This gigantic tree died a few months ago. It dried and rotted. The branches (large and heavy) began to fall, each time bringing the electric grid to the ground, offering, of course, danger.
History repeats itself almost every fortnight. The local power distributor is called to do the “maintenance” again.
Is there anything wrong with this story?
Anyone who wants to look at “the glass half full” will rightly argue that the power distributor came quickly (in about 3 hours), fulfilling exemplarly with the regulatory obligations for this type of occurrence.
For those who have a more critical view, will find that the City Hall has been advised of the need to remove the tree given the danger it represents. The Secretariat for Green and Environment was informed of the urgency of authorizing the procedure. Firefighters explained that they could only act (removing the tree) after being certified that they were not violating environmental standards.
In other words, we have a list of public institutions, paid for with taxes, completely unrelated to efficiency. Objectively, the right, simple, safe and fast procedure would be:
- A technician identifies the danger that the tree represents
- Firefighters and City Hall quickly remove the tree to avoid risks to the population
- The electric grid is then reestablished
But reality insists, regrettably, on showing us that we are wasteful. We “prefer” to see the public grid fall several times to the ground, that the distributor is always called again, and that consumers spend many hours without electricity.
It is a dumb system because we do not learn and improve as we should. But most importantly: who cares?
In times of high price volatility in Brazil, it makes sense to evaluate the all available energy source options. Particularly gas x electricity.
The following case is a real-life example comparing residential water heating using gas and power. This household has two water heaters: one runs with gas and the other with power. Which one is more economical?
- The power cost
The total power bill divided by the energy consumed by this household was R$ 0.65/kWh (1 USD = R$ 3.30)
- The LNG price
The cost of gas is R$ 0.51/kWh
The most economical source is gas! The economy is 22%.
In real life, for the corporate world, the reasoning is the same. The differences are the power rates, the natural gas rates and of course the “boundary conditions” especially associated with commuting from one source to the other when it comes to operational issues.
The message is simple: it will be worth permanently evaluating the alternatives to make the best decision on a month by month basis!
The energy bill paid by the corporate world is usually a Top 10 cost, often Top 5. It is very common for someone from the operations, such as a maintenance engineer or a buyer, to take care of this account. This is in line with the prevailing tendency in Brazil, to contract energy at the lowest price at that specific moment.
A really interesting check is answering these 10 questions:
- What are the strategic ways to approach “energy contracting”?
- How does each influence the price that will be closed?
- What types of prices can be contracted?
- How to form the portfolio of power/energy volumes and prices?
- When is it best to close prices?
- What metrics should be employed?
- How to consult the market?
- How price arbitrage may help (including all available energy sources)?
- Who should lead the contracting strategy?
- How will the decision-making process be conducted all the way?
The proposal to reach and maintain a new level of competitiveness in the energy cost is to make sure an Energy Adviser is involved. I know from my own experience, helping the corporate world to contract more than USD 600 Million in the deregulated power markets in Brazil. The opportunities are incredible because the differences between doing the traditional and a “structured” way are enormous.
Industrial, commercial and institutional customers always say that they seek the “minimum cost” when it is about power contracting for a new period.
But what is the benchmark for assessing whether the prices offered by the market are attractive?
The prevalent trend of the corporate world in Brazil is comparing them with the average past prices. But this procedure is “weak” because it is equivalent to looking in the rear view mirror, when what is at stake is the future.
There are two lines of thought: one linked to risk and another to certainties. Knowing them well is essential for good decision-making.
- Volatility of short and medium term prices due to the small capacity of hydroelectric reservoirs
- Relative variation of prices between contracted energy sources for each case
- Exchange rate and its influence on power prices since investments in the sector are capital-intensive
- Fragile regulation will maintain the unpredictability of the official management of the power sector
- The never ending “judicialization” which will continue at the speed of Brazilian justice, measured in years
- Macroeconomic environment characterized by significant budget deficits
How to deal with each of these variables? Good quality responses are the key to reaching and maintaining competitive power prices. This is exactly why when I am called by a new consulting customer I realize that there is a huge variation of contracted prices. From R$ 200 to 350/MWh (1 USD = R$ 3,3).
If you want to close really attractive prices you have to take a “structured” way because power contracting prices should not be a matter of “luck”.
The recently published results from selected energy companies show that the power sector can be attractive to their investors! This is a great signal!
On the other hand for customers of these companies, the electricity bill is out of global competitive parity. The diagnosis is very clear and refers to 10 facts that have been known for many years::
- Power deft represent a national practice
- Doubtful incentives for selected energy users
- “Judicialization” associated with power settlement operations
- The systemic insufficiency of the hydroelectric reservoirs
- The increasing dispatch of (more expensive) thermal power plants
- The choice of intermittent and more expensive sources than the available firm alternatives
- Energy companies controlled by the Government generating systemic devaluation
- Officers of the regulatory & planning without real independence
- Lack of transparent and well-defined targets on prices and tariffs to be achieved
- Eternal complacency with (bad) results from official energy companies and public entities
We need a dose of creativity, innovation, honesty and professionalism to turn around the electric power sector and thus aim to compete globally.
This is the current situation:
- The installed capacity in power plants in Brazil is double the maximum demand
- The average demand is about 80% of the maximum demand
- It means that it is necessary to have an installed capacity of 2.5 GW/average GW
- The CAPEX for a power plant is R$ 5 Million/MW installed and its expected life of 20 years
- The realistic internal rate of return to include Brazil risk is 20% per annum
- Thermal plants pay R$ 1/m3 for natural gas and other variable costs
- The power matrix is 70% renewable (hydro and wind) and 30% thermal
The calculation of the technical price:
- The investment in generation is R$ 12.5 million/average MW
- The amortization is R $ 0.2 Million/month, which equates to R$ 260/MWh
- The variable cost of a gas-fired power plant is R$ 100/MWh
- The average cost: [70% x R $ 260/MWh] + [30% x (R$ 260/MWh + R$ 100/MWh)] = R$ 300/MWh
Summary: The future cost is R$ 300/MWh (USD 100/MWh in rough numbers), about 25% above the current level.
The market should oscillate with supply and demand, but in the long term, it will be necessary to tend to the technical price for the simple fact that without a reasonable remuneration, it is impossible to imagine that entrepreneurs will invest in the expansion of capacity.
In the corporate and institutional world, decision-making processes involving power contracting are important because a significant financial value is at stake.
What prices can be considered attractive?
The answer depends on perceived risks and uncertainties.
Risks for this purpose are the factors that influence market conditions (supply and demand is a great example) which may be addressed by using conventional risk management tools.
Uncertainties are situations that may have real importance but are out of control (Brazilian regulatory weaknesses and judicialization are classic “representatives”).
Power contracting decisions are therefore reasonably complex in Brazil because the uncertainties are perceived as very relevant. Very challenging times indeed!
On Nov 7th I was a speaker at the risk management event produced by VIEX-AMERICAS in São Paulo, Brazil.
Click on this link to have access to the PPT presentation is available (in Portuguese)
Most areas involving technical solutions prefer to approach decision-making processes by comparing alternatives – it is about choosing those that are most interesting and convenient.
The image shows the natural line of thought: replacing lighting using more efficient technologies. It is obvious that no one would think of using incandescent bulbs. Much less candles.
The intriguing aspect of the choices that are made in the corporate world, in my opinion, is that it has a certain (and important) amount of subjectivity. Even though there is – always – a solid search for rational, transparent and above all auditable choices.
If a company prefers that the subject at stake be “born” by the technical echelon and then rise to the executive ranks for a decision, surely the outcome will be different from what would happen if the path were the reverse. Because the assumptions are different, the way of thinking has another approach.
Solutions that are chosen in the real world depend on boundary conditions. They usually cover technical, financial and management issues. And then the possibilities multiply exponentially!
It was a spectacular journey! I met great people, learned a lot, crafted new solutions for Interact consulting clients, was awarded in Brazil and the United States and, of course, I made my mistakes too! I earned my life with energy consulting! What else could I wish but grandma’s delicious apple pie?
At the end of this year, my career ends as a proactive consultant for the corporate world, who has been incessantly focused on achieving and maintaining excellent results with respect to energy contracting, physical projects, as well as energy efficiency.
My new role will be contributing with the transfer of my experience to managers, directors and advisors. An activity, without the huge day-to-day running around tight schedules, ambitious results to be met in tight deadlines and a relentless demand from my interlocutors and of course from myself as well.
It was a wonderful 40-year experience. And here is my big thank you!