Over the last month, news on the Brazilian energy sector revolved around two mega-operations involving Chinese capital: the purchase of CPFL by the State Grid Corporation of China and that of Duke Energy by the China Three Gorges Corporation (CTG). These investments have increased the standing of the two companies in their respective areas: State Grid now distributes 20% of Brazil’s electricity, and CTG is the second-largest energy generator in the country. These figures are not the only striking factor: both State Grid and CTG are state-owned enterprises that are overseen by the central Chinese government and their presidents enjoy ministerial status.
So why are these Chinese companies interested in Brazil?
We need to demystify the role that central Chinese government firms are playing on the international market. It is no longer viable to assume that these companies are coming into Brazil with the strategic objective of gaining control of energy assets that will later put Brazil at a disadvantage in possible negotiations with China. Indeed, Brazil has sufficient institutional mechanisms to prevent the creation of monopolies, especially when it comes to those controlled by foreign governments. What is attracting these companies to Brazil is an interesting combination of domestic factors within China and certain features of the Brazilian market.
Within China’s borders, the first factor is a certain degree of saturation in the possibility for expanding investment in the electricity sector.
In the hydropower sector, China currently has 320 GW of installed capacity, and the Five-Year Plan for the sector stipulates potentially increasing this by up to 180 GW, 130 GW of which are economically exploitable.
It should be remembered that China’s hydropower potential lies on the edges of the Himalayas, a region that is not only far from the country’s major urban centers but is also of great political importance for Beijing.
The central Chinese government would certainly not wish to have to deal with relocations and possible protests against the construction of hydroelectric power stations there. The plan for electricity distribution is to expand China’s current grid by up to 40%, which implies more than one million kilometers of new gridlines. Although these numbers may seem high, they are actually lower than what these companies have achieved over the past decade.
As a consequence, there is pressure from within China for them to go international.
According to Forbes, State Grid is the second-largest company in the world and its interests now reach far beyond domestic Chinese demand. The two firms currently need to seek investments that bring them greater returns than they would obtain on the Chinese market. Before the global financial crisis, the returns on investment of state-owned Chinese enterprises was very similar to those of private companies, with barely a 5% gap between the two. Today, state-owned companies are far less profitable than private ones, with an average rate of return on investment that is almost 10% below that of the private sector. The Chinese government has thus encouraged its state-owned enterprises to look to the international market for better investment alternatives.
The Brazilian market’s potential for expansion is precisely what is attracting Chinese companies there.
For example, in the hydropower sector, Brazil has an installed capacity of 92 GW and a potential capacity of 260 GW. Brazil and China are geographically similar, which also contributes to Chinese companies venturing to make inroads into the Brazilian market. As in China, vast distances separate the places where energy is generated in Brazil and where it is consumed. The characteristics of the Brazilian market are not the only thing that Chinese firms find attractive: technology is another fundamental factor behind State Grid’s arrival in Brazil. In China, State Grid is the market leader in the construction and management of ultrahigh voltage power lines, which transmit high voltages while minimizing transmission losses. This type of technology is currently being used at the Belo Monte project and is extremely useful given the enormous distances mentioned above. This technology implies the importation of Chinese machinery and equipment into Brazil to be used for both electricity generation and transmission.
The great challenge ahead of these companies is how to expand within the Brazilian market.
So far, it is clear that their integration strategy is through mergers and acquisitions of companies that are already operating in Brazil. However, the Brazilian market’s expansion capacity is linked to a series of greenfield projects. The natural path would be for Chinese companies to learn from their local partners and then leverage this learning for more complex projects. What will eventually unfold remains to be seen.