By: Mark S. Langevin, CESP Faculty Associate
This interview was originally published by The Dialogue and is reprinted here with permission from the author.
Brazilian President Jair Bolsonaro came into office in 2019 vowing to privatize state companies and sell government assets, with the large state presence in the energy industry as a focal point. In early June, the first major privatization of Bolsonaro’s administration finally came to fruition as the government reduced its share in Eletrobras, one of Latin America’s largest power companies, from 72 percent to 45 percent. Later in the month, the measure was approved by Congress. The share sale, which had been years in the making and raised roughly US$6.9 billion, was the world’s second largest of 2022 and has significant implications for a company that accounts for 28 percent of Brazil’s power generation and 40 percent of its transmission lines.
Meanwhile, Bolsonaro has repeatedly discussed the full privatization of mammoth oil company Petrobras, which is currently 36 percent owned by the government—an effort that was expected to gather steam in the event of a second term. However, under Adolfo Sachsida, the new energy minister who took office in May, the government has made the Petrobras privatization a top priority, requesting studies and preparing a bill on the measure in June. This acceleration took place as Bolsonaro’s long-standing conflict with the firm over its policy of linking fuel prices to international levels reached a fever pitch following Russia’s invasion of Ukraine and the ensuing spike in global oil prices. This clash produced two new CEOs in just two months, bringing the number of chief executives under Bolsonaro to four.
With the first round of Brazil’s presidential election less than three months away, the Petrobras privatization timeline appears tight. Furthermore, former President Luiz Inácio Lula da Silva, a fervent critic of privatizing state companies, has led first-round polls by as much as 19 points, raising questions over whether he could reverse what Bolsonaro has managed to achieve, including the successful privatization of Eletrobras.
To learn more about the implications of the Eletrobras sale, the prospects of Petrobras privatization, and how both are affected by the likely return of Lula, the Energy, Climate Change, & Extractive Industries Program at the Inter-American Dialogue (IAD) spoke to Dr. Mark Langevin, adjunct professor and senior fellow at George Mason University and senior advisor to Horizon Client Access.
Comments from Mark Langevin:
Question (Q): Let’s start with Eletrobras, the privatization that has gone through. While the company is expected to cut costs under its new ownership structure, congressional opponents argued that the privatization would raise electricity prices. What will be the main impacts of the reduction of the government’s stake on the company’s competitiveness and electricity rates in Brazil?
Answer (A): The privatization of Eletrobras raises questions about Brazil’s national energy security and climate change strategies after last year’s devasting drought. President Jair Bolsonaro’s administration and his congressional allies promised that the state-owned enterprise’s tender would attract private investment to the generation and transmission sectors and lower consumer rates for electricity. The company was profitable before its privatization despite the government’s neglect over the past several years. Federal Accounts Court Minister Vital do Rêgo, the only dissenting opinion on the vote to authorize the privatization, suggested that the estimated sale price would fall far short of the real market value of the company. The difference between the stock offer and estimates of fair market value are sufficiently significant to suggest that the tender was rushed, and the model designed to favor the financial services sector rather than strengthen the power sector. Most importantly, the privatization does not directly advance the country’s low-carbon development path, although Eletrobras plays a central role in generation and transmission.
While it is too early to draw any conclusions, the sell-off of Eletrobras was messy and will probably trigger considerable legal activity to reshuffle the transactions’ distribution of costs. In the process leading up to the privatization, the administration and Chamber of Deputies President Arthur Lira conceded to several conditions, including attaching a gas-to-power mandate, that increases the costs of generation over the longer term and diverts investment away from cheaper renewables while also leaving public finance to assume much of the risk for the construction of gas pipelines. Prominent analysts, including former Energy Research Office President Mauricio Tolmasquim, have estimated that the gas-to-power mandate and accompanying need for gas transport infrastructure could cost an additional US$10 billion beyond the costs of displacing gas-fueled generation with renewables, aside from the lost opportunity to further reduce carbon dioxide and methane emissions. This gigantic opportunity cost wipes out the gains made from the tender of Eletrobras shares and will probably lead the new management to either seek the removal of these onerous conditions or obtain compensatory subsidies.
Meanwhile, the current administration will redirect earnings from the sale of Eletrobras to indirectly subsidize residential and industrial tariffs to win votes. In my view, it is too early to conclude that the company’s privatization will increase its competitiveness and profitability, decrease rates, or keep the lights on for all Brazilians. Under private management and the onerous gas-to-power conditions, Eletrobras will have to cherry-pick short-term, higher-earning opportunities rather than invest in the lower-earning, longer-term energy transition. Moreover, we can expect the divestment of assets with lower-earning horizons to further undermine the strategic role of the company in the nation’s development. The challenge of meeting shareholders’ expectations could encourage the company to focus on the “free consumer” market rather than a broader-based strategy to advance energy security and deepen low-carbon development. (The “free” market provides flexibility to choose a power supplier and negotiate pricing and other terms for large consumers in energy-intensive industries, in contrast with the “regulated” market, which mandates that consumers purchase power from a utility or a company with a distribution concession at a rate set by the energy regulator ANEEL.) Certainly, the new management will invest in renewable energy and associated transmission when it is profitable in the shorter term, but such a time horizon is not compatible with an aggressive national strategy to guarantee energy security and a steady reduction of greenhouse gas emissions. Unlike most countries, Brazil has what it takes to lead on the energy transition, but the privatization of Eletrobras takes the biggest tool out of the kit.
Q: The prospectus for the share offering alludes to renewable energy, transmission, and energy storage, as well as emerging technologies such as artificial intelligence and blockchain, as possible areas for investment. To what extent will the company’s new shareholders and management accelerate its focus on the energy transition? What role will digitalization play in this effort?
A: Shareholder fragmentation, subsidiary sell-offs, and the government’s retention of a golden share veto will discourage efforts to reimagine the company, although it will certainly undergo restructuring to mitigate the onerous conditions and maximize its earnings. The restructuring and application of information and communication technologies will likely be concentrated toward the free consumer market after the initial round of negotiations over contract duration and tariff rates amid the gradual phase-in of expanding supply to these special consumers over the next five years. While this market consumes only 10 percent of Brazil’s overall generation capacity, Eletrobras will lobby for additional increases to this market because of its earnings potential, leaving the country with an increasingly segmented market between free and regulated markets. The company will likely invest in technological innovation to reduce generation costs and transmission losses for the free segment that serves energy-intensive industries while the government struggles to coordinate a patchwork of lower-earning private generators, public finance mechanisms, subsidies, and regulations to spur on a similar effect for more regulated segments. We should expect that Eletrobras and other firms servicing the free segment will work with their large customers to jointly pursue technological development to achieve greater energy efficiency and cost savings. However, these gains will not be immediately passed on to residential users. At some point, policymakers will need to decide whether the bifurcation of the national power system is politically sustainable, and if not, whether the government needs to get back in the game, as the French government plans to do by regaining full control of state power utility Électricité de France.
Q: In the event of a Lula victory in October, would Lula seek to reverse the Eletrobras privatization? What barriers would he face, and what would be the likelihood of his success?
A: Former President Lula opposed Eletrobras’ privatization. However, I do not expect him to reverse it, although other political forces will continue to challenge it in the courts. Rather, a Lula administration would exercise its shareholder voice and policy influence to try to bend the company around its energy security and low-carbon development strategies. Even with a minority stake, a government with a well-defined energy sector strategy can move the company toward its policy objectives through pressure on management, subsidies, and regulation. Lula has told me that he wants Eletrobras and Petrobras to become “development” companies rather than just generation-transmission and exploration & production (E&P) firms, respectively. His vision entails greater research and development investments in cutting-edge technologies that can advance energy security and the transition while also spinning off goods and services that add value to the economy, create jobs, and raise human development. His ambitions go beyond low tariffs, although he is certainly mindful that energy costs can make or break a Brazilian enterprise in a competitive market environment.
I think Lula favors working with private-sector shareholder representatives at Eletrobras, in collaboration with Petrobras and the newly created Empresa Brasileira de Participações em Energia Nuclear e Binacional (ENBpar), to jointly finance and administer aggressive research and development investments aimed at energy efficiency, renewables, and carbon capture within a broader fourth industrial revolution push. During my own work with the Lula camp in the past year, the former president has emphasized Brazil’s urgent need to work with environmental, social, and governance (ESG) investors and the information and communications technology sector to advance the country’s sustainable development goals and strengthen the energy sector.
Q: Moving on to Petrobras, first of all, what is behind the sudden push for Petrobras privatization so close to the election? What are the prospects of such a measure passing in the Brazilian Congress and/or achieving Bolsonaro’s political objectives?
A: Bolsonaro has promised voters lower fuel prices and investors a controlling share in Petrobras ownership. In essence, the president’s gambit exchanges the possibility of the national oil company (NOC)’s privatization, if re-elected, for tolerance of his meddling in the pricing policy of company. His gambit appeals to motorists, truckers, and the financial services sector, which would accrue immediate gains from the tender of the NOC’s controlling shares.
However, a majority of Brazilians do not support the privatization and most of these citizens will vote for Lula. If Lula wins, the next government will not only suspend the NOC’s divestment program but will likely expand Petrobras’ portfolio, returning it to a broad-based energy company that will make the most of the pre-salt play but also invest in low-carbon development. Even if Bolsonaro were to win re-election, the proposed privatization would elicit steadfast opposition within Congress, face legal challenges and trigger significant social mobilization to slow, if not kill the process.
Q: What is the administration’s target timeline for privatizing Petrobras? Is it seeking to do so before the election, or before Bolsonaro’s current term ends on December 31? If so, how likely would that be? For one thing, the national development bank, BNDES, is required to evaluate the proposal, and the bank has not taken less than 15 months in previous privatization processes.
A: If Bolsonaro loses, which is likely, then his administration will pull out all the stops to privatize and concurrently accelerate the divestment of Petrobras assets with a focus on the re-tendering of the Alberto Pasqualini Refinery in Porto Alegre and the Gabriel Passos Refinery in Betim, Minas Gerais. These efforts have galvanized protests by the Federation of Petroleum Workers and other civil society organizations opposed to the dismantling of the company. Although BNDES would normally take more time to assess the privatization plan, the Bolsonaro administration is not timid about casting aside precedent, standard operating procedures, and rules to achieve its political goals. Bolsonaro, Economy Minister Paulo Guedes and Mines and Energy Minister Adolfo Sachsida will pressure the bank to finalize its evaluation, eliminating one more obstacle to the sell-off.
Overall, the drive to privatize Petrobras before the end of 2022 poses a high level of legal uncertainty, discouraging congressional collaboration and, most importantly, investors. I think there are too many legal and legislative obstacles to tender the company in such short order. However, if the incumbent were to win, then he would be obligated to advance the process, but at a slower pace. This would necessarily require significant logrolling in Congress—vote trading for earmarked spending. Such a legislative route would intersect with Chamber of Deputies President Arthur Lira’s re-election bid, further delaying deliberations until the lower chamber selects its leader in early February 2023. Although Lira has openly supported the privatization of Petrobras, he would have to carry much of the political burden on an issue that is unlikely to win him additional supporters but will cast a spotlight on his relations with current and prospective shareholders. If Lira is re-elected, then his focus will turn toward removing the constitutional prohibition on his continued tenure, a goal he will do just about anything to achieve. If the NOC’s privatization can advance this goal, then he will move forward, but if it cannot, he will retreat.
Q: What would be the impacts of fully privatizing Petrobras in terms of its strategy, efficiency, and the overall Brazilian oil and gas industry, which it currently dominates?
A: Since the impeachment of former President Dilma Rousseff in 2016, we have witnessed the asset-by-asset divestment of the NOC, mostly focused on the downstream and marginal fields. Under a privatized Petrobras, this process would accelerate, leaving the remaining corporate structure with the highly profitable pre-salt play and other low-risk, high-return fields. The company would be very profitable for average and high crude-price scenarios but removed from national efforts to speed up the energy transition. While the company could be expected to collaborate with international oil companies (IOCs) interested in carbon capture projects, it would be poorly positioned to pivot toward a broader portfolio as several of its international competitors and partners have done in recent years. More importantly, under the current government, the returns from its privatization would not be spent on decreasing the public debt or investing in low-carbon development. Rather, it would likely be spent on more populist measures aimed at boosting Bolsonaro’s approval and legacy.
In the longer run, Brazilian E&P will become increasingly shared among the NOC, IOCs, and domestic private firms, with capital-intensive projects coordinated through partnerships and bidding consortia. Governments at the federal, state, and municipal levels will continue to count on royalties and taxes paid by Petrobras, but its large carbon footprint could attract considerable opposition from an increasingly robust national environmental protection movement. I expect this opposition to grow along with the renewable energy sector and as the Brazilian government retakes its historic leadership role in global environmental governance initiatives.
Q: Same question as in the case of Eletrobras regarding Lula’s return. Would he be able to reverse any progress made by Bolsonaro on privatizing Petrobras?
A: I do not think that Bolsonaro will be re-elected or that Petrobras will be privatized before he exits the presidential palace on January 1, 2023. However, if the incumbent administration successfully privatizes or tenders key assets of the NOC before the inauguration of the next president, then the next administration will challenge the legality of any such measures. Currently, under newly appointed CEO Caio Mário Paes de Andrade, the company has re-tendered several refineries that failed to attract bidders in the past. To successfully carry out these tenders and award a contract to the winning bidder, the company would have to agree to a very low asking price, a move that could be easily challenged in the Federal Accounts Court or Supreme Court. The same investors that grabbed Eletrobras shares in June would be more reluctant to assume the risk of buying Petrobras assets given the likely prospects of a Lula victory in October. Moreover, a Lula victory will usher in greater legal and political scrutiny of prior divestments. For this reason, I think many investors will shy away in the coming weeks and months if the polls continue to show a significant lead for Lula.
Image: The Dialogue