Fitch: New initiatives lower Brazilian power distributors' risk

The liquidity risk for power distribution companies in Brazil declined in 2015 due to the government's recent implementations of the tariff flag and the extraordinary tariff review (RTE) for end consumers, according to Fitch Ratings. We believe the measures also have the potential to lower volatility in terms of operational cash flow generation for distributors. Fitch considers both important and positive initiatives for the sector as they transfer to consumers more realistic energy and sectorial costs and tend to eliminate the dependence on resources from the National Treasury or from banks to offset liquidity issues.

The tariff flag eliminates distributors' risks associated with high energy costs due to the massive thermal plants dispatch in the past couple of years. It also addresses the cost related to the involuntary exposure that distribution companies are presenting since the beginning of 2013 due to an amount of energy contracted below the effective consumption demand. Until the end of 2014, distributors had to fulfill this gap acquiring energy at the spot market paying extremely high prices due to low hydrology conditions in Brazil. The average spot price dramatically increased from /MWh in 2012 to /MWh in 2013 and /MWh in 2014 at the Southeast/Midwestern Subsystem, the most representative in Brazil. Starting in 2015, the federal government reduced the cap for the energy spot price to /MWh from /MWh, which was also positive for distributors as generators with uncontracted energy become more stimulated to sign long-term power purchase agreements to distribution companies than to sell at the spot market.

Fitch expects that the amount collected through the tariff flag mechanism incorporated at the end consumers' monthly bill in 2015 will be enough to cover distributors' higher cost due to continuing intensive thermal plants dispatch and the low to moderate 2.36% overall involuntary exposure of distributors for the year, considering that the spot price should be at the cap during 2015. Agencia Nacional the Energia Eletrica (Aneel), the Brazilian power regulatory agency, defined three different color options for the tariff flag (green, yellow, and red) to be applied on a monthly basis, depending on hydrology conditions. The green flag means normal conditions and no extra cost for consumers, while the yellow and the red ones mean and per each KWh of consumption, respectively. Positively, the entire revenue coming from the tariff flag will be centralized as a pool and transferred to distributors in accordance with each particular need to cover the deficit.

The RTE implementation on March 1, 2015, which averaged 23.4% among 58 distribution companies, is a key measure for distributors rebalance their operational cash flow generations. The purpose of RTE was to cover the distributors' higher costs with the Conta de Desenvolvimento Energetico, which is a sector fund that incorporates several sectorial cash needs. In addition, RTE was implemented to support the higher energy cost that several distributors are incurring with energy purchased from Itaipu, a bi-national hydroelectric power plant jointly controlled by the governments of Brazil and Paraguay. Itaipu's dollar-denominated tariff increased 46% in USD since the beginning of 2015. The RTE will also support the energy acquired by distributors in the auction promoted by Aneel on January 2015, its price of /MWh was not fully reflected on tariff to end users.

Fitch considers that potential risks related with the tariff flag and the RTE still need to be monitored, even with their positive effects. In the case of Itaipu, the FX rate in the date of the RTE announcement was equivalent to , compared to in March 24, 2015, which means that the companies should continue to carry some temporary currency risk. Fitch sees the potential increase of delinquency and losses, as well as consumption reduction as other risks for distributors, as power tariffs became more expensive for consumers after the RTE and the tariff flag implementations. The potential impact of the weak economic environment for Brazil in 2015 should also be monitored. Fitch forecasts a negative GDP of 0.4% for Brazil in 2015.