How Brazil is emerging as a global clean energy leader

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With demand for 5-7GW of new generating capacity each year, and solid financial backing, Brazil will be one to watch in the clean energy stakes.

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In world-leading economies such as China, Germany, India and the US, huge investments are being made to position for a low-carbon future. The rationale behind this investment includes the benefits of improved energy security, stronger trade balances, growth in employment and industry leadership, plus the associated environmental gains. In this article, we look at the massive expansion and modernisation of the energy sector in Brazil.

Why is Brazil intriguing?

– Brazil is the 10th largest country in the world in terms of electricity generation;

– In contrast to the very subdued economic growth globally, Brazil continues to grow GDP in excess of 5% annually (clearly holding its own among the four BRIC nations);

– Electricity demand is forecast to grow at +5 per cent annually through to 2020. This means that 5-7GW of new generating capacity will be required each year, putting Brazil behind only China and India in terms of global net new electricity capacity additions;

–In 2011 the Brazilian government announced its Second Accelerated Growth Program, which includes a $US600 billion investment program in its electricity sector;

– Brazil has undertaken long-term planning supported by significant investments in energy capacity generation at such an aggressive level that it has largely achieved its long-term goal of energy security through self-sufficiency;

– Energy security has also been significantly improved by Brazil’s goal of energy diversity, with significant contributions from hydroelectricity, ethanol from sugarcane, biomass, imported natural gas and deep sea oil. Wind is now also rapidly increasing in significance;

– Brazil has aggressively utilised its very successful state-owned Brazilian development bank (BNDES) to provide financing for the rollout of renewable energy, transmission, energy efficiency and deforestation programs;

– Brazil generates 78 per cent of its electricity from hydro sources, and targets adding another 10 per cent from renewable energy sources by 2020 (primarily wind, run-of-river and biomass);

– Brazil has on-shore wind capacity utilisation rates of 30-45 per cent, some of the highest in the world, and double the global average (by comparison China, the world’s largest installed wind market, delivered only 20-22 per cent net utilisation rates in 2011);

– Very high wind utilisation rates combine with very competitively priced wind turbines plus readily available financing (underpinned by BNDES) to make unsubsidised wind power available at $US55-65/MWh (5.5-6.5c/kWh) which is at lower cost than gas, the second cheapest option in Brazil;

– Finally, Brazil is tendering for a 500 km, $US19 billion high speed train connection between Sao Paulo and Rio de Janeiro for completion by 2022.

Brazil – Economic Growth of over +5% pa

Brazil has averaged 5 per cent pa GDP growth over 2010 and 2011, and the Brazilian Finance Ministry has forecast over 5 per cent pa growth to continue through to 2014. This growth is more patchy than China, with 2009 registering GDP -0.3 per cent, then +7.5 per cent in 2010 dropping to +2.7 per cent in 2011 as a significant currency appreciation undermined growth and interest rates rose to 11 per cent pa on the back of inflation of 6.5 per cent pa. However, the favourable economic outlook is underpinned by unemployment at a record low of 4.7 per cent in December 2011. Brazil also retains very robust international financial reserves ($US352 billion) and has seen record direct foreign investment of $US67 billion in 2011.

In 2011 the Brazilian government announced its Second Accelerated Growth Program, which includes a $R1.1 trillion ($US600 billion) investment program in its electricity sector, half of which is to be undertaken in the 2011-2014 period, with the balance for implementation beyond 2014. The Brazilian National Energy Research Institute forecasts electricity demand will grow at 4-5 per cent pa from 2011-2021 – implying an almost doubling of electricity consumption to 736,000 GWh during this period.

Brazil’s Government Policy Background

Since 2002 Brazil has been systematically building up its National Policy on Climate Change (PNMC). This integrated plan was last updated by Congress in December 2009 (for Portuguese readers, please refer here!) and covers five key domestic areas of related policies: Climate Strategy; Agriculture & Forestry; Energy Efficiency; Low Carbon Energy production; and Finance.

1. Brazil’s Climate Strategy is built around a national emissions target which aims to reduce Brazil’s emissions by 36-40 per cent relative to a Business As Usual (BAU) baseline for 2020. This target was signed into law in 2009.

2. Agriculture and Forestry represent a combined 80 per cent of Brazil’s emission reduction target. The key government policies in this area reflect the country objective of zero net forest loss by 2015, with the central effort focused on reducing the deforestation in the Amazon by 80 per cent by 2020 relative to the average for the period 1996-2005 (as per the Presidency Decree of December 2010). Given the starting point of 15-20,000 square kilometres pa of deforestation across Brazil, this challenge is huge. However, by 2011, a 60 per cent reduction had already been achieved.

3. Energy Efficiency is another key policy platform. Since 1998, the Brazilian Electricity Regulatory Agency (ANEEL) has required all utilities to invest a minimum 1 per cent of annual revenues into energy efficiency programs. In 2008 the electricity demand target was set to reduce electricity demand by 10 per cent by 2030 per unit of real GDP. The further targets include reducing non-technical transmission and distribution losses by 1,000GWh annually by 2019 and a 2,200GWh reduction of energy use in buildings through the use of solar heating by 2015.

4. Low Carbon Energy Generation: the National Energy Plan aims to rapidly scale up electricity generation from renewable sources. The original policy was set out in 2002 under the Programme of Incentives for Alternative Energy Sources (PROINFA). In the latest PROINFA update that covers the 2010-2020 period, Brazil is targeting the addition of biomass and sugarcane bagasse capacity of 5 GW (to 9 GW), small hydro of 2.5GW (to 6GW) and 11GW of onshore wind (to 11.5GW).

5. Finance: The Brazilian Government owned development bank BNDES is key to providing first round debt financing for renewable energy, grid transmission and energy efficiency programs. BNDES provided some $US3 billion, or 45 per cent, of the total $US7 billion of climate specific investments in Brazil in 2011. BNDES is also instrumental in managing international pledges towards avoided deforestation.

Wind Farms – 2 GW in 2012?

The total cumulative capacity of Brazilian wind farms operating at the end of 2011 was 1.5GW. This saw the addition of 587MW in 2011 alone, a 60 per cent expansion in the total Brazilian installed wind base in a single year. The Global Wind Energy Council expects total Brazilian onshore wind farm additions in 2012 to potentially reach 2GW, five times Brazil’s last three years average rate of new installs. This would put Brazil as the fourth largest installer of wind globally in 2012 (up from 11th in 2011) behind China, America and India.

Having only passed the 1GW milestone in 2011, the Brazilian Wind Energy Association (Abeeolica) forecasts total installed capacity will reach 7GW by 2016. We at Arkx think this will be easily exceeded (we forecast 9-10GW by 2016). With tendering preference given to domestic industry manufacturing, global wind turbine firms such as Gamesa, GE, Enercon, Suzlon and Vestas are all in the process of building Brazilian manufacturing bases. As such, Brazilian turbine capacity is likely to reach 2-3GW pa by end of 2012, such that turbine prices will continue to fall due to significant overcapacity (a global phenomenon in the renewables sector).

EDP Renovaveis (EDPR) is a Portuguese listed renewable energy company that is currently the fourth largest wind farm owner in the world, with 7.9GW of windfarms in operation globally (behind three other listed renewable energy utilities: Nextera Energy (US); China Longyuan (China); and Iberdrola (of Spain)). Having been one of the key developers of windfarms in Portugal, Spain and more recently in America, EDPR has now moved to aggressively build-up its Brazilian wind farm portfolio. EDPR commissioned its second 70MW windfarm in Brazil in May 2011 (taking total capacity to 84MW). EDPR won its tender to build another 120MW windfarm in the December 2011 PROINFA A-5 auction. Under this reverse (or Dutch) auction, EDPR accepted a 20 year power purchase agreement (PPA) from the 52 per cent state-owned listed power utility Eletrobras, at R$105/MWh (which represented $US66/MWh at the then exchange rate). All up, in May 2012 EDPR reported plans underway to add up to 1.6GW of wind capacity in Brazil in its own right.

In August 2011 a world record low was set for wind power tariffs. Under Brazil’s PROINFA A-3 Energy Auction, 1.9 GW of wind farm PPAs were awarded at an average price of R$99/MWh (at the then foreign exchange rate, this was US$63/MWh or US6.5c/kWh). By comparison, we understand the lowest PPA awarded for wind in Australia to-date is in the order of A$90-95/MWh.

In trying to understand how large-scale commercial wind PPAs could be tendered for in Brazil at $US55-65/MWh, we would indentify a number of key features. Firstly, the firm awarding the PPA is Eletrobras, a BBB+ rated utility. Secondly, BNDES provides ready access to lending facilities based on the security of these PPAs. Thirdly, the domestic price of turbines in Brazil has been falling rapidly over the last few years, reflecting the strength of the Brazilian Rand, in combination with aggressive discounting by turbine manufacturers to build up orders in the fastest growing market for wind in the world. Fourthly, world leading capacity utilisation rates are forecast for part of Brazil. EDPR’s existing 70MW wind farm in Brazil has a reported 30 per cent utilisation rate.

By comparison, IMPSA Energy (which reports it is the leading turbine supplier in Brazil with a national market share of 22 per cent) forecasts load factors on wind farms it currently has under construction at world record levels of 47-50 per cent. Even if the sustainable rate comes in closer to EDPRs first large project, this would still imply utilisation rates of 35-45 per cent – a dramatically higher rate than the 20-22 per cent seen in China, 25-30 per cent in Europe and 30-33 per cent in North America. Only NZ and Chile have reports of 40-50 per cent utilisation rates for onshore wind farms.

State Development Bank BNDES

A key Brazilian government support mechanism for the roll-out of renewable energy and transmission projects is the provision of long term commercial term lending by BNDES, the state-owned development bank for Brazil. At the end of 2011, BNDES had a total loan book of R$635 billion ($US400 billion), which represented 14 per cent growth on 2010. In 2011 BNDES made advances of $R140 billion ($US76 billion), with 40 per cent of this going into large national infrastructure projects. BNDES generated a net profit for the state of $R9 billion in 2011 and delivered an average return on equity of 15 per cent in the last three years. BNDES currently has total loans outstanding of $R6.4 billion ($US4 billion) across 78 Brazilian wind farms (including $R228 million to EDPR).

As an aside, the Australian federal government’s proposed Clean Energy Finance Corporation will have a similar, if narrower, mandate to BNDES. We at Arkx believe it is no coincidence that each of the leading countries in the world investing in low carbon technologies all have State owned development banks (BNDES, China Development Bank, the US Department of Energy/Treasury, the UK Green Investment Bank and Germany’s KfW). It is also clear to us that the dual mandate of providing commercial funding for renewables and the profit focus of these development banks is readily compatible if management/board independence is adhered to.

Hydroelectricity – the key to Brazil’s clean energy policy

Hydroelectricity capacity was 80GW (74GW within Brazil plus 6GW from the river on the border with Paraguay) as at the end of 2009. This represents 78 per cent of Brazil’s total electricity generating capacity of 104GW. The balance is 13GW from coal/natural gas, 2GW from nuclear and 8GW from alternatives (wind, biomass, small hydro). Brazil’s 80GW of hydro is second only to China’s 230GW of hydro capacity.

According to the Ten Year Expansion Plan for Energy to 2020, Brazil has 24GW of contracted large-scale hydro projects in train, plus another 9GW of planned large-scale hydro and 2.5GW of small-scale hydro. While hydro will remain key to Brazil’s electricity system, the Brazilian PROINFA is in part focused on diversifying energy sources into wind, biomass, gas and solar in order to provide better energy security, particularly in periods of drought.

We would also note that environmental movements are gaining increased power to run interference in Latin American hydro expansions, as Origin Energy found with their newly acquired $733 million Cuervo hydro project in Chile.

Biofuels

Brazil’s government plans to boost investment in sugar-cane plantations by $R35bn during the next four years to ensure an adequate supply of crops for the nation’s ethanol industry.

The government plans to introduce measures aimed at spurring the renewal of 6.4 million hectares of aging plantations and the development of 5.2 million hectares of new fields, according to the Ministry of Agriculture. Brazil is the world’s leading producer of biofuels.

Given Arkx does not currently invest in biofuel firms, we will leave this area of renewables for another time.

Vehicle Fuel Efficiency

Brazil continues to tighten it’s auto industry fuel efficiency standards, with EURO IV for autos and Euro V legislation standard for trucks coming into effect over 2012. The current standard (based on Euro III) targets 150 mg/km of NOx for petrol based autos, whereas Euro IV targets 80 mg/km of NOx and Euro V targets 60 mg/km of NOx.

High-Speed Rail

One additional proposal could further boost Brazil’s move towards a low carbon future – high-speed rail. Brazil is currently tendering for a 511km $US19 billion high-speed train connection between Sao Paulo and Rio de Janeiro for completion by 2022. The government has offered private industry a 40 year concession as public-private-partnership and modeled a proposed speed of 350km per hour. We would note that three tenders in the last two years have already been cancelled due to insufficient bid certainty. This is the first such project in Latin America and is predicated on dramatically reducing Brazil’s reliance on domestic air-travel.

Smart Grid rollout

Over the coming decade, Brazilian power utilities are forecast to invest $R30 billion ($US16 billion) in the national rollout of 64 million smart meters. One of the key drivers of this policy is to dramatically reduce “non-technical losses in distribution” (power theft). The National Electricity Regulator of Brazil estimates losses currently run at R$8bn annually, and proposes to bring in legislation by end 2012 to require utilities to replace all meters. Like in India, power theft is the key driver of this government policy in Brazil. We at Arkx believe this investment will also underwrite the development of a smart grid whereby all electricity customers will be able to optimise their energy usage via time of use pricing, peak demand curtailment and the introduction of smart appliances – key applications of energy efficiency.

Solar Capacity – limited so far

Brazil currently has no solar feed in tariff policy. The current policy for solar PV in Brazil is directed toward off-grid installations, where there are utility programs to provide off-grid subsidies for areas that are too far removed from the grid for grid connection to be feasible.

However, with some of the best solar radiation rates in the world, we would expect Brazil to rapidly scale up its solar installation rates beyond 2014 as wholesale grid parity rates draw closer. We view the distributed nature of solar as being a key to further diversifying Brazil’s already world leading clean energy system and reducing the already huge demands on additional grid transmission infrastructure.

In conclusion, Brazil already has one of the lowest carbon emissions electricity systems in the world. Despite the forecast for very strong economic growth through to 2020, Brazil will further embrace a range of low carbon energy solutions including energy efficiency, reducing deforestation, rolling out a high speed rail network, in combination with a dramatic expansion of wind, solar, small scale hydro and biomass electricity generation.

It will additionally continue to embrace biofuels as its answer to the rapid expansion of its automotive fleet. A strong government commitment to a ten year energy plan backed by the impressive financial profile of BNDES, assures us that Brazil will be a leading economy in the low-carbon future.

Tim Buckley is a Portfolio Manager and Elizabeth Robertson is a Graduate Trainee at Arkx Investment Management. Arkx Investment Management focuses its investment approach on a portfolio of high conviction stocks in the listed global clean energy universe. It looks for proven performers with world leading technologies backed by strong balance sheets and priced on sensible valuation metrics. We have investments in some of the companies mentioned (EDPR and China Longyuan).

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