No.17 Feb 1999 Gas Market Development in Brazil How Gas-Fueled Power Plants Can Operate in Brazil's Hydro Dominated System Peter L. Law and Hernan G. Garcia This paper discusses the issues faced in introducing Eventual use of the pipeline's full capacity--30 mil- new gas fired power generation plants into Brazil's lion cubic meters a day at full compression--offers hydropower dominated system. Ordinarily, power pro- substantial upside potential. Moreover, the project ject developers seek to operate their plants at high will improve air quality by displacing polluting fuels, load factor over the plant lifetime to ensure financial viability. However, the year to year variation of rain- such as fuelwood and high-sulfur fuel oil, that are cur- fall in Brazil--which could result in a surplus of rently used by industrial consumers in urban areas. hydropower in some periods and a shortfall in oth- ers--posed major questions concerning how the gas After the gas sales agreement was signed, Brazilian fired plants would operate. agencies commissioned several studies to assess the financial viability of the pipeline project. In general, In 1993 two state oil companies, YPFB of Bolivia these studies concluded that viability would be and PETROBRAS of Brazil, signed an agreement for enhanced if new gas-fueled power generation were the export of up to 16 million cubic meters a day of located in São Paulo, thereby ensuring that large vol- natural gas from Bolivia to Brazil over a 20-year umes of gas would be absorbed in the early years of period. Gas will be transported from gas-rich areas the agreement. But these studies evaluated the viabili- around Santa Cruz to the industrial markets of south- ty of gas-fueled thermal plants operating in isolation southeast Brazil--including São Paulo--through a from Brazil's hydropower-dominated electrical sys- 3,000 kilometer, 32-inch pipeline costing about $2 tem, where in periods of high rainfall it might be billion. The World Bank approved financing for the expected that hydroplants would be dispatched in project in December 1997, and construction of the preference to thermal plants to avoid spillage of pipeline is under way and scheduled for commissioning water. And so a key question was left unanswered: Is in 1999. (For the history of the project and the evo- gas-fueled power generation an economically viable lution of hydrocarbon sector reforms in Bolivia option in Brazil's hydropower-dominated power sys- and Brazil, see Viewpoint Note No. 144 http:// tem? If it is, how will the gas plants operate under dif- www.worldbank.org/html/fpd/notes/energy.htm) ferent hydrological conditions? Imports of Bolivian gas will allow Brazil to increase Brazil's Power Sector the share of natural gas in primary energy supply Over the past 30 years Brazil's power sector has from 2 percent to at least 10 percent within 10 years. grown rapidly under an investment policy that gave The World Bank Group · Energy, Mining & Telecommunications · Finance, Private Sector and Infrastructure Network Peter L. Law (Plaw@worldbank.org) is a Senior Gas Specialist who joined the World Bank in 1990. He has par- ticipated in energy sector project appraisal and supervision operations in Eastern Europe and Latin America, and is the author of natural gas and power sector strategy studies for Romania, Hungary, Poland, Brazil, Pakistan, and Turkey. Before joining the Bank, he worked for British Gas. Hernan G. Garcia (Hgarcia2@worldbank.org) is a Principal Power Engineer who joined the World Bank in 1981. He has specialized in electricity planning, project appraisal and economic evaluation. He has partici- pated in numerous power development projects in Latin America, Africa and Asia, and is currently involved in a number of power sector reform and privatization projects. 2 How Gas-Fueled Power Plants Can Work in Brazil's Hydro-Dominated System priority to domestic natural resources. This approach nearly all this capacity would be met through hydro favored the development of large hydro projects and a plants. But the prospect of Bolivian gas imports has controversial nuclear program. Thermal generation opened the door for gas-based thermal options. was relegated to a minor role, with only a few plants using low-quality indigenous coal. Thermal generation The Planning Exercise based on imported fuels--including hydrocarbons and Recognizing that gas-fueled power generation could coal--was not favored because it would have improve the financial viability of the Bolivia-Brazil increased dependence on external resources. pipeline through the use of upside capacity, ELETROBRAS, in cooperation with the World Bank, The electricity industry developed as two unconnected set out to analyze the economics of thermal genera- power grids. Today the combined installed capacity of tion--including gas, oil, and coal--operating within these grids is 54 gigawatts, of which 96 percent is the hydro system. hydro-based. The larger grid supplies 74 percent of Brazil's electricity consumption, serving 10 states in the A systematic review was made of the cost of a large south-southeast and midwest, including São Paulo and catalog of hydro projects identified by ELETROBRAS. Rio de Janeiro. The grid's more than 200 hydro plants The review found that for projects where basic designs are supplemented by 23 thermal units (coal, oil, and and cost estimates had been prepared in the 1980s, nuclear), which account for a small portion of costs needed to be updated using 15 price indices installed capacity. The smaller grid supplies 23 per- instead of the single consumer price index used by cent of electricity consumption and serves 11 states in ELETROBRAS in earlier evaluations. The newly the north-northeast. considered price indices better reflect the current cost of civil works, and of mechanical and electrical In 1995 ELETROBRAS--the state-owned national equipment, as well as engineering services. electricity company responsible for integrated power Following review, the estimates of implementation sector development--forecast that power consumption costs of the projects were 20 to 30 percent lower than in Brazil would grow by 4.7 percent a year. At this rate previously calculated. about 28 additional gigawatts of installed capacity would be needed within 10 years, most of it in the Methodology south-southeast. Investment requirements were esti- Brazil's power system expansion was defined in two mated at $7 billion a year, about half of which was stages. First, a long-term (30-year) expansion opti- for additional generation. In line with its traditional mization plan was prepared using a linear program- planning philosophy, ELETROBRAS anticipated that ming model. The model defines the system least-cost Power Sector Reforms The Brazilian government is making efforts to demo- The Electricity Services Law (1995) regulates power nopolize and create competition in the power sector. services and introduced competition in the bulk supply The Concessions Law (1993) provides the basis for market by permitting large consumers to contract sup- delegating traditional government responsibilities--as ply directly with generating companies. Decree 2655 provider of public services--to the private sector. The (July 1998) mandates the creation of an independent law eliminated the uniform tariff and guaranteed rate system operator responsible for dispatch and supervi- of return systems, identifies separate sector activities sion of generation and transmission facilities and (generation, transmission, and distribution), and creation of a wholesale market. A regulatory com- mandates that bulk energy supply be contracted for mission (ANEEL) was created in late 1996 and start- among generators and distributors. It also provides ed functioning in the late 1997. The new legal and for open access to transmission systems to promote regulatory framework enables the private sector to competition in generation. play a larger role in power generation and distribution. Energy Issues 3 expansion by selecting a set of generation plants and hydro capacity in the system upgrades a block of sec- their commissioning dates from a group of hydro and ondary energy (with low economic value) to firm ener- thermal candidates under a maximum risk of power gy (with higher economic value)1, which makes the deficits lower than or equal to 5 percent (the planning thermal plants economically very attractive. Future criterion used by ELETROBRAS). The price of gas to expansion of Brazil's power system will easily absorb thermal plants was set at the economic cost of gas to all the gas-fueled generation that can be built using be imported from Bolivia, rather than the current cost the gas supplies that are likely to become available. of domestic gas from the Campos and Santos basins. The investment and operating costs of gas-fueled The medium term simulation of the system showed plants (and other thermal candidates, including power that, in the first five years of gas imports, due to the plants fueled by oil and imported coal) were based on short term capacity constraints noted above, gas-fueled recent international costs. An important feature of the generation would operate at high plant factors--typi- simulation was the assumption that the systems in the cally 75 percent (Figure 1). After this period the risk of south-southeast and the north would be connected deficits would reduce to a normal level and gas-fueled by 2000, a project that is now being implemented. plants would be economically dispatched at lower This interconnection will allow energy transfers average load factors, which would then increase over between the two systems because of their hydrologi- time. But due to the need to optimize the use of water cal complementarity. stored (the simulation model includes a reservoir dynamic optimization sub-routine) the operation of Second, a detailed medium-term (15-year) simulation gas-fueled plants is uneven. Thermal plants would of selected configurations was made using a dynamic operate at full capacity during periods of drought, or programming model. This model defines the detailed stand idle during periods of high hydraulicity. expansion of the system by simulating the system However, even though the plant factors for each year operations on a monthly basis for different hydrological over the planning horizon would vary, the average situations over the planning period, and the behavior of plant factor would increase steadily over time as the hydro reservoirs under operational policies based shown in Fig 1. on the economic optimization of stored water. The Secondary Market for Gas The results Power generators using natural gas from the pipeline The long term optimization process resulted in a least will have to pay the full firm cost--that is, the cost solution which includes 6,800 megawatts of gas- reserved pipeline capacity charge plus the gas com- fueled generation inserted by 2005, increasing to modity charge--regardless of whether or not their 21,000 megawatts by 2015. Of this capacity, about plants are operating. It will also be necessary to devel- 2,000 megawatts could be commissioned almost op a secondary (industrial) market for the gas that is immediately because, due to delayed investments in not required by gas-fueled power plants during peri- additional hydro capacity, the risk of power deficits in ods of high hydraulicity. Such arrangements will dif- south-south east Brazil had become much higher than fer from the conventional interruptible contracts for the 5% criterion noted above. The optimization selected industrial consumers used by many of the world's gas gas fueled plants because: (i) the capital costs of gas markets. Usually such contracts do not include a fueled combined cycle plants are lower than hydro reserved pipeline capacity charge within the gas price, plants, and (ii) increasing the proportion of thermal to since the gas supply can be interrupted at a moment's 1 In a system dominated by hydropower, the total installed capacity to supply a given demand is usually higher than in a system which has a substantial proportion of thermal generation. This is because the hydro system must be designed to provide sufficient energy (firm energy) to meet demand during periods of low rainfall, thus leaving additional energy (secondary energy) which could be generated during periods of higher rainfall not dispatched. Installing thermal plants in such a system can be considered a risk mitigation measure, since by using them to complement the operation of the hydro plants, it allows secondary hydro energy to be dispatched and sold rather than being stored or spilled. 4 How Gas-Fueled Power Plants Can Work in Brazil's Hydro-Dominated System notice to accommodate load balancing require- The interruption times and schedules, gas price ments of the supply (transmission) system. (commodity and reserved pipeline capacity Brazil's power system, however, offers a novel charge), and priority fee are matters of commercial opportunity for the secondary market to share the negotiation between the gas supplier, power plant pipeline capacity charge with the power plants. developers, and secondary consumers. These This feature is made possible by the large (five- arrangements would offer a practical way to year) capacity of the country's hydro reservoirs, include gas-fueled power plants, while ensuring a which will allow the plant factors of gas-fueled base load offtake of natural gas from the Bolivia- plants to be anticipated with confidence. Thus Brazil pipeline. industrial consumers will be able to plan their fuel supplies well in advance. Conclusion Introducing gas-fueled generation capacity in The proposed contract arrangement would be to Brazil's south-southeast power system is shown to Energy Issues is published by be the optimum solution for a wide range of the Energy, Mining and charge a small priority fee to power plants when Telecommunications Sector they are not running, and charge secondary (indus- assumptions on fuel prices and other economic Family in the World Bank. trial) consumers the full firm gas price less the parameters. Due to the large existing reservoir The series is intended to encourage debate and dis- priority fee. Power plants would be given priority capacity, the production schedules of these plants semination of lessons and in using the gas supply, and industrial consumers can be predicted with enough confidence to allow ideas in the energy sector. The views published are would have an incentive to accept a programmed the development of a secondary market for gas. those of the authors and interruption of supply if required. When power The contractual framework based on the priority should not be attributed to the World Bank or any of its plants are running, they would pay the full firm fee as described in this paper could be applied in affiliated organizations. cost of gas supply and industrial consumers would other countries where there is an opportunity to To order additional copies develop gas-fueled power generation within a please call 202- 473-3364. switch to an alternative fuel. If you are interested in writing hydro-dominated system. an Energy Issues note, contact Kyran O'Sullivan, editor, internet address, kosullivan@worldbank.org. The series is also available on-line at http://www. Figure 1 worldbank.org/html/fpd/ National Average Plant Factor of Gas Fired Plants energy/ The World Bank also publishes the Viewpoint series. Viewpoints are targeted at a multidiscipli- nary audience and aim to promote debate on privatiza- tion, regulation and finance in emerging markets, espe- cially in the energy, transport, water, and telecommunica- tions sectors. The series aims to share practical insights and innovations that cross sectoral boundaries. The series is available on-line at www.worldbank.org/html/ fpd/notes/notelist.html