News Release

Brazil’s consumers ‘pay price’ for power costs problems

Wood Mackenzie study sees flaws in thermal auction mechanisms

New research from global natural resources consultancy Wood Mackenzie indicates the fuel pricing mechanism used by Brazil’s Energy Planning Agency (EPE) in the country’s power auctions does not align with the New Gas Market programme – and Brazilian electricity consumers may pay the price for this.

Henrique Anjos, from Wood Mackenzie’s gas and LNG team, said: “There is a disconnect between the gas market reform schedule and thermal power contracting, especially when you look at contract thermal power based on domestic gas supply.

“The gas market reforms schedule still has to define third-party access to gas transport pipelines and liquefied natural gas (LNG) regasification terminals, the migration to entry-exit transport tariffs, and taxation aspects.

“These issues must be solved for new gas supply agreements, especially for independent gas producers and independent power plants connected to the transport grid. Otherwise, these players will be limited to LNG-to-power projects or gas-to-wire, bypassing the transport system solutions.”

Anjos said the reference gas price formula used in the power auction also has a number of flaws which have an adverse impact on the sector.

“The reference prices released by EPE are sourced from different agencies’ price outlook reports. Although the intention is to increase transparency and reliability, unfortunately inconsistencies often occur. As each agency uses a different methodology, it results in conflicting outlooks.”

Gabriel Dufflis, from Wood Mackenzie’s power team, added: “The length of the power purchase agreements (PPAs) also creates problems. The formula does not reflect a power plant’s fuel cost during the PPA’s 25-year term. The current fuel reference price for the auction considers an average price calculated on a forecast for the 10 years following the auction.”

He added: “The approach used to compare powerplants’ costs in the auction is based on a system base case operation scenario that reflects the only the first five years of the total PPA.  This does not reflect the long-term evolution of the Brazilian power mix.”

Changes in the generation mix will affect power pricing, particularly because hydro no longer dominates the country’s capacity additions. Brazil’s power system is very volatile. Depending on rainfall, actual prices can vary significantly from the base case projections used for auctions.

Dufflis said: “This is a big risk for developers. If system long-term marginal costs are lower than the ones in the reference case, players would produce less energy than they expect. It would expose them to the short-term market settlements, causing financial losses.

“It can be a lose-lose situation: a player that used a clever strategy at auction can end up in difficulty even though users are paying more for power purchased under its PPA.”

Both analysts said that there are ways to make the power auction framework better – for EPE, power producers and for consumers.

“First, it would be sensible to use a unique source for price forecast. Second, to adjust the timeframe of the price forecast to calculate the EPE reference price to be aligned with the lifetime of the PPA.

“A definitive solution will be to prize thermal power developers that take long-term fixed fuel price paths, so they can design their own creatives approaches of portfolio and hedging strategies, something which would reduce the risk to market and consumers.”