How an Electricity Shortage Is Blacking Out Brazil's Growth

The crisis is forcing investors to cancel projects

For the citizens of Sorocaba, an industrial satellite of São Paulo, Brazil, it was a heavy blow. On May 25, the local unit of Flextronics International Ltd. (FLEX ) of Singapore, a manufacturer of info-tech equipment, announced it would not, after all, build two new plants next to its factory there. The $85 million investment would have created 500 new jobs. Why was it axed? Because there was no guarantee Flextronics could get a steady supply of electricity, owing to the widening power shortages in Brazil.

This is no local difficulty. Under a crisis plan in effect from June 1, residential and corporate users in an area containing four-fifths of Brazil's population must cut electricity consumption--or face higher charges and blackouts.

RECESSION? The result: a nasty setback to much needed expansion. "It's going to be much worse than the government thinks," says André Segadilha, an energy analyst at Banco Brascan in Rio de Janeiro. He points to a government study showing that under the crisis plan, the bulk of Brazilian families will have to spend as much as 14% of their budget on electricity, up from 5% to 8% now. "That's going to have a big impact on consumption," Segadilha says. "There's a big risk of recession."

Those fears are hitting investment across the board. "We planned to invest $26 million this year and $35 million next year," says Axel E. Schaefer, industrial director at the Brazilian subsidiary of Bayer (BAYZY ), a German petrochemicals and pharmaceuticals group that has five factories in four Brazilian states from the south to the northeast. "Those plans will certainly be affected." Some 20% of manufacturers in São Paulo, Brazil's most industrialized state, are considering lay-offs because of the crisis: 65% will reduce or delay investments.

The immediate power crisis is partly caused by drought. More than 90% of Brazil's electricity comes from hydroelectric dams. At this time of year, near the start of the six-month dry season, reservoirs in the southeast should be more than half full. Instead, because of low rainfall this past rainy season, they're one-quarter full.

But even if rainfall returns to normal in the November-to-April rainy season, structural issues will still bedevil the power sector. While demand for electricity has grown by 5% a year for the past two decades, generating capacity has grown by just 4% a year.

BIZARRE EXCEPTIONS. Who's to blame? Mostly the government--for failing to invest or provide the conditions for foreign investment. While electricity distribution has been privatized, generation is still largely in state hands, and tight budgetary targets have put limits on spending. "The government hasn't found the right mix of regulations to encourage international investors," says Frank J. McGann, a utility analyst at Merrill Lynch & Co. in New York. So officials are scrambling to update regulations to allow dozens of thermoelectric power stations to be built, partly with private money. But they won't come on stream for two years.

The waffling bureaucracy has not made things any easier. First, there was to be a freeze on new electrical connections. That meant no construction of new buildings. Now, exceptions will be made. Soccer matches and other entertainments were to be banned after dark. Bizarrely, traveling circuses are exempt from the restriction. "Every day, the rules change a little," says Bayer's Schaefer.

There is even more uncertainty over how successful the plan will be. The government hopes to cut use in the affected regions by 20%. Yet Mário Lopes, director of the National System Operator, which coordinates the various utilities, has said savings of up to 35% will be needed to avoid rationing before the rainy season. This is turning into a year that most Brazilians will want to forget.

By Jonathan Wheatley in São Paulo

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