May 18, 2020
Possible Effects of the Covid-19 Crisis
Summary
TR Soluções estimates that the Covid-19 crisis will impact distribution concessionaires' cash flow by approximately BRL 15 billion. The calculations factored in energy over-contracting, tariff deferral, losses tied to Portion B, and rising payment delinquency. Methodologically, the analysis was based on the crisis's effects that could be felt in 2020 and 2021 tariffs, considering the regulatory procedures and tariff calculations set by ANEEL, and assuming distribution companies would be able to absorb short-term financial costs. These projections indicate that, on average, tariffs would rise 7% this year and fall 1.4% in 2021. Capitalizing distribution companies through a loan so they can meet their short-term obligations tied to the Covid-19 crisis should reduce these tariff variations.
1. Introduction
The crisis caused by the pandemic from the new coronavirus, which the Brazilian market started to feel starting in April 2020, has challenged every sector of the economy to find solutions capable of mitigating the damage.
Social distancing and the suspension of economic activities deemed non-essential resulted in a significant drop in electricity consumption. Combined with the economic crisis, the administrative decision [1] that prevented cutting off electricity supply for three months has contributed to a marked increase in payment delinquency and, consequently, worsening cash-flow difficulties for distribution concessionaires.
Tariff repositioning scheduled to happen in April and May is being deferred until the end of June 2020, which puts pressure on companies' cash, even factoring in temporary compensation measures for distribution companies' partial payment of monthly Energy Development Account (CDE) quotas.
A possible transfer of funds to distribution companies via the CDE has already been approved through Provisional Measure No. 950/2020. The size of that transfer and how the credit operation to enable it will be structured are being worked out by the government.
2. Objective and Methodology
As a way to contribute to the debate, TR Soluções, a technology company specializing in the power sector, carried out a technical study on the crisis's impact on distribution concessionaires. The study was based on the regulatory procedures and tariff calculations set by the National Electric Energy Agency (ANEEL). Assuming distribution companies took on economic-financial imbalances, especially impacting short-term cash flow, TR estimated the 2020 and 2021 tariff scenarios, relying solely on regulation in force.
The possible variations seen in tariffs this year and next can, for the most part, be explained by the knock-on effects of lower consumption and the deferral of April and May 2020 tariff repositioning.
Regardless of how risks are allocated, TR estimates that the crisis's impact on electricity distribution companies' cash flow has the potential to reach BRL 15 billion. This article presents the analyses and the study's main results.
3. Analyses
3.1. Energy Over-Contracting
Even before the new-coronavirus pandemic, there was already an expectation that distribution companies would see, in 2020, contractual surplus levels of about 8% relative to the energy injected into their systems. The pandemic's effects are amplifying these surpluses, which should reach 20% for the year, or 8,109 average MW.
In 2018, the PLD used to settle contractual surpluses on the short-term market was 77% higher than distribution companies' average energy-purchasing mix. This difference between the PLD and the purchasing mix resulted in a positive margin for distribution companies of BRL 5 billion. In 2019, the difference was 5%, representing BRL 400 million.
Table 1 - Estimated Electricity Contracting by Distribution Companies
Source: TR Soluções, based on public ANEEL and CCEE information.
Given the PLD observed through April and the Electric Energy Trading Chamber's (CCEE) May-through-December projections in its May 2020 InfoPLD Presentation, the average annual PLD to be used in settling surpluses on the short-term market should be BRL 107.00/MWh, 48% lower than distribution companies' average energy-purchasing mix (BRL 206.00/MWh).
As a result, over-contracting could represent a BRL 7 billion loss for distribution companies. That figure doesn't factor in scenarios of further contractual reductions distribution companies might carry out through the Surplus Sales Mechanism (MVE) or the Surplus and Deficit Compensation Mechanism (MCSD).
In 2021, if average short-term market prices approach the values seen in 2019, even if the surplus level stays above 18%, results should be favorable for concessionaires, on the order of BRL 400 million.
3.2. Deferral of Tariff Repositioning
Starting in April 2020, although ordinarily carrying out tariff proceedings and approving new repositioning at board meetings, ANEEL suspended applying the new tariffs, keeping the tariffs approved in 2019 in effect through June 30.
ANEEL did, however, recognize distribution companies' right to the full amounts related to not collecting additional tariff revenue during the suspension period. These installments, duly adjusted, will be restored. The difference in revenue between the tariff to be approved and the previous tariff will be adjusted based on the market observed through June 30, 2020, and factored into the subsequent tariff proceeding.
Table 2 - Estimated Deferred Amounts and Effect to Be Felt in 2021
Source: TR Soluções.
Data updated as of: May 25, 2020
TR Soluções simulated the total amounts that would be deferred for the ten distribution companies with tariff events in April and May. Of the ten companies considered, only Cemig hadn't yet had its repositioning approved, but for it too, the tariff suspension through June 30 was assumed.
Suspending the application of new tariffs for the ten distribution companies whose tariff events fall between April and May, through June 30, should result in a cost of more than BRL 500 million. The final impact of this suspension on 2021 tariff events will depend on the volume not collected during the period. TR Soluções estimates it will be, on average, 1 percentage point (pp) in the tariff events of the distribution companies in question.
3.3. Portion A Variations on Portion B
Distribution companies' economic and financial losses tied to reduced energy consumption should represent an impact of BRL 3.1 billion for the year. The calculations factored in that, among the 38 distribution companies (about 98% of the market) tracked by TR and included in this study, half are subject to PRORET (Tariff Regulation Procedure) and the other half to PRORET A.
Distribution companies whose concession contracts were extended under Decree No. 8,461/2015, or that amended their contracts under ANEEL Order No. 2,194/2016, are subject to PRORET A. The remaining distribution companies, whose concession contracts haven't yet been extended or amended, are subject to the previous rules, known simply as PRORET.
When distribution concessions were renewed, in 2015, ANEEL saw it as an opportune moment to improve the contracts, especially regarding economic clauses. Several changes were made to the new contract aiming to shield Portion B and thereby mitigate risks, especially those tied to the effect of Portion A[2] variations on Portion B[3].
Among the changes, two deserve special mention: one that extended neutrality to all Portion A components, and one that changed how Portion B is adjusted, no longer by difference, but by market variation, prices, and the X Factor.
The Federal Court of Accounts (TCU) had already addressed the topic in Rulings No. 2,210/2007 and No. 3,438/2012, having ordered ANEEL to adjust distribution concession contracts in order to mitigate risks tied to market variations.
In Order No. 2,194/2016, ANEEL decided to "approve the draft amendment to the electricity distribution concession contract, optional in nature, for concessionaires whose contracts weren't extended under Law No. 12,783, of 2013." (our emphasis)
PRORET A's Sub-module 4.4A, when addressing the other financial components, explains that "except for sectoral-charge neutrality, neutrality will be calculated only from the last day of the month the concession-contract amendment was signed, per Order No. 2,194/2016, capped at the reference period, that is, the last 12 months."
3.3.1. Impacts of Variations on 2020 Tariff Events
Under current conditions, application tariffs are expected to rise, on average, 7% in 2020. Tariff-event results can basically be explained by variation in energy-purchasing costs, the CDE quota, Fio A[4], and Fio B[5]. Energy purchasing is pressured both by Itaipu energy's dollar-denominated costs and by falling revenue from settling energy surpluses on the short-term market. Additionally, this year's tariff proceedings have been strongly affected by the 24% increase in the 2020 CDE quota (set in December 2019 and unrelated to the pandemic).
Along the same lines, we can explain the expected rise in Basic Grid (Fio A) expenses due to new transmission facilities now included in the Permitted Annual Revenue (RAP) for transmission, and the revocation of an injunction obtained by the trade associations Abrace, Abividro, and Abrafe. In 2017, they secured a court injunction ordering ANEEL to exclude the so-called "remuneration" portion from the calculation, applying only the "update" portion. Unable to apply that decision only to the parties that filed the petition, ANEEL's board decided to extend the injunction's effects to all transmission-system users. The regulator's decision resulted in an annual RAP reduction of about BRL 1 billion, over the eight years of paying the financial portion tied to the Existing Systems Basic Grid (RBSE).
With the trade associations' injunction revoked, ANEEL should apply, starting with the 2020/2021 cycle, the full requirement set out in MME Ordinance No. 120/2016. By TR Soluções' calculations, the total liability disregarded by ANEEL due to the court decision is BRL 9.2 billion, at June 2020 values. TR assumed this liability will be spread across the tariff in an annual series through the end of the RBSE's financial-portion payment, that is, through the 2024/2025 cycle.
Portion B, in turn, can be heavily affected by market variations, imposing annual economic gains or losses if the distribution company is subject to PRORET. Meanwhile, tariffs corresponding to the Fio B component for distribution companies subject to PRORET A aren't affected by market variations in adjustment events.
The same applies to costs related to transport and energy purchasing. Companies subject to PRORET A have guaranteed neutrality, gaining no economic advantage or loss from those cost elements.
Regulation applied to distribution companies under PRORET A reduces the risk of economic and financial losses during periods of reduced consumption. Portion B losses due to reduced consumption in the period between May 2020 and April 2021, for companies under PRORET A, should be BRL 686 million. For the other distribution companies under PRORET, these losses should reach BRL 2.4 billion.
Regarding economic losses related to the transport and energy items making up Portion A, the amounts are less significant. While companies under PRORET A can pass on BRL 53 million in tariffs related to neutrality, companies under PRORET should total losses over the same period, which can't be passed on to tariffs, of BRL 150 million due to these items lacking neutrality.
3.3.2. Impacts on 2021 Tariff Events
Although one might intuitively expect substantial tariff repositioning in 2021, the results obtained under the scenario used are surprising: TR Soluções expects application tariffs to show an average negative repositioning of 1.4% in 2021.
It's important to stress that the repositioning figures indicated for 2020 and 2021 are averages. Each distribution company will see different variations depending on each concession's intrinsic characteristics.
The macroeconomic scenario adopted for 2021 factors in the expectations from the Central Bank's Focus Report of 5/8/2020. For 2020 only, TR adopted the World Bank's GDP projection [6], a 5% drop in Brazilian GDP. As for short-term market prices, we assumed they would approach the values seen in 2019.
Pushing tariffs up are transmission costs for companies with a tariff event scheduled for the first half of the year, energy surpluses, and the deferral of 2020 tariffs noted earlier. Pulling the other way, notably, is the CDE quota.
The expected reduction in the CDE quota is due to Decree No. 9,642/2018, which, starting January 1, 2019, required a reduction, at a rate of 20% per year until reaching zero, in subsidies granted to rural, water/sewage/sanitation, and irrigator consumer units, and small distribution companies. In 2021, the impact from applying this provision alone should reduce CDE expenses by BRL 2.6 billion relative to the 2020 approved budget for the "tariff discounts" expense item.
In a scenario where 2020's economic and sectoral indicators are maintained for 2021, just the projected variations for the Transport, Deferral, and CDE quota cost items would already imply a 1.44 pp reduction in average application tariffs.
The effect of energy surpluses, in turn, can be broken down into two moments: the settlement results in 2020 and in 2021. We assumed that all observed surpluses would be treated by ANEEL, in tariff events, as involuntary surpluses.
As mentioned earlier, contractual surpluses expected for 2020 should reach the 20% mark, in an amount exceeding 8,000 average MW, which could represent a BRL 7 billion loss for distribution companies. Due to tariff-event dates, only BRL 1.5 billion of that total would be factored into 2020 tariff events. The rest, BRL 5.5 billion, would only be factored into 2021 tariff events.
For calendar year 2021, even if the contractual-surplus level stays above 18%, the result from settling these surpluses on the short-term market would be positive and on the order of BRL 400 million. This result assumes average short-term market prices for the year approach those seen in 2019. Again, tariff-event dates will determine when these results are factored into the tariff.
With the rise in distribution companies' average energy-contracting mix in 2020, the difference between tariff coverage and expenses under Quantity-modality Energy Purchase Contracts in the Regulated Environment (CCEAR-Q) and Firm Capacity Quota Contracts (CCGF) grows, generating financial balances to be recognized in 2021 tariffs, in consumers' favor, as detailed in Table 3 below.
Finally, another factor contributing to a negative average tariff variation in 2021 is the reduction, in 2020, in variable costs related to CCEAR-D (Availability). This happens because tariff coverage observes the Green Flag PLD limit, of BRL 150.00/MWh, while the PLD recorded in 2020, in several months, should stay close to the minimum level of BRL 40/MWh.
Table 3 - Expected Energy CVA
Source: TR Soluções.
Unlike the free market, where payment of expenses tied to the Reserve Energy Charge (EER) is concerned, for the regulated market, ANEEL annually projects, in the tariff, economic coverage corresponding to the costs arising from contracting reserve energy, the responsibility of captive consumers. Unused funds generate financial balances in the consumer's favor in the subsequent tariff event. Under a low-PLD scenario, expected fund usage rises.
Distribution tariffs' financial components consist of amounts (BRL) calculated by ANEEL each tariff period, and added to or subtracted from distribution companies' revenue as part of tariff proceedings. Table 3 shows TR Soluções' expectations for the balances of the 38 distribution companies analyzed in the Compensation Account for Variation in "Portion A" Item Values (CVA).
3.4. Payment Delinquency
As part of the proceeding addressing demand billing for Group A consumers during the new-coronavirus pandemic, ANEEL presented, in Technical Note No. 0018/2020-SRD/SGT (NT 18/2020), information on distribution companies' payment delinquency observed in April, comparing it to figures from the same month in 2019. ANEEL notes that the delinquency rate more than tripled, generating a revenue reduction in April of BRL 1.64 billion.
Under a scenario that assumes this additional delinquency level is maintained for three months, the estimate is that the cumulative total for that period will reach nearly BRL 5 billion.
The current regulatory model isn't able to ordinarily recognize, in tariffs, losses caused by significant, cyclical increases in delinquency.
4. Final Considerations
Based on the regulatory procedures and tariff calculations set by ANEEL, and assuming distribution companies were able to absorb short-term financial costs, TR Soluções analyzed and presented the main effects of the Covid-19 crisis that could be felt in 2020 and 2021 tariffs.
Assuming the Brazilian economy contracts 5% in 2020, contractual surpluses resulting from reduced demand at distribution companies, settled at a PLD 48% lower than companies' average energy-purchasing mix, could result in a loss for distribution companies of about BRL 7 billion in 2020. It's important to stress that, although cash flow is initially affected, since these are involuntary surpluses, they would be restored, via tariffs, in the next tariff event.
Factoring in the deferral, through June 30, 2020, of the results of tariff proceedings for companies with tariff events in April and May 2020, we estimate an impact of BRL 500 million, resulting in an effect, in 2021, of 1 pp on the average tariff variation for consumers of the ten distribution companies analyzed.
Despite authorization to transfer, to distribution companies, the reserve fund for future relief of the System Service Charge (ESS), and the alternatives ANEEL is studying and that were presented in Technical Note No. 01/2020-GMSE/ANEEL, the results presented in this study don't factor in any alternative funding source. The scenarios TR used for its 2020 and 2021 tariff projections also don't factor in any external financial contribution, such as what would correspond to the so-called Covid Account.
So, when we factor in a loan to distribution companies so they can meet their short-term obligations, the tariff variations expected for both 2020 and 2021 should be smaller than those presented in this study.
Considering only results arising from energy over-contracting, tariff deferral, Portion B losses, and increased delinquency, TR Soluções estimates an impact on distribution concessionaires' cash flow of an overall amount of approximately BRL 15 billion. It's worth noting that, since Portion B losses and increased delinquency aren't addressed as part of the tariff calculation, only about BRL 8 billion would be recognized in tariffs via ordinary tariff repositioning, as indicated in items 3.3.1 and 3.3.2.
[1] ANEEL Normative Resolution No. 878, of March 24, 2020.
[2] Corresponds to non-manageable costs related to energy purchasing, transmission (Fio A), and sectoral charges. For companies under PRORET A, uncollectible revenue (delinquency) is also part of Portion A.
[3] Corresponds to distribution companies' capital and operating costs, known as manageable costs.
[4] Tariff component corresponding to energy-transmission costs.
[5] Tariff component corresponding to Portion B (the distribution company's capital and operating costs).