Risk Desk in Brazil
This article first appeared in the June 2006 issue of The Risk Desk , and is reprinted with the permission of Scudder Publishing www.scudderpublishing.com
When it comes to Risk Management in the volatile South American Market, energy companies are often stuck with licking their finger and holding it up to test the wind. It’s not that there aren’t sophisticated risk managers, but it’s a completely physical market with no financial instruments available at all,” so managing their risk is extremely difficult to do,” says Leigh Parkinson , energy consultant at RiskAdvisory.
We caught up with Parkinson after his recent jaunt to Brazil , where he met with a half-dozen independently owned electricity providers who have good models for estimating value, but are hungry for more. As a first mover in this market, launched from the offices of its well-established parent company (business intel software giant SAS has been in the Latin American finance and telecom sectors for a couple decades), SAS/RiskAdvisory hopes to provide software that will expand Brazilian risk managers’ tools beyond the metaphorical finger in the wind – meaning the spreadsheet.
“The opportunity to do very advanced analytics seems to hold a great deal of appeal for (Brazilian energy risk managers). Where there are liquid markets, as in North America , it’s pretty easy to develop a feel for where value is and how you would price contracts to customers,” he says. “Even in a less liquid market like Brazil , customers are still asking for pricing options, pricing alternatives that a utility will try to deliver and price into a contract – load factor options, take-or-pay arrangements, etc. In a market like theirs, it’s not very easy to come up with what those option values are worth that you’re building into physical contracts.”
Brazil ’s market is different from ours in a number of ways. For starters, 80 percent of available electricity is hydro generation, so beyond the cost of construction, power is pretty cheap. That’s a good thing, because most of the country’s massive population lives well below the poverty line. In fact, it’s commonplace for poor Brazilians in one of the large hillside shantytowns to simply run their own power lines from a nearby pole to bring current into the house free of charge. That adds another wrinkle: “Whatever the costs are (of pirated power) have to be shared by those that are paying for power, so that loss gets translated and distributed among a narrower group,” Parkinson says.
These market limitations are not to suggest that there is any lack of sophistication amongst utility practitioners in Brazil . Companies who are active in the free market (unregulated customers) that I met with my resident colleagues clearly had a handle on the market's dynamics and nuances and they exuded confidence and comfort with the models they've built and they have been very successful so far.
“Most of the customers are still regulated. Where we found the most interest in our offerings was with utility companies competing with each other in the ‘free customer market,’ as they describe it. Most of the smaller utilities serve the regulated market for the most part. But they have a competitive market of some magnitude, and the handful of more sophisticated companies are probably competing for something in the neighborhood of 500 industrial customers,” he says.
The country is large, growing and has adequate natural resources now to supply power. In fact, Brazil ’s E&P monopoly is a net exporter of oil and gas, and unlike the US , the country’s power prices are unaffected by geopolitics and global supply issues. But concerns abound about where the money will come from to build new facilities. “New facilities are expensive: the country isn’t wealthy, the government doesn’t have the money and the inconsistencies of regulatory environments throughout South America make even the existing players that are native to those countries nervous that the rules are going to change at any moment,” he says. The volatility of the country’s political and regulatory climate tends to discourage outside investment (though some power companies have parent companies in Portugal ). Outside investors may also be put off by what tends to hit the headlines in Brazil : corruption, kidnapping, street violence, robberies, protest rallies, terrorism and so on. The country is the size of the lower 48 but has four times the murder rate, and crime is rising steeply in the cities. “In Rio de Janeiro , efforts by jailed drug lords to exert influence over the city have led to a violent backlash against local authorities and businesses,” according to this week’s US State Department data. Risk management takes on whole new connotations when operating a business in this environment. That said, Parkinson found the country on a path to developing a sophisticated and regulated energy marketplace modeled off the North American pattern. “They are putting the right sort of departments in place from a regulatory standpoint that mirror the kinds of things we’ve seen here, in terms of a pooled concepts, who’s managing the pool, who’s regulating it, market surveillance. All of those issues are being addressed,” he says. “The potential customers we are talking to are quite comfortable in a competitive environment there, but realize they are playing in a narrow field.” In terms of risk software, “tracking their physical transactions and how they price their contracts are their two main issues,” he says. The Brazilian risk managers took a keen interest in RiskAdvisory’s Energy BookRunner as a deal-capture system for physical and financial markets. Back office capabilities and system solutions for billing to speed up the settlement process on electricity transactions, and to provide services to customers based on usage and other criteria, also attracted a lot of attention. From a risk-management or middle-office point of view, the Brazil energy companies were interested in another SAS product called Risk Dimensions, a powerful analytics engine that would enable them to expand their ability to analyze.
Parkinson thinks the future of Brazil ’s energy business seems bright. Financial instruments for energy could occur as more customers leave the regulated environment, but not until the energy market is more consistent and stable, has a track record and is “much bigger in terms of a free market,” he says. “That’s going to be an ongoing problem for them. It’s a relatively poor country with a lot of natural resources. You tend to end up with political parties that are more socialistic...”
But for now, RiskAdvisory is on to a good thing. Brazil ’s energy companies are quite profitable and are increasingly interested in software tools for forecasting, billing, metering, fraud prevention and the other uses in the electricity business. “From what we got to see of their environment in terms of a utility environment and business practices, you wouldn’t know you weren’t anywhere else, except everyone’s speaking Portuguese. They clearly are moving in the direction of having a completely normal, regulated utility environment,” he says. “It’s really the free market players looking for any competitive edge they can find.”