In the End, Who Will Pay the Price?

But what can be said about the possible economic losses expected for 2016 that are outside distribution companies' control, yet tied to Portion B^[1]? What might be the tariff impacts resulting from an extraordinary tariff review focused on manageable costs?

Distribution companies have faced several challenges in recent months, some caused by rising energy-purchasing costs, some by a systematic shrinking of their market. Rising energy-purchasing costs strongly affected tariffs in 2015 and, combined with tariff-flag application, drove up Brazilians' electricity bills by about 48%. This contributed to an average 14% increase in electricity-bill payment delinquency ( Source: O Estado de São Paulo).

Higher tariffs, combined with the economic crisis, directly affected Brazil's electricity consumption, which fell in 2015 compared to 2014 ( Source Folha de São Paulo ).

Lower consumption led to energy over-contracting by distribution companies. Since these surpluses will be settled at the short-term market price, and the expectation for 2016 is that it will stay near its lower bound, there's concern these settlements could generate billions in losses for distribution companies ( Source: EXAME).

Regarding energy surpluses due to market shrinkage, ANEEL is trying to ease the problem by proposing regulatory and commercial improvements, as presented in Public Hearings 004 and 012, both from 2016. However, market shrinkage also brings negative effects for quantifying distribution companies' annual Portion B revenue figures.

At the time of a tariff review, the rules for applying the X Factor in tariff adjustments are set. The X Factor's purpose is to pass on to consumers the productivity gains the concessionaire achieved (the X Factor's Pd Component) and the results of applying the incentive mechanisms ANEEL set in tariff proceedings. The X Factor is used in calculating annual adjustment tariffs, when Portion B's value is adjusted by the IGP-M minus the X Factor.

The approach ANEEL adopts to calculate the X Factor at the periodic tariff review seeks to define it based on potential productivity gains, consistent with market growth, the number of consumer units, and service quality, while also promoting a transition toward efficient operating costs. The Pd component is set at the time of the tariff review and is used in subsequent adjustments, until the next tariff review, when it will be recalculated.

It's important to stress that, for most of the distribution companies going through adjustment in 2016, one of the parameters that fed into the Pd component, calculated at the time of the reviews, used the average annual market variation of Brazilian distribution companies, over the 2005-to-2012 period, at 4.65% p.a. ( Source ANEEL ).

Contrary to this historical market-growth trend, a variation of -1.80% was observed between 2014 and 2015.

Of the 38^[2] distribution companies TR Soluções tracks, 20 should together see, in 2016, a Portion B decrease of BRL 1.06 billion compared to 2015 figures, and, in some more extreme cases, these reductions could represent up to 10% of expected Portion B revenue.

On top of these losses due to market shrinkage, applying the Pd component in these 20^[3] distribution companies' tariff adjustments will mean sharing with consumer units about BRL 230 million in regulatory productivity gains for the distribution activity that, in reality, won't actually happen.

Combining these two expected reductions, Portion B's value losses in 2016 should total about BRL 1.30 billion. That amount represents, in 2016, on average, 6.3% of expected Portion B revenue for these 20 electricity distribution companies. Regardless of what market growth looks like in the coming years, the Portion B value reductions expected for 2016 won't be recovered.

Given ANEEL's argument that the regulatory model already provides mechanisms to compensate for possible Portion A variations, the outcome of distribution companies' requests for the regulator to carry out an extraordinary tariff review (RTE) could have been different had they been analyzed from Portion B's perspective.

In a hypothetical extraordinary review that assessed the 2016 economic-financial imbalance from Portion B's perspective, TR Soluções estimates there would be an average increase of 2.5 percentage points relative to what's expected for each tariff-adjustment proceeding.

Regardless of whether an extraordinary review addressing the Portion B reduction happens or not, TR Soluções' assessment is that, in 2016, both consumers and distribution companies will have to "pay the price." Consumers, because their tariffs recognize surpluses exceeding 105% of required energy, for reasons outside their control over electricity contracting management; and distribution companies, because they have to bear the risk of a market downturn at a time when short-term prices are low.

^[1] Also known as "manageable costs," Portion B is basically made up of operating and capital costs. Operating costs are those needed for the company to provide the energy-distribution service, including people-management costs, physical-infrastructure operation and maintenance, plus material costs. Capital costs remunerate investment in and depreciation of distribution assets.

^[2] The 38 distribution companies TR Soluções tracks represent 95% of the Brazilian market.

^[3] These 20 distribution companies alone represent 54% of the National Interconnected System - SIN.