The Restructuring of the Brazilian Electric Power Market.

The Brazilian government has made remarkable progress over the past three years in stabilizing the Brazilian currency and reducing inflation to single-digit figures. However, Brazil's budget deficit, equivalent to 5 percent of its Gross Domestic Product, and Brazil's foreign debt, which currently stands at $173.9 billion, have yet to be brought under control. The pressing need to raise capital has spurred the government to implement a large and rapid privatization and foreign investment program which includes Brazil's government-owned electric utilities.

Brazilian Electric Power Market in a State of Transition

With demand for electricity growing at approximately 5 percent per year, analysts estimate that Brazil needs capital investment of approximately $6 billion a year to keep up with rising demand. To raise the required capital through the private sector, many federal and state-owned electricity distribution and generation companies have been or will be put up for sale over the next two or three years. However, unlike a capitalization program in which private investments are made directly with the utility, supplying it with a fresh source of capital for investment in necessary infrastructure, revenues from the Brazilian privatization program are being received directly by Brazil's federal and state governments. This means that additional post-privatization capital investment will be required to permit supply to meet the growing demand.

What makes the privatization process in Brazil particularly interesting--in addition to prices being paid for electric utility assets which vastly exceed minimum asking prices--is that this process is occurring simultaneously with a wholesale overhaul of the electric utility regulatory infrastructure in Brazil. The rationale for regulatory reform in Brazil is that such reform is needed to attract foreign capital for privatizations and greenfield development and to foster the development of a competitive electricity market. The irony, of course, is that many of the privatizations have already occurred without any such reform having been implemented. In fact, the market seems to have taken a "buy now, ask questions later" approach, suggesting that investors are simply positioning themselves in advance of--and possibly to influence--the inevitable reforms.

The regulatory reform is being overseen by the Brazilian Ministry of Mines and Energy (MME), which is responsible for the electricity sector. The regulatory reform is being implemented by the National Agency for Electric Energy (ANEEL), an independent agency which has taken over the role of the Department of Water and Electric Energy (DNAEE). The MME commissioned Coopers & Lybrand to prepare an independent report setting forth its recommendations for the establishment of a competitive electric power market in Brazil (the Restructuring Report). The National Energy Secretary has suggested that the recommendations in the Restructuring Report will form the basis for new electricity sector regulations, and has proposed further that the regulations be implemented by government decree in order to circumvent a potentially lengthy process of congressional approval. It was reported that the government intended to publish a draft set of regulations by the end of 1997, with a final version to follow some months thereafter. However, as of this writing, the draft regulations have yet to be released.

The government's firm resolve to continue its privatization program even before the future regulatory structure of the industry has been determined raises interesting questions as to whether, in the near term, the regulatory reform process will drive the privatization process or vice versa.

Overview of the Brazilian Electric Power Sector

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