September 14, 2021

With Tariffs Climbing, Who Will Migrate to the Free Energy Market?

Paulo Steele*

Summary

Who are the main candidates for migrating to the free energy market, and where are they located? They're certainly companies similar to those that recently migrated to this contracting environment, located in regions where electricity tariffs are highest. Based on these assumptions, this study presents a methodology to identify these consumers. The goal is to help the free market's continued expansion, in a context of rising energy costs and growing competition in the segment.

1. Introduction

The pursuit of lower electricity-consumption expenses has driven companies to migrate to the Free Contracting Environment (ACL). In just over three years, the number of new ACL connections grew 150%, concentrated mainly in the South and Southeast regions.

Figure 1 - Evolution of ACL Connections (Loads) and Geographic Location

In times of water crisis and high inflation, tariff escalation shows no signs of slowing and should keep driving this process. At the same time, growing competition among traders makes it increasingly important to identify who and where the consumers with migration potential are, among those who haven't yet made the switch.

Figure 2 - Tariff Escalation: Tariffs More Than Doubled in Nine Years

In the second half of 2021, the Executive Branch announced emergency measures aimed at easing the impact of the current water crisis on the tariff repositioning expected for 2022:

• creation of the "water-scarcity tariff flag," in effect through April 30, 2022, a 49.6% increase relative to the current red flag level 2 (the flag's associated value rose from BRL 9.49 to BRL 14.20 per 100 kWh);
• transfer of additional revenue to the Energy Development Account (CDE) from Eletrobras (Article 3 of MME Resolution 15, of 2021), reducing the portion of the charge borne by captive consumers.

Additionally, there are the effects of lower average generation costs from plants under the Incentive Program for Alternative Sources of Electric Energy (Proinfa) (Article 23 of Law 14,182, of 2021); the reduction in the Itaipu debt portion starting in 2022 (only for quota-holding companies); and the expectation that the reversal of tax credits will be maintained — or even grow.

Table 1 - Measures to Ease the Repositioning Expected for 2022

Of all the revenue sources listed in Table 1 with a positive impact on tariff moderation, the only uncertainty lies in the expected volume of tax credits. Through August 2021, about BRL 7 billion in tax credits had already been reversed in consumers' favor. The expectation is that another BRL 1 billion, related to distribution companies that hadn't yet gone through tariff repositioning, will be added to that amount still in 2021. Assuming all distribution companies reverse tax credits in 2022, we can expect that, in an optimistic scenario, the volume of funds will reach BRL 11.6 billion.

Given that amount and the other factors presented above, next year's expected average repositioning could be 2% for all consumers.

Table 2 - Repositioning Expected for 2022

Either way, over a 10-year accumulation, this scenario points to an average tariff increase of at least 110%. So, even with recent efforts to keep adjustments relatively low, arguments favoring migration to the ACL remain ever-present. This article presents criteria for identifying these potentially free consumers, and points to the main categories of consumers expected to take part in the next waves of migration.

2. Advantages of the ACL

Information from the Brazilian Association of Energy Traders (Abraceel) shows that, beyond energy-price reductions on the order of 20%, migrating consumers seek the predictability of contracts, which usually last up to five years. Another advantage is that, in the ACL, there are no tariff flags, which becomes quite relevant given the water-scarcity flag.

Either way, it's worth noting that not all costs covered with tariff-flag funds are avoided by migrating, such as, for example, the System Service Charge for Energy Security. By no longer paying tariff flags, the free consumer avoids costs tied to hydrological risk associated with Quantity-modality Electricity Trading Contracts, whose risk was renegotiated in 2015, Itaipu, and Firm Capacity Quota Contracts (CCGF), plus expenses related to Availability-modality contracts (CCEAR-D).

To give an idea, in the public consultations ANEEL held in 2021 to set tariff-flag surcharges, the regulator quantified that, depending on the flag color, the hydrological-risk value can range between BRL 25 and BRL 76/MWh, and the CCEAR-D value between BRL 43 and BRL 54/MWh.

3. Market Conditions

Reduced eligibility requirements for companies to become free consumers are opening the door for more and more medium-voltage captive loads to migrate. Today, becoming a free consumer requires at least 1,500 kW of contracted demand, dropping to 1,000 kW starting January 1, 2022, and 500 kW starting January 1, 2023.

Additionally, the free-market access thresholds are expected to gradually decline in the coming years, and, according to a study by Abraceel¹, it's possible for the entire market to open up by 2027.

4. The Profile of Those Who Migrated in Recent Years

Migration to the free energy market has been dominated by companies that can act as special consumers. These are companies with contracted energy demand equal to or greater than 500 kW, able to purchase "incentivized" energy. Additionally, through actual or legal joint ownership, several consumer units under the same CNPJ (corporate taxpayer ID) can combine their demands to reach the minimum required to become eligible for migration. Incentivized-source energy comes from renewable-source ventures (solar, wind, small hydroelectric plants, biomass, or qualified cogeneration) that inject power equal to or below 50 MW into the grid.

Given the regulatory provisions governing ACL migration eligibility criteria, free consumer units show consumption and demand characteristics quite different from those seen in special consumer units.

Currently, special consumers represent more than 20,000 loads in the ACL, against just over 3,000 in the free-consumer category. Average capacity per connection, on the other hand, is inversely proportional to the number of loads, averaging 522 kW for special consumers and 8.9 MW for free consumers, as shown in Table 3.

Table 3 - Characterization of Connections (Loads) in the ACL

5. The Profile of Companies That Haven't Yet Migrated

This study assumes new free consumers will have a profile similar to today's special consumers. These companies can be identified within the ACR by characterizing business activities based on Federal Revenue Service data, which organizes the country's economic activities into five layers with different levels of detail:

• 21 Sections;
• 86 Divisions;
• 282 Groups;
• 670 Classes; and
• 1,349 CNAE codes.

Analyzing the data at the first level of this organization (Sections) shows that, although the Motor Vehicle and Motorcycle Sales and Repair activity has the highest number of connections (7,980), the Manufacturing Industry activity (6,454 connections) accounts for most of the energy consumption observed in the ACL among all sections of that classification, as shown in the charts in Figure 3.

The large number of companies classified as Manufacturing Industry acting as special consumers can be a good indicator of ACR activities more likely to migrate. Building on this, it's possible to drill down through the Federal Revenue Service's data layers in search of more detail on companies with these characteristics. At the end of this analysis, the CNAE code for Animal Feed Manufacturing would be identified as the most numerous in the ACL within the Manufacturing Industry Section.

Figure 3 - Who Today's Special Consumers Are

Still within Manufacturing Industry specifically, the analysis could focus not on quantity, but on finding the ACL CNAE code with the highest energy demand. In this case, drilling down through the Federal Revenue Service's layers, the CNAE code found is Manufacturing of Allopathic Medicines for Human Use.

Additionally, by comparing CCEE-provided ACL data with Federal Revenue Service information on similar companies that haven't yet migrated to the free market, it's possible to identify ACR companies more likely to migrate, since they share economic characteristics similar to the most representative ones in the layer analyzed.

Figure 4 - Highest Energy Demand, Special Type, Manufacturing Industry

There are currently about 190,000 consumer units connected at high and medium voltage as captive consumers. Lacking technical registration data for these consumer units, TR Soluções, building on the strategy above and drawing on the lookalike concept, identified, within the Federal Revenue Service's CNPJ database, groups of companies that may have economic characteristics making them eligible for the ACL.

6. Most Likely Location of Companies Interested in Migrating

Tariff values and energy prices negotiated in the free market are effectively the triggers for the migration process.

Data presented in ANEEL Technical Note No. 17/2021–SRM indicate that distribution companies with a captive market below 500 GWh/year, such as CERBRANORTE, CEJAMA, and COORSEL, have achieved significant reductions in electricity-purchasing spending relative to historically observed values, on the order of up to 56%. While these companies see average energy prices around BRL 180.00/MWh, other concessionaires have been seeing figures around BRL 280.00/MWh.

Tariffs charged by electricity permission holders are, in most cases, more competitive than those charged by concessionaires. For this reason, TR Soluções' analysis didn't consider as potentially eligible for ACL migration (that is, they were excluded from the Federal Revenue Service's CNPJ database) companies located in municipalities served, in whole or in more than 5% of existing consumer units, by permission holders.

Finally, our analyses indicate that, of the more than 20 million active CNPJs in the country, about 50,000 belong to consumer units potentially eligible for ACL migration, whether through joint ownership or not.

Figure 5 - Location of Potentially Eligible Connections in the ACR

This universe of potentially eligible companies was defined considering, among other criteria, only five types of legal structure (out of 88 available), and is limited, based on assessing how representative electricity cost is within production or service costs, to 149 CNAE codes, out of the 689 economic activities that have already migrated to the ACL, within the Federal Revenue Service's universe of 1,349 different CNAE types.

So, although there are still potentially eligible ACL consumers in nearly every part of the country, the selection criteria TR Soluções adopted in this study show that the largest concentration is still located in the South and Southeast regions.

Obviously, traders seek to maximize their margins when selecting potential clients. So, identifying eligible consumers in concessions with a higher break-even is always more advantageous.

Figure 6 - Break-Even Ranking (in BRL/MWh)

Figure 6 shows the break-even ranking based on tariffs expected for 2021, at A4, under the Blue tariff modality, without wire discounts obtained by special consumers or taxes. Under these conditions, disregarding tariff-flag surcharges, the gap between the highest and lowest break-even value can reach 140%. However, depending on how the consumer unit uses electricity (load modulation), the tariff modality, or wire discounts, the break-even can exceed BRL 560.00/MWh.

But if the tariff-flag surcharge is also factored into the break-even calculation, depending on the flag, the break-even value's² increase can exceed 120%.

7. Possible Strategies for Identifying Eligible Consumers

Beyond the approaches adopted in this study, strategies for finding consumer units eligible to migrate to the ACL vary widely, and can include: identifying companies whose activities are energy-intensive, or whose competitors have mostly already migrated to the ACL; seeking companies whose activities are growing even amid the challenging economic backdrop of the Covid-19 pandemic; or companies that are part of groups, such that they reach, through joint ownership, the minimum demand required to become eligible for migration.

The fact is that the landscape described in this article is dynamic. Changes can happen due to sharp migration to the ACL — which could turn today's supporting loads into new leading players — or even due to economic dynamics, which drive the creation and growth of new businesses or the closure of countless companies in a short span of time.

* Paulo Steele is managing partner at TR Soluções, a technology company specializing in electricity tariffs.

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¹ https://abraceel.com.br/wp-content/uploads/post/2021/08/Contribuic%CC%A7a%CC%83o-Abraceel_TS-10-Aneel-_-Abertura-de-Mercado.pdf

² The break-even indicates the maximum value a captive consumer could pay for energy while still keeping their total monthly input spending unchanged — that is, the spending tied to both transport costs and energy purchasing.