At the end of January the Brazilian Congress was considering passage of a new law governing the electricity market, and project finance bankers hope that once these new regulations are in place they will kickstart a new round of projects in what has become a slow moving market.

There were only a handful of financings completed during 2003, since planning work on new greenfield projects had previously slowed down while sponsors and lenders waited to see how business friendly the new administration of president Luiz Inacio Lula da Silva would be.

At the same the focus of Banco Nacional de Desenvolvimento Economico e Social (BNDES) within the power sector was on the restructuring of sizeable loans made to US utility AES, rather than new projects.

The result is that the project finance market is entering 2004 with a situation where there is more financing available than projects to work on. The international banks and institutional investors are once again becoming comfortable with Brazil country risk, and sovereign and blue chip corporates have launched well received bond offerings.

Thus, in spite of the pullback from project finance of several international banks over the past few years, new Brazilian projects will be well placed to attract funding. The problem is uncertainty over the rules that will apply in the energy market.

?The shrinking of the global project finance market has now happened, and a number of players have exited, so whoever is still there is there to stay, and there is currently more appetite than deals,? says Philippe Ventoze, vice president at BNP Paribas in Sao Paulo.

?Hopefully the new regulations for the power sector will soon be established, and also faster economic growth in Brazil should increase the pipeline of deals, so the overall environment for deals will probably be more optimistic than it was early last year.?

Jaime Areizaga, lawyer at Clifford Chance in Sao Paulo, agrees that market participants are eagerly awaiting the new power market regulations. ?In early December the government issued a framework for the new energy market, and those rules are being developed, and some time early this year should take a clearer shape,? he says.

?The next cycle of power projects, which will be based on these regulations, is just starting up, so plans are still on the drawing board at the sponsor companies. Consequently there are few financial closings expected in the near future, though the Termo Fortaleza financing is expected to come to market during 2004.?

The ministry of energy was busy working on a new model for the power sector throughout last year. ?Instead of working on what was already there, and making it better, they decided to throw the whole lot into the garbage can and start all over again ? so it is a huge reform,? says one banker.

?There will now be a pool system, where generators will sell to all of the 64 distribution companies in Brazil, and there will be no more self dealing ? the distribution companies will not be able to own generating assets,? says Pedro Seraphim, lawyer at Tozzini, Freire, Teixeira e Silva in Sao Paulo. ?The generators will sell through this pool. This is a solution to the problem that in the past many projects did not go through because they could not find a suitable client to buy the energy under a long term power purchase agreement (PPA). This is now mitigated because the generators can sell into the pool system.?

The reforms were presented to congress as a provisional measure in late December, and congress has until the end of February to pass them or block them. But this approach in itself may cause problems, because congress is being asked to approve only a general set of principles, with the details of the new model to be implemented later via presidential decrees or other instructions set out by market regulators.

?This means that the government has too much power to change things ? for example everything can change when we eventually get a new president after Lula, or even a new minister of energy,? says one project lender. ?That makes it very difficult for projects which will have an operating life of 15 or 20 years.?

But at least the passage of the new rules will be a step in the right direction. On a more negative note, bankers in Sao Paulo are worried that BNDES, which often provides a local currency tranche to help get deals done, is leaning in the direction of policies that may hit project lending.

?BNDES is looking at taking a harder line with foreign sponsors, to the point where they may be looking for some kind of parent guarantee for loans, which would jeopardise limited recourse financings,? says one banker.

?Unfortunately BNDES has been looking at acquisition finance and project finance together. In the past they financed holding companies for acquisitions, and have had trouble getting loans repaid. But BNDES has many greenfield projects on their books, and are getting paid on time, but it looks like everything is being put in the same basket.?

The most high profile problems have involved the power plants associated with Electropaulo, the largest electric utility in Latin America. BNDES extended sizeable loans in association with the 1998 privatisation of Electropaulo Metropolitana, which was acquired by a consortium led by AES Corp.

Over the past year these loans have been subject to intense restructuring negotiations with AES. ?It took most of their time last year,? says one banker. ?The media were following the story closely, and there was a lot of outrage about BNDES having lent so much money to a big US utility like AES, so the political pressure on BNDES was worse than the financial impact created by the non-performing loans.?

But that process has now been resolved. On 16 January AES Corporation president Paul Hanrahan visited BNDES headquarters in Rio de Janeiro, and with BNDES finance director Roberto Timotheo da Costa officially confirmed the details of the deal that had been struck in December.

That agreement involves the creation of a new holding company, Brasiliana Energia, in which BNDES holds 49.9% of the voting shares, and AES 50.1%. AES equity interests in Electropaulo, Uruguaiana and Tiete, together with $90 million contributed by AES and its Brazilian subsidiaries, have been applied to reduce the outstanding debt owed to BNDES from $1.2 billion to $510 million This remaining $510 million is non-recourse to AES, and will be payable over an 11-year period.

Parallel with the BNDES talks, AES was also negotiating with private creditors, and has agreed on rescheduling of $787 million of outstanding debt, in a move that will make 70% of the re-profiled debt denominated in reais, the Brazilian currency. This agreement is subject to definitive documentation to be signed no later than 16 February. And in another parallel set of negotiations, it is possible that a debt restructuring involving AES Sul creditors may also eventually mean that AES Sul will be added to the Brasiliana Energia holding company.

These negotiations took up a great deal of time and effort at BNDES last year. Analysts say the bank needs to press ahead with new projects that address Brazil's growing electricity requirements, if the country is not to suffer a repeat of the electricity shortages seen in 2001.

Petrobras carries the market

Nonetheless, two big power project financings did close during 2003, the first of which was for the 226MW Ibirite gas-fired power station in the state of Minas Gerais, which featured a commercial bank loan arranged by BNP Paribas. The $65 million loan is partially guaranteed by export credit agency SACE, a result of the heavy Italian involvement in the project, with Edison as joint sponsor alongside Petrobras, plus the use of an Italian-built steam turbine.

There is also a $66 million direct loan from US Ex-Im, reflecting the involvement of General Electric as gas turbine supplier, plus a $22 million equivalent local currency tranche from BNDES. The loan had its final closing in December, and featured BNP Paribas as sole arranger and global co-ordinating agent.

The second was for the Macae power project ? an 895MW power plant sponsored by El Paso located in Rio de Janeiro state. El Paso originally dubbed Macae a merchant plant, and included it in its Gemstone financing vehicle, which closed at the end of 2001. Gemstone, a share trust vehicle, was unwound and the sponsor approached the IFC for financing, this time on the back of a Petrobras contract.

The contract does not formally constitute a tolling agreement, but involves Petrobras buying whatever energy Macae produces with fuel cost pass-through. Until the spot market recovers, therefore, the agreement works much like a toll. The deal features support from the IFC, which agreed terms with the sponsor and mandated SG to run a B loan in 2002.

This closed in December, and the package also features $150 million equivalent from BNDES, $200 million from the Overseas Private Investment Corporation (Opic). The IFC's debt consists of a $75 million A loan and $50 million B loan, which sold down to Fortis and the Indian Development Bank, according to sources at SG.

In the oil and gas sector, there was also an important closing for the gas pipelines system known as Projeto Malhas (which is the Portuguese word for networks). This featured $260 million of commercial bank debt partially guaranteed by Nippon Export and Investment Insurance (Nexi), plus a direct loan totalling $394 million from Japan Bank for International Co-operation (JBIC). BNDES also came in with an R830 million loan.

Two special purpose companies have been created for the project, Nova Transportadora do Nordeste (NTN) and Nova Transportadora do Sudeste (NTS).

These are owned by Mitsui & Co (holding 40%), plus Mitsubishi Corporation and Itochu Corporation with 30% each. All three are big players in the Brazilian oil and gas sector, and are benefiting from a more aggressive stance on the part of Nexi and JBIC to promote Japanese industrial interests in Latin America and elsewhere in the world.

Petrobras plays a key role in the project by guaranteeing to buy the capacity of the pipelines, which will help promote the use of gas in the residential, industrial and thermo-generating sectors.

?The Malhas project involves a number of pipelines which unify different parts of the existing network, and create a backbone of gas pipelines in the southeast and the northeast of Brazil,? says Areizaga at Clifford Chance, which represented Petrobras on the deal. ?This expanded gas pipeline network will be important for the development of the gas market in Brazil.?

Fortaleza ? the 2004 menu in full?

The biggest closing anticipated during 2004 is the 310MW Termo Fortaleza power plant, which will include funding from the IFC. The project sponsor is Endesa, which also has a distribution presence in northern Brazil, via its holding in Coelce.

The plant is located in Pecem, Fortaleza, which is the capital of Ceara state in the northeast of the country.

The project agreement was originally signed early in 2002 as part of the Brazilian government's Priority Programme for Thermoelectricty (PPT), which took on added urgency because of the electricity shortages of 2001 as a result of a drought. Endesa signed a guaranteed gas supply contract for 20 years, and also attracted BNDES funding to help source Brazilian-made equipment. The construction contract was awarded to Mitsui.

But aside from the Fortaleza deal, 2004 looks set to be quiet. Most new plants are at the early planning stages, and Petrobas is no longer an aggressive player in the power project sector, having made sizeable provisions in its 2003 accounts for losses related to its thermoelectric generation activities.

The provisions had to be boosted from 2002 levels because of the failure to place power generating capacity into long term PPAs, and the low level of power being dispatched by the eight plants. These investments had originally been attractive for Petrobras as a supplier of gas, but taking merchant risk on power sales has not been a successful strategy for the company.

The lull in activity in the Brazilian market is unfortunate timing, since all the indications are that the international capital markets, and bank lenders, are looking favourably at Brazil. And at home the domestic capital markets, which have been used for previous hydro deals such as Machadinho, are also seeing heightened activity.

?There was volatility early on in 2003, with people waiting to see what was going to happen with the new government, but conditions for domestic bond issuance are now favourable,? says Marcio Guedes at Citigroup Global Markets in Sao Paulo. ?Interest rates are coming down, while real interest rates are already low, and a lot of companies such as CSN are focussing on the domestic capital markets.?

?In addition there have been some longer dated bonds sold internationally recently, which indicates that international institutional investors have an appetite for Brazil.?

Thus, with debt capital ready to move into Brazil, and global sponsors completing their restructurings and looking for deals, any Brazilian power projects that do get underway are expected by bankers to attract plenty of interest.