Thesis Athir Nouicer

UNIVERSIDAD PONTIFICIA COMILLAS
ESCUELA TCNICA SUPERIOR DE INGENIERA (ICAI)
OFFICIAL MASTER'S DEGREE IN THE

ELECTRIC POWER INDUSTRY
Masters Thesis
Diffusion of new renewable power in Brazil:

A Real Options Approach
Author:
Athir Nouicer
Supervisor:
Luciano Losekann
Co-Supervisor:
Edmar Luiz Fagundes de Almeida
Florence, July, 2015
ESCUELA TCNICA SUPERIOR DE INGENIERA (ICAI)
OFFICIAL MASTER'S DEGREE IN THE

ELECTRIC POWER INDUSTRY
Masters Thesis
Diffusion of new renewable power in Brazil:

A Real Options Approach
Author:
Athir Nouicer
Supervisor:
Luciano Losekann
Co-Supervisor:
Edmar Luiz Fagundes de Almeida
Florence, July, 2015

INSTITUTO DE ECONOMIA DA UNIVERSIDADE FEDERAL DO RIO DE JANEIRO
Master in Economics and Management of Network Industries (EMIN)
ABSTRACT
A major problem in the expansion of renewable energies sources is finding the most adequate
way to support them. The design of a suitable support scheme is necessary for an efficient
development of renewable energies sources (RES). In Brazil, Many projects are delayed after
getting the construction license due to financing problems. Some of them are even abandoned.
Experiences of two European countries (Germany and UK) were analyzed in order to find
efficient alternatives for RES expansion in Brazil. These countries are currently implementing
new RES support schemes in order to increase electric systems efficiency; Contract for
differences for UK and a tendering scheme in Germany. The recent results show mitigated
outcomes. They are however encouraging considering investors caution against new
regulatory policies. Brazil has already adopted a similar scheme, the auction mechanism,
since 2004. Still, its share from RES apart from hydro and biofuels is very small, 4% for wind
energy and less than 1% for solar energy. It has, nevertheless, an attracting potential.
To investigate on this problem, we applied a Real Options approach to value the investment
opportunities in a wind farm project. Compared to the traditional NPV calculation, The Real
Options method excels in terms of covering the managerial flexibility for delaying the
investment decision.
The considered project is subject to a multistage investment strategy consisting of design,
construction and operation phases. A binomial approach through a decision tree was
elaborated to model the investment opportunity. Two scenarios were adopted for wind farms
that will participate in the 2017 A-3 auction. The results suggest that the option of delaying
the project has significant value, since the investor can wait until the uncertainties get
revealed.
This study can serve as a guide to ANEEL, the Brazilian electricity regulatory agency, and to
RES investors for the type of strategy to undertake in order to increase RES generation in
Brazil.
Good planets are hard to find...
List Of Figures
Content
List Of Figures.................................................................................................................................................. 3
List Of Tables ................................................................................................................................................... 4
ABBREVIATIONS .......................................................................................................................................... 5
1.
2.
INTRODUCTION..................................................................................................................................... 6
1.1.
Motivation ....................................................................................................................................... 6
1.2.
Objectives of the Master Thesis ........................................................................................................ 7
1.3.
Methodology.................................................................................................................................... 7
LITERATURE REVIEW .......................................................................................................................... 8

2.1.
2.1.1.
Regulatory entities ....................................................................................................................... 9
2.1.2.
Regulatory scheme to increase renewable integration .................................................................... 9
2.1.3.
Characteristics of RES-E technologies ........................................................................................ 10
2.2.
3.
Support Mechanism for Renewable Energies .................................................................................. 11
2.2.1.
Price-driven strategies ................................................................................................................ 11
2.2.2.
Quantity driven strategies ........................................................................................................... 13
2.2.3.
Indirect strategies ....................................................................................................................... 14
EUROPEAN EXPERIENCES FOR RENEWABLE ENERGY SUPPORT MECHANISMS .................... 16

3.1.
European regulatory framework...................................................................................................... 16
3.2.
Historical development and current status of RES-E deployment in EU countries ............................ 17
3.2.1.
Historical development at EU level ............................................................................................ 17
3.2.2.
Progress at country level ............................................................................................................ 17
3.3.
4.
Regulation ....................................................................................................................................... 8
Country-specific learned lessons..................................................................................................... 19
3.3.1.
Case study Germany .................................................................................................................. 19
3.3.2.
Case study UK ........................................................................................................................... 22
THE BRAZILIAN CONTEXT ................................................................................................................ 26

4.1.
Overview of Brazil ......................................................................................................................... 26
4.2.
Electricity policies of Brazil ........................................................................................................... 27
4.2.1.
First reform of the electricity market: 1990s .............................................................................. 27
4.2.2.
Second reform of electricity market: 2004 .................................................................................. 28
4.2.3.
National Policy on Climate Change: 2009 .................................................................................. 28
4.3.
Renewable energy potential ............................................................................................................ 28
4.4.
RES support mechanisms ............................................................................................................... 29
4.4.1.
Proinfa: quota & feed-in tariff scheme ........................................................................................ 29
4.4.2.
Incentives on wire costs for selling energy contracts at the free market ........................................ 29
4.4.3.
Current Structure: Technology-specific auctions ......................................................................... 30
4.5.
Investment decision in renewable energies in Brazil........................................................................ 31
4.6.
Lessons from European experience to Brazil................................................................................... 32
4.6.1.
The auction system .................................................................................................................... 32

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List Of Figures
4.6.2.
5.
Possible improvement for Brazil................................................................................................. 32
THE REAL OPTIONS METHOD ........................................................................................................... 34

5.1.
Presentation of the method ............................................................................................................. 34
5.2.
Renewable energy policy evaluation using real option models ......................................................... 34
5.3.
Real Options method for the Brazilian Market ................................................................................ 36
5.4.
Mathematical modeling .................................................................................................................. 37
5.4.1.
Discounted cash-flow (DCF) method.......................................................................................... 37
5.4.2.
Estimation of wind farm cash-flow return volatility .................................................................... 37
5.4.3.
The Event tree............................................................................................................................ 39
5.4.4.
The Decision Tree ...................................................................................................................... 40
6. A REAL OPTION APPROACH FOR RENEWABLE ENERGY INVESTMENT IN BRAZIL: A case

study of a wind farm ....................................................................................................................................... 41
6.1.
Project description.......................................................................................................................... 41
6.2.
Methodology.................................................................................................................................. 42
6.2.1.
Estimation of cash flow return volatility ..................................................................................... 42
6.2.2.
The Cash flow............................................................................................................................ 43
6.2.3.
The Event Tree .......................................................................................................................... 45
6.2.4.
The project decision tree ............................................................................................................ 47
6.3.
Analysis of the failure of the last wind auction ................................................................................ 50
6.4.
Model discussion ........................................................................................................................... 52
CONCLUSION .............................................................................................................................................. 53
REFERENCES ............................................................................................................................................... 55
ANNEX ......................................................................................................................................................... 60
ANNEX A .................................................................................................................................................. 60
ANNEX B .................................................................................................................................................. 62
List Of Figures
List Of Figures
Figure 1 : Differences between the RES support mechanisms .......................................................................... 13
Figure 2 : Tradable green certificates scheme .................................................................................................. 14
Figure 3 : Diversity of RES-E support schemes in the EU-28 ........................................................................... 17
Figure 4 : EU member states RES targets for 2020 .......................................................................................... 18
Figure 5 : RES Installed Capacity and Cost in Germany .................................................................................. 20
Figure 6 : Wind and Solar energies installed capacities in Germany ................................................................. 21
Figure 7 : The operation of an intermittent FiT with Cfd .................................................................................. 23
Figure 8 : RES Installed Capacity and Cost in UK ........................................................................................... 24
Figure 9 : Brazil Installed Capacity in 2014 ..................................................................................................... 26
Figure 10 : Price serie and deseasonalized serie for 2020-2050 ........................................................................ 42
Figure 11 : Free Cash Flow of the first scenarios investment........................................................................... 44
Figure 12 : Free Cash Flow of the second scenarios investment ...................................................................... 45
List Of Tables
List Of Tables
Table 1 : EU Member States RES indicative trajectory .................................................................................... 18
Table 2 : The Binomial tree ............................................................................................................................. 39
Table 3 : Characteristics of the project ............................................................................................................. 41
Table 4 : The two scenarios ............................................................................................................................. 42
Table 5 : S1 Traditionnal Investment Analysis ................................................................................................. 43
Table 6 : S2 Traditionnal Investment Analysis ................................................................................................. 44
Table 7 : Compound Option features ............................................................................................................... 45
Table 8 : S1 Event Tree (R$) ........................................................................................................................... 46
Table 9 : S2 Event Tree (R$) ........................................................................................................................... 46
Table 10 : S1 Second Investment Option (construction phase) valuation Tree .................................................. 47
Table 11 : S1 First Option (invest R$4 million design phase) valuation Tree .................................................... 48
Table 12 : S1 Project Decision Tree ................................................................................................................ 48
Table 13 : S2 Second Investment Option (construction phase) valuation Tree .................................................. 49
Table 14 : S2 First Option (invest R$4 million design phase) valuation Tree .................................................... 49
Table 15 : S2 Project Decision Tree ................................................................................................................ 50
Table 16 : Event Tree (R$) .............................................................................................................................. 50
Table 17 : Second Investment Option (construction phase) valuation Tree ....................................................... 51
Table 18 : First Option (invest R$4 million design phase) valuation Tree ......................................................... 51
Table 19 : Project Decision Tree ..................................................................................................................... 51
ABBREVIATIONS
ANEEL Brazilian Electricity Regulatory Agency
BNDES Brazilian National Development Bank
CCEE Brazil's power trade chamber
CCGT Combined Cycle Gas Turbine
COFINS Contribution to Social Security Financing
CO2 Carbon dioxide
DCF Discounted cash flow
EDF Electricit de France (French Company)
ETS European Emission Trading System
EPE The Energy Research Company
EU European Union
FCE/ACL Free Market
FCF Free Cash Flow
FINAME Financing of machinery and equipment
FIT Feed-in Tariff
FIP Feed-in Premium
IMF International Monetary Fund
KW Kilowatt
KWh Kilowatt-hour
O&M Operation and Maintenance
ONS National Electric System Operator
NPV Net Present Value
PIS Social integration program
PPA Power Purchase Agreement
PROINFA Programme of Incentives for Alternative Electricity Sources (Brazil)
PV Photovoltaic
RCE /ACR Regulated Market
RES Renewable energy sources
RES-E Electricity from renewable energy sources
RO Real options
RPS Renewable Portfolio Standard
R$ Brazilian Real
SHP Small Hydro Plant
TGC tradable green certificates
TSO Transmission System Operator
UK United Kingdom
WACC Weighted average cost of capital
INTRODUCTION
1. INTRODUCTION
1.1. Motivation
Worldwide, the diffusion of renewable power sources is the main drive to mitigate CO2 emissions. It
justifies the use of subsidies to promote those sources, especially wind and solar. EU countries, like
Germany and Spain, have led this process. New laws and norms are continuously being approved
following successes and failures of the previous ones. Also, new regulatory instruments are
continuously under study to cope with the generated challenges to power system operation and
expansion.
Intermittency of renewable generation is a challenge. As to provide security of supply, it is necessary
to keep backup units to compensate renewable generation when weather conditions are inappropriate.
However, when the diffusion is intense, traditional thermo-power plants dispatch is lower and their
average cost increases. Many countries are orienting funds into renewable energies sources, such as
wind turbines, solar farms and geothermal plants. However, countries, like Denmark and Germany,
which reached large share of renewable generation face the highest energy prices. Without efficient
and attractive support schemes, investors wont take the risk and put their money in a renewable
energy farm.
In Brazil, the diffusion of renewable sources apart from hydro is peculiar. The Brazilian power system
presents an unusual composition. The Brazilian power mix is dominated by hydropower. Hydropower
generates 80% of Brazils electricity. So, the drive to mitigate CO2 emissions is less significant. The
large reservoirs of hydropower plants constitute in fact a way to deal with intermittence of new
renewable sources. However, the challenge is to reduce the dependency on hydro sources and rain
falls. Moreover, distances from the best generation sites to the main load centers are long. This gives
makes challenging for the Brazilian Regulator ANEEL to design efficient RES support schemes in
order to boost solar and wind energy expansion.
In electricity power systems regulation, policy learning between countries is an important driver for
improving policy design. In this project, we will start by analyzing the European experience to get
lessons for the Brazilian power system. Previous European experiences suggests that a well-designed
feed-in tariff can generate rapid growth for targeted RE technologies by creating conditions that attract
capital to those particular sectors. However, in the long run, the best way to encourage renewable
would be by means of taxation and/or introducing market-conform instruments such as a wellfunctioning system of competitive auctions. The use of auction schemes is increasing when compared
to other mechanisms, as FiT and FiP, although they still the most popular mechanisms, especially in
developing countries. This confirms the country specific aspect of the support mechanism design.
The choice of support scheme by the government and any alterations to this choice can have a
considerable impact on both the timing of investments and the generating capacity of projects. The
associated regulatory uncertainty creates incentives for investors to wait until the type of support
scheme and the corresponding level of support is sufficiently attractive. Thus, answering how and to
what extent political factors, i.e. RES support schemes, influence the renewable energy integration
turns out to be a critical question.
To assess this impact, we will use a real option analysis. This concept has slowly but surely been
gained academic ground. Real options valuations specifically provide an alternative to the standard net
present value assessment when investment involves some underlying uncertainty and built-in
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INTRODUCTION
flexibility. In particular, in contrast to the static nature of the net present value, real option valuations
allow the investor to exploit the flexibility in the dynamic decision process as uncertainty evolves.
Indeed, with uncertainty and irreversibility, NPV rule is often wrong and option theory gives better
answers.
1.2. Objectives of the Master Thesis

The goal of the thesis is in a first step to use the EU experience to identify advantages and difficulties
to increase renewable share in the Brazilian power mix.
Second, a real option analysis will be used in order to assess investors behavior under the current
Brazilian auction scheme for renewable energies projects.
1.3. Methodology
In the first part of this thesis, we investigate the different European countries experiences on
renewable energy support schemes design and their effects on the behavior of investors. Advantages
and Disadvantages of each experience and their adaptability with the Brazilian power system are
analyzed to point out the qualitative findings that would benefit to the renewable energy expansion in
Brazil. Analyzing the Brazilian electricity power system and investment decisions is necessary to
better assess the adaptability of these experiences.
A valuation of renewable energy project timing is carried out through real options. This analysis has
been previously used in Oil refinery and conventional power plants valuation. There are different
factors that take part in the valuation of a renewable energy project. Mainly; upfront costs, electricity
price uncertainty and public incentives.
LITERATURE REVIEW
2. LITERATURE REVIEW
2.1. Regulation
Classical microeconomic theory is based on the assumption of pure and perfect individuals rationality
that maximize their welfare by minimizing their costs and with a perfect and transparent information at
any time. In reality, these conditions are difficult to reach: to maximize their profits, producers have
often the incentive in making their consumers irrationals to make their products more attractive. To fix
the market imperfections, regulation is necessary, but the level of government (or public body)
intervention between producers and consumers is not so obvious. One main hurdle is to keep
incentives to an efficient behavior.
Nevertheless, the word regulation is not easy to define. People might hold several interpretations
about regulation, but they do not know what regulation means. Oxford dictionary define it: A rule
or directive made and maintained by an authority, in other words it is an act or legislation issued by a
government minister or a charged entity, whose aim is to organize, guide or secure the application of
an activity.
Regulation should be simple, however, simplicity is not easy to attain. Steve Jobs figured out that you
have to work hard to get your thinking clean to make it simple. In Antifragile (Taleb, 2014) , Nassim
Nicholas Taleb described it through the Arab expression for trenchant prose: no skill to understand it,
mastery to write it.
As a general policy, the deregulation of energy markets led to the shift of the risk from the
governments side to the private parties side. It gave the last a right to carry the investment instead of
the governments. However the more complex the regulation, the more bureaucratic the network, the
more an agent who knows the loops and misshapes would benefit from it later. On the contrary,
several examples of energy industry shows that with the evolution of private expertise in energy
markets, investors tend to have more knowledge than their regulator and trying to use this asymmetry
of information to have more convenient regulations. This is a franchise, an asymmetry one has at the
expense of others. For example, according to Nassim Nicholas Taleb (Taleb, 2014) Toyota Cars
Company hired former U.S. regulators and used their expertise to handle investigations of its car
defects.
When talking about regulation we should reorient our views in two ways: first with respect the
regulator attitude regarding the impact of the implemented policies on the national budget and on the
investors behavior and second with respect to focusing on the resiliency and adaptability of the
financial system established following these procedures.
The electricity industry is not an exception. As any other industry, it is subject to the laws and
principles that govern both the physical characteristics of electricity and also to the fulfillment of the
expectations of utilities and consumers. For instance, to insure the stability of the power system, the
regulator might consider attracting more heterogeneous power producers, so that different generators
might hold different compositions of assets, parameters and costs.
The regulation of the power industry is based on three elements (Prez-Arriaga, 2013) ; the design of
rules to control the agents behavior, the structure of the power industry and the supervision of agents
performance. The design of the rules is the main tool to guide the different market agents towards the
goal decided by the regulator. An example of the rules is the design of the remuneration of renewable
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LITERATURE REVIEW
project. Different schemes have been used to increase the integration of RES. Each one has different
characteristics; either a price driven strategies, quantities driven strategies or tax exemption in order to
make the investment in RES attractive to private parties. The structure refers to the generation,
transmission, distribution and supply activities organization especially after the privatization of the
electricity market. In a well functioning market, a sufficient number of similarly sized competitors
must participate to enhance market competition. If not, the regulators must set rules that prevent
adverse effects of large agents and natural monopolies on market efficiency. The last element is the
supervision of agents performance. Market agents are not altruistic. The regulator should supervise
them to assure the respect of the rules he sets.
2.1.1. Regulatory entities

Chile was the first country to change the traditional power sector regulation in 1981 (Prez-Arriaga,
2013). Then, a wave of reform was led in many other countries to transform the institutional
framework, organization, and operating environment of the infrastructure of electricity industry. Each
country has adopted a different structure of its power sector and the approaches to reform vary across
the countries but the main objective is common; to improve efficiency. Regulatory entities are set to
put the national policies into application. They organize and supervise the functioning of the electricity
markets for the benefit of the consumers and producers with being consistent upon the objectives of
energy policy. To exercise their function, regulatory entities (Prez-Arriaga, 2013) have several
instruments of different nature (economic, structural, etc.). They attempt to manage Cost-of-service
subject to regulatory oversight, benchmarking of regulated monopolies, Price or revenue caps,
unbundling of the electricity industrys activities, enhancing competitiveness and application of other
incentives such as setting quality standards (ISO- 9001) and other regulatory measures that may also
be deployed, such as command and control (standards, targets, penalties, etc.) and operating license
requirements.
2.1.2. Regulatory scheme to increase renewable integration

The major characteristic of an energy sources to be defined as renewable energy is its sustainability.
One of the most interesting definitions comes from Mr. Bernard L Cohen, former professor at
University of Pittsburg (Cohen, 1983). He introduced the term 'indefinite' (the necessary time period
for an energy source to be sustainable enough to be considered as renewable energy) in numbers by
using the relation between the sun (solar energy) and the earth. According to Professor Cohen, if the
energy source could last as long as the relationship between the Earth and Sun is supposed to last,
about billion years, then it is considered as a renewable energy source. Another characteristic of a
renewable energy source is its environmentally-friendly features. The expansion of renewable energies
limits the dependence in fossil fuels and therefore contributes in the reduction of CO2 emissions.
In recent years, a considerable number of countries are adopting different policies to increase
renewable energy share in their power mix. The main advantage is their limited environmental impact
comparing to fossil sources. Thus, the power grid is getting greener through a profound transformation
that will continue over the next few decades to decarbonize the world energy model.
Consequently, different challenges are raising for the system operators from the technical, economic
and regulatory perspectives; RES-E induces changes in the management of generation systems
(C.Batlle, 2012) and grid operations (Wholesale market functioning, Price dynamics...). In addition to
that, the design of markets and grid regulation has an impact on the deployment of RES, as well as the
design of support mechanisms for RES-E affects the system operation and wholesale market
outcomes. RES-E have a highly variable and unpredictable output and they are frequently called
intermittent generation. Most of these technologies have high investment costs but very low (or
null) variable costs. The wind energy has experienced the highest growth in the last years due to
technological advances leading to lower costs and the incentivizing government policies for renewable
investments (The Wall Street Journal, 2013).
While there are several significant numbers of experiences and literature that can help us to describe
the efficiency of the different previous alternatives for promoting renewable energies, the mutual
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LITERATURE REVIEW
implications of electric power systems and RES-E related regulation has not been sufficiently studied
yet. An explanation could be that the regulatory design of electric power systems has been conceived
without considering the impacts that a large penetration of RES-E has on them (C.Batlle, 2012).
Indeed, since some countries have experienced a high RES-E penetration, the weakness of their
regulatory schemes has shown up. Countries like Spain has suffered from an over investment in RES
obliging the Spanish regulation authority to review their RES support scheme which were excessively
attractive for investors but costly to consumers.
The main issue is to extract a previous experience from its context and adapt it in another one. This
may rise from the countries topological nature and socio-economic environment. In addition to that,
different policies will induce different types of RES, with different characteristics, and this will result
in different impacts on electricity power system. The design of support schemes is critical: On the one
hand, the support schemes and the investors revenues need to be predictable and last for the whole
regulatory period. On the other hand, the regulator, i.e. the policy maker, should design flexible
support schemes that can adapt to new situations (Ro, 2015). As a matter of fact, support schemes
need to have flexibility property without raising uncertainty and doubt among investors.
Thus, the regulation authorities need to deal with the new changes in the electricity power system
through adapting the market design and grid regulation. These changes should be different according
to the RES-E policy and consequently on the type of RES-E technologies which is being promoted.
Previous studies have analyzed RES expansion largely as a market process influenced by
governmental policies. However, analyzing directly the influence of political institutions and
government political ideologies, in the RES integration process, has been given less consideration.
2.1.3. Characteristics of RES-E technologies

In addition of being very sensitive to policy instruments, the RES-E expansion is highly dependent on
the characteristics of the technology which is being promoted and its potential in the given area. It is
not easy to say which technology is better. Technologies have their advantages and drawbacks. The
choice between one of them is highly dependent on the application and the location of the system. This
study will focus in two renewable energy sources; wind and solar.
2.1.3.1.
Wind energy
Sailing vessels can be considered as the first human use of wind energy (Wikipedia, 2015). In 3500
B.C, the Sumerians have already sailed with sails. The use of wind energy has evaluated across the
years. The first Wind Turbine Generator was invented in the IXXth century. Becoming more and more
powerful and efficient, wind energy is now an important RES. It is the renewable source that has
experienced the most impressive growth in recent years.
Mostly, in every country in the world, there are wind turbines. Nevertheless, the amount of installed
capacities and the share in the energy mix vary highly among them. It depends mainly on the policies
adopted by each country to increase the renewable integration. China, USA and Germany have the
largest installed capacity with respectively 114,763 MW, 65,879 MW and 39,165 MW. However, for
the wind energy share, Denmark, Portugal and Spain have the highest percentages with 33.8, 24.6 and
20.9% in 2013 (Roney, 2014). Denmark was the only country to produce one third of its electricity
from wind energy in 2013. In Germany and the UK, wind contributed nearly 8% of electricity
generation in 2013. Moreover, four states in northern Germany get half or more of their electricity
from wind.
An important factor of this increasing integration is that the cost of producing wind energy has come
down steadily over the last few years. The main cost is the installation of wind turbines. However,
costs of electricity from wind energy depend strongly on wind speed and regularity. Wind farms
located in regions with high wind potential might generate much more profits than the ones located in
less advantageous regions. Thus, location-specific support mechanisms might be set depending on the
energy source condition to avoid windfall profits.
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LITERATURE REVIEW
2.1.3.2.
Solar energy
As the name indicates, solar energy transforms the suns radiation into electricity. It presents an
important potential especially in regions with high exposition to sun radiation. This gross potential can
cover 8,000 times the human primary energy demand (Letcher, 2008). The main issue is the efficiency
of the methods used to transform this energy. There are two main methods for producing electricity
from solar radiation; first, solar photovoltaics (PV) and second concentrated solar power (CSP). Solar
PV uses cell arrays to produce direct current electricity from solar radiations, and CSP consists on
concentrating solar energy in order to heat water or another liquid to produce steam that feeds a
turbine. Solar energy is the most socially accepted way of distributed generation (Devine-Wright,
2008). It is preferred to wind energy in isolated areas or small installations to make them autonomous
being though a very good investment for individuals.
However, the main drawback for solar energy is its intermittency. This is mainly because of the
weather conditions. The panels produce much in the summer when demand is lower. On the contrary,
the production of energy in winter is lower while the consumption is higher. Solar energy produces in
the day and depending on the weather, not depending on energy demand. There is a need therefore to
invest in energy storage or backup energy means which are very expensive.
2.2. Support Mechanism for Renewable Energies

The economic attractiveness is a critical part of renewable energies deployment and expansion
strategy. If RES do not present a financial return to investors, they will not be able to compete with the
conventional resource technologies. However, it is not obvious to compare a unit cost of renewable
energy to conventional sources. External costs, such as the social and environmental costs, are
included.
Support instruments for RES-E are characterized by three main parameters the type of support
instrument chosen, the degree of harmonization and the specific design elements (C.Batlle, 2012).
All of these have an indirect influence on electricity markets and on grids flows through their impact
on the technology mix and geographical location but also can have a direct influence for example by
setting rules for the participation of RES in the market.
The support mechanisms used to foster renewable energy projects can be classified into direct and
indirect policy instruments. Direct policy measures (Haas, 2010) aim at the stimulation of RES-E on
the short run, however indirect ones focus on developing long-term more favorable framework.
Another layer is considered in the support schemes classification, is whether they are price or quantity
driven mechanism and whether they address the installed capacity or the generated electricity. Support
mechanism design vary from technology-neutral mechanism to technology specific ones, the
differentiation depends mainly on the RES required targets to meet. The differentiation is made on
purpose so that it doesnt allow windfall profits for the cheapest technology. Nevertheless, this is a
source for complexity for policies design parameterization and transaction costs.
2.2.1. Price-driven strategies

The price driven strategies are a financial support in terms of a subsidy received by RES generators. It
can be for the installed capacity (per kW) or a payment for the energy produced (per kWh). Pricedriven strategies such as feed-in tariffs or feed-in premiums tend to be technology-specific instruments
(Haas, 2010), different contracts are offered according to the generation technology and regulators
target.
2.2.1.1.
Investment focused strategies
Entrepreneurs aiming to invest in renewable energy projects can benefit from investment subsidies or
low interest loans. Development banks like BNDES in Brazil, offer attractive financing for renewable
energy projects. Generally, they offer favorable terms including, for example, sixteen-year loans with
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LITERATURE REVIEW
interest rates lower than the other banks. Loans and non-tax mechanism encourage new RES-E
capacity expansions; they lower the cost of investments for entrepreneurs.
Another example is the European Regional Development Fund (A.Poullikkas, 2012) for renewable
energy projects. It supports investors under certain conditions like maximum amount and subsidys
percentage from the eligible costs. These conditions differ according to the location and the size of the
project or company with eventual ceilings to prevent windfalls remunerations.
Whether they are fiscal or financial measures, non-tax mechanisms play an important role in RES
projects expansion today. They are tools used by regulators to trigger supply or demand. Ecotaxes
and carbon taxes for example are imposed on conventional electricity generators. Consequently, they
benefit to RES producers. In addition to that, they send direct message to end-users about the added
value of RES-E. Tax incentives should, nevertheless, be a supplement to attract investors, but not be
the principal focus. Indeed, usually, they dont provide a long-term certainty for investors
(A.Poullikkas, 2012).
2.2.1.2.
Generation based strategies
Feed-in tariffs (FIT)
A feed-in tariff (FIT) support scheme is a fixed payment to RES generators for each unit of electricity
generated. The price is fixed for a certain period under a contract and it is independent of the
electricity market price.
FITs can be differentiated according to the environment they are implemented in. Different contracts
durations, settlement of a cap for particular technologies, installed capacity differentiation levels, and
in some countries, combining this schemes with auctions are factors subject to differentiation.
In the European Union countries, the introduction of FIT was a way to boost renewable energy
expansion, as well as the R&D activities related to the development of this sector. The energy
consumption in European countries is among the highest in the world. They have targeted to generate
20% of their energy production from renewable energy by 2020.
Recently, FIT rates in Germany were reviewed and lowered, the same case happened also in other
European countries. Today, FIT for photovoltaic KWh in Germany pays between 13.50 and 19.50
cents/KWh, depending on the size of photovoltaic projects. These prices are becoming closer to gridparity1.
Since Feed-in tariffs are more applicable in a technology-specific form, it promotes market
development of less mature technologies, leading to potential cost reductions and therefore allow a
high dynamic efficiency. In some cases, the remuneration may be paid for the installed capacity
instead of the generation. It is used to trigger investors reaction to the regulators targets.
FITs have shown remarkable achievements in term of RES expansion as a support mechanism
according to previous experiences. The main factor of this success is reducing uncertainty for
investors; stable revenue flows are offered to them. The level of the feed-in tariff is typically
determined by an administrative procedure on the basis of levelized costs or using an auctioning
mechanism referring to the potential benefits of using RES (Erika de Visser, 2014).
Feed-in premiums (FIP)
In a feed-in premium (FIP) support scheme, RES generators receive a fixed payment on top of the
market price. They have to sell the electricity directly in the market and receive an additional payment,
called premium. It can be a fixed payment or dependent of market price in order to limit both the price
risks for producers and the risks of making excessive profits at the same time (Held, 2014). To
1
Grid parity is a state, at which a developing technology (i.e RES) will be able to produce electricity at the same
cost as conventional technologies.
12
LITERATURE REVIEW
understand the difference between FITs and FIPs; for fixed FITs the total feed-in price is fixed, for
premium scheme, only the amount on top of market price is fixed (see figure 1). For the renewable
plant owner, the total price received per kWh, in the premium scheme (electricity price plus the
premium), is less predictable than under a feed-in tariff because it depends on a volatile electricity
price.
A FiP with cap and floor prices can minimize both the upside and the downside risks as only a certain
revenue range is allowed for RES generators. The cap and floor feature aims to avoid large
divergences between profits and losses. In case of the sliding premium or contract for difference
(CfD), the premium is a function of the market price. The higher the market price, the lower the
Premium (Ragwitz, 2012) .
Figure 1 : Differences between the RES support mechanisms (Meeus, 2012)
2.2.2. Quantity driven strategies

Quantity driven strategies are used by regulators to define the desired level of generation of RES.
They are partly implemented in a technology-neutral manner. In the last years, several countries like,
Italy, Poland, Sweden started implementing quotas mechanisms through technology-differentiation.
This differentiation is established through accrediting different number of certificates to each
technology or via splitting up the target in sub-targets 2 (Held, 2014). Other countries are moving to
auction and to tendering system since they believe it fosters competition and price disclosure. The
financial support for this schemes can either be investment focused or generation based. A
differentiation between tender mechanism and auction is that in auctions, the selection of offers (bids)
is based on price, while tenders may include additional qualitative and quantitative criteria. By
contrast, tender mechanisms use an auction (Grau, 2014) to determine the required remuneration
levels. The tendering process is considered competitive if the total cumulated capacity or generation
bidden exceeds the capacity or the generation that is being tendered. The remuneration of the chosen
bids can be pay-as bid or a common (clearing) price, which correspond to the highest accepted Price.
A maximum Price is set by the regulator or the government to limit the risk of excessively high bids
which can induce a costly support scheme.
2.2.2.1.
Investment focused strategies: Tendering system
Under this scheme, regulator, announce the amount of capacity to be installed. A bidding process is
defined and winners benefit from a set of favorable investment conditions, including investment grants
per installed kW. The level of the incentives to invest is usually technology-specific.
In auctions mechanisms there are three key rules: bidding, clearing, and pricing (Luiz T. A. Maurer,
2011). The bidding rules organizes how offers can be submitted. The clearing defines the methods of
comparison of the bids and the designation of the winner as well as the allocation of the product.
Finally the pricing determines the Price at which bidders will be paid, for example, there is pay-as-bid
type where winners will be paid by the Price they have bidden with. A second type is the uniform
price sealed-bid auction where the winners are paid the highest accepted bid.
called carve-out, where individual markets for tradable certificates are created for each technology.
13
LITERATURE REVIEW
Tendering systems for long term contracts use government or regulator established system to meet
planned targets. Potential investors submit bids with /kWh and they are evaluated by the government
and most suitable bidder is selected and has the exclusive right to benefit from the support granted.
Local electricity distributors or incumbent suppliers are then obliged to buy electricity from the
successful plants on the basis of a long-term contract. Tendering and auctions system has been gaining
ground over the other support schemes due to successful experiences in countries like Brazil and
China. Thus, during the last years, Germany and UK started for instance migrating to auction system
to increase competition among RES generators and to reduce the cost of supporting renewable
energies generators. European countries started using these schemes very lately, starting by Spain in
2007 and UK and Germany in 2013.
2.2.2.2.
Exchangeable quotas
Exchangeable quotas or Quota certificate schemes are used for supporting renewable energy in e.g.
UK (ROC), Italy (Certificati Verdi). They can be compared to the European Emission Trading System
(ETS) with the exception that they depend on the power system regulation and promote RES
expansion, instead of limiting CO2 emissions (Grexel Systems Ltd, 2014) .
Exchangeable quotas introduce binding targets for electricity suppliers to buy either green electricity
directly from the RES-E producers (Adrien De Hauteclocque, 2011), or green certificates issued by
RES-E producers. These targets are defined as a percentage of their electricity deliveries. A
compensation mechanism for the opportunity cost incurred by purchasers is usually introduced.
The basic functioning of energy certificate systems can be divided into three steps: first, producers are
issued electronic certificates for units (typically per MWh) on electricity they inject into the grid.
Second, they can then sell these certificates separately from electricity. Third, the value of the
certificates is derived from their end-use (see figure 2), which is either to comply with a set green
quota and/or to prove that sold or consumed energy originates from the source identified in the
certificate. Non-compliance with the quota leads to a financial penalty higher than the certificates
market price.
Figure 2 : Tradable green certificates scheme (Meeus, 2012)
In a quota system (such as Renewable Portfolio Standard (RPS) or Renewable Purchase Obligation
(RPO) an obligation to buy energy certificates is imposed on a suitable party such as electricity
suppliers and large electricity consumers.
Combination of price and quantity driven strategies happens in practice (e.g. UK and Germany
recently). Indeed, in countries using a quota obligation or auction mechanisms as main support
mechanism, the more small PV farms can be supported through feed-in tariffs.
2.2.3. Indirect strategies

The support for RES can have other form from the one already presented which can be less explicit.
These strategies can have indirect impact on RES diffusion. Aside from strategies which directly
address the promotion of one (or more) specific renewable electricity technologies, there are other
strategies which may have an indirect impact on the dissemination of RES. The most important are:
Eco-taxes on electricity produced with non-renewable sources;
Taxes/permits on CO2 emissions;
14
LITERATURE REVIEW
Removal of subsidies previously given to fossil and nuclear generation;

The promotion of renewable electricity via energy taxes or environmental taxes, two options exist:
- The exemption from taxes (energy taxes, sulfur taxes, etc.);
- If there is no exemption for RES, taxes can be (partially or wholly) refunded.
Regulatory
Voluntary
Summary of the fundamental types of promotion strategies (Haas, 2010)

Direct
Indirect
Price-driven
Quantity-driven
Investment focused Investment incentives
Tendering system for Environmental taxes
Tax credits
investment grant
Simplification
of
Low interest/soft loans
authorization procedures
Simplification
of
authorization procedures
Generation based
FIT/FIP
Tendering system for
long term contracts
Tradable
green
certificate system
Investment focused Shareholder programs
Voluntary agreements
Contribution programs
Generation based
Green Tariffs
15
EUROPEAN EXPERIENCES FOR RENEWABLE ENERGY SUPPORT MECHANISMS
3. EUROPEAN EXPERIENCES FOR RENEWABLE ENERGY SUPPORT

MECHANISMS
For historical reasons, the European electricity network was mainly built on a national basis, or local.
But soon after the war, one of the first acts of the reconstruction of the European countries was to
interconnect their national grids, on the principle of energy solidarity (ENTSO-E, 2013). Since then, a
certain percentage of electricity can cross the countries borders allowing the complementarities of
different networks and different sources of production.
Energy policies are different from a European country to another; however, they fall under the same
objectives set by the European Commission;
- Ensuring the security of supply in the long-term. The Green Paper on energy efficiency points out
that by 2030, based on the present trends, the EU will be 90% dependent on oil imports and 80% on
gas ones. So, diversification is needed.
- Fulfilling the Kyoto commitments on reducing greenhouse gas emissions
- Improving energy efficiency
- Developing renewable energy
- Ensuring sustainable development
To meet these objectives, every European country has implemented different support schemes to
increase the RES integration. This is due to the industrial, political and geographical characteristics of
these countries. Member States are implementing a single or hybrid support scheme by combining all
or some of the RES support schemes. These support schemes have increased penetration of the RES-E
in Europe, making them interesting to the Brazilian case. However, there is still a long way in order to
achieve the 2020 target.
3.1. European regulatory framework

The EU energy policies are set under the same framework through common successive directives set
in order to establish a common market design that aims to the promotion of energy efficiency and the
use of RES. With 96/92/ EC Directive of December, 19th 1996 and the Directive 03/54/EC of June
26th 2003 related to internal electricity market, the European Union concretized the idea of setting up
an integrated electricity market at the level of EU member countries. Yet some countries have not
waited for the EU to liberalize their energy sector, they started setting market reforms for several years
before in a move to liberalize their energy markets. These countries experiences 3 are the inspiration of
these directives of the European Union.
The liberalization of electricity markets in Europe passed by three major steps. The first one is the
stated above 96/92/EC directive. This directive established the grounds for a competitive market for
electricity. It requires a separation of the accounts (of the generation, transmission and distribution
activities) but not ownership of the vertical integrated utilities. It hasnt stated anywhere a requirement
to privatize the electricity sector. Besides, it organizes third party access to the transmission and the
distribution network which can be negotiated or regulated towards a completing the electricity market.
The electricity Directive (2003/54/EC) established the basic regulatory framework for the European
regional market (EP, 2003). It emphasizes on the fair access to the network in order to trigger the
3
UK started market deregulation on 1989 and Norway on 1990

16
market competitiveness that was seen as not sufficient after the previous directive. It defines the
organization of the power sector as well as market access, auctions procedure and network access
conditions.
The third directive 2009/72/EC and the regulation 714/2009 organize the cross-border exchanges in
electricity. The 713/2009 establishes the organization and cooperation schemes between regulatory
authorities. This directive was considered as a completion of the internal European market. It is
supposed to separate the electricity industrys activities; Generation, transmission, distribution and
supply.
3.2. Historical development and current status of RES-E deployment in EU

countries
3.2.1. Historical development at EU level
The European Union (EU) has already tuned its energy policy into achieving maximum carbon
dioxide (CO2) emissions reduction from power generation plants. In this context, it has already set out
a strategic objective of achieving at least a 20% reduction of greenhouse gases by 2020 compared to
1990 levels (Poullikkas, 2011). This strategic objective represents the core of the new European
energy policy. Recognizing the positive effects of renewable energy sources (RES) technologies
towards achieving this goal, the EU has taken a range of specific actions in the direction of enhancing
the integration of RES in the existing European power generation system as a major step towards the
reduction of global warming and climate change phenomena.
3.2.2. Progress at country level

The EU policy has set through the Directive 2009/28/EC of the European Parliament and of the
Council on RES a mandatory national target for each Member country for the share of energy from
RES in the final energy consumption. Thus every country has adopted different RES support schemes
to achieve theses target. These differences are due to the particular characteristics of each country:
RES potential, existent energies, political orientation.
The main support mechanisms at the national level in Europe:
-Feed-in tariffs (FIT), Feed-in premiums (FIP), Quota obligations with TGC, Loans, Investment
grants, Tax incentives and Tendering schemes
Figure 4 shows the policies choices by country at the European level.
Figure 3 : Diversity of RES-E support schemes in the EU-28 (Ecofys, 2013)

17
The goal is to reach the 2020 targets. National target levels are different from a country to another
according to the initial generation mix of the year 2005. Table 2 shows the indicative trajectories of
the EU member states over the years from 2010 to 2020. The targets percentage is calculated by the
equations in table 1 is reported in Figure 5 that presents the percentage of RES in the gross
consumption in year 2005 and the target set for 2020. It indicates the average share of RES that the
member states should have in every two years period until 2020. The concerned States have to
implement adequate policies to reach or exceed the share of energy from RES.
Table 1 : EU Member States RES indicative trajectory
Indicative trajectory
S2005 + 0.2 (S2020-S2005)
Notes
As an average
to 2012
S2005 + 0.3 (S2020-S2005)
As an average
to 2014
S2005 + 0.45 (S2020-S2005)
As an average
to 2016
S2005 + 0.65 (S2020-S2005)
As an average
to 2018
S2005= The share of the member state RES in 2005
S2020= The target share of the member state RES in 2020
for the two year period 2011

source: The Renewable Energy Directive 2009
Figure 4 : EU member states RES targets for 2020

According to Eurostat News release of 10 March 2015, Sweden with 52.1% of RES share has by far
the highest share of energy gross final consumption at the EU level. It is followed by Latvia with
37.1% and Finland with 36.8%. In those countries, renewable energy share is historically high due to
hydropower. In contrast, the lowest proportions of RES are in Luxembourg 3.6%, Malta 3.8% and the
Netherlands 4.5%.
The EU countries achievements as for 2013 differ between countries. Energy from RES in gross final
consumption reached 15.0% compared to 8.7% in 2005. Three countries Bulgaria, Estonia and
Sweden out of the 28 have already reached their 2020 targets according. Moreover, countries like
Italy, Lithuania and Romania are less than 0.5 percentage points from their 2020 targets. On the
opposite side of the scale, the United Kingdom (9.9% from 2020 target), the Netherlands (9.5%) and
France (8.8%) are on the bottom of the ladder.
18
3.3. Country-specific learned lessons

In order to focus into specific countries experiences in RES support schemes, we chose to focus in two
different European experiences; Feed-in Tariffs in Germany and Quota mechanism in United
Kingdom. This choice is driven by the type of the mechanisms they have deployed, their achievements
and their future plans. The German experience has achieved interesting performance in matter of RES
expansion. The FIT chosen has reignited controversy due to the high cost of this mechanism. The
British experience has been chosen to analyze the performance of the quota mechanism deployed
there. Both of the countries are currently passing by a transitory period where they are changing their
support schemes to boost RES expansion in a competitive and cost efficient environment.
3.3.1. Case study Germany

3.3.1.1.
Overview of the German experience
Germany is one of the countries that have experienced a rapid growth of renewable energy integration
in the last years. The German experience can be portrayed as a success story. In addition to European
goals, Germany has, for many years, its own energy policy promoting renewable energy: The
Energiewende or the energy transformation. After Fukoshima disaster in 2011, the German
government has decided the complete cessation of nuclear plants by 2022. It seeks for establishing a
nuclear-free and a low-carbon economy through increasing RES share. Germanys national goals are
the reduction of carbon dioxide emissions by 90 % compared to 1990 levels and to reach 80% of its
electricity generation by RES in 2050.
In 1989, Germany launched a market stimulation program to boost the installation of 250 MW of wind
power. It offered a fixed payment per kWh in addition to investment incentives for private operators
such as farmers. This program was effective until 1995.
In parallel, Germany has set in 1991 a fixed FIT support scheme for RES-E through the Electricity
Feed Law of December 1990. This program aimed at the direct market integration of RES started
promoting significant amounts of RES by promoting its investments. The significant advantage of the
Electricity Feed-In Law is its simplicity. It stated that grid operators pay about 80 % of electricity
retail prices as FIT for RES-E (Held, Feed-In Systems in Germany, Spain and Slovenia, 2007).
Furthermore, it obliged electricity suppliers to accept the electricity fed into the grid as well as priority
scheduling and dispatch,.
In year 2000, a Renewable Energy Act succeeded to the fixed FIT and a target of 12.5% for the
RES-E was set for 2010. This act introduced the uncoupling of the tariff level from the electricity
retail price. A differentiation for tariffs was set on technology level and also within the same
technology: the location for wind farms and fuel type for biomass. This new tariffs were based on the
real generation costs of a technology. Contracts up to 20 years for the FIT were proposed to attract
risk-averse investors.
In a later stage, the regulatory authorities introduced a cap to prevent excessive charges on grid
operators. A cap of 5% of the share of RES-E in the grid to be paid by grid operators was set.
The Renewable Energy Act introduced also a tariff digression for new installations to encourage
cost reduction also called the ratchet effect. The FITs for new projects decrease each year by a legal
percentage (or by law amendments). It encourages technology learning and R&D improvements in
order to decrease the policies costs.
In 2011, the German decision to phase out nuclear power has led to the shutting down of eight
reactors. First, Germany imported more electricity to compensate these plants. However, after one
year, there was a reversal trend, particularly related to the ongoing development of renewable energy,
which helped to drag the wholesale electricity market prices down in Germany. But not only that, the
decline in the price of coal and CO2, rooted in the electricity prices in Germany participated in falling
the prices (Agora Energiewende, 2014).
19
Another current challenge in Germany is the location of the majority of their wind plants. They are
concentrated in the northern part of the country. They are adding grid constraints not only to the
national network operators but also in operators in the neighboring countries. Indeed, Central and
Eastern European countries like Czech Republic and Poland are moving to disconnect their power
lines from Germany as wind-generated electricity is overloading their network and might cause
blackouts (The Institute for Energy Research, 2013). However, supporters of RES integration
dissociate this problem and put it on the grid operators side.
In 2014, a new reform of the German renewable energy law has introduced an auction model aiming
to replace over the feed-in tariff. Several previous experiences in Brazil, California and China showed
interesting results in competitive auctions. Indeed, due to longer project durations for large PV
projects there are high uncertainties about price modules and FIT levels.
The German renewable energy law of 2014 states that support for RES will be determined in
competitive tendering procedures beginning no later than 2017 (European Commission, 2013). Only
the details of solar PV are disclosed so far. An amount of 600 MW of solar PV capacity per year will
be tendered in two or three auctions starting from 2015. It targets PV arrays larger than 100 kilowatts
but smaller than 10 megawatts.
The first tendering was done on April 2014 and resulted in a winning Price of US$101.91/MWh for 25
projects and a capacity of 157 MW. The authorities received 170 bids being 4 times the tendered
amount for a ceiling Price of US$130/MWh (Business spectator, 2015).
The result was however marginally above the market Premium model for solar power prices which is
$100/MWh.
100000
25
80000
20
60000
15
40000
10
20000
Cost (b)
Installed capacity (MW)
3.3.1.2.
Cost of the mechanism
During the last decade, German policy makers have created different mechanism and policies to
support renewable energy. Generous subsidies and purchase tariffs were imposed to finance energy
policy "Energiewende" which targeted a nuclear-free economy and low CO2 emissions.
Although these subsidies have fostered an impressive deployment of renewable energy sources since
the 2000s, they have also created an imbalance of energy markets affecting the reliability of
production. This results in increases in electricity prices for most users, and distortions on investments
decisions. Every new megawatt (MW) of RES is subsidized which make them not market price
sensitive.
Moreover, policy makers have underestimated the cost of subsidies to renewable energy and its impact
on the national economy. As figure 6 shows, the cost of RES has been increasing considerably since
its establishment reaching 21.7 bn in 2014 for a total of more than 300 bn.
On the other hand, conventional energy generators are now operating in less stable conditions to
compensate the intermittency of renewable energy sources generation to maintain the balance between
supply and demand. Moreover, expensive renovations are needed for these plants to enable them to
answer quickly to any unforeseen change in their operational requirements. As a result, gas production
units receive financial compensation in order to remain economically viable in case of temporary
needs.
20002001 20022003 200420052006 20072008 200920102011 201220132014

Installed capacity of RES
Cost of the RES
Figure 5 : RES Installed Capacity and Cost in Germany (Oxera and Energiewende, 2014)
20
3.3.1.3.
Social acceptance
The energy transition in Germany is driven primarily by citizens. According to a survey done by Forsa
in 2010, 95% of German citizens ask for more RES deployment and 73% agree on having RES farms
on their neighborhood (RWE, 2012). However, it isnt guaranteed to continue if the electricity prices
keep increasing. On the other hand, Citizens investment in RES distributed generation appears as a
promising alternative that governments support to increase renewable energies diffusion. In Germany,
the number of cooperatives jumped from 77 in 2005 to 1000 in 2015 with about half of the renewable
energies installed capacity. The involvement of German citizens focuses on photovoltaic, onshore
wind and biomass.
3.3.1.4.
Lessons
The RES integration in Germany has allowed the saving of tones of CO2 and the creation of about
370,000 jobs. However, an important drawback of the FIT support schemes is it is high cost, one of
the highest at the European level during the last 15 years.
Globally, the German experience is considered a success story so far. Thanks to the implemented
support schemes, the installed capacity of wind and solar energies has been continuously increasing.
However, we can see in figure 7 that there are different trends between wind and solar plants
deployment. The wind energy has experienced an important growth between the year 1999 and 2010
while the solar energy diffusion started latter. Indeed, the solar energy installed capacity has only
grown after 2006. But, it experienced an exponential increase to surpass the wind capacity for the first
time in 2012. This is due to the preferential FiT that expresses the governments objectives.
40000
35000
30000
25000
20000
15000
10000
5000
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Wind installed capacity (MW)
Solar installed capacity (MW)
Figure 6 : Wind and Solar energies installed capacities in Germany
However due to the high cost of this support, the regulatory authorities are moving towards a
tendering mechanism for electricity investment. This is done in order to limit windfall gains from
which benefited for some investors under the FiT scheme. Even though, the auction of April 2015 has
resulted in a price marginally higher than the market premium. It is still not very positive according to
the expected results. Another problem with the recently implemented tendering is the lower limit for
projects capacity, which is 100 KW; it is hard to expect small businesses to go through the auction
paperwork. Auctions should be for professional investors (FGinsight, 2013).
The German model of cooperative society could serve as support for reflection on how this can be
implemented in other framework. It is clear that this is due first to the general awareness of German
citizens. However the German case is leading due also to a simplified legal framework and less
hampered economic viability. Indeed, only three members are needed to create a cooperative, the fact
of limited liability of members is recognized, the capital is variable without a minimum of
21
establishment and the association of new members is done without notarial requirements. Finally, if
there can be democratic governance (1 member = 1 vote), it can also be based on the shares held. The
involvement of local actors is a key asset for the success of community projects. Such participation
allows the community to achieve its goals of energy policy in the context of a shared approach with
the locals.
In Germany, cooperatives are exempted from the obligation of financial prospectus publication and
thus the need to obtain authorization from the Financial Regulator. However, they are audited by the
regional federation of cooperatives control.
In addition to that, the profitability of cooperative societies isnt something to hide, but instead
represents a key element of massive deployment of renewable projects by citizens taking advantage of
relatively favorable regulatory framework and access to preferential loans. The cooperatives show a
return on investment of 4% on average (Actu-environnement, 2014).
The self-support feature of the cooperatives and the direct benefit of ownership to the cooperative
members raised the popular acceptance of the energy transition and made people more aware about the
process leading them to change their behavior. The benefit isnt only financial; people are directly
involved by owning a part of the energy system. This social complicity in the energy transition
boosted the private investment in RES generation and formed a helping hand to the government in its
policy to increase the RES share.
3.3.2. Case study UK

3.3.2.1.
Overview of the UK experience
The UK is on track to meet its renewable energy targets. With a quarter of its existing generation
capacity set to close over the next 10 years due to environment barriers, new regulation or lifecycle
limit, wind and solar power are trying to replace conventional generation farms. To support this
transition, there are different RES support schemes for electricity generation: feed-in tariffs, Contracts
for Difference 4(Cfd) and a quota system in terms of a quota obligation and a certificate system.
The Quota Obligation was set in 2002 in England and Wales, and Scotland, followed by Northern
Ireland in 2005 (Ofgem, 2013). It was the main support mechanism for RES projects until 2014. It
places an obligation on UK electricity suppliers to allocate an increasing amount of the electricity they
supply from RES. The quota scheme concerns electricity suppliers with a capacity higher than 5 MW.
A quota is satisfied if he presents a certain number of green certificates. These certificates are traded
between conventional and renewable energies suppliers. If suppliers do not present a sufficient number
of TGC to meet their obligation, they must pay a penalty.
Smaller scale generation, plants with a capacity under 5 MW, is mainly supported through the Feed-In
Tariff. Eligible plants must undergo to an accreditation process (RES-Legal, 2014) and the scheme
may differ according to generating plant size and energy source. Once this process is completed and
the plant has been accredited, the electricity is fed into the grid and bought by the FiT licensee. The
FiT rates are corrected yearly by the Gas and Electricity Markets Authority (Ofgem). This scheme is
applicable to England, Wales and Scotland only.
In 2014, The UK government has published the final framework governing how it will allocate
contracts for difference (CfDs), a new support scheme that will replace the existing ones including the
Quota Obligation (QO), which will be phased out by the year 2017.
A Contract for difference as defined in wikipedia is a contract where both parties agree a strike price for
defined time periods. Then when the spot Price in any time period is higher than the strike price, the generator
will refund the difference. Similarly a retailer will refund the difference to the generator when the actual price is
less than the strike price.
22
Under the Contracts for Difference (CfD) scheme, a RES-E generator and a CfD Counterparty enter
into a contract, which is based on a difference between the market price and an agreed strike price.
Currently, the scheme is applicable in England, Wales and Scotland. It is expected to be introduced in
Northern Ireland in 2016. Starting from April 2017, the CfD scheme will be the only support scheme
for all new RES-E plants exceeding 5 MW.
Figure 7 : The operation of an intermittent FiT with Cfd (EMR White Paper, 2014)
The figure above explains the functioning of a Cfd. A strike price with the top redline is set at
70/MWh and the wholesale price is represented by the black line. When the wholesale price is below
the strike price, the public authority pays the generator the difference (green area). On the contrary,
when the wholesale price exceeds the strike Price on the right of the graph the generator pays the
public authority the difference shown in the red line down.
The replacement of quota obligation by Cfd came since the QO and Final investment decision (FID)
enabling scheme failed to bring the expected results and defending consumers interests. They caused
relatively windfall gains for generating (RES-Legal, 2014).
The FID was actually introduced to enable investors take investment decisions impacting on the time
to commissioning the Project. It was established especially to reduce the uncertainty caused by the
transition to the CfD regime.
3.3.2.2.
Cost of the Mechanism
The main mechanism adopted for RES support in UK was Renewables Obligation deployed since
2002 to enhance RES expansion and attract private investors. It is a complex mechanism that puts an
obligation on suppliers to purchase a percentage of their electricity from renewable producers. The
value of this scheme can be divided in two layers; the value of the fine avoided, and the expected share
of the fines paid by other competitors (REF, 2011).
There is theoretically a risk for the value of the certificate, however according to data history this
value would remain stable over the life of the scheme with 50 approximately. The wholesale
electricity Price has varied in the recent years from 25 to over 40 now. As a consequence, the
renewable generator expects to receive between 75 and 100/MWh which is around 50% above of
the electricity wholesale price. This RO can be seen though as a cost pass-through to costumers. The
costs of the Renewables Obligation were nearly 1.8bn a year in 2011 to 2012, rising to 3.2bn a year
in 2014 as shown in Figure 9.
23
30000
3,5
25000
3
2,5
20000
15000
1,5
10000
Cost (b)
Installed capacity (MW)
5000
0,5
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Installed capacity of RES
Cost of the RES
Figure 8 : RES Installed Capacity and Cost in UK (Ofgem, 2013)
This generous scheme has attracted several investors and resulted in a high deployment of Renewable
energies generators as it can be seen in figure 9. Installed capacity has grown especially after 2010 but
its level is still below the annual targets. It indicated that regulators needed to change this scheme to
meet the 2020 targeted capacity.
The quota mechanism has however led to huge differences between renewable technologies
overcompensation for ones (wind energy) while giving not sufficient remuneration for others (solar).
For this reason and others, OFGEM, the British regulator for electricity and gas, and the British
government decided to replace the Renewables Obligation scheme with the Contract for Difference
(CfD) based on auctions starting from 2014. However, the RO scheme will be kept open as an
alternative for new RES projects until March 2017 and the tradable green certificate market will be
running until the end of their period, 2037.
3.3.2.3. Social Acceptance
Public acceptance is as an important issue shaping RES deployment by influencing political decisions.
In UK, some regional surveys have attempted to identify levels of public understanding and awareness
opposition towards renewable energy. There is a common trend for supporting RES among UK
population with 73% of them holding positive attitudes towards RES-E. The main driver is
environmental concern about climate change (Mastropietro, 2014).
However, levels of awareness and opposition change between age groups being lower in younger and
older ones (1624 and 65+) compared to middle-aged respondent class (3544 and 5564 years). On
the other hand, the social class, income and age present a positive correlation with the levels of
support for RES-E expansion. In addition to that, Devine-Wright empirical studies (Devine-Wright,
2008) show political decisions are in phase with social acceptance of RES technologies. Solar
technology is however more supported than other type of RES with 84% of the population supporting
the use of it compared to 72% for wind and 64% for biomass according to the British Department of
Energy & Climate Change data of 2012.
Since 2012, a growing number of people start choosing to start renewable energy cooperatives in their
communities. This shows that the British population made a further step in their support of RES being
directly active in RES diffusion. With financial crisis, this is a considerable help for governments in
order to achieve their RES targets set by EU.
24
3.3.2.4.
Lessons
The CfD regime is considered as a massive improvement compared to the previous support schemes.
It is an enhancement in both budget management and RES plants competitiveness.
CfDs will provide guaranteed payments to operators and thus decreasing uncertainties for them
without risking excessive remuneration when market prices are high. The payments are set according
to the technology strike Price and the market reference Price. The chosen generators are the ones with
lowest bids below the maximum.
To better evaluate the increase of competitiveness, an analysis of the Contract for difference auction
results is necessary. The results published on February 26th 2015 shows the acceptance of 27 projects
with a total capacity of 2.1GW sharing subsidies of 315million per annum by 2020/21.The resulting
strike prices were around 17-18% lower than the auction starting prices (Howard, 2015).
For distributed power generation projects, UK has in turn made the choice of a fund with 10 million
pounds (about 12m) to support them. Considering the German cooperatives experience, the British
government wants to encourage the development of cooperatives and collective actions to reduce
energy consumption. For now, only 60 MW of projects have been financed by citizens. Studies (Actuenvironnement, 2014) estimate between 0.5 and 3 GW the volume of projects that could be financed
collectively by 2020 in the solar, wind and hydropower, accounting for 2.2 to 14% of installed
renewable capacity by the same date.
25
THE BRAZILIAN CONTEXT
4. THE BRAZILIAN CONTEXT

4.1. Overview of Brazil
Brazil is the world's seventh largest economy in term of GDP and the largest in Latin America. The
economical growth that happened over the last two decades is due to the abundant natural resources
(oil, gas, minerals, hydropower potential) and dynamic industrial sectors (food industry, biofuels,
aviation, automobile). The current Brazilian governments priorities are accelerating growth and
reducing inequality in compliance with fundamental economic balances. However, it needs to cope
with the recession in which the Brazilian economy fell the last year. Indeed, after a very strong
growth, the economy showed signs of slowing since 2010 (GDP growth was 7.5% in 2010, 2.7% in
2011, 0.9% in 2012, 2.3% in 2013, 0.1 % in 2014), (BBC, 2014) "This recession shows the exhaustion
of a growth model that has been centered on internal consumption," said Eduardo Velho, chief
economist at investment firm INVX Global in Sao Paulo to BBC. The decrease of commodities export
prices and the decline of household consumption, industrial activity and investment are the main
factors that led the Brazilian economy to enter recession in the first half of 2014. Over the year,
economic growth was 0.1% and IMF forecasts a reduction of Brazilian GDP in 2015. In addition to
that, Brazil is facing difficulties to control inflation, a devaluation of the Real and a degradation of
Public Accounts (deficit of 5.9% GDP in 2014).
Concerning the electricity sector, the Brazilian interconnected system has an installed capacity of 125
GW, which is expected to reach 200 GW by late 2023 (Melo, 2007) . The RES share is 80% of total
installed capacity as presented in figure 3. This is mainly due the important share of Hydropower
which accounts for about 67% of existing capacity in Brazil. Some of the hydropower plants have
multiannual reservoirs. In addition to that, the main conventional sources used are nuclear, oil, natural
gas and coal plants.
Industrial gas 1%
Wind 4%
Biogas 0,1%
Solar 0,01%
Coal 3% Nuclear 1%
Hydro
Fossil 6%
Natural Gas
Biomass
Fossil
Biomass 9%
Coal
Natural Gas 9%
Nuclear
Hydro 67%
Industrial gas
Wind
Biogas
Solar
Figure 9 : Brazil Installed Capacity in 2014 (Ministrio de Minas e Energia, 2014)
26
4.2. Electricity policies of Brazil

The Brazilian energy sector was partly privatized in the 1990s. The decision to privatize the power
sector was made by President Cardoso at the beginning of his first term in 1995 (Ferreira, 1999). This
reform took place due to the need for boost investments as to ensure the security of supply. Privatizing
the electric power sector meant also to reduce public sector debt. Brazil main focus was to ensure
enough thermal and renewable resources to provide firm energy during a dry period, as hydropowers
share in the power mix was about 90% of electricity generation at that time. It makes the Brazilian
power sector one of the greenest or bluest in the world. However, this reliance on hydropower has
shown its limit in 2001 after several consecutive drought years. Diversifying the Brazilian energy mix
was necessary to avoid the impact of drought scenarios.
In the last 22 years, electricity production was multiplied by 2.5 (Barroso C. B., 2011), however the
production of renewable energy couldnt follow this pace. Although hydroelectricity doubled its
production and biomass increased nine times, the total RES growth was only 116%. The rest is
supplied by conventional energy sources; nuclear power has multiplied its production by seven. Thus
it was necessary to use fossil fuels to complete: their production increased by eight, and their share in
the energy mix grew from 10% to 14.6%.
The largest power company in Brazil is Centrais Eltricas Brasileiras (Eletrobrs). The Federal
government owns it. Through its subsidiaries, Eletrobras controls 40% of electricity production
capacity in Brazil and 69% of the national grid. Since 2008, it was allowed by a new legislation to
invest outside of Brazil. It is the largest electric utility in South America. Tractebel Energia is the
major privately owned company in the Brazilian electricity sector. It owns 11 power plants in Brazil: 6
of them are hydroelectric and 5 are thermal.
The different structural reforms adopted since the liberalization of the Brazilian electricity are cautious
and gradual. However, this didnt prevent some retrograding steps between the different reforms
introduced in the regulatory framework. More details are given below.
4.2.1. First reform of the electricity market: 1990s

Brazil started to reform its power sector in 1995 with privatization of its major electricity distribution
companies and the unbundling of the electricity main activities. The reform allowed IPPs to enter the
electricity market and generation companies was partly or fully privatized. Besides, a nationwide
system operator ONS, Operador Nacional do Sistema Eltrico, and an independent regulator (ANEEL)
were created. Consequently a wholesale electricity market was established in 1998. This reform was
introduced to attract private investment since it was difficult for the Brazilian government to follow
the pace of the economic growth and the increasing need for new electricity generation. However, due
to the complexity of the Brazilian electricity industry and the incomplete regulatory reform structure;
an important part of the industry remained state-owned. Indeed, ANEEL was created by Law 9427 of
December 26, 1996, about two years after the start of the reform. Due to the need for investments,
government wanted to give a liberalization friendly image in order to attract investors. Thus, it started
the reform even before an electricity regulator had been established. In two years, about 10 distribution
companies had been divested for $12 billion (Almeida, 2005). This reform was encouraged by the
economic crisis in the 1990s and the perception of a lack of efficiency of the public utilities. It led,
however, to a divestment of state assets.
This market-oriented reform wasnt much successful. It hasnt covered all the generation investment
needs and it resulted in higher consumer tariffs. As a matter of fact, in the last semester of the year
2001, Brazil faced a severe electricity supply crisis. A reform of the reform was led by the recently
established Chamber of Management of the Electricity Crisis which brought some structural changes
to improve the model. Many problems still existing however thats why there was a need to revise the
reform as a whole to correct the occurring problems.
27
4.2.2. Second reform of electricity market: 2004

The second electricity reform process started in 2004 following an electoral commitment of President
Lula. It was seen as a counter-reform, implemented to overcome problems of the previous reform. It
came due to the gradual loss of control over electricity planning. It aimed to insure the security of
supply and limit the rise of electricity prices. The short term wholesale market introduced in the first
reform was replaced by long term contracts which became the only way to trade electricity (Melo,
2007).
The main changes introduced by this reform were the creation of two energy trading markets; The
Regulated Contracting Environment (ACR in Portuguese) where a distribution companies buy energy
in public auctions and a Free Contracting Environment (ACL) where large consumers and generators
are free to choose each other outside the centralized auctions. The energy is negotiated through
bilateral contracts.
The results of the second reform process remain somewhat ambiguous to date. It increased the pace of
generating capacity expansion; however, the new power plants are expensive and bring high CO2
emitting sources.
4.2.3. National Policy on Climate Change: 2009

Between 1990 and 2005, Brazils greenhouse gas emissions rose by 60%. Thus, In December 2008,
the Brazilian Government launched the National Climate Change Plan. It aims mainly to reduce GHG
gas emissions through mitigation and adaptation efforts (UNESCAP, 2013), promotion of renewable
energy, reducing deforestation and loss of forests and R&D. The plans objectives concerning energy
are:
Increasing of ethanols domestic consumption by 11% per year by 2020
Increasing the contribution of co-generation electrical energy, especially of sugarcane biogases, to
11.4 % of the total supply of electricity in the country by 2030.
4.3. Renewable energy potential

There is a foggy issue that needs to be explained when dealing about renewable energy in Brazil; it is
true that Brazil produces 83% of its electricity from RES. However, 77% is from hydropower. The
wind energy share among the installed capacity is around 4% and the solar installed capacity is even
lower. Brazil wants to increase the share of new RES to insure the security of supply. Diversifying its
procurement sources next to the hydro ones will reduce the rain dependency and the fear from dry
years.
Brazil can rely on an interesting wind potential, variable according to estimates, particularly in the
northeast of the country on the coasts and mountains where the average wind speed is the most
important, averaging over 8 m/s. On the other hand, located on either side of the equator, the country
enjoys a sunshine therefore greater than 5300 Wh/m2/day (E. Melo, 2010) in most parts of the country
and therefore in favor of photovoltaic and sugar cane cultivation.
Photovoltaic has a huge potential. The little use of it may seem surprising. However, the development
of this energy in a centralized market is hard especially with the competition of other types of sources.
The installation of photovoltaic panels connected to the grid would be a better energy security
guarantee against a weakened network by a massive hydroelectric reliance produced at places far from
the consumption.
Moreover, Brazil, has a considerable advantage in a solar industry thanks to its high production of
metallurgical silicon (3rd in the world), a basic raw material to manufacture solar PV. Although, there
is a certain dynamic in the private sector investments with the development of several projects and the
construction of power plants, the installed solar PV power current is still very limited. Brazil must
invest in R&D, but also provide a framework that supports the deployment. This framework should be
28
both legal and in particular for connecting PV panels to the network via an inducement of financial
assistance since the cost of this energy is still high.
In 2011, UTE Norte Fluminense, a subsidiary of EDF has opened the doors of the first solar plant in
the country. Located in Maca, in the State of Rio de Janeiro, the installation consists of 1,800
photovoltaic panels with a capacity of up to 320 KW in times of strong sunlight. The solar energy
provides power to the thermoelectric plant in Maca and reduces CO2 emissions by 250 tons per year.
4.4. RES support mechanisms

In 2002, following the first reform of the Brazilian energy sector, a FIT support scheme was set by the
Brazilian government under PROINFA, the Programme of Incentives for Alternative Electricity
Sources (IRENA, 2013). The PROINFA supported three sources; wind, biomass and small-scale
hydro.
4.4.1. Proinfa: quota & feed-in tariff scheme

The program, called Proinfa (Programa de Incentivos s Fontes Alternativas de Energia Eltrica in
portuguese) helps RES independent producers to increase their contribution of the national grid
supply. Proinfa was designed in two phases. The first involved the installation of energy infrastructure
capable of producing 3,300 megawatts of electricity, a little more than 4% of electricity generating
capacity in 2002, divided evenly between biomass, small hydro and wind power. The second phase of
the program was to increase the share of these energy sources by 10%. However, new regulations on
the energy sector forced the revision of these objectives and the second phase of PROINFA was not
accomplished.
Project submission was open until December 2006 in order to benefit from the PROINFA tariffs,
however, the implementation has been gradually postponed until 2012. A 20 year contract was offered
to each selected project. The generated electricity by RES producers is purchased by Eletrobras, which
sells it to final consumers as a portion of their actual consumption. The cost of this FIT is levied to
customers electricity bills. The average price paid under this scheme for wind farms in 2010 was
about 140 US$/MWh, USD 96/MWh for small hydro, and USD 70/MWh for biomass (Barroso C. B.,
2011). PROINFA led to the development of 1,136 MW of wind power, 111 MW of biomass, and 992
MW of small hydropower.
Regarding the RES integration, PROINFA could be seen as a successful policy for starting the RES
expansion in Brazil. However, if we focus in the cost of it, it turns out that this success was very
expensive. In fact, it resulted in an increase the electricity prices. The efficiency of this reform is a big
issue; information asymmetry between suppliers and government was the main hurdle for reaching
efficient payment rates. In addition to that, projects were selected based on the date of environmental
permit submission in a first-come, first-served base. This has led to a black market for environmental
licenses (IRENA, 2013). In addition to that, obtaining the environmental license isnt easy to take as
their requirements change often. Moreover, due to grid connections issues, several RES projects have
to be kept offline during some periods of the day. Several projects faced larger cost, delayed or even
aborted. Another difficulty was the BNDES local content requirement to finance RES projects. It
required that 60% of a RES projects costs to be supplied by local Brazilian manufacturers. However,
for wind projects at that time, there was only one supplier in Brazil, which caused several delays for
wind projects.
4.4.2. Incentives on wire costs for selling energy contracts at the free market
In 2007, under the framework of the second reform, an additional support mechanism took place in the
form of a deduction to free consumers 5 on distribution and transmission tariffs for buying energy from
RES. Indeed, depending on the distance between generation and consumption sites, the consumer pays
the distribution companies for using the grid. These consumers get a discount in form of a cross
5
Consumers which has the right to choose their suppliers and whose demand exceeds 3 MW in voltage, equal or
superior to 69 kV, or at any voltage level if the supply started after July 7th 1995
29
subsidy on wires tariffs paid by all captive consumers. It can be seen as an additional support for RES
so that they can sell high-priced energy contract and compete with the other conventional producer.
The tariff is set by the regulator, who is responsible for adjusting it so that he guarantees the economic
balance of the distribution companies.
4.4.3. Current Structure: Technology-specific auctions

Brazil with Chile, UK and Portugal were among the first countries to adopt renewable energies auction
schemes. The Brazilian Federal government laid the foundations for a New Model for the Electricity
sector between 2003 and 2004, based on different laws, and decrees.
The 2004 Model created an entity to establish long term planning in the electricity sector (The Energy
Research Company EPE). It also implemented an institution to assess the security of electricity
supply (the Electric Sector Monitoring Committee-CMSE) and an institution dealing with
commercialization of electricity in Interconnected System (the Electric Energy Commercialization
Chamber -CCEE), which substituted an old one (The Wholesale Energy Market MAE). Other
important changes occurred such as the definition of the Ministry of Mines and Energy (MME) as the
Conceding Authority and expansion of the autonomy of the National Electric System Operator
(ONS).
With regard to energy commercialization, two environments were established for contracting energy:
the Regulated Contracting Environment (ACR), with the participation of energy generation and
distribution agents, and the Free Contracting Environment (ACL), in which Generation Agents,
Traders, Importers & Exporters and Free Consumers participate.
4.4.3.1.
The Regulated Contracting Environment (ACR)
In Brazil, the auction process is centralized and project specific in order to attract new generating
capacity in a competitive way to ensure efficiency. It takes place in the ACR, Regulated Contracting
Environment. The auction scheme is a hybrid type one, where the first phase operates as a descending
clock auction6 then the second phase operates as a pay-as-bid sealed-bid auction. In this case, the use
of a hybrid auction aims at taking advantage of the benefits of both auction systems: price discovery in
the descending clock auction and avoidance of collusion (Luiz T. A. Maurer, 2011). In descending
clock auction, participants can exit at any specified intermediate Price. The Price is then known by the
rest of the bidders. However, winners are not obliged to disclose their bottom lines. This type of
auctions allows a more precise expression of bidders costs and provides valuable feedback to bidders
of competitors prices in real time. Along with its transparency, descending clock auction selects the
most efficient firms as suppliers7.
The distribution utilities sign then bilateral contracts with the generators who offer winning bids in
each auction. Since each producer signs contracts with every distribution utility, risks are spread out
among sellers (as well as among buyers). ACR is expected to achieve gains of scale. The contracts
duration are for 15 and 30 years in order to reduce risks for investors and generate efficient price
signals to enhance the planning of the generation capacities expansion.
There are three types of ACR Auctions separated for a better risk allocation between existing and new
plants:
Auctions of Energy from Existing Power Plants;
Auctions of Energy from New Power Plants;
Auctions of Energy Adjustment (just for Existing Power Plants).
In decending clock auctions, all items are auctioned simultaneousl. In each round, the auctioneer announces the
current price for each product (electricity) which is lower than the previous round one and bidders answer by
staying in or going out of the process. Every exit is definitive. Prices go down until the aggregate supply
reachs demand. At the end, everybody is paid the closing Price.
7
Latter the first phase was removed.
30
The objective of the auctions for existing power plants is to meet the current demand. However, for
auctions of energy from the new plants, they must add capacity to meet the demand growth. The
Auctions of Energy Adjustment correct any mismatch between contract and actual load.
The existing energy auctions take place under contracts from 5 to 15 year and with energy delivery of
one year ahead (A-1) (E. Melo, 2010). The New energy auctions contracts last between 15 (thermal)
and 30 (hydro) years and with delivery five (A-5) or three (A-3) years ahead.
For Adjustment Auctions the contracts dont last more than two years and they are signed up to one
year ahead between one seller and one distribution utility.
Under the ACR framework, there are two modalities for auctions supply contracts (E. Melo, 2010):
Contracts for delivered energy in which all hydrologic risks are taken by producers to supply the
energy contracted.
Contracts for energy availability, in which all risk of energy production deviations relative to the
contract are assigned to the pool and then passed through to captive consumers.
4.4.3.2. The Free Contracting Environment (ACL)
The Free Contracting Environment (ACL) was established by Law 9,074/1995, altered by Law
9,648/1998 and then by ANEELs Resolution 264/1998. Under this framework, free consumers can
choose their electricity supplier. Electricity is freely traded between generators, IPP, self-producers,
traders, importers and Free Consumers while paying transmission and/or distribution tariffs to the
system operator. The ACL includes also bilateral contracts between generators and distributing
companies, signed before the establishment of the ACL law. They remain effective until their
expirations. The contracts last for different periods, however, short-term contracts are predominant
(Sioshansi, 2013). Agents are free to define prices, quantities, durations and hedge clauses for these
contracts. Only Public generators need to pass through public auctions when they contract in the ACL.
The Law 10,848/2004 established new rules allowing free consumers who had contracts with
distribution companies to migrate to the ACL. They must inform 1 to 3 years in advance to switch to
the ACL.
Once a consumer opts for the Free Contracting Environment they may only return to the regulated
environment after notifying their local Distributer five years in advanced, or a shorter period, at the
discretion of the Distributer.
4.5. Investment decision in renewable energies in Brazil

An agent who is planning to invest in new power plants has now two options:
Bid in the ACR market (auctions)
Sell a long term bilateral contract in the ACL
In 2014, auction prices were among the lowest ever recorded for solar energy (BNEF, 2014) which
caused certain reluctance among RES investors. Auction prices for wind energy werent much more
attractive. The auction for wind energy of last year resulted in the contracting of 769 MW across 31
projects at a clearing price lower than the estimated best-in-class. Which for a country seeking to
increase its RES-E, apart from hydro, makes- the situation more challenging for regulators to set the
suitable policy.
Few years ago, electricity prices were also relatively low in Brazil; there have been only few projects
with sufficiently low costs than could be implemented. However, the FIT scheme that was set until
2005 played an important role to support RES projects. Then with the auction schemes implemented,
more uncertainty raised for investors. Indeed, there are a number of factors that influence expectations
from electricity market. This makes future profitability highly uncertain in this industry and hence
holds back investments. This relationship has always been known intuitively. Thus the actual decrease
in auction prices is a real hurdle for attracting RES investors.
31
Each year, there are at least two rounds of auction; one for the existing plants and the other for new
plants. For the existing plants, the contracts last for a maximum period of 8 years and starts from the
next year. They cover usually the recently expired contracts or the new loads in the grid. Prices are
correlated to the current spot market prices, thus, the option of selling in the spot market may be
relevant.
For the new plants, there is two types of contracts (Hammons, 2011) ; one with a delivery starting five
years ahead and with a contract duration of 15 to 30 years (A5) and the other whos with a delivery
starting three years ahead with the same contract duration (A3). The latter can be seen as an
adjustment of the energy contracted in A-5.
The establishment of long term contracts trough auctions was a response to the Brazilian electricity
crisis in 2001. It came to bring more stability for RES investment. However, the government contracts
do not cover all the uncertainties that the investors deal with. The common reasons are interest rates,
construction costs, equipment costs, labor costs, and environmental regulation which affect mainly
hydro projects.
4.6. Lessons from European experience to Brazil

4.6.1. The auction system
When analyzing RES support schemes, learning from other countries experiences is important and
gives interesting insights for policies makers. However, it is necessary to take into account the
particularities of the country under studies; i.e. Geographical, political, industrial and economic
factors.
The Brazilian electricity system, for instance, present very different characteristics compared to the
European ones. However, a general overview from these experiences shows a common recent trend
between the European countries to move towards energy auction for RES investments assessment to
boost RES expansion and to reduce risk among investors. Indeed, Auctions are part of an integral part
of a countrys energy policies. Brazil has chosen this mechanism about 10 years ago.
The Brazilian auction system which happen in the ACR environment aim to ensure the energy supply
to captive consumers in a equitable and economically efficient way through auctions. A particular
auction design is needed for each type of energy sources such as wind, solar, SHP and others. It is a
Taylor-made process aiming to a better risk allocation between the different sources. They provide
transparent and sustainable outcomes that are robust towards political and institutional changes.
Several conditions need to be respected to guarantee the success of an auction. An important one is the
participation of a sufficient number of bidders to enhance competitiveness and consequently
effectiveness. Setting a maximum bidding price for RES projects is an important factor for attracting
bidder. In August 2015 auction, the solar price ceiling was 30% above of the R$ 260 cap in October
2014 one to reflect the dollar appreciation and increased interest rates from BNDES, the Brazilian
Development Bank. Setting a price cap aims to ensure moderate tariffs. However, the price caps
should be consistent with the aim of ensuring the feasibility of the projects with long useful duration.
Another important element is that auctions should project the regulatory stability and transparency.
Bids disclosure increases investors perception about the fairness of the mechanism.
Thus one might say that Brazil has an efficient mechanism and should have attracted already many
RES energy projects and have a considerable share of renewable energy generation (apart from hydro)
in its energy mix. However, as stated in this thesis, this is not true yet.
4.6.2. Possible improvement for Brazil

It is true that Brazil has shown to the world that wind energy doesnt need direct subsidies. The
Brazilian wind power plants, for example, have higher capacity factor compared to other countries
being between 23-50%. In addition to that, Brazil has one of the lowest wind generation costs. For
32
solar energy, the current installed capacity is very low. This is due to the high cost compared to other
energies, i.e. wind. To improve this, more solar only auctions should be organized.
The competitive auctions process has driven onshore wind prices to world record lows. The reached
levels are even too low to attract investors. Moreover, Brazils development bank, BNDES, the second
largest in the world, is raising interest rates, making it more difficult to finance new RES projects. In
addition to that, a RES project needs to comply with different rules to get licensed from the BNDES.
The major one is the locally manufactured components, which enter under the FINAME8 program
requirements of the BNDES. Up to 2012, each wind farm had to comply with 60% of local content or
they will be disqualified from the BNDES financing. In December 2012, a new methodology was
implemented fixing progressive local content goal for the main components of a wind turbine. The
method is applied to gradually increase local components. However, for solar energy this is currently
an important hurdle, due to the cost differences between local and imported equipment.
Financing a new project is indeed one of the main hurdles for the Brazilian energy sector. Several
projects that are accepted in the auctions are delayed or abandoned. For instance, according to LAS
Research an American market research firm (Renewable Seenews, 2015), the vast majority of the
winning solar projects in Brazils October 2014 auction will not be carried out due to financing issues.
October 2014 solar auction resulted in an average electricity sale Price for the 20-year power purchase
agreements of R$215 (US$ 71/ 65.7)/MW.
Both, low interest rates of BNDES loans and a higher number of auctions are necessary to attract more
RES projects. This is getting even worse with the dollar appreciation since the majority of the products
are imported, making the components more expensive. As a matter of fact, investors are facing
increasing costs of imported components, local expensive ones and low auctions prices. Consequently,
many projects that won the auction are cancelled. In the last auction of April 2015, only few bids for
wind energy were done and from the 500 MW capacity auctioned, only 70 MW was contracted.
To guarantee projects completion several additional requirements should be added to the selection
process. To get registered in the next auction, ANEEL should set a longer list of technical prerequisites. Bid bonds9 and project completion guarantees are also necessary for insuring the fulfillment
of ANEELs targets through each auction. In addition to that, delays of investment should be more
controlled through penalties in case of delays and license withdrawal if construction delays are higher
than 1.5 year without proper justification (Barroso L. , 2012). A reduction of contract price can be a
solution while plant is delayed with providing a replacement firm energy for the delayed period.
Expectations for August and November 2015 auctions indicate that higher prices will be reached
resulting in more realistic and attractive projects. Indeed, the fast decrease of the prices in the last
auction has driven investors to bid in non realistic projects. Future auctions might meet a higher
success in the following years.
FINAME program provides financing to companies for the acquisition of new machinery and equipment
manufactured in Brazil with subsidized rates. Financing is granted through accredited financial agents.
9
A written guaranty from a third party guarantor submitted to ANEEL by the investor (bidder). A bid bond
ensures that on acceptance of a bid, the RES generator will proceed with the contract. Otherwise, the guarantor
will pay the customer the difference between the contractor's bid and the next highest bidder.
33
THE REAL OPTIONS METHOD
5. THE REAL OPTIONS METHOD

5.1. Presentation of the method
In order to analyze the Brazilian auction mechanism, we chose to study the Real Options approach and
its application for investments behavior under the auction system. It is a quantitative method which is
gaining ground in assets valuation in the energy sector. It addresses the investment decision problem
by analyzing not only the expected net present value (NPV), but also adding flexibility to the decision
maker by considering the value of the option to wait for a better timing, the option to discontinue, to
increase or to decrease the investment (Damodaran, 2007). The real options value is thus the
difference between the expanded present value (taking into account the managerial flexibility) and the
traditional present value, which does not account flexibility.
Real Options Value = Vexpanded - Vtraditional
The Real Options theory is based on financial options from (Scholes, 1973) and (Merton, 1976)from
which came the idea of incorporating investment valuation methods under uncertainty. According to
(Antikarov, 2003), the analysis of real options method is more relevant when there is a large
uncertainty and flexibility to adapt. (Siegel, 1986) was the first to realize the gaps in the discounted
cash flow method (DCF), since this method assumes that all projects with positive NPV create value
for shareholders. (A. K. Dixit, 1991) states that traditional methods do not consider two important
characteristics in the majority of investment projects: investments can be delayed and the initial
investments are often irreversible. This investment deferral option allows investors wait for new
information.
To be able to determine the value of real options such as expanding, delaying, switching or selling a
project, a traditional valuation through NPV method should be done first without considering
flexibility. Then when adding the uncertainties related to the project, it is possible to construct the
different paths that its value may have in the future which will affect the investors decision.
Proposed by (Antikarov, 2003), the above concept can be used by constructing a binomial tree
containing the possible project values determined by the modeling. The different levels of the tree
correspond to steps in the future and the probabilities describe how likely it is that certain jumps in the
tree will occur.
5.2. Renewable energy policy evaluation using real option models

The underlying stochastic variable of the investment option is the generating company revenue. This
revenue depends on the RES support scheme decided by the regulator. After the investment is
undertaken, the investor starts receiving fixed payments associated to the power plant operation during
its lifetime.
Assessing the impact of RES support schemes using real options approaches has been analyzed under
different framework. In (Boomsma, 2012) paper, a real option analysis has been carried out to evaluate
renewable energy project under FIT and Renewable energy certificates. Discrete changes of support
scheme with Markov switching process were set to may occur at random points in time. The value of
investment timing and capacity choice numerically using a least squares Monte Carlo approach to
option pricing. The study is based on wind power and was applied to Norway which has a similar
power mix as Brazil but a different electricity market design. It concluded that the feed-in tariff
encourages earlier investment. However, when investment has been undertaken, renewable energy
certificate trading creates incentives for larger projects.
34
(I. Ritzenhofen, 2014) study has undertaken similar approach to evaluate the timing and the likelihood
of RES investments of a single investor under three different scenarios: FiT, free market and switching
regime10. The model has been applied to an onshore wind farm but it can be adapted to other RES
projects. The paper states that under and attractive FIT schemes, future policy changes have a limited
impact on current investment decisions. However, we find that after a regulatory decision to switch
from a FIT scheme to a free-market, investment behavior changes dramatically: investment is delayed
or even abandoned.
Another study realized by (L. Abadie, 2014) analyzed also the wind projects investments behavior
under different supports schemes including a fixed FIT, a premium on top of the electricity market
price and transitory subsidy11 when there are futures markets with long maturities. The real option
approach applied has shown that investors would benefit from delaying their projects when their
remuneration comes from electricity market price only. A FIT will however, as in (I. Ritzenhofen,
2014), encourage early investments. When it comes to a lump-sum subsidy, a one-time or a transitory
initial subsidy is better for foster an investment than a higher subsidy spread for a longer period. The
one-time subsidy can also outperform a constant premium per MWh received over the projects
lifetime. Increasing the electricity price with the TGC price significantly raises the value of the
project; nonetheless, it is proven to be similar to a fixed premium in that it does not contribute
effectively to early investment.
However, the different real option methods applied in previous works are focused on developed
financial electricity markets where short and long term transactions take place regularly and it is
possible to remunerate a RES project with pure or mixed market based schemes. For the case of Brazil
this market doesnt exist and applying the real option method to evaluate the implementation of
different support schemes policies is complicated. Indeed, the problem is that real option method is
based in continuous negotiation markets that currently dont exist in Brazil. A solution would be either
we imagine a market or to adapt the real option method to the Brazilian case. In addition to that, the
renegotiation during the investment period doesnt happen, the risk neutral approach wont be realistic
and a Modeling of a green certificate market is not possible. Using the short term liquidation market
and identifying it as a spot market could be a possibility.
The investment decision in Brazil is done through auctions. The decision of wait and see, means that
the investor will analyze the project value during the period (3 years) preceding the production starting
date and assess the best investment decision he can make. If there is no incentive to invest, the
generator will not take part in the auction, skip it and wait for the following one. The study of
(Caminha-Noronha, 2006) has undertaken this approach with valuating new hydraulic generation
assets that will be traded in the new energy auction. Uncertainties were modeled in setting up the cash
flow for the investments incorporating some possible managerial flexibility associated with waiting for
investing or abandoning the project. The evaluation was taken in a multi-stage investment consisting
of a first phase of design and licensing and a second phase of construction and operation phases. It was
treated as a sequential compound option and a binomial approach was introduced to model this
approach. The paper hasnt used, however, stochastic dynamic programming such as the Dixit and
Pindyck model stated in his book (A. K. Dixit, 1991). The reason it says is that it would bring more
complexity to the problem without considerable gain. Another critic to this paper is that between
auctions, different variables change and it is not necessary that you will get more information.
There are other studies that have been carried out with applying Real Options method to evaluate the
flexibility. The paper of (Juliana de Moraes Marreco, 2005) has used a similar approach to valuation
study of operational flexibility in the Brazilian system. The Real Options approach used was for
10
The switching regime model is a scenario that starts with a fixed FIT for a certain period of time with an expected switching to to the free
market regime in the future. The switching time is calculated through a on a combination of actual RES capacity, installation targets, and
incurred support scheme costs.
11
A subsidy that is only available at the initial time but if the investor opts to postpone the investment the subsidy is foregone.
35
calculating the fair value of a financial subsidy to be paid to thermal generators for being ready to
produce when needed in dry periods. The problem was modeled with the Real Options method in
order to calculate gains that could be obtained from the flexible system, a system with more thermo
complementarities. The results should represent the fair value to be paid for the thermal generators.
The payment is the capacity payment for the flexible generators currently implemented or being
implemented in some power systems.
The (Minardi, 2009) article has applied a Real Options approach to valuing the managerial flexibility
of delaying a small hydro power (SHP) project during the 2004-2008 period. A simulation of energy
prices behavior in the long run was done and prices were collected from electricity contracted by
distribution utilities only for the ACR contracts since ACL contracts arent public. Then the authors
estimated the volatility of returns of SHP cash flows through considering long term and short term
scenarios and a simulation of projected five years of cash flows was run for each scenario. Finally, for
the Real Options modeling a five-year horizon to price the deferral option was used and the process
was started by underlying asset price tree. The results suggested that the deferral option has significant
value, because the entrepreneur can wait until prices are high to sell the energy or the authorization.
5.3. Real Options method for the Brazilian Market

Due to significant increase in electricity prices and growing environmental issues in Brazil, there is a
focus on the possibility of introducing more RES-E generation capacity. Hydro-electricity is facing
drought and other environmental hurdles. Wind and solar generation projects are indeed a good
alternative to tackle this problem.
Few years ago, when electricity prices were relatively low in Brazil, there have been only few projects
with sufficiently low costs than could be implemented. Thus a FIT scheme was set until 2005 to
support RES projects. Then with the auction scheme implemented, more uncertainty raised for
investors since they were exposed to more risks. Indeed, there are a number of factors that influence
expectations from electricity market. This makes future profitability highly uncertain in this industry
and may hold back investments. This relationship has always been known intuitively, but with the
introduction of real option theory, one has a tool for a more precise measurement of the uncertaintys
impact on investment behavior.
In this study, we will focus on the ACR Market, in which a high percentage of transactions occur
through the Auction system. Comparing the impact of different possible support schemes for the
Brazilian electricity market isnt as obvious as in other markets. The main cause is that there is not a
daily electricity markets as in the majority of liberalized electricity systems. The risk neutral
characteristic of real option in electricity market is not very relevant to analyze. Risk neutral
probability in the Brazilian power system is not very useful because Brazil doesnt have a liquid
market where you can adjust your position every time. In Brazil RES project can compete in the free
market. However, the free market, which is a market for large consumers, usually is not oriented to
finance new projects in Brazil.
Further, an option would be is to simplify the calculation and considering the NPV to assess the
attractiveness of renewable energy projects under the existent RES support schemes. However this
simplification would result in the loss of the advantages of the real options method. We analyzed also
a method on which we consider a Brazilian market with more CCGT and other conventional plants,
the opportunity cost refereeing the bid of the most expensive plant dispatched. With this we can model
a risk neutral price process for gas, coal and transforming it to price of electricity. Then we generate
scenarios for the different electricity prices. After that, we need to build a decision tree to implement
the option valuation and the effect of changes that we can implement if we use green certificates or
FIT. This option involves, however, the use of many approximations and thus the results wont be
very accurate.
After reviewing different implementation of the Real Options method in Brazil in (Caminha-Noronha,
2006), (Juliana de Moraes Marreco, 2005) and (Minardi, 2009), the more appealing way to analyze
36
investment behavior on RES, is to focus on investments opportunities under the auction scheme with
highlighting the factors that influence the investment decision such as Electricity prices, WACC or
currency exchange rates.
Thus, the applied Real Options approach will evaluate a new wind power project that will participate
in the 2017 A-3 energy auction. The auctions winner has to sign long-term power purchase
agreements (PPA) simultaneously with all distributors at the bidding-price. This approach models the
uncertainties in setting up the future cash flow for an investment and incorporates some possible
managerial flexibility associated with the decision taken along the investment forecast. This flexibility
has a value; it represents the real options associated with the project.
Our approach is based on (Caminha-Noronha, 2006) and (Minardi, 2009) studies, in which we
incorporate the flexibilities regarding the waiting to invest in a new solar/wind farm and the abandon
option, representing the transfer of concession rights. Since the project involves a multistage
investment consisting of design, construction and operation phases, it can be treated as a sequential
compound option.
This approach models the uncertainties in setting up the future cash flow for an investment and
incorporates some possible managerial flexibility associated with the decision taken along the
investment forecast.
5.4. Mathematical modeling

The main idea of real option is that Investment decision can be treated as the exercising of an option.
A RES investor has option to invest. It exercises the option now or wait for more information that can
be revealed by the time. One thing that should be kept in mind is that investing in electricity
generation is irreversible. There is an opportunity cost of investing now rather than waiting. The value
of option or the opportunity cost can be important. Moreover, the value of the option to invest gets
higher when the uncertainty is higher.
The model that will be used in this analysis is inspired from (Antikarov, 2003) and (CaminhaNoronha, 2006). The investment analysis regarding this plant will be made in four main steps that are
usually followed when real options are incorporated into a binomial model (Meeus, 2012) , namely:
-Calculation of the present value without flexibility, using the discounted cash-flow method;
-Simulation of electricity prices and estimation of the uncertainties;
-Building the event tree based on the set of combined uncertainties driving the volatility of the project;
-Incorporation of the flexibilities, by building a decision tree and assessing the investment decision;
5.4.1. Discounted cash-flow (DCF) method

In order to estimate the value that the power plant would have if it existed today, we will calculate the
NPV through the Discount cash flow method. We used the following equations and assumptions.
Cash Flow = Net Profit + Depreciation
Net Profit = Earnings Before Taxes - Income Tax - Social Contribution on Net Income
EBT= EBITDA - Depreciation
EBITDA = Net Revenue- Operating and Maintenance Expenses Fee for using the Transmission
System - Administrative Expenses
Net Revenue = Gross Revenue - PIS - COFINS TFSEE
More details on tax calculation will be given in the case study through a real example.
5.4.2. Estimation of wind farm cash-flow return volatility

Different factors can explain the volatility of electricity prices. The main one is that production and
consumption have to be continuously balanced due to the non storability characteristic of electricity.
37
Thus, this imbalances cannot automatically be recovered without the participation of different
generators with different costs which will have a direct effect on equilibrium prices (Seifert, 2007).
Another factor which turns out to be relevant especially for the Brazilian case is the electricity demand
and production is weather-dependent due to the hydro-generators rainfall precipitation dependency.
5.4.2.1.
Simulation of Electricity prices
From the well known techniques for parameter estimation, there are Least Square regressions and
Maximum Likelihood. Both method are known to be good at estimating the standard deviation and
the mean , but poor in estimating the jump intensity .
In order to estimate cash-flow return volatility, we constructed 2000 long term energy sales scenarios
by compiling the forecast of short term electricity price. The scenarios are a forecast of monthly
electricity prices provided by EPE from January, 2020 to December 2024. An assumption of the
Brazilian energy planning is that short term price must converge to the energy expansion cost.
The model used in this study is the Maximum Likelihood parameter estimation derived from
Simulating Electricity Prices with Mean-Reversion and Jump-Diffusion model (Mathworks, 2014).
The electricity price is modeled as
log( ) = ( ) +
With P(t) being the short-term electricity forecasted price. The logarithm of electricity price is
modeled with two components: f(t) and Xt. The component f(t) is the deterministic seasonal part of the
model, and Xt is the stochastic part of the model.
f(t) is modeled by trigonometric functions (Seifert, 2007)as follow:
( ) = sin(2 ) +
(2 ) + sin(4 ) +
(4 ) +
With si,i=1..5, are constant parameters and t is the annualized time factors. The stochastic components
Xt is modeled as an Ornstein-Uhlenbeck process (mean-reverting) with jumps.
5.4.2.2.
Calibration
First, the deterministic seasonality part is calibrated using the least squares method. After the
calibration, the seasonality is removed from the logarithm of price.
The second stage is to calibrate the stochastic part. The model for Xt, needs to be discretized in order
to conduct the calibration. To discretize, we assume a Bernoulli process for the jump events. That is,
there is at most one jump per day since we are calibrating against daily electricity prices. The
discretized equation is:
= +
+
With probability (1-t) and,
= +
+
+ +
With probability t where and are independent standard normal random variables, and
. The density function of
given
based on (.Escribano, 2002) and (Pablo, 2003).
(
)=(
)= 2
) = (2
) + (1
exp (

2
)
= 1
38
The parameters ={ , ,
function in Matlab:
log (
The first inequality constraint
, } are calibrated by minimizing the negative log likelihood
) Subject to
< 1,
> 0,0
> 0,
< 1 is equivalent to
> 0, the volatilities
and
must be positive.
Finally for
has to be between 0 and 1 as it represents the probability of a jump occurring in
time. In this model, is one month, thus there is 12 jumps a year. The Matlab function MLE from
the Statistics and Machine Learning Toolbox is used to solve the above maximum likelihood
problem. Then we will get the parameters needed for the Event tree analysis.
5.4.3. The Event tree

The calculated uncertainty is applied to building an event tree. The event tree models the values that
the project may along the time. Initially its present value is introduced in step 0. The price of the
underlying asset can either increase by factor u or drop by factor d in each step as shown in Table 2.
The underlying asset is the present value of the project. The factors u and d are related to the volatility
of the underlying asset return according to the equations
The equations from binomial model used for the event tree are:
We estimated the risk neutral probability according to the following expression (Antikarov, 2003):
=
)
( )
Where rf is the risk-free interest rate.
Table 2 : The Binomial tree

Steps
2
3
3
V0
V0*u
V0*d
V0*u
V0*u*d
2
V0*d
V0*u
V0*u2*d
V0*u*d2
V0*d3
5
V0*u5
V0*u4
3
V0*u *d
2
V0*u *d
V0*u*d
4
V0*d
V0*u4*d
V0*u3*d2
V0*u2*d3
V0*u*d4
V0*d5
Since the project involves a multistage investment consisting of design, construction and operation
phases, it can be treated as a sequential compound option. A binomial approach was elaborated to
model this investment opportunity analysis V0 is the present value of the project in the baseline case,
i.e. in year 0 and without considering managerial flexibility.
39
5.4.4. The Decision Tree

After the event tree, the following step is to build the decision tree. This is done through a backward
analysis of the decision tree.
We will analyze the investment decision in two phases; a design phase and a construction phase. The
first one is at the end of the first year, where the investor can proceed to invest R$ 4M in the design
phase which will give him the right to proceed to the construction and the second on is at the end of
the third year where, the investor can make his final decision.
The valuation begins in the last tree columns. Therefore, in the last period the option value is
calculated as follows:
V = Max [S - X; 0]
If the project present value (S) of the event tree is higher than the invested value (X), the exercise
price, the option should be exercised and its price will be the difference S X. If not, the option
shouldnt be exercised, and its value is zero. Then, for each previous step is evaluated using the
replicating portfolio method to estimate the value of the project if it was kept alive. The same process
is done for the first option, which is the investment of R$ 4M at the end of the second semester. The
two values of the first step will allow us to calculate the option value at the step 0 which is to invest
R$ 1M.
40
A REAL OPTION APPROACH FOR RENEWABLE ENERGY INVESTMENT IN BRAZIL: A case study of a
wind farm
6. A REAL OPTION APPROACH FOR RENEWABLE ENERGY

INVESTMENT IN BRAZIL: A case study of a wind farm
6.1. Project description
The objective of this part is to illustrate by way of case study the use of the real option valuation
model to assess investment opportunities for a wind farm project in Brazil. The applied method can be
used for a wind or solar farm. However, since the data for solar projects are not available yet as not
enough solar energy auctions took place so far, we will analyze investment opportunities in wind
project. Precisely, a 30MW wind farm project that will be participating in the 2017 A-3 auction.
The project considered is:
Characteristics
Installed Power
Building Investment Cost
Average Energy Price
Generation O&M Cost
TUST (in North East region)
TUST wind discount
TFSEE
PIS/COFINS
Administrative Expenses
Tax (IRPJ + CSLL)
Operation period
Construction period
Table 3 : Characteristics of the project

Value
30 MW
1574,07 US $/KW
57,26 US $/MWh
21 R$/MWh
4,1 R$/KW
50% of TUST
3,09 R$/KW
9,15% of Gross Income
100,000 R$/Year
(IRPJ + CSLL) 34% of EBT
20 years
6 months
When the project gets accepted in the auction, it has 3 years for building it. However, since the
construction period is about 6 months, we analyzed the investment decision in a 6 months period. We
have though 6 steps for the decision tree of the Real Options method.
The multistage investment allows treating the problem as a sequential compound option; R$1 M
investment in the first semester creates the right to invest R$4 M in the second one, and the exercise of
that choice creates the option to invest to build the plant or the option to abandon the project,
representing the transfer of concession rights that worth, we suppose, twice the gross income of a year
(Caminha-Noronha, 2006). Its value depends on the scenario chosen below.
To better understand the added value of the Real Options Analysis, two scenarios will analyzed, an
optimistic and a pessimistic one. Both of them under the simulated average energy price of R$ 142,
36/MWh from the previous wind energy auction of October 2014. The differences between them are
the values of WACC, the Real exchange rate and load factor. As for the WACC, it depends on the
share of the BNDES loan in the project financing and consequently on the NPV value. In the first
scenario we consider a 70% share of BNDES resulting in a WACC of 6.1% and a WACC of 12%
when only own capital is considered. Then, for the Real Exchange rate, it affects the investment cost.
Indeed, recently the Brazilian Real to US Dollar exchange rate is subject to a high volatility. For the
first scenario, we considered an Exchange rate of 3.08 which is the average of the last year values and
for the pessimistic scenario we considered a rate of 3.12 which is the current exchange rate.
Concerning the load factor, it affects the yearly gross revenue for the wind farm and varies according
to the projects location. The weighted average for the wind farms that started operation after 2014, it is
46% and the minimum used for the pessimistic case is 32%.
41
wind farm
Summary of the two scenarios:

Table 4 : The two scenarios
Scenario 1 (Optimistic)
6,1%
3,087533
46%
Characteristics
WACC
Exchange rate ($ to R$)
Load Factor
Scenario 2 ( Pessimistic)
12%
3,12364
32%
6.2. Methodology
6.2.1. Estimation of cash flow return volatility
To estimate the cash flow volatility, we simulated the electricity prices for the wind farm project, a
forecast for future marginal cost provided by EPE was used. It is composed from a 2000 scenarios of
monthly average prices for the period going from January 2020 to December 2024. The series are
calculated by NEWAVE software, the computational model for the optimization of medium-term
plans provided by EPE. Some operational restrictions need to be added such as minimum and
maximum limits which are R$ 30.26 and R$ 388.04, respectively. A sample is drawn in figure 10.
This database is used for estimating the volatility of the returns for the project.
In our case we modeled the electricity as described in the part 5.4.

log( ) = ( ) +
The component f(t) is the deterministic seasonal part and Xt is the stochastic part. The logarithms of
price and seasonality trends are plotted below. Also, the deseasonalized logarithm of price is plotted in
Figure 10.
log(price) and Seasonality
log(Prices)
6
5
4
3
2020
2021
2022
2023
2024
2025
2024
2025
Date
log(price) with Seasonality Removed
log(Prices)
200
100
0
-100
2020
2021
2022
2023
Date
Figure 10 : Price serie and deseasonalized serie for 2020-2050
Then to conduct the calibration of the stochastic part, the model for Xt needs to be discretized. Thus,
we assume a Bernoulli process.
The discretized equation is
= +
+
With a probability of (1-t) and,
42
wind farm
With probability t where
and
= +
+
+ +
are independent standard normal random variables, and
= 1
The function MLE from the Statistics and Machine Learning Toolbox is well suited to solve the
above maximum likelihood problem.
After running the Matlab code from Annex A, this has been executed for the 2000 price series in order
to calculate the standard deviation of the electricity prices for every series. Then the weighted standard
deviation of the 2000 series found is =19,4448%
6.2.2. The Cash flow

Modeling the Real Options method involves building an event tree, which projects the possible future
values of the plant under two scenarios, in our case. Consequently, it is necessary to estimate the value
of the plant as if it exists today. This is done through the discounted cash flow method for both
scenarios to calculate the net present value of the project.
6.2.2.1.
Cash flow of the first Scenario
The first scenario considers relatively favorable investment conditions (Table 4). The WACC of 6.1%
which considers a 70% share of BNDES, a common share value that has been used in among wind
farm projects in Brazil. The BNDES has indeed a lower cost of capital than other banks that allows it
to charge low interest rates on loans and still have a positive net interest margins.
The Exchange rate R$/US$ used is an average of last year exchange rates values and the load factor is
the weighted average load factor for the wind farms installed in Brazil that started operation from 2013
to 2015. (See Annex B)
We conducted a traditional investment analysis (Table 5) to estimate the free cash flow and the NPV
value. The total investment in the three years depends in the Real exchange rate. Thus, it is different
between the two scenarios.
The average investment cost US$ 1.574M/MW according to data provided by the Brazilian Wind
Energy Association. The wind farm project will cost immediately R$1 M for environmental studies,
which will take 6 months to complete. At the end of that year, the firm could invest R$ 4 M to
complete the design stage. Even though, this step can be simulated using Computer softwares, field
investigations are still a significant step for a full project valuation. This step provides with an
estimation of possible environmental impacts that can influence the following construction phase. The
latter, can be exercised for our project in the following four semesters, we assumed 13% of the capital
cost for the each of the two first semesters and 32% for the two last ones.
Table 5 : S1 Traditionnal Investment Analysis
Period
1st semester
2nd semester
3rd semester
4th semester
5th semester
6th semester
3rd to 23rd year
Gross
Revenue
17 210
NPV= -3 638 R$ Million <0
Costs
4 275
EBITDA
12 935
Depreciation
6 548
Taxes
2 171
Free Cash Flow

(1 040)
(3 948)
(19 323)
(19 323)
(50 906)
(50 906)
10 763
Dont invest
43
wind farm
Millions
Considering the investment flow illustrated in the figure 11 and a WACC of 6.1%, the NPV value is
negative. According to the NPV analysis there is no incentive for this investment. For the case of
Energy commodities and especially Electricity, which is subject to high price volatility, we should go
further in the investment analysis to the Real Options analysis.
20
10
0
-10 0,5 1,5 2,5
10
12
14
16
18
20
22
-20
-30
-40
-50
-60
Figure 11 : Free Cash Flow of the first scenarios investment

6.2.2.2.
Cash flow of the second Scenario
The second scenario is built under pessimistic circumstances that could happen, especially with the
financial crisis that is occurring in Brazil. The WACC is calculated without any participation of the
BNDES. Moreover, the exchange rate is high, however, it can get even higher in the future and the
load factor is the lowest that has been deployed in the two last years.
Table 6 : S2 Traditionnal Investment Analysis
Period
1st semester
2nd semester
3rd semester
4th semester
5th semester
6th semester
3rd to 23rd year
Gross Revenue
Costs
EBITDA
Depreciation
Taxes
11 972
3 023
8 949
-6 643
784
NPV = -54,147 R$ Million
Free Cash Flow

(1 053)
(3 999)
(19 573)
(19 573)
(51 566)
(51 566)
8 165
Dont invest
For the Scenario 2, the pessimistic one, after considering the investment flow illustrated in figure 12
and a WACC of 12.1%, the NPV is negative and it has a much lower value. Thus, according to the
traditional NPV value, the investment seems to be non-profitable. This is due to a high WACC 12%.
We only considered own capital in this case and without the participation of BNDES. The higher
exchange rates than the first scenario influence the investment capital since the main parts of the wind
turbines are imported. Concerning, the low load factor it influence the annual gross revenue which is
proportional to the energy generated. We used the lowest average load factor for the wind farms that
started operation between 2013 and 2015. Its value is 32%.
44
Millions
wind farm
20
10
0
-10 0,5 1,5 2,5
10
12
14
16
18
20
22
-20
-30
-40
-50
-60
Figure 12 : Free Cash Flow of the second scenarios investment
6.2.3. The Event Tree

The calculated volatility in IV.5.1 is applied for building the event tree in each scenario. The tree
shows the evolution of the power plant values that the asset may have along the time. The tree is
constructed through the following equations:
Growth rate:
Reduction rate:
With
= 1,147396542
= 0,871538272
= 19% and = 0,5
We estimated the rising movement probability according to the following expression (Antikarov,
2003):
=
( (
)
)
= 0,538911042
Where rf is the risk-free interest rate.

The compound option features are presented in the table 7 below:
Table 7 : Compound Option features
Scenario 1
Scenario 2
Tree Steps Quantity

Option
Expiration
Time (Semesters)
Base line Price
Project PV
Exercise Price
Initial Investment
Project PV
Exercise Price
Initial Investment
First Option
5
1
142,36 R$
121.944.257
R$3.948.405
R$1.040.000
142,36
58.085.463,2
R$ 3.999.683
R$1.053.000
Second Option
4
128.770.404
120.586.000
Due to the irreversibility of the investment, we assumed that all investment flows happen at one point
in time, the beginning of the semester, and that the cash flow is generated at the end of the semester.
45
wind farm
Scenario 1 has a higher starting present value which explains the higher value of the first event tree
compared to the second one
6.2.3.1.
First scenarios event tree
For the each scenario, we introduced initially the present value in the step and then the other elements
are obtained by multiplying by u for the upper element and by d for the lower one.
The difference between the first scenario event tree (table 8) and the second scenario one (table 9) is in
the first step, the project present value. The equations and values used to build the trees are the same.
For the first Scenario, the Project present value is 122.459.323. For the Step 1, it was multiplied by u
and d as follow:
Vup =122.459.323*1.14=140.509.403
Vdown= 122.459.323*0.87=106.727.986
Step 0
Step 1
Table 8 : S1 Event Tree (R$)

Step 2
Step 3
Step 4
Step 5
243.533.964
212.249.170
184.983.275
161.220.004
140.509.403
122.459.323
184.983.275
161.220.004
140.509.403
122.459.323
106.727.986
140.509.404
122.459.323
106.727.986
93.017.525
106.727.987
93.017.525
81.068.333
81.068.333
70.654.155
61.577.800
6.2.3.2.
Second scenarios event tree
For the second Scenario, the project present value is 60.986.985. For the Step 1, it was multiplied by u
and d as follow:
Vup= 60.986.985*1.14=69.976.255
Vdown= 60.986.985*0.87=53.152.491
Due to the difference of the of investments condition, we can notice that all the project values during
the design and construction phases are lower in the second scenario than in the first one.
Step 0
Step 1
Table 9 : S2 Event Tree (R$)

Step 2
Step 3
Step 4
Step 5
121.284.373
105.703.973
92.125.058
80.290.514
69.976.255
60.986.985
92.125.058
80.290.514
69.976.255
60.986.985
53.152.491
69.976.255
60.986.985
53.152.491
46.324.430
53.152.491
46.324.430
40.373.514
40.373.514
35.187.063
30.666.872
46
wind farm
6.2.4. The project decision tree

In order to build the decision tree, we started from a backward analysis starting from the last step of
the tree. In the last step the option value is calculated as follow:
V = Max[S - X; 0]
where V = Real Option Value, S = Event tree PV and X = price to exercise the option.
When the project present value (S) from the event tree is higher than the price to exercise (X) which is
the invested value the option should be undertaken and its price will be S X. When it is lower, the
option shouldnt be exercised and it will be equal to zero. Tables 10 and 11 for the first scenario and
tables 13 and 14 for the second scenario illustrate the application of the method
For the Table 10, above, the exercise price which is the Investment Present Value in the third year the
last column value is calculated as follow:
V=Max[243.533.964-128.770.404;0]=114763559
For the previous steps, we used the replicating portfolio method to assess the project value.
6.2.4.1.
First scenarios decision tree
Table 10 : S1 Second Investment Option (construction phase) valuation Tree

Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
114.763.559
87.235.251
63.616.258
56.212.870
44.946.086
36.206.085
30.972.142
22.901.827
11.738.999
20.916.057
14.284.331
6.548.544
8.810.043
3.653.074
0
2.037.849
0
0
0
0
0
The calculation of the values in the previous steps is made using the replicating portfolio method
(Caminha-Noronha, 2006)as below. For example for the upper value in the step 4:
We calculate
114763559 56212870
=
243.533.964 184.983.275
and
Then
= 56212870
=
184.983.275
212.249.170 +
= 87.235.251
Finally, V = Max[S - X; Portfolio] = Max [212.249.170-128.770.404; 87.235.251] = 87.235.251

This calculation is made with Excel software for all the other steps.
47
wind farm
Then, in order to evaluate the option to invest after the design stage, we integrated a second option
value to invest the R$4 to finalize the design phase. The completion of the plant design through an
American call option or the transfer of concession right through a European put option.
In step 1 for example the lower value in the step 1 is calculated as follow:
V= Max [8.810.043 3.948.405; 34.419.231-3.948.405-8.810.043; 0] = 21.660.783
The right to invest R$1 M in the first semester is also calculated by the replicating portfolio method
for either 27.023.737or 21.660.783 resulting in 24.020.593.
Table 11 : S1 First Option (invest R$4 million design phase) valuation Tree
Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
114.763.559
87.235.251
63.616.258
44.946.086
27.023.737
24.020.593
56.212.870
36.206.085
22.901.827
14.284.331
21.660.783
11.738.999
6.548.544
3.653.074
2.037.850
0
0
0
0
0
Then, following the results of the Valuation tree, we build the final Project decision tree.
Step 0
Table 12 : S1 Project Decision Tree

Step 1
Step 2
Step 3
Step 4
Step 5
Invest R$128
M
Wait
Invest R$128
M
Wait
Wait
Invest R$4 M
Invest R$1 M
Wait
Invest R$128
M
Wait
Wait
Transfer Rights
Wait
Wait
Wait
Dont Invest
Wait
Wait
Dont Invest
Wait
Dont Invest
From the Project decision tree we can see that there are opportunities for investing in this project
although the NPV is negative in this scenario. In fact, depending on the uncertainty of the market,
there is a probability of 53% in each step to go to the next upper case. The option of selling the
concession rights at the end of the first year is relevant since there is a lower probability for the
investment to be worthwhile. Thus the value of the European put option of the transfer right should be
48
wind farm
undertaken. If the option of investing R$ 4M is made and the design phase done, it can be seen that
the investment has a higher probability of success. Indeed, the right to invest R$4 M is equal to
24.020.593 which is 23.020.593 more than the R$1 M which forms the initial projects cost.
6.2.4.2.
Second scenarios decision tree
For the scenario 2, which is the pessimistic one, the investment conditions are less attractive that the
first one, the WACC, load factor and exchange rate. The NPV method doesnt incentivize investing in
the project with a value equal to -51.245.094.
Table 13 : S2 Second Investment Option (construction phase) valuation Tree
Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
698.641
446.939
285.918
0
182.909
0
117.012
0
0
74.855
0
0
0
0
0
0
0
0
0
0
0
The last column of the Valuation tree was constructed as follow:
Max [121.284.373 -120.585.732; 0] = 698.641
i.e. when the project value is higher than the invested value, the option should be exercised.
For the second value in the last column its value is calculated as:
Max [92.125.058-120.585.732; 0] =0
This means that the option shouldnt be undertaken and the same for the remaining values in the last
column.
The previous steps values are calculated with the same replicating portfolio method as in the first
scenario. That is to allow us to complete the valuation tree in the second option.
For the First option valuation tree in Table 14, either to invest R$4 million design phase with an
American call option or the transfer of concession right with a European put option.
The lower value in the first step is calculated as follow:
V= Max [0-3.999.683; 23.943.8133.999.683-0; 0] = 19.944.130
Table 14 : S2 First Option (invest R$4 million design phase) valuation Tree
Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
698.641
446.939
285.918
182.909
19.827.118
18.770.575
0
0
0
0
19.944.130
0
0
0
0
0
0
0
0
0
49
wind farm
The right to invest R$4 million in the second semester of the project is determined using the same
technique; the replicating portfolio method. Then based on the value of the valuation tree, we build the
final decision tree of the project.
The right to invest R$1 M in the first semester is also calculated by the replicating portfolio method
for either 19.827.118 or 19.944.130 resulting in 18.770.575.
Table 15 : S2 Project Decision Tree
Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
Invest R$120 M
Wait
Wait
Dont Invest
Wait
Wait
Dont Invest
Invest R$4 M
Wait
Wait
Invest R$1 M
Wait
Wait
Dont Invest
Transfer Rights
Wait
Wait
Wait
Dont Invest
Wait
Dont Invest
In the second scenario, it is clear that there is less probability that the project will turn out to be
worthwhile. However, even though the NPV is negative (R$ -54 M), there is a small probability that
the investment will proceeded in the future. Table 15 illustrates the optimal strategies for the
investment forecasting. The right to invest R$4 M is equal to 18.770.575 which is 17.770.575 more
than the R$1 M which forms the initial projects cost. Thus the first phase of design investment (R$1
M) should be exercised
6.3. Analysis of the failure of the last wind auction

In this part, we will apply the real option method to understand the reluctance of investors to
participate in the last A-3 wind energy auction. During this auction, in April 2015, only 70MW was
contracted from the 500MW auctioned. This happened, even though that the ceiling prices for wind
was raised by the government to R$ 179 /MWh. For this we kept the condition of the first scenario and
we changed only the baseline Price of 142.36R$/MWh to the ceiling Price of R$ 179 /MWh. Under
these conditions, the Project has now a positive NPV equal to R$ 26M. The IRR found is 7.37% is
higher than the WACC which is 6.1%. According to the NPV method, this investment is worthwhile.
Thus we will conduct the Real Options Analysis to reevaluate the investment decision.
Table 16 : Event Tree (R$)
Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
303.626.105
264.621.771
230.628.001
201.001.129
175.180.177
152.676.229
230.628.001
201.001.130
175.180.177
152.676.229
133.063.176
175.180.177
152.676.229
133.063.176
115.969.651
133.063.177
115.969.651
101.071.989
101.071.990
88.088.107
76.772.156
From the event tree in the table 16 we can see that the project has higher value during its life compared
to the two previously analyzed scenarios. One thing has to be high lightened is that we used the ceiling
50
wind farm
price as a major factor for calculating the annual gross revenue. The investors have to bid below this
price. Usually the average auction is two to three Reals lower than the ceiling price. However, this
case presents the most attracting possible conditions. Under these conditions we build the following
valuation trees:
Table 17 : Second Investment Option (construction phase) valuation Tree
Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
174.855.700
139.607.852
109.260.984
83.174.627
61.596.623
75.987.210
53.813.160
36.800.698
44.495.913
101.857.596
24.539.840
46.409.772
27.662.310
16.420.258
9.711.654
4.292.772
2.394.702
1.335.873
0
0
0
The second and first options valuation tree are constructed following the same process used in the two
previous scenarios with calculating the option value in the last column and then using use of the
replicating portfolio method for the previous ones.
Table 18 : First Option (invest R$4 million design phase) valuation Tree
Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
174.855.700
139.607.852
109.260.984
83.174.627
57.648.218
40.662.691
101.857.596
75.987.210
53.813.160
36.800.698
20.591.434
46.409.772
27.662.310
16.420.258
9.711.655
4.292.772
2.394.702
1.335.873
0
0
0
Finally according to the calculated values from the valuation trees, we, build the final Project decision
tree (see table 19 below)
Table 19 : Project Decision Tree
Step 0
Step 1
Step 2
Step 3
Step 4
Step 5
Invest R$128 M
Wait
Wait
Wait
Invest R$4 M
Invest R$1 M
Invest R$128 M
Wait
Wait
Wait
Invest R$4 M
Invest R$128 M
Wait
Wait
Wait
Invest R$128 M
Wait
Wait
Dont Invest
Wait
Dont Invest
51
wind farm
The right to invest R$4 M is equal to 40.662.691 which is 39.662.691 more than the R$1 M which
forms the initial projects cost. Thus the first phase of design investment (R$1 M) should be exercised.
The option to finish the whole design phase should be exercised as well since in both cases the right to
invest is higher than the investment cost. However, after this phase, the investor should wait until the
uncertainties get revealed to process to the final investment.
From the results of the Real Options analysis, we can perceive from the table 19, that although the
NPV of the project is positive and the IRR higher than the WACC, there is a probability that the
project will turn out to be unprofitable. It is true that the probability is lower than the previous
scenarios where we used a lower average baseline scenario price. But the risk exists for these wind
power plants that were supposed to start generating power on July 1st, 2017. These results can explain
the fact that in the analyzed auction only 70MW from the 500MW auctioned were contracted. It also
illustrates the growing hurdles for RES investors. Indeed, the weak Real is driving the investments
cost up which affects the auctions prices. Thus, if the Real will continue falling with keeping the
current market condition i.e interest rates, one should expect that the energies prices will grow from an
auction to the other.
6.4. Model discussion

For electricity projects, the studied wind farm is subject to price volatility and the project value
changes over the time. In this case various external events can change the project value and
consequently the investment decision.
The established model presents a methodology to analyze investment opportunities in a wind energy
farm. The model can be adapted to other type of energy plants by adapting the model inputs. The
binomial approach was used to model the Real Options since we included combined option in the
analysis. The use of stochastic dynamic method, such as Mean reverting method or the Geometric
Brownian Motion in this problem, would bring more complexity to the problem especially since we
used the forecasted prices provided from EPE.
From the results obtained we can see that changes in currency exchange rate, WACC and annual gross
income (trough load factor) have a substantial impact on investment decision. When changing these
different factors, the NPV might become negative the investment should not be exercised since it can
result in substantial loss for the company according to the NPV method.
For the case of April 2015 last wind auction, the results show that even though we used the ceiling
price for the baseline scenario for the optimistic scenario, the project is subject to uncertainty and the
waiting option is important to calculate.
An improvement of the model can be by including an American option in the investment decision
which means that the project can be built before the end of the start of the PPA and the investor can
trade in the free market. This however needs a data of the transactions occurring in the free market
which are not easy to get since not all the details are disclosed.
52
CONCLUSION
CONCLUSION
The analysis of the European experiences in renewable energies support schemes has shown that quota
mechanisms are a losing ground compared to the others support schemes. Feed-in Tariffs are also
regressing and their levels, in Italy and Spain for example, are being reduced. On the contrary, Sliding
Feed-in Premium, Contracts for differences and auctions schemes are getting more popular in Europe,
respectively in Netherlands, UK and Germany. Considering country-specific aspects of the power
market, renewable support schemes should be designed on a tailor made basis. Notwithstanding,
learning from previous experiences has a considerable role in the prevention of falling into the similar
other countries errors.
In Brazil, the wind energy has experienced a fast development in the last years to reach 4% of the
installed capacity. Its share still, however, far from the share of the European countries. The growth of
the wind generating capacity is facing several problems. The major one is financial. For solar energy,
the Brazilian policy is not clear yet. The solar energy market is growing very slowly. The first solar
only auction was held in Pernambuco in December 2013 for 123MW of capacity. The winning
Projects have faced licensing and granting problems and many of them were delayed.
The Brazilian development bank, BNDES, is raising interest rates making the financing of new RES
project more complicated. In addition to that, it imposes strict requirements for the investors in order
to benefits from its loans. Indeed, many companies have been rejected from the energy markets for
non compliances with the 60% quota of locally manufactured components. This quota is needed to
benefit from the banks financial support. The local content requirement is reviving debates on its
efficiency and fairness. It takes place in the context of the national economic strategy to promote the
made in Brazil and protecting it from international competition. In addition to that, the weak Real is
making the importation of necessary component more and more expensive
To summarize, the scarceness of BNDES loans that are also requiring local content, the non stable
Brazilian Real and the increasing returns on equity are making the auction ceiling prices very low to
attract investors. Their bids are getting more risky causing several projects abandonment during the
development phase.
The attractiveness issue and the effects of financial instruments have been analyzed in the quantitative
part of the thesis through the Real Options approach. Two scenarios have been built to assess
investors behavior during the auction. We included managerial flexibilities in the investment decision
allowing the investors to delay the project, to sell it at the end of the first year or to abandon it after the
design phase. The option of delaying the investment is valuable for investors who wants to build a
RES farm, but wants to check if the market investments conditions will become more favorable before
entering such an irreversible investment plan. The managerial flexibility is especially valuable in
electricity markets since it is subject to high uncertainties.

The results showed that according to the traditional analysis NPV was negative and there was no
incentive to invest. However, when considering all the possible flexibilities in the market such as
transferring the concession or delaying the investment, the calculated NPV were positives due to the
aggregated value of the options.
We applied also the Real Options Method to understand the investors reluctance during the last April
wind auction. We found that even though in average the projects have a positive NPV, the investment
53
CONCLUSION
still have chances to be unprofitable. The ceiling price of 179 R$/MWh set by ANEEL to compensate
other non attractive market condition isnt sufficient and the price that will guarantee a secure
investment with regards to market uncertainties is 304,39 R$/MWh, which is very high for the
Brazilian market.
The Real Options method is a good solution for companies that need a higher management tools,
more accurate than the NPV method. The stochastic electricity market conditions can demonstrate that
a project with a negative NPV has a probability to be profitable and that the Manager needs to wait
before taking a yes or no decision.
This study can serve as a guide to RES investors on how to plan their investment behavior. It can also
allow the estimation of the auction ceiling prices with taking into account the market investment
conditions. The analysis made in this thesis can be adapted to other RES project with changing the
necessary input in the model. The results accuracy can be improved by modeling the long-term energy
price and estimate more accurate costs of the project in calculating the free cash flow. Also we can add
a deferral penalty if the project has been delayed more than the allowed time by ANEEL. Also, we can
incorporate the ability for the project to trade in the free market before the PPA starting date, which
will add dividends payments in the free cash flow method.
54
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EU? The European IEE project towards2030-dialogue.
Roney, J. M. (2014, May). Denmark, Portugal, and Spain Leading the World in Wind Power. Retrieved
from www.earth-policy.org/data_highlights/2014/highlights46
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www.rwe.com/web/cms/mediablob/en/1716210/data/1701408/6/rwe/responsibility/acceptancestudy/blob.pdf
Scholes, B. &. (1973). The Pricing of Options and Corporate Liabilities. The Journal of Political
Economy, Vol. 81, No. 3 , 637-654.
Seifert, J. U.-H. (2007). Modelling Jumps in Electricity Prices: Theory and Empirical Evidence. Review
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Siegel, M. R. (1986). The Value of Waiting to Invest. Quarterly Journal of Economics , 101, 707-727.
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58
<REFERENCES
UNESCAP. (2013). Case study: Brazils National Plan on Climate Change and Law. Low Carbon Green
Growth Roadmap for Asia and the Pacific .
Wikipedia. (2015). History of wind power. Retrieved from
en.wikipedia.org/wiki/History_of_wind_power
59
ANNEX
ANNEX
ANNEX A
load('simprices')
labels=datestr(simprices(1,:));
minp=30.26;
maxp=388.04;
for k=1:60
xtic{k}=([(labels(k,4:11))]);
end
data= [xtic{:}];
for fg=2:2001
fg
Prices=simprices(fg,:);
for i=1:60
if Prices(i)==0
Prices(i)=1;
end
end
PriceDates=simprices(1,:);
figure(1)
plot(PriceDates,Prices)
datetick();
set(gca, 'XTickLabel', xtic(:))
xlabel('Date');
Obtain log of prices
logPrices = log(Prices);
% Obtain annual time factors from dates
PriceTimes = yearfrac(PriceDates(1), PriceDates(60));
PriceTimes =5;
% Calibrate parameters for the seasonality model
seasonMatrix = @(t) [sin(2.*pi.*t) cos(2.*pi.*t) sin(4.*pi.*t) cos(4.*pi.*t) t ones(size(t, 1), 1)];
C = seasonMatrix(PriceTimes);
seasonParam = C\logPrices;
% Plot log price and seasonality line
figure(2);
subplot(2, 1, 1);
plot(PriceDates, logPrices);
datetick();
title('log(price) and Seasonality');
xlabel('Date');
ylabel('log(Prices)');
%T
% Plot de-seasonalized log price
60
ANNEX
[X,S,P] = remst(Prices,12,1);
subplot(2, 1, 2);
plot(PriceDates, X);
datetick();
title('log(price) with Seasonality Removed');
xlabel('Date');
ylabel('log(Prices)');
% Prices at t, X(t)
Pt = X(1:end);
% Prices at t-1, X(t-1)
Pt_1 = X(1:end)/10;
Pt_1(60) =0;
% Discretization for monthly prices
dt = 1/12;
% PDF for discretized model
mrjpdf = @(Pt, a, phi, mu_J, sigmaSq, sigmaSq_J, lambda) ...
lambda.*exp((-(Pt-a-phi.*Pt_1-mu_J).^2)./ ...
(2.*(sigmaSq+sigmaSq_J))).* (1/sqrt(2.*pi.*(sigmaSq+sigmaSq_J))) + ...
(1-lambda).*exp((-(Pt-a-phi.*Pt_1).^2)/(2.*sigmaSq)).* ...
(1/sqrt(2.*pi.*sigmaSq))+minp;
% Constraints:
% phi < 1 (k > 0)
% sigmaSq > 0
% sigmaSq_J > 0
% 0 <= lambda <= 1
lb = [minp minp minp minp minp minp];
ub = [maxp maxp maxp maxp maxp maxp];
% Initial values
x0 = [100 100 100 100 100 100];
% Solve maximum likelihood
params = mle(Pt,'pdf',mrjpdf,'start',x0,'lowerbound',lb,'upperbound',ub,'optimfun','fmincon');
% Obtain calibrated paramters
alpha = params(1)/dt;
kappa = params(2)/dt;
mu_J = params(3);
sigma = sqrt(params(4)/dt);
sigma_J = sqrt(params(5));
lambda = params(6)/dt;
sigmas(fg)=sigma;
end
61
ANNEX
ANNEX B
Power Plant
Instaled
Capacity
(MW)
Load
State
Factor[57]
Araas
Curva dos Ventos
Igapor Alvorada
Igapor Guirap
Igapor Licinio
Igapor Conceio
Igapor Planaltina
Morro
Colnia
Embuaca
Fasa I
Fasa II
Fasa III
Fasa IV
Fasa V
Icara I
Icara II
Munda
So Jorge
so Cristovo
Santo Ant. de Padua
Taba guia
Taba Andorinha
Cear II
Fonte dos Ventos
Areia Branca
Mar e Terra
Miassaba 3
Rei dos Ventos I
Rei dos Ventos 3
Caracar
Dreen
Asa Branca
Atlantic
Copel
CPFL
167,7
56,4
38,4
52,8
73,6
76,8
52,8
117,6
18,9
27,3
29,4
27,3
25,2
25,2
29,4
27,3
37,8
30
24
26
14
23,1
14,7
87
79,9
27,3
23,1
68,47
58,45
60,12
90
94
160
60
75,6
108,2
48,0%
44,1%
53,6%
46,7%
42,3%
44,5%
45,6%
51,6%
43,7%
40,8%
31,9%
34,9%
33,0%
33,9%
30,9%
47,7%
34,4%
50,7%
55,0%
54,6%
58,6%
46,3%
44,8%
40,0%
45,2%
43,0%
36,3%
33,4%
49,4%
35,0%
52,1%
49,3%
44,1%
50,3%
53,8%
48,5%
BA
BA
BA
BA
BA
BA
BA
BA
CE
CE
CE
CE
CE
CE
CE
CE
CE
CE
CE
CE
CE
CE
CE
CE
PE
RN
RN
RN
RN
RN
RN
RN
RN
RN
RN
RN
62
Dobreve
Modelo
Morro dos Ventos
Renascena
Santa Clara
ndios 2
ndios 3
Quinta 1
Quinta 2
Palmar
Total/Average
89,16
56,4
145,2
150
188
29,9
23
105,3
64
334
3192,8
52,6%
50,2%
47,3%
45,8%
42,1%
38,5%
38,3%
50,0%
41,3%
50,6%
46,0%
RN
RN
RN
RN
RN
RS
RS
RS
RS
RS
63

Thesis Athir Nouicer

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UNIVERSIDAD PONTIFICIA COMILLAS

ESCUELA TCNICA SUPERIOR DE INGENIERA (ICAI)

OFFICIAL MASTER'S DEGREE IN THE

Diffusion of new renewable power in Brazil:

Edmar Luiz Fagundes de Almeida

Florence, July, 2015

UNIVERSIDAD PONTIFICIA COMILLAS

ESCUELA TCNICA SUPERIOR DE INGENIERA (ICAI)

OFFICIAL MASTER'S DEGREE IN THE

Diffusion of new renewable power in Brazil:

Edmar Luiz Fagundes de Almeida

Florence, July, 2015

UNIVERSIDAD PONTIFICIA COMILLAS

Good planets are hard to find...

Objectives of the Master Thesis ........................................................................................................ 7

LITERATURE REVIEW .......................................................................................................................... 8

Regulatory entities ....................................................................................................................... 9

Regulatory scheme to increase renewable integration .................................................................... 9

Characteristics of RES-E technologies ........................................................................................ 10

Support Mechanism for Renewable Energies .................................................................................. 11

Price-driven strategies ................................................................................................................ 11

Quantity driven strategies ........................................................................................................... 13

Indirect strategies ....................................................................................................................... 14

EUROPEAN EXPERIENCES FOR RENEWABLE ENERGY SUPPORT MECHANISMS .................... 16

European regulatory framework...................................................................................................... 16

Historical development and current status of RES-E deployment in EU countries ............................ 17

Historical development at EU level ............................................................................................ 17

Progress at country level ............................................................................................................ 17

Country-specific learned lessons..................................................................................................... 19

Case study Germany .................................................................................................................. 19

Case study UK ........................................................................................................................... 22

THE BRAZILIAN CONTEXT ................................................................................................................ 26

Overview of Brazil ......................................................................................................................... 26

Electricity policies of Brazil ........................................................................................................... 27

First reform of the electricity market: 1990s .............................................................................. 27

Second reform of electricity market: 2004 .................................................................................. 28

National Policy on Climate Change: 2009 .................................................................................. 28

Renewable energy potential ............................................................................................................ 28

RES support mechanisms ............................................................................................................... 29

Proinfa: quota & feed-in tariff scheme ........................................................................................ 29

Current Structure: Technology-specific auctions ......................................................................... 30

Investment decision in renewable energies in Brazil........................................................................ 31

Lessons from European experience to Brazil................................................................................... 32

The auction system .................................................................................................................... 32

Possible improvement for Brazil................................................................................................. 32

THE REAL OPTIONS METHOD ........................................................................................................... 34

Presentation of the method ............................................................................................................. 34

Renewable energy policy evaluation using real option models ......................................................... 34

Real Options method for the Brazilian Market ................................................................................ 36

Mathematical modeling .................................................................................................................. 37

Discounted cash-flow (DCF) method.......................................................................................... 37

Estimation of wind farm cash-flow return volatility .................................................................... 37

The Event tree............................................................................................................................ 39

The Decision Tree ...................................................................................................................... 40

6. A REAL OPTION APPROACH FOR RENEWABLE ENERGY INVESTMENT IN BRAZIL: A case

Estimation of cash flow return volatility ..................................................................................... 42

The Cash flow............................................................................................................................ 43

The Event Tree .......................................................................................................................... 45

The project decision tree ............................................................................................................ 47

Analysis of the failure of the last wind auction ................................................................................ 50

Model discussion ........................................................................................................................... 52

1.2. Objectives of the Master Thesis

2.1.1. Regulatory entities

2.1.2. Regulatory scheme to increase renewable integration