The material on this site is for financial institutions, professional investors and their professional advisers. It is for information only. Please read our Terms & Conditions, Privacy Policy and Cookiesbefore using this site. Please see our Subscription Terms and Conditions.

All material subject to strictly enforced copyright laws. © 2022 Euromoney, a part of the Euromoney Institutional Investor PLC.

Brazil: Energy options running dry

Election campaign delays rationing; ‘pray for rain’ say analysts.

rain window-envelope

Independent hydrology experts have privately labelled the Brazilian government’s targeting of reservoir levels of 10% by November as “irresponsible", according to Euromoney sources. 

Brazil is suffering a severe drought, especially in its south-east region, which produces 75% of the country’s hydroelectric power. The country relies on hydroelectric generation for 68% of all energy and is dependent on productive reservoirs in the south-east.

Rio-based consultancy PSR declined to give Euromoney an update in its projection for the likelihood of energy rationing in 2014 – which was at 48% in June and rainfall levels have remained below the long-term average since then. 

However, PSR has since told clients that it recommends a 6% cut in energy consumption to maintain reservoir levels at 25% by the end of November 2014. The government’s agencies – such as CMSE, the monitoring committee of the electricity sector, meanwhile say there is no need to ration energy but its projections are believed to come with an internal tolerance to end November at reservoir levels of just 10%.

João Carlos Mello, president of energy consultancy firm Thymos Energia, wrote in an emailed response to questions about the outlook for energy rationing: “We are not forecasting rationing this year, however we are very dependent on the next the rainy season.”

Further reading
Brazil: special focus

Beyond the issue of the likelihood of the reservoir levels being repleted should they fall to around 10%, there are practical concerns about operating hydroelectric power plants as levels fall: “At 15% levels, the operational efficiency of the plants would drop materially and there could be operational issues, expositing the system to the risk of collapse,” according to a Morgan Stanley client report.

One of the difficulties in predicting the likelihood of rationing is the political element in the decision. Facing a presidential election in early October (with a probable run-off election on October 26), the administration is keen to avoid introducing energy rationing during the campaign. 

The last time rationing was introduced, in 2001, the approval rate of president Fernando Henrique Cardoso fell and the PT won the subsequent election in 2002. Today, president Dilma Rousseff is already trailing her rival Marina Silvia in projections for the run-off election (by seven percentage points, according to an Ibope poll on September 4). 

Also, the economic fallout from energy rationing would come just as Brazil has entered a recession in the first half of the year.

Criticism of the government’s refusal to implement rationing centres on the risks of beginning the next rainy season, at the end of November, with very low reservoir levels. 

The governmental agencies’ working assumption is that good hydrology will solve the current problem, which even critics concede that it may well do. However, many in the private sector advocate adopting a more conservative approach to conserving reservoir levels, pointing to the fact that good or even average rainfall levels are not guaranteed. 

In a report to clients about Brazil’s energy industry, UBS cites climate expert Paulo Etchichury, who says that the chances of having consecutive years of drier weather has increased after a new 10-year cycle of a colder Pacific Ocean started in 2012.

Beyond official policies, one analyst says whoever wins would be best advised to 'pray for rain'

The government uses models incorporating assumptions that do 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 says that the current ONS (the operator of Brazil’s national grid) model also underestimates reservoir depletion rates, which it has verified as a big gap between estimated and actual reservoir levels (one probable cause for this is the absence in the model of the impact of the increase in irrigation licences in recent years, as well as greater theft of water, in the model).

The bank also suggests that ONS underestimates the amount of water required to produce energy and its forecasts for reservoir levels are inaccurate, even if their forecast for rainfall is in line with their assumptions. 

Serious flaws

UBS says there are serious flaws in ONS’s methodology, not least that LTAs are not correct: in the north east of the country it has rained less than 100% of the LTA for the region. Also, with regards to new sources of energy being included in ONS models, the organization isn’t taking into account the impact of delays into project start-ups.

Despite the falling economic projections for Brazil in 2014 and 2015 (Central Bank gathered estimates are now 0.52% growth in 2014 and 1.1% in 2015) these estimates do not include the fallout of any energy rationing caused by below average hydrology in the coming rainy season. 

In May, UBS’s Brazil economist Guilherme Loureiro, estimated that a 10% energy rationing for 12 months would lead to GDP growth to fall by between 0.7 percentage points and 1.5 percentage points, with inflation increasing by 120bp and unemployment by 0.5 percentage points. HSBC outlined a scenario in a research report that predicted an energy-deficit blow to 2015 GDP could push the country into a stagflationary cycle, with FDI collapsing and the exchange rate depreciating up to 33%.

Energy experts say that whoever wins the next election will have to boost new generation projects, end judicial delays and consider building gas-fired plants which can be ready in 12-24 months, to add capacity to the system (although Silva is against thermal power and so this is unlikely should she become president, in which case renewables producers would be the likely winners). 

In the short-term, rationalization is a growing probability and also controlled electricity prices will likely be liberalized – or at least increased – to temper demand (although will create inflation issues). Beyond official policies, one analyst says that whoever wins would be best advised to “pray for rain”.