Measures for modernization of the energy sector

Since 2017, some initiatives have been implemented to make possible a comprehensive reform of the energy sector, with emphasis on its modernization, sustainability, and legal certainty. The purpose of this article is to describe (i) the main initiatives taken so far; and (ii) the prospective changes in the energy sector´s institutional model with a focus on the on-going modernization measures brought by the current Brazilian government.

Among these initiatives, it is worth mentioning Public Consultation No. 33, opened in 2017 by the Ministry of Mines and Energy (“MME”), which presented proposals for the modernization of the energy sector, having received several contributions from the agents that resulted in a proposal for a bill of law. Given the urgency of the matter and to push forward the implementation of the necessary legal measures to change the commercial model of the sector, such bill was linked to two other bills already in progress: Bill No. 1,917 / 2015, of the House of Deputies, and  Bill No. 232/16, of the Federal Senate (“Bills”).

In addition, in April 2019, already  within the context of the new government, the MME enacted Ordinance MME No. 187 establishing a working group (“WG”) to evaluate measures for the modernization of the energy sector (“Modernization Measures”), aiming at a sustainable  expansion by promoting the opening of the market  and an efficient costs and risks allocation.

The Modernization Measures seek development of proposals that deal with the following topics in an integrated manner,: (i) market environment and mechanisms for the expansion of the energy system; (ii) pricing mechanisms; (iii) rationalization of charges and subsidies; (iv) Energy Reallocation Mechanism (“MRE”); (v) allocation of costs and risks; (vi) insertion of new technologies; and (vii) sustainability of distribution services. In an effort to organize its work, the WG has established 14 thematic subgroups that have been developing their analyzes along “3 Waves”, scheduled for completion in October: (i) 1st Wave: pricing formation, supply criteria, distribution, and transmission sustainability, hiring process, bureaucracy reduction, process improvement and introduction of new technologies; (ii) 2nd Wave: the relationship among physical guarantees (i.e., the amount of energy a generation equipment can supply given a defined supply criterion) , energy and the MRE; and (iii) 3rd Wave: market opening, costs and risks allocation, rationalization of charges and subsidies, governance and auction system. The MME opened a new public consultation on the topic “physical guarantees and energy”, that is currently being discussed in the 2nd Wave of the WG. After 110 days of the creation of the WG, the MME released a general diagnosis[1] of what was analyzed so far along with some improvement proposals, which were divided into five major topics:

  • Expansion and allocation of costs: the diagnosis was that (i) the Free Contracting Environment (“ACL”) plays a relevant role in enabling generation expansion and has increased the profile of projects that are feasible with a price mix of Regulated Contracting Environments (“ACR”) and the ACL; and (ii) energy reliability and safety include the contracting of hydroelectric and/or thermoelectric plants in the ACR. The conclusion is that a review of the current arrangement is required to create a market for the new system requirements, including supply security criteria and measures to review plant physical guarantees. In this context, all agents should pay for system services.
  • Rationalization of charges and subsidies: the diagnosis that a high level of charges is borne by consumers was not new to the sector. In this case, the desirable improvements identified by the government are that it is necessary to: (i) implement the recommendations of the Structural Expenditure Reduction Plan related to the Energy Development Account – “CDE”; (ii) implement outcome monitoring policies related to the subsidies; and (iii) adjust subsidies allocation to reflect desired policy;
  • Tariff policy and digitization: the diagnosis is that the world is undergoing several transformations, including the decentralization of power generation systems, the digitization of networks, the electric mobility, the valorization of individual choice possibilities and the predominance of renewable sources in the world electrical energy matrix. Hence, desirable improvements include promoting the articulation between energy policy and sector regulation with due respect of institutional competences;
  • The MRE and pricing: the diagnosis is that: (i) since 2014, Brazil has been experiencing periods of unfavorable hydrology, burdening the industry and generating contractual exposures by hydroelectric plants to higher spot market prices (“PLD”); (ii) there is an increasing judicialization regarding the extent of hydrological risk (also known as GSF – Generation Scale Factor) that must be borne by the plants, and (iii) the MRE has fulfilled the role of sharing individual risks, but there is a high systemic risk. In this context, the desirable improvements involve the restructuring of the MRE by eliminating foreign factors to the hydrological risk; and the mechanism improvement aiming at the performance improvement of the participating plants and the creation of a voluntary hedge mechanism; and
  • Orderly market opening: the diagnosis is that, on one hand, in the global context, the energy consumer has more decision-making power and, on the other hand, there is a challenge to adapt the current sector model to eliminate barriers to technological transformations. As a desirable enhancement, the government indicated the introduction of an integrated plan for the opening of the market, including the definition of the wholesale and retail boundaries, conditions for migration, regulation and monitoring mechanisms of the traders and energy exchange associated to a clearing mechanism.

In the context of the above diagnosis, the MME opened two Public Consultations, namely: (i) Public Consultation No. 76/2019, with a draft Decree proposal related to the mandatory representation of electricity consumers with a total load of 1MW or less per retail trader in the free market; and (ii) Public Consultation No. 77/2019 in order to expand the possibilities for consumers to freely contract energy by changing the schedule already provided for in the Bills. Both proposals aim at improving the trading conditions in the ACL and providing greater efficiency, sustainability and security to the energy sector.

In addition, the MME has determined the implementation of a new operational model and hourly pricing formation, based on the Short-Term Hydrothermal Dispatch Model – Dessem. It will be implemented in two phases: the first in 2020, when the National System Operator – “ONS” will adopt this model in the daily schedule of the operation, and the second in 2021, when the Power Trading Chamber – “CCEE” will start to adopt the model in the calculation of PLD, as well as in the accounting and settlement of the short term market.

Last, but not least, the above topics are mostly covered in the Bills and have also been mapped and commented in the Public Consultation 33. The major challenge will be, on one hand, to align the topics within the scope of the Bill with the other issues arising from the Modernization Measures that do not require change or legal provision, and, on the other hand, to be agile and assertive in the implementation of regulatory changes resulting from the Modernization Measures. Precisely because of these challenges, it seems to us that the government has prioritized the issues that can be addressed at the regulatory level.

[1] Available at http://www.mme.gov.br/documents/1138763/0/Diagn%C3%B3stico+Geral+e+Propostas+de+Aprimoramentos.pdf/0795891b-458c-46be-93ae-0a1cc0732647