RIO DE JANEIRO--()--The measures announced by the Brazilian government for renewing energy concessions that mature between 2015 and 2017 were unexpected by Fitch Ratings and substantially heighten risks for companies with concessions expiring during this period. Previously, Fitch anticipated that concessions would be renewed at levels that provide for continuity of operations, as well as profit levels that would provide incentives for management in addition to investments in these critical assets.
The companies that will be most affected by the government's actions are:
--Centrais Eletricas Brasileiras S.A. (Eletrobras, Issuer Default Rating [IDR] 'BBB/AAA(bra)'),
--Companhia de Transmissao de Energia Eletrica Paulista S.A. (CTEEP, IDR 'AA+(bra)');
--ISA Capital do Brasil S.A., CTEEP's controlling company (IDR 'BB+/AA-(bra)');
--Companhia Energetica de Minas Gerais (CEMIG, IDR 'AA(bra)').
Companhia Paranaense de Energia (COPEL, IDR 'AA+(bra)') will likely be affected as well but to a much lesser extent. Risks may be somewhat lower for companies that have concessions expiring beyond 2017, as future governments may deal with renewals differently.
The main objective of the government's proposal is to lower electricity tariffs for end users in order to benefit residential consumers and improve industrial competitiveness. The decline in cash flow for the affected companies would likely lead to lower investment in the sector in the future, which would have negative consequences. The companies will have 30 days to decide whether they accept the government's final proposal, or maintain the concessions until their final maturities and, thereafter return them to the government. Fitch sees little room for deviating from the proposal, however, as the government has already announced its commitment to lower tariff for end users on a defined percentage.
The Brazilian government's proposal for renewing the concession includes an upfront payment to the concessionaires in exchange for a significant reduction in revenues going forward, both of which are to be determined. The upfront payment is intended to compensate concession holders for their assets net of depreciation. The value, which would be calculated by the sector's regulator ANEEL, is uncertain and likely would not fully compensate companies for all of their investments. The government's proposal also includes a significant decrease in revenues to levels that would only be intended to cover operating cost, which prevents them from generating profits and creates disincentives for future investments. As part of the government's proposal, the concession renewal date would be moved to 2013 from 2015 to 2017, and companies would likely have to forego the revenues that were to be generated during this period.
Fitch believes the government's interference in the concession renewal process weakens the perception of the country's regulatory framework and increases regulatory risk. The degree by which the perception of the country's regulatory strength deteriorates would depend upon how fairly the regulator values the concession holders' assets. The government's intention to lower electricity tariffs for end users, which is believed to be the driver of its actions, would pressure cash flow generation. This would have severe implications for the investment capacity of sector participants, mainly stated owned Eletrobras.
The government's proposal could also have negative implications for attracting foreign direct investment into the country, if the market perceives the government does not compensate existing companies fairly. In addition, non-power concessions such as toll roads could be impacted, as participants get a glimpse of what is to come when their own concessions expire. If the government's actions are very negative, other concession holders could adjust by lowering maintenance expenditures, for example.
The degree by which the credit quality of companies would be impacted depends upon the fairness of the upfront payment, the ensuing cash flow generation and any weakening of the respective capital structures. The credit ratings of concession holders could be downgraded by several notches should they accept the government's proposal without using some of the proceeds for the government's payment to strengthen their capital structures to compensate for a precipitous decline in their future cash flow generating capacity.
Cemig and Eletrobras are among the companies with relevant generation concessions maturing between 2015 and 2017. The government's proposed measures are not expected to have an immediate impact upon generation companies such as Tractebel and Tiete, which do not have concessions maturing over the next few years. In the short term, these generators should benefit from the reduction of transmission costs for the market agents, which include the energy generators, leading to a slightly positive impact upon their cash flow. Nevertheless, as the price of energy produced by generators with expiring concessions diminishes, the energy purchase price mix in the regulated market would decline and could put downward pressure upon the average amounts to be practiced in the free market.
The transmission companies with relevant concessions maturing between 2015 and 2017, namely Cemig, CTEEP and Eletrobras, should also face significant negative impacts. These companies hold older concessions that tend to be more profitable than new concessions that have been assigned under a more competitive environment. Transmission companies will also be affected negatively from a cash flow perspective, as the Brazilian government intends to pay companies at a level that would only cover their operating and maintenance costs. For the companies that do not have concessions maturing in the next years, such as Taesa, Alupar and Abengoa, the immediate impact is currently neutral.
The Brazilian government is still studying the measures to be adopted for distribution companies with concessions maturing between 2015 to 2017, which includes Cemig, Copel and Eletrobras. Nevertheless, Fitch considers that the periodical tariff review processes for this segment leave a limited room for additional reductions in profitability. The reduction in energy tariffs aims at stimulating the country's economic growth, which could bolster energy consumption and increase distribution companies' cash flow generation. Cheaper tariffs also tend to increase per capita consumption of electricity and reduce delinquency rates. Under this scenario, distribution companies or groups with a large participation in the distribution segment, such as Cemar, CPFL Group, Eletropaulo, Energisa Group, Light Group and Rede Group, tend to capture higher energy sale volumes with the announced measures.
Additional information is available at 'www.fitchratings.com'.