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INFOPETRO

Bulletin
Analysis of the Brazilian Oil and Gas Industry
September 2003 Year 4 n.9
Energy Economics Group Institute of Economics UFRJ
www.ie.ufrj.br/infopetro

INTRODUCTION

The Editorial this month focuses on Brazils energy agenda, arguing that the biggest challenge
facing policymakers today is to make national energy policy compatible with the policies currently
guiding the different sectors of the energy industry
In the first article, Edmar de Almeida and Leandro Arajo analyze the results of Leasing Round
Five, held in August by Brazils National Petroleum
Agency (ANP). The authors estimate the impacts
of this latest round on exploratory activity in the
country.

Next, Helder Queiroz and Vanessa Geminiano


discuss the evolution of oil consumption in China,
emphasizing the impact of Chinese demand on
world oil price fluctuations.
In the Essay of the Month, Professor Ronaldo
Bicalho examines the reforms in Brazils electric
power industry. Bicalho discusses the industrys
complexity and attempts to clarify the debate concerning the alternatives that exist for implementing
reform.

The opinions expressed in this newsletter reflect solely the


views of the individual authors and do not represent the
position of the institutions involved in this project.

STAFF
Editor-in-Chief:
Edmar Luiz F. de Almeida
Editorial Board
Edmar Luiz F. de Almeida
Carmen Alveal
Helder Queiroz Pinto Jr.
Ronaldo Bicalho
Editors
Mariana Iootty
Nicholas Trebat
Akio Nakamura
Contact
Tel: (21) 3873-5270
Fax: (21) 2541-8148

e-mail: infopetro@ie.ufrj.br

THIS ISSUE
Editorial...........................................................................................................2
Petroleum
Leasing Round Five: Performance and Impacts ..........................................3
The Evolution of Oil Consumption in China
and its Impact on the International Market ................................................6
Essay of the Month
Competition in the Electric Power Market:
A Complex Institutional Construction........................................................8
News Briefs ..................................................................................................13
Statistical Annex ........................................................................................15
Support
ONIP / FINEP / FNDCT / CTPETRO

Editorial
For an Integrated Energy Policy
industry-wide standpoint. Policy alternatives,
therefore, need to be considered and negotiated
within a much broader context.

Guided by the belief that national energy policy


cannot simply be a collection of various sectorial
policies, the debate concerning Brazils power industry forces us to consider a comprehensive
energy policy for the country.

In terms of thermal generation, an activity that


links the electricity sector to other industries, we
must consider a structural fact of unquestionable
importance: the generous supply of oil, gas, water
and renewable energy resources in Brazil. We
must also take into account that Brazil is the largest regional market for electricity, gas and fuel
liquids.

The role of thermal power generation in this


new model is a clear example of a decision that
goes beyond the frontiers of the power sector,
having an impact on the natural gas market in
Brazil as well as on the issue of regional integration (both economic and political). The expansion
of the gas market in Brazil depends on two factors: the role of natural gas in the new model for
the power industry and the investments of gas distribution companies. As for the first factor, this
decision will be made within the power industry itself, with the natural gas sector having little say
over the use of the fuel in generating electricity.

It is reasonable to believe that, with such resources and potential, it is possible to find an
economic-institutional solution that combines resources and available capacity to generate
synergies and sustainable gains through time.
In deciding upon a policy for the power industry, it is very easy to become entangled in minor,
short-term details that do not concern the industry
as a whole. Observing, reflecting upon and negotiating energy policy is by definition a lengthy
process requiring deep analysis of data and structural factors (both the favorable and unfavorable
ones). Nonetheless, by enduring this process it
will be possible to identify which possibilities are
economically viable. And in Brazil the range of
possibilities are wider than most think.

Simply put, allowing the power industry to


make a decision that will have a profound impact
on other energy sectors, such as the natural gas
industry, is narrow-minded. Furthermore, it gives
continuity to a tradition that, if fragile under the old
standards of organizing the energy industry, is totally inadequate today after the restructuring of the
energy industries in Brazil.
Though economic agents (power companies,
policymakers, etc.) in the power industry may
know the optimal policy orientation from a sectorial point of view, their actions could result in suboptimal policies, and even liquid losses, from an

Infopetro Bulletin

Editorial Board

August 2003

PETROLEUM
Market

Leasing Round Five: Performance and Impacts


Edmar de Almeida
Leandro dos Reis Araujo
On August 19 and 20, the National Petroleum
Agency (ANP) held its fifth leasing round of oil and
gas blocks in Brazil. Round Five was accompanied with great interest on the part of agents
concerned with the changes made in the leasing
rules (see Infopetro, May 2003). Given these
changes, a major question concerns the performance of Round Five relative to the previous
rounds.

ning of August the company was forced to give


back its blue blocks, acquired in Round Zero. In
four of the blocks it acquired, Petrobras joined
forces with the company Partex, who will be the
operator of the four leases. Other companies participating in Round Five were: Newfield (two
blocks), Maersk (two blocks) and the Brazilian
companies Auriznia Empreendimentos (six
blocks) and Sinergy Group (5 blocks). Among
these, Auriznia is worthy of special mention, paying approximately R$2 million for block POT-T401. This represents the greatest price differential
between the floor price set by the ANP and the
signing bonus of the winning bid. The only two
blocks in which no companies expressed interest
were SES-AR2, located in shallow water in the
state of Esprito Santo, and SC-AP1, located in
deep water in the Campos basin.

Before coming to any conclusions, it is worth


emphasizing that it is the very introduction of
these changes that makes it difficult to compare
Round Five to the previous rounds. The most crucial modifications were made to block size and to
the relative importance given to the signing bonus,
the exploratory work program and the local content requirement.
Only six firms registered to make bids in
Round Five, much fewer than the roughly 20 that
signed up for each of the previous four rounds. 44
companies positioned themselves in Brazil during
the first four rounds, the majority of which are
awaiting results from current exploration before
making decisions about future investments. Another factor limiting participation was the taking of
office of a new political party (the Workers PartyPT). This spread tension among the players concerning possible changes in the industry`s fiscal
and regulatory framework. Thus, the dominant attitude among investors is one of caution. Finally,
add to this the ANP`s decision to target smaller,
independent companies in Round Five.

Graph 1 below illustrates the size of the areas


leased in each of the five leasing rounds as well
as the value of the signing bonuses. Note that
these two variables have steadily decreased, especially the signing bonus.
Regarding area size, the downward trend
represents a natural cooling down of investments
in the Brazilian upstream, following a surge of interest on the part of major players after the
liberalization of the oil and gas sector. As for the
sharp decrease in the value of the signing bonuses in Round Five, this is a result of the
reduced importance of this variable in the ANP`s
leasing criteria. In previous rounds, the signing
bonus accounted for 85% of the agency`s lease
decision (concerning who wins the right to a given
block). In Round Five, this percentage fell to 30%.
The revenues from signing bonuses in this latest
round reached R$29 million, three times less than
the amount collected in Round Four (R$92 million).

Given the context described above, the results


from Round Five were surprisingly positive. The
ANP leased 107 blocks, for a total of 23,296 km.
This is practically the same total area as was
leased in Round Four (see Graph 1). In all, the
ANP leased 26 onshore, 69 shallow water and 12
deep-water blocks in Round Five.

The changes in the leasing rules allowed two


new companies to enter the scene: Auriznia and
Sinergy Group. The onshore blocks, smaller in
size and demanding less technical capacity to operate (classified as type C blocks, compared to
the type A and B blocks requiring greater technological sophistication), became the entryway into

This good performance is mainly a result of


Petrobras`s strong showing in the leasing round.
The company shelled out R$21.9 million in acquiring 88 blocks (95% of the blocks offered). This
impressive display is explained by the companys
need to expand its exploration area. In the begin-

Infopetro Bulletin

August 2003

PETROLEUM
Market
should define the extent of exploration (in terms of
work-units) in the first period of the block lease.
The size of this offer will account for 30% of the final evaluation of the company`s bid.

the Brazilian upstream for these companies, as


well as a battleground of competition between
them. The most sought-after blocks are located in
the Potiguar Basin, 19 of which onshore blocks
(out of a total of 26). The dispute for block POT-T558 was a clear example of the consequences of
the rule changes introduced in Round Five, above
all with respect to the reduced importance of the
signing bonuses. For example, though Auriznia
offered to put down twice as much cash up-front
for this block than its nearest competitors, it lost
out because of a relatively weak Minimum Exploratory Program (PEM). Auriznia`s fixed its
PEM at only 10 work-units (measure of the exploration effort bidders commit themselves to), while
the Partex/Petrobras consortium offered 1000
work-units.

Since the PEM data for Round Five has not yet
been released, it is more difficult to estimate the
impacts of this latest round in terms of wells drilled
by 2010 (see Infopetro, January 2003). To estimate the exploratory effort on recently-leased
blocks, we extrapolated the PEM from Round
Four. Graph 2 demonstrates the estimate for well
drilling before and after the results of Round Five.
Observe that, based on the estimate, the latest
round offers a boost to the drilling cycle, whose
peak is forecasted to occur in 2007.
Based on the number of work-units bid winners
committed themselves to, we can estimate the
minimum level of investments during the exploratory period on the blocks leased. For onshore
blocks, the average PEM was 21,250 work-units,
which, according to ANP estimates, should generate investments on the order of R$64.6 million.
For shallow water blocks, companies promised to
apply 7,694 work-units, representing R$138.5 million in investments. In deep waters, the PEM was
4,457 work-units, equivalent to investments of
R$160.45 million. With this, the minimum expected investment for the exploration phase will
be somewhere around R$365.5 million.

Another important element of Round Five was


the government`s decision to impose higher local
content requirements (minimum amount bidders
must spend on Brazilian-made goods and services). For onshore blocks in the exploration
phase, companies promised to access the Brazilian market for 99% of goods and services used for
geophysical and geological data collection. For
data processing and interpretation, the companies
offered 91%; for drilling, 87%. For the development phase of oil and gas blocks, 97% of the
detail engineering and 89% of well drilling, complementation and evaluation will be performed
with domestic goods and services.

Comparing Round Five to the two previous


rounds, we can say that, even with a reduced
number of participants, the latest round was a
success.

For shallow water blocks, companies in the


exploration phase promised to tap the Brazilian
market for 79% of their processing and data
evaluation activities and 55% of their drilling activities. For the development phase, domestic goods
and services will account for 88% of expenditures
on detail engineering services and 71% of expenditures on drilling and complementation activities.

We conclude by emphasizing two positive factors: the size of the total area leased and the local
content guarantees. The rule changes for Round
Five were consistent with regard to these factors.
Given the need to replenish the exploration areas
controlled by the majors, we should see an increase in the total area leased in the next round;
if, that is, the majors maintain their interest in Brazil. With the tax reforms currently being introduced
in Brazil, along with the offering of the blue
blocks originally acquired by Petrobras in Round
Zero, this interest should in fact remain strong.

For deep water blocks, 100% of expenditures


on data processing and evaluation will be directed
towards domestic goods and services. For drilling
this percentage falls to 30%. For the development
phase, the average domestic goods and services
index was 90% for detail engineering services and
50% for drilling and complementation. Auriznia
stood out by committing itself to buy 100% Brazilian in each of the three phases of the lease
concession.

Professor IE-UFRJ/Researcher GEE

According to the new leasing rules, the PEM,


though still obligatory, is no longer pre-established
by the ANP. Upon placing a bid, companies

Infopetro Bulletin

(edmar@ie.ufrj.br)

ANP Scholar/Research Assistant GEE

August 2003

PETROLEUM
Market

Graph 1

Size of Lease Areas and Signing Bonus Revenues from


ANP Leasing Rounds 1-5
1.200.000.000

50.000

1.000.000.000

40.000

800.000.000

30.000

600.000.000

20.000

400.000.000

10.000

200.000.000

rea

5
R
ou
nd

4
R
ou
nd

3
R
ou
nd

R
ou
nd

R
ou
nd

0
1

Signing Bonus
(R$)

Area (km)

60.000

Bnus

Graph 2

Estimates of Wells Drilled (1998-2010)


120
100
80
60
40
20

At Round 4

Infopetro Bulletin

20
10

20
09

20
08

20
07

20
06

20
05

20
04

20
03

20
02

20
01

20
00

19
99

19
98

At Round 5

August 2003

PETROLEUM
Market

The Evolution of Oil Consumption in China and its Impact


on the International Market
Helder Queiroz Pinto, Jr.
Vanessa Geminiano
US Department of Energy predicts that China will
be importing 4.2 million barrels/day by 2010.

Analyses of the international oil market will in


the next few years be focused increasingly on the
structure of supply and demand in a single country: China. In the past few decades, this country
has had one of the highest growth rates in the
world. China`s GDP has grown at an annual rate
of 8.2% since 1971, arriving at a total of 1.24 trillion dollars in 2002. The International Energy
Agency (IEA) predicts this value will more than
quadruple by 2030.

Aware of the changes in the country`s energy


consumption patterns and the effects of this process on the environment, the Chinese government
has focused on programs to reduce carbon dioxide emissions. The government published its 10th
Five-Year Plan (2001-2005) stating its main objectives: diversify the country`s energy mix;
guarantee total security in the supply of energy,
improve energy efficiency; protect the environment.

Consequently, economic growth has stimulated rapid growth of energy demand. This
accelerated pace is explained by a combination of
several factors evolving in relatively short time.
Among these include: population growth and observed demographic transformations; a change in
living standards; the acceleration of urbanization
and industrialization processes. An additional factor has been a major increase in automotive
vehicle traffic.

In analyzing China, we cannot ignore the importance of the institutional transformations that
have thrust China onto the stage of world trade.
With the entrance of China into the World Trade
Organization in November 2001, the Chinese
government signed agreements liberalizing trade
and opening the country to foreign investment.
For the energy sector, this decision could lead to
an increase in foreign investment and the possibility of attracting foreign operators to upstream
projects.

As a result of this process, which should continue throughout the next several years, China
became in 2002 the second largest oil consumer
in the world, ahead of Japan and behind only the
United States. As in most of the industrialized
countries, consumption in Japan has stabilized
over the past few decades (see Graph 1). As is
well known, this stabilization of demand is a result
of conservation and energy substitution policies
implemented in the 70`s and 80`s, as well as of
the loss of economic dynamism reflected in the
low rates of GDP growth.

The transformations described above show


that China will be one of the main actors in the
world oil industry and trade in the next few years.
For this reason, we expect Chinese imports in the
short-term to increase as well (assuming demand
continues to grow at current rates). Exploratory efforts in China are uncertain and even if we see an
increase in China`s oil reserves, it would take
several years before this increase begins to have
an effect on imports. Thus, we expect the behavior of oil demand in China to be one of the most
important variables in monitoring fluctuations in
world oil prices in the years to come.

When we examine China`s demand for oil visa-vis the demand of other large industrial nations,
it becomes clear that the former has grown much
faster. In the 1990`s, annual oil consumption
growth in China was 7.2%. In most industrialized
nations, annual growth rates were below 1.5%.

Professor IE-UFRJ/Researcher GEE


(helder@ie.ufrj.br)

ANP Scholar/Research Assistant GEE

Under such circumstances, China has become


a major oil importer (close to 1.5 million barrels/day). Since 1993, Chinese oil imports have
increased continuously to satisfy the country`s rising energy demand (Graph 2). The average
growth rate in the last nine years was 8% and the

Infopetro Bulletin

August 2003

PETROLEUM
Market

Graph 1

thousand
barrels/day

Oil Consumption: China vs.


Industrialzed Countries
6000
5000
4000
3000
2000

China

Japo

Itlia

Frana

Alemanha

Canad

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

1973

1000

Inglaterra

Graph 2

6.000
5.000
4.000

Imports

3.000
2.000
1.000

Consumo

Infopetro Bulletin

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

1973

1971

1969

1967

0
1965

1000 barrels/day

Oil Consumption and Production in


China

Produao

August 2003

Essay of the Month

Competition in the Electric Power Market: A Complex


Institutional Construction
Ronaldo Bicalho
The main characteristic of the restructuring of
the power industry is the complexity of the process. This complexity is the fruit of technical and
economic aspects unique to the industry, such as
the interdependence between agents in the electricity market. The complexity of economic
relations between agents, both along the productive chain and in the power market itself, is a
result of the need to make short and long-term
decisions having consequences that affect the
system as a whole. Obviously, restructuring an industry with such characteristics is not a simple
affair, especially when the process involves a
radical change in the way in which agents interact.

their ideal of a competitive market,under the assumption that the further you go in this direction
the greater will be the benefits enjoyed.
The ideal and the real in the power sector
Visions of competition such as the one described above impoverish analysis by separating it
from reality and weakening its capacity to generate precise and useful studies of institutional
intervention and business behavior in the electricity market. The reductionism inherent in freemarket idealism, as it concerns the power industry, results in an overly ambitious, unrealistic
reform agenda.

Without a doubt, there are certain basic decisions that must be made in any reform of the
power sector, just as there are certain fundamental questions that must be answered by any model
intending to guide the reform. Distinguishing these
decisions and questions helps clarify the debate
over existing alternatives, permitting a better
evaluation of the costs, benefits, possibilities and
limitations of these alternatives. Given the strong
politico-institutional character of power industry reform, society should be aware of the decisions
being made. More importantly, it should know why
they are being made.

In reality, competition represents a struggle for


power between actual companies operating in actual markets under very objective conditions.
These conditions are given by the technology and
resources available and by the institutional
framework. In abstracting from these conditions,
free-market idealists develop politico-institutional
strategies incompatible with reality. Choosing not
to accept reality, the idealists believe that every
promise is possible and all objectives are plausible as long as the ideal market configuration is
achieved. Therefore, they focus all their efforts, in
vain, on creating such a market.

The questions raised below do not profess to


be exhaustive. Their objective is simply to emphasize that we can no longer restrict the debate over
the reforms to the same dialogue of ten years
ago. Rather, we must try to learn from the reform
experiences in both Brazil and other countries.

According to the idealists, reform failures are


always associated with political obstacles to perfect markets, rather than with their own ideological
flaws. Thus, every failure comes equipped with a
ready-made justification, making the defense of
competition a very convenient, though impractical,
argument. Convenient in the sense that the purported benefits emerge only in the long-run, in
such a way that real short-term problems are
weighed against imaginary (at least for the time
being) long-term solutions. Impractical because
although the ideal solutioncompetitionhas
been identified, it is very difficult to implement
given the imperfections of the real world, especially in the electricity sector.

The Introduction of competition in the electricity sector


Those endowed with a very limited notion of
competition often harbor certain hopes followed
by disappointment with reform in the power industry. Many analysts have a vision of an atomized,
homogenous competitive market, and believe that
models deviating from this ideal generate allocative and productive inefficiencies. For such
observers, the objective of reform is to achieve

Infopetro Bulletin

August 2003

Essay of the Month

institutions, between conflict and cooperation, between autonomy and centralization. By analyzing
these trade-offs objectively, we can see that the
power market will always have, in varying doses,
characteristics of a free market, of conflict and
autonomy, and finally, of institutions, cooperation
and centralization. The quantity of each item in
this final recipe will depend on the industrial and
institutional conditions in each power market.

The predominance of the vision of competition


outlined above puts long-term promises in conflict
with concrete short-term results. This wipes out
political consensus regarding a competitive future.
Eventually, discussion focuses more on concrete
problems and less on the future benefits of competition. This leads to a gradual abandoning of the
notion that competition is an end in itself. In other
words, as experiences with reform accumulate,
the role of competition as a solution to the problems of the power industry changes.

The specificities of the product electricity and


its demand

The trade off between competition and coordination

The essential attribute of electric power as a


product is that it cannot be stored. This problem is
not one of preserving the product from one day to
the next, as with the traditional fish market (so
dear to economists), which forced suppliers to
seek out demand before their product spoiled. In
the case of electricity, production and consumption occur simultaneously. When supplier and
buyer agree on a transaction, the product to be
supplied does not yet exist. It will only exist at the
moment of consumption. Thus, the demand negotiated is always a forecast. In the same way, the
negotiated supply is nothing more than a forecast
as well, since the supplier promises to supply
electricity at the moment the buyer decides to
consume the product. Both supply and demand,
hence, are statements of intent; promises, if you
will. The electricity market functions as a futures
market in which the capacity to honor ones obligations is not measured by the quantity of product
one has available, but by the inputs and installed
capacity at one`s disposal to generate and ship
the product.

Given the intense systemic interdependence to


which agents in the electricity market are subject
to, the need to coordinate plans and behavior is
inevitable. It is impossible to imagine the survival
of the power market without coordination. This
does not mean simply technical but economic coordination as well. Separating technical from
economic coordination is a mistake because the
two are intertwined, with the latter existing in large
part because of the presence of the former.
Therefore, increasing competition does not in any
way imply a reduction in the need for coordination.
As stated above, the struggle for power in
which companies seek to increase the value of
their capital is at the heart of the capitalist dynamic. Coordination is a management strategy of
the agents involved in this process, agents that
may be operating within the same firm, in any
segment of the productive chain, or in different
firms in search of some kind of cooperation in a
given market. Therefore, competition and coordination are distinct phenomena in terms of
problems and challenges and should not be contrasted with one another. Competition is a process
and coordination is an action with a very clear objective: increase the forecasting ability of agents
interacting in the market. This reduces the complexity and uncertainty of the agents` individual
decisions.

The power market: a market of contracts


Since the power market is essentially a futures
market, transactions in this market are made
through contracts in which one side agrees to deliver a given quantity of the product at a given
price at a future date, while the other side agrees
to purchase this quantity at the given price and
date. The date, in principle, does not matter. What
is essential is that it is always in the future.

In this sense, the main discussion focused on


which institutional arrangement should govern the
operation and expansion of the power sector. A
fundamental question is whether the market can
achieve this coordination on its own. The market
dimension we are concerned with here is not
competition (the locus of capitalist struggle), but
the coordination of both the short and long-term
decisions of economic agents.

A Special Kind of Futures Market


The impossibility of electricity storage makes
for interesting peculiarities in the power market.
The first has to do with demand. Electricity demand crystallizes only when power is consumed.
It is not possible to determine, a priori, exactly
how large this demand will be. It is worth remembering that, in the case of electricity, demand
pushes production, and not the contrary. In eco-

The trade-off, thus, is not between competition and coordination, but between the market and

Infopetro Bulletin

August 2003

Essay of the Month

electricity, transactions cannot be coordinated


through the price mechanism alone. Agents must
seek institutional solutions that transcend the
price mechanism. The institutional solutions consist of a set of arrangements offering distinct
governance structures and rules of the game. The
existence of a collective contract is fundamental
for the proper functioning of the market.

nomic terms, demand stimulates the use of resources, be it utilization of installed capacity, be it
use of inputs and labor. In this sense, there is always a difference between demand contracted ex
ante and demand ex post. In a future contract involving an ordinary good or service, it is possible
to determine exactly how much of the product will
be delivered. This is not the case with electricity.
When an agent promises to deliver power in the
future, what he actually does is promise to make
available, in the future, a portion of his installed
capacity and a certain quantity of input. In essence, what is being negotiated is productive
capacity, and not a product.

A power market cannot exist as a set of independent bilateral relations. In the power market,
institutions counta lot. From the moment agents
intermediate between the present and the future,
institutions become crucial elements in the design
and performance of markets. As institutions have
a very local character, the specific characteristics
of each socioeconomic space will determine the
configuration of each electricity market.

Furthermore, the interdependence determines


that the delivery of the product depends on a set
of agents that transcends the two agents involved
in the initial transaction. In this sense, the supply
promise does not depend only on the individual
supplier, but on the system as a whole. This fact
makes contractual relationships in the power market very complex.

Each power market is a power market, principally


when
considering
the
various
products/services offered along the chain and in
the electricity market. This was true before the
power crisis in the 1970s, and continued to be so
throughout the reform processes of the 80s and
90s. Under the best of hypotheses, markets are
structured according to a basic logic. However, at
the moment of implementing this structure, supply
and demand conditions in each market and the
specific institutions in each country end up defining the actual development of these markets.

Bilateral Relations in the Power Market


Every bilateral contract in the power market
has to be a part of a larger collective contract.
Given the interdependence between agents, it is
not possible to escape from a collective arrangement, which ends up defining the limits and
possibilities of bilateral interactions between buyers and sellers.

The local specificities of markets makes the


challenge of reform not one of simply coming up
with the best rule but rather rules acceptable to
the institutions and agents present. Different
agents will support rules that satisfy their particular interests. On the other hand, they will reject
those that threaten their interests. We should not
forget that we are talking about an economic
sphere with a strong political element, where public authority meets private interests. In the sense
that it is a public issue, private interests (i.e.
power companies, investors) are forced to conquer their legitimacy, to the detriment, or benefit,
of other interests (be they contradictory or convergent). This battle for legitimacy is essentially
political. To underestimate this dimension of the
power market, under the illusion that the debate is
strictly technical, is a profound mistake. In fact, to
do so is fallacious and above all dishonest, in that
it obscures the core issue of the debate.

Impossibility of storage, interdependence of


agents and volatility
The impossibility of electricity storage makes
the power market not only a futures market but a
virtual one as well. It could also eventually become a market of sale and purchase promises.
Therefore, there is always a time gap to be filled
between the contracting and the actual consumption of electricity. The interdependence simply
raises the tension between the present and the future. In fact, this permanent tension between the
present and the future typifies the power market.
Given that the gap between the present and the
future is filled in by expectations, these expectations become very slippery. The volatility of
expectations translates into the significant price
volatility in the power market.
Volatility and institutions

The electricity market: an institutional construction

Agents respond to the elevated uncertainties in


the power industry by shaping institutions capable
of reducing them. Obviously, in a market such as

The power market is an institutional construction. It has to be this way since the most crucial

Infopetro Bulletin

10

August 2003

Essay of the Month

Risk-management and competition in a very


unique commodities market

step in creating a functional electricity market is to


create a collective contract to reduce the constant
tension between the present and the future. There
is no way to ignore the importance of institutions
for the construction of this market. In other words,
there is no pure electricity market, free of institutions capable of reducing risks and uncertainties
and stabilizing expectations. In this way, the institutional contract is a powerful mechanism for
reducing risk, and agents understand this. Without
such contracts it would be impossible to explain
the trajectory of the power market throughout the
20th century.

The introduction of competition, with regard to


the monopolistic and verticalized model that used
to exist, results in a de-fragmentation of the market and the electric power industry. In this context,
risk and uncertainty increase, turning the decision
process of the agents present in the market more
complex. To the extent that cooperation is replaced
by
confrontation,
the
solidarity
mechanisms of managing risk disappear. Therefore, it is up to each agent to find a way to
manage their individual risks. The fundamental
question is whether these mechanisms exist. It is
in this sense that the question of whether electricity is a commodity or not becomes meaningful.

A relevant question in the electric power sector


is whether risk should be managed individually or
collectively. The 1990s were prodigious in terms
of financial innovations. These innovations were
used, for at least a brief period, in the power market. However, agents have encountered a series
of problems with applying financial innovations in
the electricity business. Given these difficulties,
the apparently simply question concerning who is
responsible for risk-management, consumers or
business, becomes more complex. Companies
would seem to be more capable of managing risk
individually than consumers. However, it is difficult
to implant the existing mechanisms for such a solution given the characteristics of the power
market. Companies, thus, are not able to protect
their interests. The final result is greater exposure
to risk for the system as a whole, principally for
consumers, excluding the few large consumers,
who can ameliorate their situation through hedge
mechanisms.

An electricity derivatives market requires a


spot market that offers fast responses to variations in supply and demand. This requires a
robust generation and transmission system capable of transferring electric power from areas of
oversupply to undersupplied areas, and quickly.
However, for this to be possible the system needs
to have excess capacity capable of injecting
liquidity into the system when necessary.
Therefore, the construction of such a market has
various costs. Among these is the construction of
excess capacity to facilitate greater competition.
Without such a liquid market, it is not possible to
reduce price volatility to the point where financial
mechanisms of risk management can be applied.
Thus, the basic question returns to the possibility
of creating a competitive electricity market.

For this reason, introducing individual management of risk, for both the system and the
consumer, ends up increasing risk for both sides.
The consumer, furthermore, was forced to find solutions for a problem that he, individually, is
incapable of resolving.

Competition, Autonomy and Excess Capacity


A fundamental question for competition is the
exercise of autonomy on the part of agents. There
is no sense in restricted and limited forms of competition. The advantage of competition derives
from the use of various market survival strategies
that make the industry more efficient. Autonomy is
directly related to the existence of excess capacity, both in generation and transmission. It follows
that capacity expansion is a necessary condition
for competition.

It in this context of risk management that the


discussion concerning the properties of electricity
as a consumer product becomes relevant. The
question of whether electricity is or is not a commodity like any other only has importance in this
sense. To associate the debate over whether or
not electricity is a commodity with competition is,
in principle, meaningless. This is because competition does in fact exist in non-commodity markets.
Arguing that the existence of competition necessarily implies the existence of a competitive
commodities market is a very limited position, and
does not get to the heart of the question.

Infopetro Bulletin

A careful analysis of the debate reveals that


the reduction of excess capacity, held up by some
as a positive result of market logic (a more efficient utilization of assets), in fact limits
competition and increases volatility, uncertainty
and risk. In turn, the increase in uncertainty discourages investment, reducing reserve margins
and restricting competition. In short, the system
enters a vicious circle resulting in energy short-

11

August 2003

Essay of the Month

The future of reform

ages and forced electricity rationing (as occurred


in Brazil in 2001). When this occurs, the greatest
challenge of the electricity sector becomes how to
administer scarcity.

The electricity market is an institutional construction restricted by the specific conditions of


each power industry. This restriction places concrete limits on the exercise of political will,
regardless of its nature. In other words, reforms
do not occur in a vacuum, but in a space endowed
with possibilities defined by the existing institutions and level of technology. Since this is a
complex framework, the simple choice between
competition or monopoly has little practical utility.
Without knowledge of the rules, institutions, incentives and penalties of the system, little concrete
evaluation can be done. Framing the discussion in
terms of monopoly and competition had some justification several years ago; today it has none. The
future of the power sector is beginning to be seen
not simply as one of transforming monopoly into
competition, but of choosing between complex alternatives that involve varying elements of these
two extremes. Thus, there has been an increase
in the range of possibilities to be analyzed. Once
we recognize that electricity is an essential good
in modern societies, evaluating reform becomes
simple. All one has to do is ask: did the changes
guarantee electricity supply at a reasonable price?
If electricity is supplied at a low price, the reform is
a success. If not, reform represents an institutional and intellectual failure.

The diversity of reform


Given the technical, organizational and institutional diversity, the evolution of markets does not
assume a unique trajectory. As a result, there are
various reform processes underway, all differing in
style and form of implementation. Considering that
industry is in a transition phase, there does not
exist a single dominant logic. Therefore, reform
processes amount to institutional experiments that
should be faced as such. Any acritical attempt to
take one of these experiences as a reference for
all the others is an exercise in reductionism that
underestimates the local character of the industry
and the institutions. In addition, such an attitude
treats an ongoing process as if it were already
concluded. To avoid this strategic error, it is important to evaluate international experiences
within their specific contexts. In doing so, we can
extract lessons from these experiences, making
sure not to commit the same errors. What we
cannot do is allow ourselves to believe that solutions in one market can simply be replicated in
another. Even the logic guiding the set of reforms
has to be taken carefully. Depending on the stage
in which the development of each industry is at,
the challenges faced can be different.

Professor IE-UFRJ/Researcher GEE


(bicalho@ie.ufrj.br)

World Forum on Energy Regulation


Date: October 5-9, 2003

Location: Rome, Italy


More information: http://www.energyforum2003.org

Infopetro Bulletin

12

August 2003

News Briefs
Petrobras Contemplates Gas-Fired Thermal
Power Plant in Manaus

Petrobras Announces Giant Discovery off


Coast of Sao Paulo

According to the Jos Juhas, managing director of planning and development at Petrobras, the
company should invest between US$450-US$500
million in a thermal power plant running on natural
gas in Manaus, the capital of the state of Amazonas. The plant will have a capcity of 1,000 MW.
The project is part of the companys plans to take
advantage of gas reserves in Amazonas, which
produces roughly 20% of total national gas production. Due to the lack of pipelines in the region,
almost all gas produced in Amazonas is reinjected
into the Urucu fields. Therefore, the thermal plants
operating in the region use either more expensive
fuels, such as diesel, or lower-quality fuels like
fuel oil.

Petrobras directors informed investors on August 30 that the natural gas reserve discovered in
April in the Santos Basin contains more than 400
billion cubic meters (bcm), surpassing by almost
seven times the original estimate of 70 bcm. Although the discovery still cannot be defined as a
proven reserve (the gas has not yet been declared marketable), it increases total known
reserves in Brazil from 231 bcm to approximately
650 bcm. Bolivia and Argentina, holders of the
largest gas reserves in the Southern Cone, possess 775 and 764 bcm, respectively.
The reserve was discovered in shallow water
(485 meters) 137 km off the Sao Paulo coast. The
well in which the gas was found has a depth of
4,956 meters. The new reservoir has a capacity to
produce 55 mcm per day (mcm/d) for a period of
20 years. This is greater than Petrobrass total
current production of 46.2 mcm/d in Brazil and
abroad. The discovery presents new questions
and challenges for Petrobras, the most important
of which is the strategy for exploiting the reserve.
The governments thermal power program
planned to install more than 40 gas-fired thermal
plants by 2010, consuming between 25-35
mcm/d. However, due to competition with hydroelectric generation in the country, few of these
plants are in operation.

The supply of natural gas to the new plant depends on the construction of the Coari-Manaus
gas pipeline, which, according to Petrobras, could
begin in the first quarter of 2004 and completed in
2 years. Until the pipeline is completed, the dualfuel plant in Manaus will run on fuel oil.
Location of New Refinery Remains a Mystery
Contradicting the affirmation of Gilberto Prado,
head of the Northeast Refinery project, Petrobras
stated that the company still doesnt know where it
will build the installation. Prado, president of the
company in charge of the project, claimed in early
September that President Luiz Incio Lula da
Silva had already chosen his native state of Pernambuco as the location for Brazils new oil
refinery. The alleged decision was made at the
expense of 12 other states competing for the refinery, including Cear and Rio Grande do Norte.

Another obstacle to the growth of the gas market in the country is the price of Bolivian gas,
which is as much as 40% more expensive than
domestic gas. The high price, a consequence of
the elevated transport cost, has scared away
large industries in Sao Paulo and southern Brazil,
who prefer to consume heavy fuel oil or biomass.
In this sense, the news of the discovery in the
nearby Santos Basin could stimulate industrial
consumption of natural gas in southern and
southeastern Brazil.

According to Eduardo Dutra, president of


Petrobras, the state-controlled company is modernizing its existing refineries to expand
processing capacity of domestic oil. Dutra confirmed that the project for the new refinery is
scheduled to begin in 2004 and begin operating in
2008. The government still has not confirmed the
location of the refinery in order to avoid political
conflicts between governors during the voting for
tax reform. President Lula, however, stated that
the decision concerning the location will take into
account, in addition to technical questions, the
governments policy of regional economic development.

Infopetro Bulletin

A good part of Petrobrass current production


comes from Bolivia, where the state-controlled
company possesses significant reserves in the
San Alberto and San Antonio fields. Petrobras
also has an import contract with Bolivia, requiring
payment for more than 14 mcm/d of natural gas.
As a result of the lack of demand in Brazil, the
company is actually importing only 11 mcm/d.

13

August 2003

Mexican Market for Oil Equipment and Service


Expenses at US$12 Billion Annually

Ltda and its directors are being investigated for


adulterating fuels and for owing money to the Brazilian Treasury (Receita Federal). Barros affirmed
to lawmakers that the authorization was given because the process was already underway and
could have generated judicial action if it had been
interrupted, as the MME demanded. We did everything with the utmost legality, claimed Barros.

The signing of a free trade accord with Mexico


could guarantee Brazil access to an oil equipment
and services market worth close to US$12 billion
per year. Mexicos state oil company PEMEX intends to invest heavily in the next few years
around US$100 billion through 2010on 47 platforms worth US$7 billion, and 1.6 thousand km of
pipelines, of which 600 km will be underwater
pipelines. In addition, PEMEX plans to build 13 oil
tankers and reform two refineries. PEMEX has a
goal to increase its oil production from the current
3.5 million barrels/d to 4 million by 2006. In the
same period, the company wants to increase
natural gas production from 4 million cubic feet to
7 mcf.

Price of Kitchen Gas Could Rise, says Sindigs president


According to Lauro Muniz Costa, President of
the National Union of Gas Distribution Companies
(Sindigs), the price of bottled butane (sold in 13kg containers and used mainly for cooking) could
increase in the next few months if Petrobras does
not abandon its policy of international price parity.
The declaration was made on September 3 in a
public audience before the House of Representativess Commission of Financial Fiscalization and
Control.

Beyond the requirement that countries interested be signatories to the free trade accord,
PEMEX could require companies to spend 40% of
their project investments on Mexican goods and
services. For leases requiring more advanced
technology, the state company could eliminate
completely the domestic goods and services requirement.

Oil Workers Threaten to Strike on September


10
At least 35 thousand oil workers in Brazil represented by the Unified Oil Workers Federation
(FUP) threatened to paralyze activity for 24 hours
on September 10 if Petrobras does not make a
proposal to adjust salaries. FUP delivered its list
of demands to Petrobras in early August. According to the union, the strike will take place
nationwide and at all units of Petrobras and
Transpetro.

According to Petrobras President Eduardo


Dutra, PEMEX expressed its interest in forming a
partnership with Petrobras, known for its experience in deep water exploration.
Ministry Criticizes ANP For Stance on Fuel
Formulators

Fels Setal Will Build the Hull of P-52

The ANPs decision to authorize Golfo Brasil


Petrleo Ltda to operate as a new fuel formulator
generated conflict between the regulatory organ
and the Ministry of Mines and Energy (MME). According to MME Minister Dilma Rousseff, the ANP
granted authorization without prior consent at the
ministerial level, which had ordered the agency to
suspend the resolution. The Ministry argues that
the presence of a formulator (a company that
buys, sells and transforms fuels) in an immature
market brings instability to the sector by engaging
in undue practices.

Petrobras granted its contract to build the hull


and deck of platform P-52 to Fels Setal/Technip,
who offered US$770 million for the service. By the
terms of the lease, which impede the same company from winning both contracts, the decision
disqualifies Fels Setal from participating in the
lease for platform P-51. Petrobras considered the
prices offered by consortiums for P-51 excessive
and decided to cancel the platform lease. The
state-controlled company could still review its
stance through direct negotiations with Odebrecht/Saipem and Samsung.

The MMEs harsh criticism of the ANP convinced Sebastio Rego Barros, secretary-general
of the regulatory agency, to make a surprise appearance at a congressional hearing on fuels.
According to lawmakers, Golfo Brasil Petrleo

Infopetro Bulletin

14

August 2003

STATISTICAL ANNEX

Graph 1

Source: EIA

Graph 2

Source: ANP

Infopetro Bulletin

15

August 2003

STATISTICAL ANNEX

Graph 3

Source: ANP

Graph 4

Source: Brasil Energia

Infopetro Bulletin

16

August 2003

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