This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 BRASILIA 002834 
 
SIPDIS 
 
SENSITIVE 
 
NSC FOR MIKE DEMPSEY 
STATE PLEASE PASS TO USTR FOR SCRONIN 
DEPT OF TREASURY FOR FPARODI 
USDOC FOR 4332/ITA/MAC/WH/OLAC/SHIELDS 
USDOC ALSO FOR 3134/ITA/USCS/OIO/WH/RD/CREATORE 
USDA FOR FAS/ITP AND FAS/FAA/WH 
DOE FOR SARAH MARQUIS 
STATE PASS OPIC FOR MORONESE, RIVERA, MERVENNE 
STATE PASS EXIM FOR NATALIE WEISS, COCONNER 
STATE PASS USTDA FOR AMCKINNEY 
 
E.O. 12958: N/A 
TAGS: ENRG EINV BEXP PGOV ETRD BR
SUBJECT:  AMBASSADOR AND MINISTER OF MINES AND ENERGY 
DISCUSS GOB'S NEW ENERGY MODEL/NRG INVESTMENT DISPUTE 
 
REF:   A) BRASILIA 528, B) RIO DE JANEIRO 518 
 
¶1. (SBU) SUMMARY AND INTRODUCTION.  ON NOVEMBER 8, 
AMBASSADOR PAID A COURTESY CALL UPON MINISTER OF MINES AND 
ENERGY DILMA ROUSSEFF.  THE MINISTER EXPLAINED TO THE 
AMBASSADOR THE THINKING BEHIND THE GOB'S NEW ENERGY MODEL, 
WHICH MINISTRY OFFICIALS CHARACTERIZE AS A "HYBRID" AIMED 
AT PROMOTING COMPETITION IN THE MARKET WHILE STRENGTHENING 
STATE CONTROL.  THE AMBASSADOR MADE THE POINT THAT MAJOR 
U.S. INVESTORS (INTER ALIA, DUKE POWER) CURRENTLY OPERATING 
IN THE ELECTRICITY GENERATION MARKET FELT THAT THE NEW 
MODEL RETROACTIVELY CHANGED THE RULES OF THE GAME TO THEIR 
DETRIMENT.  (A DIRECTOR OF THE ELECTRICITY SECTOR 
REGULATORY AGENCY SEPARATELY EXPRESSED SKEPTICISM OF THE 
NEW MODEL AND POINTED TO THE GOB'S DECEMBER AUCTION TO 
SUPPLY POWER AS THE NEW MODEL'S FIRST MAJOR TEST.) 
AMBASSADOR ALSO URGED MINISTER ROUSSEFF TO MOVE QUICKLY TO 
HELP ENSURE THAT PETROBRAS PAID AN USD 83 MILLION ARBITRAL 
AWARD DUE THE U.S. FIRM NRG.  ROUSSEFF PLEDGED TO 
FACILITATE DISCUSSION BETWEEN NRG AND PETROBRAS ON THE 
MODALITIES FOR PROCEEDING WITH THE PAYMENT.  IN CLOSING, 
MINISTER ROUSSEFF EXPRESSED APPRECIATION FOR ALL THE HELP 
THAT DOE - AND IN PARTICULAR, SECRETARY ABRAHAM - HAS BEEN 
ABLE TO PROVIDE IN TERMS OF SUPPORT ON ISSUES SUCH AS 
ALTERNATIVE ENERGY SOURCES. END SUMMARY AND INTRODUCTION. 
 
NRG ADVOCACY 
------------ 
 
¶2. (SBU) IN A NOVEMBER 8 COURTESY CALL UPON MINISTER 
ROUSSEFF AND HER CHIEF OF STATE (NELSON JOSE HUBNER 
MOREIRA), AMBASSADOR, (ACCOMPANIED BY ECONCOUNS, DEPUTY 
SENIOR COMMERCIAL OFFICER, AND SPECASST) URGED THE GOB TO 
QUICKLY COME TO AN UNDERSTANDING WITH THE US FIRM NRG 
ENERGY, INC. REGARDING THE TIMING/METHOD FOR PAYMENT OF AN 
USD 83 MILLION ARBITRAL AWARD DUE THE COMPANY.  ALTHOUGH 
NRG PREVAILED AGAINST PETROBRAS IN ARBITRATION REGARDING 
THE LATTER'S MOVE TO ASSUME OPERATIONAL CONTROL OVER THE 
TERMO RIO PROJECT, TO DATE PETROBRAS HAS NOT COMPENSATED 
NRG AS REQUIRED BY THE ARBITRAL AWARD. 
 
¶3. (SBU) MINISTER ROUSSEFF EXPRESSED SURPRISE THAT THIS 
ISSUE WAS OUTSTANDING, NOTING THAT THE PETROBRAS BOARD HAD 
DECIDED TO MOVE FORWARD WITH THE PAYMENT OVER TWO MONTHS 
AGO.  SHE EXPLAINED THAT THERE WERE THREE POSSIBLE 
MECHANISMS FOR EFFECTING PAYMENT:  A) NRG COULD SET UP A 
COMPANY IN BRAZIL AND RECEIVE IN REAIS, B) PETROBRAS COULD 
REMIT DOLLARS TO NRG (WHICH WOULD REQUIRE CENTRAL BANK 
APPROVAL), AND C) PETROBRAS COULD PAY NRG FROM ITS OVERSEAS 
DOLLAR ACCOUNTS.  MINISTER ROUSSEFF PLEDGED TO IMMEDIATELY 
PHONE PETROBRAS FINANCIAL DIRECTOR GABRIEL TO REQUEST THAT 
HE ENTER INTO CONTACT WITH NRG TO ASSURE THEM THAT PAYMENT 
WOULD BE FORTHCOMING.  NOTE: PER NOV. 10 DISCUSSIONS 
BETWEEN FCS AND PETROBRAS, IT APPEARS THAT NRG AND 
PETROBRAS WILL SOON RESUME DIRECT TALKS. PETROBRAS WAS 
UPSET THAT THE USG DID NOT FEEL THAT IT WAS NOT 
COMMUNICATING OPENLY WITH NRG OR THE USG.  HOWEVER AFTER 
MANY UNSUCCESSFUL ATTEMPTS TO SCHEDULE AN APPOINTMENT WITH 
PRESIDENT DUTRA, PETROBRAS DID APPEAR TO BE AVOIDING THE 
SUBJECT. 
 
NEW ENERGY MODEL 
---------------- 
 
¶4. (SBU) AMBASSADOR THEN QUERIED ROUSSEFF ABOUT HER PLANS 
FOR RESTRUCTURING THE ENERGY SECTOR.  ROUSSEFF NOTED THAT 
UPON ENTERING THE MINISTRY IN 2003, SHE FOUND THAT THE 
SECTOR WAS IN A PRECARIOUS STATE.  ASSETS PRICES HAD 
DROPPED WORLDWIDE, AND BRAZIL FACED A DOUBLE WHAMMY AS ITS 
ECONOMY WAS IN CRISIS.  HOWEVER, SINCE THEN, SHE SAID, THE 
HEALTH OF THE COMPANIES (BOTH PUBLIC AND PRIVATE) IN THE 
SECTOR HAS BEEN RESTORED, EVEN THOUGH THE GOB NEEDS TO DO 
MORE IN TERMS OF STREAMLINING OF LICENSE/ENVIRONMENTAL 
REQUIREMENTS, ESPECIALLY FOR HYDRO GENERATION PLANTS. 
 
¶5. (SBU) THE AMBASSADOR POINTED OUT THAT US INVESTORS 
(INCLUDING DUKE ENERGY) WERE UNHAPPY WITH THE MINISTER'S 
PLAN TO SUB-DIVIDE THE ENERGY GENERATION MARKET INTO "OLD 
ENERGY," I.E. ESTABLISHED PRIOR TO JANUARY 1, 2000, AND 
"NEW ENERGY," POST JANUARY 1, 2000.  OLD ENERGY WOULD BE 
SUBJECT TO LONG-TERM CONTRACTS AND LESS PRICE VARIATION; 
NEW ENERGY WOULD BE FREE TO FLUCTUATE WITH THE MARKET.  AS 
DUKE ENTERED THE MARKET PRE JANUARY 1, 2000, ITS PLANTS 
WOULD BE CONSIDERED OLD ENERGY AND WOULD HAVE TO COMPETE 
PRINCIPALLY WITH FULLY-DEPRECIATED STATE-OWNED PLANTS.  THE 
MINISTER REPLIED THAT SHE UNDERSTOOD DUKE'S COMPLAINTS, BUT 
THAT WHAT THEY WANTED WAS SOMETHING SHE COULD NOT PROVIDE. 
BECAUSE NEW INVESTORS FACED HIGHER RISKS - AS THEIR 
FACILITIES WERE NOT IN PLACE - IT WAS ONLY LOGICAL TO 
REWARD THEM WITH THE OPPORTUNITY TO EARN HIGHER RETURNS. 
 
REGULATORY AGENCY SKEPTICAL OF NEW MODEL 
---------------------------------------- 
 
¶6.  (SBU) IN A SEPARATE MEETING WITH PAULO PEDROSA, ONE OF 
THE DIRECTORS OF THE ENERGY REGULATOR (ANEEL) AND HIS 
ADVISOR, RULEMAR PESSOA, ECONOFFS HEARD ANEEL'S CONCERNS 
WITH THE MINISTRY'S HYBRID MODEL.  PEDROSA, WHO WAS 
APPOINTED BY PREVIOUS PRESIDENT CARDOSO, CHARACTERIZED THE 
MINISTRY'S NEW HYBRID MODEL AS A PARADIGM SHIFT.  HE STATED 
THAT BRAZIL IS MOVING FROM FDI-CENTRIC MODEL, BASED ON A 
FIXED LEGISLATIVE FRAMEWORK AND INDEPENDENT REGULATORY 
REGIME, TO A MODEL THAT SEEKS TO LEVERAGE INFRASTRUCTURE 
DEVELOPMENT WITH MONEY FROM THE NATIONAL DEVELOPMENT BANK 
(BNDES) AND PENSION FUNDS.  THE ERA OF FREE 
COMMERCIALIZATION OF ENERGY WAS "ABORTED," PEDROSA SAID, 
WITH THE HYBRID MODEL NOW GIVING THE STATE A LEADING ROLE. 
FOR EXAMPLE, IN THE FUTURE THE STATE WILL DETERMINE HOW 
MUCH NEW CAPACITY IS NEEDED, BASED ON FORECASTS FROM A 
NEWLY-CREATED AND PURPORTEDLY- INDEPENDENT ENERGY RESEARCH 
INSTITUTE (IPE).  (NOTE:  WITH THE ECONOMY EXPANDING 
BRISKLY, SOME INDUSTRY FORECASTERS ARE ALREADY PREDICTING 
ELECTRICITY SHORTAGES BY 2008 UNLESS SUBSTANTIAL INVESTMENT 
IS MADE TO KEEP PACE WITH THE BURGEONING DEMAND.  THE 
MINISTER HERSELF HAS PUBLICLY STATED THAT THE COUNTRY NEEDS 
INVESTMENT OF USD 2.9 BILLION IN GENERATING CAPACITY, USD 1 
BILLION IN TRANSMISSION, AND USD 2 BILLION IN 
DISTRIBUTION.) 
 
¶7. (U) IN MOVING TO THE NEW MODEL, HOWEVER, THE MINISTRY OF 
MINES AND ENERGY (MME) HAD TO ACCOUNT FOR EXISTING 
GENERATORS AND INVESTMENT IN A MODEL DESIGNED WITH NEW 
POWER IN MIND.  THIS WAS THE ORIGIN OF THE MME'S AWKWARD 
DUAL POOL MODEL: THE FIRST A POOL OF "OLD ENERGY," PRODUCED 
BY PLANTS THAT CAME ON LINE BEFORE THE CUTOFF DATE, AND A 
SECOND OF "NEW ENERGY," PRODUCED BY NEW PLANTS THAT CAME ON 
LINE AFTER THE CUTOFF (REFTELS).  THIS DIVIDES INTO TWO 
SEPARATE COMPETITION GROUPS POWER GENERATORS THAT HAD NOT 
YET AMORTIZED THEIR INVESTMENTS (NEW ENERGY) AND THOSE THAT 
HAVE (OLD ENERGY).  THE GOB IS FORGING AHEAD WITH PLANS TO 
IMPLEMENT THE MODEL, BEGINNING WITH AN EARLY DECEMBER 
"MEGA-AUCTION" FOR 55 MW OF OLD ENERGY, TO BE SOLD TO MEET 
EXISTING, PRIMARILY RESIDENTIAL AND SMALL BUSINESS, POWER 
DEMAND. 
 
¶8. (U) PEDROSA EXPLAINED TO ECONOFFS THAT POWER SOLD INTO 
THE OLD ENERGY POOL WILL BE BOUGHT BY DISTRIBUTORS AND 
RESOLD TO "CAPTIVE" CONSUMERS, PRIMARILY RESIDENTIAL 
CUSTOMERS AND SMALL BUSINESSES.  GENERATORS THAT DO NOT 
SELL INTO THE POOL MAY COMPETE FOR LARGE COMMERCIAL OR 
INDUSTRIAL CUSTOMERS, KNOWN AS "FREE" CUSTOMERS, WHO RETAIN 
THE RIGHT TO CONTRACT DIRECTLY FOR POWER SUPPLIERS.  THE 
POOL IS OBLIGATED TO PURCHASE MORE EXPENSIVE POWER (3000 MW 
WORTH) FROM SMALL HYDROELECTRIC PLANTS, WIND PLANTS AND 
SOME THERMAL POWER GENERATION PLANTS.  ISOLATED POWER GRIDS 
IN THE AMAZON, PRIMARILY RELIANT ON DIESEL FUEL-BASED 
GENERATION, RECEIVE A SUBSIDY. 
 
¶9.  (U) IN EARLY 2005, ACCORDING TO PEDROSA, THE GOB PLANS 
TO AUCTION OFF AUTHORIZATIONS TO BUILD NEW POWER PLANTS. 
THE AMOUNT TO BE AUCTIONED WILL BE BASED ON DEMAND 
PROJECTIONS DRAFTED BY THE IPE.  THESE NEW PLANTS WOULD BE 
REQUIRED TO SELL INTO A "NEW ENERGY" POWER POOL, WHICH 
WOULD BE USED MEET THE IPE-FORECASTED EXPANSION OF DEMAND. 
THE AUTHORIZATIONS TO BUILD NEW PLANTS WILL BE AWARDED TO 
THOSE WHO OFFER THE LOWEST FINAL ENERGY PRICE.  OLD ENERGY, 
GIVEN ITS ALREADY-AMORTIZED INVESTMENT, WOULD BE ABLE TO 
UNDERCUT THE PRICES CHARGED BY NEW PLANTS AND WOULD 
THEREFORE NOT BE GIVEN ACCESS TO THE NEW ENERGY MARKET. 
 
¶10. (SBU) PEDROSA BELIEVES THAT THE RESULTS OF THE DECEMBER 
AUCTION WILL BE INDICATIVE OF HOW THE POWER SECTOR VIEWS 
THE NEW MODEL.  FOR EXAMPLE, IF FEW LONG-TERM CONTRACTS FOR 
SALES TO THE POOL ARE OFFERED, IT WOULD INDICATE POWER 
GENERATORS ARE BETTING ON RISING POWER PRICES AND UNWILLING 
TO TIE UP THEIR CAPACITY FOR LONG WITH SALES TO THE POOL. 
THIS WOULD BE AN IMPLICIT CALCULATION THERE WOULD NOT BE 
SUFFICIENT CAPACITY IN THE FUTURE, AND TO SOME DEGREE AN 
INDICTMENT OF THE MODEL ITSELF.  LIKEWISE, OLD ENERGY 
PRODUCERS COULD DELIBERATELY BID HIGH SO AS TO LOSE OUT ON 
SALES TO THE POOL BUT THEREBY RESERVE THEIR CAPACITY TO 
COMPETE FOR THE LARGER INDUSTRIAL AND COMMERCIAL CUSTOMERS 
("FREE CUSTOMERS") THAT ARE ALLOWED TO CONTRACT DIRECTLY 
FOR THEIR POWER SUPPLIES. 
 
COMMENT 
------- 
 
¶11. (SBU) WITH RESPECT TO THE NEW ENERGY MODEL, ROUSSEFF 
AND THE MINISTRY REPEATEDLY HAVE RESPONDED TO CRITICISM 
FROM BOTH INDUSTRY AND ANEEL WITH THE SAME STOCK ANSWERS 
THAT SHE GAVE THE AMBASSADOR.  ROUSSEFF BELIEVES STRONGLY 
THAT THE STATE MUST PLAY A FAIRLY CENTRAL ROLE IN 
ORGANIZING MARKETS.  THE MARKET, HOWEVER, WILL SOON HAVE 
ITS OWN SAY; THE DECEMBER OLD ENERGY AUCTION WILL, AS 
PEDROSA POINTED OUT, SPEAK VOLUMES ABOUT INDUSTRY 
EXPECTATIONS.  EXISTING GENERATORS, HOWEVER, ARE STUCK, AND 
MUST TO SOME DEGREE MAKE PEACE WITH THE NEW MODEL.  THE 
EARLY-2005 NEW ENERGY AUCTION WILL PROVIDE A MORE 
DEFINITIVE ANSWER, BECAUSE NEW-TO-MARKET INVESTORS WILL BE 
FREE TO AVOID IT ALTOGETHER. 
 
CHICOLA