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Moving Markets for Energy Efficiency in Brazil

Background

Brazil was the eighth-largest economy in the world in 1997 with a GDP over US$ 800 billion. The GDP declined in 1998 and in 1999 it is estimated to be approximately US$ 557 billion. It is a highly diversified economy with wide variations in levels of development. Most large industry is concentrated in the south and southeast. Although traditionally the poorest part of Brazil , the Northeast is beginning to attract new and much needed investment.

Despite its economic problems in the early 1990s, Brazil has shown signs of an impressive recovery. The currency has regained some its strength, the return of much feared inflation has been kept in check, and interest rates - which had reached 45% in March 1999 - had dropped to 23.5% by June 1999. Assuming Brazil 's government continues with much needed fiscal reforms, Brazil should be able to return to a period of economic growth during the late part of 1999 and early 2000. Brazil has one of the most advanced industrial sectors in Latin America . Accounting for one-third of GDP, Brazil 's diverse industries range from automobiles, steel, and petrochemicals, to computers, aircraft, and consumer durables.

Brazil 's power generation capacity currently amounts to approximately 60,756 MW. At the end of 1998, the vast majority (92.7%) of this domestic electricity generation was still in the hands of the state and federal governments. Brazil 's main source of electricity comes from hydro-electric power which provides roughly 95% of the country's electrical energy. The National Electric Power Agency (ANEEL) controls and supervises all power companies in Brazil . Eletrobrás, the government's electric utility, currently generates 60% of the country's electric power and is responsible for 64% of the nation's transmission lines. Prior to the economic crisis, Brazil 's electricity demand was expanding at a relatively rapid rate of 7% per year. Most of this growth was taking place in the less-developed Northeast region of the country. These high levels of growth are expected to return after the financial crisis and to continue for the next decade. As a result, it is expected that Brazil will need to add an additional 3,650 MW per year and will require investments of US$ 8 billion to US$ 9.5 billion per year for the next 5 years, totaling an estimated US$ 50 billion over the next 10 years.

In 1985, in response to heavy dependence on interruptible imported petroleum, many oil importing countries, including Brazil , shifted their energy strategy to focus on domestic sources of energy and energy efficiency. Brazil created PROCEL as a cell within its national utility (Eletrobrás) to begin focusing on energy efficiency. Since that time, PROCEL has been very active in promoting efficient use of energy and while there are many success stories, market-based mechanisms to stimulate private sector investment in energy efficiency in Brazil are largely absent. Financing requirements for achieving even a fraction of the overall energy efficiency potential are formidable and Eletrobrás, the government, the donors, and the privatized utilities cannot alone meet the overall capital demand. Brazil presents a strong case for an economy where market-based energy efficiency investments are the only long-term solution to the investment needs in the energy efficiency sector.

Given the current operating characteristics of Brazilian companies, conservatively, one could expect that at least 15% of total energy could be economically saved -- even at current electricity prices. As the prices of electricity increase, which is expected as a result of privatization, the overall potential for electricity savings could go up significantly in the medium- to long-term. In addition, given the high cost of captive power generation, a significant potential also exists for industrial cogeneration which is now permitted under Brazilian law. The key to realizing the energy efficiency potential at the end-use level in Brazil will eventually have to include (i) market-based investments in energy efficiency projects and (ii) the availability of attractive financing for ESCOs and other energy service companies to implement economically viable projects.

The Association of Brazilian Energy Service Companies (ABESCO), an ESCO trade association, is very active in identifying attractive energy efficiency projects and influencing energy efficiency policy in Brazil . Other major industry associations -- National Confederation of Industries (CNI) and Federation of Industry in the State of Sao Paulo (FIESP) are also very active in sponsoring activities to promote energy efficiency. Both FIESP and CNI have been cosponsoring targeted regional workshops on energy efficiency and cogeneration in partnership with the Canadian Environmental Industries Association (CEIA).

Brazil has an enormous energy savings potential in all sectors of its economy. In the area of lighting and air conditioning in the commercial sector, the total potential for annual energy savings has been estimated to be 2,609 GWh or approximately 30 percent of the current energy consumption. The total monetary value of the estimated energy savings is US$ 110.5 million, at an investment of US$ 285.6 million. In the public sector, the total potential for savings has been estimated to be 4.020 GWh or 22.6 percent of the total energy consumed annually. The monetary value of the potential energy savings is estimated to be US$ 239.2 million per year at an investment of US$ 419.8 million, representing a simple payback period of 1.75 years (or a simple rate of return at close to 50 percent per year). In the industrial sector, the total potential is of the order of 10-15 percent of total consumption per year.

The business climate in the country continues to be a great barrier to energy efficiency as the government has often incentivized export-led production expansion over efficiency and productivity improvements. There are no tax incentives, such as import duty reduction, for energy efficient appliances and equipment, making it difficult for distributors of foreign equipment to find a "ready" market for energy efficient technology and equipment in the private sector. Brazil has made significant progress in reforming its legal system in recent years. However, many of the laws suffer from cumbersome or vague implementing regulations. In order for the markets to operate freely and competitively, the government needs further legal reforms.

Brazil is a key Global Climate Change (GCC) country and the link between energy efficiency and climate change benefits has not been sufficiently articulated. Both the public and the private sectors need to appreciate that energy efficiency offers both productivity improvement and direct (or avoided) carbon reduction.

Financing of energy efficiency projects continues to be a major barrier to energy efficiency in Brazil . The banking sector in Brazil is extremely conservative and typical financing availability is either for overdraft protection or major projects. Project financing for small projects including EE projects is virtually nonexistent. Also, commercial interest rates for short-term borrowing - typically needed for EE projects - are prohibitive. The banking sector, in general, does not view EE project lending as attractive due to the small size of the projects and the high transaction costs associated with them. Furthermore, there is a clear lack of qualified project developers and financial intermediaries who typically develop and package bankable projects, thereby reducing the transaction costs of the financial institutions.

At the same time, the financial sector is becoming aware of the enormous market potential for energy efficiency and distributed cogeneration. BNDES, the national development bank, is currently developing a new financing facility for small and medium sized projects that could be available for energy efficiency projects as well. In addition, Credibanco, a commercial bank has shown a strong interest in pursuing the energy efficiency market along the lines of its financing for water conservation projects where the bank has gained significant experience. The creditworthiness of end-users and a lack of private ESCO financing are also strong barriers to investments even in the most viable EE projects. In the short term, financing of energy efficiency projects will be questionable as short-term interest rates are prohibitive, ranging from 15% to 30% per month.

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CORE's Project Activities

In 1999, USAID selected a joint team of Bechtel and CORE International, Inc. (CORE) to implement a multi-year multi-country energy efficiency project - Moving Markets for Energy Efficiency. Three countries were selected to be the focus of this project - India , Brazil , and Egypt . CORE was assigned the responsibility to lead the effort for Brazil under this project. The focus of this effort was to conduct an assessment of the technical, financial, institutional, regulatory, and legal environment in Brazil and develop a strategy for a comprehensive private sector led energy efficiency program. Through a series of missions and site visits, CORE conducted a detailed assessment of the overall technical potential for energy efficiency in various sectors of the Brazilian economy. The assessment also included the institutional, financial and the regulatory environment and developed specific recommendations for reforms to promote private sector led energy efficiency investments.

CORE's assessment found that a sizable potential existed for not only energy savings, but also industrial co-generation throughout Brazil . However, a considerable number of barriers existed. These included (i) a relative lack of local availability of technology, equipment, and products, (ii) few successful ESCOs, (iii) limited financial support to the ESCOs, and (iv) perceived risks of energy efficiency technologies. As a result, even for the most attractive energy efficiency projects, there was often limited implementation of energy efficiency and the limited capabilities of the ESCOs and technology risks essentially have not moved the market.

While the availability of energy efficient technology and equipment was generally not a constraint in Brazil , the presence and capability of ESCOs continued to be a major barrier to energy efficiency implementation. There was little emphasis on enhancing the capability of ESCOs to develop, package and finance energy efficiency projects through EPCs. In addition, the supporting infrastructure to assist ESCOs was virtually missing.

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CORE developed a comprehensive strategy with the following key components:

Policy Intervention at the National Level: The energy sector in Brazil , for several decades, operated in a monopolistic fashion with both ownership and operation of key energy enterprises in the government's hands. With respect to energy efficiency, ANEEL required that utilities invested 1% of their annual revenues in energy efficiency projects (both on the supply-side and at the end-use level). The utilities were required to submit their plans for the 1% fund and ANEEL had the authority for approving these plans. The CORE team that there was considerable room for clarifying and improving the project implementation procedures in order to accelerate investments in energy efficiency.

With respect to energy efficiency policy, there was considerable room for appropriate intervention. Some of the key initiatives recommended by CORE included the following:

• Creation of a public/private "National Energy Efficiency and Productivity Improvement Council" or similar organization to develop a national energy efficiency policy, targets, and approaches.
• Technical Assistance to the MME Task Force on Energy Efficiency\
• Policy guidance on enhancing the institutional capacity of energy efficiency NGOs, such as INEE
• Policy guidance to ANEEL to take a more proactive approach to encourage utilities to select private sector EE projects and leverage portions of their 1% funds to generate additional financing for their customers interested in implementing EE projects.

CORE's report also made specific recommendations with respect to the design of fiscal and financial incentives to promote energy efficiency as a viable business. Some of the specific recommendations included the following:

• A reduction in import duties for energy efficient appliances and equipment for a limited period of time for projects with high potential for replication
• Tax write-offs to the consumers for selected EE investments
• Government-sponsored energy audits of industrial and commercial facilities
• Cost-shared demonstration of EE projects with high potential for replicability
• Possible creation of a national energy efficiency fund, similar to Korea and Thailand
• Government-sponsored training to consumers, service providers, equipment suppliers, and ESCOs on different aspects of EE (project development, and equipment marketing

Other recommendations by CORE included the development of performance standards for appliances and equipment in accordance with best industry practices world wide. With respect to the virtual absence of utility sponsored DSM programs, CORE recommended that all utilities be required to institute modern DSM programs throughout their systems.

In the area of public education and outreach, the CORE team developed a detailed public outreach and information program for installation within the Ministry of Mines and Energy. Finally, the report also focused on specific approaches to building the institutional capacity of the private sector, including ESCOs, small and medium size financial institutions, and industry associations.

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Major Accomplishments

This project, conducted over a two-year period, resulted in a number of first time reforms in the Brazilian energy sector. New legislation and policies were developed which mandated both consumers and utilities to implement energy efficiency. Standards were developed for appliances and equipment in order to enhance their performance and energy use indexes. As a result of extensive regulatory reform, both requiring energy efficiency as a major practice, as well as incentivizing energy efficiency investments, the capital markets in the country began to partner with the government in financing energy efficiency schemes. A number of new ESCOs and EPCs germinated throughout the country as energy efficiency investments began to become profitable. In addition, as a result of avoided energy use, there was considerable reduction in environmental pollution and carbon dioxide production. The public information and outreach component of the project created an awareness throughout the vast country resulting in visible signs of energy efficiency in common day to day activities.

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