2004 - delta natural gas in brazil

CONFIDENTIAL

Gas Sector in Brazil:

Liberalisation and Pricing Policy

Cairo, May 9th 2004

Future Planning for Egypt's Gas Industry

Luiz Nelson Porto Araujo

This report is confidential. It may contain confidential, proprietary or legally privileged information. No confidentiality or privilege is waived or

lost by any access to it. You must not, directly or indirectly, use, disclose, distribute, print, or copy any part of this report without the written

consent of Delta economics & finance.

2

Agenda

• Reform of the Economy and the Energy Sector

• Market Structure and Regulation

• Gas Sector - Fundamentals

• Tariff Review

• Annex

3

Reform of the economy – an ongoing process

• Stabilization of the inflation rate at low levels

• Redefinition of the role of the State in the economy

• Liberalisation and concession of public services

• Comercial and financial liberalization (kick off)

• Fiscal Responsibility Law

• Central Bank Independence

• Social Security Reform

• Tax Reform

• Comercial and financial liberalisation (conclusion)

• Income distribution

• Social policies (education, security, food)

Source: Delta analysis

Adjustments Implemented Adjustments to be Implemented

Within the context of the economic and social reforms it is relevant to notice that:

• the institutional, legal and regulatory framework for the energy sector are strongly related

• the regulatory environment is still under construction

• the stability of the regulatory rules is still a major problem

The reform of the economy has implied an entirely new approach to

government production of goods and services

The choice between a public or private solution to the energy sector is one of

the main issues for its development

4

Key issues in rebuilding the energy sector

• Brasil has had a long tradition

for subsidies in the economy.

Began a phasing-out in the late

1980´s

• Subsidies for energy sector were

widespread, at a time when the

country was heavily importing oil

• Most of the energy business was

conducted by state owned

companies

• Energy conservation and

efficiency were not seen as

incentive mechanisms

Tariff Policy Private Sector Participation Regulatory Policy


• The fiscal distress in the late

1980´s implied that a new

source to finance the necessary

investments was to be sought

• International experience had

already demonstrated the

benefits of private sector

participation in infrastructure

• Private sector involvement

called for a new regulatory policy

and agencies

• Until the early 1990´s regulatory

policy was non-existent – except

for tariff control

• International experience had

already demonstrated the

benefits of credible regulatory

policy and agencies

• Government believed that the

introduction of a new regulatory

policy should be associated with

a change in the market structure

These issues were deeply and jointly analysed by the government and the

private sector as the reform of the economy proceeded

5

Guiding principles for the energy sector – 1993

promote

competition

stimulate

efficiency and

quality of

service

stimulate

private

investment

consumer

protection

Guiding

Principles

• competitiveness and efficiency

• stability of regulatory rules

• optimization of supply and demand

• fulfillment of market demand

• investment capacity

• environmental conservation

• improvement of role of State as

regulator

• private sector involvement

• quality of service

• fairness of tariffs


The guiding principles for the energy sector are an important reference for

any discussion concerning its improvement. It reflects the vision for that

sector. They are fundamental in a regulated business

6

Congress

Regulatory State

Agencies

Consumer

Protection

Consumers

Councils

Competion Law

Agencies

President

Consumers

Ministry of Mining

and Energy

ANP

(oil and gas)

ANEEL

(electricity)

Development Bank Planning

Policy

Regulation

Market

Institutional

Agents

Institutional framework of the energy sector – regulated business

Production Importation

Transportation

Distribution

G

T

D

C

Source: MME, Aneel, ANP; Delta analysis

7

Agenda




• Tariff Review

• Annex

8

Framework for private sector participation

Assumptions for private sector involvement (1997)

Opportunities for private sector involvement

• Government does not have resources to

invest in generation, transmission, and

distribution of electricity. The same applies

for the exploration of natural gas at the local

level

• Macroeconomic conditions (exchange rates,

growth, interest rates) favorable to

investment by residentes and non-residents

• Expectation of tariffs adjustments and

economic growth

• Regulatory framework which guarantees the

passthrough of costs together with a price

cap model which gave incentives to

productivity gains

• Franchising of electricity distributors (state

and federally owned). Franchising of gas

distributors in São Paulo and Rio de Janeiro

• Trading of energy for free consumers

• Franchising of electricity generators (state

and federally owned)

• Expansion of generation through new

auctions for hydro and licenseing of thermal

plants

• Auctions for construction of new

transmission lines

• Trading of new energy/reduction of volumes

of initial contracts


The privatization program (1990), the concession law (1995), and

amendments to the constitution (1995) were an important reference for

private sector involvement in the energy sector

9

The dynamics of the regulatory agencies

Source: Aneel, Anatel, ANP; Delta analysis

electricity

ANEEL

Eletrobrás: state owned

Local utilities: private owned

Competition: expected

telecom

ANATEL

Telebras: franchise

Competition: earlier

ANP

Petrobras: state owned

Private companies

Competition: expected

oil and gas

The government adopted a framework in which regulatory agencies were

assigned responsabilities for different sector. The dynamics of agencies has

turned out to be very different

10

Regulation of the energy sector in practice

• Regulatory framework approved by a

law passed by Congress

• Relatively high public image of the gas

sector and the regulator (vis-à-vis other

public services)

• Interaction between regulatory and

competition laws predicted

• Rights and obligations of service

providers and consumers defined before

privatization (as part of concession law

and concession contract)

• Lack of long-term government

infrastructure policies

• Possibility of lock-up by regulators

• Very strict service obligations, even

under extreme situations

• No independent administrative or

judiciary appeal instances

Strengths Weakness

There are many challenges faced by regulators, among them lack of

experience in the regulation of public services; integration of regulation and

competition law; and utility integration (energy, telecom, water & sewerage)


11

Agenda




• Tariff Review

• Annex

12

Agents

• Supply contracts at freely

agreed prices

Producers Transporters Distributors

Source: ANP; Delta analysis

• Regulated tariffs

• Long term transport contracts

• Tariff adjustments predicted in

contract

• Embryonic capacity resale

market

• Regulated distribution service,

with exclusive rights within the

area (concession contract

anticipates free consumers after

a period of time

• Ceiling prices with pass-through

adjustment mechanism for gas

price and transportation tariff

variations

• 5-year Tariff Review. Adjustment

by and X Factor (expected

efficiency gains)

The market structure of the gas sector is clearly defined. Nevertheless some

adjustments are called for to improve total welfare

13

Demand for natural gas

47

29 28

2421

15

6

0

5

10

15

20

25

30

35

40

45

50

Argentine Italy Mexico USA Germany France Brazil

Demand for natural gas

% - 2003

Argentine Italy Mexico USA Germany France Brazil

Comments

• Consuption growth has been increasing in

most regions of the country and market

segments

• Network expansion is a major challenge

• The recent results of a tariff review in São

Paulo – for Comgas, the gas company – are

expected to be very relevant as a signal for

private investors

• New model for electricty sector is expected

to increase the demand for gas, through the

dispatch of thermal plants

Source: MME, Petrobras; Delta analysis

Total demand for natural gas in Brazil is behind that observed in other

countries. Nevethelss, growth potential is very high

14

Comgás – the most important gas company in Brazil

Consumers (in thousands)

329 345378

416

2000 2001 2002 2003

Volume (in MM m3)

(except for thermal generation)

1,68

2,24

2,953,30

2000 2001 2002 2003

Investments (in R$ MM)

103

229201

242

2000 2001 2002 2003

Network (in km)

27162965

32003600

2000 2001 2002 2003

Source: Comgás, Delta analysis

Company growth depends on good regulation and market potential. Growth

has implied consumer access, network expansion, and new investments. All

contribute to more jobs, tax collection, and better service quality

15

Benefits of regulatory stability and credibility

Higher consumer

access

• significant growth in number of consumers – in all segments – with access to gas

supply. Improvement in population welfare

Increased

network

expansion

• significant growth in size of netwok, besides substituion of old pipes. Externalities in

other economic activities (production, employment, tax, etc)

Better and higher

investments

• private investor was able to invest the amounts necessary to fufill requirements of

service quality and market demand. Externalities in other economic activities

More

employment

• increase em jobs, both direct and indirect. Also, increase in quality of manpower.

Improvement in population welfare (income, schooling)

Better

service quality

• better perfornance, lower waste of time and cost of quality. Higher efficiency and

lower service cost

Increase in tax

collection

• increase in tax revenues. Reduction in fiscal deficits and possibility of higher

transfers to poorer sectors

Source: Comgás, Delta analysis

16

Challenges for natural gas growth

NGV

• Tarrifs

• Access – availability and security of supply

• Involvement of auto makers

• Tax incentives for gas powered vehicles

Residential and

comercial

• Pricing of LPG – butagas (subsidized)

• Access – availability and security of supply

• Development and introduction of new products and services

Industrial

• Expansion of distribution network

• Pricing of fuel oil (subsidized)

• Availability and security of supply; contracts (take or pay clause, interruptable etc)

Co-generation

• Joint use with industries and large commerce

• Investiments in techonology and non-interruptible supply

• Feasibility of distribution projects

• Tax incentives


17

Agenda




• Tariff Review

• Annex

18

Key dimensions of a tariff review

Legal

EconomicSocial

Political

Nature of

Business

• Market growth potential

• Competition of

alternative fuels

• Regulation of tariffs

and market access

• Stakeholders interests

Nature of

Regulation

• Framework and

Agenda

• Accountability and

Independence

• Forecastibility of Rules

• Enforceability of

Contracts

• Conflict Resolution

• Energy policy

• Fundamentals of

energy – ang gas in

particular – regulation

• Petrobras strategic

plan


A successful tariff review should take into account the interests of the major

stakeholders involved with the business

19

Final Tariff to

Consumer

Operacional

Expenses

Capital

Remuneration

InvestimentsMaximum

Margin

Gas Cost +

Transportation

Tariff review – implications


Tariff reductions in general imply lower return to investment which impacts

the incentives for firm growth, investment, employment, tax collection, and

the expansion of the network

20

Limitation supply growth

Deterioration of credit rating and increase in

the cost of capital

Worsening of social involvement

Worsening of the economic-financial desequilibrium of

contract

Limitation investments

Risk of deterioration of the quality of

services

Consequences of loss in cash flow in

tariff reviews

Tariff review – implications (cont.)


The overall limitations imposed by a badly conducted tariff review are very

significant, and not only at the firm level

21

Agenda




• Tariff Review

• Annex

22

Restructuring the energy sector – main issues

Historical development

and diagnostic

• state private

• planning

• franchising and concession

• investiments

• regulatory framework and tariff policy

Characteristics

of sector

• economics of networks

• hydro base and oil import

• distance between generation and consumption

• energy sources

New investment

decisions

• regulation, risk and return

• new markets

• competition and liberalization

• consolidation

Restrucuturing and

regulatory framework

• state reform

• institutional model

• regulatory framework and tariff policy

• transition phases

• strategic positioning of utility companies


23

The gas sector – development and diagnostic

• Between 1953 and 1995 Petrobras monopoly

(extraction and production; transportation; and

trading)

• Natural gas was not a priority

• Until 1988 distribution activities (industrial consumers)

were performed by Petrobras in all States except in

São Paulo and Rio de Janeiro

• Starting in 1988 (with the new Constitution) the

granting of distribution concessions was given to local

(State) governments

• The Constitutional Amendment n° 9, of 1995, redefine

the State Monopoly in oil and gas

• Insufficient investment to increase supply

• Insufficient network (extension of pipeline grid)

• Need of a new tariff policy with incentive-based

mechanism

• Petrobras monopoly was a significant constraint in

private sector participation


Historical Development Diagnostic in 1997

The development of the gas sector openned new business opportunities for

private investors. Legal and regulatory framework have changed drastically

24

Franchise Restructuring Regulation

Electricity, Water & Sewerage, and Transportation

Franchise

(conception)

Restructuring Regulation

Telecommunications, Oil & Gas

Franchise

(operation)


Privatization and regulation

The government has approached franchising and regulation for

infrastructure differently, depending on the sector

25

Investment and return in a regulated business

Legal Stability

Fundamentals

of Regulation

Existence of

Legal Framework

Institutional Stability

Existence of

Institutional

Framework

Fiscal Stability

Stabilization and

Growth

State Reform

Investments

and Returns

Tariff Model

Market

Oganization

Regulation


In Brazil, investments and returns are conditioned by Legal, Institutional and

Fiscal Stability, which have to do with the state of the economy

26

Main markets and power connections

transmission lines

pipelinesArgentina

Bolivian

Gas

Venezuela

Itaipu

Source: MME, Delta analysis

Integration of the energy

infrastrucuture in Latin

America will increase in the

coming years

27

Natural gas in the southern cone


• High potential for growth in gas demand in Brazil:

• gas represents only 6% of the energy sources

• 80% of total power generation is hidro

• residential, industrial and thermal consumption

are likely to increase

• south/southeast have best potential market

• Chile, Paraguai, and Uruguai: other potential markets

• Argentina: export potencial

• Future supply is expected from Bolívia (Argentina?

Peru?) to Brasil

• Petrobras supply position:

• significantreserves in Southern Cone

• controls Brazil –Bolivia pipeline

• controls transportation infrastructure

• Petrobras currently has an average stake of 40% in

the develpment of 16 thermal plants, with eight plants

in operation, or in testing, and three under

construction

Peru

Bolivia

Argentina

Brazil

28

Natural gas – Brazil-Bolivia pipeline

Source: ANP; Delta analysis

Brazilian Gas Chain

transfer pipes

UPGN

transportation pipelines distribution pipelines

consumptionproduction city gate

Bolivian Gas Chain

production

Transierra/

Transredes

compression

GTB

city gate consumption

TBG

TBG

Transpetro distribution pipelines

The current infrastructure for the exploration of natural gas through the

Brazil-Bolivia pipeline is clearly defined

29

Energy sources and penetration of natural gas

hydro

7%

30%

11%

10%

6%

36%

oil

sugar cane

coal

natural gas

others

Energy sources Reasons for low penetration of gas

• Significant hydro generation

• Focus on exploration and production

of oil

• Limits on the domestic supply of gas

• High cosf for the expansion of

transportation and distribution

networks

• Supply of competitive fuels – sugar

cane, coal and fuel oil

Source: MME; Delta analysis

Mostly because of geographic location and lack of incentives for natual gas

the energy sources in Brazil are concentrated in hydroelectricity and oil

30

Supply of natural gas and infrastructure

• Recent discoveries

have tripled the total

reserves of natural

gas

• Investments in

pipelines now allows

Brazil to import gas

from Bolivia

• Production has

grown very rapidly

– 9,8%a.a. since

1980 e 9,0%a.a.

(between 1998-

2003)

• Since jul/99 Brazil

has been importing

gas from Bolivia –

nearly 14 MM m3/

day

• “Cabiúnas Project”

intends to reduce

the burning of gas

in flares by 5,2 MM

m3/day

• Construction of

Gasbol is a major

landmark

• Additions to the initial

pipeline allows the

gas to reach the

south region of the

contry

• New “Network

Project” intends to

consolidate the north

and south networks

• Pivate sector

participation in

distribution

companies has

made a major

difference in

investment, service

quality, employment

and security of

supply to

consumers


ReservesProduction and

ImportsTransportation Distribution

The supply of natural gas has increased sharply as a result of major

decisions taken by the government. More recently, private sector

participation has also been very relevant

31

Challenges for natural gas growth

Regulation and

transportation

• Conflicts among regulatory agencies

• Unbundling of networks

Pricing the

Bolivian gas• The contract needs revision to take into account developments in both countries

Thermal power

development

• Most power generation is still hydro based; there is insecurity as to the usage of

thermal plants

Price of fuel oil in

domestic market

• Relative price of fuel oil and natural gas is distorted by all sort of subsidies in the

former

Environmental

Policy• Lack of clear cut policy for the emission of gas by vehicles


The challenges cover a wide range of issues. The government and the private

sector are involved in exploring new opportunities to increase the usage of

gas in all segments of the economy

32

Tariff policy – price adjustments and reviews

Tariff

Adjustment

(X =0)

0 Year

IGPM

IGPM - X

EFE

IGPM

IGPM

IGPM

Review

(X >0)

EFE

Tariff

Adjustment

Tariff

Review

Tariff

Adjustment


The regulatory framework for tariffs – price cap model – takes into account

the economic-financial equilibrium of the concession contract

33

Tariff review – managing regulation, risk and return

Regulatory

Framework

Tariff

Policy

Equilibrium of

the Contract

Risk and Return

of the Investiment

• X Factor

• Cost of capital

• Regulatory

Asset Base

Regulatory

Risk

Investment


Tariff policy is fundamental in defining the economic-financial equilibrium of

the concession contract, and therefore the risk and return of the invesment

34

Tariff reviews – defining the new tariffs

Allowed

Return

Exogenous

Expenses

Endogenous

Expenses

Depreciation

Tariff

Review

+

+

+

Required

Revenues

Supply and

Other Revenues

Net Required

Revenues

Verified

Revenues

-

Tariff = return on investment (RABt x Wacct)+

expenses +

return of investment (depreciation

Source: Concession Contracts; Delta analysis