulatory
Asset Base
Regulatory
Risk
Investment
Source: Delta analysis
Tariff policy is fundamental in defining the economic-financial equilibrium of
the concession contract, and therefore the risk and return of the invesment
34
Tariff reviews – defining the new tariffs
Allowed
Return
Exogenous
Expenses
Endogenous
Expenses
Depreciation
Tariff
Review
+
+
+
Required
Revenues
Supply and
Other Revenues
Net Required
Revenues
Verified
Revenues
-
Tariff = return on investment (RABt x Wacct)+
expenses +
return of investment (depreciation
Source: Concession Contracts; Delta analysis