Luiz MaurerTHE WORLD BANK - EWDEN

Rome, October 6, 2003

Energy Rationing: A Market-Based Approach

No one likes to talk about power rationing 

Most of the electric sector reforms omit this subjectPerhaps because no one believes it is going to occur if reform is implementedOr perhaps because it is not perceived as “politically correct”, and may defeat the purpose of the entire reform Not many countries have experience in implementing rationing measures

However, it is unavoidable - energy and/or capacity scarcity is becoming widespread

Chile - 1998 Ivory Coast, Ghana, Togo and Benin – 1998Tanzania, Kenya - 2000California – 2000 - 2001Yugoslavia – 2000-2001Norway – 2001, 2003New Zealand – 2001Russia – 2001Brazil – 2001-2002Dominican Republic – 2002-2003Venezuela - 2002Marahashtra - India – 2002

Objective of this presentation – to discuss the case study of Brazil

Present nature and extent of the energy crisis in 2001-2002

Discuss how the government dealt with this crisis

Assess consumer response and achievement of the initially stated conservation goals

Evaluate other implications – economic, institutional, regulatory

Discuss lessons learned that may be applied to other countries

We will be focusing on one element of power system reliability

RELIABILITY

SECURITY(Public Good)

ADEQUACY(Private Good)

PROTECTION EQUIPMENT

OPERATION PROCEDURES

ANCILLARY SERVICES

• Ability to withstanddisturbances

ENERGY

CAPACITY

RISK OF DEFICITX

COST OF DEFICIT

LOLPX

VOLL• Ability to meet

aggregate power and energy requirements

FOCUS OF THIS PRESENTATION(Source: Oren, 2000)

NATURE AND EXTENT OF THE BRAZILIAN ENERGY CRISIS IN 2001

Nature and extent of the energy crisis in 2001

The most serious energy crisis in recent historyAffecting 80% of the electric system, including the heavily industrialized and populated Southeast regionSector was “energy constrained” – hydro reservoirs were getting depleted at a very fast paceReservoirs would be completely depleted in 4-5 months at the prevailing rate of consumptionIt was necessary to conserve 20-25% of historical energy consumption, at least for 8 monthsSome experience in the past in dealing with similar situations – but not to this extent and magnitude

The crisis was not a surprise 2001 only a wake up call

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Jan Fev Mar Abr Mai Jun Jul Ago Set Out Nov Dez

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1997 1998 1999 2000 2001

First and most important decision –How to implement rationing?

Proposal I – “Rolling Black-Outs” or “Apagão”Geographical regions disconnected on a rotating basis, according to a pre-agreed schedule Priority loads preserved – e.g. hospitals, police, etc.Apparent advantage – immediate implementation and 100% effectiveness

Proposal II – “Quota System” Allocate “quotas” to customers, taking into account historical consumption, and define saving targets = “baseline consumption”Enforcement for those who exceed the quota – financial penalty, threat of disconnection, or bothApparent disadvantages – complex, subject to complaints, demand elasticity was unknown – possibly jeopardizing overall effectiveness

Implementation of “rolling black-outs” would have been more complex than allegedNetworks are inter-meshed - preserving “essential” customers would exclude part of the load from the rolling black-outs –up to 40% Not a peak shaving issue - significant “intra-day” load shiftThose two factors would entail a disproportionate burden on some customers -- 10 to 16 hours/day !!Due to the manual nature of disconnection operations, it would have been very difficult to follow a precise timetableLack of energy, even during short periods of time, would create social and economic chaos in certain areas

• Traffic lights and crime rates in large cities• Hurting some manufacturing activities with continuous

processes

Despite large number or supporters, “rolling black-outs” were overruled

A “quota” was set for each customer, Based on a three-month average (or estimate) of 2000 consumptionDifferentiated by customer group

Financial penalties for those who exceeded the quotasBonuses for overachievers Possibility given to large users to exchange quotas in the secondary marketPenalties linked to the energy price at wholesale levelDisconnection threat for those who did not meet targets

A quota system is not ideal – but it is certainly the best solution in a regulated world

Quota itself sounds “interventionist” – and it is indeed However, in a regulated world, prices are not allowed to fluctuate to convey the cost of scarcity Which creates two distortions:

Demand does not adjust itself when electricity becomes more scarce – otherwise mandatory rationing would not be necessaryGives a misleading impression that demand for this commodity is “inelastic” – in reality, regulation has muted the price signal

If rationing becomes necessary, a sensible solution is to force customers to “see” marginal price for the consumption above those individual reduction targets

A quota system is a sensible solution, from an economic, legal, and technical standpoint Economic

Cutting “across the board” – a very inefficient way to allocate a scarce resource whose willingness to pay vary within a wide range – from US$ 100 to 6,000/MWhWith “quotas”, customers “see” the real cost of scarcity via prices, and make consumption and conservation decisions accordingly

LegalBy being based on real economics, price increases more defensible

TechnicalNo need to operate feeders, or reshuffle the networkSome additional effort to handle customer complaints, disconnections, and public lightning

Load response was fast and effective – without black-outs or brown-outs

MW Peak Consumption

Significant energy savings were achievedTotal savings = 26 TWh, 13,000 MW peak

For a total national consumption of 284 TWh

Results of PROCEL = National Conservation Program (1994-2000)

10.7 TWh

640 MW peak (2000)

Savings continued after rationing measures ceased – overall 2002 consumption similar to 1998 levels

Average residential = 1994 levels

Industrial consumption grew 3.4% vis-à-vis 2001

Residential – energy savings beyond Government targets

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Jan Fev Mar Abr Mai Jun Jul Ago Set Out Nov Dez

Average May/Jun/Jul- 20005.738.340 MWh

4.730.516 MWh Tar

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-24,1%

5.108.071MWh

-14,2% -27,9% -28,3% -26,2% -26,5% -23,7%

Residential customers have changed their habits, on a permanent basis

91% of households changed consumption habits during rationing – from those 65% still maintain savingsAverage consumption pre and post rationing

SE – from 199 kWh/mo to 145 kWh/moNE – from 113 kWh/mo to 85 kWh/mo

Energy efficiency is now part of the decision making process to buy appliances

8% before crisis58 % after crisis

IMPLICATIONS – ECONOMIC, INSTITUTIONAL, AND REGULATORY

A rationing of this magnitude represents a significant cost shift

Distribution companies experienced a significant reduction in revenuesHydro generators were not able to to honor their contractual obligationsAn existing “dry period relief” clause in the PPAs pushed some risk to distributors – however, physical delivery was still short of contractual commitmentsCreating imbalances to be settled at prevailing spot price (close to US$ 300/MWh) Strong pressure upon government to bail-out sector

A rationing of this magnitude is a real strain for any institutional model

It is a combination of several factors, involving two supply and one demand shocksHowever, someone has to be blamed for the demiseSuch a visible and important event weakens institutions and their personnel, particularly those institutions in their infancyAfter the smoke cleared, there seems to be consensus that a half-away restructuring process was a major factor determining the difficulties faced by the electric sector

Economic impact was mitigatedA significant economic impact was expected

GDP reductionUnemploymentPrice increasesDeterioration in the balance of trade

Due to a well designed rationing scheme, none of these things materialized

Quick and strong reaction from residential customers – more energy left for productive activitiesMechanism of trading quotas helped improve energy allocation amongst industrial customers Some industries even benefited from rationing – e.g. capital goods, growing 13%A lot of room for rationalization and efficient usage became evident

A very conservative estimate – scheme saved 1% of GDP

LESSONS LEARNED THAT MAY BE APPLIED TO OTHER GEOGRAPHIES

Important lessons can be drawn from this case study …

No excuses for Brazil getting into this situation However, the country was able to implement a very effective rationing schemeRelying on economic/market signals – as opposed to more popular “rolling black-outs”With an dynamic coordination by the Civil House Minister throughout the entire process – a missing ingredient in some phases of the electric sector reformAnd an honest perception of crisis being transmitted Contrary to some initial expectations, society became an allyConsumer behavior has changed on a permanent basis

Lessons may be applied, to varying degrees, to other countries and situations

Brazil was an “energy constrained” case – in some aspects, easier to handle than “capacity constrained” sectors …

Where market signals should be conveyed on a real time basisAnd real time pricing/metering rarely exists

Brazil leveraged on a few market driven institutions in place Wholesale market, albeit in its infancyVested contracts with built in incentives for Discos to engageSome retail competition

Some lessons need to be underscoredContrary to common wisdom, electricity was a commodity which rapidly responded to prices Price signals were key to harness demand side opportunities

Should the system be implemented on a permanent basis? – e.g. Fixed-Variable Tariffs for mass markets, creating some exposure? Subject deserves further thinking and refinement

Quotas were differentiated by customer segment

2000 Consumption

Reduction Target

Financial Charges (Penalties)

Bonuses? Individual Cuts?

Residencial Till 100 kWh/mo Optional No 2 to 1 saved NoResidencial From 101 till 200

kWh/mo20% No 1 to 1 saved

beyond targetYes

Residencial From 201 till 500 kWh/mo

20% 50% of tariff, if above target

1 to 1 saved beyond target

Yes

Residencial Above 500 kWh/mo 20% 200% of tariff, if above target (1)

1 to 1 saved beyond target

Yes

Industrial/Commercial (High Voltage)

Above 500 kWh/mo 15% to 35% MAE price for consumption above

target

No (2) Yes (3)

Industrial/Commercial (Low Voltaqe)

Above 500 kWh/mo 20% MAE price for consumption above

target

No Yes (3)

Rural No limit 10% No No YesPublic Services No limit 15% to 35% No No Yes

(1) Corresponds approximately to MAE price

(2) May trade quotas. In the wholesale market, if load > 2.5 MW

(3) Cuts by number of days to achieve target, unless company "buys" quotas in the market