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Brazils Energy Matrix and

Prospects for Energy Integration


with South America
Brazil in Context
Brazil Upstream Guide
Brazil in Context Brazils Energy Matrix and Prospects for Energy Integration with South America 3
Brazil alone is equal to half of the rest of South
America by almost any measure. Its GDP for 2009 and
estimated population at the end of that year were
US$1,573 billion and 191 million, respectively. This
makes Brazil the eight largest economy in the world.
The surface area of the country is bigger than that of
the continental U.S., excluding Alaska. These facts,
combined with its central location on the continent,
make Brazil key to any potential future energy
integration in South America.
Primary Energy Supply Matrix
The country migrated from a wood and coal-powered
economy in the 1940s to an economy powered by a
balanced mix of energy sources. This change mirrored
a population shift from rural areas to the cities and the
country is now predominantly urban.
Remarkably, Brazils renewable energy resources
account for some 47% of its primary energy supply
matrix, compared to 7% for OECD countries. And,
interestingly, even though hydropower generates
more than 70% of Brazils electricity, sugarcane
products and other renewable fuels already exceed
hydropower as a source of total Brazilian energy.
Key factors in the development of the new fuel
sources include Brazils huge potential for hydropower
generation, the founding of Petrleo Brasileiro S.A.
Petrobras, Brazils national oil company in 1953,
and the 1979 oil crisis, which stimulated Brazilian
development of sugarcane products as an alternative
fuel source.
Other fuels did not flourish to the same extent in
the 35 years up to 2005. Natural gas now makes up
8.3% of the energy supply matrix, but development
of gas production has been hampered by a
combination of the costliness of establishing the
requisite infrastructure, competition from fuel oil
and the lack of a regulatory framework. The easy
availability and abundance of gas from neighboring
Bolivia also removed the initial urgency to develop
Brazils gas reserves. Brazils nuclear program was
virtually still-born due to universal concerns about
nuclear energy security and the resulting restrictions
on project financing. It may be about to enjoy a
renaissance.

Trends in Brazils primary energy supply matrix (%)
1970 2005 2030
28
15,5
6,9
5,5
18,5
9,1
3
13,5
37,7
47,6
3,6
5,4
5,1
0,3
9,4
38,7
14,8
13
13,8
2,9
6,3
1,2
Oil and derivatives
Natural gas
Coal
Nuclear
Hydro Electricity
Fire wood and charcoal
Cane products
Other renewable
4
Renewable Fuels
Hydro Generation
The country is blessed with one of the greatest
hydropower potentials in the world and hydro power
generation provides 77% of its electricity needs
(85% if imports are counted). Total Brazilian
hydropower potential amounts to 260 GW
1
of
which only 78 GW is currently exploited, by 828
hydroelectric plants. The greatest undeveloped
hydropower generation potential is in northern Brazil
(44%) with projects for new plants on the Madeira
River (UHE Jirau 3,300 MW and UHE Santo Antnio
3,150 MW), and on the Xingu River (UHE Belo
Monte 11.233 MW)
2
. The Madeira River projects
are expected to start operations in February 2013 and
May 2012, respectively and Belo Monte, in January
2015. Altogether some 33,000 MW of capacity,
including Belo Monte, is expected to come on
stream between 2015 and 2019
3
.
The industry is haunted by the electricity shortage
crisis of 2001 which resulted from underinvestment in
generation capacity together with record droughts.
Environmental concerns and the long distances to
consumers are behind the delayed development of
the norths hydropower potential. However, these
issues are likely to be successfully addressed in order
to ensure the energy supply needed for Brazils
expected growth.
Power generating companies work within a model
designed by the Brazilian government to create an
investment-friendly environment. Its starting point
is the guarantee of fair remuneration for investors in
order to foster the expansion of the countrys power
generating capacity while keeping electricity prices
at modest levels, securing the continuity and quality
of energy supplies and ensuring universal access to
and use of electricity services by all consumers.
The model envisages the coexistence of two
contracting environments:
Regulated Contracting Environment (ACR Ambiente
de Contratao Regulada): In this environment, all
power generating companies (public utilities and
independent producers) will sell their output to
power distribution companies (bidding individually)
by means of auctions to be held at the Electric
Power Commercialization Chamber (CCEE Cmara
de Comercializao de Energia Eltrica) with the
lowest price prevailing.
Free Contracting Environment (ACL Ambiente
Contratao Livre): In this environment, buyers (large
energy consumers) and sellers are free to settle the
price and volume of energy put up for trading. These
transactions are held at the CCEE.
Transmission
The resources used to expand the Brazilian
transmission system have come from the private sector
and from public-private partnerships since 1999.
The 96,140 km extension of transmission lines in the
Brazilian Electricity Grid (SIN Sistema Interligado
Nacional) almost completely interconnect the country
from north to south. SIN consists of companies
operating in the south, southeast, Midwest, and
northeast regions, and in one part of the north region,
carrying approximately 97% of the domestic demand
for energy.
The rest of the country is covered by isolated systems
covering almost 50% of the Brazilian territory, located
mainly in the Amazon region and consuming only
about 3% of the energy produced in Brazil. Diesel
is an important source of energy for electric power
generation in these isolated systems, which also
transmit energy generated in Venezuela.
Access to the national grid is a key issue for the
systems efficiency. In Brazil, it is regulated by the
Country-wide Systems Operator (ONS), and it
involves two key features:
1 Plano Decenal de Expanso
de Energia 2008/2017
EPE, 2009
2 Atlas de Energia Eltrica do
Brazil 3 edio. ANEEL,
2008.
3 Plano Decenal de Expanso
de Energia 2019 EPE,
2010
Brazil in Context Brazils Energy Matrix and Prospects for Energy Integration with South America 5
(i) Mandatory free access to power transmission grids;
(ii) Fixing of non-discriminatory usage and connection
rates that concomitantly provide economic signals
for determining the location of the power generation
hubs and major consumers, in addition to ensuring
remuneration for the grid owners.
ANEEL, the Electricity Industry Regulator, has
held transmission line auctions since 2004. Initial
transmission fees are determined by the winning bid
at auction. From then on, such revenues are subject
to the revenue cap system, through which the initially
permitted revenues are adjusted each year by the
inflation rate minus an efficiency factor, in order to
encourage productivity gains.
The Brazilian federal government offers special
financing terms through the BNDES (National Bank for
Economic and Social Development) as an important
investment incentive. In order to provide potential
concessionaires with information, the bank has been
disclosing the terms of loans offered prior to auction
dates.
Distribution
The electric power distribution market is serviced by a
total of 64 (private and state-owned) concessionaires
that provide public services countrywide. Overall,
60% of the energy is distributed by companies whose
control is in the hands of private capital. About 47
million consumer units are serviced, of which 85%
are residential consumers in over 99% of Brazilian
municipalities.
The regulatory framework for electricity distribution
was developed in the 1990s based on the United
Kingdom model. Since 1996, the concession
agreements for the privatized distribution utilities
have established a price cap system that consists of
an initial price cap stipulated by the regulator for the
distributors. Until the next tariff review, the price cap
is adjusted annually for inflation minus a productivity
factor (X). Tariffs are reviewed every 4 to 5 years
depending on the distributors concession contract,
and are designed to maintain economic and financial
sustainability for the concessionaires while providing
incentives for them to improve their efficiency and pass
on the attendant gains to consumers via lower prices.
6
Bio Fuels
Sugar Cane Products
Compared to hydropower generation, the sugarcane
fuel industry has been relatively unstructured,
unregulated, and fragmented. Even so, it contributed
more to Brazils primary energy supply matrix in
2008 than hydropower (in terms of barrels of oil
equivalent) and produced 27.5 billion liters of ethanol
in the 2008/9 harvest, of which 4.7 billion liters were
exported. The players are Brazilian companies which
started off initially as traditional food providers. Some
of these were capable of repositioning themselves as
heavy-weight fuel producers with a competitive edge
over traditional energy companies unfamiliar with
the agro-industrial world.
At this stage of biofuel development, it is not yet
clear at which point in the industry cycle the power
to extract economic rent will reside. This may be with
the growers, the processors (who are usually the
growers), the technology owners or the distributors.
Some players are testing the water by taking part in all
parts of the chain only to the extent needed to learn
the business.
A market changing event took place in 2008 when
COSAN, a major Brazilian ethanol producer, surprised
the market by acquiring EXXON Brazils retail fuel
distribution chain in the face of competition from
traditional fuel distribution companies. In 2010, this
move was followed by a Joint Venture between Shell
and COSANs ethanol production and fuel distribution
operations and by the announcement of Petrobrass
proposed strategic partnerships with two of the
largest Brazilian ethanol producers.
Brazils ethanol is competitive with that produced
elsewhere, but its ultimate success may depend
on other factors. These include U.S. import tariffs,
continued high oil prices, and the ability of the
industry to develop and improve its fuel efficiency
and process productivity, as well as to increase
production volumes to a suitable level for meaningful
international trading. As in the past, decreases in oil
prices may also result in an about-turn in government
policy for the sector.
More prosaic problems also face the industry,
principally in product standardization, distribution,
storage, and shelf-life. Promising investments are
being made into the genetics of sugarcane plants and
into the production of fuel from alternative crops.
While there is optimism that these initiatives will yield
results, it is still too early to know what impact these
will have on the industry.
The industry has suffered from grave public
interest allegations about encroachment on land
in the Amazon, the crowding out of food crops
by using arable land for fuel production (and the
resulting pressures on food prices) as well as about
questionable treatment of employees. The first two
allegations now appear to be less than proven,
though the industry may still have a lot of explaining
to do before it can convince the public (especially
U.S. and European taxpayers and legislators) that
this is so. As the industry rapidly becomes more
structured and more dependent on access to capital
markets, the market itself will exercise a virtuous
effect in sanitizing legal and moral abuses which
may be beyond the reach of government
enforcement today.
Brazil in Context Brazils Energy Matrix and Prospects for Energy Integration with South America 7
Firewood and Charcoal
The firewood and charcoal segment is even more
unstructured, unregulated, and fragmented than that
of sugarcane. It is also subject to similar public interest
complaints to that of the sugarcane sector and suffers
from the fact that it is not an environmentally clean
segment. Unlike the sugarcane segment, it is generally
felt that there is some foundation to the complaints.
Unsurprisingly, the Brazilian government sees this
sector as marginal and expects it to play a diminishing
role in the future.
Other renewable fuels
The government estimates the total required private
investment for alternative fuels at approximately
R$10.1 billion and expects to increase the share of
alternative sources of energy in the Brazilian energy
matrix from 3.1% to 5.9% by the end of the program.
Solar energy is suited to the small, isolated
communities which abound in the north of Brazil.
Wind power is thought to be more suitable for
coastal areas, principally in the northeast of Brazil.
As elsewhere, these segments are expected to be a
welcome complement to the Brazilian energy matrix,
but their characteristics make them likely to remain
relatively small niches areas.
The Brazilian federal government established a
program (PROINFA) to develop alternative energy
sources including Small Hydroelectric Plants (PCHs),
biomass, and wind power. The goal is to achieve a
total capacity of 3,300 MW. By the end of 2010, the
program is estimated to have added 1,591 MW of
generating capacity, 414 MW from PCHs, 66 MW
from biomass and 1,110 MW from wind power. The
connection of new points of energy generation to the
grid was made feasible through federal government
support, such as incentives for PCH construction and
tax discounts for those using the transmission and
distribution systems. Additionally, the program enjoys
a 10 year credit line offered by BNDES, which finances
70% of the total investment.
Non-Renewable Fuels
Oil
In 2009, Petrobras produced 1,971 thousand barrels
per day and had a refining capacity of approximately
1,791 thousand barrels per day.
Petrobras was established in 1953 as a
government-controlled national oil company. It was
the sole concessionaire for Oil & Gas Exploration
& Production (E&P) until 1998
4
, when the Brazilian
Federal Government introduced the first round
of competitive bids for new E&P concessions and
other players entered the Brazilian market. This
competition together with the lack of funding
from its shareholder, the government, encouraged
Petrobras to seek capital in global financial markets
and to reinvent itself as a major regional oil company,
operating primarily in the triangle between Brazil/
Argentina, the Gulf of Mexico, and Nigeria.
Ultimately, the strategic re-positioning of Petrobras
served as an incentive to accelerate its Exploration &
Production (E&P) program and led it to the discoveries
of apparently substantial reserves in the pre-salt layer,
some 6,000 plus meters below sea level.
These discoveries have led to a change in the E&P
regulatory framework in Brazil. Exploration in the
Brazilian pre-salt has resulted in the discovery of
an estimated 8 to 20 billion BOE over the past
4 years, starting with the drilling of Tupi (2006).
The announcement of the discovery of oil and gas
resources, in reservatories, in 2007, indicated the
existence of a major, new oil province in Brazil, with
estimates of significant reserves in the Esprito Santos,
Campos and Santos basins, in an area known
as Pre-Salt.
4 Passed in 1997, the Oil
Law 9,478 introduced
regulations of the Federal
Union monopoly for oil
exploration and production.
In 1998 the first partnership
agreements for petroleum
exploration were signed
between Petrobras and
private companies, under
which Petrobras obtained 397
concessions in exploration
blocks of development
and production fields from
the Brazilian Petroleum
Regulatory Agency
(ANP).
8
The establishment of a new institutional framework
for oil and gas exploration production in the Pre-Sal
area consists of the four following measures:
New regime (production sharing contracts) will
apply only for new E&P concessions in the Pre-Salt
area, preserving the rules for previously existing
concession contracts. Petrobras will be the operator
of all production share contracts, holding a
minimum 30% share in each consortium.
Creation of a New Public Organization, which will
be responsible for the administration of production
share contracts, as well as the trading of oil and gas
in the Pre-Salt area, preserving the Federal Unions
interests.
Creation of a New Social Fund to manage the
government take collected from these areas in
the pre-salt. The goal is for the fund to increase
social programs related to education, science and
technology and the combat of poverty.
Authorizing the Brazilian Federal Government to
subscribe for shares in the capital stock of Petrobras
through the transfer of rights (cesso onerosa)
to explore and produce oil, natural gas and other
fluid hydrocarbons in pre-salt areas not under
concession, limited to the production of 5 billion
barrels of oil equivalent.
The technical difficulties of dealing with the geology
of the finds and the resulting effects on the cost
of operating at pre-salt depths while maintaining
satisfactory safety and environmental standards are
still relatively uncertain. But, hard as it may be to cope
with such factors, the lack of human and financial
resources on the scale required to develop and
produce from the new-found reserves may turn out to
be an even greater challenge.
Brazil in Context Brazils Energy Matrix and Prospects for Energy Integration with South America 9
The proposed regulatory framework would have
important implications for the development of Brazils
oil sector. Some analysts raise the concern that
obliging Petrobras to act as the sole operator in the
pre-salt basin would place an undesirable financial
and operational burden on the Company and
potentially slow the pace of development of
new projects, especially considering the companys
already-aggressive development plans for its existing
pre- and post-salt oil reserves.
Petrobras is expecting to invest US$33 billion in the
Pre-salt area until 2014, to include the construction
of additional port facilities, platforms, floating
production vessels and the like. Indicative of the scale
and breadth of investments which will be required
to service the pre-salt fields are the 26 contracted
Drilling Rigs plus the 28 to be built by 2020, besides
504 Supply and Special Vessels and 84 Production
Platforms
5
.
The investment in Post Salt fields will be even more
significant and are expected to total US$75 billion in
the same period.
Petrobras with its pre-salt discoveries is a game-
changer for the oil and gas industry. Its ambitions,
stretching well beyond its current 5-year investment
plan, make Brazil and Petrobras the epicenter of the
oil service industry as the scope of the development
work scope required will be substantial.
Even before the pre-salt finds, Petrobras was
planning to increase its refinery capacity with 4 new
oil refineries between 2010 and 2030 with a total
nominal capacity of 950 thousand barrels of oil per
day and 2 new petrochemical refineries between
2010 and 2020 with a total nominal capacity of 300
thousand barrels of oil per day.
Gas
Brazil had 12.9 trillion cubic feet (Tcf) of proven natural
gas reserves in 2009. The Campos and Santos Basins
hold the majority of reserves. Natural gas production
has grown slowly in recent years, mainly due to a lack
of domestic transportation capacity and low domestic
prices. In 2008, Brazil produced 446 billion cubic feet
(Bcf) of natural gas, mostly unchanged from 2007.
The largest share of Brazils natural gas production
occurs from offshore fields in the Campos Basin in Rio
de Janeiro state. Most onshore production occurs in
Amazonas and Bahia states.
The discoveries in Brazils offshore Pre-Salt areas have
generated considerable excitement. Along with their
potential to significantly increase oil production in the
country, the Pre-Salt areas are estimated to contain
sizable natural gas reserves as well, which allow the
country to be self-sufficient in the gas market.
Until then, one of Petrobrass solutions to assure
energy supply security was to install two floating
re-gasification plants through January 2009, so as to
accelerate the importation of LNG (Liquefied Natural
Gas). These plants, one in the North West (Pecem)
and the other in Rio de Janeiro, have a total capacity
of 21 million cubic meters per day.
Nuclear
The Brazilian constitution prohibits private sector
operation of nuclear energy plants. Brazil has
two controversial plants in Rio de Janeiro and the
government announced the start of construction on
a third plant in mid-2009, on the same site as that of
the previous two. Angra 3, the third plant is currently
being installed and has an estimated cost of US$4,5
billion dollars.
5 Business Plan
2010 2014 Petrobras
10
The minister for Mines and Energy also has announced
the construction of 50 nuclear power plants over
the next 50 years with planned total incremental
electricity generation of 60,000 MW. Curiously, only
4 such plants are scheduled to be built within the next
20 years (until 2028), two of which are planned to be
in northeast Brazil and two in southeast Brazil.
Forecast Energy Investment in Brazil
through 2030
In summary, Brazil plans to reach 2030 with its Primary
Energy Supply Matrix still broadly in line with its
current profile. In other words, just under half of its
energy supply will continue to come from Renewable
Fuels, despite expecting to grow the total supply by
154% in the 25 year planning period then ending.
This considerable achievement will require estimated
cumulative spending in excess of US$800 billion
shown as below.
Prospects for South American Energy
Integration
Political and economic stability are conditions
precedent to any serious regional energy integration
and South America can be no exception to this rule.
Naturally, any perception that there may be populist
governments with undemocratic tendencies would
generate concern about enforceability of multilateral
agreements of the type needed to establish
trans-continental cooperation.
In recent years, the prospects for integration appear
to have receded rather than progressed. Events in
Bolivia and in Argentina have reduced cross-border
gas trading. Paraguay is the one country which is fully
integrated with Brazil because of the common interest
in the 12,600 MW Itaipu hydro-electric dam which
spans the border between the two countries. But
Paraguay is now intent on renegotiating with Brazil
its existing energy supply contractual arrangements,
providing further doubt as to the durability of
commercial treaties on the continent.
Geography also presents natural impediments to
energy integration. Brazil has the Amazon to the
North and the Andes to its West, physically impeding
access to its neighbors on those borders. While
Venezuela has offered to share in a transcontinental
pipeline to supply gas to Brazil and the Southern
Cone, the practical challenges of geography and
distance alone make experts believe this offer to lack
substance. Venezuela does provide a small quantity of
electricity to part of the Brazilian Amazon region
using an independent transmission system.
Regrettably, present circumstances would suggest
that South American Energy Integration appears to be
a remote possibility for the near future, though, most
Brazilians would hope that it could become a reality
within the 2030 planning time-frame adopted by the
Brazilian Federal Government.
Source : Matriz Energtica Nacional 2030 MME 2007
Accumulated Investment by Segment: 20062030 (%)
Oil and derivatives
Natural gas
Sugarcane
Electricity
48,8
11,8
3,7
35,6
US$ 803 billion
Contacts
William Ballantyne
Oil & Gas Leader - Brazil
+55 21 3981-0650
wballantyne@deloitte.com
Carlos Vivas
Oil & Gas Leader Tax
+55 21 3981-0482
cavivas@deloitte.com
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