Cancelled auction a nasty surprise for Brazil's renewables industry

The cancellation of last week’s auction was a horrible surprise to Brazil’s wind and solar power industries.

The decision is not shocking. Eroding electricity demand caused by recent economic turmoil was cited as the culprit for the cancellation. The figures issued recently by Brazil’s EPE show electricity demand has fallen 1.6% over the last year. Brazil’s Ministry of Mines and Energy stated that demand will be 3.48GW lower than previously expected in 2019. So from a supply/demand perspective, the cancellation makes sense.

Still, the decision is surprising. The timing of the announcement, a week before the auction, is irresponsible. Falling demand has been well documented for months and the supposed capacity over-contraction is well known. Still, the government led both industries to believe that an auction would be held to support the domestic supply chain. This type of auction, a reserve auction, is intended to balance the power system and is not entirely demand dependent. Now, most component suppliers face a bleak outlook starting in 2018. Furthermore, ahead of the auction, several developers acquired new projects at sites unaffected by grid delays to participate in the auction. A cancellation made months earlier would have been more responsible.

The auction cancellation is bad news for the supply chain. Many suppliers are already under stress due to high competition and reduced order volumes from other end markets. A year without orders could precipitate the exit of several companies. Most supply chain companies are unlikely to ride out a domestic market lull by exporting due to poor cost positions. It is possible that some supply chain companies adopt a strategy of exporting production at cost to keep the doors open. This makes sense for turbine OEMs, which want to demonstrate commitment in front of developers to maintain a long-term position in what remains a strong market in the future. Furthermore, the cancellation decision threatens several ongoing investments within the wind power supply chain in Brazil.

The decision signals that the new government will not support wind and solar power through reserve auctions during this period of turmoil. Still, intense lobbying by both the wind and solar power industries over the next year is highly likely. The groups will argue that a reserve auction in 2017 is necessary to sustain supply chain jobs. Any of the likely closures of high profile factories or abandoned investment plans would lend credence to the associations’ arguments.

Ultimately, the cancellation is a short-sighted and, possibly, poorly considered decision. Much of the contracted capacity that contributes to this theoretical overcapacity will likely come online years late or not at all. More than 3GW of thermal projects lack completion timelines. Furthermore, two thirds of the solar capacity awarded PPAs at previous auctions with 2017 CODs have yet to break ground, with more than half being officially labelled as not economically viable. Additionally, widespread transmission build delays threaten the connection of GWs of capacity already under construction.

Brazil still remains too dependent on hydroelectricity. For example, Brazil experienced widespread blackouts and electricity pricing reaching ceilings less than two years ago during drought. Lastly, electricity demand continues to increase in the north and northeast regions of the country, where most wind and solar capacity is being developed. Given wind power’s well known complimentary relationship with the country’s hydro resource and its regional footprint, “over contracting” still makes sense.

This decision will likely have a bigger impact on the PV industry which is in an early stage of supply chain localization. This cancellation could completely freeze investment in supply chain. Without support at reserve auctions, Brazil may be forced to abandon its PV manufacturing ambitions. Furthermore, the Brazilian solar industry could face another setback if the government moves forward with cancelling PPAs at delayed sites. This could disproportionally impact the PV industry, which has struggled with a rapidly changing FX landscape. These dynamics would be a crippling blow to utility-scale PV and its supply chain.

The cancellation’s legacy could have repercussions beyond the power industry. The government’s reversal of implied support will likely send a chill through future plans by any entities considering investing in Brazil. Abandoning the wind and solar power industries at reserve auctions or through the rumored removal of BNDES support would be bad faith after compelling manufacturers to invest in the market in spite of prevailing global supply and demand dynamics. Through this cancellation, the Brazilian government has introduced a dynamic long-loathed by the global wind industry in what has been a fairly stable market – policy uncertainty.

Brian Gaylord is senior analyst for Latin America and Southern Europe at MAKE Consulting.