|Brazil's emptying reservoirs could lead to recession|
The government maintains the chances of rationing remain low and while the major banks have yet to model the impact of rationing, there is more open discussion about the effect that it would have on 2015 GDP. Most economists say the impact on the Brazilian economy would be a fall in GDP of between 1.5 and 2.0 percentage points. With consensus expectations of annual GDP growth at around 1%, this would lead to Brazil falling into recession next year, with the added complication of an inflationary supply-side shock.
Marcelo Carvalho, chief economist at BNP Paribas in Sao Paulo, has not included rationing in his prediction for zero growth in 2015 and says that any rationing would therefore “without doubt” push the country into a recessionary year. “There are really only two things that can stop Brazil from having to impose power and water rationing, in our view: very poor economic growth (once again) and lots of lots of rain,” writes Carvalho in a client note. “After one month of the rainy season, rainfall has been at 60%-70% of the long-term average and reservoir levels continue to fall.” A UBS report says that the levels of rainfall in November “mean high rationing risks if rainfalls remain at current levels”.
Significantly, power companies CPLF and CEMIG provided analysts on their 3Q earnings calls guidance for a likely 9%-10% hydro-generation shortfall through 2015.
The government bases its low prediction of the likelihood of rationing on data supplied by ONS, the operator of Brazil’s national grid. These projections have consistently been higher than private sector estimates. ONS, recently cut its predictions in early December for rainfall in the south-east for the coming weeks of 107% of LTA to 94% (the region that accounts for 70% of hydroelectric power generation) following November’s low level of precipitation. It also cut its estimates for the level of reservoirs at the end of 2014 to 22.1% – a week earlier its prediction had been 24.3%. ONS has been continually criticized for making predictions about rainfall and reservoir levels that prove to be over-optimistic.
In the second half of 2014 UBS criticized ONS’s model because it does not consider correlations between monthly rainfall series – for example if the month-ending is dry, there is a likelihood that the following month will also be similarly dry. UBS also said that ONS continually underestimates reservoir depletion rates, which it has verified as a big gap between estimated and actual reservoir levels.
Despite the low level of rain and falling reservoirs there have been very few attempts to conserve water, beyond PR campaigns to encourage voluntary reduction in water usage. “Water levels have been sailing perilously close to critical levels all year, but little has been done to remedy the situation,” notes Carvalho. “In fact, nothing has been done at all to reduce energy consumption; if anything the government has done the opposite by keeping prices artificially low in a time of scarcity. We suspect that this year’s elections and a desire to avoid unpopular measures played a significant role in both cases. Rationing is not a vote winner. Denial appears to be more palatable politically.”
Euromoney has reported since June 2014 the concerns of private sector hydrology experts who have been warning about the potential consequences of a failure to conserve water for energy generation. More than 70% of Brazil’s electricity comes from hydro-electricity. The government has been using all of its available thermal power plants since the beginning of 2014 to prevent a recurrence of the last time Brazil had power rationing in 2001. (According to official statistics, water levels at the hydro reservoirs ended October at 23.1%, while at the end of 2001 they were at 24%.) The use of thermal plants caused the spot-price of electricity to jump to its maximum charge of R$822Mwh, which led to large industrial customers selling electricity to the grid to book profits rather than for production, which slowed the economy further. That poor 2014 growth, however, has helped the chances of averting rationing in 2015.
According to Carvalho: “Brazil’s economy has been limping along at a pretty dismal pace for a while now. Ironically, this is actually great news in terms of water and energy consumption. More growth means more energy consumed. So, had Brazil been growing at the robust rates of 2004-10, it would probably have run out of energy by now. In 2015, we expect the economy to stagnate. So, while this might not be good news for the economy, it will help keep the lights on and the taps flowing.”
Carvalho’s prediction of zero growth this year, even without rationing, is at the low end of the range of estimates of private sector economists – most of whom point to a slight rebound next year. However, Carvalho believes that the new finance minister, Joaquim Levy, whose appointment was warmly welcomed by the market, will face a tougher task than widely appreciated. Also, according to BNPP, inflation will reach 7% as the government unwinds its price controls on gasoline and electricity, causing Selic to rise to 13% – also above the average expectations for interest rates to peak at about 12.25%.