Credit Risk in the Pool - Implications for Private Capital Investments in Brazilian Power Generation

Abstract:     
The new Brazilian Electric Sector Regulation issued in 2004 introduced two negotiation markets for the energy supply: the regulated pool (ACR) and the free market (ACL). Competition is enforced via energy auctions, where the winning generator has to sign long-term power purchase agreements (PPA) simultaneously with all distributors at the bidding-price. In order to estimate the appropriate credit risk spread of the pool, we implement a clustering methodology to rank and rate the distributors. The results show an average spread between 5.75% and 8.5% for the pool, which corresponds to a credit rating of B- (two levels below the Brazilian country risk). This estimation is at least 208 basis points higher than the credit rating Ba1/BB+ assigned to the distributors by the National Electric Energy Agency (Aneel) in the periodic tariff revisions, which implies an underpricing of risk. On average, distributors with higher risk/spread are located in the South-Southeast region, compared to the low risk/spread ones that are concentrated in the North-Northeast. This behavior is kept during the period of study (2001-2004). Due to the risk sharing mechanism of the pool, a generator that used to trade just in the North-Northeast market is now bearing a risk 480 basis points higher. We estimate the opportunity cost of capital in real terms in the range 13%-16% to account for the credit risk of the pool. Essential to determine the bidding price at the auctions, this estimation is considerably higher than the 11.26% opportunity cost estimated by Aneel in the 2003-2004 periodic revisions. Since efficient markets should correctly price the risks and returns, the pool's credit risk has to be taken into consideration, especially for compensating private capital investments in Brazilian power generation.

Number of Pages in PDF File: 19

Keywords: Credit Risk, Brazilian Electric Power Market, Clustering, Economic Feasibility in Power Generation

JEL Classification: G38, G33, Q48

working papers series