Brazil’s changing energy landscape

. Aug 02, 2019
brazil energy production

The past few weeks have been disruptive for the energy sector in Brazil. One of the country’s most strategic has been rocked by a series of events, including the announcement of a new plan to promote a sharp drop in gas prices, Petrobras’ discoveries of major oil and gas reserves in Sergipe, and the privatization of BR Distribuidora—Brazil’s largest fuel distributor—the first in what is expected to be a series of divestments. 

The measures are part of Economy Minister Paulo Guedes’ plan to make Brazil more competitive by way of what he calls a “shock of cheap energy,”

which he believes will benefit industries—notably segments such as ceramics. The idea is to provide better conditions for investments and thus create a more sustainable growth cycle, instead of going all-in on consumption as a solution to spur growth—the go-to strategy of previous administrations. </p> <p>The task is ambitious. His goal is to break Petrobras’ monopoly across the <a href="">entire energy sector </a>and boost competition in a bid to lower gas and <a href="">fuel prices</a>. For oil derivatives, such as gasoline, this will be done by loosening Petrobras’ control on refining and reducing its share in distribution chains—a step that was kickstarted by the privatization of BR Distribuidora. For the gas sector, the government&#8217;s New Gas Market program is based on additional production, changes in regulation and further investments in infrastructure that are expected to slash prices by 40 percent over the next two years.&nbsp;</p> <p>“We believe the impact of re-industrialization may reach 8 percent of the GDP in 10 years (&#8230;) We’re working to re-industrialize the Brazilian economy through cheap energy,” <a href="">said</a> Mr. Guedes, upon launching the program.&nbsp;&nbsp;</p> <p>Undoubtedly, the potential is enormous for the entire energy generation and consumption chain in Brazil. But experts consulted by <strong>The Brazilian Report </strong>point out that, while the rewards are great, the journey to reach them won’t be easy or fast.</p> <h2>Rome wasn’t built in a day</h2> <p>The speed of a process is always determined by its slowest step. In the case of the New Gas Market program, the weak link is construction. This phase of the plan will be tackled on two fronts: increasing pipeline networks and building exploitation projects that will produce more gas.&nbsp;</p> <p>According to Mines and Energy Minister Bento Albuquerque, Brazil has only 9,400 kilometers of gas pipelines. Argentina, meanwhile, has 29,000 km. Considering that Brazil’s production comes from the sea, these are complicated projects that will take up to three years to be concluded, explains Anton Schwyter, from energy consultancy Thymos Energia.</p> <p>To speed up that process, Brazil’s antitrust watchdog has reached a <a href="">deal</a> with Petrobras. The state-owned energy company pledged to provide free access to the entire infrastructure for natural gas that already exists, as well as selling its remaining 10-percent stakes in assets such as gas distributors TAG and NTS. As Petrobras and TAG—which owns a 4,500-kilometer pipeline network—agreed to <a href="">keep the transportation contracts</a> signed before TAG’s sale, there was a fear that the de facto monopoly would remain.</p> <h2>Construction projects</h2> <p>The recent discovery of gas fields in Sergipe and Alagoas could produce up to 20 million cubic meters of natural gas per day, and has become another big wager to give natural gas a more relevant role in Brazil&#8217;s energy matrix. Again, Mr. Schwyter expects it will take years before Petrobras’ offshore platforms begin pumping oil and gas from the deepwater reserves.&nbsp;</p> <p>“There has to be a mapping of the area, an assessment of its size—and then you have to create distribution channels to bring the production to the shore. You may build the gas pipelines simultaneously, but I believe it will also take up to three years, because you have to do a project, file for environmental permits,” he said.</p> <p>But as Carlos Daltozo, head of variable income of Eleven Financial research highlights, the industry works on a different cycle. Its investments are more based on long-term scenarios than other sectors of the economy. Although he praises the program as a relevant signal to boost confidence, he believes it is necessary to provide further incentives.&nbsp;</p> <p>“The funding structure for these investments has to be addressed. Will [Brazil&#8217;s National Development Bank] take it over, as it did in the past, or will there be incentives for banks, for capital markets, for corporative bonds? There’s a lot of fronts yet to be addressed,” he points out.</p> <h2>Electric shockwaves</h2> <p>Although industries are the main target of the New Gas Market, the project may have deeper effects on the <a href="">country’s energy generation</a>. That’s because gas may also be used to generate electricity in thermoelectric power plants. Currently, <a href="">this is the most expensive model</a> and is used only when cheaper sources—such as hydroelectric—fail.&nbsp;</p> <p>Hydroelectric energy has been the most important model for energy generation in Brazil for decades, but the share has been dropping from almost 90 percent in 2002 to nearly 60 percent in 2019. Part of this reduction is due to an increase in other sources, <a href="">such as solar and wind power</a>, but the system has also been affected by the drier climate.</p> <p>“With the sluggish economic activity and climate changes, thermoelectric power plants have been using more gas than the industry. This source of generation will also benefit if gas prices fall,” explains Mr. Schwyter.</p> <p>Looking ahead, gas may pose an advantage for another challenge facing Brazil: negotiations with Paraguay over the Itaipu dam. The binational power plant accounts <a href="">for 15 percent of the energy consumed in Brazil</a> and 90 percent in Paraguay. The neighboring country is entitled to 50 percent of the overall energy generated, but uses only 14 percent and sells the rest back to Brazil.</p> <p>“If Paraguay decides to sell 84 percent of its energy on the free market, that could cause a rupture in the Brazilian energy market. Gas is an alternative to foster competition, it boosts the opening of the transporting market and may avoid a problem with Itaipu,” said Mr. Daltozo.</p> <p>The terms of the current deal will expire in 2023 and negotiations are becoming increasingly tense. On Thursday, both countries were forced to<a href=""> cancel an agreement established in May</a> that changed the rules for energy purchasing after Paraguay’s president, Mario Abdo Benítez, was threatened with an impeachment process. In broad terms, the deal would make Paraguay pay an extra USD 200 million for the energy, as part of a review of the prices agreed in 2007.</p> <h2>Fuels</h2> <p>Privatizing BR Distribuidora has been another major step towards breaking Petrobras monopoly. The oil company sold about half of its shares in the fuels distributor, raising a much-needed BRL 9.6 billion boost to its divestment and debt-reducing plan.</p> <p>However, that doesn’t mean the company will be completely free of political interference, as Petrobras remains BR Distribuidora’s biggest shareholder, with a <a href=",br-distribuidora-nao-e-mais-controlada-pela-petrobras,70002935175">37.5-percent stake.</a> For Mr. Daltozo, the company will be leaner and more agile, “but government interference will continue.” In his view, there’s little upside for BR Distribuidoras shares, which have risen 10 percent after the follow-on offer was announced.&nbsp;</p> <p>“The market has priced the company’s better margins on Q1, so now, as a private company, we see room for cost-cutting only. We also see a more adverse competitive scenario, even though it will reap the benefits of becoming a pulverized capital company and reducing costs,” said Mr. Daltozo.</p> <p>BR Distribuidora and TAG are just the first of Petrobras&#8217; assets up for sale. Next in line is gas distribution company Liquigás. Petrobras has already tried to sell it to Ultragaz, of Grupo Ultra, but the deal was blocked by antitrust authorities. Considering the concentration of the market, both specialists see a chance that foreign players will take an interest in the asset.</p> <h2>Regulation matters</h2> <p>As usual in Brazil, tangled regulation can be a stubborn roadblock. As seen in other pivotal sectors, the gas supply chain is regulated by different agencies and levels of government: exploration and production, for example, are federal matters, but distribution is decided at a state level.&nbsp;</p> <p>“Each state has an agency to regulate gas distribution companies. A large part of these are state-owned, but there has been news about potential privatizations. The concession is given by the states and the rest is regulated on a federal level. Sometimes the regulations do not always complement each other. Each state also charges different tax rates. That has to be arranged,” said Mr. Schwyter.</p> <p>He also praises the government’s efforts in integrating all administration levels on the Natural Gas Market Opening Monitoring Committee, which can boost the effort to integrate federal, state, and municipal government. But he highlights that these efforts to reduce the price for final consumers cannot be fulfilled without a close follow-up on the bottom of the chain.

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Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Before joining The Brazilian Report, she worked as an editor for Trading News, the information division from the TradersClub investor community.

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