Utilities Sector

1
Utilities Sector

• Pedro Batista Eduardo Haiama, CFA Rafael Espírito
  Santo
• Strategist Analyst Analyst
• 5521 3262 9849 5521 3262 9655 5521 3262 8636
• pedro.batista_at_ubs.com eduardo.haiama_at_ubs.com
  rafael.espiritosanto_at_ubs.com

This material has been prepared by UBS Pactual
S.A.
September 2008
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2
Agenda

• Key themes remain mostly intact
• Main Events in the Short-/Mid-Terms
• Concession Renewal Issue
• Consolidation process
• New energy auctions
• Eletrobras Role in the Future
• Brasiliana sale of BNDES stake?
• Conclusion of methodology for the reference
  company costs
• Supply x Demand
• Transmission auctions
• Distributions tariff revision
• Companies overview

3
Key Sector Themes

• Reservoir levels and potential rationing risk
  now only in 2009 or later
• Tight supply x demand to remain until 2010
  leading to high spot prices
• Concession renewals
• Secular increase in generation prices
• Positive impact of Investment Grade on the sector
• Regulatory risk perception with the
  implementation of second cycle of tariff
  revisions
• Consolidation move in Brazil and worldwide
• Eletrobras role in sector investments
• Favorable macro scenario
• More attractive financing lines (?)
• Comfortable financial situation of companies

4
Main Events
5
Main Events in 2008
Cemig, Paulista, RGE (CPFL), Enersul (EDB)
Tariff Revision
Light Tariff Revision
Copel Tariff Revision
Brasiliana Sale??
DEC
JAN FEB MAR APR MAY JUN JUL
AUG SEP OCT NOV DEC
JAN FEB MAR APR MAY JUN JUL AUG
SEP OCT NOV
2 0 0 8
CESP Privatization failure
Rio Madeira Auction (Jirau)
Transmission auction
New energy auctions
Auction for Rio Madeira transmission
Reserve energy auction - Biomass
Source UBS Pactual, ANEEL
6
Concession Renewal Issue

• Different methodologies for Generation,
  Transmission and Distribution
• Generation
• Re-auction of the assets?
• Low price cap or UBP?
• Impacts on free and captive markets unknown
  depending on the proposed solution
• Probable scenario renewal of the concessions
  with low fee (political solution)
• Transmission
• Probable scenario renewal with full tariff
  process for all revenues (as opposed to todays
  regulatory framework that only applies to
  investments made after 1999)
• RAP decrease by about 30 (real terms) in 2015 to
  adjust revenues to full tariff revision
• Distribution
• Probable scenario concession renewal
• Regulatory framework for tariff revisions already
  implemented (return on RAB)

7
Concession Renewal Issue

• Capacity expiring in 2015 (already renewed once)
• Cesp 63
• Cemig 9
• Copel 5
• Eletrobras 44
• Should government re-auction the concessions?
  What could be the alternatives?
• Highest concession rights (UBP)?
• Lowest tariffs?
• Impact on long-term energy prices (?)

Copel
Cemig
Cesp
() Adjusted by Cemigs stake in each plant
8
Concession Renewal Issue
Eletrobras
9
Consolidation process

• Most straightforward MA already made Cemar,
  Elektro, small independent distributors
• Remaining companies are mostly financially sound
  (net debt/EBITDA less than 2.0x), limiting need
  for cash inflow
• Smaller deals at competitive prices (at low
  implied IRR strategic players willing to invest
  at rate of returns below 10 for existing assets)
• Potential opportunities among small companies
  with good pipeline of projects and lack of access
  to capital
• Big assets for sale CESP and Brasiliana?

10
New energy auctions

• Another thermal auctions (A-3 and A-5)
• Lack of competitive supply (gas, fuel oil)
• Coal should be the winner. In 2009, scenario
  should change
• Lack of hydro power plant projects to increase
  thermal generation in future auctions
• Lack of reservoirs translating into more
  volatility to spot prices
• Energy reserve the federal governments solution
  for reducing higher volatility? It seems so.

11
Eletrobrass role

• Improving corporate governance?
• ADR listing closer than before
• New investments centralized at the holding level
  
• Mitigates risk of unrealistic / unsustainable low
  required rate of returns
• Reduces internal struggles between subsidiaries
• Internationalization
• Not an easy path Bolivia to invest alone Peru
  reluctant to allow investments, etc
• Need of bi-national treaties
• Improvements in the federalized companies?
• Single management structure for all distribution
  companies
• Goal to eliminate cash drag in about 1-1.5 year

12
Multiples Comparison
13
Electricity Supply/Demand
14
Supply/Demand Balance - Scenarios
Alternative Scenario (Demand growth 5.5, 40 of
Proinfa, Delays in LNG)
Base Case (Demand growth 4.8)
Source Aneel and UBS Pactual estimates
Source Aneel and UBS Pactual estimates
15
Price Signals

• Tight supply/demand scenario already driving
  energy prices up
• LT energy prices in the free market are already
  above those of regulated market.
• New energy auctions pointing to prices around
  R130/MWh (understated in our view on unrealistic
  fuel cost for thermal plants).
• Upside risk on upcoming auctions as fuel costs
  are adjusted and lower competitiveness for fuel
  oil thermal plants.

Price EvolutionRegulated vs. Free Market
Source CPFL and UBS Pactual
16
Contractual Situation
Cemig
Copel
CESP
Tractebel
Source CCEE, Companies, UBS Pactual
17
Contractual Situation
Furnas
Eletronorte
Chesf
Source Companies and UBS Pactual
18
Energy Supply Which Sources?
Price per Source of Energy (R/avg MW) for an IRR
of 13
Source PSR and UBS Pactual
19
Electricity Supply Which Sources?
20
Energy Supply Which Sources?

• Challenging supply scenario gt higher energy
  prices
• Lack of new hydro power projects. Only Rio
  Madeira so far (slightly above 1-year demand
  growth). It might take many years to approve new
  projects. Rising transmission and environmental
  costs to increase marginal cost of new power
  plants.
• Gas supply issues. Problems with Bolivian supply
  and high demand growth to limit gas availability
  to thermal plants. LNG supply does not seem a
  feasible alternative. Recent gas crisis to
  benefit other energy sources such as coal.
• Coal. Abundant commodity in the world and more
  stable prices (than oil and gas). Main problem is
  logistics for imported coal (plant sites).
• Nuclear. High cost and even more difficult to
  approve environmental licenses. Angra III should
  provide only 1,350 MW of installed capacity.
• Fuel oil / Diesel. Competitiveness in recent
  auctions reduced, as the federal government
  changed methodology for ICB (cost benefit for
  thermal capacity).

21
Energy Supply Alternatives Sources of Energy?

• PCH (small hydro power plants). Competitive
  prices with subsidies (TUSD/TUST discount, lower
  regulatory fees and tax rate) but with increasing
  costs for greenfield projects and acquisitions.
  On top of that, Aneel is changing regulatory
  framework for authorization process that creates
  uncertainty to the development of some projects.
  Estimated feasible capacity expansion around
  5,000MW.
• Biomass. After hydro power plants, it is the most
  preferred source of energy by the federal
  government. The economics are interesting
  (especially for greenfield projects). Problems
  are firm supply of bagasse for 15 years,
  connection to the grid and lack of equipments in
  the short-term. Total supply could reach
  10,000avg. MW (considering retrofit projects).
  Same regulatory / fiscal benefits as PCHs. Last
  auction for energy reserve was a failure and only
  contracted 548 avg. MW of an estimated demand of
  1,500-2,000 avg. MW.
• Wind power. Least preferred source of energy by
  the federal government (after fuel oil).
  Potential supply of 70GW but still too many
  uncertainties on the demand side. Only feasible
  with federal auctions that should occur in 2009.
  Other bottleneck is the current high price of EPC
  in the country.

22
Alternatives Hydro

• Undergoing feasibility studies by the federal
  government.
• No environmental license yet (only Rio Madeira so
  far) and it might be difficult to obtain (Amazon
  region or Indian territories) gt more costly.
• New power plants should have lower assured
  capacity (lack of reservoirs)
• Location of new power plants far away from
  consumption sites (higher transmission costs).
• Optimistically, new plants might be offered in
  2009/2010
• So far, most of power plants were mostly
  allocated to regulated market.

Plants With Approved Feasibility Studies but not
Auctioned
Plants With Feasibility Studies Under Aneels
Analysis
Source EPE
Source EPE
23
Alternatives - Hydro
Main Plants With Feasibility Studies Under
Development
Source EPE
24
Alternatives - Hydro

• Rio Madeira Not an indication for long-term
  prices
• Not sufficient to cover demand growth.
• Assured capacity of Santo Antonio and Jirau
  should be 4,000 avg. MW over 4 to 5 years
  (versus an annual demand growth of about 3,000
  avg. MW)not to mention potential delays in
  construction schedule
• Tucuruí hydro plant took 10 years to be
  constructed
• Initial budget of US4.2 billion increased to
  US7.5 billion at the end of the work
• Flooded area, initially estimated in 1,630 km2
  was actually 2.850 km2, with a significant
  environmental impact
• Price cap distorted by high assured energy
  capacity
• Load factor of about 70 (vs. Brazilian average
  of about 55), although run-of-river with no
  reservoir.
• Assuming load factor of 55, cap would increase
  to R153/MWh
• Rising energy price for captive consumers
• Auctions already contracted 3,320 MW of hydro at
  above R130/MWh and 6,368 MW of thermal at prices
  above R135/MWh
• Considering R110/MWh for Rio Madeira, weighted
  average price is R126/MWh (which we believe is
  conservative)
• New thermal plants should be dispatched more
  often than current official simulation (around 5
  of the time) and at a cost higher than initially
  expected.

25
Alternatives Natural Gas

• As an alternative for gas supply, Petrobras is
  implementing two LNG regasification units in
  Brazil to attend the existing gas power plants
• We believe the country still faces some
  difficulties in securing gas supply in the long
  run. Besides just supplying the thermal plants,
  LNG should also be used to reduce the dependence
  on Bolivian supply
• We foresee limited availability of this fuel for
  thermal generation in Brazil, considering
• Challenges in growing domestic gas production
• Suppliers political instability (Bolivia,
  Argentina)
• Increasing demand for industrial use of natural
  gas,

Natural Gas Supply/Demand Balance in Brazil
Source Gas Energy
26
Transmission
27
Transmission

• Clear and stable regulatory framework attracted
  private investments to the segment
• First auctions (2000-2001) presented low or no
  discount to maximum revenues
• Real IRR to Equity above 20
• Entrance of new players, particularly Spanish and
  construction companies increased competition in
  the segment
• Higher discounts
• Lower returns (as low as 5)

Transmission Auctions Players Breakdown
IRR Evolution
Source Aneel and UBS Pactual estimates
Source Aneel and UBS Pactual
28
Distribution Tariff Revisions
29
How to Evaluate a Distribution Company?

• The best proxy to evaluate a distribution company
  is to compare it to a FRN (floating-rate note)
  which has coupons reseted every 4/5 years.
• Main factors are
• Regulatory Asset Base (RAB)
• Regulatory WACC
• Reference Costs
• X Factor

The main difference is the possibility of
obtaining higher or lower returns than the coupon
due to the real performance compared to the
reference company.
30
Regulatory EBITDA x Real

• Until now companies EBITDA drop indicate an
  average of 30 to 40.
• Despite that, most of results were relatively
  more predictable.
• Most companies still trading at EV/RAB of
  1.0x-2.0x after the tariff revision process.
• What can be different from our forecasts?
• Higher / Lower demand growth
• Better other revenues gt key example is Coelce
• Better or worse manageable expenses
• Better or worse energy losses / delinquency rate
• Different mix of clients (average tariff)
• Sharper drop in regulatory WACC in the future
  (after the investment grade received by the
  country)