Annual Report - EDP

notes to the EDP consolidated - Energias de Portugal, and company S.A. financial statementsNotes to for the the Consolidated years and ended Company 31 december Financial Statements 2012 and 2011for the years ended 31 December 2012 and 2011The distribution companies must estimate the amount of electricity to contract in auctions and they are obliged to purchase 100% of their needs respecting thecondition that, market increases must be met by energy from new ventures, contracted 3 years (Auction A-3) or 5 years (Auction A-5) in advance. Failure to complywith the supply of energy to its markets may result in severe fines.Liberalised systemIn the liberalised market, electricity is traded among production concessionaires, independent power producers, auto-producers, agents and free consumers. In thismarket, the contractual conditions, such as price, duration and amount of the contract are traded freely and negotiated between the parties (Decree No. 5.163/04).Free consumers can return to the regulated system under certain conditions.The Federal Government has defined changes in the electric sector through Provisional Measures. The Provisional Measure 577, published on August 31, 2012, relateswith the extinction of public service concessions of electricity and the temporary service on the suitability for the public service of electricity.The Provisional Measure 579 of 11 September 2012, provides a reduction in the price of electricity to the consumer. An average reduction of 20.2% is expected, due tothe government action on two fronts: sectoral charges (7%) and concessions renewal (13%).Regarding concessions renewal, the generation concessionaires which contracts expire between 2015 and 2017 may renew their concessions and shall makeavailable their physical energy garantee for the quotas system to be distributed proportionally to the size of each distributor, affecting the energy acquisition.The transmission concessionaires which contracts expire between 2015 and 2017 may renew their concessions and, considering that the assets bounded to theelectricity transmission service are totally depreciated, only the operational and maintance costs will be considered for the annual allowed revenues calculation.The hydropower concessions held by EDP Group - Energias do Brasil have been granted after February 1995, corresponding to the date of the entry into force of Law8987, thus they are not covered by the regulatory changes introduced. Still, these changes will influence the rules that will be applied on the renewal of theseconcessions in the future, according with the following conditions:§§§Each hydroelectric plant should be remunerated by a tariff calculated by the Agência Nacional de Energia Eléctrica (ANELL);Power selling (Physic guarantees) defined through production quotas dedicated exclusively to the regulated sector, that is to the distributors; andCompliance with the quality service standards determined by ANEEL.GenerationThe generation market is based predominantly on the existence of Power Purchase Agreements (PPA) between generators and distributors, with tenders to supplylong-term demand, the adjustment of medium and short term and daily market for deviations, or spot market.Electricity generation in Brazil relies mostly on hydroelectric technology. Power generation plants are the object of concession, permit or registration, according to thetype of plant, the power capacity to be installed and the destination of the energy. Depending on the destination of energy, power generation plants can be classifiedas:§Generation companies, producing electricity for public service distribution;§ Independent producers, who assume the risk of the sale of electricity with distributors or directly with free consumers;§ Auto-producers (energy generation for own consumption, the excess of which can be sold through an authorization).TransmissionThe brazilian transmission system, with a capacity equal or above 230 kV, is divided into transmission and sub-transmission networks, depending on thedisaggregation level of the consumers market. The primary network is responsible for the transmission of electricity to large consumers and the supply of energy toany consumer of high dimension. The secondary network is basically an extension of the primary network with the objective of delivering electricity to small consumersand providing energy to large industrial customers.In December 2012, ANEEL published the Authorization Resolution No. 3788, authorizing the transfer of the corporate direct control of Evrecy Participações Ltda., ownedby EDP - Energias do Brasil S.A., to the Companhia de Transmissão de Energia Elétrica Paulista - CTEEP.DistributionThe public service concession arrangements for electricity distribution are allocated by tender and establish rules regarding price, regularity, continuity, safety,timeliness and quality of services and supplies provided to consumers and users. These arrangements also define penalties for possible irregularities.In most states, mainly in the North and Northeast, the concession area corresponds to the state boundaries. However, mainly in São Paulo and Rio Grande do Sul, theconcessions for distribution may cover smaller areas than the state itself. In same cases, the concession area is extended beyond the geographical limits of the statewhere the distribution company is located.The distribution activity operates in a regulated environment, with tariffs determined in the context of incentive regulation ("price cap") with a remuneration basis in theassets used in the distribution energy service (BRR). The tariff also includes a portion to cover the operating costs established from a standard company, the referencecompany (with costs that would be charged by an efficient operator at the concession area). The regulatory EBITDA has two parts, which: (i) regulatory depreciation ofBRR assets and (ii) return on capital prudently invested multiplied by the regulatory WACC, ie by the rate of weighted average cost of capital of sector companies.Finally, the tariffs also consider the costs of acquiring energy, hiring the use of transmission and sector-based as costs to be included in the tariff. The tariff portion thatincludes the regulatory remuneration, the depreciation charge and the value of the operating costs is called portion B. The costs of buying energy, hiring of basicnetwork and charges, set up the portion A of the tariffs as set out in the concession contracts for distribution companies.EDP - Annual Report 2012175