The Executive Branch of the Brazilian Government opened a process of public consultation to discuss adjustments in the implementation of the market model adopted five years ago for the Brazilian power sector. Among the themes that were raised, one stands out in its importance and implications: the regulation and control of the remaining state-owned generation, after the Initial Contracts begin to phase out. Prior to this, the Congress made a proposal to deal with issue that essentially bifurcates the generation market in a privately owned independent power producer (IPP) segment and a public service segment. All generation that has not been privatized would be placed in the latter category and would remain subject to price regulation, in effect extending the Initial Contracts of such generators.

NERA prepared a report for Duke Energy International (DEI) to assess the effect of this is possible measure with respect to the objectives of the power sector reform, and particularly its effect on the willingness of investors to place funds into the sector. NERA finds that a segmentation of the market is fundamentally and fatally flawed from the perspective of attracting and maintaining private investment in the generation market. Segmentation discourages private investment and creates significant barriers to entry for incremental IPP projects because:

• It locks a high percentage of electricity demand into extended Initial Contracts;
• Much of the remaining demand could be served by Distribution Company own-generation; and
• Competition for “free customers” will be distorted due to tariffs that favor the low-cost public service generation.

Segmentation would solve only one problem, rate shock, and that solution is at best temporary and at worst will result in more frequent rationing episodes.

The report concludes that, at least conceptually, this proposal will fail because it attempts to maintain simultaneously the reform market model and the pre-reform public power model, which are incompatible concepts.