Argentina & Brazil - Thailand


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Implementation of Energy Market
Lessons learned from
Argentina and Brazil

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Argentina & Brazil - Thailand

  1. 1. Implementation of Energy Markets Lessons learned from Argentina and Brazil Luiz T. A. Maurer Bangkok, Thailand October 14, 1999
  2. 2. AGENDA <ul><li>INTRODUCTION </li></ul><ul><li>OVERVIEW - ARGENTINA AND BRAZIL </li></ul><ul><li>MOTIVATION FOR CREATING AN ENERGY MARKET </li></ul><ul><li>OBJECTIVES AND CONSTRAINTS </li></ul><ul><li>BASIC CHARACTERISTICS </li></ul><ul><li>STATUS OF IMPLEMENTATION </li></ul><ul><li>TRANSITIONAL MEASURES </li></ul><ul><li>BENEFITS SO FAR </li></ul><ul><li>LESSONS LEARNED </li></ul><ul><li>NATURAL GAS CHALLENGES </li></ul>
  3. 3. INTRODUCTION <ul><li>We will talk about Argentina and Brazil cases </li></ul><ul><li>Two success stories in transforming their energy sectors </li></ul><ul><li>Focus of the presentation: electric sectors </li></ul><ul><li>Particularly in the establishment of competition ... </li></ul><ul><li>And the creation of energy markets </li></ul><ul><li>In both countries, markets already in operation </li></ul><ul><li>But in different stages of development </li></ul><ul><li>Many points in common and lessons to be learned </li></ul>Despite the unique characteristics of each sector, we think that international experiences can provide meaningful lessons to other countries embarking on similar ventures
  4. 4. OVERVIEW ARGENTINA AND BRAZIL 165 62 340 7 130 35 20 72 39 683 Population Installed Electric Natural Gas Natural Gas (million Capacity Energy Production Reserves inhabitants) (G W) Production (b c m / y r.) (b c m) O R D E M E P R O G R E S S O O R D E M E P R O G R E S S O
  5. 5. MOTIVATION FOR CREATING AN ENERGY MARKET <ul><li>Part of an overall process of reform of the public sector </li></ul><ul><li>Introduce workable competition on the supply and demand sides </li></ul><ul><li>Attract private capital to support expansion and help mitigate impending energy crisis </li></ul><ul><li>Pave the road for privatization of G and D assets </li></ul><ul><li>Before, supply side was basically in the government hands, as a producer, seller, and agent in charge of operating the systems - no competition existed </li></ul>
  6. 6. OBJECTIVES AND CONSTRAINTS <ul><li>Preserve the benefits of system optimization </li></ul><ul><li>No additional risks of supply disruption </li></ul><ul><li>Create a competitive market where agents can settle contracts, buy or sell differences, hedge against price fluctuations </li></ul><ul><li>With transparent rules and no barriers for new players </li></ul><ul><li>To enable competition at the contract and spot levels </li></ul><ul><li>Where contract prices, volumes and terms can be freely negotiated </li></ul><ul><li>Transitional phase - as smooth as possible, to avoid tariff shocks </li></ul>
  7. 7. BASIC CHARACTERISTICS <ul><li>Overall reform - driven by highest government levels, with legislative support </li></ul><ul><li>Central optimization system with no relation to contracts </li></ul><ul><ul><li>In Brazil, very tight pool, virtually no bidding </li></ul></ul><ul><ul><li>In Argentina, more flexibility for power plants to bid </li></ul></ul><ul><li>A lot of emphasis on long term bilateral contracts </li></ul><ul><ul><li>To reduce spot price volatility for Gs and D/Rs </li></ul></ul><ul><ul><li>To facilitate privatization of generation </li></ul></ul><ul><ul><li>Regulatory mandates for minimum contracting requirements </li></ul></ul><ul><li>Active spot market for uncontracted demand </li></ul><ul><ul><li>All energies are taken into account to form the spot price </li></ul></ul><ul><ul><li>Price as an economic signal for expansion/contracting </li></ul></ul><ul><ul><li>Spot price to settle uncontracted generation/demand </li></ul></ul>
  8. 8. BASIC CHARACTERISTICS (Continued) <ul><li>New private agencies created for operational and commercial purposes </li></ul><ul><ul><li>In Brazil - separate WEM (MAE) and ISO (ONS) </li></ul></ul><ul><ul><li>In Argentina - combined (CAMMESA) </li></ul></ul><ul><li>Central planning roles limited in scope </li></ul><ul><ul><li>In Argentina - no planning for G or T </li></ul></ul><ul><ul><li>In Brazil - ISO plans T, Government produces indicative planning for G </li></ul></ul><ul><li>New, independent, regulatory agencies as part of sector reform - ENRE in Argentina, ANEEL in Brazil </li></ul><ul><li>Simultaneous, gradual deregulation of the demand side - open access and retail choice for larger customers </li></ul><ul><li>Transitional measures to move to a competitive market </li></ul>
  9. 9. BASIC CHARACTERISTICS (Continued) <ul><li>ARGENTINA </li></ul><ul><li>* Tight Pool </li></ul><ul><li>* Thermal to Hydro Competition </li></ul><ul><li>* Pool price based on thermal bidding and “cost of water” </li></ul><ul><li>* Spot price smoothing for load ; also capacity fee </li></ul><ul><li>* Initially very contracted - today 42 % spot </li></ul><ul><li>* No hydro dispatch risk mechanism </li></ul><ul><li>* Some emerging merchant plants </li></ul><ul><li>* Multiple nodal prices, which include T short term costs </li></ul><ul><li>* One agent to operate the system and settle contracts </li></ul><ul><li>* Up and running </li></ul><ul><li>BRAZIL </li></ul><ul><li>* Very tight pool </li></ul><ul><li>* Hydro - thermal still subsidized </li></ul><ul><li>* Pool price based on central cost calculation - no bidding for now </li></ul><ul><li>* No spot price smoothing, except capacity fee, to avoid spot price to reach VLL </li></ul><ul><li>* Fully contracted (ICs) - Expected 10 to 15% spot </li></ul><ul><li>* Hydros share dispatch risk </li></ul><ul><li>* No merchant plants - unlikely </li></ul><ul><li>* 4 Pool prices (sub-markets), adjusted for short term losses </li></ul><ul><li>* Two agents: one to operate the system, one to settle contracts </li></ul><ul><li>* Under implementation </li></ul>O R D E M E P R O G R E S S O
  10. 10. STATUS OF IMPLEMENTATION <ul><li>In both cases, markets up and running - but at different stages of development </li></ul><ul><li>Argentina started first, in 1991 - about 2 years to make market operational, in a kind of “big bang” approach </li></ul><ul><li>Brazil started later, in 1996 and is taking longer </li></ul><ul><ul><li>2 years to design and approve the new model </li></ul></ul><ul><ul><li>1 year to implement MAE and Market Rules (ongoing) </li></ul></ul><ul><ul><li>1-2 years yet to build the infrastructure - metering, systems </li></ul></ul><ul><li>Horizontal separation concluded in Argentina and only partial in Brazil, as privatization takes place </li></ul><ul><li>In both cases, regulations lag behind in creating the trading function (separate from wire business) and in enforcing non discriminatory, open access rules </li></ul><ul><li>Financial risk management tools at early stages </li></ul>
  11. 11. STATUS OF IMPLEMENTATION (Continued) Why things move at different speeds ? <ul><li>Different perceptions of crisis - Argentina was in the middle of a major, national blackout when reforms initiated </li></ul><ul><li>Argentina started at the beginning of a Presidential term - and had Government support across the entire process </li></ul><ul><li>Technical complexities also matter </li></ul><ul><ul><li>Brazil is basically hydro based - cascade and multiple ownership effects </li></ul></ul><ul><ul><li>Contrary to Argentina, where thermal x hydro competition existed from the start </li></ul></ul><ul><li>Political complexity is also important - balance of power between Federal and State Governments in Brazil </li></ul><ul><li>Brazil had to “pass the baton” very early to the private agents - conflicts between Gs and D/Rs drag the process </li></ul>
  12. 12. TRANSITIONAL MEASURES <ul><li>Competition in the generation business is desirable - but it can not be achieved overnight </li></ul><ul><li>Moving from a regulated to a free market pricing system entails two challenges (see chart): </li></ul><ul><ul><li>Windfall profits - accounting costs below [expected] market prices </li></ul></ul><ul><ul><li>Stranded costs - accounting costs above [expected] market prices </li></ul></ul><ul><li>How to handle those problems on the supply side? </li></ul><ul><ul><li>Long term contracts, to smooth transition and reduce risk to G buyers (see graph) </li></ul></ul><ul><ul><ul><li>Initial Contracts in Brazil - 8 years, declining 25% p.a </li></ul></ul></ul><ul><ul><ul><li>Long term contracts for large privatized plants in Argentina </li></ul></ul></ul><ul><ul><li>Set bulk prices at politically acceptable levels </li></ul></ul><ul><ul><li>Mix “old” and expensive energies in a single portfolio </li></ul></ul><ul><ul><li>Net effect = still some costs to be absorbed by the taxpayer </li></ul></ul><ul><ul><li>Stranded costs solved via write-off on reduced privatization proceeds </li></ul></ul>
  13. 13. WINDFALL PROFITS - STRANDED COSTS Cost (U$/MWh) Rate of Return on Asset Base = 10 % Cumulative Generation (TWh) O R D E M E P R O G R E S S O
  14. 14. CONTRACTS ARE KEY TO TRANSITION Spot Market Current Situation Competitive Market (Bilateral Contracts) Transition period (Initial Contracts) Year
  15. 15. BENEFITS SO FAR - BENEFITS OF DEREGULATION ARE CLEAR Source : Brookings Institution/George Mason University Price Decline (%) 2 years 5 years Transport. Roads Airlines Long Distance Calls Natural Gas 50 40 30 20 10 0 40% 10 years
  16. 16. BENEFITS SO FAR - ELECTRIC SECTORS <ul><li>In Argentina </li></ul><ul><ul><li>Spot prices went down </li></ul></ul><ul><ul><li>Contract prices following similar paths </li></ul></ul><ul><ul><li>New investments </li></ul></ul><ul><ul><li>Increased availability of thermal plants </li></ul></ul><ul><ul><li>Increased operational efficiency </li></ul></ul><ul><ul><li>Dramatic reduction on energy not served (ENS) figures </li></ul></ul><ul><ul><li>No one talks about crisis any longer </li></ul></ul><ul><ul><li>Excess energy to be exported to Brazil </li></ul></ul><ul><li>In Brazil - still early but: </li></ul><ul><ul><li>Competition for new contracts (thermal and hydro) </li></ul></ul><ul><ul><li>New G being offered below marginal costs </li></ul></ul><ul><ul><li>Pressure to diversify energy mix and bring gas </li></ul></ul><ul><ul><li>First free trading transactions -- win-win situations </li></ul></ul>O R D E M E P R O G R E S S O
  17. 17. The UK example showed the world that generation horizontal separation is a structural pre-requisite to create a competitive market REAL MARKET POWER HAS TO CONSIDER * Sub-markets, T constraints * Cross-ownership * “Behind-the-market” contracts * Single buyer model * Vertical desintegration requirements (T/G) Isolated Systems (17 D/Rs) 2 % O R D E M E P R O G R E S S O ARGENTINA BRAZIL 72 %  40 GENERATORS 14% 14 % 62 % 11 GENERATORS 10% 28 % 76 %  40 DISTRIBUTORS 24 %  10 D/Rs 80 % 16 DISTRIBUTORS 18 %  60 D/Rs Bi-national Cos State Owned 18 Other Gs Itaipu share allocated to  20 D/Rs
  18. 18. LESSONS LEARNED <ul><li>Creating a market is not an isolated action - major, concerted piece of a sector reform - institutional, regulatory, commercial, technical </li></ul><ul><li>Not an easy task either </li></ul><ul><ul><li>Very important sectors - changes have strong economic and political dimensions </li></ul></ul><ul><ul><li>Cultural changes, as it challenges old established monopolies </li></ul></ul><ul><ul><li>Government has to refrain from temptation to control prices </li></ul></ul><ul><ul><li>Competition not ingrained in culture/institutions </li></ul></ul><ul><ul><li>Deregulation per se creates winners and losers </li></ul></ul><ul><li>It required strong, constant government support at all levels </li></ul><ul><ul><li>Executive and Legislative branches </li></ul></ul><ul><ul><li>Regulatory and Funding Agencies </li></ul></ul><ul><ul><li>Privatization Cabinets </li></ul></ul><ul><li>It also requires initial investments - advisors, metering, revised optimization systems, accounting and settlement, new agencies, etc.- but it certainly pays off </li></ul><ul><li>1 a Comercialização de Energia/Livre Acesso/Livre Escolha </li></ul><ul><ul><li>Enron Comercializadora de Energia </li></ul></ul>
  19. 19. NATURAL GAS CHALLENGES <ul><li>Very different stories - despite a common backdrop of opening up the industry and fostering private capital participation </li></ul><ul><li>In Argentina natural gas is the “fuel of choice” </li></ul><ul><ul><li>Large reserves and production (up to 107 MM cu.meters/day) </li></ul></ul><ul><ul><li>Large participation in energy matrix - more than 40% </li></ul></ul><ul><ul><li>Well developed infrastructure </li></ul></ul><ul><ul><li>Prior to privatization, large company in place (Gas del Estado) </li></ul></ul><ul><li>In Brazil, situation was the opposite </li></ul><ul><ul><li>Limited reserves and production, with no imports </li></ul></ul><ul><ul><li>Negligible participation in the energy matrix (2%) </li></ul></ul><ul><ul><li>Small LDCs, in a few, limited geographical areas </li></ul></ul>
  20. 20. NATURAL GAS - Argentina was poised for industry deregulation <ul><li>Major deregulation/privatization effort developed in 1992 </li></ul><ul><li>Lessons learned from previous industry restructuring efforts - airlines, telecommunications, electricity </li></ul><ul><li>Government had a clear objective of creating a competitive market, fostering private capital participation and solving supply problems </li></ul><ul><li>Gas del Estado, a large national company, was split and sold in 10 parts - two transcos and 8 LDC´s </li></ul><ul><li>Many benefits achieved - privatization was a success, new investments, more production, T bottlenecks solved </li></ul><ul><li>Challenge is to create a real market, with support from regulator - customer choice not a clear reality yet </li></ul>
  21. 21. NATURAL GAS - Brazil faces the challenge to build the infrastructure <ul><li>A major gas pipeline, connecting Bolivia to Brazil, was a significant effort to increase supply sources - others to follow </li></ul><ul><li>Market pressure has been intense to have access to gas </li></ul><ul><ul><li>Industrial users - key to competitiveness </li></ul></ul><ul><ul><li>Power generation - only solution to imminent crisis </li></ul></ul><ul><li>Petrobrás more interested in increasing gas penetration </li></ul><ul><ul><li>Respond to market needs </li></ul></ul><ul><ul><li>Contestability - other potential suppliers, after end of monopoly </li></ul></ul><ul><li>Brazil is still a long way to go to build the required infrastructure - supply, transportation and distribution </li></ul><ul><li>Still far away from establishing a competitive industry </li></ul>
  22. 22. Enron: Commitment in the Southern Cone Cuiabá 0 350 700 MATO GROSSO DO SUL B R A Z I L SANTA CRUZ B O L I V I A P A R A G U A Y A R G E N T I N A MATO GROSSO Kilometers Belo Horizonte Vitória Rio de Janeiro Curitiba Brasília GOIÁS MINAS GERAIS ESPÍRITO SANTO RIO DE JANEIRO BAHIA PARANÁ RIO GRANDE DO SUL A T L A N T I C O C E A N Porto Alegre SANTA CATARINA U R U G U A Y Santa Cruz de La Sierra P A C I F I C O C E A N SERGIPE ALAGOAS PERNAMBUCO La Paz Asunción Montevideo Buenos Aires Santiago C H I L E P E R U RONDÔNIA Porto Velho TOCANTINS Cuiabá 480 MW and 390 mi Pipeline Transredes Pipeline 3,093 Miles TGS 4,104 Miles Gas/Power Trading Projects/Businesses Under Construction Existing Assets and Operations PARAÍBA Emserg á s 0.1 MMcm/d 18 Customers Alg á s 0.3 MMcm/d 5 Customers PBG á s 0.1 MMcm/d 18 Customers Compagás CEG/Riogás LDCs 3.3 MMcm/d 551,000 Customers Elektro 1.6 Million customers 10,500 GWh <ul><li>Enron Southern Cone </li></ul><ul><li>Participation in 15,206 km of oil and gas pipelines, representing over 75% of regional gas pipeline capacity </li></ul><ul><li>Participation in 9 gas LDCs and 1 electric LDC with over 2 million customers and exclusive franchises for over 60 million people </li></ul><ul><li>First IPP and first private gas pipeline in Brazil </li></ul><ul><li>First gas/power trading deals in Argentina and Brazil </li></ul><ul><li>Several other investments under consideration </li></ul>Campo Grande São Paulo SCGás Bahiag á s 1.6 MMcm/d 21 Customers Coperg á s 0.5 MMcm/d 37 Customers SÃO PAULO Florianópolis Bolivia-Brazil Pipeline 1,864 Miles