Brazil’s intention to further develop its solar power sector in this year’s solar auctions recalls an important lesson of Projects 101: an allocated risk is not necessarily a mitigated risk. To be sure, risk allocation will be on the minds of solar investors seeking to avoid the issues that arose during the hydropower supply shock of 2001-2002, which ensued during Brazil’s last prolonged drought.[i]
As thermal power investors who swept into Brazil during and after the 2001-2002 crisis can attest, even short-term power purchase agreements can collapse in the face of unsustainable risk allocations. As demonstrated by that experience, contractual tariffs can be disputed or altogether abandoned once rains return and provide lower-cost hydropower (especially in the case of thermal power, which unlike solar power, involves highly variable fuel costs),[ii] and foreign-denominated debt obligations can quickly diminish local revenues when hyperinflation weakens the value of the local currency.[iii]
Certainly, much has changed since the energy crisis of 2001-2002: sector reform has matured; the regulatory framework is more lucid; and the energy auction system (recognized as an optimal energy pricing mechanism) has made energy prices far more efficient.[iv] However, as Brazil continues to rely heavily on its hydropower resources (a reliance that still hovers at approximately 65% of the country’s overall power generation),[v] investors would be well-advised to consider the risks of investing in Brazil’s solar power market:
- Inflation has reduced the value of the real by approximately 20% since the last solar auction in October 2014,[vi] and further depreciation is expected;[vii]
- Import duties exceed 20%;[viii]
- Brazil’s equipment manufacturing industry for solar power plants is underdeveloped;[ix] and
- The Brazilian Development Bank (BNDES), a regular source of financing for renewable developers in Brazil, has increased its benchmark interest rate of approximately 10%; this higher rate remains favorable to the country’s market rates, which have soared as high as 50% and are predicted to rise further.[x]
Such considerations may leave some investors asking “what if it starts raining again?”
Even if hydropower never fills the gap between energy supply and demand in Brazil, the outcome of the October 2014 solar auction demonstrates the gravity of these concerns. Indeed, a significant number of the solar projects awarded in that auction may never be developed because the ongoing depreciation of the real has rendered impracticable the foreign-denominated debt necessary to purchase components outside of Brazil.[xi]
Despite these factors, Brazil remains an appealing target for solar power investment:
- At 349 reais (US$103)/MWh, the ceiling price for the upcoming solar auction in August[xii] is approximately 25% higher (in U.S. dollar terms) than the ceiling price of the last solar auction in October 2014, which was 262 reais (US$82.4)/MWh;[xiii]
- By the end of 2024, Brazil plans to leap from the 15 MW of utility-scale solar capacity currently installed to 6.9 GW—a 460-fold increase;[xiv]
- President Rousseff has committed to cut energy bills by a fifth,[xv] which signals her goal to increase and diversify Brazil’s energy supply rather than resort to the stiff rationing mechanisms that further crippled new investment during and after the 2001-2002 crisis;[xvi]
- BNDES is offering lower-cost financing of up to 65% of project costs, and depending upon local content levels, an additional 15% of project costs may be financed by the BNDES Climate Fund Program;[xvii]
- Those solar plants that begin operations by December 31, 2017, will receive an 80% discount on the tariff for use of transmission and distribution systems; [xviii] and
- Several states are offering their own tax-incentive programs.[xix]
In addition to these bright spots in Brazil’s solar power sector, Brazil’s “reserve energy auction” and contract process provide an ideal energy pricing mechanism because it passes the cost of the contracted solar capacity onto both regulated consumers and non-regulated consumers through a fixed charge that is assessed on all energy payments. Through this process, Brazil’s Energy Trading Chamber (CCEE) pays a fixed price for the solar energy produced by the developers who are awarded projects through the auction. CCEE then re-sells the energy on a merchant basis at the spot market price. Any revenues from such sales flow back to consumers in the form of offsets to the fixed charge. As a result, consumers become quasi-investors, and the risks of intermittent energy supply and volatile energy demand is distributed among the entire consumer base.[xx] This mechanism provides a mitigant to the “what if it rains” risk, which proved to be unsustainably allocated for many thermal generation projects developed during and after the 2001-2002 energy crisis.
To be sure, solar energy investors will need to apply their best analysis to maximize their margins and protect themselves against the risks – both new and old – in Brazil’s energy sector. To this end, industry analysts and Brazil’s regulatory experts have already offered some sage advice:
In anticipation of the solar auction in August and the solar and wind auction in November, it will be critical to address these points. Indeed, investors should maintain a conservative view of costs and expenses, as well as realistic margins, to avoid underbidding. Commercial arrangements will need to be tailored to capture sustainable risk allocations reflective of the dynamic factors in the Brazilian energy sector. Otherwise, penalties and surrendered financial guarantees await those who are unable to fulfill their awarded contracts.[xxiii]
 A special thank you to Luiz T.A. Maurer with the International Finance Corporation of the World Bank Group, for his invaluable insight on this subject and comments to earlier drafts of this article.
 The Brazilian Electricity Regulatory Agency (ANEEL) has scheduled two solar auctions to take place this year: the first, scheduled for August 28, will auction only solar power projects (which must be built by August 2017); and the second, scheduled for November 1, will auction solar and wind projects (which must be built by November 2018). See Ben Willis, Hopes high for solar in 2015 Brazil power auctions, PVTech (March 20, 2015) [hereinafter Willis (2015)].
 To price energy supplied to its regulated consumers, Brazil uses a hybrid auction system comprised of two phases. During phase I, ANEEL sets a ceiling price, which provides the starting point for pricing in the auction. Bidders then respond with the level of generation capacity that they are willing to provide at this price. As long as the total capacity offered by the bidders exceeds ANEEL’s total target capacity by an undisclosed margin, ANEEL will lower the energy price. Once the price elicits an amount of total capacity within the undisclosed margin of ANEEL’s total target capacity, the auction enters phase II, at which point the remaining bidders submit sealed bids offering to develop a certain capacity at a certain price. Each successful bidder then enters a bilateral contract with the applicable distribution company, or, the in the case of the renewables auctioned through the reserve energy auction described below, with Brazil’s Energy Trading Chamber (CCEE). See Luiz T.A. Maurer and Luiz A. Borroso, Electricity Auctions: An Overview of Efficient Practices, World Bank Study (2011) [hereinafter Maurer and Borroso (2011)].
[i] See Brazilian energy: Rain-checked, The Economist (February 15, 2014) [hereinafter Brazilian energy: Rain-checked (2014)].
[ii] See Adilson de Oliveira, Eric J. Woodhouse, Luciano Losekann, and Felipe V.S. Araujo, The IPP Experience in the Brazilian Electricity Market: Working Paper #53, Program on Energy and Sustainable Development at the Center for Environmental Science and Policy, Stanford University (October 2005).
[iii] See id.
[iv] See Maurer and Borroso (2011).
[v] See Willis (2015); see also Ricardo Luz de Brito Fabiano, Loss Giovani, Sorj Pablo, Werneck Bruno Mattos Filho, Veiga Filho, Marrey Jr. e Quiroga Advocados, Getting the Deal Through, Electricity Generation 2015, Brazil (2015), available at Bloomberg Law [hereinafter Luz de Brito Fabiano et al. (2015)].
[vi] See Vanessa Dezem, Solar market suffering ‘hangover’ after Brazil currency slumps, The Tribune (Ames, Iowa) (May 15, 2015), available at Bloomberg News [hereinafter Dezem (2015)].
[vii] See Q2 2015: Brazil Country Risk Report, BMI Research (April 1, 2015) [hereinafter Q2 2015: Brazil Country Risk Report (2015)].
[viii] See Rugigana Kavamahanga, Brazil’s Solar Market Marches Forward with Two Solar Auctions in 2015, Breaking Energy (May 14, 2015) [hereinafter Kavamahanga (2015)].
[ix] See Growing Costs to Challenge Solar Power Investment, BMI Research (July 10, 2015) [hereinafter Growing Costs (2015); see also Kavamahanga (2015); Dezem (2015); Financing issues put at risk many Oct solar auction winners in Brazil, SeeNews Renewables (April 22, 2015) [hereinafter Financing issues (2015)].
[x] See Alexandre Spatuzza, In Depth: Soaring solar interest keeps Brazil’s BNDES busy, Recharge (June 1, 2015) [hereinafter Spatuzza (2015)]; Growing Costs (2015).
[xi] See Brazil solar power auction changes date to August 28, SeeNews Renewables (June 19, 2015); see also Kavamahanga (2015); Dezem (2015); Financing issues (2015).
[xii] See Brazil sets bidding terms for solar tender, Business News Americas (July 28, 2015).
[xiii] See Alexandre Spatuzza, Brazil PV tender attracts 382 projects totally 12.5GW, Recharge (June 1, 2015); see also Leigh Collins, Brazil PV tender ceiling prices ‘need to rise by a fifth,’ Recharge (June 10, 2015).
[xiv] See Alexandre Spatuzza, Analysis: Why Brazil still looks at renewables with caution, Recharge (June 16, 2015); see also Jeff Mason and Valerie Volcovici, U.S., Brazil pledge to raise renewable energy in power output, Reuters (June 30, 2015).
[xv] See Brazilian energy: Rain-checked (2014).
[xvi] See Fiona Woolf, Vivek Gambhir, Ivan Londres, and Leo Simpson, Brazil: Brazil’s Electricity Market: A Successful Journey And an Interesting Destination, mondaq (February 11, 2010); see also Luiz Maurer, Mario Pereira, and José Rosenblatt, Implementing Power Rationing in a Sensible Way: Lessons Learned and International Best Practices, Energy Sector Management Assistance Program (August 2005).
[xvii] See Kavamahanga (2015).
[xviii] See Luz de Brito Fabiano et al. (2015).
[xix] See Solar Deals & Company News, Recharge (June 1, 2015); see also Rafael Herzberg, Brazil: the State of Minas Gerais, Latam.SOLAR (May 7, 2015); Brazil’s Minas Gerais extends tax break for solar generation, SeeNews Renewables (July 14, 2015).
[xx] See Maurer and Borroso (2011).
[xxi] See Kavamahanga (2015).
[xxii] See Spatuzza (2015).
[xxiii] See Ross McCracken, Auction house rules, Platts Energy Economist (April 1, 2015).