The energy market
Electric Energy Sector in Brazil
In the last decade, the private capital participation in the sector has been increasing, in special with the privatizations of the distributors, occurred in the end of the decade of 90. At present, the private sector detains 65% of the distribution, 21% of the generation, and 15% of the national transmission lines.
In the offer side, the great hydraulic power projects have been suffering more and more restrictions in environmental terms, being that most of the hydric resources are already exhausted in places next to the main consumer centers.
In such case, in spite of being a country with a hydric vocation, in 15 years (1990-2005) other energy sources have increased their participation.

PROJEÇÃO DE OFERTA E DEMANDA DE ENERGIA NO BRASIL


Source: ONS / PSR Consultoria

The supply/ demand balance appears quite tight in the short term, up to the year 2011, when from this year on, the addition of new capacity will be necessary (besides the energy already contracted in auctions).
After the privatization of the decade of 90, the energy rationing of 2001, and the natural gas crisis that started in 2004, the Brazilian government published in the period of 2004/2005 a new regulatory mark for the sector.
This new regulation is completely founded in laws, and it was consolidated from the Law 10.848/2004, regularized by the Decree 5.163/2005. The sector model has three main objectives:

- To guarantee the safety of the electric energy supply: The model demands that 100% of the demand for energy in the regulated market is contracted, besides considering a more realistic calculation of the energy ballasts (secured energy or physical guarantee of the enterprises);

- To promote the tariff moderateness, through the energy efficient contraction: The consumers of the regulated market acquire energy of the distributors. The tariff moderateness consists in assuring the energy supply in a reliable, isonomic way and the generation as economical as possible. For that, the regulated market agents will be obliged to buy and sell energy though auctions; and

- To promote the social insertion in the Electric Sector, in particular by the service universalization programs: The Energetic Development Count (CDE in Portuguese), will be used with priority for new consumers access to the system, subsidy for low income consumers, and tariff moderateness in the North, Northeast and Middle-West regions.

To carry out such objectives, the following rules were taken, also predicted in the regulation:

- Creation of two energy contraction environments, the Regulated Contraction Environment (ACR in Portuguese) and the Free Contraction Environment (ACL in Portuguese);

- Modification in the auctions criterion, being that the biggest use for the public asset was replaced by the least tariff criterion;
- The distributors obligatoriness of being 100% with their demand contracted;

- Disverticalization of the sector, in other words, separation of the energy generation, distribution, marketing and transmission activities;

- Elimination of the self dealing, in other words, prohibition of bilateral contractions in the Regulated Contraction Environment (ACR in Portuguese) among connected parts; and
- Creation of new institutional agents, for monitoring and execution of the sector policies.

Balance between Energy Supply and Demand
Historically, the elasticity between the energy demand growth and the (PIB in Portuguese) is superior to 1, in other words, the energy demand grows to taxes superior to the GDP(Gross Domestic Product) or PIB (in Portuguese). This is a common characteristic to developing countries.
According to the PSR Consultancy studies of September 2007, Brazil can face an imbalance between firm energy supply (with ballast) and demand. In the short and middle term, this imbalance may not be mitigated, given the short space of time for the construction of new capacity. However, it is necessary to emphasize that the lack of firm energy does not mean that there will be a rationing, but it indicates that the system is not capable to attend the demand in an eventual period of drought. In other words, the risk of rationing increases. In the long term, it will be necessary to build new capacity to mitigate the imbalance between contracted energy supply and demand, as shown in the chart below:

BALANÇO ENTRE OFERTA DE ENERGIA FIRME E DEMANDA


Source: PSR Consultoria

market agents
The electric energy generation activity has a competitive character, being that all the generation agents can sell energy as much in the ACR (Regulated Contraction Environment), as in the ACL (Free Contraction Environment).

Generation Agents
- Generation Public Service Franchisees: titular agent of the Federal Public Service, delegated by the Conceding Power by means of auction, in the modality of competition, to the legal entity or enterprises partnership for the exploration and public services installment of electric energy, in terms of the Law 8.987/1995.

- Electric Energy Independent Producers (PIE in Portuguese): they are individual agents or joined in partnership that receive concession, permission or authorization of the Conceding Power to produce electric energy being intended for the marketing on their count and risk.

- Self�producers: they are agents with concession, permission or authorization to produce electric energy being intended for their exclusive use, being able to market eventual energy excess, since authorized by the ANEEL.

- Shared self-production: The Law 10.488/2007 allowed that free consumers who have participation in Specific Purpose Society (SPEs in Portuguese) of energy generation projects have the benefits of charges reduction of the sector (CCC, CDE and PROINFA- in Portuguese) like the self-producers, being such benefit limited to the energy parcel being intended for the agent�s own consumption. This eliminated the previous restriction that only allowed the agglutination of self-production interests trough partnership, hypothesis that created difficulties in the financing acquisition for the generation enterprises. The basic concept of Shared Self-Production consists in a simple way, to divide the physical guarantee (marketing limit) of the power station among the project shareholders.

Distribution Agents
The distribution activity is orientated for the net service and the energy sale to the consumers with tariffs and supply conditions controlled by the ANEEL (captive consumers). The Law 10.848/2004 established that the energy acquisition by the distributors for their market supply might be done only trough regulated auctions, in other words, the distributors have compulsory participation in the regulated market, celebrating energy contracts with prices resultant from actions.

Marketing agents

-Importers: agents that detain authorization of the Conceding Power to carry out electric energy import for supply of the national market.

-Exporters: sector agents that detain authorization of the Conceding Power to carry out electric energy export for supply of the nearby countries.

-Traders: agents that buy energy through bilateral contracts celebrated in the free market and can sell energy to the free consumers, in the free market itself, or to the distributors through the auctions in the regulated market.

- Free consumers: they are consumers that, attending to the requisites of the legislation in force, can choose their electric energy suppliers (generators and traders) through free negotiation, as well as the terms of their bilateral energy contracts.

Electric Energy Marketing
The new electric sector model created two environments of energy marketing the ACR and the ACL (in Portuguese).

Regulated Contraction Environment (ACR)
In the ACR, the distribution enterprises buy the energy they expect to trade with their captive consumers, through auctions controlled by the ANEEL and organized by the CCEE. The electric energy purchases are done with the Generators, Traders and importers of electric energy (told together like "Seller Agents").
One of the aspects that differentiate the new institutional model of the previous one is its scheme of contraction for the captive consumers. For to the previous scheme, a distributor might establish bilateral contracts straightly with independent energy generators or producers (PIE in Portuguese). In the new model however, the distributors must contract their energy only through public auctions.
The energy purchase auctions regulated by the distributors are separated in existent energy auctions (that aim for the contracts renovation) and new energy auctions (for contractions of new power stations). The government also has the right of organizing special auctions of renewable energy (biomass, PCH-"Small Hydro Schemes", solar and wind power). These auctions are driven annually by the ANEEL and CCEE.
The energy generated by (i) low generation capacity projects, located near the consumption central offices ("Distributed Generation"); (ii) qualified power stations in the terms of PROINFA, according to the definition below; and (iii) Itaipu, will not be subject to centralized auction processes for the energy supply in the ACR. The electric energy produced by Itaipu is marketed by Eletrobr�s and the volumes that must be bought by each Distributor are compulsorily determined by the ANEEL. The prices by which the energy produced by Itaipu is marketed are denominated in North-American dollars, and established in accordance with a pact signed between Brazil and Paraguay. Consequently, the prices for Itaipu are subject to the variation of the exchange dollar / "real" (The Brazilian currency).
The acquisition by the energy Distributors originating from Distributed Generation processes, wind sources and PCH (small hydro schemes) must observe a competitive process of public call, which guarantees publicity, transparency and access equality.
The contracts are of two sorts (i) Energy Quantity Contracts; and (ii) Energy Availability Contracts.
In terms of an Energy Quantity contract, the Seller Agents pledge themselves to supply a determined quantity of electric energy and assume the risk that the supply can be affected by hydrological conditions and low levels of reservoirs, among other factors that can affect or reduce the electric energy supply, and in case of supply lack they will have to buy the energy in the market to carry out their supply commitments.
Otherwise, in terms of an Energy Availability Contract, the generator unit pledges itself to make available a determined capacity to the ACR. In this case, the income of the Generator is guaranteed and the hydrological risk of such power stations dispatch (payment of variable costs is assumed by the Distributor. Together, these contracts form the CCEAR (in Portuguese)

Free Contraction Environment (ACL in Portuguese)
In the ACL the energy sale is carried out among generation dealerships, independent producers, self-producers, electric energy traders, energy importers and Free Consumers. The ACL also includes bilateral existent contracts among generators and distributors up to its respective expiry, when they will have to be celebrated in terms of the Electric Sector New Model Law rules.

EVOLUÇÃO DO CONSUMO NO ACR E ACL


Source: PSR Consultoria

Energy Auctions
The energy marketing in the regulated market happens through the new energy auctions, existent energy auctions and settlement auctions. The above-mentioned auctions, for the thermo electrical generators, have been carried out for the capacity sale, called "auction for availability", whereas for the hydroelectric generators, they are turned for energy sale, called "auctions for quantity". Since the ONS dispatches the power stations in the SIN in a process of "merit order", the kind of the auctions for thermo electrics is equivalent to a "fuel costs management" by the system. The contraction scheme is multilateral, with generators signing contracts with all the distributors that participated of the auction for service of their captive market. The contracts in the new energy auctions have been of 15 years for thermals and 30 years for hydro electrics. In the auctions of existent energy, the contracts are of 8 years and in the settlement auctions of up to 2 years.
Considering "A" like the year predicted for the beginning of the electric energy supply acquired by the Distributors, basically four types of auctions were established. The new energy auctions are carried out for three (3) and five (5) years ahead of the current year, respectively so-called (A-3) and (A-5). The existent energy auctions are carried out annually for delivery from the next year (A-1). Now, the settlement auctions are carried out every four months, with delivery terms of up two years, depending on the necessities of the distributors.

ENERGY AUCTIONS


Source: ANEEL, elaborated by the Company

The regulated auctions implementation began in 2004, when the first existent energy auction was carried out. From that time on, several other existent energy and new energy auctions were carried out, involving a total energy volume of more than average 29 GW (firm energy, not capacity peak).

Auctions Summary

Auction	Date	Description	MWm
1st-existent energy special auction	dec/04	Contracts of 8 years with delivery beginning in 2005,2006 and 2007	17.008
2nd-existent energy special auction	apr/05	Contracts of 8 years with delivery beginning in 2008 and 2009	1.325
3rd- and 4th -existent energy special auctions	oct/05	Contracts of 3 years with delivery beginning in 2006 and contracts of 8 years with delivery beginning in 2009.	1.268
5th- existent energy auction	dec/06	Contracts of 8 years with delivery in 2007	204
1st - new energy auction (A-3. "A-4" e A-5)	dec/05	Contracts with delivery beginning in 2008, 2009 and 2010 (15 years for thermos and 30 years for hydro electrics)	3.284
2nd- new energy auction (A-3)	jun/06	Contracts with delivery beginning in 2009 (15 years for thermos and 30 years for hydro electrics)	1.682
3rd- new energy auction (A-3)	oct/09	Contracts with delivery beginning in 2011 (15 years for thermos and 30 years for hydro electrics)	1.104
1st- alternative sources energy auction	jun/07	Contracts with delivery beginning in 2010	186
4th- new energy auction (A-3)	jul/07	Contracts with delivery beginning in 2010 (15 years for thermos).	1.304
5th- new energy auction (A-3)	oct/07	Contracts with delivery beginning in 2010 (15 years for thermos).	2.312
Total of sold energy			29.677

MONTANTES DE ENERGIA CONTRATADOS NOS LEILÕES


Source: CCEE

It is noticed that the new energy auctions turned in bigger prices than those of existent energy, reflecting thus in the more correct form, the marginal price of the system expansion Additionally, in function of the imbalance perspective between firm energy supply and demand, a new energy prices elevation is observed.

PREÇOS MÉDIOS CONTRATADOS NOS LEILÕES


Source: CCE

"Spot" price formation
The energy marketing in the SIN is not carried out like in an energy stock market, with prices and quantities freely negotiated.
Instead of that, the marketing in the short term is done in a regime called "tight pool", where the "spot" prices are defined by the CCEE, from data supplied by the ONS and with basis on the computational tools of optimization used in power-stations operation programming. This involves the centralized calculation of the opportunity costs associated to the water stored in the reservoirs. The hydroelectric generators cannot do offers of prices for their energy to compose the dispatch, in other words, the hydroelectric stations production capacity is "offered" with basis in calculated opportunity costs of centralized form. The thermoelectric generators do not offer prices either, declaring only variable operation costs, which need to be technically justified for the ANEEL.
The "tight pool" use is justified by the little thermo electrical presence in the interconnected Brazilian systems and by the complex hydraulic bonds among different hydroelectric stations. Additionally, the presence of multiple owners of different hydroelectric stations in the same waterfall creates the necessity of coordination in the hydroelectric dispatch.
The competition in the generation and in the marketing happens in the search for bilateral contracts of energy purchase and sell, as much in the regulated market as in the free market, which are the natural "hedge" for the variation in the energy "spot" price, and for lack of physical ballast.

The Brazilian Electric Sector Model
Authorizations
Enterprises or partnerships that want to act in thermal marketing or generation in Brazil must ask for permission or authorization to MME or ANEEL, according to the case. The enterprise, to ask for authorization, needs to do a preliminary technical- economical study and present it to ANEEL.

Concessions
The enterprises or partnerships that want to build and/or operate installations for hydroelectric generation with power above 30 MW, transmission or distribution of energy in Brazil must participate of auction processes.

Applicable penalties to the Electric Sector Agents
According to the CCEAR, in the contracts for availability, the seller agents will be responsible for the payment to the buyer agent, in case of physical guarantee (ballast) lack.

The ANEEL regulations predict the application of sanctions and penalties to the electric sector agents and classify the penalties with basis in the nature and relevance of the violation (including warnings, fines, temporary suspension of the right of participating in auction processes for new concessions, licenses or authorization and caducity).

Main Regulatory Entities

Ministry of Mines and Energy � MME
The MME is the main regulating organ of the Federal Government energetic sector, acting as Conceding Power in the name of the Federal Government, and taking as main attribution the establishment of the sector policies, rules and regulation. Subsequently to the approval of the Electric Sector New Model Law, the Federal Government, acting mainly by means of the MME, assumed certain attributions previously of the ANEEL responsibility, including the rules elaboration that govern the concessions granting and the expedition of norms that govern the auction process for public utilities concessions and electric energy installations.

Electric Energy National Agency � ANEEL (in Portuguese)
The electric Brazilian sector is regulated by ANEEL, federal autonomous autarchy. After the promulgation of the Electric Sector New Model Law, the main ANEEL responsibilities started being (i) to regulate and to supervise the electric sector according to the policies determined by the MME; and (ii) to respond to matters delegated to it by the Federal Government and by the MME. The current ANEEL responsibilities include, among others, (i) concessions inspection for electric energy marketing, generation, transmission and distribution activities, including electric energy tariffs approval; (ii) promulgation of regulations for the electric sector; (iii) implementation and regulation of the energy sources exploration, including the use of hydroelectric energy; (iv) promotion of the auction process for new concessions; (v) administrative lawsuits solution among the electric sector agents; and (vi) definition of the criterions and methodology for transmission tariffs determination.

Energy Policy National Council-CNPE (in Portuguese)
In August of 1997, the CNPE was created for the development and creation of the energy national policy. It is directed by the MME, being that most of its members are ministers of the Federal Government. Its finality consists in optimizing the resources use to guarantee the energy supply in the Brazilian territory.

Electric System National Operator-ONS (in Portuguese)
The ONS was created in 1998 and is characterized like a private right entity without profitable aims formed by generators, transmitters, distributors and free consumers. The Electric Sector New Model Law granted to the Federal Government power to indicate three directors for the Executive Directorship of the ONS. The basic ONS role is to coordinate and control the generation and transmission operations of the Interconnected System, subjected to the ANEEL regulations and supervision.

Electric Energy Marketing Chamber-CCEE (in Portuguese)
One of the main roles of the CCEE is to make viable the electric energy marketing in the SIN, conducting the electric energy public auctions in the Regulated Environment. Besides, the CCEE is responsible, among other things, for (i) to register all the energy marketing contracts in the ACR, the contracts resultant of contraction adjustments and the contracts celebrated in the ACL; and (ii) to account and liquidate the short term transactions.
According to the Electric Sector New Model Law, the calculation of the electric energy price bought or sold in the "spot" market (Liquidation of Differences Price-PLD) is of the CCEE responsibility that takes into account, among other factors, (i) the optimization of the use of the electro- energetic resources for the system loads supply; (ii) the electric energy necessities of the agents; and (iii) the cost of the electric energy deficit.

Energetic Research Enterprise-EPE (in Portuguese)
Created on August 16, 2004, through the Decree number 5.184, the Energetic Research Enterprise, or EPE (in Portuguese), is a federal public enterprises linked to the MEE, whose authorization for creation was granted by the Law number 10.847, of March 15, 2004, being in charge of conducting strategic researches in the electric sector, inclusive with regard to electric energy, oil, gas, coal and renewable energetic sources. The researches carried out by the EPE will be used to subside the formulation, the planning and the implementation of the MME actions in the energetic national policies context.

Energy Sector Monitoring Committee-CMSE (in Portuguese)
The Electric Sector New Model Law authorized the creation of the Monitoring Committee of the Electric Sector ("CMSE" in Portuguese), which acts under the direction of the MME. The CMSE is responsible for the monitoring of the system supply conditions, including actions in the demand side, of the contraction of a reserve on the offer side and others according to the conjunctures.

Government limitations of the Agents Participation in the Market
In 2000, the ANEEL established new limits to the concentration of determined services and activities in the electric sector. In accordance with such limits, with the exception of the participant enterprises of the "Programa Nacional de Desestatiza��o", in other words, the "Privatization of the State Monopoly", (that must only observe such limits since the final restructuring of their partnership is concluded), no company of the electric sector can (i) detain more than 20,0% of the distribution Brazilian market, 25,0% of the distribution market of the South/ Southeast/ Middle West regions, or 35,0% of the distribution market of the Northern/ Northeast regions, except in the event of an increase in the energy distribution superior to the national or regional growth rates; or (ii) detain more than 20,0% of the trading Brazilian market for final users, 20% of the trading Brazilian market for non-final users or 25,0% of the sum of the percentages above.

Incentives to Alternative Energy Sources
Since the promulgation of the Law number 10.438, of April 26, 2002, programs of incentive to the alternative sources of electric energy generation have been created, such as: (i) PROINFA, administrated by the MME, which guarantees to the enabled undertakings the purchase, by Eletrobr�s, of the electric energy produced for the term of 20 years and financial support of the BNDES (National Bank of Development); (ii) reduction in the use tariffs of the electric energy distribution and/or transmission systems (in the production and in the consumption), with a discount not less than 50,0%; and (iii) special condition for migration to the free market of consumers with load between 500KV and 3MW (Special Consumers), since such consumers acquire electric energy of generators from electric energy alternative sources, increasing thus the consumer market of these producers.