Agency notes Brazilian drought impact on hydro

Three years into the current drought and in the midst of sluggish GDP performance, Brazil’s largely hydro-powered energy sector is feeling the strain.

After three years of drought, Brazil's largely hydro-powered energy sector is feeling the strain, according to a report released from Standard & Poor's Ratings Services (S&P).

Hydro power accounts for 66 percent of Brazil's installed capacity and supplies 98 percent of total electricity consumption, the report said.

Prepared by director of utilities and infrastructure ratings Sergio Fuentes, the outlook report notes that at the end of January, water reservoir levels were at just 16.8 percent of capacity in the Southwest-Midwest subsystem, and only 16.4 percent in the Northeast subsystem, which provide 70 percent and 18 percent of Brazil's total reservoir capacity, respectively.

“Distribution companies are suffering the most because they're buying a relatively high level of power on the spot market, and there's a time lag for passing these costs through to end customers. As a result, distributors' EBIDTA generation has been weaker and more volatile since 2013, which has eroded credit metrics given that the central government's financial support hasn't fully covered the higher cost of distributors' power purchases,” the report reads.

In a Tuesday morning call, Fuentes said: “Spot price in Brazil should be well lower than R$100 (€31.22; $35.34) per megawatt-hour (MWh), but soared to R$260/MWh in 2013 and R$650/MWh in 2014. This is causing a liquidity problem for distribution companies.”

Fuentes said overall spot market purchase costs exceeded R$20 billion across Brazil's 64 distributors in 2014. In recent years, the Brazilian government has provided financial support to alleviate this burden, but indicated that such support will not continue in 2015.

Instead, three new measures are being implemented to ease the burden.

First, energy sector regulator Agencia Nacional de Energia Eletrica (ANEEL) reduced the spot price cap to R$388.48/MWh from R$822/MWh in December 2014. Second, a new rate flag mechanism introduced in January brought an infusion of cash flow into the market. And, perhaps most importantly, ANEEL is expected to announce an extraordinary rate increase in the next two to three months, which would help move the spot price burden away from distributors.

If no rate increase occurs, Fuentes said the likelihood of power rationing increases.

“We believe the government will try to avoid power rationing,” Fuentes reported. “However, if rainfall between February and March is too low to push Southeast-Midwest reservoir levels back up to about 35 percent by the end of April, the chances of rationing at some point between May and November 2015 will rise significantly.”

Fuentes said power rationing could be financially positive for hydro generators that don't meet contract sales, and said transmitters are shielded from the drought's effects through a natural monopoly.

Marcello Schwarz, also a director of utilities and infrastructure ratings for S&P, said the industrial impact of the drought is minimal.

“The most vulnerable [industries] are steel producers and mining,” Schwarz said, “but still overall impact on performance will be quite limited.”

Fuentes' outlook concluded by saying S&P will not take any rating action on companies it rates in the sector until there is more clarity on the upcoming extraordinary rate increase for distributors.