Aligning regulatory incentives and price signals in the Brazilian wholesale and retail electricity markets

Abstract

Managing electricity supply and demand for electricity in Brazil is particularly challenging because of the great variability of supply and demand. The variability of supply is due to the stochastic nature of renewable power sources that account for most of Brazil's generation capacity, while the variability of demand is due to the changing structure of its economy and to macroeconomic instability. This high variability of supply and demand requires careful risk management. The introduction of an electricity market can help deal with this volatility by increasing consumer awareness and responsiveness to aggregate supply and demand dynamics. The market also fosters the development of hedging instruments that help stabilize market financial flows, induce better market monitoring, and adoption of prudent practices. For the market to work properly, however, it is essential that the market pricing accurately reflect supply and demand conditions, and that the market structure, and supporting regulation, provide proper incentives to both wholesale and retail market participants - both of which have been an ongoing challenge in Brazil. Pricing of electricity is particularly complex in Brazil because a large share of the generation is derived from renewables that have negligible marginal costs. This means that much of the time wholesale spot market prices are determined by the opportunity costs of these renewable power plants, based on expectations of future supply and demand conditions. Brazil has developed sophisticated tools to aid in the determination of proper pricing, but further improvements are needed. The development of financial instruments has been a key milestone in the evolution of the Brazilian electricity market, but refinements are needed to promote better alignment of the physical and financial markets. Brazil's current market structure and regulation has evolved over time in response to various needs and concerns, which are not always entirely aligned. This has resulted in the creation of two different Contracting Environments in Brazil, each designed to meet specific needs of different sets of market players, but that have also introduced market distortions. In the coming years, Brazil should further improve the price-setting mechanism, and adopt additional regulatory reforms to promote market integration, increase market liquidity and flexibility, and improve price responsiveness of all market participants. © 2016 CIGRE. All rights reserved.