Energy prices offer investment plays in Brazil
Short-term gains for some energy firms and industrials; longer-term energy strategy review needed.
Investors in Brazil’s power sector are facing volatile earnings and share prices as a drought has forced up the spot price for energy to its government-enforced ceiling of R$822/Mwh.
Generation companies that have shortfalls in their contracted energy supply face heavy costs of compensating the electricity grid, while those companies that have spare capacity will be facing short-term windfalls.
Experts say the high electricity prices – caused by reliance on more expensive thermo power plants as the hydroelectric plants face low reservoir levels – are also adversely affecting the earnings of manufacturing companies, many of which are beginning to scale down production to sell energy to the grid at big profits.
The crisis will also have longer-term implications for the country’s power network, with the next government likely to foster a more benign investment climate for international power projects in Brazil.
The 15 constituents of stock exchange Bovespa’s electricity segment have all posted losses this year and the index is down over 11%. Moody’s estimates that most of the hydro-generation companies are fully contracted through medium-term and long-term supply contracts or have little energy to sell on the spot market.
Should rationing be implemented in the country for the first time since 2001 – the chances of which are now set at 46% by private sector consultancy PSR – these companies would be even more severely affected on cashflows and liquidity positions.
Those most exposed, according to Moody’s, are Electrobras, Duke, AES Tiete and Energest. Generation companies that have uncontracted energy to sell at the ceiling price would actually benefit, with Moody’s identifying Cesp and Cemig in this category.
The hit to earnings is creating potentially lucrative speculative trades, with investors trying to identify which of the generation companies are most vulnerable.
“We see good opportunities to go short along with the 1Q14, given that most companies will likely report very poor earnings in the upcoming quarters, caused by a negative [supply-contract position to the national grid],” says a JPMorgan client note.
The effects are beginning to cross over from the utilities sector and affect the strategy of industrial companies, which will also have an impact on GDP growth.
The government is reportedly talking with large industrial users to lower demand in that sector, which accounts for 40% of total energy consumption.
|Source: Thymos Energia|
Jose Rosenblatt, senior consultant at Rio-based energy consultancy PSR, says the market will be more effective than any negotiations, with those large-scale users that are on the grid able to cut back their monthly energy allowances and sell at spot: those that can lower or stop production will be well rewarded to do so.
“They are not trying to cut energy consumption, at least officially,” says Rosenblatt. “But on the other hand the short-term price is very high and that means that any large industrial can sell its energy contract in the short-term market and diminish energy consumption – this is incentive enough to save energy. That’s the role of price.”
At the end of April the government announced an auction of 2,046MW at the price of R$268/Mwh for five years and eight months.
João Carlos Mello, president of energy consultancy Thymos Energia, expected only about 1,000MW to be found at such short notice – commitments for supply began immediately – but the inclusion of companies such as Votorantim boosted participation. The sellers will get paid roughly twice the 10-year average.
In March Alcoa said it was suspending 147,000 tonnes of local aluminum production due to “increased costs that have made the smelters uncompetitive” and sugar producer.
Mello says: “Votorantim sold almost 250MW so that means that either it has back-up contracts or it has reduced its loads to sell this energy – and the long-term nature of the contract is a good example of industrial companies committing to selling energy – rather than consuming it – for the next five years.”
Investors in these companies will see a short-term spike in earnings as the high energy sales go through and, in the short term, should see a boost in equity price performance.
However, as these companies take energy profits by scaling back production the wider impact to the economy could be negative.
Analysts say that as yet the likely impact on economic activity is unclear, but it is likely to lead to lower 2014 GDP growth – consensus forecasts by economists polled by the central bank are already for a modest 1.7%.
Mello says the crisis will also force the government to foster a more benign environment for international companies wanting to build new power plants in the country.
“We have some lessons to be learned,” he says. “We have a big problem on the supply side, with delays to the new river hydro-plants, as well as some renewables. After the troubles we are having in 2014 there will be closer follow-up and monitoring of the new commissions and existing projects by the government in the future.”