Energy prices offer investment plays in Brazil

Investors in Brazil’s power sector are facing volatile earnings and share prices as a drought has forced up the spot price for energy to its government-enforced ceiling of R$822/Mwh.

Generation companies that have shortfalls in their contracted energy supply face heavy costs of compensating the electricity grid, while those companies that have spare capacity will be facing short-term windfalls.

Experts say the high electricity prices – caused by reliance on more expensive thermo power plants as the hydroelectric plants face low reservoir levels – are also adversely affecting the earnings of manufacturing companies, many of which are beginning to scale down production to sell energy to the grid at big profits.

The crisis will also have longer-term implications for the country’s power network, with the next government likely to foster a more benign investment climate for international power projects in Brazil.

The 15 constituents of stock exchange Bovespa’s electricity segment have all posted losses this year and the index is down over 11%. Moody’s estimates that most of the hydro-generation companies are fully contracted through medium-term and long-term supply contracts or have little energy to sell on the spot market.

Should rationing be implemented in the country for the first time since 2001 – the chances of which are now set at 46% by private sector consultancy PSR – these companies would be even more severely affected on cashflows and liquidity positions.

Those most exposed, according to Moody’s, are Electrobras, Duke, AES Tiete and Energest. Generation companies that have uncontracted energy to sell at the ceiling price would actually benefit, with Moody’s identifying Cesp and Cemig in this category.

The hit to earnings is creating potentially lucrative speculative trades, with investors trying to identify which of the generation companies are most vulnerable.

“We see good opportunities to go short along with the 1Q14, given that most companies will likely report very poor earnings in the upcoming quarters, caused by a negative [supply-contract position to the national grid],” says a JPMorgan client note.

The effects are beginning to cross over from the utilities sector and affect the strategy of industrial companies, which will also have an impact on GDP growth.

The government is reportedly talking with large industrial users to lower demand in that sector, which accounts for 40% of total energy consumption.

For the full article visit Euromoney Magazine

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