20-F 1 cigform20f_2020.htm CIGFORM20F_2020

Table of Contents 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

or

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2020

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

or

SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report: N/A

Commission file number 1-15224

 

COMPANHIA ENERGÉTICA DE MINAS GERAIS – CEMIG

 

(Exact name of Registrant as specified in its charter)

ENERGY CO OF MINAS GERAIS

(Translation of Registrant’s name into English)

BRAZIL

(Jurisdiction of incorporation or organization)

1200, Avenida Barbacena; Belo Horizonte/MG, Brazil CEP 30190-131

(Address of principal executive offices)

Leonardo George de Magalhães

Chief Officer for Finance and Investor Relations

ri@cemig.com.br – +55 (31) 3506-5024

1200, Avenida Barbacena; Belo Horizonte/MG, Brazil CEP 30190-131

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of each class: Trading Symbol (s) Name of exchange on which registered:
Preferred Shares, R$5.00 par value CIG New York Stock Exchange*
American Depositary Shares, each representing 1 Preferred Share, without par value New York Stock Exchange
Common Shares, R$5.00 par value CIG.C New York Stock Exchange*
American Depositary Shares, each representing 1 Common Share, without par value New York Stock Exchange

*Not for trading but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the Securities and Exchange Commission.

 

Securities registered or to be registered pursuant to Section 12(g) of the Act: None

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common share as of the close of the period covered by the annual report:

566,036,634 Common Shares

1,127,325,434 Preferred Shares

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes No

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes No

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer Accelerated filer Non accelerated filer Emerging growth company

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards* provided pursuant to Section 13(a) of the Exchange Act.

* The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP   International Financial Reporting Standards as issued by the International Accounting Standards Board Other  

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:

Item 17 Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Yes No

 

 

Table of Contents

PART I

Item 1. Identity of Directors, Senior Management and Advisers  7
Item 2. Offer Statistics and Expected Timetable 7
Item 3.     Key Information 7
Item 4.     Information on the Company 49
Item 4A. Unresolved Staff Comments 104
Item 5. Operating and Financial Review and Prospects  104
Item 6. Directors, Senior Managers and Employees 144
Item 7. Major shareholders and related party transactions  156
Item 8. Financial Information 158
Item 9. Offer and Listing Details 168
Item 10. Additional Information 173
Item 11. Quantitative and Qualitative Disclosures about Market Risk 194
Item 12. Description of Securities Other than Equity Securities 197
PART II  
Item 13. Defaults, Dividend Arrears and Delinquencies 198
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds 198
Item 15. Controls and procedures 198
Item 16A. Financial Specialist of the Audit Committee 202
Item 16B. Code of Ethics 202
Item 16C. Principal Accountant Fees and Services 203
Item 16D. Exemptions from the Listing Standards for Audit Committees 203
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers 204
Item 16F. Change in Registrant’s Certifying Accountant 204
Item 16G. Corporate Governance 204
Item 16H. Mine Safety Disclosure 205
Item 17. Financial Statements 205
Item 18. Financial Statements 205
Item 19. Exhibits 206

 

3 

 

PRESENTATION OF FINANCIAL INFORMATION

The Companhia Energética de Minas Gerais – CEMIG is a state-controlled mixed capital company (‘sociedade por ações, de economia mista’) organized under the laws of the Federative Republic of Brazil, or Brazil. References in this annual report to ‘CEMIG’, the ‘CEMIG Group’, the ‘Company’, ‘we’, ‘us’, ‘our’ and ‘ourselves’ are to Companhia Energética de Minas Gerais – CEMIG and its consolidated subsidiaries, and references to ‘CEMIG Holding’ are to Companhia Energética de Minas Gerais – CEMIG on an individual basis, except when the context otherwise requires. References to the ‘Real,’ ‘Reais’ or ‘R$’ are to Brazilian Reais (plural) and the Brazilian Real (singular), the official currency of Brazil. References to ‘U.S. dollars’, ‘dollars’ or ‘US$’ are to United States dollars.

We maintain our books and records in Reais. We prepare our statutory financial statements in accordance with generally accepted accounting practices adopted in Brazil, and with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB). For purposes of this annual report, we prepared the consolidated statements in accordance with IFRS, as issued by the IASB. Our consolidated financial statements for the years ended December 31, 2019 and 2018 and the opening balance as of January 1, 2019 have been restated to reflect the change in accounting policy disclosed in note 2.8 of our annual consolidated financial statements.

Ernst & Young Auditores Independentes S.S. (‘EY’) audited the consolidated statement of financial position of Companhia Energética de Minas Gerais – CEMIG as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2020. The consolidated balance sheets of Madeira Energia S.A.  as of December 31, 2020 and 2019, and the related consolidated statement of operations, of comprehensive (loss) income, of changes in equity and of cash flows for each of the three years in the period ended December 31, 2020 were audited by PricewaterhouseCoopers Auditores Independentes (‘PWC’) whose report related to this financial statement has been presented to EY and are the sole base for the opinion of EY on the financial statements of Madeira Energia S.A., which is a significant investment of the Company accounted for under the equity method.

This annual report contains translations of certain Real amounts into U.S. dollars at specified rates solely for the convenience of the reader. Unless otherwise indicated, such U.S. dollar amounts have been translated from Reais at an exchange rate of R$5.1935 to US$1.00, as certified for customs purposes by the U.S. Federal Reserve Board as of December 31, 2020. See “Item 3. Key Information – Exchange Rates” for additional information regarding exchange rates. We cannot guarantee that U.S. dollars can be converted into Reais, or that Reais can be converted into U.S. dollars, at the above rate or at any other rate.

4 

 

MARKET POSITION AND OTHER INFORMATION

The information contained in this annual report regarding our market position is, unless otherwise indicated, presented for the year ended December 31, 2020. It is based on, or derived from, reports issued by the Brazilian National Electric Energy Agency (Agência Nacional de Energia Elétrica, or ‘ANEEL’), and by the Brazilian Electric Power Trading Chamber (Câmara de Comercialização de Energia Elétrica, or ‘CCEE’).

Certain terms are defined the first time they are used in this annual report. As used herein, all references to ‘GW’ and ‘GWh’ are to gigawatts and gigawatt hours, respectively, references to ‘MW’ and ‘MWh’ are to megawatts and megawatt-hours, respectively, and references to ‘kW’ and ‘kWh’ are to kilowatts and kilowatt-hours, respectively.

References in this annual report to the ‘common shares’ and ‘preferred shares’ are to our common shares and preferred shares, respectively. References to ‘Preferred American Depositary Shares’ or ‘Preferred ADSs’ are to American Depositary Shares, each representing one preferred share. References to ‘Common American Depositary Shares’ or ‘Common ADSs’ are to American Depositary Shares, each representing one common share. Our Preferred ADSs and Common ADSs are referred to collectively as ‘ADSs,’ and our Preferred American Depositary Receipts, or Preferred ADRs, and Common American Depositary Receipts, or Common ADRs, are referred to collectively as ‘ADRs.’

The Preferred ADSs are evidenced by Preferred ADRs, issued pursuant to a Second Amended and Restated Deposit Agreement, dated as of August 10, 2001, as amended on June 11, 2007, by and among us, Citibank N.A., as depositary, and the holders and beneficial owners of Preferred ADSs evidenced by Preferred ADRs issued thereunder (the ‘Second Amended and Restated Deposit Agreement’). The Common ADSs are evidenced by Common ADRs, issued pursuant to a Deposit Agreement, dated as of June 12, 2007, by and among us, Citibank, N.A., as depositary, and the holders and beneficial owners of Common ADSs evidenced by Common ADRs issued thereunder (the ‘Common ADS Deposit Agreement’ and, together with the Second Amended and Restated Deposit Agreement, the ‘Deposit Agreements’).

5 

 

FORWARD-LOOKING INFORMATION

This annual report includes certain forward-looking statements, mainly in “Item 3. Key Information”, “Item 4. Information on the Compay”, “Item 5. Operating and Financial Review and Prospects” and “Item 11. Quantitative and Qualitative Disclosures about Market Risk”. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting our business. These forward-looking statements are subject to risks, uncertainties and contingencies including, but not limited to, the following:

·General economic, political and business conditions, principally in Brazil, the State of Minas Gerais (‘Minas Gerais’), as well as other states in Brazil;
·Inflation and fluctuations in exchange rates and in interest rates;
·Increases in the costs of projects and delays or the failure to successfully complete projects;
·Result in the failure of facilities to operate or generate income in accordance with our expectations;
·Existing and future governmental regulation as to energy rates, energy usage, competition in our concession area and other matters;
·Existing and future policies of the Federal Government of Brazil, which we refer to as the Federal Government;
·On-going high-profile anticorruption investigations in Brazil;
·Our expectations and estimates concerning future financial performance and financing plans;
·Our level, or maturity profile, of indebtedness;
·Our ability to comply with financial covenants;
·The likelihood that we will receive payment in connection with accounts receivable;
·Our capital expenditure plans;
·Our ability to implement our divestment program;
·Failure or hacking of our security and operational infrastructure or systems;
·Our ability to renew our concessions, approvals and licenses on terms as favorable as those currently in effect or at all;
·Our ability to integrate the operations of companies we have acquired and that we may acquire;
·Changes in volumes and patterns of customer energy usage;
·Competitive conditions in Brazil’s energy generation, transmission and distribution markets;
·Trends in the energy generation, transmission and distribution industry in Brazil, particularly in Minas Gerais;
·Changes in rainfall and the water levels in the reservoirs used to run our hydroelectric power generation facilities;
·Existing and future policies of the government of Minas Gerais (the ‘State Government’), including policies affecting its investment in us and its plans for future expansion of energy generation, transmission and distribution in Minas Gerais;
·Impacts of the Covid-19 global pandemic on our businesses and on our results of operations, financial condition and cash flows and our ability to timely and efficiently implement measures to address these impacts; and
·Other risk factors identified in “Item 3. Key Information—Risk Factors”.

 

The words ‘believe,’ ‘may,’ ‘could,’ ‘will,’ ‘plan,’ ‘estimate,’ ‘continue,’ ‘anticipate,’ ‘seek,’ ‘intend,’ ‘expect’ and similar words are intended to identify forward-looking statements. We do not undertake to publicly update or revise any forward-looking statements because of new information, future events or otherwise. Considering these risks and uncertainties, the forward-looking information, events and circumstances discussed in this annual report might not materialize as described. Our actual results and performance could differ substantially from those anticipated in our forward-looking statements.

6 

PART I

 

Item 1.Identity of Directors, Senior Management and Advisers

Not applicable.

 

Item 2.Offer Statistics and Expected Timetable

Not applicable.

 

Item 3.Key Information

 

The following tables present our selected consolidated financial and operating information prepared in accordance with IFRS as of the dates and for each of the periods indicated. You should read the following information together with our consolidated financial statements, including the notes thereto, included in this annual report and the information set forth in “Item 5. Operating and Financial Review and Prospects” and “Presentation of Financial Information”.

The selected consolidated financial data as of December 31, 2020 and 2019 and for each of the years ended December 31, 2020, 2019 and 2018, prepared in accordance with IFRS, has been derived from our audited consolidated financial statements and the notes thereto included elsewhere in this annual report. U.S. dollar amounts in the table below are presented for your convenience. The selected consolidated financial data as of December 31, 2018, 2017 and 2016 and for each of the years ended December 31, 2017 and 2016 has been derived from our audited consolidated financial statements not included in this annual report on Form 20-F, which have not been restated to reflect the change in accounting policy.

 

7 

Consolidated Statement of Income Data

Year Ended December 31,

2020

2020

2019 (4)(5)

(Restated)

2018 (3)(5)

(Restated)

2017 (6)

2016 (6)

  (in  millions of US$) (1) (in  millions of R$, except per share/ADS data or otherwise indicated)  
NET REVENUE 4,858 25,228 25,486 22,299 21,712 18,773
             
Operating costs and expenses            
Energy purchased for resale (2.332) (12,111) (11,286) (11,084) (10,919) (8,273)
Charges for use of the national grid (337) (1,748) (1,426) (1,479) (1,174) (947)
Depreciation and amortization (190) (989) (958) (835) (850) (834)
Personnel (246) (1,276) (1,272) (1,410) (1,627) (1,643)
Gas purchased for resale (209) (1,083) (1,436) (1,238) (1,071) (877)
Outsourced services (244) (1,265) (1,239) (1,087) (974) (867)
Post-employment obligations (84) (438) (408) (337) 229 (345)
Materials (15) (79) (91) (104) (61) (58)
Operating provisions (reversals) (81) (423) (2,401) (467) (854) (704)
Employee’s and managers’ profit sharing (27) (142) (263) (77) (5) (7)
Infrastructure construction costs (304) (1,581) (1,200) (897) (1,119) (1,193)
Other operating expenses, net

(57)

(297)

(494)

(405)

(393)

(155)

Total operating costs and expenses (4,127) (21,432) (22,474) (19,420) (18,818) (15,903)
             
Periodic Tariff Review, net 97 502 - - - -
Share of profit (loss), net, of affiliates and jointly-controlled entities 69 357 125 (104) (252) (302)
Dividends declared by investee classified as held for sale - - 73 - - -
Remeasurement of previously held equity interest in subsidiaries acquired - - - (119) - -
Impairment loss on Investments - - - (127) - (763)
Result of business combinations 10 51 - - - -
Income before finance income (expenses) and taxes 906 4,706 3,210 2,529 2,642 1,805
Finance income (expenses), net (174) (906) 1,358 (518) (996) (1,437)
Income before income tax and social contribution tax 732 3,800 4,570 2,011 1,646 368
Income taxes expense (180) (936) (1,600) (599) (644) (34)
Net income for the year from continuing operations 552 2,864 2,970 1,379 1,002 334
Net income after tax from discontinued operations - - 224 363 - -
Net income for the year 552 2,864 3,195 1,742 1,002 334
             
Non-controlling interests:            
Non-controlling interests from continuing operations - (1) (1) (1) (1) -
Non-controlling interests from discontinued operations - - - (41) - -
Net income for the year attributed to equity holders of the parent 551 2,863 3,194 1,700 1,001 334
             
Net income for the year 552 2,864 3,195 1,742 1,002 334
Other comprehensive income (loss) (1) (7) (1,055) (463) (302) (553)
Comprehensive income for the year 550 2,857 2,139 1,279 700 (219)
             
Basic earnings:            
Per common share (7) 0.33 1.69 1.89 1.02 0.37 0.10
Per preferred share (7) 0.33 1.69 1.89 1.02 0.84 0.35
Per ADS common share (7) 0.33 1.69 1.75 0.83 0.37 0.10
Per ADS preferred share (7) 0.33 1.69 1.75 0.83 0.84 0.35
             
Diluted earnings:            
Per common share (7) 0.33 1.69 1.89 1.02 0.37 0.07
Per preferred share (7) 0.33 1.69 1.89 1.02 0.84 0.32
Per ADS common share (7) 0.33 1.69 1.75 0.83 0.37 0.07
Per ADS preferred share (7) 0.33 1.69 1.75 0.83 0.84 0.32

8 

 

Statement of Financial Position Data

Year Ended December 31,

2020

2020

2019 (4)(5)

(Restated)

2018 (3)(5)

(Restated)

2017 (6)

2016 (6)

  in  millions of US$ (1) (in  millions of R$ except per share/ADS data or otherwise indicated)
Assets            
Assets classified as held for sale 242 1,258 1,258 19,446 - -
Other current assets

2,734

14,198

9,096

8,520

8,537

8,285

Total current assets 2,976 15,456 10,354 27,966 8,537 8,285
Property, plant and equipment, net 463 2,407 2,450 2,662 2,762 3,775
Intangible assets 2,274 11,810 11,624 10,777 11,156 10,820
Concession financial assets 731 3,799 3,759 3,812 6,605 4,971
Other assets

3,969

20,611

22,339

15,122

13,180

14,185

Total assets 10,414 54,083 50,526 60,339 42,240 42,036
             
Liabilities            
Current loans, financing and debentures 396 2,059 2,747 2,198 2,371 4,837
Liabilities directly associated to assets held for sale - - - 16,272 - -
Other current liabilities

1,469

7,631

5,218

4,967

6,292

6,610

Total current liabilities 1,866 9,690 7,965 23,437 8,663 11,447
Non-current loans, financing and debentures 2,496 12,961 12,030 12,574 12,027 10,342
Non-current post-employment obligations 1,259 6,538 6,421 4,736 3,954 4,043
Other non-current liabilities

1,428

7,416

8,007

3,507

3,266

3,270

Total non-current liabilities 5,183 26,915 26,458 20,817 19,247 17,655
             
Share capital 1,462 7,594 7,294 7,294 6,294 6,294
Capital reserves 433 2,250 2,250 2,250 1,925 1,925
Profit reserves 1,937 10,061 8,750 6,362 5,729 5,200
Equity valuation adjustments (468) (2,431) (2,407) (1,327) (837) (489)
Subscription of shares to be capitalized - - - - 1,215 -
Retained earnings………………………………………………………….. - - 212 146    
Equity attributable to non-controlling interest

1

4

4

1,360

4

4

Total equity

3,365

17,478

16,103

16,085

14,330

12,934

Total liabilities and equity 10,414 54,083 50,526 60,339 42,240 42,036

 

9 

 

Other data

 

 

2020

2019

2018

2017

2016

Outstanding shares basic:          
Common 566,036,634 566,036,634 566,036,634 487,614,144 420,764,639
Preferred 1,127,325,434 1,127,325,434 1,127,325,434 970,577,739 837,516,297
           
Dividends per share:          
Common R$0.99 R$0.52 R$0.59 R$0.03 -
Preferred R$0.99 R$0.52 R$0.59 R$0.50 R$0.50
Dividends per ADS common R$0.99 R$0.52 R$0.59 R$0.03 -
Dividends per ADS preferred R$0.99 R$0.52 R$0.59 R$0.50 R$0.50
           
Dividends per share: (2)          
Common US$0.19 US$0.13 US$0.15 US$0.01 -
Preferred US$0.19 US$0.13 US$0.15 US$0.15 US$0.15
Dividends per ADS common US$0.19 US$0.13 US$0.15 US$0.01 -
Dividends per ADS preferred US$0.19 US$0.13 US$0.15 US$0.15 US$0.15
           
Outstanding shares—diluted:          
Common 566,036,634 566,036,634 566,036,634 487,614,144 420,764,639
Preferred 1,127,325,434 1,127,325,434 1,127,325,434 970,577,739 837,516,297
           
Dividends per share diluted:          
Common R$0.99 R$0.52 R$0.59 R$0.03 -
Preferred R$0.99 R$0.52 R$0.59 R$0.50 R$0.50
Dividends per ADS diluted common R$0.99 R$0.52 R$0.59 R$0.03 -
Dividends per ADS diluted preferred R$0.99 R$0.52 R$0.59 R$0.50 R$0.50
           
Dividends per share diluted: (2)          
Common US$0.19 US$0.13 US$0.15 US$0.01 -
Preferred US$0.19 US$0.13 US$0.15 US$0.15 US$0.15
Dividends per ADS diluted common  US$0.19 US$0.13 US$0.15 US$0.01 -
Dividends per ADS diluted preferred  US$0.19 US$0.13 US$0.15 US$0.15 US$0.15
             
(1)Converted at R$5.1935/US$, the exchange rate on December 31, 2020. See ‘Exchange rates’.
(2)This information is presented in U.S. dollars at the exchange rate in effect as of the end of each year.
(3)From January 1, 2018, we adopted IFRS 9 and IFRS 15. Since we used the modified retrospective approach when adopting such standards, we did not restate our financial statements as of and for the years ended December 31, 2017 and 2016.
(4)From January 1, 2019, we adopted IFRS 16. Since we used the modified retrospective approach when adopting such standard, we did not restate our financial statements as of and for the years ended December 31, 2018, 2017 and 2016.
(5)Data for the years ended December 31, 2019 and 2018, have been restated to reflect to retrospective application of a change in an accounting policy, as described in note 2.8 to our consolidated financial statements.
(6)We have not restated data for 2017 and 2016 to reflect retrospective application of a change in an accounting policy, as described in note 2.8 to our consolidated financial statements.
(7)For the year ended December 31, 2018, 2019 and 2020, new shares issued through a capital increase in April 30, 2021 were included. See “Item 4. Information on the Company”.

 

 

 

10 

Exchange Rates

On March 4, 2005, the National Monetary Council (Conselho Monetário Nacional, or ‘CMN’), consolidated the commercial rate exchange market and the floating rate market into a single exchange market. Such regulation, as restated in 2008, allows subject to certain procedures and specific regulatory provisions, the purchase and sale of foreign currency and the international transfer of Reais by a foreign person or company, without restriction as to the amount. Additionally, all foreign exchange transactions must be carried out by financial institutions authorized by the Brazilian Central Bank (Banco Central do Brasil, or the ‘Central Bank’), to operate in this market.

Brazilian law provides that whenever there (i) is a significant deficit in Brazil’s balance of payments or (ii) are major reasons to foresee a significant deficit in Brazil’s balance of payments, temporary restrictions may be imposed on remittances of foreign capital abroad. In the past, the Central Bank has occasionally intervened to control unstable movements in foreign exchange rates. We cannot predict whether the Central Bank or the Federal Government will continue to let the Reais float freely or will intervene in the exchange rate market. The Reais may depreciate or appreciate against the U.S. dollar and other currencies substantially in the future, Exchange rate fluctuations may affect the U.S. dollar amounts received by the holders of Preferred ADSs or Common ADSs. We will make any distributions with respect to our preferred shares or common shares in Reais and the depositary will convert these distributions into U.S. dollars for payment to the holders of Preferred ADSs and Common ADSs. We cannot make assurances that such measures will not be undertaken by the Brazilian Government in the future, which could prevent us from making payments to the holders of our ADSs. Exchange rate fluctuations may also affect the U.S. dollar equivalent of the Reais price of the preferred shares or common shares on the Brazilian stock exchange on which they are traded. Exchange rate fluctuations may also affect our results of operations. For more information see ‘Risk Factors—Risks Relating to Brazil—Exchange rate instability may adversely affect our business, results of operations and financial condition and the market price of our shares, the Preferred ADSs and the Common ADSs’.

The table below sets forth, for the periods indicated the low, high, average and period-end exchange rates for Reais, expressed in Reais per US$1.00.

 

 

Reais per US$1.00

Year Ended December 31,

Low

High

Average

Period-end

2016 3.1142 4.1299 3.4839 3.2532
2017 3.0557 3.3823 3.1916 3.3121
2018 3.1470 4.2016 3.6513 3.8804
2019 3.6501 4.2594 3.9440 4.0190
2020 4.0378 5.9204 5.1587 5.1935

 

 

Reais per US$1.00

Month

Low

High

Average

Period end

October 2020 5.5220 5.7790 5.6253 5.7588
November 2020 5.3069 5.7425 5.4482 5.3785
December 2020 5.0538 5.3016 5.1447 5.1935
January 2021 5.2304 5.4809 5.3673 5.4479
February 2021 5.3153 5.5724 5.4132 5.5724
March 2021 5.4750 5.8084 5.6351 5.6590
April 2021 (through April 27, 2021) 5.4971 5.7075 5.6144 5.5011

Source: U.S. Federal Reserve Board.

 

 

11 

Risk Factors

The investor should take into account the risks described below, and the other information contained in this Annual Report, when evaluating an investment in our Company.

 

Risks Relating to CEMIG

The Covid-19 pandemic and its ongoing effects could adversely affect our business, operational results and financial condition.

The Company is closely monitoring the impacts of the Covid-19 pandemic on the Brazilian macroeconomic environment, especially in relation to its business and the market in which it operates, and deciding on actions to maintain the sustainability of its operations, mitigate economic and financial effects, and protect the health of its employees. The Company established the Coronavirus Crisis Management Committee (‘Comitê Diretor de Gestão da Crise do Coronavírus’) in March 2020, to ensure its readiness to making decisions in light of the fast-changing situation, which has become more widespread, complex and systemic. Several measures were taken to protect the Company´s liquidity, such as capital expenditure restraint and expenses reduction, payment of only minimum mandatory dividends to shareholders, and deferral of dividends and interest on equity to the end of 2020 and the negotiating of contracts with its customers on the free market.

In order to cope with the reduction in collections resulting from the economic crises, measures to support the sector have been implemented by the Grantor and regulated by ANEEL, with a view to ensure that companies maintain adequate liquidity, and are able to comply with contracts in the electricity sector supply chain. This scenario resulted in the need for internal reassessment by the Company of its Investment Program, revision of the budgets for revenue and expenses, and alteration of the assumptions used in calculating the fair and recoverable value of certain financial and non-financial assets. Among the measures implemented by ANEEL having a greater financial impact on us was the creation of the ‘Covid-account’, issued on May 18, 2020, to support the energy distribution sector, which, as the customer interface, is the basis of the energy sector financial flow, aimed either to cover the distribution agents revenue/cash flow deficit or to anticipate sector receivables. The ‘Covid-account’ increased CEMIG D cash flow by R$1.4 billion in 2020 enabling it to meet its financial obligations, in spite of the collection reduction resulting from the economic crisis.

 

The total load carried by the Brazilian electricity system fell by approximately 1.5%, comparing 2020 to the year before, with gradual recovery since that period. The effects for the Company in the energy Market were also observed on a similar scale to these national effects with a consequent decrease in its revenue.

The most critical period to date of the pandemic regarding the energy supply in Brazil occurred in the second and third quarters of 2020. The Company cannot foresee the duration of these effects on the economic condition arising from social isolation, and its future impact on its market and revenue, nor the effectiveness of the ongoing actions that are being implemented by the federal government, such as the beginning of the population´s vaccination program, as well as the mitigation of the effects of the crisis. The continuing duration or a worsening of the pandemic could have a material adverse effect on our business, liquity, capital resources, results of operations and financial condition.

 

We are not certain whether new concessions or authorizations, as applicable, will be obtained, nor that our present concessions or authorizations will be extended on terms similar to those currently in effect, nor that any compensation we receive in the event of non-extension will be sufficient to cover the full value of our investment.

We operate most of our power generation, transmission and distribution activities under concession agreements entered into with the Brazilian Federal Government or pursuant to authorizations granted to companies of the CEMIG Group. The Brazilian Constitution determines that all concessions related to public services must be granted through a bidding process. In 1995, in an effort to implement these constitutional provisions, the Brazilian Federal Government adopted certain laws and regulations, which are collectively known as the ‘Concessions Law,’ which governs bidding procedures in the electric power industry.

12 

On September 11, 2012, the Brazilian Federal Government issued Provisional Act No. 579 (‘PA 579’), later converted into Law No. 12,783 of January 11, 2013 (‘Law No. 12,783/13’), which governs the extensions of concessions granted prior to Law No. 9,074/95. Law No. 12,783/13 determines that, as of September 12, 2012, concessions prior to Law No. 9,074/95 can be extended once, for up to 30 years, provided that the concession operators accept and meet certain conditions described in such Law. With respect to generation activities, the Company chose not to accept the mechanism offered to extend the generation concessions that would expire in the period from 2013 to 2017. These concessions are: Três Marias, Salto Grande, Itutinga, Volta Grande, Camargos, Peti, Piau, Gafanhoto, Tronqueiras, Joasal, Martins, Cajuru, Paciência, Marmelos, Dona Rita, Sumidouro, Poquim and Anil.

Following publication of the tender documents for Generation Auction No. 12/2015, on October 7, 2015 (‘Auction 12/2015’), which was held under the revised regulatory structure for renewal of concessions of existing power plants as set forth in Law No. 13,203 of December 8, 2015 (‘Law No. 13,203/15’), the Company’s Board of Directors authorized CEMIG Geração e Transmissão S.A. (CEMIG GT) to bid at an auction, held on November 25, 2015, in which CEMIG GT was successful. In the auction, CEMIG GT won the concessions for the 18-hydroelectrical plants comprising ‘Lot D’, for 30 years: Três Marias, Salto Grande, Itutinga, Camargos, Cajuru, Gafanhoto, Martins, Marmelos, Joasal, Paciência, Piau, Coronel Domiciano, Tronqueiras, Peti, Dona Rita, Sinceridade, Neblina and Ervália. The total installed capacity of these plants is 699.5 MW, and their offtake guarantee is 420.2 MW average.

In relation to the Jaguara, São Simão and Miranda power plants, which the date of the first contractual extension of their concessions fell after the issuance of PA 579, the Company understood that the Generation Concession Contract No. 007/1997 enables the extension of the concessions of these power plants for 20 years, i.e. until 2033, 2035 and 2036 respectively, without any restrictions.

Based on this understanding, on February 21, 2017, CEMIG GT filed for a judicial order of mandamus against the actions of the Brazilian Mining and Energy Ministry (MME) to safeguard its rights to an extension of the concession term for the Jaguara, São Simão and Miranda Hydroelectric Power Plant, under the terms of Clause 4 of the Generation Concession Contract No. 007/1997, and in accordance with the original terms and conditions of that agreement, which was signed prior to Law No. 12,783/13.

Nevertheless, on September 27, 2017, the Brazilian Federal Government auctioned the concessions of Jaguara, São Simão, Miranda and Volta Grande hydroelectric power plants formerly owned by CEMIG GT with a total capacity of 2,922 MW for a total of R$12.13 billion. In each case, the winning bidder of the concessions is unrelated to CEMIG. Volta Grande power plant concession was transferred to the winning bidder on November 30, 2017, Jaguara and Miranda power plants concession were transferred on December 30, 2017 and São Simão power plant concession was transferred on May 9, 2018.

The applications for mandamus relating to the Jaguara and Miranda hydroelectric plants have now reached final judgment against the Company and further appeal is not possible. Because of these judgments, the Company assesses that the chances of success in the application for mandamus in relation to the São Simão hydroelectric plant, which has not yet reached final judgment, is remote.

In parallel to the discussions on extension of the generation concessions, because the concession for various plants operated by CEMIG under Concession Contract 007/1997 have expired, CEMIG GT has a right to be reimbursed for the assets not yet amortized, as set out in the concession contract. The accounting balances corresponding to these assets are recorded as financial assets and are analyzed by Brazilian Regulatory Agency (ANEEL).

On August 31, 2018, CEMIG received R$1,139 million as indemnification for the basic project of the São Simão and Miranda plants. This amount had been adjusted by the Selic rate up to the date of its receipt.

13 

Considering the degree of discretion granted to the Brazilian Federal Government in relation to new concession contracts or new authorizations, as applicable, and renewal of existing concessions and authorizations, and due to Law No. 12,783/13 and amendments, for renewals of generation, transmission and distribution concession agreements, we cannot guarantee that: (i) new concessions and authorizations will be obtained; (ii) our existing concessions and authorizations will be extended on terms similar to those currently in effect; nor (iii) the compensation received in the event of non-extension of a concession or authorization will be in an amount sufficient to cover the full value of our investment. Our inability to obtain new or extended concessions or authorizations could have a material adverse effect on our business, results of operations and financial condition. For more information about the renewal of our concessions and authorizations, see “Item 8. Financial Information – Legal and Administrative Proceedings”.

On September 9, 2020, the Law 14,052 was issued, changing the Law 13,203/2015 and establishing new conditions for renegotiation of hydrological risk in relation to the portion of costs incurred due to the GSF, borne by the holders of hydroelectric plants participating in the Energy Reallocation Mechanism (MRE) since 2012, when there was a serious crisis in water sources.

The compensation to the holders of hydroelectric occurs through the extension of the concession period for generation grants and will be recognized as an intangible asset in exchange for a compensation of electricity costs.

This renegotiation represents important progress for the electricity sector, reducing levels of litigation – and also for CEMIG, in that it enables extension of the periods of its generation concessions.

The periods of extension, published by the CCEE, which are still awaiting approval by ANEEL, indicate an extension of approximately two years for two of our principal power plants, Emborcação and Nova Ponte, and also extensions of seven years for the plants of Lot D – as well as extensions for the other plants where we hold an equity interest directly or through investees.

 

Our subsidiaries might suffer intervention by Brazilian public authorities to ensure adequate levels of service, or be sanctioned by ANEEL for non-compliance with their concession agreements, or the authorizations granted to them, which could result in fines, other penalties and/or, depending on the severity of the non-compliance, legal termination of concession agreements or revocation of authorizations.

We conduct our generation, transmission and distribution activities pursuant to concession agreements entered into with the Brazilian Federal Government, through ANEEL, and pursuant to authorizations granted to companies of the CEMIG Group, as the case may be.

ANEEL may impose penalties or revoke a concession or authorization if we fail to comply with any provision of the concession agreements or authorizations, including those relating to compliance with the established quality standards. Depending on the severity of the non-compliance, these penalties could include:

·Fines for breach of contract of up to 2.0% of the concession holder’s revenues in the financial year immediately prior to the date of the breach;
·Injunctions related to the construction of new facilities and equipment;
·Temporary suspension from participating in bidding processes for new concessions for a period of up to two years;
·Intervention by ANEEL in the management of the concession holder that is in breach;
·Revocation of the concession; and
·Execution of the guarantees related to the concession.
14 

 

Further, the Brazilian Federal Government can revoke any of our concessions or authorizations before the expiration of the concession term, in the event of bankruptcy or dissolution, or by legal termination, if determined to be in the public interest. It can also intervene in concessions to ensure adequate provision of the services, full compliance with the relevant provisions of agreements, authorizations, regulations and applicable law; and where it has concerns about the operations of the facilities of the Company.

Delays in the implementation and construction of new energy infrastructure can trigger the imposition of regulatory penalties by ANEEL, which, under ANEEL’s Normative Resolution No. 846 of June 11, 2019, can vary from warnings to the termination of concessions or withdrawal of authorizations.

Any compensation we may receive upon rescission of the concession agreement or revocation of an authorization may not be sufficient to compensate us for the full value of certain investments. If we are responsible for the rescission of any concession agreement, the effective amount of compensation could be lower, due to fines or other penalties. The imposition of fines or penalties or the early termination or revocation by ANEEL of any of our concession agreements or authorizations, or any failure to receive sufficient compensation for investments we have made, may have a material adverse effect on our business, financial condition and results of operations, and on our ability to meet our payment obligations.

Rules under the Fifth Amendment to the distribution concession contract came into effect in 2016. They contain new targets for service quality, and requirements related to CEMIG D’s economic and financial sustainability. These targets must be complied with over the 30 years of the concession. Compliance with these targets is assessed annually, and non-compliance could result in an obligation for CEMIG to inject capital into CEMIG D or a limitation on distribution of dividends or the payment of interest on equity by CEMIG D to CEMIG. According to ANEEL regulations, in case of failure to comply with global annual targets for collective continuity indicators for two consecutive years, or three times in five years, or at any time in the last five years of the agreement term, distribution of dividends or payment of interest on equity may be limited until compliance is resumed.

 

We are subject to extensive and governmental legislation and regulation which may be subject to change, and any changes to such legislation and regulation could have a material adverse effect on our business, results of operations and financial situation.

Our operations are highly regulated and supervised by the Brazilian Federal Government, through the MME, ANEEL, the National System Operator (Operador Nacional do Sistema, or ‘ONS’), and other regulatory authorities. These authorities have a substantial degree of influence on our business. MME, ANEEL and ONS have discretionary authority to implement and change policies, interpretations and rules applicable to different aspects of our business, particularly operations, maintenance, health and safety, consideration to be received and inspection. Any significant regulatory measure implemented by such authorities may result in a significant burden on our activities, which may have a material adverse effect on our business, results of operations and financial condition.

The Brazilian Federal Government has been implementing policies that have a far-reaching impact on the Brazilian energy sector. As part of the restructuring, Law No. 10,848, of March 15, 2004 introduced a new regulatory regime for the Brazilian energy industry. This regulatory structure has undergone several changes in recent years, the most recent being the changes added by PA 579 (which was converted into Law No. 12,783/2013), which governs the extension of some concessions governed by Law No. 9,074/1995. Under this law, such concessions can, from September 12, 2012, be extended only once, for up to 30 years, at the option of the concession authority.

Currently, the Law Project 232/2016 is under evaluation by the Congress. This draft law proposes changes in the legislation, arising from the former Public Consultation No. 33/2017, which includes some proposals for changes in the current regulatory model of the sector. These changes consist of subsidy reductions and revision of the allocation of costs, among others, creating the basis for a more open market.

15 

Amendments in the legislation or regulations relating to the Brazilian energy industry could adversely affect our business strategy and the conduct of our activities if we are not able to anticipate the new conditions or if we are unable to absorb the new costs or pass them on to customers. In addition, we cannot guarantee that measures taken in the future by the Brazilian Federal Government, in relation to development of the Brazilian energy system, will not have a negative effect on our activities. Further, we are unable to predict to what extent such measures might affect us. If we are required to conduct our business and operations in a way that is substantially different from that specified in our business plan, our business, results of operations or financial position may be negatively affected.

 

Changes in Brazilian tax law or conflicts regarding its interpretation may adversely affect us.

The Brazilian Federal, state and municipal governments regularly implement changes in tax policies that affect us. These changes include the creation and alteration of taxes and charges, permanent or temporary, related to specific purposes of the government. Some of these governmental measures can increase our tax burden, which could affect our profitability, and consequently our financial situation. We cannot guarantee that we will be able to maintain our cash flow and profitability after an increase in taxes and charges that apply to us, and this might result in a material adverse effect on the Company.

 

We are subject to restrictions on our ability to make capital investments and to incur indebtedness, which could adversely affect our business, results of operations and financial condition.

Our ability to carry out our capital expenditure program is dependent upon a number of factors, including our ability to charge adequate rates for our services, access to the domestic and international capital markets, and a variety of operational and other factors. Further, our plans to expand our generation and transmission capacity are subject to compliance with competitive bidding processes. These bidding processes are governed by Law 13,303/2016 (the ‘State Companies Law’).

In relation to loans from third parties: (i) as a state-controlled company, we are subject to rules and limits relating to the level of credit applicable to the public sector, including rules established by the National Monetary Council (Conselho Monetário Nacional, or ‘CMN’), and by the Brazilian Central Bank; and (ii) we are subject to the rules and limits established by ANEEL that regulate indebtedness for companies in the energy sector. Also, although we may access both the international and local capital markets, we, as a state-controlled company, can only be financed with funds extended by local commercial banks if such debt is guaranteed by receivables, as well as with funds extended by Brazilian federal banks in transactions with the purpose of refinancing financial obligations contracted with entities of the Brazilian financial system.

Further, we are subject to certain contractual conditions under our existing debt instruments, and we may enter into new loans that contain restrictive covenants or similar clauses that could restrict our operational flexibility. These restrictions might also affect our ability to obtain new loans that are necessary for financing our activities and our growth strategy, and for meeting our future financial obligations when they become due, and this could adversely affect our ability to comply with our financial obligations. We have financing contracts and other debt obligations containing restrictive covenants, including Brazilian local market debentures and Eurobonds on international market.

We have approximately R$12.6 billion of outstanding debt with financial covenant restrictions, and any breach could have severe negative consequences to us. See ‘– The Company has a considerable amount of debt, and it is exposed to limitations on its liquidity – a factor that might make it more difficult for the Company to obtain financing for investments that are planned and might negatively affect its financial condition and its results of operation.’

16 

 

If, for example, we breach a financial covenant under the CEMIG GT’s 9.25% Senior Notes due 2024 (the ‘Eurobonds’), we would be subject to an interest increase or acceleration of certain debt as a result of cross-default provisions under certain of our outstanding debt agreements. Similarly, if the Company violates a covenant under our debenture issuance, the debenture holders may accelerate the maturity of the debt in a meeting organized by the Fiduciary Agent (‘Trustee’), unless 75% of the debenture holders decide not to do so. Any acceleration of our outstanding debt could have a material adverse effect on our financial situation and may trigger cross-default clauses in other financial instruments.

In the event of a default and acceleration, our assets and cash flow might be insufficient to repay amounts due, or to comply with the servicing of such debt. In the past, we have, on certain occasions, failed to comply with certain financial covenants that had conditions that were more restrictive than those currently in place. Although we were able to obtain waivers from our creditors in relation to past non-compliance, we cannot guarantee that we will be successful in obtaining any particular waiver in the future.

 

The Company could suffer adverse effects in connection with its minority interest in Renova Energia S.A. if such entity is unable to continue as a going concern

We have a 36.23% investment in Renova, which is currently in a court-supervised reorganization, and has reported recurring losses and equity deficit for the year ended December 31, 2020.

However, in view of the investee’s equity deficit, the Company reduced the carrying value of its equity interests in Renova to zero. No further losses have been recognized, considering the non-existence of any legal or constructive obligations to the investee. Additionally, since June 30, 2019, considering Renova's financial situation the Company recorded an impairment of the full amount of credits with the jointly controlled entity in the amount of R$688 million.

On October 16, 2019, the request for processing the court-supervised reorganization of Renova Group was granted by São Paulo Bankruptcy Court and the respective court-supervised reorganization plans were approved by Renova goup of creditors at the General Meeting of Creditors held on December 18, 2020 and ratified by the Second Bankruptcy and Court-Supervised Reorganization Court of São Paulo. The main effects of the the court-supervised reorganization plan were recorded on Renova’s financial statements at December 2020 and its measures are in progress. See Note 16 to our Financial Statements.

Further, Renova is being investigated by the Civil Police of Minas Gerais State and the Brazilian Federal Police, see risk factor ‘Anti-corruption investigations currently in progress in Brazil, which have received wide public exposure, and any allegations against CEMIG or anti-corruption investigations of CEMIG, could have adverse effects on perception of Brazil and of CEMIG’.

Since the Company´s investment in Renova is fully impaired at December 31, 2020, and since no contractual or constructive obligations in relation to the investee have been assumed by the Company, it is not expected that effects resulting from the court-supervised reorganization process (the plan was approved and if its implementation is successful), or the investigations, or the operational activities of this investee can significantly impact the Company’s financial statements (refer to Note 16 to our consolidated financial statements for more detail).

Renova signed with the Company Debtor in Possession (DIP) loan agreements in the total amount of R$37 million. The funds of these loans, made under specific rules of court-supervised reorganization proceedings, were necessary to support the expenses of maintaining the activities of Renova, and were authorized by the second State of São Paulo Bankruptcy and the Court-supervised Reorganization Court. They are guaranteed by a fiduciary assignment of shares in a company owning assets of a wind power project owned by Renova, and they also have priority of receipt in the court-supervised reorganization process.

17 

 

On May 2, 2020, the State of São Paulo Bankruptcy and Court-supervised Reorganization Court issued a decision ordering that the DIP loan, in the total amount of R$37 million, with asset guarantee, already constituted and registered, would be subscribed as a capital increase in Renova. Company has filed a Motion for Clarification and in a virtual and permanent session of the 2nd Chamber of Business Law of the São Paulo Court of Justice, decided to uphold the appeal. Thus, the clauses of the court-supervised plan that deal with the loan contracts signed by the Company are maintained.

 

A reduction in our credit risk rating or in Brazil’s sovereign credit ratings could adversely affect the availability of new financing and increase our cost of capital.

The credit risk rating agencies Fitch Ratings, Moody’s, and Standard and Poor’s attribute a rating to the Company and its debt securities on a Brazilian basis, and also a rating for the Company on a global basis.

Ratings reflect, among other factors, the outlook for the Brazilian energy sector, the hydrological conditions of Brazil, the political and economic conditions, country risk, and the rating and outlook for the Company controlling shareholder, the State of Minas Gerais.

In the event of a downgrade due to any external factors, our operational performance or high levels of debt, our cost of capital could increase and our ability to comply with existing financial covenants in the instruments that regulate our debt could be adversely affected. Further, our operating or financial results and the availability of future financing could be adversely affected.

In addition, probable reductions in Brazilian sovereign ratings could adversely affect the perception of risk in relation to securities of Brazilian issuers, and, as a result, increase the cost of any future issues of debt securities. Any reductions in our ratings or Brazil’s sovereign ratings could adversely affect our operating and financial results, and our access to future financing.

 

Disruptions in the operation of, or deterioration of the quality of, our services, or those of our subsidiaries, could adversely affect our business, operating results and financial condition.

The operation of a complex system that interconnects numerous power generation plants with large transmission lines and distribution networks involves various risks, operational difficulties and unexpected interruptions, caused by accidents, equipment failure, underperformance or disasters (such as explosions, fires, climate events, floods, landslides, sabotage, terrorism, vandalism and other similar events). In the event of any such occurrence, the insurance coverage for operational risks may be insufficient to fully repay the asset damage or service interruption costs incurred. In addition, National Grid Operator decisions, Regulatory Agency acts, and Environmental Authority demands could adversely affect our business.

The Company's income is strongly dependent on equipment availability, service quality and regulatory compliance of the assets and facilities it builds, operates and maintains. Failing to comply may lead to business losses. For example, the distribution business may be penalized in the tariff revision process with a higher "X-factor", reducing its expected annual revenue requirement; the transmission business may have its annual permitted revenue reduced due to any asset unavailability; and the generation business may have its earnings affected if a power plant does not meet a minimum availability, since that when hydro generation is less than the previously contracted energy, the equivalent shortfall has to be acquired at the spot price, which is highly volatile.

Penalties and financial compensation are applicable depending on the scope, severity and duration of the service or equipment unavailability. Thus, disruptions in power plants, transmission and distribution facilities, substations or networks, may have a material adverse effect on our business, financial situation and operating results.

 

18 

We have a considerable amount of debt, and we are exposed to limitations on our liquidity – a factor that might make it more difficult for us to obtain financing for investments that are planned, and might negatively affect our financial condition and our results of operations.

In order to finance the capital expenditures needed to meet our long-term growth objectives, we have incurred a substantial amount of debt. As of December 31, 2020, our total loans, financing and debentures (including interest) was R$15,020 million; an increase of 1.64% compared to the R$14,777 million reported as of December 31, 2019 and an increase of 1.68% compared to R$14,772 million reported as of December 31, 2018. Currently, 27.14 % of our existing loans, financing and debentures - totaling R$4,076 million, have maturities in the next three years. To meet our growth objectives, maintain our ability to fund our operations and comply with scheduled debt maturities, we will need to raise debt capital from a range of funding sources. To service its debt after meeting the capital expenditure targets, the Company has relied upon a combination of cash flows provided by its operations, sale of assets, drawdowns under its available credit facilities, its cash and short-term financial investments balance and the incurrence of additional indebtedness. Any further lowering of its credit ratings may have adverse consequences on the Company’s ability to obtain financing or may affect its cost of financing, also making it more difficult or costly to refinance maturing obligations. If, for any reason, the Company were to face difficulties in accessing debt financing, this could hamper its ability to make capital expenditures in the amounts needed to maintain its current level of investments or its long-term targets and could impair its ability to timely meet its principal and interest payment obligations with its creditors. A reduction in the Company’s capital expenditure program or the sale of assets could significantly and adversely affect its results of operations.

 

Our strategy for maximizing value for CEMIG’s shareholdings depends on external factors that could impede its successful implementation.

CEMIG’s strategy for shareholdings is the maximization of value and capital recycling based on three pillars:

·Divestments: non-strategic or low synergy assets, and opportunistic offerings;
·Expansion: mainly through investments in our distribution and transmission concessions, greenfield projects in renewable sources and with the renewing of power generation concessions; and
·Management: synergy improvement, capital structure and distribution policy and governance enhancing.

 

All those pillars can be affected by external factors, especially divestment that has to take into consideration particular risks associated to each business such as performance (technical, operational, commercial and financial), market risks, sectorial risks and national and international macroeconomic risks (e.g. market volatility). Furthermore, closing of divestment operations will depend on favorable development of negotiations with potential investors regarding the conditions of the possible transactions.

 

We might be unable to implement the strategies in our long-term strategic planning within a desired time, or without incurring unforeseen costs, which could have adverse consequences for our business, results of operations and financial condition.

Our ability to meet strategic objectives depends, largely, on successful, cost-effective and timely implementation of our Long-term Strategy and our Multi-year Business Plan. The following are some of the factors that could negatively affect this implementation:

·Inability to generate cash flow, or obtain the future financing, necessary for implementation of the projects;
·Inability to obtain necessary governmental licenses and approvals;
·Unexpected engineering and environmental problems;
·Unexpected delays in the processes of eminent domain and establishment of servitude rights;
19 
·Unavailability of the necessary workforce or of equipment;
·Labor strikes;
·Delay in delivery of equipment by suppliers;
·Delay resulting from failings of suppliers or third parties in compliance with their contractual obligations;
·Interference by climate factors, or environmental restrictions;
·Changes in the environmental legislation creating new obligations and causing additional costs for projects;
·Legal instability caused by political issues;
·Substantial changes in economic, regulatory, hydrological or other conditions; and
·The extension of the duration and severity of the coronavirus (Covid-19) pandemic and its impacts on our business.

 

The occurrence of the above factors, separately or taken together, might lead to a significant increase of costs, and might delay or impede implementation of initiatives, and consequently compromise the execution of the strategic plan, negatively affecting our operating and financial results.

Furthermore, as we are a mixed-capital company controlled by the State of Minas Gerais, we are subject to changes to our board of directors and executive officers because of change in the political agents of the Executive Branch of government due to the electoral process and due to political instability. These types of changes may adversely affect the continuity of the Company’s strategy.

 

The operating and financial results of our subsidiaries, jointly controlled entities and affiliates, minority investees or from those companies, which may be acquired in the future, might negatively affect our strategies, operating results and financial situation.

We own equity in and do business through various subsidiaries and investees, including companies with assets in energy generation and transmission, energy and natural gas distribution and other correlated business. The future development of our subsidiaries, jointly-controlled entities and affiliates, such as Transmissora Aliança de Energia Elétrica S.A. (‘Taesa’) and Aliança Geração de Energia S.A. (‘Aliança’) as well as Renova Energia S.A. (Renova), Guanhães Energia S.A., Norte Energia S.A. (‘NESA’) and Madeira Energia S.A. (‘MESA’), in which the Company has significant financial commitments, could have a significant impact on our business and operating results. The Company’s ability to meet its financial obligations is correlated, in part, to the cash flow and the profits of its subsidiaries and investees, and the consequent distribution to the Company of such profits in the form of dividends or other advances or payments. If these companies’ abilities to generate profit and cash flow are reduced, this might cause a reduction of dividends and interest on capital paid to the Company, which could have a material adverse effect on our results of operations and financial position.

In addition, the investees might not reach the results expected when they were acquired. The process of integration for any acquired business could subject the Company to certain risks, such as, for example, the following: (i) unexpected expenses; (ii) inability to integrate the activities of the companies acquired with a view to obtaining the expected economies of scale and efficiency gains; (iii) possible delays related to integration of the operations of companies; (iv) exposure to potential contingencies; (v) legal claims made against the acquired business that were unknown at the moment of its acquisition, might negatively affect our strategies, operating results and financial situation, (vi) environmental licensing and liabilities, (vii) hydrological risk, (viii) power system operation and control, and (ix) general claims. The Company might be unsuccessful in dealing with these or other risks, or problems related to any other operation of a future acquisition and be negatively affected by the companies acquired or which may be acquired in the future.

Further, some of our subsidiaries and investees might, in the future, enter into agreements with creditors that could restrict dividend payments or other transfers of funds to the Company.

20 

Due to the Covid-19 pandemic, results of subsidiaries and investees might be affected, since the reduction on economic activity has the potential to decrease energy consumption, leading some of those companies to lose their abilities to generate profit, reducing cash flow and dividends and interest on capital paid to the Company. These subsidiaries are separate legal entities. Any right that we might have in relation to receipt of assets or other payments in the event of liquidation or reorganization of any subsidiary, will likely be in fact structurally subordinated to the demands of the creditors of such subsidiary (including tax authorities, commercial creditors and lenders to those subsidiaries).

Any deterioration in the operating results or financial conditions of these subsidiaries, and any sanctions or penalties imposed on them, could have a material adverse effect on the Company’s results of operations or financial condition.

 

Delayed completion of construction projects or late capitalization of new investments in our generation, transmission and distribution companies could adversely affect our business, operation results and financial condition.

We are constantly engaged in the construction and expansion of our plants, transmission lines, distribution networks and substations, and studying other potential load expansion projects. The company’s capability to complete projects within deadlines and on budget, without adverse economic effects, is subject to various risks. For instance, we may encounter the following:

·Numerous complications in the planning and execution stages of load expansion projects and other new investments may occur, such as strikes, lagging suppliers of materials and services, delays in tender processes, embargos on work, unexpected geological and climate conditions, political and environmental uncertainties, financial instability of our partners, contractors and subcontractors;
·Regulatory or legal challenges that delay the date expansion projects are put into operation;
·New assets might operate below the planned capacity, or their operation/installation costs might be greater than planned;
·Difficulty to obtain adequate working capital to fund the expansion projects;
·The unintentional shutdown of the transmission assets during the execution of the load expansion projects can reduce the revenue of the Transmission business;
·ONS’s (‘Operador Nacional do Sistema’, Brazil’s ISO) refusal to authorize the execution of work on the transmission grid, due to power system restrictions;
·Environmental demands and claims by local communities during construction of power generation plants, transmission lines, distribution lines, distribution networks and substations; and
·Depletion of the outage duration indicator limit – SAIDI-i (known as Duração Equivalente de Interrupção por Unidade Consumidora - DECi) forcing construction to halt. If SAIDI-i limit is violated (either by system fault, equipment failure or construction work) for two years in a row between 2016 and 2020, or violated specifically in the year 2020, this will result in the Regulator initiating a legal process for the termination of the concession agreement. In 2020, CEMIG did not exceed the limit for the SAIDI-I limit, and in the fifth year of the concession, the Company achieved the best result in its history, 9.58 hours, compared to the limit of 10.44 hours set by the Regulator (‘ANEEL’).

 

If faced with any of these or similar issues related to the new investments or to the expansion of our generation, transmission or distribution capacity, the Company might incur increased costs or lower profitability than originally expected for the projects.

 

21 

The level of default by our customers could adversely affect our business, operating results and/or financial situation as well as those of our subsidiaries.

On December 31, 2020, the total of our past-due receivables owed by customers, traders and power transport concession holders was approximately R$1,510 million (R$1,635 million in 2019), corresponding to 5.99% of our consolidated net revenue in 2020 (6.42% in 2019). We have recorded in 2020 an allowance for doubtful accounts in the amount of R$712 million (R$810 million in 2019). The possibility exists that we might be unable to collect amounts receivable from various customers, which are in arrears. If such debts are not totally or partially settled, we will suffer an adverse impact on our business, operation results and/or financial situation. Additionally, the amount of debts in arrears from our customers that exceeds the allowance could cause an adverse effect on our business, operating results and/or financial condition.

 

CEMIG D’s economic and financial sustainability is directly related to the effectiveness of the actions to control energy losses, and the regulatory limits established for it. If CEMIG D fails in successfully controlling energy loss, its business, operations, profit and financial situation could be substantially and adversely affected.

The energy losses of a distribution company comprise two types of losses: technical losses and non-technical (commercial) losses. Technical losses are inherent to the process of transporting and transformation of electric power and occur in the cables and equipment of the energy system. Non-technical losses comprise energy that is supplied and not invoiced, which may be the result of illegal connections (theft), fraud, metering errors or failures in internal processes.

CEMIG’s Total Losses Index as of December 31, 2020, using a 12-month window was 12.57%. This percentage is in relation to the total energy injected into the distribution system (the total volume of losses was 6,545 GWh). Of that percentage, 8.77% comprised technical losses, and 3.80% comprised non-technical losses. This result was 0.16 percentage points lower than the result for December 2019 (12.73%), and above the regulatory target set by ANEEL for 2020 (11.43%).

From a regulatory point of view, ANEEL has been increasingly rigorous in establishing target caps for distribution losses. The target caps for non-technical losses are set based on a benchmarking model that compares using an index, which measures the social-economic complexity of each concession area and how efficient the distributors are in combating non-technical energy losses. For the targets for technical losses, ANEEL uses metering measurements and power flow software.

In light of this complex scenario, involving regulatory uncertainties, even with the implementation of a strategy to reduce technical and commercial losses, CEMIG cannot guarantee that the target caps for losses established by ANEEL will be met in the short term, and this could affect the Company’s financial situation and operating results, since the portion of a distribution company’s power losses that exceeds the regulatory cap cannot be passed through to the customer as an expense in the form of an increase in tariffs.

 

Dams are part of the critical and essential infrastructure in the Brazilian energy sector. Dam failures can cause serious damage to affected communities and to the Company.

There is an intrinsic risk of dam failure, due to factors that may be internal or external to the structure (such as, for example, failure of a dam upstream from the site). The scale, and nature, of the risk are not entirely predictable. Thus, we are subject to the risk of a dam failure that could have repercussions far greater than the loss of hydroelectric generation capabilities. The failure of a dam could result in economic, social, regulatory, and environmental damage and potential loss of human life in the communities downstream from dams, which could have a material adverse effect on the Company’s image, business, results of operations and financial condition.

 

22 

We might be held responsible for impacts on our own workforce, on the population and the environment, due to accidents related to our generation, transmission and distribution systems and facilities.

Our operations, especially those related to transmission and distribution lines, present risks that may lead to accidents, such as electrocutions, explosions and fires. These accidents may be caused by natural occurrences, human errors, technical failures and other factors. As a significant part of our operations is conducted in urban areas, the population is a factor to be constantly considered. Any incident that occurs on our facilities or in human occupied areas, whether regularly or irregularly, can result in serious damages such as human losses, environmental and material damage, loss of production and liability in civil, criminal and environmental lawsuits. These events may also result in reputational damage, financial compensations, penalties for the Company and its officers and directors, and difficulties in obtaining or maintaining concession contracts and operating licenses.

 

Requirements and restrictions imposed by environmental agencies might require the Company to incur additional costs.

Our operations relating to generation, distribution and transmission of energy and distribution of natural gas are subject to various Federal, state and municipal laws and regulations, and to numerous requirements relating to the protection of health and the environment. Delays by the environmental authorities, or the refusal of license requests by them, or any inability on our part to meet the requirements set by these bodies during the environmental licensing process, may result in additional costs, or even, depending on the circumstances, prohibit or restrict the construction or maintenance of these projects.

Any non-compliance with environmental laws and regulations, such as construction and operation of a potentially polluting facility without a valid license or authorization, could give rise to the obligation to remedy any damages that are caused (third party liability) and result in criminal and administrative sanctions. Under Brazilian legislation, criminal penalties, such as imprisonment and restriction of rights, may be applied to individuals (including managers of legal entities), and penalties such as fines, restriction of rights or community service may be applied to companies. With respect to administrative sanctions, depending on the circumstances, the environmental authorities may: (i) impose warnings, or fines, ranging from R$50,000 to R$50 million; (ii) require partial or total suspension of activities; (iii) suspend or restrict tax benefits; (iv) cancel or suspend lines of credit from governmental financial institutions; or (v) prohibit us from contracting with governmental agencies, companies or authorities. Any of these actions could adversely affect our business, results of operations and financial condition.

We are also subject to Brazilian legislation that requires payment of compensation if our activities have polluting effects. According to Federal Law No. 9,985/2000, Federal Decree No. 6,848/2009, and Minas Gerais State Decree No. 45,175/2009, up to 0.5% of the total amount invested in the implementation of a project that causes significant environmental impact should be used to pay for offsetting, based on the project’s specific level of pollution and environmental impact. State Decree 45,175/2009 (‘Decree 45,175’) also indicated that the compensation rate will be applied retroactively to projects implemented prior to promulgation of the present legislation.

Among the provisions of law that can lead to operating investments and expenses, one is compliance with the Stockholm Convention on Persistent Organic Pollutants (the ‘Convention’), to which Brazil is a signatory, assuming the international commitment to withdraw the use of PCB by 2025, and its complete prohibition by 2028, through Decree No. 5,472, of June 20, 2005. The legislation to be enacted for this purpose could have a major effect on the energy industry and on CEMIG, due to the possibility of obligations to list, replace and dispose of equipment and materials containing substances included in the Convention such as Polychlorinated Biphenyls (PCBs).

If we are unable to meet the technical requirements established by the environmental agencies during the process of licensing, this might prejudice the installation and operation of our projects, or make carrying out of our activities more difficult, which could negatively affect our results of operations.

23 

Finally, the adoption or implementation of new safety, health and environmental laws, new interpretations of existing laws, increased rigidity in the application of the environmental laws, or other developments in the future might require us to make additional capital expenditure or incur additional operating expenses in order to maintain our current operations. They might also restrain our production activities or demand that we take other action that could have an adverse effect on our business, results of operations or financial condition.

 

Cyber-attacks, or violation of the security of our data might lead to an interruption of our operations, or a leak of confidential information either of the Company, or of our customers, third parties or interested parties, might cause financial losses, legal exposure, damage to reputation or other severe negative consequences for the Company.

We manage and store personal and sensitive or confidential data related to our business. Our information technology systems may be vulnerable to a variety of and cybersecurity breaches and incidents. Computer hackers may be able to penetrate our network security and misappropriate or compromise our confidential information or that of third parties, create system disruptions, or cause shutdowns. Computer hackers also may be able to develop and deploy viruses, worms and other malicious software programs that attack our products or otherwise exploit any security vulnerabilities of our products.

The costs we may incur to eliminate or address the security problems and security vulnerabilities before or after a cyber-related incident could be significant. Our remediation efforts may not be successful and could result in interruptions, delays or cessation of service, and loss of existing or potential customers that may impede our critical functions.

Successful cybersecurity attacks, breaches, employee malfeasance, or human or technological error may result in unauthorized access to, disclosure, modification, improper use, loss or destruction of data or systems, including those belonging to us, our customers or third parties; theft of sensitive, regulated or confidential data including personal information; the loss of access to critical data or systems through ransomware, destructive attacks or other means; transaction errors; business delays; and service or system disruptions. We have observed an increase in cybersecurity attacks worldwide in 2020, and the remote working arrangements that we have implemented due to the Covid-19 pandemic have increased our dependence on information technology systems and infrastructure, and they may further expand our vulnerability to this risk. In the event of such actions, we, our customers or other third parties could be exposed to risk of loss or improper use of this information, resulting in litigation and potential liability, damage to our brand and reputation, or otherwise harm our business. In addition, we rely on third-party infrastructure providers whose potential security vulnerabilities could have impact in our business.

On December 25, 2020 an anomalous behavior, related to ransomware attacks, was detected by our Security Operation Center (SOC). Due to a quick and efficient response by CEMIG Cyber Security Team (CSIRT) the Industrial Control System (ICS) related to our critical infrastructure and the main databases (customers, billing and enterprise management) were not affected and no data was exfiltrated, causing no impact to customer services this way.

The regulatory environment with regards to cybersecurity, privacy and data protection issues is increasingly complex and may have impacts on our business, including increased risk, costs and expanded compliance obligations.

 

Failures in the security of our databases containing customer personal data, as well as events related to non-compliance with data privacy and protection legislation may have an adverse effect on our business, results of operation and reputation.

We have databases containing collected personal data from our customers, partners and collaborators. Any improper use of this data, or failures in the correct use of our security protocols may negatively affect the integrity of those databases. Unauthorized access to information concerning our customers, or unauthorized disclosure of sensitive information, may subject us to lawsuits, and as consequence, we might incur financial liabilities, penalties and reputational damage.

24 

The Brazil General Data Protection Law (Lei Geral de Proteção de Dados Pessoais, or LGPD), was signed into law in August 2018 and came into effect on September 18, 2020, with the exception of the administrative sanctions, which are expected to come into effect in August 2021. This law establishes rules and obligations regarding the collection, processing, storage and use of personal data and will affect all economic sectors including the relationship between customers and suppliers of goods and services, employees and employers and other relationships in which personal data is collected, whether in a digital or physical environment. Violations of the LGPD carry financial risks due to penalties for data breach or improper processing of personal data. The new legislation establishes penalties for non-compliance that include application of fines of up 2% of revenues, limited to R$50 million, for the most serious infringements. An increased number of data protection laws around the globe may continue to result in increased compliance costs and risks. The potential costs of compliance with or imposed by new or existing regulations and policies that are applicable to us may affect our business and could have a material adverse effect on our results of operations.

Increases in energy purchase prices could cause an imbalance in CEMIG D’s cash flows.

The expense on purchase of power from the distributors is currently strongly linked to the PLD price (Availability Contracts, Physical Guarantee quotas, and Itaipu Hydroelectric Plant quotas) and to MRE’s adjustment factor (Physical Guarantee quotas, Itaipu quotas and Hydrological Risk of the plants that have been renegotiated).

In 2018, a combination of negative factors affected purchases by the distributors, including (i) an adverse period in terms of rainfall, resulting in high spot prices from May to October; and (ii) seasonalization of the physical guarantee of the MRE, allocating a large volume of energy in the second half of 2018, resulting in very low MRE adjustment factors between June and October. In 2019, the spot prices were not as high as in 2018.

The ‘Flag Account’ (Conta Centralizadora de Recursos de Bandeiras Tarifárias – CCRBT or ‘Conta Bandeira’) manages the funds that are collected from captive customers of distribution concession and permission holders operating in the national grid, and are paid, on behalf of the CDE, directly to the Flag Account. The resulting funds are passed through by the CCEE to distribution agents, based on the difference between the realized amounts of costs of thermal generation and the exposure to short term market prices, and the amount covered by the tariff in force.

The first half of 2019 had a smaller deficit on the Tariff Flag account compared to same period in the previous year and, as of June, 2019, the account no longer presented a deficit and 2019 ended with an accumulated surplus of R$745 million for all distribution companies in Brazil. This positive result was due to the better hydrological conditions of the system.

In 2020, the surplus lasted for almost the entire year, but started a declining trend from October, reaching a deficit of around R$3 billion in November for all distribution companies. The reason for the deficit was the increase in energy costs, mainly due to a considerable increase in PLD prices in that month. Due to the actions undertaken to mitigate the impacts of the pandemic, ANEEL suspended the application of tariff flags in 2020, but with the scenario getting worse, there was a necessity to reapply it in December 2020 at its maximum value.

The methodology of the Tariff Flag system is reviewed every year, always seeking improvements, but under the present methodology, when very adverse situations occur the system cannot respond sufficiently, resulting in negative effects on the distributors’ cash position. This factor could have an adverse effect on our business, operating results and financial condition.

25 

Brazil’s supply of energy is heavily dependent on hydroelectric plants, which in turn depend on climatic conditions to produce energy. Adverse hydrological conditions that result in lower generation of hydroelectric power could adversely affect our business, results of operations and financial condition.

Hydroelectric generation is predominant in Brazil. The advantages of hydroelectric power have also been widely publicized due to it is a renewable resource and avoids substantial expenditures on fuels in thermal generation plants. At the same time, the main difficulty in the use of this resource arises from the variability of the flows to the plants. There are substantial seasonal variations in monthly and annual flows, which depend fundamentally on the volume of rain that falls in each rainy season. Adverse hydrological conditions in the Brazilian southeast region caused drought and water scarcity in the states of São Paulo, Minas Gerais and Rio de Janeiro in recent past. These conditions might become worse during the dry period, which occurs from April through September. This could cause rationing of water consumption and/or energy, which could have a material adverse effect on the Company’s business and results of operations.

To deal with this difficulty, the Brazilian system has a complementary component of thermoelectric generation plants, and a growing portfolio of wind farms and Photovoltaic solar farms. It also has accumulation reservoirs, the purpose of which is to secure water from the rainy to the dry period and from one year to the next. However, these mechanisms are not able to absorb all the adverse consequences of a prolonged hydrological shortage, like the one that we have seen in the recent past.

The National Energy System Operator (Operador Nacional do Sistema, or ‘ONS’) coordinates the operation of the Brazilian energy system. Its primary function is to achieve optimal operation of the resources available, minimizing operating cost, and the risks of shortage of energy. In periods when the hydrological situation is adverse, a decision by the ONS might, for example, reduce generation by hydroelectric plants and increase thermal generation, which results in higher costs for the hydroelectric generating agents, as happened in 2014. In the distributors, this increase in costs generates an increase in the purchase price of energy that is not always passed through to the customer at the same moment, generating mismatches in cash flows, with an adverse effect on the business and financial situation of those distributors. In addition, in extreme cases of scarcity of energy due to adverse hydrological situations, the system might undergo rationing, which could result principally in reduction of cash flow.

The MRE aims to mitigate the impact of the variability of generation of the hydroelectrical plants. This mechanism shares the generation of all the hydroelectrical plants in the system in such a way as to supplement the shortage of generation of one plant with excess generation by another. However, this mechanism is not able to eliminate the risk of the generation players, because when there is an extremely unfavorable hydrological situation, to the extent that all the plants in aggregate are unable to reach the sum of their Physical Guarantee levels of energy output, this mechanism makes an adjustment to the Physical Guarantee of each plant through the Physical Guarantee Adjustment Factor (Fator de Ajuste da Garantia Física, or ‘GSF’), resulting in the generating companies being exposed to the short-term (‘spot’) market.

The company transferred to captive customers the hydrological risk related to Queimado and Irapé power plants (Regulated Market Contracts), in exchange for payment of a ‘risk premium’, while also receiving indemnity for the losses suffered in 2015 through.

In the free market, we do not have the same process, since even with the payment of the premium, generation companies would have had to continue assuming the hydrological risk at moments of critical hydrology. Thus, no plant that sells energy in the free market signed up for any renegotiation of hydrological risk.

Those operators that did not subscribe to the renegotiation continued to have injunctions preventing charging of the hydrological risk in full. These injunctions are causing a deficit of approximately R$10.030 billion in the short-term market as of December 2020. This position increases the level of default calculated by the CCEE, thus reducing the amounts received by creditor agents in the short-term market. To avoid this effect, some creditor agents filed for further injunctions to acquire the right to priority in receipt. This effect leads to uncertainty in the market, reduction of liquidity, increase of default, and reduction in amounts received in the short-term market, representing a risk for the Company.

26 

Any substantial seasonal variation in the monthly flows and in the total of flows over the year could limit hydroelectric generation, making it necessary to use alternative generation systems, which could have a significant adverse effect on the Company’s costs, including court fees and expenses relating to the subject.

Law 14,052/2020 and Resolution 895/2020, proposed the reimbursement of agents holding the concession of hydraulic plants in the MRE of the effects: (i) generation in disregard of the merit order which means dispatching energy to the grid in disregard of the ascending price ranking for energy generation, (ii) anticipation of delivery of firm energy to the system of relevant power plants, and (iii) restriction to the supply of energy to the grid due to delay in the transmission system. These effects will be calculated retroactively from 2012 to 2020, updated and remunerated at the ANEEL rate of 9.63%. The amount will then be paid through extension of the plants' concession. With this new agreement, injunctions are expected to be withdrawn and market deficits to be settled. In this way, the liquidity of the market in the short term and the default in the CCEE should return to their historical values.

 

The rules for energy trading and market conditions may affect the sale prices of energy.

Under applicable laws, our generation companies are not allowed to sell energy directly to distributors. Thus, the power generated by our companies is sold in the Regulated Market (Ambiente de Contratação Regulado, or ‘ACR’) – also referred to as the ‘Pool’ – through public auctions held by ANEEL, or through the Free Market (Ambiente de Contratação Livre, or ‘ACL’) through bilateral negotiations with customers and traders. The applicable legislation allows distributors that sign contracts for existing energy supply (‘energia existente’) with generation companies in the Regulated Market to reduce the quantity of energy contracted by up to 4%, per year, in relation to the amount of the original contract, for the entire period of the contract. This exposes our generation companies to the risk of not selling the de-contracted supply at adequate prices.

We conduct trading activities through power purchase and sale agreements, mainly in the Free Market, through our generation and trading companies. Contracts in the Free Market may be entered into with other generating entities, energy traders, or mainly, with ‘free customers.’ Free customers are customers with a demand of 1.5 MW or more: they are allowed to choose their energy supplier, this limit will be reduced to 1.0 MW in 2022 and 0.5 MW in 2023 (Ordinance 465, published by the Ministry of Mines and Energy in December 2019). Some contracts have flexibility in the amount sold, allowing the customer to consume a higher or lower amount (5% on average) from our generating companies than the original amount contracted, which might cause an adverse impact on our business, operating results and/or financial situation.

Other contracts do not allow for this kind of flexibility in the purchase of energy, but increased competition in the Free Market could influence the occurrence of this type of arrangement in purchase contracts.

In addition to the free customers referred to above, there is a category of customers referred to as ‘Special Customers’, which are those with contracted demand between 0.5 MW and 1.5 MW. Special Customers are eligible to participate in the Free Market provided they buy energy from incentive-bearing alternative sources, such as Small Hydroelectric plants, biomass plants or wind farms. As envisaged by the Ordinance 465/ 2019, by 2023 the demand restriction for free consumers will suffer reduction from 3.0 MW to 0.5 MW, and consider there will be no more separation of free and special consumers. The Company has conducted sales transactions for this category of energy from specific energy resources in particular companies of the CEMIG Group and, since 2009; the volume of these sales has gradually increased. The Company has formed a portfolio of purchase contracts, which now occupies an important space in the Brazilian energy market for incentive-bearing alternative power sources. Contracts for the sale of energy to these customers have specific flexibilities to serve their needs, and these flexibilities of greater or lesser consumption are linked to the historic behavior of these loads. Higher or lower levels of consumption by these customers may cause purchase or sale exposures to spot prices, which can have an adverse impact on our business, operating results and/or financial situation. Market variations, such as variations of prices for signature of new contracts, and of volumes consumed by our customers in accordance with flexibilities previously contracted, can lead to spot market positions, which can potentially have a negative financial impact on our results.

27 

The MRE aims to reduce the exposure of generators of hydroelectric power, such as our generation companies, to the uncertainties of hydrology. It functions as a pool of hydroelectric Generation Companies, in which the generation of all the plants participating in the MRE is shared in such a way as to meet the demand of the pool. When the totality of the plants generates less than the amount demanded, the mechanism reduces the assured offtake levels of the plants, causing a negative exposure to the short-term (‘spot’) market and, as a consequence, the need to purchase power supply at the spot price. Correspondingly, when the total generation of the plants is higher than the volume demanded, the mechanism increases the guaranteed offtake level of the plants, leading to a positive exposure, permitting the liquidation of power at the PLD. In years of poor rainfall, the reduction factor, which applies to the assured energy levels, can reduce the levels of the hydroelectric plants by 20% or more.

Low liquidity or volatility in future prices, due to market conditions and/or perceptions, could negatively affect our results of operations. Further, if we are unable to sell all the power that we have available (our own generation capacity plus contracts under which we have bought supply of power) in the regulated public auctions or in the Free Market, the unsold capacity will be sold in the CCEE at the PLD, which tends to be very volatile. If this occurs in periods of low spot prices, our revenues and results of operations could be adversely affected.

The PLD’s value is calculated through the results of the optimization models of the operation of the national grid used by the ONS and by the CCEE. The PLD is currently published weekly by the CCEE for three load levels (light, medium and heavy). The models depend on entry data revised by the ONS at each period of four months, monthly, and weekly. In this system, there is the possibility that errors occur during the input of data into the model, which can lead to an unexpected change in the PLD. Alteration of these models, and errors in data input, constitute risks for the trading business, because they cause uncertainty in the market, reducing liquidity, and financial losses due to the unexpected change of price. To mitigate the risk of change of the models during the current year, the National Energy Policy Council (CNPE) published a note in 2016 which established that changes in the mathematical models used in the sector will need to be approved by the CPAMP (‘Comissão Permanente para Análise de Metodologias’ – Standing Committee for Methodologies Analysis and Energy Industry Computer Programs) by July 31 of each year in order to be in force in the subsequent year.

The Covid-19 pandemic has put the world on alert, prompting countries to take measures to contain people to reduce the spread of the virus. In Brazil, these measures started in Mid-March of 2020 and their impacts on the Brazilian energy market were noticed almost immediately with a reduction in the energy consumption of the National Integrated System of approximately 13% in the week following the implementation of these measures. The reduction in consumption, with the consequent deceleration of the economy, lead to an increase in the levels of the reservoirs, since less hydroelectric generation is necessary to meet the lower consumption. Thus, the combination of these factors led to a reduction in prices in the short-term market. With regard to market prices, the evolution of systemic conditions and the revision in market forecasts led to a reduction in contract prices in the medium term. In this sense, the increase or decrease in exposure will depend on the contractual position and contract flexibility at each moment.

In 2020, the frequency of changes in the PLD were increased to hourly. Having an hourly PLD improves the PLD’s adherence to the real operation of the system, which will then better capture the hourly changes in the intermittent sources (solar and wind). This better alignment of price with operation tends to reduce the System and Service Charges (‘ESS’), and to remunerate the thermoelectric generation plants more efficiently when they are activated. On the other hand, the quality of the entry data when input on an hourly basis, especially for solar and wind sources, introduces one more element of uncertainty to the pricing of the market.

28 

The anticorruption investigations currently in progress in Brazil, which have had large-scale public exposure, and any allegations against or anticorruption investigations of CEMIG, might have adverse effects on the perception of the country, and on us.

Certain anti-corruption investigations could have adverse effects on CEMIG or other companies of the CEMIG Group. Investors’ perception about Brazil has been adversely affected by investigations of public corruption in large Brazilian companies, and by political events, which might represent potential risks to the social and economic outlooks for Brazil.

Among the Brazilian companies involved in these investigations are state-controlled companies in the oil and gas, electricity and infrastructure sectors, and private companies in the construction and equipment supplier sectors, which are being submitted to investigations due to accusations of corruption by the Brazilian Securities Commission (‘CVM’), the Federal Police, the Brazilian Public Attorneys, the Federal Audit Board, the U.S. Securities and Exchange Commission (‘SEC’) and the U.S. Department of Justice (‘DOJ’), among others.

In the energy industry, Eletrobrás has set up an independent internal investigation into possible non-compliances with law and/or regulations indicated by media reports that alleged illegal acts related to service providers of Norte Energia S.A. (NESA) and of Madeira Energia S.A. (MESA) for the construction of Belo Monte and Santo Antônio hydroelectrical plants, respectively and some other special purposes entities, in which Eletrobras holds a minority stake. There have been no direct findings against NESA or MESA nor against any of its managers or employees, and the supposed illegal acts are in fact alleged to have taken place before NESA was formed. The internal investigation, however, estimated the economic and financial impact of these alleged illegal acts, related to NESA’s service providers at R$183 million, and this was considered by Eletrobras and by NESA in accounting analyses and conclusions for the year ended December 31, 2015. This total supposedly represents amounts estimated in excess for acquisition of machines, equipment, services, capitalized charges and administrative expenses, since the alleged improper payments were not made by NESA, but by contractors and suppliers of the Belo Monte hydroelectrical plant; and this impedes identification of the amount and precise periods of the payments.

CEMIG holds, through CEMIG GT, an 11.69% indirect minority stake in NESA, through the jointly-controlled entities Aliança Norte Energia Participações S.A. and Amazônia Energia S.A. and the estimated amount of losses has already been recorded in CEMIG’s consolidated financial statements as of and for the year ended December 31, 2015.

The independent internal investigation of MESA, concluded in February 2019, in the absence of any future developments such as any leniency agreements by third parties that may come to be signed or collaboration undertakings that may be signed by third parties with the Brazilian authorities, found no objective evidence enabling it to be affirmed that there were any supposed undue payments by MESA that should be considered for possible accounting write-off, pass-through or increase of costs to compensate undue advantages and/or linking of MESA with the acts of its suppliers, in the terms of the witness accusations and/or cooperation statements that have been made public.

Since 2017, Renova, a company in which CEMIG has a direct stake of 36.23%, is part of a formal investigation conducted by the Civil Police of Minas Gerais State in relation to certain injections of capital made by some of its controlling shareholders, including the Company, and capital injections made by Renova in certain projects under development in previous years.

On April 11, 2019, the Brazilian Federal Police commenced the ‘Operation E o Vento Levou’ as part of the Lava Jato Investigation, and executed a search and seizure warrant issued by a Federal Court of São Paulo at Renova’s head office in São Paulo, based on allegations and indications of misappropriation of funds harmful to the interests of CEMIG. Based on the allegations being investigated, these events are alleged to have taken place before 2015. On July 25, 2019, the second phase of such investigation initiated.

The ‘Operation E o Vento Levou’ and the police investigation of the Minas Gerais State Civil Police have not yet been concluded. Thus, there is a possibility that material information may be revealed in the future. If a criminal action is filed against agents who damaged Renova, Renova intends to act as auxiliary to the prosecution in any criminal proceedings, and subsequently sue for civil recovery of the damages suffered.

29 

In 2019, the tax authority issued infraction notices against Renova, questioning the calculation of income tax and social contribution tax, and payment of withholding income, relating to contracts of services which allegedly did not have the due perfomance, in the estimated amount of R$89 million. Based on the opinion of its legal advisors, Renova provided for this amount as contingency on its financial statements.

Due to these third party investigations, the governance bodies of Renova requested the opening of an internal investigation, conducted by an independent company with the support of an external law firm. The internal investigation was concluded on February 20, 2020, and according to a statement Renova issued at the time, no concrete evidence of acts of corruption or diversion of funds to political campaigns was identified.

However, the independent investigators identified irregularities in the conducting of business and agreement of contracts by Renova, including: (i) payments without evidence of the performance of services, in the total amount of approximately R$40 million; (ii) payments not in accordance with the company’s internal policies and best governance practices, in the total amount of approximately R$137 million; and (iii) deficiencies in the internal controls of the investee.

As a result of the analysis of the above mentioned values, Renova concluded that R$35 million relates to effective assets and therefore no impairment was necessary. The remaining amount of R$142 million was already impaired in previous years, producing no impact on the consolidated financial statements for the year ended December 31, 2019.

In response to the irregularities found, and based on the recommendations of the Monitoring committee and legal advisers, the Board of Directors of Renova decided to take all the steps necessary to preserve the rights of the investee, continue with the measures to obtain reimbursement of the losses caused, and strengthen Renova’s internal controls. Additionally, the Executive Board of Renova hired a Chief Officer for Governance, Risk and Compliance, who will be responsible, among other duties, for ensuring the effiectiveness of Renova´s internal controls and compliance processes.

Since our investment at Renova is fully impaired at December 31, 2020, and since no contractual or constructive obligations in relation to the investee have been assumed by the Company, it is not expected that effects resulting from the investigations can significantly impact the Company’s financial statements, even if such effects may not yet be recorded by Renova.

In addition to the cases above, there are investigations being conducted by the Public Attorneys’ Office of the State of Minas Gerais (MPMG) and by the Civil Police of the State of Minas Gerais (PCMG), which aim to investigate possible irregularities in the investments made by CEMIG in Guanhães Energia S.A. and in MESA (Santo Antônio Energia S.A. or ‘SAESA’). Additionally, on April 11, 2019 agents of the Brazilian Federal Police were in the Company’s head office in Belo Horizonte to execute a search and seizure warrant issued by a São Paulo Federal Court in connection with the ‘Operation E o Vento Levou’, as described above. These proceedings are being investigated by reviewing of documents requested by the respective authorities, and by hearing of witnesses. At present, it is not possible to determine what the results of the MPMG and PCMG’s investigations will be.

Taking into account these investigations, we contracted specialized independent advisers to analyze the internal procedures related to these investments, as well as the Company internal proceedings related to the acquisition of Light’s interest in Enlighted (see Note 25 of the Financial Statements). The specialized independent company’s investigation was subject to oversight of an independent investigation committee whose creation was approved by our Board of Directors. The specialized independent advisers’ investigation was completed in May 2020 and identified no objective evidence substantiating illegal acts made by Company in the Company’s investments that were the subjects of the investigation. Therefore, there was no impact in the consolidated financial statements as of December 31, 2020.

30 

By the end of 2020, CEMIG initiated internal investigations into allegations that are the subjects of inquiries conducted by the Minas Gerais State Public Attorneys´ Office, regarding certain alleged irregularities in public bidding and purchasing processes. The investigations are being conducted by a new Special Investigation Committee (Comitê Especial de Investigação – ‘CEI’), with support from specialized independent advisers.

The Executive Board determined the establishment of a disciplinary administrative process (‘Processo Administrativo Disciplinar) to verify the veracity of the allegations and to pursue the preventive removal of certain personnel from the Supply and Logistics area, which aims to ensure impartiality and exemption in the investigations.

CEMIG is and has been fully cooperating with any and all investigation and inspection by competent authorities, whether in the United States or Brazil. For example, in July 2019, pursuant to the DOJ’s Corporate Enforcement Policy, the Company disclosed the above-described investigation to the DOJ and the SEC and has been cooperating with those agencies. We cannot guarantee that CEMIG or companies of the CEMIG Group will not in the future become target of legal actions based on these or future investigations, whether in the United States or Brazil.

Any future anti-corruption actions, which might find failures of conduct by the management of the Company or by third parties, might result in fines, penalties or significant negative postings in the accounts, or intangible damage, such as damage to reputation, and/or other significant, unforeseen, adverse effects.

 

We may be exposed to behaviors that are incompatible with our standards of ethics and compliance, and we might be unable to prevent, detect or remedy them in time, which might cause material adverse effects on our business, results of operations, financial condition and reputation.

Our businesses, including our relationships with third parties, are oriented by ethical principles and rules of conduct. We have a range of internal rules that aim to orient our managers, employees and contractors, and to reinforce our ethical principles and rules of professional conduct. Due to the wide distribution and outsourcing of the production chains of our suppliers, we are unable to control all the possible irregularities of the latter. This means that we cannot guarantee that the financial, technical, commercial and legal evaluations that we use in our selection processes will be sufficient for preventing our suppliers from having problems related to employment law, or sustainability, or in the outsourcing of the production chain with inadequate safety conditions. We also cannot guarantee that these suppliers, or third parties related to them, will not involve themselves in irregular practices. If a significant number of our suppliers involve themselves in irregular practices, we might be adversely affected.

Further, we are subject to the risks that our employees, contractors or any person who may do business with us might become involved in activities of fraud, corruption or bribery, circumventing our internal controls and procedures, misappropriating or using our assets for private benefit to the detriment of the Company’s interests. This risk is exacerbated by the fact that there are some affiliates, such as special-purpose companies and joint ventures, in which we do not have control.

Our internal controls systems to identify, monitor and mitigate risks may not be effective in all circumstances, especially in relation to companies that are not under our control. In the case of companies we have acquired, our internal controls systems might be incapable of identifying fraud, corruption or bribery that took place prior to the acquisition. Any failing in our capacity to prevent or detect non-compliance with the applicable rules of governance or of regulatory obligation could cause harm to our reputation, limit our capacity to obtain financing, or otherwise cause material adverse effects on our, business, results of operations, financial condition and reputation.

 

31 

Two members of our board of directors are party to administrative and judicial proceedings and ongoing corruption investigations.

One member of our board of directors is a defendant in two "Civil Actions of Administrative Impropriety due to Damages to the Public Treasury" and another member of our board of directors is a defendant in a ‘Tax Evasion Action’, all in pre-trial proceeding stage. For more information, see “Item 6. Significant Civil and Criminal Proceedings Involving Key Management Members”. We cannot assure you that judicial and administrative proceedings, or even the commencement of new judicial and administrative proceedings against any members of our management or board of directors, will not impose limitations or restraints on the performance of the members of our management and board of directors that are a party to these proceedings. In addition, we cannot assure you that these limitations will not adversely affect us and our reputation.

 

The multiple uses of water and the various interests related to this natural resource might give rise to conflicts of interest between CEMIG and society as a whole, which might cause losses to our business, results of operations or financial condition.

At present, considering projects and companies that are jointly controlled, CEMIG has more than 70 hydroelectric power plants, with 5,969 MW and representing 98.1% of our installed capacity.

Water is the main raw material for CEMIG’s production of energy, and is a resource that is sensitive to climate change and vulnerable to the consequences of exploration of other natural resources, significantly impacted by human actions and subject to a regulatory environment.

CEMIG’s operation of reservoirs for generation of hydroelectric power essentially requires consideration of the multiple uses of water by other users in a river basin; and this in turn, leads to the need to take into account a range of constraints — environmental, safety, irrigation, human consumption, waterways and bridges, among others. In periods of severe drought, like those of 2013 until 2019, monitoring and forecasting the levels of reservoirs and the constant dialogue with the public authorities, civil society and users were essential for ensuring the generation of energy, and the other uses of this resource.

Finally, CEMIG uses a Risk Management System to analyze scenarios and determine the degree of financial exposure to risks, considering the probability of occurrence and its effect. In the scenarios relating to potential conflicts with other users, CEMIG evaluates both the effects arising from prolonged droughts, which can lead to an increase of competition between the energy sector and other users, and the effects of flood events occurring due to excessive rain. While CEMIG engages with other essential users, and takes steps to analyze community input and studies on issues relating to the impact of water use, competing interests relating to water use could, subject to certain minimum limits previously established by law, affect its availability to us for use in the operations of certain of our projects, which could adversely affect our business results of operations and financial condition.

 

We are controlled by the government of the State of Minas Gerais, which might have interests that are different from the interests of the other investors, or even of the Company.

As our controlling shareholder, the government of the State of Minas Gerais exercises substantial influence on the strategic orientation of our business. Currently it holds 51% of the common shares of CEMIG and as majority shareholder has full powers to decide on business relating to the Company’s objects as stated in the by-laws, and to adopt whatever decisions it deems to be necessary for the defense of its interests and development.

The government of the State of Minas Gerais can elect the majority of our senior management and has the competency to approve, among other subjects, matters that require a qualified quorum of shareholders. The latter include transactions with related parties, shareholding reorganizations and the date and payment of dividends.

32 

The government of the State of Minas Gerais, as our controlling shareholder, has the capacity to direct us to engage in activities and to make investments that promote the controlling shareholder’s economic or social objectives, and these might not be strictly aligned with the Company’s strategy, adversely affecting the direction of our business.

Our processes of governance, risk management, compliance and internal controls might fail to avoid regulatory penalties, damages to our reputation, or other adverse effects on our business, results of operations or financial condition.

Our Company is subject to various different regulatory structures, of which the following are examples: (a) laws and regulations of the Brazilian energy sector, such as Law No. 10,848/04 (on trading in energy), regulations by ANEEL; (b) the laws and regulations that apply to listed companies with securities traded on the Brazilian capital market, such as Law No. 6,404/76 (the ‘Corporate Law’), regulations of the CVM; (c) laws and regulations that apply to Brazilian companies with majority state-owned shareholdings, such as Law No. 13,303/2016 (the ‘State Companies Law’); (d) laws and regulations that apply to Brazilian companies that have securities registered with the SEC, such as the Sarbanes-Oxley Act of 2002, the Foreign Corrupt Practices Act (FCPA) and regulations of the SEC; and (e) laws and regulations regarding privacy and data protection, such as Law no. 13,709/2018 (the ‘General Data Protection Law, LGPD’), among others.

Furthermore, Brazil has intensified and improved its legislation and structures relating to maintaining competition, combat of improbity and prevention of corrupt practices. For instance, Law No. 12,846/13 (the ‘Anticorruption Law’) established objective liabilities for Brazilian companies that commit acts against Brazilian or foreign public administration, including acts relating to tender processes and administrative contracts, and established tough penalties for those companies that are punished.

The Company has a high number of administrative contracts with high values and a large number of suppliers and customers, which increases its exposure to risks of fraud and administrative impropriety.

Our Company has structures and policies for the prevention and combat of fraud and corruption, audit and internal controls, and has adopted the recommendations for Best Corporate Governance Practices recommended by the Brazilian Corporate Governance Institute (Instituto Brasileiro de Governança Corporativa, or ‘IBGC’) and the framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, due to the majority interest held by the State Government in our shareholding structure, we are required to contract the greater part of our works, services, advertising, purchases, disposals and rentals, through competitive tenders and administrative contracts, which are ruled by the Tenders Law, State Companies Law and other complementary legislation.

However, despite the Company having processes of governance, risk management and compliance, we might be unable to avoid future violations of the laws and regulations to which we are subject (regarding labor, tax, environment, energy, among others), or violations of our internal control mechanisms, our Declaration of Ethical Principles and Code of Professional Conduct, or the occurrence of fraudulent or dishonest behavior by employees, or individuals or legal entities that are contracted, or other agents that may represent the company in dealings with third parties, especially with the Public Authorities.

33 

Our management has identified material weaknesses in internal control over financial reporting, and has concluded that our internal control over financial reporting was not effective on December 31, 2016, 2017, 2018, 2019 and 2020, which may have a material adverse effect on the Company’s results of operations and financial condition.

Our management identified material weaknesses in our internal control over financial reporting for the last 5 years. For further information on the material weakness identified by our management, see “Item 15 - Controls and Procedures - Management’s Annual Report on Internal Control over Financial Reporting”. Because of the identified material weaknesses, our management concluded that our internal control over financial reporting was not effective as of December 31, for the last 5 years. Although we have developed and implemented several measures to remedy these material weaknesses, we cannot be certain that we will remedy our existing material weakness or that there will be no other material weaknesses in our internal control over financial reporting in the future.

If our efforts to remediate the material weaknesses are not successful, we may be unable to report the Company’s results of operations for future periods accurately and in a timely manner and make our required filings with government authorities, including the SEC and the CVM. Due to its inherent limitations, our internal control over financial reporting may not prevent or detect misstatements, and we cannot be certain that in the future additional material weaknesses will not exist or otherwise be discovered. Any of these occurrences could adversely affect our and the Company’s business, results of operations and financial condition.

 

Potential shortages of skilled personnel in operational areas could adversely affect our business and results of operations.

It is possible that we will experience shortages of qualified key personnel. In recent years, we have been carrying out voluntary severance incentive programs open to all of our employees. Such programs may reduce our employees’ headcount by more than our ability to hire new ones to fill key positions. Our success depends on our ability to continue to successfully train our personnel so they can assume key positions in the organization. We cannot assure you that we will be able to properly train, qualify or retain key staff, or do so without costs or delays. Nor can we assure you that we will be able to hire new qualified personnel, in particular in operational areas, should the need arise. Any such failure could adversely affect our results of operations and our business.

 

Our ability to distribute dividends is subject to limitations.

Whether or not the investor receives dividends depends on whether our financial situation permits us to distribute dividends under Brazilian law, and whether our shareholders, on the recommendation of our Board of Directors, acting in their discretion, determine suspension, due to our financial circumstances, of the distribution of dividends in excess of the amount of mandatory distribution required under our by-laws in the case of the preferred shares.

Because we are a holding company with no revenue-producing operations other than those of our operating subsidiaries, we can only distribute dividends to shareholders if the Company receives dividends or other cash distributions from its operating subsidiaries. The dividends that our subsidiaries can distribute depend on our subsidiaries generating sufficient profit in any given fiscal year and on restrictive covenant clauses in contracts for loans and financing of these subsidiaries as well as by any restriction imposed by the regulator, all of which place limits upon their payments of dividends. Similarly, we have a limitation on the payment of dividends which cannot exceed the mandatory minimum of 50% of the net income for the business year, as contained in our by-laws, due to restrictive covenant clauses in the contracts for loans and financing of the subsidiaries in which we are guarantors. Dividends are calculated and paid in accordance with applicable Brazilian corporate law Brazilian Corporate Law’) and the provisions of the by-laws of each of our regulated subsidiaries.

 

34 

ANEEL has discretion to establish the rates that distributors charge their customers. These rates are determined by ANEEL in such a way as to preserve the economic and financial balance of concession contracts entered into with ANEEL.

Concession agreements and Brazilian law have established a mechanism that permits three types of rate adjustment: (a) the Annual Adjustment; (b) the Periodic Review; and (c) the Extraordinary Review. The purpose of the Annual Adjustment (‘Reajuste Annual’) is to compensate for changes in costs that are beyond a company’s control, such as the cost of energy for supply to customers, the sector charges that are set by the Federal Government, and charges for use of the transmission and distribution facilities of other companies. Manageable costs, on the other hand, are adjusted by the IPCA inflation index, less a productivity and efficiency factor, known as the X Factor, which considers aspects such as distribution productivity and service quality standards. Every five years, there is a Periodic Tariff Review (Revisão Periódica Tarifária, or ‘RTP’), the purpose of which is to: identify the variations in costs referred to above; provide an adequate return on the assets that the company has constructed during the period, establish a factor based on economies of scale, which will be taken into account in the subsequent annual tariff adjustments and define the efficient operational costs. An Extraordinary Tariff Review takes place whenever there is any unforeseen development that significantly alters the economic/financial equilibrium of the concession. Thus, although CEMIG D’s concession contracts specify preservation of their economic and financial balance, we cannot guarantee that ANEEL will set tariffs that do remunerate us adequately in relation to the investments made or the operating costs incurred due to the concession, and this might have a material adverse effect on our business, financial situation and operating results.

 

ANEEL has established the Permitted Annual Revenue (Receita Anual Permitida or ‘RAP’) of our transmission companies; if any adjustments result in a reduction of the RAP, this could have a material adverse effect on our results of operations and financial condition.

ANEEL defines the RAP that we receive through our transmission companies, on behalf of the Federal Government. The concession contracts provide for two mechanisms for the adjustment of revenues: (a) the annual tariff adjustments; and (b) the Periodic Tariff Review (‘Revisão Tarifária Periódica’). The annual tariff adjustment of our transmission revenues takes place annually in June and is effective in July of the same year. The annual tariff adjustments take into account the permitted revenues of the projects that have come into operation, and the revenue from the previous period is adjusted by the inflation index (IPCA for Contract No. 006/1997 and IGP-M for Contract No. 079/2000). The periodic tariff review takes place every five years. During the periodic tariff review, the investments made by a concession holder in the period and the operating costs of the concession are analyzed by ANEEL. The regulator takes into account only investments that it deems to be prudent, and operating costs that it assesses as having been efficient, using a benchmarking methodology. Thus, the tariff review mechanism is subject to some extent to the discretionary power of ANEEL, since it may omit investments that have been made, and could recognize revenues for operating costs lower than those actually incurred. This could result in a material adverse effect on our business results.

An Extraordinary Tariff Review takes place whenever there is any unforeseen development that significantly alters the economic/financial equilibrium of the concession. Thus, although our concession agreements specify that the economic and financial balance of the contract shall be preserved, we cannot guarantee that ANEEL will set tariffs that adequately compensate us in relation to the investments made or in relation to the operating costs incurred because of the concession. This may have a material adverse effect on our business, financial condition and results of operations.

 

35 

 

We have strict liability for any damages caused to third parties resulting from inadequate provision of energy services.

Under Brazilian law, we are strictly liable for direct and indirect damages resulting from the inefficient rendering of energy generation, transmission and distribution services. In addition, when damages are caused to final customers as a result of outages or disturbances in the generation, transmission and distribution system, whenever these outages or disturbances are not attributed to an identifiable member of the ONS or to the ONS itself, the liability for such damages is shared among generation, distribution and transmission companies. Until a party with final responsibility has been identified, the liability for such damages will be shared in the proportion of 35.7% to the distribution agents, 28.6% to the transmission agents and 35.7% to the generation agents. The number of votes establishes these proportions that each of these types of energy concession holders receives in the general meetings of the ONS, and as such, are subject to change in the future. Consequently, our business, results of operations and financial condition might be adversely affected in the event we are held liable for any such damages.

 

We may incur losses and reputational damage in connection with pending litigation.

We are party to several legal and administrative proceedings relating to civil, administrative, environmental, tax, regulatory, labor and other claims. These claims involve a wide range of issues and seek indemnities and restitution in money and by specific performance. Several individual disputes account for a significant part of the total amount of claims against the Company. See “Item 8. Financial Information – Legal and Administrative Proceedings”. Our consolidated financial statements include provisions for risks in a total amount of R$1.9 billion, as of December 31, 2020, for actions in which the probability of loss have been assessed as ‘probable’.

One or more unfavorable decisions against us in any legal or administrative proceeding may have a material adverse effect on us. In addition to making provisions and the costs associated with legal fees, we may be required by the court to provide collateral for the proceedings, which may adversely affect our financial condition. In the event that our provisions for legal actions are insufficient, payments for actions in excess of the amounts provisioned could adversely affect our results of operations and financial condition.

In addition, certain members of our management are involved as defendants in criminal proceedings that are currently pending, which may distract our management and negatively affect us and our reputation. See “Item 6. Significant Civil and Criminal Proceedings Involving Key Management Members”.

 

Environmental regulations require us to perform environmental impact studies on future projects and obtain regulatory permits.

For reasons of obligations imposed by Brazilian environmental law, we must conduct environmental impact studies and obtain regulatory and environmental permits and licenses for our current and future projects. We cannot assure that these environmental impact studies will be approved by environmental agencies, that environmental licenses will be issued, that public opposition will not result in delays or modifications to any proposed project, or that laws or regulations will not change or be interpreted in a manner that could materially adversely affect our operations or plans for the projects in which we have an investment. We believe that concern for environmental protection is also an increasing trend in our industry. Although we consider environmental protection when developing our business strategy, changes in environmental regulations, or changes in the policy of enforcement of existing environmental regulations, could have a material adverse effect on our results of operations and our financial condition by delaying the implementation of energy projects, increasing the costs of expansion.

Furthermore, the implementation of investments in the transmission sector has suffered delays due to the difficulty in obtaining the necessary regulatory and environmental permits and approvals. This has led to delays in investments in generation due to the lack of transmission lines to provide for the outflow of the energy generated. If we experience any of these or other unforeseen risks, we may not be able to generate, transmit and distribute energy in amounts consistent with our projections, which may have a material adverse effect on our financial condition and results of operations.

36 

 

We operate without insurance policies against catastrophes and third-party liability.

Except for use of aircraft, we do not have third-party liability that covers accidents and we do not seek proposals for this type of insurance. CEMIG has not sought a proposal for, and has not contracted, insurance coverage against disasters, such as earthquakes or floods, that might affect our facilities. Any events of this type could generate unexpected additional costs, resulting in adverse effects on our business, results of operations and financial condition.

 

The insurance contracted by us might be insufficient to reimburse costs of damage.

Our business is normally subject to a range of risks, including industrial accidents, labor disputes, unexpected geological conditions, changes in the regulatory environment, environmental and climatic risks, and other natural phenomena. In addition, we and our subsidiaries might be found responsible for losses and damages caused to third parties as a result of failures to provide generation, transmission and/or distribution service.

We only maintain insurance for fire, risks involving our aircraft, and operational risks, as well as those types of insurance coverage that are required by law, such as transport insurance of goods belonging to legal entities.

We cannot guarantee that the insurance contracted by us will be sufficient to cover in full or at all any liabilities that may arise in the course of our business nor that these insurance policies will continue to be available in the future. The occurrence of claims in excess of the amount insured, or which are not covered by our insurance policies, might generate significant and unexpected additional costs, which could have an adverse effect on our business, results of operations and/or financial condition. Further, we cannot guarantee that we will be able to maintain our insurance coverage at favorable or acceptable commercial prices in the future.

 

Strikes, work stoppages or labor unrest by our employees or by the employees of our suppliers or contractors could adversely affect our results of operations and our business.

All of our employees are represented by labor unions. Disagreements on issues involving divestments or changes in our business strategy, reductions in our personnel, as well as potential employee contributions, could lead to labor unrest. We cannot ensure that strikes affecting our production levels will not occur in the future. Strikes, work stoppages or other forms of labor unrest at any of our major suppliers, contractors or their facilities could impair our ability to operate our business, complete major projects and adversely affect our ability to achieve our long-term objectives.

 

A substantial portion of the Company’s assets is tied to the provision of public services and would not be available for attachment as collateral for the enforcement of any court decision.

A substantial portion of the Company’s assets is tied to the provision of public services. These assets can not be attached as collateral for the enforcement of any court decision because the assets revert to the concession-granting authority to ensure continuity in the provision of public services, according to applicable legislation and our concession agreements. Although the Brazilian Federal Government would be obligated to compensate us for early termination of our concessions, we cannot assure you that the amount ultimately paid by the Brazilian Federal Government would be equal to the market value of the reverted assets. These restrictions on liquidation may lower significantly the amounts available to holders of the notes in the event of our liquidation and may adversely affect our ability to obtain adequate financing.

37 

Loss by our subsidiary Gasmig of its concession could cause losses in Gasmig’s results.

In 1993, Gasmig obtained the concession for commercial operation of supply of piped gas to the industrial, automotive, commercial, institutional and residential sectors in the state of Minas Gerais for a period of 30 years (‘the Concession Contract’). The concession was extended to January 10, 2053 under the Second Amendment to the Concession Contract, dated December 26, 2014.

On September 19, 2019, Gasmig executed the Third Amendment to the Concession Contract, which replaced the obligation of Gasmig to build a gas pipeline from the city of Queluzito, in Minas Gerais, in the direction of the city of Uberaba, Minas Gerais, for a compensatory grant payment of R$852 million to the State of Minas Gerais, and confirmed extension of the Concession Contract to January 10, 2053. In addition, Gasmig committed to reach a total of 100,000 clients served by the end of 2022, and to build networks to serve the seven meso-regions of the State of Minas Gerais. Currently, Gasmig serves five of these meso-regions.

Under Article 35 of Law 8987 of February 13, 1995 (‘the Concessions Law’), the concession is subject to termination under certain circumstances, including the following: (i) expiration of the contractual term; (ii) the operation being taken over by the state; (iii) termination for other reasons, usually of time, arising from law; (iv) rescission of the contract (amicably, or by the courts); (v) annulment of the concession contract as a result of a failing or irregularity found in a tender or public bid procedure or in the manner of its grant; or (vi) bankruptcy or extinction of the concession holder. In any of these circumstances, the concession assets will revert to the Concession-granting Power, the state of Minas Gerais (‘the Grantor’). In the event that Gasmig loses its concession for any reason, we cannot guarantee that any indemnity payable to Gasmig will be sufficient to compensate its investments, the implicit rate of return, nor loss of future profits relating to the assets not yet totally amortized or depreciated.

The activities carried out by Gasmig are subject to interruptions, disturbances and risks in the distribution system, caused by accidents, operational difficulties, damage, failure of equipment or processes, natural causes or catastrophes (such as explosions, fires, floods, landslides, sabotage, terrorism, vandalism, and others), which might result in Gasmig having an obligation to indemnify clients that suffer damages and might expose it to administrative or court proceedings.

In addition, Gasmig may suffer the intervention of the Grantor in the event that, in the Grantor´s opinion, there is a risk of Gasmig failing to perform the services, or if Gasmig has failed to perform its obligations under the concession contract or the applicable law. In such events, the Grantor could also levy fines against Gasmig or even revoke its concession.

Early termination of the Concession contract, and penalties in connection with such termination, would generate significant impacts on Gasmig’s results, and affect its capacity to pay and comply with its financial obligations. Gasmig’s concession will expire in January 2053, and may be extended, at the sole discretion of the Grantor.

 

Changes in the methodology and parameters adopted by the regulatory authorities in connection with the tariff review cycles of Gasmig may adversely impact our operations and financial condition

The general parameters of tariff regulation are specified in the Concession Contract, which: (i) determines the general guidelines for adjustment of tariff; (ii) guarantees pass-through of the cost of acquisition of gas and of the tariff review; and (iii) determines the distribution margin, which enables the economic and financial sustainability of Gasmig in accordance with the best practices used by Brazilian and international regulatory agencies for the natural gas distribution sector.

The concession contract also provides that the tariff will be reviewed if events occur that put the economic and financial equilibrium of the Concession Contract at risk, in the form of and for the periods necessary to avoid losses due to tariffs becoming inadequate.

38 

 

In November 2019 the Economic Development Department of Minas Gerais State (SEDE), a division of the Minas Gerais State Government, responsible for regulating the distribution of piped gas, completed the first tariff review cycle, in which the parameters for the remuneration rate, expectations of investments, costs and volumes for determining the tariffs in the 2018-2022 cycle were determined. In addition, SEDE included the impact of the payment of the Compensatory Grant in tariffs.

Changes in the tariff review cycles could cause a material adverse effect on Gasmig’s activities, affecting its financial condition and the results of its operations. These changes may also impact on market conditions and the prices of securities in Brazil, consequently adversely affecting Gasmig, and could change the price of gas or increase the costs of its activities.

 

Gasmig might not succeed in implementing the strategies in its long-term strategic plan at the desired moment, or might incur unexpected costs, which could have adverse consequences for its business, operational results and financial condition.

Gasmig’s capacity to comply with the strategic objectives depends, largely, on timely and successful implementation, with a good cost-benefit ratio, of its long-term strategy.

The following are some of the factors that could negatively affect this implementation:

·Substantial alterations in the economic conditions;
·Substantial alterations in regulatory matters;
·Capacity to generate cash flow, or obtain future financings, necessary for implementation of projects;
·Inability to obtain necessary governmental licenses and approvals;
·Unexpected engineering problems;
·Unexpected investments in environmental matters arising from alterations in legislation and/or incidents that demand indemnities for environment damage;
·Unexpected delays in the processes of expropriation and establishment of easements;
·Non-availability of the workforce or of the necessary equipment;
·Strikes;
·Delay in delivery of equipment by suppliers;
·Inappropriateness of the physical facilities and equipment for ensuring uninterrupted activities of the business and protecting the critical processes against failures and accidents;
·Delay resulting from failings by suppliers or third parties to comply with their contractual obligations;
·Interference by climate factors, or environmental restrictions;
·Significant variations of hydrological conditions from the historic average, that is to say, occurrence of rains in a volume or frequency not in accordance with the historic average;
·Changes in the environmental legislation, creating new obligations and causing additional costs for projects;
·Legal instability caused by political issues;
·Continuation, for a long period, of the restrictive conditions imposed by Covid-19; and
·Occurrence of any of the above factors could result in significant increases in costs, or delay or inhibit implementation of initiatives, and consequently compromise the execution of Gasmig’s strategic plan, with negative effect on the operational and financial results of Gasmig and CEMIG.

 

39 

 

The existence of a single supplier of natural gas in Brazil affects competitiveness in the market in which Gasmig operates.

The Brazilian gas market is undergoing a process of opening, but there are still some obstacles to be overcome. Currently, Petrobras holds the monopoly on supply and transport of natural gas. Gasmig and Petrobras entered into a Purchase Agreement for the supply of natural gas under the ‘Firm Inflexible’ regime, specifying the quantity contracted, the price of gas, and other factors. The price of gas acquired from Petrobras varies according to a contractual formula, and is adjusted in accordance with changes in the price of Brent oil, and the US dollar exchange rate. In 2020, the price of acquisition for gas other than for thermoelectric power varied significantly, decreasing by as much as 27.4%, but later increased at the end of the year to a price 3.7% lower than at the end of 2019.

The contract is for the period up to 2023, and the pricing of the molecule portion may be altered only by agreement between the parties. The price of the transportation of natural gas is regulated by, and may be revised by, the National Oil, Natural Gas and Biofuels Agency (ANP). If ANP changes the pricing, the difference is passed through to the distributors.

 

Changes in the prices and/or pricing policies of products that are substitutes for the product that Gasmig sells could affect the price of the energy products sold by Gasmig.

Petrobras also controls the prices of the principal energy substitutes that compete with natural gas. In 2017, Petrobras revised its pricing policy for energy sources that compete with natural gas. The prices of LPG (‘Liquefied Petroleum Gas’) and Fuel Oil fluctuated significantly during the last year. The prices of these energy products also vary in accordance with the oil price, and the US dollar exchange rate, which might result in their maintaining their competitiveness in relation to gas.

Petrobras may revise its pricing policy at any time. Any changes could influence the market´s demand for natural gas and its competing fuels, such as LPG, petroleum gas, and/or Fuel Oil, which could positively or negatively impact Gasmig’s operational results and financial situation.

 

Opening of the gas market or measures to encourage reduction of the price could affect the profitability of Gasmig.

In 2016 the Brazilian federal government launched the ‘Gás para Crescer’ (‘Gas for Growth’) program, with the objective of fostering the natural gas market in Brazil, through implementation of changes in the regulatory environment of the natural gas sector, preparing it for a reduction in the participation of Petrobras. The proposals of the Gás para Crescer program were incorporated into a draft law, which has been going through Brazil´s Congress for some years. Also because of this program, the National Oil, Natural Gas and Biofuels Agency (ANP) issued Requests for Public Contributions, with a view to receiving contributions from agents in the natural gas chain to enable the entry of new players in the market.

The ‘Gás para Crescer’ program was succeeded by the ‘Novo Mercado de Gás’ (‘New Gas Market’) program. The main directives of the program are consolidated in CNPE Resolution 16/2019, which sets principles and objectives for the promotion of free competition in Brazil’s natural gas market.

Among the directives, it is established that there should be an incentive for the States and the Federal District to adopt good regulatory practices that contribute to effective liberalization of the market, increase in transparency and efficiency, de-verticalization of the sector, and appropriate pricing in the supply of natural gas, by segment of users. This will likely also involve an incentive for the States and the Federal District to adopt reforms and structuring measures, including a possible amendment to concession contracts to reflect good regulatory practices, which include the regulatory principles for Free Consumers, independent producers and independent importers. Finally, there would be an incentive for the States to arrange for privatization of the local state piped gas concession holders.

40 

In July 2019, Petrobras and the Brazilian antitrust authority CADE (‘Conselho Administrativo de Defesa Econômica’, or Economic Defense Administrative Council) signed an Undertaking for Cessation (‘Termo de Compromisso de Cessação –TCC’), under which Petrobras undertook to sell the holdings that it presently owns in the transporters Nova Transportadora do Sudeste S. A. – NTS (10%), and TBG - Transportadora Brasileira Gasoduto Bolívia-Brasil S.A. (51%). Petrobras will also sell indirect equity interest in distributors, by selling either its shares in Gaspetro or Gaspetro’s equity interests in the distributors. Petrobras also made an undertaking to adopt certain measures to give more transparency to the contracts for transport, and for third parties to have access to the capacity of the existing assets.

These measures, if implemented, might affect Gasmig, and there could be a variation in the cost price of gas and in the competitiveness of natural gas compared to other energy sources, generating a possible devaluation of natural gas in the market and altering Gasmig’s operational cash flow – i.e. it might have to pay a higher price than expected for the same product, generating negative financial consequences for Gasmig.

 

The renewal or extension of the gas supply contracts is not guaranteed, and the growth strategy might be adversely affected.

The gas supply contracts have specific periods of validity, and Gasmig might be adversely affected if this renewal and/or extension does not take place on terms that are favorable to Gasmig’s growth strategy – this might occur in view of the possibility of entry of new agents into the gas market.

Further, Gasmig will have to comply with certain requirements for the renewal of the gas supply contract, and for this reason cannot guarantee that this contract will be renewed, or that it will be renewed on the same terms. If the supply contract is not renewed, or if it is renewed on less favorable terms, the business, financial situation and operational results of Gasmig could be negatively affected.

 

The volumes of natural gas supplied by Gasmig are concentrated in few sectors, and few clients.

The large-scale industrial market sustains the sales volume, and constituted 77% of the volume of gas not sold to thermal electricity generation plants in 2020. Gasmig’s largest clients are in steel, metallurgy, mining, and manufacture of wood pulp.

In the event of reversal of expectations and/or an adverse economic scenario, continuity of the structure of the market served by Gasmig might have a negative effect on Gasmig’s business, operational results and financial situation.

 

Discussions in progress on the new directives of public policies in relation to the gas market in Brazil could negatively affect Gasmig’s business, if implemented.

Since the second half of 2016, Petrobras has been reducing its presence in the natural gas supply chain. In 2017 it sold 90% of its stockholding interest in Nova Transportadora do Sudeste S.A. – NTS, to the Canadian company Brookfield Infrastructure Partners, and in June 2020, completed the sale of 100% of its interest in Transportadora Associada de Gás S.A. – TAG, to the group comprising Engie and the Canadian fund Caisse de Dépôt et Placement du Québec (CPDQ).

Even with these divestitures, Petrobras continues to have a dominant position in the market, because it has a contract for the transport of gas from these assets, and continues to be the monopoly supplier in the Brazilian gas market.

In 2019 the ‘Novo Mercado de Gás’ (‘New Gas Market’) program, developed by the Mining and Energy Ministry in partnership with the Economy Ministry, ANP, CADE and EPE, was instituted, with four sectors: Promotion of competition; Integration of natural gas with the electricity and industrial sectors; Harmonization of the state and federal regulations; and Removal of tax barriers. As practical results of the program, we highlight Resolution 16 of June 24, 2019, enacted by the National Energy Policy Council (CNPE) and the signature of the Cessation Undertaking (TCC) between the monopolies authority CADE (‘Conselho Administrativo de Defesa Econômica’) and Petrobras. CNPE Resolution 16 details guidelines of energy policy to achieve the objectives of the ‘New Gas Market’, especially in relation to promotion of competition. The TCC signed by CADE and Petrobras aims to stimulate competition in the sector and prevent future occurrence of anticompetitive conduct, covering total disposal of transport assets by the dominant agent, release of excess transport capacity to the market, and negotiation of non-discriminatory access for third parties to the infrastructures of outflow and processing of natural gas.

41 

Finally, Draft Law 6407/2013, known as ‘The New Gas Law’ (‘Nova Lei do Gás’), which brings together some measures that are necessary for formation of an open natural gas market, was passed by the Senate on December 10, 2020, and now requires only passage by the Chamber of Deputies (the lower house of Congress) and signature by the President.

The proposed changes could contain negative impacts on the natural gas distribution business, and generate uncertainties on some aspects. The adoption of systems of entry and exit to the transport activity generates uncertainties in relation to the future cost of the service of transport. The incentive for the States to adopt harmonized regulatory principles for free agents (independent producers, independent importers) could represent risks to the distribution concession holders of having to bear the burden of commitments to minimum withdrawals included in supply contracts, or even suffer physical bypass by the large consumers.

 

The regulatory agency responsible for the distribution of piped gas is controlled by the government of Minas Gerais State, whose interests might conflict with the interests of economic balance of the concession granted to Gasmig.

The Brazilian Federal Constitution lays down that the commercial operation of local piped gas services is a function of the States, directly or through concessions. Gasmig is indirectly controlled by the State of Minas Gerais, through the majority stockholding position held by CEMIG in Gasmig. The Minas Gerais Economic Development Department (SEDE) is a division of Minas Gerais State government, responsible for the function of regulation of piped gas distribution services. Further, SEDE is also responsible for the promotion of sustainable development in Minas Gerais State.

As indirect controlling shareholder of Gasmig, and at the same time regulator of the public service, through SEDE, the government of Minas Gerais State has the authority to direct the efforts and investments of Gasmig in accordance with its own interests – political, economic or social which could have a negative impact on the economic equilibrium of the concession.

 

Risks Relating to Brazil

Political and economic instability in Brazil could have effects on the economy and affect us.

Historically, the Brazilian political environment has influenced, and continues to influence, the performance of the country’s economy. Political crises have affected and continue to affect investor confidence and that of the general public, which resulted in economic deceleration and heightened volatility in the securities issued by Brazilian companies. The President of Brazil has power to determine the governmental policies and actions related to the Brazilian economy and, consequently, to affect the operations and financial performance of companies, including ours.

Further, Brazilian markets have experienced a high level of volatility due to the uncertainties arising from on-going anti-corruption and other investigations being carried out by the Brazilian Federal Prosecutors, and their impact on the economy and on the Brazilian political environment. Such events could cause the trading value of our shares, preferred and common, of our preferred and common ADSs, and our other securities to be reduced, and could negatively affect our access to the international financial markets. Furthermore, any political instability resulting from such events, including upcoming political elections at the federal and state levels, if it affects the Brazilian economy, could cause us to re-evaluate our strategy.

42 

The Brazilian Federal Government has exercised, and continues to exercise, significant influence on the Brazilian economy. Political and economic conditions can have a direct impact on our business, financial condition, results of operations and prospects.

The Brazilian Federal Government frequently intervenes in the country’s economy and occasionally makes significant changes in monetary, fiscal and regulatory policy. Our business, results of operations and financial condition may be adversely affected by changes in government policies, as well as other factors including, without limitation:

·Fluctuations in the exchange rate;
·Regulatory policy for the energy sector;
·Inflation;
·Changes in interest rates;
·Fiscal policy;
·Other political, diplomatic, social and economic developments which may affect Brazil or the international markets;
·Liquidity of the domestic markets for capital and loans;
·Development of the energy sector;
·Controls on foreign exchange and restrictions on remittances out of the country; and/or
·Limits on international trade.

 

Uncertainty on whether the Brazilian Federal Government will make changes in policy or regulation that affect these or other factors in the future might contribute to the economic uncertainty in Brazil and to greater volatility of the Brazilian securities-markets and the markets for securities issued outside Brazil by companies. Measures by the Brazilian Federal Government to maintain economic stability, and speculation on any future acts of the Brazilian Federal Government, might generate uncertainties in the Brazilian economy, and increase the volatility of the domestic capital markets, adversely affecting our business, results of operations and financial condition. If the political and economic situations deteriorate, we may also face increased costs.

Additionally, there are uncertainties regarding the federal government's capacity to promote actions in 2021 that minimize the impacts of Covid-19 and promote a faster economic recovery.

These uncertainties, together with the current economic crisis that Brazil is undergoing and other future developments in the Brazilian economy, may adversely affect our business, results of operations and financial condition.

The stability of the Brazilian Real is affected by its relationship with the U.S. dollar, inflation and Brazilian Federal Government policy regarding exchange rates. Our business could be adversely affected by any recurrence of volatility affecting our foreign currency-linked receivables and obligations as well as increases in prevailing market interest rates.

The Brazilian currency has experienced high degrees of volatility in the past. The Brazilian Federal Government has implemented several economic plans, and has used a wide range of foreign currency control mechanisms, including sudden devaluation, small periodic devaluation during which the occurrence of the changes varied from daily to monthly, floating exchange market systems, exchange controls and parallel exchange market. From time to time, there was a significant degree of fluctuation between the U.S. dollar and the Brazilian Real and other currencies. On December 31, 2020, the exchange rate between the Real and the US dollar was R$5.1935 for US$ 1.00. There is no guarantee that the Real will not depreciate, or appreciate, in relation to the US dollar, in the future.

43 

 

The instability of the Brazilian Real/U.S. Dollar exchange rate could have a material adverse effect on us. Depreciation of the Real against the United States dollar and other principal foreign countries could create inflationary pressures in Brazil and cause increases in interest rates, which could negatively affect the growth of the Brazilian economy, and consequently, our growth. Depreciation of the Real could cause an increase in financial and operating costs, since we have payment obligations under financing contracts and import contracts indexed to exchange rate variations. In addition, depreciation of the Real could cause inflationary pressure that might result in abrupt increases in the inflation rate, which would increase our operating costs and expenses, which might adversely affect our business, results of operations, or outlook.

We generally do not enter into derivative contracts or similar financial instruments or make other arrangements with third parties to hedge against the risk of an increase in interest rates. To the extent that such floating rates rise, we may incur additional expenses. Additionally, as we refinance our existing debt in the coming years, the mix of our indebtedness may change, specifically as it relates to the ratio of fixed to floating interest rates, the ratio of short-term to long-term debt, and the currencies in which our debt is denominated or to which it is indexed. Changes that affect the composition of our debt and cause rises in short or long-term interest rates may increase our debt service payments, which could have an adverse effect on our results of operations and financial condition.

Inflation and certain government measures aimed to control it might contribute significantly to economic uncertainty in Brazil, and could have a material adverse effect on our business, results of operations, financial condition and the market price of our shares.

Brazil has historically experienced extremely high rates of inflation. Inflation, and some of the Federal Government’s measures taken in an attempt to curb inflation, have had significant negative effects on the Brazilian economy. Since the introduction of the Real in 1994, Brazil’s inflation rate has been substantially lower than in previous periods. Brazilian annual inflation as measured by the IPCA index in the years 2018, 2019 and 2020 was, respectively, 3.75%, 4.31% and 4.52%. No assurance can be given that inflation will remain at these levels.

Future measures taken by the Federal Government, including increases in interest rates, intervention in the foreign exchange market or actions intended to adjust the value of the Real, might cause an increase in the rate of inflation, and consequently, have an adverse economic impact on our business, results of operations and financial condition. If Brazil experiences high inflation rates in the future, we might be unable to adjust the rates we charge our customers to offset the effects of inflation on our cost structure.

A significant increase in interest rates or inflation would have an adverse effect on our finance expenses and financial results as a whole. At the same time, a significant reduction in the CDI rate, or in inflation, could negatively affect the revenue generated by our financial investments, but also have the positive effect of revaluing adjustments to the balances of our concession financial assets. Substantially all of our cash operating expenses are denominated in Reais and tend to increase with Brazilian inflation. Inflationary pressures might also hinder our ability to access foreign financial markets or might lead to further government intervention in the economy, including the introduction of government policies that could harm our business, results of operations and financial condition or adversely affect the market value of our shares and as a result, of our preferred ADSs, common ADSs and other securities.

 

Risks relating to the Preferred and Common Shares, and the Preferred and Common ADSs Instability of the exchange rate could adversely affect the value of remittances of dividends outside Brazil, and the market price of the ADSs.

Many Brazilian and global macroeconomic factors have an influence on the exchange rate. In this context, the Brazilian Federal Government, through the Central Bank, has in the past occasionally intervened for the purpose of controlling unstable variations in exchange rates. We cannot predict whether the Central Bank or the Federal Government will continue to allow the Real to float freely or whether it will intervene through a system involving an exchange rate band, or the use of other measures.

44 

This being so, the Real might fluctuate substantially in relation to the United States dollar, and other currencies, in the future. That instability could adversely affect the equivalent in US dollars of the market price of our shares, and as a result the prices of our ADSs, common and preferred, and also outward dividends remittances from Brazil. For more information, see “Item 3. Key Information – Exchange Rates”.

 

Changes in economic and market conditions in other countries, especially Latin American and emerging market countries, may adversely affect our business, results of operations and financial condition, as well as the market price of our shares, preferred ADS and common ADSs.

The market value of the securities of Brazilian companies is affected to varying degrees by economic and market conditions in other countries, including other Latin American countries and emerging market countries. Although the economic conditions of such countries may differ significantly from the economic conditions of Brazil, the reactions of investors to events in those countries may have an adverse effect on the market value of the securities of Brazilian issuers. Crises in other emerging market countries might reduce investors’ interest in the securities of Brazilian issuers, including our Company. In the future, this could make it more difficult for us to access the capital markets and finance our operations on acceptable terms or at all. Due to the characteristics of the Brazilian power industry (which requires significant investments in operating assets) and due to our financing needs, if access to the capital and credit markets is limited, we could face difficulties in completing our investment plans and the refinancing our obligations, and this could adversely affect our business, results of operations and financial condition.

 

The relative volatility and illiquidity of the Brazilian securities market may adversely affect our shareholders.

Investing in Latin American securities, such as the preferred shares, common shares, preferred ADSs or common ADSs, involves a higher degree of risk than investing in securities of issuers from countries with more stable political and economic environments and such investments are generally considered speculative in nature. These investments are subject to certain economic and political risks, including, as examples, the following:

·Changes to the regulatory, tax, economic and political environment that may affect the ability of investors to receive payment, in whole or in part, related to their investments; and
·Restrictions on foreign investment and on repatriation of capital invested.

 

The Brazilian securities market is substantially smaller, less liquid, more concentrated and more volatile than the major securities markets in the United States. This might substantially limit an investor’s ability to sell the shares underlying his preferred or common ADSs for the desired price and within the desired period. In 2020, the São Paulo Stock Exchange (Brasil, Bolsa, Balcão S.A or ‘B3’), the only stock exchange in Brazil on which our shares are traded, had an annual market capitalization of approximately R$5.14 trillion, and average daily trading volume of approximately R$29.8 billion.

 

Holders of the preferred and common ADSs, and holders of our shares, may have different shareholders’ rights than holders of shares in U.S. companies.

Our corporate governance, disclosure requirements and accounting practices are governed by our by-laws, by the Level 1 Differentiated Corporate Governance Practices Regulations (‘Regulamento de Práticas Diferenciadas de Governança Corporativa Nível 1’) of the B3 (the main Brazilian stock exchange) by the Brazilian Corporate Law (Federal Law No. 6,404/76) and by the rules issued by the CVM. These regulations may differ from the legal principles that would apply if our Company were incorporated in a jurisdiction in the United States, such as Delaware or New York, or in other jurisdictions outside Brazil. In addition, the rights of an ADS holder, which are derived from the rights of holders of our common or preferred shares, as the case may be, to have his interests protected in relation to decisions by our board of directors or our controlling shareholder, may be different under the Brazilian Corporate Law from the rules of other jurisdictions. Rules against insider trading and self-dealing and other rules for the preservation of shareholder interests may also be different in Brazil if compared to the United States rules, potentially establishing a disadvantage for holders of the preferred shares, common shares, or preferred or common ADSs.

45 

Exchange controls and restrictions on remittances from Brazil might adversely affect holders of preferred and common ADSs.

The investor may be adversely affected by the imposition of restrictions on the remittance to foreign investors of the proceeds of their investments in Brazil and the conversion from Reais (R$) into foreign currencies. Restrictions of this type would hinder or prevent the conversion of dividends, distributions or the proceeds from any sale of preferred shares or common shares from Reais (R$) into U.S. dollars (US$). We cannot guarantee that the Federal Government will not take restrictive measures in the future.

Foreign shareholders may be unable to enforce judgments given in non-Brazilian courts against the Company, or against members of its Board of Directors or Executive Board.

All of our directors and officers reside in Brazil. Our assets, as well as the assets of these individuals, are located mostly in Brazil. As a result, it may not be possible for foreign shareholders to effect service of process on them within the United States or other jurisdictions outside Brazil, or to attach their assets, or to enforce against them, or against the Company in United States courts, or in the courts of other jurisdictions outside Brazil, judgments that are predicated upon the civil liability provisions of the securities laws of the United States or the respective laws of such other jurisdictions.

In order to have a judgment rendered outside of Brazil enforced in Brazil, the party seeking enforcement would need to be recognized in the courts of Brazil (to the extent that Brazilian courts may have jurisdiction) and such courts would enforce such judgment without any retrial or reexamination of the merits of the original action only if such judgment had been previously ratified by the STJ, in accordance with Articles 216-A to 216- X of the Internal Regulations of the STJ (RISTJ), introduced by Regulatory Amendments No. 18/2014 and No. 24/2016. Notwithstanding the foregoing, no assurance can be given that ratification will be obtained.

Exchange of preferred ADSs or common ADSs for underlying shares may have adverse consequences.

The Brazilian custodian for the preferred shares and common shares must obtain an electronic certificate of foreign capital registration from the Central Bank to remit U.S. dollars from Brazil to other countries for payments of dividends, or any other cash distributions, or to remit the proceeds of a sale of shares.

If the investor decides to exchange his preferred ADSs or common ADSs for the underlying shares, the investor will be able to continue to rely, for five business days from the date of the exchange, on the depositary bank’s electronic certificate of registration in order to receive any proceeds distributed in connection with the shares. After that period, the investor may not be able to obtain and remit U.S. dollars abroad upon sale of our common/preferred shares, or distributions relating to our common/preferred shares, unless he or she obtains his or her own certificate of registration or registers the investment under CMN Resolution No. 4,373/2014, dated September 29, 2014, which entitles registered foreign investors (‘Resolution No. 4,373/2014’) to buy and sell on a Brazilian stock exchange. If the investor does not obtain a certificate of registration or register under Resolution No. 4,373/2014, the investor will generally be subject to less favorable tax treatment on gains with respect to our common shares.

If an investor attempts to obtain his or her own certificate of registration, the investor may incur expenses or suffer delays in the application process, which could delay his or her ability to receive dividends or distributions relating to our common shares or the return of his or her capital in a timely manner. The custodian’s certificate of registration or any foreign capital registration obtained by an investor may be affected by future legislative changes, and additional restrictions applicable to the investor, the disposition of the underlying common/preferred shares or the repatriation of the proceeds of disposition may be imposed in the future.

46 

If the investor decides to exchange his preferred or common shares back into preferred ADSs or common ADSs, respectively, once he has registered his investment in preferred shares or common shares, he may deposit his preferred or common shares with the custodian and rely on the depositary bank’s registration certificate, subject to certain conditions. We cannot guarantee that the depositary bank’s certificate of registry or any certificate of foreign capital registration obtained by an investor may not be affected by future legislative or other regulatory changes, nor that additional Brazilian restrictions applicable to the investor, or to the sale of the underlying preferred shares, or to repatriation of the proceeds from the sale, will not be imposed in the future.

An investor of our common shares and ADSs might be unable to exercise preemptive rights and tag-along rights with respect to the common shares.

U.S. investors of common shares and ADSs may not be able to exercise the preemptive rights and tag-along rights relating to common shares unless a registration statement under the U.S. Securities Act of 1933, as amended, or the Securities Act, is effective with respect to those rights or an exemption from the registration requirements of the Securities Act is available. We are not obligated to file a registration statement with respect to our common shares relating to these rights, and we cannot assure you that we will file any such registration statement. Unless we file a registration statement or an exemption from registration is available, an ADR investor may receive only the net proceeds from the sale of his or her preemptive rights and tag-along rights or, if these rights cannot be sold, they will lapse and the ADR investor will receive only the net proceeds from the sale of his or her preemptive rights and tag-along rights or, if these rights cannot be sold, they will lapse and the ADR holder will receive no value for them.

Judgments of Brazilian courts with respect to our shares will be payable only in Reais.

If proceedings are brought in the courts of Brazil seeking to enforce our obligations in respect of our common shares, we will not be required to discharge any such obligations in a currency other than Reais. Under Brazilian exchange control limitations, an obligation in Brazil to pay amounts denominated in a currency other than Reais may only be satisfied in Brazilian currency at the exchange rate, as determined by the Central Bank, in effect on the date the judgment is obtained, and any such amounts are then adjusted to reflect exchange rate variations through the effective payment date. The then prevailing exchange rate may not afford non-Brazilian investors full compensation for any claim arising out of, or related to, our obligations under our common shares.

Sales of a substantial number of shares, or the perception that such sales might take place, could adversely affect the prevailing market price of our shares, or of the preferred or common ADSs.

As a consequence of the issuance of new shares, sales of shares by existing share investors, or the perception that such a sale might occur, the market price of our shares and, by extension, of the preferred and/or common ADSs, may decrease significantly.

The preferred shares and preferred ADSs generally do not have voting rights, and the common ADSs can only be voted by proxy by providing voting instructions to the depositary.

Under the Brazilian Corporate Law and our by-laws, holders of our preferred shares, and, consequently, holders of our ADSs representing preferred shares, are not entitled to vote at our shareholders’ meetings, except in very specific circumstances.

47 

Holders of our preferred ADSs may also encounter difficulties in the exercise of certain rights, including the limited voting rights. Holders of the ADSs for our common shares do not have automatic entitlement to vote in our General Meetings of Shareholders, other than by power of attorney, by sending a voting instruction to the depositary. Where there is not enough time to send the form with voting instructions to the depository, or in the event of omission to send the voting instruction, the holders of ADSs for CEMIG’s preferred and common shares may be unable to vote by means of instructions to the depository.

Future equity issuances may dilute the holdings of current holders of our common shares or ADSs and could materially affect the market price for those securities.

We may in the future decide to offer additional equity to raise capital or for other purposes. Any such future equity offering could reduce the proportionate ownership and voting interests of holders of our common shares and ADSs, as well as our earnings and net equity value per common share or ADS. Any offering of shares and ADSs by us or our main shareholders, or a perception that any such offering is imminent, could have an adverse effect on the market price of these securities.

The Brazilian Government may assert that the ADS taxation for Non- Resident Holders shall be payable in Brazil.

Pursuant to Section 26 of Law No. 10,833, published on December 29, 2003, the sale of property located in Brazil involving non-resident investors is subject to Brazilian income tax as of February 1, 2004. Currently, the Company understands that ADSs do not qualify as property located in Brazil and, thus, should not be subject to the Brazilian withholding tax; nevertheless, the Brazilian Tax Authorities may try to assert Brazilian tax jurisdiction in such situation, incurring on the payment of tax income in Brazil for the Non-Resident Holders.

 

48 

Item 4.Information on the Company

 

Organizational and Historical Background

Companhia Energética de Minas Gerais – CEMIG is a state-controlled mixed capital company (‘sociedade por ações de economia mista’). CEMIG has its registered office located at Avenida Barbacena, 1200, Belo Horizonte, Minas Gerais, Brazil. The U.S. Securities and Exchange Commission (the “SEC”) maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants, such as us, that file electronically with the SEC. Our internet address is https://www.cemig.com.br. The information posted on our website or that could be accessed through our website is not an integral part of, or attached to or incorporated by reference into, this Form 20-F.

CEMIG built its first three hydroelectric power plants in the 1950s and commenced its energy transmission and distribution operations in 1960. CEMIG was incorporated on May 22, 1952 and is organized and existing under the laws of Brazil and the State of Minas Gerais. In the 1970s, CEMIG took over the distribution of energy in the region of the city of Belo Horizonte, commissioned the São Simão hydroelectric power plant and advanced the transmission of energy with the construction of 6,000 km (3,728 miles) of power lines.

In the 1980s, a partnership between CEMIG, Centrais Elétricas Brasileiras S.A. (‘Eletrobras’) and the Brazilian Federal Government launched the Minas-Luz Program, to expand service to low-income populations in rural areas and outer urban suburbs, including the shantytowns. The Emborcação hydroelectric power plant, at the Paranaíba River, started operating in 1982. At that time, together with the São Simão plant, the Emborcação plant tripled the Company’s generation capacity. In 1983, CEMIG created its Ecological Program Coordination Management Unit, which is responsible for planning and developing the Company’s environmental policies. This new unit fostered the research of alternative energy sources, such as wind power and solar generation, biomass and natural gas. Since then, the Company has focused its research projects on such alternative energy sources.

In 1986, CEMIG’s subsidiary Companhia de Gas de Minas Gerais – Gasmig, a natural gas distribution company, was incorporated. By the end of the 1980s, CEMIG’s energy distribution business had a market share in the State of Minas Gerais of 96%.

In 2000, CEMIG was listed in the Dow Jones Sustainability Index for the first time and continues to be listed since then. We believe this to confirm our dedication to the balance between the economic, environmental and social pillars of corporate sustainability. In 2001, CEMIG’s ADRs representing its preferred shares were upgraded to Level 2 on the New York Stock Exchange. In 2004, due to new legal and regulatory requirements, CEMIG transferred its operations to two wholly owned subsidiaries: the energy generation and transmission company CEMIG Geração e Transmissão S.A. (‘CEMIG GT’) and the energy distribution company CEMIG Distribuição S.A. (‘CEMIG D’).

In 2006, CEMIG began to operate in other states, with the acquisition of a significant interest in Light S.A. (‘Light’), which concession is in the state of Rio de Janeiro, and Transmissoras Brasileiras de Energia – TBE, which owned transmission lines in Northern, Midwest and Southern Brazil. In 2008, CEMIG initiated its participation in the UHE Santo Antônio generation project at the Madeira River. In April 2009, CEMIG GT acquired Terna Participações S.A., now called Transmissora Aliança de Energia Elétrica S.A. (‘Taesa’). In May 2013, it increased its holdings in the energy transmission sector with the acquisition of equity interests in five other transmission companies. This increased CEMIG’s market share in Brazilian energy transmission from 5.4% to 12.6% at that time. In 2011, CEMIG GT expanded its participation in relevant generation and transmission assets, including the acquisition, by Amazônia Energia S.A. (in which CEMIG and Light have, respectively, 74.5% and 25.5% of the total capital) of a 9.77% stake in Norte Energia S.A. (‘NESA’), the owner of the concession for the construction and operation of Belo Monte Hydroelectric Power Plant, in Xingu River, State of Pará. The transaction added 818 MW of generation capacity to our total activities and increased Light’s total generation capacity by 280 MW. Also in 2011, CEMIG acquired a controlling stake in Renova Energia S.A. (‘Renova’), which has been working with Small Hydroelectric Power Plants (SHPs) and wind farms for over a decade. In 2015, the association between Vale S.A. (‘Vale’) and CEMIG GT to form Aliança Geração de Energia (‘Aliança’) was concluded. The two companies subscribed shares issued by Aliança which were paid in by means of the equity interests they held in the following energy generation assets: Porto Estrela, Igarapava, Funil, Capim Branco I, Capim Branco II, Aimorés and Candonga; plus a 100% interest in the following wind generation Special-Purpose Entities (‘SPEs’): Central Eólica Garrote Ltda., Central Eólica Santo Inácio III Ltda., Central Eólica Santo Inácio IV Ltda. And Central Eólica São Raimundo Ltda. CEMIG GT won the concession for Lot D in ANEEL’s Auction No. 012/2015, for placement of concessions for hydroelectric plants under a regime of allocation of generating capacity and physical offtake guarantees. Lot D is comprised of 13 plants that were previously owned by CEMIG, and an additional five plants which were owned by Furnas Centrais Elétricas S.A. (‘Furnas’). The aggregate installed generation capacity of these 18 plants is 699.57 MW.

49 

On July 17, 2019, in connection with the public offering of shares by Light, the Company sold 33,333,333 shares that it held in that investee, at the price per share of R$18.75, in the total amount of R$625 million.

On January 22, 2021, the Company sold 68,621,264 shares that it held in that investee, at the price per share of R$20.00, in the total amount of R$1,372 million. The transaction is part of the execution of CEMIG’s divestment program. With the completion of this transaction, CEMIG is no longer a stockholder of Light.

2020 Capital Increase

On July 31, 2020, the Shareholders’ Ordinary General Meeting approved an increase in the Company’s capital, of R$0.3 million, from R$7,294 million to R$7,594 million, through issuance of 60 million new shares, each with nominal value of R$5.00, comprising 20,056,076 common shares and 39,943,924, preferred shares. The shares that were subscribed in the capital increase of July 31, 2020, were considered in full in the calculation of basic and diluted profit for 2020, since these new shares already had potential for subscription since that date, as decided by the shareholders.

2021 Capital Increase

Considering that on December 31, 2020 the profit reserves, with the exclusion of the Tax Incentive reserves, exceeded the registered share capital by R$1,529 million, the Annual General Meeting of Shareholders approved on April 30, 2021, the Management´s proposal for increase of the registered share capital to R$8,467 million, as per Article 199 of the Brazilian Corporate Law through the issuance of new shares through a stock dividend available only to the Company’s existing shareholders, with the following terms and conditions (the ‘Capital Increase’):

·Amount of the Capital Increase through stock dividend: R$873 million through the issuance of 174,609,467 new shares (58,366,345 nominal common shares and 116,243,122 nominal preferred shares) each with nominal value of R$5.00, for both common and preferred shares; and
·The new shares have the same rights of the shares of the same class, including with respect to dividends and/or distributions on equity that may be declared by the Company.

 

Auction of Former CEMIG GT Generation Concessions and Indemnification

The concessions of the Jaguara, São Simão, Miranda and Volta Grande hydroelectric plants, operated by CEMIG GT, expired in August 2013, January 2015, December 2016 and February 2017, respectively.

As per the original terms of the concession contracts of Jaguara, São Simão and Miranda plants, CEMIG GT believed that it had the right for the renewal of such concessions and filed administrative and court proceedings requesting for the extension the contracts. These requests, however, were rejected by the MME on the view that the request was made out of time in relation to the period/rules set by Law 12,783/13.

50 

As part of the court decision, in March 2017 the preliminary injunctions that had maintained CEMIG GT in possession and operation of the concessions of the Jaguara and Miranda plants were revoked. CEMIG GT remained in control of the assets, and recognized revenues from the sale of energy and the operating costs of the assets through the date that the preliminary injunction was revoked. From that date onwards, CEMIG GT ceased to recognize any depreciation on the assets and began to recognize revenues relating to the provision of services of operation and maintenance of these plants in accordance with the regime of quotas specified by Law 12,783/13 (the ‘Quotas Regime’). As ordered by the MME Order 432/2015, the São Simão plant was operated under the Quotas Regime since September 2015.

Despite the ongoing court legal proceedings involving the São Simão, Jaguara and Miranda plants, on September 27, 2017, the Brazilian Federal Government tendered the concessions for the São Simão, Jaguara, Miranda and Volta Grande plants. The Volta Grande plant concession contract expired in February 2017. These plants have total generation capacity of 2,922 MW, and the concession price in the bid amounted to R$12,131 million. The parties that won these concessions are not related to CEMIG.

The new concession contracts were signed on November 10, 2017, and on this date extension of the periods in which CEMIG GT was engaged to temporarily continue to operate the assets was agreed upon as follows:

·Volta Grande plant: until November 30, 2017.
·Jaguara and Miranda plants: until December 28, 2017.
·São Simão plant: until May 9, 2018.

On August 3, 2017, the MME Order 291/17 determined the amount payable to CEMIG GT for the residual value of the infrastructure assets of the São Simão and Miranda plants at the end of the contract, at R$1,028 million, of which R$244 million relates to the residual value of the São Simão Plant, and R$784 million for the residual value of the Miranda Plant – these amounts being expressed in Reais as of September 2015 and December 2016, respectively. The amounts had been adjusted by the Brazilian Selic rate for federal securities, and the total adjustment recognized in 2018 as an operating income amounted to R$55 million. On August 31, 2018, CEMIG GT received the amounts of reimbursement relating to the assets not previously amortized or depreciated in the basic plans of the São Simão and Miranda hydroelectric plants, as specified in MME Order 291/2017. The total amount received was R$1,139 million. As of December 31, 2020, investments made after the Jaguara, São Simão and Miranda plants came into operation, in the amounts of R$174 million, R$2.7 million and R$23 million, respectively, are recorded as concession financial assets, and the final determination of the amounts to be paid to CEMIG GT are under discussions with the regulator. Management does not expect losses in the realization of these amounts.

The MME has not yet established indemnification amounts with respect to the Jaguara and Volta Grande power plants.

Wind Farms in the State of Ceará

On May 17, 2018, CEMIG GT signed an agreement with Energimp S.A. (‘Energimp’).

On December 20, 2018, following compliance with the conditions specified in the transaction agreement, CEMIG GT and Energimp signed the related Memorandum of Conclusion of Elimination of Cross-holdings. With the signature of this document: (i) the cross-holdings previously existing between the parties in Parajuru, Volta do Rio and Morgado were eliminated; (ii) all shareholding partnership between the parties was terminated; and (iii) CEMIG GT now owns 100% of the share capital of Parajuru and Volta do Rio, and Energimp owns 100% of the share capital of Morgado.

51 

The following describe certain activities relating to CEMIG subsidiaries, jointly controlled entities and associates during 2020, 2019 and 2018 (aggregated by business):

 

RENOVA GROUP

Change in control of Renova

On October 15, 2019, Light sold, for R$1.00, the totality of its shares in the jointly controlled entity Renova, equivalent in total to 17.17% of the share capital of the company, to CG I Fundo de Investimento em Participações Multiestratégia, namely 7,163,074 shares and 98 preferred shares. Additionally, Lightcom Comercializadora de Energia S.A. signed an Assignment Agreement through which it assigned all the credits held against Renova to CG I. With the expiry of the period specified in the Shareholders’ Agreement of Renova, the subsidiary CEMIG GT did not exercise its right of first refusal nor its right of joint sale, and thus there has been no change in its direct equity interest in Renova.

Application by Renova for a court-supervised reorganization plan

On October 16, 2019, the second State of São Paulo Bankruptcy and Court-supervised reorganization Court granted the application for in-court reorganization applied for by Renova, and by the other companies of the group (‘the Renova Group’), and determined, among other measures, the following: (i) Appointment of an independent company to act as judicial administrator; (ii) Suspension of actions and executions against the companies of the Renova Group for 180 days, under Article 6 of Law 11,101/2005; (iii) Presentation of accounts by the 30th of each month, while the in-court reorganization proceedings continue, on penalty of the controlling shareholders of the companies of the Renova Group being removed, and replaced by administrator, under Article 52, IV, of Law 11,101/2005; (iv) Waiver to present tax debt clearance certificates so that the companies of the Renova Group can carry on with their activities; and (v) Order to publish a list of creditors, with 15 day term for presentation of qualifications and/or divergences of credits in relation to the court-supervised reorganization.

On December 18, 2020, the General Meeting of Creditors approved the court-supervised reorganization plans submitted to the court by Renova. In this sense, the plans describe the means of recovery in detail, give details of the DIP bridge loan, identify the Isolated Production Units (UPIs) and specify the procedure for resources disposal and allocation. For more details related to the court-supervised reorganization plans, see Item.3 – Risck Factors and see note 16 to our Financial Statements.

Considering the non-existence of any legal or constructive obligations to the investee, the Company has concluded that the court-supervised reorganization filed by Renova does not have any additional impact on its financial statements.

LIGHT

Divestiture of Light

On June 21, 2017, CEMIG started a process to sell all its equity interest in Light S.A. (‘Light’). On July 14, 2017, Rio Minas Energia Participações S.A. (‘RME’) and Luce Empreendimentos e Participações S.A. (‘Lepsa’) also decided to start a process to sell all their interest in Light. This formalized the joint decision of CEMIG, RME and Lepsa to divest of their aggregate 52.12% controlling interest in Light at the time.

On November 27, 2018, RME sold 4,350,000 of its common shares in Light, reducing its holding to 10.90% of Light, thus reducing the combined interest of CEMIG, RME and LEPSA from 52.12% to 49.99% of Light's share capital.

On July 17, 2019, Light announced the closing of the primary and secondary public offering of common, nominative and book-entry shares issued by Light, with no par value, free and unencumbered of any charges or liens. In the context of the offering, there were (i) 100,000,000 (one hundred million) newly issued shares of Light, following an increase in Light’s capital stock, and (ii) 33,333,333 (thirty-three million, three hundred thirty-three thousand, three hundred thirty-three) shares held by CEMIG at a price per share of R$18.75.

52 

With the settlement of the restricted offering, the Company’s equity interest in the total share capital of Light was reduced from 49.99% to 22.58%, limiting its voting rights in Shareholders’ Meetings and, as a result, its ability to direct the relevant activities of the investee.

Thus, as from that date, the Company no longer had power that gave it control of this investee. In accordance with IFRS 10 – Consolidated financial statements, the investee was no longer considered a subsidiary, and therefore was no longer consolidated in the Company’s financial statements.

On January 22, 2021, in the public offering of common shares of Light, CEMIG sold its entire remaining holding of shares in Light at R$20.00 (twenty Reais) per share for a total of R$1,372 million. With the completion of this transaction, CEMIG is no longer a stockholder of Light.

TAESA

Acquisition of 11.624% of the shares of Brasnorte Transmissora de Energia S.A. (‘Brasnorte’)

On August 30, 2019, Taesa concluded the acquisition of 11.624% of Brasnorte increasing its equity interest from 88.376% to 100.00%. For the acquisition, Taesa will pay to the seller R$18,024 million.

Acquisition by Taesa of 100% of the shares of Rialma Transmissora de Energia 1 S.A. (‘Rialma’)

On March 13, 2020, Taesa concluded the acquisition of 100% of the shares of Rialma. The asset located in the State of Rio Grande do Norte, interconnected with one of Taesa’s substations – SE Lagoa Nova of Paraíso Açu Transmissora de Energia S.A., will allow operational advantages in maintaining the new asset, and consequently contributing to Taesa´s growth plan and its consolidation in the Brazilian transmission sector. Rialma comprises the transmission line LT Lagoa Nova II – Currais Novos II, voltage of 230 kV, double circuit, with an extension of 28km and Annual Permitted Revenues (RAP) of R$12.6 million (2019-2020 cycle).

For the acquisition, Taesa will pay to the seller R$60,482 million, subject to positive or negative adjustments resulting from the variation between the net debt and the working capital between the base date and the closing date, as well as other adjustments after the closing.

Taesa – Closing of Eletrobras Auction Process

On January 15, 2019, Taesa was informed about the formal closing of the process of Eletrobras Auction No. 01/2018, regarding the lots L, N and P, for which it placed the minimum bid. Through a notice, the Sale Committee of the Eletrobras Auction No. 01/2018 stated that, on January 14, 2019, Eletrobras’s Executive Board unanimously approved, without any reservations the ratification of Eletrobras Auction No. 01/2018, referring to lot L (‘Brasnorte’) and lot N (‘ETAU’). Concerning Lot P (‘Centroeste’), CEMIG, which was already a shareholder along with Eletrobras, exercised its right of first refusal, as detailed along this document.

On April 29, 2019, Taesa concluded the acquisition of shares of ETAU, with the payment of R$32.9 million.

On May 31, 2019, Taesa concluded the acquisition of Brasnorte with payment of R$75.6 million and of Transmineiras, with payment of R$77.5 million.

 

53 

 

Taesa wins dispute for Lot 12

On December 20, 2018, Taesa won the dispute for the lot 12 related to the Transmission Auction 004/2018, promoted on this date by ANEEL. The volume of investments (CAPEX) and the construction period mentioned above are based on the call notice of the auction published by ANEEL. However, Taesa expects a reduction in the estimated volume of investments as well as in the period to conclude and energize the project.

 
   

Taesa signs a SPA for the acquisition of four operational transmission assets

On December 17, 2018, Taesa entered into a Sales and Purchase Agreement with Âmbar Energia Ltda. (‘Âmbar’) and Fundo de Investimento em Participações Multiestratégia Milão (‘FIP’ and, together with Âmbar, the ‘Sellers’), for the acquisition by Taesa of (i) all shares representing the total and voting capital of São João Transmissora de Energia S.A. (‘SJT’) and São Pedro Transmissora de Energia S.A. (‘SPT’), and (ii) of 51% of the shares representing the total and voting capital of Triangulo Mineiro Transmissora de Energia S.A. (‘TMT’) and Vale do São Bartolomeu Transmissora de Energia S.A. (‘VSB’).

On January 3, 2019, Taesa´s Extraordinary General Meeting approved the acquisition of SJT, SPT, TMT and VSB. The completion of the acquisition is subject to certain conditions precedent, including, among others: (i) regulatory authorizations of ANEEL and CADE; (ii) the non-exercise of the preemptive right by Furnas Centrais Elétricas S.A. (‘Furnas’) in relation to shares issued by TMT and the non-exercise of the preemptive right by Furnas and CELG Geração e Transmissão S.A. in relation to shares issued by VSB; (iii) confirmation of fulfillment of the obligations set forth in the Leniency Agreement signed by J&F Investimentos S.A. and the Sellers, including the commitment that no indemnifying or sanctioning measures be proposed against the purchaser; and (iv) non-occurrence of any material adverse effect.

On February 14, 2020, Taesa completed the acquisitions of SJT and SPT for an adjusted amount of R$753.2 million. The acquisitions of TMT and VSB were cancelled due to the failure to obtain the consent by the creditors.

CEMIG SIM

Launch of CEMIG Soluções Inteligentes em Energia – CEMIG SIM

On October 08, 2019, CEMIG Soluções Inteligentes em Energia – CEMIG SIM was launched. It comprises the activities developed by Efficientia and CEMIG Geração Distribuída – CEMIG GD. Efficientia's by laws were modified in order to adapt to the new object of CEMIG SIM and change of corporate name. On October 19, 2020, a CEMIG’s Extraordinary General Meeting of Shareholders approved the merger of Geração Distribuída – CEMIG GD (wholly-owned subsidiary), at book value, and as a result the investee ceased to exist and the Company took over of all its rights and liabilities.The proposal is for CEMIG SIM to act, in this first moment, but not limited, in the following segments: distributed generation, account services, cogeneration, energy efficiency (with PEE resources), and supply and storage management.

On November 25, 2020, the Company’s wholly-owned subsidiary CEMIG Sim acquired 49% of interest in seven special-purpose companies operating in photovoltaic solar generation for the distributed generation market (‘geração distribuída’), with total installed capacity of 29.45MWp, for R$55 million. On August 19, 2020 and on September 30, 2020, this wholly-owned subsidiary also acquired 49% of interest in two others SPCs operating in the same market segment for R$8 million and R$10 million, respectively, with total installed capacity of 11.62 MWp.

54 

CENTROESTE

On December 20, 2018, CEMIG notified Eletrobras stating its interest in exercising its right of first refusal to acquire the interest held by Eletrobras in Companhia Transmission Centroeste de Minas Gerais S.A. - Centroeste, which constituted Lot P of Eletrobras Auction 01/2018. As officially reported by Eletrobras on October 22, 2018, the winning bid was for R$43.2 million.

The first refusal right was exercised on the same terms as contained in the Auction Announcement. The amount stated above will be adjusted by the accumulated variation in the Selic rate over the period from the reference date to the closing date of this transaction, less dividends and/or interest on capital paid or declared in favor of Eletrobras in the period.

On January 15, 2019, CEMIG announced that it had been informed of the acceptance and ratification by Eletrobras of the exercise by CEMIG of its right of first refusal.

On January 13, 2020, Centroeste became a wholly own subsidiary of the Company through the acquisition of the remaining equity interest of 49% held by Eletrobras.

Centroeste operates in construction, operation and maintenance of the transmission facilities of the Furnas-Pimenta transmission line – part of the national grid.

The cash consideration paid amounts to R$45 million, which was the price in the Tender Announcement, adjusted by the accumulated variation of the Selic rate up to the date of conclusion of the transaction and adjusted by the dividends and/or Interest on Equity paid or declared by Centroeste in favor of Eletrobras in the period.

Prior to the acquisition above and as of December 31, 2019, the Company held a 51% share of the investee, and did not control the entity according to its shareholders agreement, therefore, the investments in Centroeste was accounted for under the equity method. See more information on Note 16 to our consolidated financial statement - Investments.

 

55 

The companies incorporated in Brazil described below are our major subsidiaries and affiliates. The subsidiary companies were recorded under the equity method (*):

 

* As of March 31, 2021 the only change in our major subsidiaries and affiliates from December 31, 2020 to March 31, 2021 was the sale of the interest on Light which was already configured as an asset held for sale. For more information, see “Divestment of Light."

CEMIG’s main subsidiaries and jointly controlled entities and affiliates include the following:

·CEMIG Geração e Transmissão S.A. (‘CEMIG GT’) – 100% owned: operates in energy generation and transmission;
·CEMIG Distribuição S.A. (‘CEMIG D’) – 100% owned: operates in energy distribution;
·Companhia de Gás de Minas Gerais (‘Gasmig’) – 99.57% owned: acquires, transports, distributes and sells natural gas;
·SPEs of Lot D – 100% owned: Geração Camargos S.A., CEMIG Geração Itutinga S.A., CEMIG Geração Leste S.A., CEMIG Geração Oeste S.A., CEMIG Geração Salto Grande S.A., CEMIG Geração Sul S.A. and CEMIG Geração Três Marias S.A.; Lot D is comprised of 13 plants, previously owned by CEMIG, and an additional 5 plants, which belonged to other companies. The aggregate installed generation capacity of these 18 plants is 699.57 MW;
·SPEs – Wind Energy - 100% owned: Central Eólica Praias de Parajuru S.A. and Central Eólica Volta do Rio S.A., wind farms with 47 wind turbines with 71.20 MW;
·CEMIG SIM - 100% owned: distributed generation, account services, cogeneration, energy efficiency, and supply and storage management;
·Centroeste – 100% owned: operates in construction, operation and maintenance of the transmission facilities of the Furnas-Pimenta transmission line – part of the national grid;
56 
·Transmissora Aliança de Energia Elétrica S.A. (‘Taesa’) – jointly-controlled entity, with ownership of 36.97% of the voting stock and 21.68% of the total stock: construction, operation and maintenance of energy transmission facilities in 17 states of Brazil and in the Federal District;
·Aliança Geração de Energia S.A. (‘Aliança’) – jointly controlled entity, with direct ownership of 45% of the voting and total share. Aliança is privately owned and operates as a platform for consolidation of generation assets and investments in future generation projects;
·Investment in the Belo Monte Plant through Amazônia Energia S.A. and Aliança Norte: Amazônia Energia S.A. and Aliança Norte are shareholders in Norte Energia S.A.-NESA, which holds the concession to operate the Belo Monte Hydroelectric Plant, on the Xingu River, in the State of Pará. Through the jointly controlled entities referred to above, CEMIG GT owns an indirect equity interest in NESA of 11.69%. After its completion, with the installation of its 18th turbine, on November 2019, the installed capacity of the dam complex is 11,233 megawatts (MW). Belo Monte Hydroelectric Plant is the largest 100% Brazilian hydroelectric plant and one of the largest in the world; and
·Investment in the Santo Antônio Plant through Madeira Energia S.A (‘MESA’) which owns 100% of Santo Antônio Energia S.A., hydroelectric plant in the Madeira River in the state of Rondônia with an installed capacity of 3,568 megawatts (MW). CEMIG GT's holds 15.51% of MESA´s total shares.

 

Long-Term Strategic Plan

The long-term strategy and the multiannual business plan, reviewed and approved by the Board of Directors in 2018, defined that our mission is to provide integrated solutions for clean power, accessible to society, in an innovative, sustainable and competitive way.

In 2021, the Board of Directors approved a revision of the strategic plan for 2021 – 2030. The principal guidelines and directives include the following:

·Transform the customer experience to become one of the top companies in customer satisfaction;
·Execute the program of disinvestment of non-core assets, assets that do not provide returns, assets in which holdings are non-material in scale, and assets with liquidity, to leverage new investment;
·Investing to modernize core businesses, expand operations and develop new line of businesses for the future creating superior value;
·Redesign and digitize internal processes as well as customer interactions;
·Ensure operational efficiency of the businesses;
·Consolidate competencies, increase productivity and optimize personnel costs;
·Consolidate Health and Safety as a value;
·Be innovative in the quest for technological solutions for the businesses;
·Comply with the regulatory requirements; and;
·Reinforce the practices of environmental, social, and governance – ESG.

 

A process of evaluation of structures for disinvestment of the Company’s equity interest in the share capital of TAESA is in progress, within the overall concept of optimization of the Company’s allocation of capital.

57 

 

Capital Expenditures

Capital expenditures for the years ended December 31, 2020, 2019 and 2018 in millions of Reais, were as follows:

 Year ended December 31,

2020

2019

2018

Distribution network 1,319 986 861
Power Generation (1) 58 26 479
Transmission network (2) 153 223 96
Others

68

68

79

Total capital expenditures (3) 1,599 1,303 1,515
(1)Includes borrowing costs, capitalized in the amount of R$55 million, R$23 million and R$31 million in 2020, 2019 and 2018, respectively. Includes the consideration paid for a 51% interest in Parajuru and Volta do Rio in the amount of R$166 million in 2018.
(2)Includes additions in transmission financial assets in the amount of R$153 million, R$223 million and R$96 million in 2020, 2019 and 2018, respectively.
(3)The capital expenditures are presented in our Consolidated Statement of Cash Flow mainly on account lines related to contract assets, acquisition of equity investees, capital contributions in investees, PP&E, acquisition of subsidiaries and intangible assets.

For 2021, we plan to make capital investments in the amount of approximately R$2,347 million, corresponding to our basic program. We expect to allocate these expenditures primarily to the expansion of our distribution system. We will also allocate R$196 million for injection of capital into subsidiaries in 2021, to meet specific capital needs. The amounts planned for 2021 do not include investments in acquisitions, and other projects, that are not remunerated by the concession-granting power – which are not recognized in the calculations of tariffs made by ANEEL and we expect to fund our capital expenditures in 2021 mainly from the cash flow from operations and, to a lesser extent, through financing.

Business Overview

General

Our business involves the generation, transmission, distribution and sale of energy, gas distribution and to provide of energy solutions.

CEMIG

We are engaged in transactions to buy and sell energy through our subsidiaries. The total volume of energy resourced in 2020 was 82,552 GWh or 0.7% more than in 2019 of 81,993 GWh or 2.9% more than in 2018 of 80,190 GWh. The amount of energy produced by us in 2020 was 9,080 GWh or 34.4% more than the 6,756 GWh produced in 2019 or 86.5% more than the 4,871 GWh produced in 2018. The amount of energy purchased by us in 2020 was 73,471 GWh or 2.3% less than the 75,237 GWh purchased in 2019 or 2.5%, less than the 75,319 GWh purchased in 2018. These figures include 5,835 GWh purchased from Itaipu in 2020, 5,659 GWh in 2019; and 5,738 GWh in 2018, and through the Energy Trading Chamber (Câmara de Comercialização de Energia Elétrica, or CCEE) and from other companies, we purchased 67,601GWh in 2020; 69,577 GWh in 2019 and 69,581 GWh in 2018.

The energy traded in 2020 totaled 82,552 GWh, an amount 0.7% more than 2019 in which, 47% of that volume (39,026 GWh), was traded to final customers, both captive and free. Total losses of energy in the core and distribution networks in 2020 totaled 7,012 GWh, which corresponds to 8% of total resources and 7.2% less than the 7,554 GWh loss in 2019. The table below presents the breakdown of resources and power requirements by CEMIG traded in the last three years:

58 

CEMIG’S ELECTRIC ENERGY BALANCE

(GWh)

2020

2019

2018

RESOURCES 82,552 81,993 80,190
Energy generated by CEMIG 7,132 5,533 3,770
Energy generated by Sá Carvalho 420 295 326
Energy generated by Horizontes 53 48 61
Energy generated by CEMIG PCH 75 96 481
Energy generated by Rosal Energia 389 192 182
Energy generated by SPE 1,011 592 451
Energy bought from Itaipu 5,835 5,659 5,738
Energy bought from CCEE and other companies 67,637 69,577 69,581

 

REQUIREMENTS 82,552 81,993 80,190
Energy delivered to final customers 39,026 42,397 42,707
Energy delivered by Sá Carvalho 522 472 472
Energy delivered by Horizontes 85 89 87
Energy delivered by CEMIG PCH 121 121 124
Energy delivered by Rosal Energia 249 213 235
Energy delivered by SPEs 940 706 882
Energy delivered to the CCEE and other companies 34,597 30,441 28,802
Losses (1) 7,012 7,554 6,881
(1)Discounting the losses attributed to generation (184 GWh in 2020) and the internal consumption of the generating plants.

Generation

The electric power generation business consists of the generation of energy using renewable energy sources (water, wind, sun and biomass).

As of December 31, 2020, we were one of the largest energy generation groups in Brazil, by total installed capacity. As of that date, we were generating energy at over 89 hydroelectric plants (small hydroelectric power plants (‘PCH’) and hydroelectric power plants (‘UHE’)), wind plants and solar plants, with total installed capacity of over 6,000 MW, with plants present in 10 states of Brazil. The vast majority of our capacity is generated at hydroelectric plants (98.1% of installed capacity), with the remaining being generated by wind plants and a solar plant.

Our top five power plants accounted for over 66% of our installed energy generation capacity in 2020 are:

Rank (Installed Capacity)

Generation Power Plant

CEMIG Group Company Holding Stake

Restricted / Unrestricted Group

Installed Capacity (MW)(*)

Start of Comm. Operations

Expiration of Concession or Authorization

Type of Power Plant

CEMIG´s Stake

1st Belo Monte Norte Energia Unrestricted 1,376 2016 08/26/2045 UHE 12.25%
2nd Emborcação CEMIG GT Restricted 1,192 1982 07/23/2025 UHE 100%
3rd Santo Antônio SAESA Unrestricted 553 2012 06/12/2043 UHE 15.51%
4th Nova Ponte CEMIG GT Restricted 510 1994 07/23/2025 UHE 100%
5th Irapé CEMIG GT Restricted

399

2006 02/28/2035 UHE 100%
Sub-Total (Top 5)

4,030

       
Total (All Plants) 6,086        

(*) the installed capacity presented refers to the CEMIG’s stake

 

59 

Transmission

The transmission business consists of transporting energy power from the facilities where it is generated to points of consumption, distribution networks and free customers (which are customers with demand equal to or greater than 3 MW, or customers with demand equal to or greater than 0.5 MW from alternative energy sources, such as wind, biomass or small hydroelectric plants. In 2021, this range will start from 1.5 MW, reaching 1.0 MW in 2022. Its revenue depends directly on the availability of its assets. The transmission network comprises energy transmission lines and substations with voltage of 230 kV or more, and is part of the Brazilian Grid regulated by ANEEL and operated by the ONS. See ‘The Brazilian Power Industry’. On January 27, 2021, CEMIG GT and other CEMIG transmission networks had approximately 4,374 miles of lines, as follows:

CEMIG GT and other CEMIG transmission networks lines in miles

Classification

CEMIG GT

Other CEMIG Group Companies (1)

> 525 kV Lines - 70
500 kV Lines 1,355 740
440 kV Lines - 68
345 kV Lines 1,230 67
230 kV Lines 477 367
220 kV Lines

-

-

Total 3,062 1.312
(1)Proportional to CEMIG’s stake in the relevant concession

Distribution

Within the CEMIG Group, energy distribution activities are conducted by a wholly owned subsidiary, CEMIG Distribution (‘CEMIG D’).

CEMIG D has four public service energy distribution concession contracts in the State of Minas Gerais, granting rights to the commercial operation of services related to the supply of energy to customers in the regulated ACR market in municipalities in its concession area, including customers that may be eligible, under the legislation, to become customers in the free market (Ambiente de Contratação Livre-ACL, the ‘Free Market’).

CEMIG D’s concession area covers approximately 219,104 square miles, or 96.7% of the territory of the State of Minas Gerais. On December 31, 2020, CEMIG D’s energy system comprised 339,086 miles of distribution lines, through which it supplied 24,240 GWh to 8,695,421 regulated customers and transported 20,078 GWh to 1,774 free customers that use our distribution networks. The total volume of energy distributed was 44,318 GWh, of which 45.6% was distributed to regulate and free industrial customers, 12.8% to regulate and free commercial customers, 24.8% to regulated residential customers, and 16.8% to other regulated and free customers.

Other Businesses

While our main business consists of the generation, transmission and distribution of energy, we also engage in the following businesses: (i) distributed generation, account services, cogeneration, energy efficiency (with PEE resources), supply and storage management, through our subsidiary CEMIG Soluções Inteligentes em Energia-CEMIG SIM; (ii) sale and trading of energy, through structuring and intermediation of purchase and sale transactions, trading energy in the Free Market, through our wholly-owned subsidiaries CEMIG Trading S.A. and Empresa de Serviços de Comercialização de Energia Elétrica S.A.; (iii) acquisition, transport and distribution of gas and its sub products and derivatives through Companhia de Gás de Minas Gerais (‘Gasmig’); (iv) cloud solution, IT infrastructure, IT management services and cybersecurity through Ativas Data Center; and (v) technology systems and systems for operational management of public service concessions, including companies operating in energy, gas, water and sewerage and other utility companies, through Axxiom Soluções Tecnológicas S.A.

60 

Revenue Sources

The following table illustrates the revenues attributable to each of our principal revenue sources, in million of Reais, for the periods indicated:

Year ended December 31,

2020

2019

(Restated)

2018

(Restated)

Energy sales to final customers 23,018 24,052 21,882
Revenue from wholesale supply to other concession holders 3,414 2,876 2,990
CVA (compensation for changes in ‘Parcel A’ items ) and other financial components 455 58 1,973
Financial component arising from PIS/Pasep and Cofins taxes refunded to customers– realization 266 - -
Revenue from use of the energy distribution systems – TUSD 3,022 2,722 2,045
Transmission operation and maintenance revenue 280 352 343
Interest revenue arising from the financing component in the transmission contract asset 438 328 311
Adjustment to expectation of cash flow from the indemnifiable financial asset of the distribution concession 16 18 -
Revenue from financial adjusting of the Concession Grant Fee 347 318 321
Construction revenues 1,637 1,292 940
Transactions with energy on the CCEE 154 432 217
Mechanism for the sale of surplus 234 - -
Supply of gas 2,011 2,298 1,995
Fine for violation of service continuity indicator (51) (58) (44)
Recovery of PIS/Pasep and Cofins taxes credits over ICMS - 1,428 -
Other 1,709 1,721 1,640
Deductions from revenue

(11,722)

(12,351)

(12,314)

Total net revenues

25,228

25,486

22,299

Power Generation and Trading

Overview

CEMIG’s top five power plants accounted for over 66% of its installed energy generation capacity as of December 31, 2020.

CEMIG’s market consists of sales of energy to:

·Regulated customers in CEMIG’s concession area in the State of Minas Gerais;
·Free customers both in the State of Minas Gerais and other States of Brazil, through the Free Market;
·Other agents of the energy sector – traders, generators and independent power producers, also in the Free Market;
·Distributors in the Regulated Market; and
·CCEE (eliminating transactions between companies of the CEMIG Group).

 

The total volume of transactions in energy in 2020 was 82,552 GWh, an increase of 0.7% in comparison to the 81,993 GWh in 2019.

61 

Generation Assets

As of the date of this annual report, the subsidiaries, jointly controlled entities and affiliates of CEMIG operated 80 hydro plants, totaling 5,937.07 MW.

We have incorporated subsidiaries in the State of Minas Gerais and other states in Brazil to operate certain of our generation facilities and to hold the related concessions.

The following are companies in which CEMIG GT owns 100% of the equity:

·CEMIG Geração Camargos S.A., CEMIG Geração Itutinga S.A., CEMIG Geração Leste S.A., CEMIG Geração Oeste S.A., CEMIG Geração Salto Grande S.A., CEMIG Geração Sul S.A. and CEMIG Geração Três Marias S.A.; CEMIG GT incorporated these companies in 2016 to hold the concession contracts for 18 hydroelectric plants won in the auction the year before. The total installed generation capacity secured to CEMIG GT’s portfolio was 699,6 MW;
·CEMIG PCH S.A. – Independent power producer, operating the Pai Joaquim small hydroelectric power plant;
·Horizontes Energia S.A. – An independent power producer, operating the Machado Mineiro and Salto do Paraopeba SHPs in Minas Gerais; and the Salto do Voltão and Salto do Passo Velho hydroelectric plants, in the State of Santa Catarina;
·Rosal Energia S.A. – Concession holder operating the Rosal hydro plant, on the border between the States of Rio de Janeiro and Espírito Santo;
·Sá Carvalho S.A. – Production and sale of energy as a public energy service concession holder, through the Sá Carvalho hydroelectric power plant.

 

The generation companies in which CEMIG GT has joint control are:

·Aliança Geração de Energia S.A. (45%) – Platform of growth and consolidation of generation assets held by CEMIG GT and Vale (55%). The assets involved in the formation of the Aliança include the Aimorés and Funil hydroelectric plants and the following generation consortia: Porto Estrela, Igarapava, Capim Branco I, Capim Branco II and Candonga. In addition to the hydroelectric plants in operation, there are four wind plants, which compose the Complexo Eólico Santo Inácio in northeastern Brazil. The company has installed capacity of 1,257 MW in operation, and will be responsible for investments in future projects of energy generation;
·Aliança Norte Energia Participações S.A. (49%) – Together with Vale (51%), the company holds participation of 9% of Norte Energia S.A., holder of the concession to operate the Belo Monte hydroelectric plant, corresponding to an indirect equity interest of 4.41% and representing an installed capacity of 495 MW;
·Amazônia Energia Participações S.A. (49% of voting share, 74.5% of total capital) – Owned jointly with Light (25.5%), holds 9.77% of Norte Energia S.A., representing an installed capacity of 818 MW indirectly held by CEMIG GT;
·Renova (48.21% of voting stock, 36.23% of total capital) –As of December 31, 2020, Renova had generation supply contracts totaling 627.8 MW of generation capacity, of which 190.5 MW were already in commercial operation;
·Baguari Energia S.A. (69.39%) – The Company operates the Baguari Hydroelectric Plant through the Baguari Hydro Plant Consortium, together with Furnas Centrais Elétricas S.A. (30.61%). Baguari Energia S.A. owns 49% of the plant in partnership with Neoenergia, which owns the remaining 51%, through Baguari I Geração de Energia Elétrica;
·Retiro Baixo Energética S.A. (49.9%) – Holds the concession for the operation of the hydroelectric power plant Retiro Baixo, located in the lower course of the Paraopeba River in the State of Minas Gerais, which has installed capacity of 82 MW and assured energy of 36.6 MW;
·Hidrelétrica Cachoeirão S.A. (49%) – An independent power producer operating the Cachoeirão SHP, located at Pocrane, in the State of Minas Gerais. The other 51% is held by Santa Maria Energética;
62 
·Hidrelétrica Pipoca S.A. (49%) – An independent power producer that built and operates the Pipoca SHP, on the Manhuaçu River, in the municipalities of Caratinga and Ipanema, in the State of Minas Gerais. The other 51% is held by Asteri Energia S.A.;
·Lightger S.A. (49%) – Independent power producer, formed to build and operate the Paracambi SHP (or PCH), on the Ribeirão das Lages river in the county of Paracambi, in the state of Rio de Janeiro. The remaining 51% shareholding is owned by Light;
·Guanhães Energia S.A. (49%) – Guanhães Energia S.A. is jointly-controlled entity, which has four wholly-owned subsidiaries – PCH Dores de Guanhães S.A., PCH Senhora do Porto S.A., PCH Jacaré S.A. and PCH Fortuna II S.A.. Guanhães Energia S.A. is engaged in commercial operation of these four SHPs. Three of them – Dores de Guanhães, Senhora do Porto and Jacaré – are in the municipality of Dores de Guanhães; and one, Fortuna II, is in the municipalities of Virginópolis and Guanhães, all in the State of Minas Gerais. In July 2019, the project reached its 44MW aggregate installed capacity;
·Madeira Energia S.A (‘MESA’) (8.54%) – MESA owns 100% of Santo Antônio Energia S.A., hydroelectric plant in the Madeira River in the state of Rondônia. CEMIG GT´s indirect holding in MESA amounts to 6.97% and takes place through the following companies: SAAG, FIP Melbourne (33.12%), Parma (56.75%) and FIP Malbec (49.92%); and
·Queimado Hydroelectric Power Plant – CEMIG GT holds an 82.5% interest in this entity and our partner in this project is CEB Participações S.A. (‘CEBPar’), a subsidiary of Companhia Energética de Brasília (‘CEB’), which owns 17.5% equity interest in the plant.

 

The following consortia were established to develop future projects:

·Tapajós Consortium – The Tapajós Consortium was created to develop technical and environmental feasibility studies of hydro plants in the Tapajos river basin. Technical studies have already been finished and sent to ANEEL for analysis while environmental studies depend on certain licenses to be concluded. In December 2020, due to lack of predictability of a bidding process to be conducted by ANEEL, CEMIG GT formalized its withdrawal from the Consortium; and
·Davinópolis Hydroelectric Plant (49%) – Consortium formed with Neoenergia (51%) to study the project's feasibility. Due to the lack of predictability regarding the holding of the ANEEL Auction and considering the economic and financial unfeasibility of the project with data previously collected, CEMIG GT intends to formalize its withdrawal from the Consortium in 2021.

 

Wind Farms

Wind farms have become one of the most promising power generation sources in Brazil. In addition to their low environmental impact, this source of energy is completely renewable and widely available in Brazil, according to numerous studies of potential wind power. Its rapid technical development over recent decades has successfully reduced costs per MWh in comparison to other power generation sources. CEMIG has monitored and observed the rapid evolution of wind energy and its inclusion in the range of Brazilian energy supply sources.

 

CEMIG GT owns 100% of the equity in the following companies with wind farms investments:

Central Eólica Praia de Parajuru S.A and Central Eólica Volta do Rio - Wind farms located in the State of Ceará with a total installed capacity of 70.8 MW.

 

CEMIG GT has joint participation in the following companies with wind farms investments:

Renova (48.21% of voting share and 36.23% of total capital) - The Alto Sertão III Phase A Wind Complex, currently under implementation and approximately 85% completed, will consist of 26 wind farms located in the State of Bahia with a generation capacity of 432.6 MW.

63 

Aliança Geração de Energia S.A. (45%) – Four wind farms, which compose the Santo Inácio Wind Project. The project, located at Icapuí, in the State of Ceará, started its commercial operation in December of 2017 and has an installed capacity of 98.7 MW. There are also two projects under construction: Projeto Eólico Acauã and Central Eólica Gravier. The latter is located at the State of Ceará, it will have a total installed capacity of 71.4 MW and its commercial operation is estimated to start at the beginning of 2022. The former is composed of Acauã I, Acauã II and Acauã III wind farms, it is located at the State of Rio Grande do Norte and has a total installed capacity of 109.2 MW. Its commercial operation is also estimated to start in 2022.

 

Expansion of Generation Capacity

Poço Fundo

On February 5, 2019, Brazilian electricity regulatory agency ANEEL approved an expansion of installed capacity of Poço Fundo, a Small Hydroelectric Power Plant located on the Machado River, in the state of Minas Gerais, from 9.16MW to 30MW. Additionally, the concession was extended until May 29, 2045. Upon completion of expansion, the plant will consist of two generating units of 15MW each.

On January 6, 2020, expansion works started and the commercial operation of its first generation unit is expected to begin by June 21, 2022.

 

CEMIG SIM

CEMIG SIM, a wholly owned subsidiary of CEMIG that operates in distributed generation and energy solutions, invested in its first year of activity (2020), approximately R$73.5 million in the acquisition of 49% stakes in nine photovoltaic plants. Currently CEMIG SIM has reached 3,000 customers in the commercial and industrial low voltage segments, which consume 6.2 GWh monthly.

In 2021, CEMIG SIM plans to invest R$113 million in the commercial and industrial segments and will also operate in the residential segment.

 

Transmission

Overview

The transmission business consists of the transfer of energy from generation power plants to customers directly connected to the basic transmission grid, free customers and distributors. The transmission system comprises transmission lines and step-down substations with voltages ranging from 230 kV to 500 kV.

All the basic transmission grid users, including generators, distributors, free customers, and others, execute contracts for the use of the transmission system – CUST with the ONS, and make payments to the transmission companies for making available the use of their basic transmission grid equipment. See ‘The Brazilian Power Industry’ and “Item 5. Operating and Financial Review and Prospects”.

The following tables give operating information on our transmission capacity for the dates indicated:

 

Circuit Length of Transmission Lines in Miles as of December 31,

Voltage of Transmission Lines

2020

2019

2018

500 kV 1,355 1,355 1,355
345 kV 1,230 1,231 1,231
230 kV

477

478

478

Total 3,062 3,064 3,064

 

64 

 

 

Transformation Capacity (1) of Transmission Substations as of December 31,

Substations

2020

2019

2018

Number of transmission substations (2) 39 38 38
MVA 18,854.65 18,104.65 17,615
(1)Transformation capacity refers to the ability of a transformer to receive energy at a certain voltage and release it at a reduced voltage for further distribution.
(2)Shared substations are not included.

 

The tables below present operational information on the transmission capacity of the joint venture (subsidiaries and affiliates transmission CEMIG), proportional to the equity interest held by the CEMIG Group in each case, on the dates indicated:

  Transmission Network Extension in Miles as of December 31,

Voltage of Transmission Lines

2020

2019

2018

>525 kV 70 59 59
500 kV 740 685 654
440 kV 68 68 68
345 kV 67 67 31
230 kV

367

307

258

Total 1,312 1,186 1,070

 

 

Transmission assets

Furnas–Pimenta Transmission Line (Companhia de Transmissão Centroeste de Minas – ‘Centroeste’) – In September 2004, a consortium formed by Furnas and CEMIG, holding 49% and 51%, respectively, won the bid for the concession of the Furnas–Pimenta transmission line. As required by the tender rules, the partners formed a company, Companhia de Transmissão Centroeste de Minas S.A., which is responsible for the construction and operation of the transmission line. This 345-kV transmission line extending for approximately 39 miles connects the substation of the Furnas hydroelectric plant to a substation at Pimenta, a city in the Center-West region of Minas Gerais. It began commercial operation in March 2010 and the concession expires in March 2035. On January 13, 2020, the Company concluded the acquisition of 49% of the share capital held by Eletrobras in Centroeste, becoming the sole owner of the investee since then.

Transmissora Aliança de Energia Elétrica S.A. – Taesa is a private company jointly controlled by CEMIG, which holds 36.97% of the voting capital and 21.68% of the total capital of Taesa, and by ISA Investimentos e Participações do Brasil S.A. which holds 14.88% of the total capital. Taesa has led CEMIG’s growth vector in the transmission segment, dedicated to the construction, operation and maintenance of transmission lines in all regions of the country. It represents the main interest that we have in one Transmission Company in the Brazilian electric sector.

 

Distribution and Purchase of Electric Power

Overview

Our distribution operation consists of transfers of energy from distribution substations to final customers. Our distribution network comprises a widespread network of overhead and underground lines and substations with voltages lower than 230 kV. We supply energy to small industrial customers, at the higher end of the voltage range, and to residential and commercial customers at the lower end of the range.

65 

In 2020, we invested approximately R$1,273 million in the construction and acquisition of the property, plant and equipment needed to supply energy to our customers, expand and increase the capacity of our distribution system.

The following tables provide certain operating information pertaining to our distribution system, on the dates indicated:

Circuit length of distribution lines in miles – High voltage (from distribution substations to final customers) as of December 31,

Voltage of distribution lines

2020

2019

2018

 
161 kV 30.25 30.25 30.25  
138 kV 7,946.62 7,970.98 7,945.68  
69 kV 2,223.91 2,221.78 2,221.78  
34.5 kV + 230 kV

633.78

633.75

633.75

 
Total 10,834.55 10,856.76 10,831.46  

 

Circuit length of distribution lines in miles – Medium and low voltage (from distribution substations to final customers)

 

As of December 31,

Voltage of distribution network

2020

2019

2018

 
Overhead urban distribution lines. 67,527.30 66,223.50 65,999.52  
Underground urban distribution lines 1,524.16 1,539.70 1,535.05  
Overhead rural distribution lines

259,200.32

256,819.88

255,024.50

 
Total 328,251.78 324,583.08 322,559.07  

 

Step-down transformation capacity (1) of distribution substations as of December 31,

 

2020

2019

2018

Number of substations 414 409 405
MVA 10,884.05 10,742.00 10,681.35
(1)Step-down transformation capacity refers to the ability of a transformer to receive energy at a certain voltage and release it at a reduced voltage for further distribution.

 

Expansion of Distribution Capacity

Our distribution expansion plan for the period of five years, comprising from 2018/ 2022, is based on projections of market growth. In order to accommodate this growth, we plan to add on distribution lines, up to 7,389 miles of medium and low-voltage, and 1,838 miles of high-voltage; 80 step-down substations, adding 2,150 MVA to our distribution network.

 

Purchase of Electric Power

During the year ended December 31, 2020, we purchased 5,835 GWh of energy from Itaipu, which represented approximately 15% of the energy we sold to final users, and 610 GWh (1.6%) of energy from PROINFA. We also purchased 1,091 GWh under Nuclear Energy Quota Contracts - Contratos de Cotas de Energia Nuclear, or ‘CCENs’. (2.8%) and 7,507 GWh of energy under Assured Energy Quota Contracts - Contratos de Cota de Garantia Física, or ‘CCGFs’. (19%). In addition to this compulsory purchase, we have two other types of supply arrangements: (i) purchases through public auctions, which accounted for approximately 24% of the energy purchased for resale during the year ended December 31, 2020; and (ii) long-term agreements existing prior to the New Industry Model Law, which represented approximately 2% of the energy purchased in 2020.

66 

 

Itaipu — Itaipu is one of the largest operational hydroelectric plants in the world, with an installed capacity of 14,000 MW. Centrais Elétricas Brasileiras S.A. (‘Eletrobras’), a holding company controlled by the Federal Government, owns a 50% interest in Itaipu, while the government of Paraguay owns the remaining 50%. Brazil, pursuant to its 1973 treaty with Paraguay, has the option to purchase all of the energy generated by Itaipu that is not consumed by Paraguay. Brazil generally purchases more than 95% of the energy generated by Itaipu.

We are one of the power distributors operating in the south, southeast and west-central regions of Brazil that are jointly required to purchase all of Brazil’s portion of the energy generated by Itaipu, in accordance with the Law No. 5,899/1973. The Federal Government allocates Brazil’s portion of Itaipu’s power among these energy companies in amounts proportionate to their respective historical market share of total energy sales. ANEEL enacted Resolution No. 2,178/2016, which set 10.39% as the percentage of Itaipu’s power production bestowed upon CCEE that CEMIG D would have to purchase in 2017. For 2018, Resolution No. 2,355/2017 set it at 10.09% and for 2019 it was set at 10.03% (Resolution No. 2,500/2018). For 2020 the Resolution no 2,642/2019 set it at 10.32% for CEMIG-D. These rates are fixed to defray Itaipu’s operating expenses and payments of principal and interest on Itaipu’s dollar-denominated borrowings and the cost in Reais of transmitting such power to the Brazilian grid. These rates are above the national average for bulk supply of power and are calculated in U.S. dollars. Therefore, fluctuations in the U.S. dollar/Real exchange rate affect the cost, in Real terms, of energy we are required to purchase from Itaipu. Historically, we have been able to recover the cost of such energy by charging supply rates to customers. According to our concession contract, increases in the supply rates may be transferred to the final customer upon approval by ANEEL.

Since 2007, ANEEL publishes at the end of each year the amount of energy to be purchased from Itaipu by each of the electric power distributors for the following year, as guidance for the five subsequent years. Based on this, the distributors can estimate their remaining energy needs in advance of the next public auctions.

CCENs: These are contracts that formalize the purchase of energy and power as established in Law No. 12,111/09 and ANEEL Resolution No. 530/12 between distributors and Electronuclear for the energy produced by the Angra I and Angra II plants.

CCGFs: Decree No. 7,805/12 regulated Provisional Act No. 579/12 and created contractual arrangements governing contracting of energy and power from the plants whose concessions were extended under Law No. 12,783/13.

Auction Contracts: We have purchased energy in public auctions on the CCEE. These contracts are formalized between CEMIG and the various vendors in accordance with the terms and conditions in the invitation to bid.

‘Bilateral Contracts’ — CEMIG D entered into ‘bilateral contracts’ with various suppliers prior to the enactment of the New Industry Model Law in 2004. Such agreements are valid under their original terms but cannot be renewed. During the year ended December 31, 2020 CEMIG D didn’t enter into new bilateral contracts.

 

 

Other Businesses

Natural Gas Distribution

Gasmig was established in Minas Gerais, Brazil, in 1986, for the purpose of developing and implementing the distribution of natural gas in the State of Minas Gerais. CEMIG holds 99.57% of the shares of Gasmig and the Municipality of Belo Horizonte owns the remaining shares.

In July 1995, the State Government granted Gasmig an exclusive 30-year concession (as from January 1993) for distribution of piped gas covering the entire State of Minas Gerais and customers located within it. On December 26, 2014, the Second Amendment to the Concession Contract was signed. This document extended Gasmig’s concession for commercial operation of piped gas services for industrial, commercial, institutional and residential use in the State of Minas Gerais for 30 years. As a result, the expiration of this concession was extended from January 10, 2023, to January 10, 2053.

67 

Gasmig’s marketing efforts focus on its ability to provide a more economically efficient and environmentally friendly alternative to oil products, like diesel and liquefied petroleum gas (‘LPG’), wood, wood products and charcoal. From January to December 2020, Gasmig supplied approximately 2,584 million cubic meters of natural gas per day to 61,414 customers in forty cities: 95 large and medium-sized industrial plants, 1,121 small industrial plants and commercial customers, 57 retail distribution stations supplying compressed natural gas (‘CNG’) to vehicles, 2 gas fired power generation plants, 5 co-generation projects, 4 distributors of CNG to industrial customers and vehicular retail stations, and 60,128 homes, 2 thermoelectric plants.

From January to December 2020, Gasmig registered an expense for the acquisition of gas of R$1,083 million compared to an expense of R$1,436 million in the period from January to December 2019, a reduction of 24.58%. Although the number of customers has increased 18.18% (mainly residential), the volumes have decreased 4% and 28% for industrial plants and retail distribution stations supplying Compressed Natural Gas (‘CNG’) to vehicles respectively mainly due to pandemic negative side effects in that sector.

Many energy-intensive industries, such as cement, steel, iron-alloys and metallurgical plants, operate at significant volume in Minas Gerais. Gasmig’s principal strategy is expansion of its distribution network to cover the part of demand that has not yet been met. Gasmig dedicates efforts to development of new projects for expansion of its natural gas distribution system, to supply customers in other areas of Minas Gerais, especially those densely industrialized.

From January to December 2020, capital expenditures totaled R$42.6 million and 67.68 kilometers were added to our natural gas network. In 2018, Gasmig began to supply the residential market in the city of Juiz de Fora, built the pipeline for supplying a new large industrial plant at the city of Jacutinga and acquired the site in which the operational center is located.

In the city of Belo Horizonte, the main projects developed were those aimed at serving the Urban Market. High Density Polyethylene (‘HDPE’) densification networks were implemented in the São Pedro, Santo Antônio, Luxembourg, Prado and Cidade Nova neighborhoods.

 

Gas distribution concessions

The concessions for distribution of natural gas are granted by each Brazilian state. In the state of Minas Gerais the regulator, the State’s Economic Development Secretariat, sets the tariffs for natural gas by market segment. The tariffs are comprised of a portion for the cost of gas and a portion for the distribution of gas. Each quarter the tariffs are adjusted to pass through the cost of gas, and once a year they are adjusted to update the portion allocated to cover the costs relating to the provision of the distribution service – remuneration of invested capital and to cover all the operating, commercial and administrative expenses of the concession holder.

The rate reviews occur every five years, from the end of the first cycle, from 2018 to 2022, to evaluate the changes in the costs of Gasmig, and to adjust the tariffs. The concession contract also specifies the possibility of an extraordinary review of tariffs if any event occurs that puts the economic-financial balance of the concession at risk.

On December 14, 2018, the Minas Gerais State Department for Economic, Scientific, Technological and Higher Education Development (‘Sedectes’ actually ‘SEDE’) or (‘the grantor’) presented a study, prepared by Fundação Getulio Vargas Business school (‘FGV’), related to financial economic rebalancing of the Gasmig concession agreement, also supported by consultation from General Attorney’s Office of the State. The rebalancing that has been requested by the grantor is based on the contractual obligation to build a gas pipeline to serve the Nitrogen Fertilizers Unit (UFN), which should have been built by Petrobras. Due to this reason Gasmig was requested to pay the State of Minas Gerais the amount of which Sedectes estimates at R$852 million. Based on the study, SEDECTES requested a response from Gasmig and began discussion for solution related to imbalance referred to, considering that one of its conditions for extension of the concession contract (from 2023 to 2053, as specified in the second amendment to the contract) was execution of investments for construction of the gas pipeline.

68 

On September 19, 2019, the Company entered into, with the State of Minas Gerais, as Grantor, the Third Amendment to the Concession Agreement for Industrial, Institutional and Residential Exploration of Piped Gas Services in the State of Minas Gerais, which represents the conclusion of the economic and financial rebalancing process of the concession contract, upon payment of a grant fee in the amount of R$852 million, updated from January 1, 2019 to the date of its payment at by the DI rate (Interbank Deposits, extra group) and ensures that Gasmig maintains the extension of the term of its concession until the year 2053.

On September 26, 2019, the Company issued Commercial Promissory Notes, in a single series, totaling R$850 million with a maturity of 12 months and interest of 107% of the DI rate, without any guarantees or endorsement. The proceeds from this issue were fully used, on September 26, 2019, to pay the granting bonus due to the Granting Authority updated by the variation of the DI rate since January 1, 2019 in the amount of R$891.2 million.

Also under Third Amendment to the Concession Agreement, the total amount paid for the compensatory grant will be added to the Company's asset remuneration base and considered in the tariff review process by the grantor as an intangible asset to be amortized until the end of the concession contract, with immediate effects on the setting and review of tariffs.

With the conclusion of Gasmig's First Periodic Tariff Review (1st RTP), in November 2019, SEDE confirmed the inclusion of the grant bonus in the regulatory asset base. The review resulted in guidance on investment and quality goals, service expansion and definition of the new tariff design, offered by Gasmig, in the 2018 to 2022 cycle.

Among the approved changes is the creation of new tariff classes, new consumption ranges, absorption of customers from other classes and changes in the collection cascades, in order to meet market demands and simplify the classification of customers in the respective categories. The proposed new tariff design includes the following categories: Industrial, Commercial and Industrial with lower consumption, Individual Residential, Residential Collective, Cogeneration, Thermoelectric, Compressed Natural Gas or Liquefied Natural Gas and Natural Gas.

 

Consulting and Other Services

CEMIG SIM was created in October 2019, as before the company Efficientia, to operate in the markets of: distributed generation, energy efficiency and energy solutions. As well as the branding and marketing strategy focused on the retail sector, and on digital transformation of the electricity sector, the organizational culture of SIM, which has a strong character of innovation and technology, is being constructed so that clients are always at the center of decisions.

In 2019, CEMIG SIM sold supply totaling 2,656 MWh/month, generated by three photovoltaic plants (the Janaúba, Corinto, Manga, Mirabela, Porteirinha I and Porteirinha II plants). CEMIG SIM achieved 810 clients as of December 31, 2019.

In 2020, CEMIG SIM sold supply totaling 3,962 MWh/month, generated by ten photovoltaic plants (the Janaúba, Corinto, Manga, Bonfinópolis II, Lagoa Grande, Lontra, Mato Verde, Mirabela, Porteirinha I and Porteirinha II plants). CEMIG SIM achieved 2,024 clients as of December 31, 2020.

In energy solutions, CEMIG SIM will operate in 2021 in implementation of photovoltaic plants at medium-voltage clients, and also in energy efficiency projects. Business models are also being developed for the markets of: energy storage, electric vehicles, and cogeneration.

 

69 

 

Sale and Trading of Energy

We provide services related to the sale and trading of energy in the Brazilian energy sector, such as evaluation of scenarios, representation of customers in the CCEE, structuring and intermediating of energy purchase and sale transactions, and consultancy and advisory services, besides services related to the purchase and sale of energy in the Free Market through our wholly-owned subsidiary companies CEMIG Trading S.A. and Empresa de Serviços de Comercialização de Energia Elétrica S.A. (‘ESCEE’).

 

Energy Losses

CEMIG

The total recorded by CEMIG as energy losses has two components: (i) an allocated portion of the losses arising in the National Grid; and (ii) the total of technical and non-technical losses (commercial losses) in the local distribution network of CEMIG D.

The total energy losses recorded by CEMIG in the year of 2020 was 7,012 GWh, a 7.2 % decrease in comparison to 2019 (7,554 GWh). The CCEE apportioned losses in the national grid totaling 467 GWh to CEMIG D. Other energy losses, totaling 6,545 GWh, include technical and non-technical losses in the local distribution system.

Technical losses were approximately 70% of the total losses related to CEMIG D for the year ended December 31, 2020. Losses in distribution are inevitable because of transport of energy and its transformation into different levels of voltage. We seek to minimize technical losses by rigorous and regular assessments of the operational conditions of the distribution facilities, and investment to expand distribution capacity, for maintaining quality and reliable levels, thus reducing technical losses; we also operate the system in accordance with certain specific voltage levels, to reduce the level of losses. Technical losses are not strictly comparable: longer distribution distances (for example, in rural areas), naturally have higher technical loss levels.

Non-technical losses were approximately 30% of CEMIG D’s total energy losses in 2020. Such losses are caused by customer fraud, illegal connections to the distribution network, and errors in metering and defects in meters. To minimize non-technical losses, preventive actions are taken regularly: customers’ meters and connections are inspected; meter readers are trained; metering systems are modernized; procedures for installation and inspection of meters are standardized; meters with quality control guarantees are installed; and the database of customers is updated.

The non-technical losses of different distributors can be partially comparable, taking into account the social complexities in the concession area and the effectiveness of efforts to prevent losses.

 

Quality indicators – DEC and FEC (SAIDI and SAIFI)

At the end of 2020, the indicators that measure the quality of supply by CEMIG D – (i) System Average Interruption Duration Index (‘SAIDI’), expressed as a figure per customer, in hours per year; and (ii) System Average Interruption Frequency Index (‘SAIFI’), also expressed as a customer-experienced average, were 9.64 and 5.05, respectively. In 2019, the figures for SAIDI and SAIFI were 10.64 and 5.06, respectively. The indicator calculation process is certified according to ISO Quality Standard 9001.

The result achieved in 2020 shows the efficiency in the application of resources, as well as the commitment to continuous improvement and customer service.

In December 2015, CEMIG D signed the contractual amendment that unified its concession contracts for the provision of public electricity distribution services, which extended the concessions from January 1, 2016 until December 31, 2045. The contract defined limits for the internal portion of the continuity indicators, Internal System Average Interruption Duration Index (‘SAIDI-i’) and Internal System Average Interruption Frequency Index (‘SAIFI-i’), and since 2016 CEMIG has been complying with the contract limits, as shown in the table below.

70 

 

 

SAIDI-i (hours)

SAIFI-i. (Interruption)

Year

2016

2017

2018

2019

2020

2016

2017

2018

2019

2020

Limit 11.62 11.32 11.03 10.73 10.44 8.12 7.76 7.39 7.03 6.67
Performed 11.57 11.18 10.42 10.56 9.58 5.37 5.44 5.13 4.85 4.86

 

 

In 2020, CEMIG did not exceed the limit for the SAIDI-i and SAIFI-i limit, and in the fifth year of the concession, the Company achieved the best result in its history, 9.58 hours, compared to the limit of 10.44 hours set by the Regulator (‘ANEEL’).

 

The concession contracts has limitation of in the distribution of dividends and/or payment of Interest on Equity to the minimum established by law, in the envent of non-compliance with the annual indicators for outages (SAIDI and SAIFI) for two consecutive years, or three times in a period of five years, until the regulatory parameters are restored. CEMIG D was non-complaint for three times in the past five years, and, in such circumstances, CEMIG D limited the amount of dividend and interest on equity, to 25% of net income.

 

Customers and Billing

Customer base

The CEMIG Group sells energy through the companies CEMIG D, CEMIG GT and other wholly-owned subsidiaries – Horizontes Energia, Sá Carvalho, CEMIG PCH, Rosal Energia, CEMIG Geração Camargos, CEMIG Geração Itutinga, CEMIG Geração Salto Grande, CEMIG Geração Três Marias, CEMIG Geração Leste, CEMIG Geração Oeste, CEMIG Geração Sul, CE Praias de Parajuru and CE Volta do Rio.

This market comprises sales of energy to:

·Regulated customers in CEMIG’s concession area in the State of Minas Gerais;
·Free customers both in the State of Minas Gerais and other states of Brazil, through the Free Market;
·Other participants of the energy sector – traders, generators and independent power producers, also in the Free Market; and
·Distributors, in the Regulated Market.

 

In 2020, we sold a total of 53,309 GWh, or -1.52% less than in 2019, while the total of power we transported for free customers was 3.8% higher, at 20,078 GWh. Sales of energy to final customers plus our own consumption in 2020 totaled 39,402 GWh, or 6.7% less than in 2019. Sales to distributors, traders, other generating companies and independent power producers in 2020-totaled 13,907 GWh – or 16.7% higher than in 2019.

In December 2020, CEMIG Group invoiced 8,698,095 customers – a growth of 1.9% in the customer base in the year since December 2019. Of these, 8,697,714 are final customers, including CEMIG’s own consumption; and 381 are other agents in the Brazilian energy sector.

 

Sales to Final Customers

Residential

The residential customer category accounted for 20.6% of CEMIG’s energy sales in 2020, totaling 10,981 GWh – or 4.2% more than in 2019 and average monthly consumption per customer in 2020 was 128.6 kWh/month, or 2.0% more than in 2019 (126,1 kWh/month).

71 

This higher consumption by the residential customer category can be explained by the growth of 2.1% in the number of customers and also because people stayed at home more in 2020 due to the social distancing measures due to the Covid-19 pandemic.

 

Industrial

Energy billed to regulated and free industrial customers in the State of Minas Gerais and other states was 23.9% of the total volume of energy traded by us in 2020, at 12,731 GWh, or 14.4% less than in 2019.

This decline is the result of a 25.6% reduction in the captive market, and a 12.3% reduction in the Free Market.

This category was strongly affected by the crisis caused by the Covid-19 pandemic.

In the captive market the number of customers was 1.2% lower than in 2019, a reduction of 350 customers. This reduction is due to the migration of customers to the free market and a reclassification of customers to other classes (registration adequacy process).

 

Commercial and Services

Energy sold to regulated and free customers in this category in Minas Gerais and other states was 16.1% of the total volume of energy traded by us in 2020, at 8,571 GWh, 8.2% less than in 2019. This reflects a decrease of 15.9% in the volume billed to regulated customers of CEMIG D, and an increase of 1.6% in the volume billed by CEMIG GT and its wholly owned subsidiaries to free customers in Minas Gerais and other Brazilian states.

The main factor that explains the behavior of the commercial category is the reflection of the restrictions and measures of social distancing caused by the Covid-19 pandemic. In the captive market the migration of customers to the free market and to distributed microgeneration also contributed to the reduction. The free market grew due to the increase in customers.

 

Rural Customers

Energy consumed by the rural customer category in 2020, at 3,766 GWh, was 0.8% less than in 2019, and 7.1% of the total in 2020.

 

Other customer categories

Supply to other categories – government, public lighting, public services, and our own consumption – totaled 3,353 GWh in 2020 or 8.7% less than in 2019. In the public lighting category, there was an impact of an adjustment made in the billing calendar (ANEEL – Resolution nº 888/2020) and the insertion of LED lamps is some cities.

 

Sales in the Free Market, and ‘Bilateral Contracts’

In 2020, total sales of energy were 11,808 GWh, or 20.3% higher than in 2019.

At CEMIG GT there was a higher volume of short-term sales to traders in the first months of 2020, aiming redeeming part of the high credit that a company has at CCEE. In addition, there were also sales acquired with supply in the second half of 2020, with the expectation of recovering part of the reduction caused by the drop in consumption by free customers.

 

72 

 

Sales in the Regulated Market

Sales in the Regulated Market in 2020 totaled 2,099 GWh or 0.4% less than in 2019.

 

The table below presents CEMIG Group’s market in more detail, itemizing transactions in 2020 compared to 2019:

Type of Sale 2020 2019 Variation YoY
Customers Energy Customers Energy Customers Energy

Amount

(un)

Participation

(%)

Amount

(GWh)

Participation

(%)

Amount

(un)

Participation

(%)

Amount

(GWh)

Participation

(%)

Variation

(%)

Variation

(%)

Traded Energy 8,698,095 100.00 53,309 100.00 8,537,540 100.00 54,134 100.00 1.88 -1.52
Sales to final customers 8,697,006 99.99 39,368 73.85 8,536,459 99.99 42,176 79.13 1.88 -6.66
Residential 7,113,837 81.79 10,981 20.60 6,966,696 81.60 10,538 19.14 2.11 4.20
Industrial 30,630 0.35 12,731 23.88 30,657 0.36 14,873 29.11 -0.09 -14.40
- Captive 29,525 0.34 1,773 3.33 29,875 0.35 2,383 4.33 -1.17 -25.61
- Free 1,105 0.01 10,958 20.56 782 0.01 12,490 24.78 41.30 -12.26
Commercial 778,119 8.95 8,571 16.08 806,602 9.45 9,335 17.38 -3.53 -8.19
- Captive 776,942 8.93 4,384 8.22 805,811 9.44 5,214 9.47 -3.58 -15.93
- Free 1,177 0.01 4,187 7.85 791 0.01 4,121 7.91 48.80 1.61
Rural 688,212 7.91 3,766 7.06 647,066 7.58 3,795 6.90 6.36 -0.76
- Captive 688,201 7.91 3,749 7.03 647,064 7.58 3,792 6.89 6.36 -1.13
- Free 11 0.00 17 0.03 2 0.00 3 0.01 450.00 453.45
Other Categories 86,208 0.99 3,319 6.23 85,438 1.00 3,634 6.60 0.90 -8.67
Own Consumption 708 0.01 34 0.06 715 0.01 38 0.07 -0.98 -9.88
Wholesale sales 381 0.00 13,907 26.09 366 0.00 11,920 20.80 4.10 16.67
- Contracts in Regulated Market 27 0.00 2,099 3.94 27 0.00 2,108 3.83 0.00 -0.44
- Free and bilateral contracts 354 0.00 11,808 22.15 339 0.00 9,812 16.97 4.42 20.35

 

73 

 

This table presents the CEMIG’s Group’s sales to the Industrial user category as a whole in 2020, by sector of activity:

Sector of activity

Volume invoiced (GWh)

(%)

Mining 1,940 15.2
Foods 1,769 13.9
Metallurgy 1,650 13.0
Nonmetallic minerals 1,469 11.5
Chemicals 1,014 8.0
Plastic Products 998 7.8
Automotive 808 6.4
Textile 654 5.1
Cellulose and Paper 425 3.3
Other sectors

2,002

15.7

Total, industrial customers 12,731 100.0

 

The ten largest industrial customers served by the CEMIG Group, located in Minas Gerais and other states of Brazil, in terms of revenue, are:

Customer

Activity

USIMINAS Metallurgy and Mining
CARBETO DE SILICIO SIKA BRASIL Chemicals
NOVELIS DO BRASIL Metallurgy
COMPANHIA BRAS DE METALURGIA E MINERACAO Metallurgy and Mining
HOLCIM Non-metallic mineral product manufacturing
WHITE MARTINS Chemicals
SAINT GOBAIN Non-metallic mineral product manufacturing
ANGLOGOLD ASHANTI Metallic Mining
ANGLO AMERICAN MINERIO FERRO BRASIL Metallic Mining
CIMENTO TUPI Non-metallic mineral product manufacturing

 

 

Billing

Normative Resolution 414/2010, published by the ANEEL, regulates billing of customers who have active supply contracts with CEMIG D, among other instruments.

According to the Resolution, consumption of energy, and other items charged, are billed monthly, based on the voltage level delivered to the customer unit and the installed load at that unit. ‘Installed load’ means the sum of the nominal potentials of the electrical equipment installed in the customer unit that is in a condition to operate, expressed in kilowatts (‘kW’). ‘Customer unit’ means the group of items comprising installations, facilities, branch connection, electrical equipment, cables and accessories (including the substation, in cases of supply at primary voltage), with receipt of energy at only one point of delivery, and individualized metering corresponding to a single customer located in one single property or in contiguous properties.

CEMIG D’s customers are divided into Low, Medium and High Voltage.

Invoices of High voltage customers, which are connected directly to the transmission network, are payable five working days after reading of the meter. These customers receive the payment document – the energy invoice – by email.

Medium Voltage customers are those that receive supply at a voltage of 2.3 kV or more, which amount to about 13,570 customers, which are billed within two business days after the meter reading. They receive invoices both in printed form and by email, payable five business days from the date of delivery at the customer’s address. Due to modernization and automation of the meter reading of these customer units, by using remote metering, CEMIG D now has approximately 96.34% of its billing automated. This enables the customer unit to be metered in Real time – so that CEMIG D records and updates consumption of energy at regular intervals.

74 

Low Voltage customers are billed in cycles, which vary between 27 and 33 days. The bill is delivered simultaneously with the meter reading. A total of 7,983 million customer units are billed using this technology, which is known as ‘On Site Billing’. These bills are payable five business days from the date of their delivery (or 10 business days for the establishments of public entities and bodies). The great majority of the amounts billed to this category of customers are for energy actually consumed. Only 0.97% of these customers are billed based on estimated consumption (i.e., on the arithmetic mean of the amounts recorded for the 12 months prior to the consumption that is not measured).

In addition to the implementation of ‘On Site Billing’, CEMIG D has invested to increase the number of bills sent by email, which grew by 54% in 2020, with approximately 471 thousand customers now receiving their billing online. CEMIG intensify campaigns to incentivize customers to choose this way of receiving their monthly bills. The reduction in the volume of printed-paper used for billing helps reduce its global cost to the Company and contributes to environmental sustainability for the planet.

In 2020, CEMIG D saved approximately R$918 thousand with the electronic invoices sent monthly. Modernization of the billing system and the distribution network has significantly contributed to customers’ satisfaction and the quality of CEMIG’s energy supply. CEMIG intends to continue with improvement in this and related fields.

 

Seasonality

CEMIG’s sales of energy are affected by seasonality. Historically, consumption by industrial and commercial customers increases in the fourth quarter due to their increase in activity. The seasonality of rural consumption is usually associated with rainfall periods. During the dry season between the months of May and November, more energy is used to irrigate crops. The table below presents quarterly figures for energy billed by the CEMIG Group to final users, regulated customers and free customers from 2018 to 2020, in GWh:

Year

First Quarter

Second Quarter

Third Quarter

Fourth Quarter

2020 10,119 9,267 9,754 10,227
2019 10,343 10,339 10,656 10,838
2018 10,309 11,090 11,014 11,110

 

 

Competition

Contracts with Free Customers

On December 31, 2020 CEMIG GT had a portfolio of contracts with 2,693 free customers. Of this total, 1,664 customers were located outside of the State of Minas Gerais, amounting to 59% of the total volume of energy sold by CEMIG GT in 2020.

The strategy adopted by CEMIG in the Free Market is to negotiate and enter into long-term contracts, thus establishing and maintaining a long-term relationship with customers. We seek to differentiate ourselves in the Free Market from our market competitors by the type of relationship we have with our customers and the quality of our services, which have added value for CEMIG GT. This strategy, together with a sales strategy that seeks to minimize exposure to short-term prices and contracts with a minimum demand on a take-or-pay basis, translates into lower risk and greater predictability of our results.

 

75 

Environmental Matters

Overview

Our generation, transmission and distribution of energy and our distribution of natural gas are subject to federal and state legislation relating to preservation of the environment. The Brazilian Constitution gives the Federal Government, states and municipalities powers to enact laws designed to protect the environment and issue enabling regulations under these laws. Generally, while the Federal Government has the power to promulgate general environmental regulations, state governments have the power to enact specific and even more stringent environmental regulation and municipalities also have the power to enact laws in their local interest. We have complied with the relevant environmental laws and regulations in all material aspects.

In accordance with our environmental policy, we have established various programs to prevent and minimize damage, aiming to limit our risks related to environmental issues.

 

Management of vegetation in the energy system

The Environmental Management Unit of CEMIG D, among other activities, develops methods and procedures for dealing with urban trees that are adjacent to the electric power system. Vegetation management is necessary due to the obligation to ensure the operational security of the system, and from the high number of interruptions in supply of energy caused by trees. In 2020, trees were the cause of approximately 33,010 energy supply outages, in both urban and rural areas, and were the sixth largest cause of unscheduled outages in the Company’s distribution system.

Investments have been directed towards technical improvements in tree pruning, so that the process can take place in such a way as to reduce risks to the employee, the system or third parties. The interventions are carried out by directional pruning, a technique considered to be more appropriate for coexistence between large trees and energy distribution networks.

Through working partnerships between its own staff and external agents, CEMIG has been developing digital applications to improve management of the process of handling vegetation and to reduce supply outages in urban areas. CEMIG also new contracts to improve the handling of vegetation in power line pathways (its Integrated Vegetation Handling methodology) to reduce costs, improve the performance of the system and help improve environmental quality.

 

Environmental Licensing

The purpose of environmental licensing is to establish conditions, restrictions and environmental control measures that should be complied with by entities and individuals to install, expand and operate entities or activities that use environmental resources or have the potential to cause damage to the environment.

Brazilian law requires obtaining licenses for various activities, including construction, installation, expansion and operation of any facility that uses environmental resources, causes significant environmental or polluting degradation or has the potential to cause environmental degradation or pollution or harm historic, cultural and archaeological heritage.

Failure to obtain and comply with the requirements of an environmental license to construct, implement, operate, expand or enlarge an entity that causes environmental impact, such as the energy plants operated and in implementation by CEMIG, is subject to administrative sanctions, such as fines, suspension of operations, as well as criminal sanctions, such as fines and imprisonment for individuals and restriction of rights for legal entities. We have projects licensed at both the federal and state levels.

 

76 

Environmental Operating Licensing

Federal Law No. 9,605, enacted on February 12, 1998, stipulates penalties for facilities that operate without environmental licenses. In 1998, the Federal Government issued Provisional Act No. 1,710 (currently Provisional Act No. 2,163-41/01), which allows project operators to enter into agreements with the relevant environmental regulators in order to comply with Federal Law No. 9,605/98. Accordingly, we have been negotiating with (i) IBAMA; and (ii) the Regional Environmental Management Units (‘Suprams’), which is the environmental authority of the State of Minas Gerais to obtain the environmental operating licenses for all our plants and transmission lines that began operating prior to February 1986.

For the generation facilities located in the State of Minas Gerais, which are subject to the environmental licensing under state level, we have agreed with Supram and IBAMA to bring our facilities into compliance on a gradual basis. For those facilities of CEMIG GT that started operations before February 1986, we have prepared the required environmental assessments, filed applications before the appropriate environmental bodies, and submitted them for analysis. Under the applicable law, the Company is allowed to operate while awaiting the requisition appreciation. In order to comply with the conditions, we used the Condition Compliance Index – ‘ICC’.

In 2020, 9 licenses and authorizations for regularization of projects of CEMIG D were obtained, in the category of Authorizing Documents for Environmental Interventions. All the above projects have been regularized in the IEFs agencies (State Institute of Forests – Minas Gerais State Environmental Agencies) spread out over the State of Minas Gerais.

Distribution of natural gas by Gasmig through pipelines throughout Minas Gerais is also subject to environmental control. In most cases the environmental authority of the State of Minas Gerais (Secretary of State for Environment and Sustainable Development – ‘SEMAD’) has issued all licenses necessary for the regular operation of Gasmig’s activities.

Environmental licenses and authorizations issued by relevant municipal, state and federal bodies usually impose conditions relating to environmental impacts inherent to our activities, which must be complied with in order for the environmental licenses to remain valid. They have to be complied with as long as the license is in force. To this end, CEMIG is taking appropriate steps for full compliance, and to provide evidence of compliance to the relevant environmental authorities, in each case to avoid any subsequent administrative or criminal penalties, which can include fines, suspension of operations or revocation of licenses.

 

Environmental Legal Reserves

Under Article No. 12 of Federal Law No. 12,651, of May 25, 2012 (the new ‘Brazilian Forest Code’), a Legal Reserve is an area located inside a rural property or holding that is necessary for the sustainable use of natural resources, conservation or rehabilitation of ecological processes, conservation of biodiversity or for shelter or protection of native fauna and flora. Generally, all owners of rural properties have to preserve an area as a Legal Reserve. However, Article 12, §7 of the new Brazilian Forest Code establishes that a Legal Reserve will not be required for areas acquired or expropriated by the holder of a concession, permission or authorization to exploit hydroelectric power potential, in which projects for electric power generation, or energy substations or transmission or distribution lines are operating.

In Minas Gerais, State Law No. 20,922, enacted on October 16, 2013, made provisions in the Forest Policy and the Biodiversity Protection Policy in the state, adapting the environmental legislation to the provisions of the Forest Code. This had the effect of revoking the requirement for a Legal Reserve in the case of hydroelectric generation projects, enabling the processes of the Corrective Environmental Licensing that had been held up in the previous year for this reason to be resumed. In the federal sphere, IBAMA’s technical licensing team, in the corrective licensing of CEMIG’s plants, expressed an opinion, in correspondence sent to us on July 29, 2008, stating that in CEMIG’s case there was no need for the constitution of Legal Reserves.

77 

The approval of the new Brazilian Forest Code and the exclusion of the hydropower projects from the need to register a Legal Reserve settled this issue allowing for the continuation of the process of the environmental licensing of the several projects of the company, with the acquisition of the pending operating licenses and the maintenance of its legal compliance.

 

Permanent Preservation Areas

The vegetation surrounding the reservoir is statutorily classified as Permanent Preservation Areas or APPs. The length of the APP varies depending on whether the reservoir is located in rural or urban areas. In rural areas, at least 30 meters should be preserved, while in urban areas, at least 15 meters should be preserved.

Lack of preservation of vegetation in APPs or unauthorized suppression of vegetation in APPs may lead to administrative sanctions, such as fines ranging from R$5,000 to R$50,000 per hectare, limited to R$50 million and criminal liability.

Law 12,651/12 regulates that the APPs of artificial reservoirs should be subject to a specific program created to regulate the use and conservation measures of the area surrounding the reservoir. Such program is called Environmental Plan for Use and Conservation of the Reservoir Surrounding Area (Plano Ambiental de Conservação e Uso do Entorno do Reservatório or ‘PACUERA’) and should be prepared according to the minimum requirements determined by the competent environmental authority in the environmental licensing proceeding.

With the new Forest Policy Law of Minas Gerais State, the requirement above was incorporated into state legislation and the preparation and approval of the PACUERA should be in a condition for the grant of operating licenses.

We have now incorporated the performance of PACUERA into the proceedings for obtaining the operating licenses of the projects subject to environmental licensing on the state level. CEMIG GT prepared and filed applications before the environmental bodies relating to all the required environmental assessments, including PACUERA, in respect to all facilities using artificial reservoir as required by law.

 

Compensation Measures

According to Federal Law No. 9,985, enacted on July 18, 2000, and to Decree No. 4,340, enacted on August 22, 2002, companies whose activities result in major environmental impacts are required to invest in and maintain conservation units in order to mitigate those impacts. Conservation units are areas that are subject to special protection and include ecological stations, biological reserves, national parks and relevant ecological interest areas. The environmental authority that is competent to license the project stipulates the environmental compensation for each company depending on the specific degree of pollution or damage to the environment.

Federal Decree No. 6,848/2009, enacted on May 14, 2009, and Minas Gerais State Decree No. 45,175, enacted on September 17, 2009, regulate the methodology for deciding these compensation measures, requiring that up to 0.5% of the total amount invested in the implementation of a project that causes significant environmental impact must be applied in compensation measures.

State Decree No. 45,175/2009 was amended by Decree No. 45,629/2011, which established the reference value of projects that cause significant environmental impact, as follows:

For projects executed before the publication of Federal Law No. 9,985, enacted in 2000, the net book value (Valor Contábil Líquido or ‘VCL’) will be used, excluding revaluations or, in its absence, the value of the investment made to the project; and

Compensation for environmental projects executed after the publication of Federal Law No. 9,985, enacted in 2000, will use the reference established in Item IV of Article 1 of Decree No. 45,175, enacted in 2009, calculated at the time of execution of the project, and updated based on an inflation-linked adjustment index.

78 

Due to the impact of the 2013 Energy Concessions Law (Law No. 12,783, enacted on January 11, 2013) on the business of CEMIG GT, the Company filed a consultation with the IEF, to be informed about the environmental compensation payable in relation to the Transmission System. The IEF submitted the inquiry to the Federal General Attorneys’ Office (Advocacia Geral da União, or ‘AGU’). As of the date of this annual report, the Company has not received a reply to this consultation.

In addition to the environmental compensation referred to above, forest compensations for cleaning of energy tower paths and accesses in which vegetation has been suppressed are routine.

Other environmental requirements can become applicable due to the impacts of various projects; such requirements could include the structuring and operation of programs to monitor fauna and flora of regions surrounding facilities of the energy system, environmental education programs, and programs for recovery of degraded areas (Programas de Recuperação de Áreas Degradadas, or ‘PRADs’).

 

Fish Management – The Peixe Vivo Program

Construction of hydroelectric plants may create a risk for fish due to various changes in the aquatic environment caused by operation of plants. One of the main activities of CEMIG’s Environmental Management Department is to prevent and mitigate environmental accidents involving the native fish population at its hydroelectric power plants. Further, CEMIG has developed a methodology for evaluating the risk of fish mortality at the plants to mitigate the impacts caused by the operation of its plants. The company also carries out research projects in partnership with universities and research centers to develop scientific knowledge to serve as a basis for more effective fish population conservation programs to be implemented by CEMIG.

In June 2007, we created the Peixe Vivo Program (‘Programa Peixe Vivo’) as a result of members of senior management believing that it was necessary to take more effective measures to preserve fish populations of the rivers where the company has operations. The program’s main activities are summed up in its mission, which is: ‘To minimize the impact on fish species, seeking handling solutions and technologies that will integrate energy generation by CEMIG with conservation of native fish species, promoting involvement of the community’. Since its creation, the program has been operating on two fronts – one seeking preservation of fish populations in the State of Minas Gerais, and the other focusing on forming protection strategies to avoid and prevent fish deaths at CEMIG’s hydroelectric plants. The adoption of scientific criteria for decision-making, establishment of partnerships with other institutions and modification of practices adopted because of the information generated are the principles that guide the work of the Peixe Vivo team.

Since 2018, the members of Peixe Vivo Program develop the fish death risk assessment program (Programa de Avaliação do Risco de Morte de Peixes – ‘PARMP´) aiming to mitigate potential risks related to maintenance and operation of hydroelectric plants. Fish fauna monitoring executed periodically and before operational procedures of plants is the main action of Peixe Vivo Program team to reach the goal of PARMP. Biologists evaluate fish density and environmental conditions based on monitoring data. The PARMP has been developed and validated during two consecutive research projects and is now implemented as a continually optimizing program of the Company. So far, a 77.7% reduction of mean monthly fish biomass impacted by operation of plants has been observed since the beginning of PARMP.

On average, over the period 2007 to 2020 CEMIG spent R$6 million per year in activities and research projects in relation to the Peixe Vivo program.

The Peixe Vivo program runs five scientific projects in partnership with research institutions, involving more than 64 students and researchers. These partnerships, which have been operating since 2007, have resulted in 656 technical publications up to today’s date, and have been referenced nationally and internationally for the practices of fish conservation and dialog with the community, presenting CEMIG’s work in several countries, and various states of Brazil. These academic results, jointly with the involvement of the community, have been used to create more efficient and practical conservation programs that make it possible for fish to coexist with generation plants in Brazilian rivers.

79 

Urban Occupation of Rights of Way and Reservoir Banks

Gas Pipelines Gasmig’s natural gas distribution networks are underground and run through rural and urban areas. Pipes are usually installed on public roads near pluvial drainage, sanitation, energy and telecommunications, among other utilities. Installation of the networks in the urban subsoil presents risks of damage to the pipelines from third party maintenance workers. However, all of our gas networks are flagged according to national standards and internal procedures. In addition to security signaling, the presence of the GASMIG network in roads, streets and other areas is shown on the Companys website, where the network map is made available in a complete and up-to-date manner. Gasmig provides free on- site guidance services for third parties excavations through its Dig Safely (‘Escave com Segurança’) program. Guidance and support for safe execution of their work can be requested through Gasmig’s 24-hour helpline.

Gasmig also has network inspection plans, in order to verify the security conditions of the system and prevent illegal intrusions, constructions or erosions nearby the pipelines.

In 2019, mitigation measurements adopted by GASMIG reduced third parties’ damages flaws comparing prior numbers. The efficiency of third parties’ damages prevention was about 99.5%, considering the total number of interventions executed near the pipelines. The loss of natural gas was reduced because of the low pressure used on damages ducts and because of the short time response to leak containment. In collaboration to shorten the response of incidents, safe zones (blockades) were created, making the attendance more effective. Gasmig also implemented a Management Plan of the Integrity of Metallic Gas Pipeline. From that plan, appropriate techniques are being used to a direct assessment threats to external and internal corrosion of gas pipelines. In parallel, Gasmig is preparing to perform the internal inspection via PIGs electronics from Linha Tronco Vale do Aço, one of the main gas pipelines of the Company.

 

Irregular occupation of high-voltage overhead lineswe have easements for our transmission and distribution networks over land subject to restrictions. A significant portion of such land areas, however, has been occupied by unauthorized construction, majority residential constructions. This type of activity causes risks of electric shock and accidents involving local residents, and constitutes an obstacle to the maintenance and operation of our energy system. We are currently seeking solutions for these problems, which will involve either resettlement of these occupants or improvements that would make it possible to maintain our energy system safely and efficiently.

To mitigate these risks, we have been monitoring and recording invasions and by taking action to prevent invasions on the paths of the transmission and sub transmission lines. A number of measures have been adopted to preserve the security of these lines, including: contracting of a company for systematic inspection, and implementation of security measures and works to minimize the risks of accidents; and removal of occupation of the transmission line pathways through agreements with local residents and partnerships with the municipalities in our concession area.

 

Irregular occupation in Generation assets security measures are adopted to protect power generation facilities against invasions. Invaders found inside the facility are included by the surveillance team and removed from the site, which occurs without resistance or violence.

The plants are marked with fences and warning signs, indicating that the property is private, that hunting, fishing and swimming are prohibited on site.

In order to optimize security at the plants, the implementation of electronic security systems is planned.

In the risk areas of hydroelectric generation facilities, there are signs indicating ownership of the prohibition on fishing and swimming, due to the possibility of a sudden rise in the water level causing fatal accidents. The use of nautical signaling buoys close to large dams indicates a safe area and prohibits the entry of vessels.

80 

The Company maintains a team to carry out periodic inspections in its areas, advising the community on the prohibition of construction and removal of irregular occupants, before the company takes legal action for repossession.

The Company is implementing in its inspection methodology the use of satellite images to identify irregular occupations.

 

The Carbon Market

We believe that Brazil has a significant potential to generate carbon credits from clean energy projects that observe the Clean Development Mechanism, or CDM’, or the Voluntary Markets. Every year, we seek to quantify our emissions and publish our main initiatives in reducing the emission of carbon dioxide, for example through the Carbon Emission Project.

The CEMIG Group participates in CDM projects registered in the United Nations Framework Convention on Climate Change (UNFCCC), which includes seven SHPs with a capacity of 116 MW and two hydroelectric power plants with a combined generation capacity of 3,708 MW and a solar power plant with capacity of 3 MW. The process of verification and emission of part of the carbon credits of Cachoeirão SHP and UHEs Baguari and Santo Antônio has been completed, corresponding to approximately 1,402 tons of CO2 emissions avoided through this program.

 

Management of equipment and waste contaminated with Polychlorinated Biphenyls, or ‘PCBs’

Brazil has signed and ratified the Stockholm Convention (‘SC’) that includes goals related to the management of PCBs within electrical equipment. Brazil has prohibited the production, import and sale of PCBs since 1981 and it has been making efforts towards the goals of the SC.

At CEMIG, almost all of the large equipment contaminated with PCB were removed from the electrical system and sent for incineration. The few large equipment contaminated with PCB still under operation are going to be properly disposed of within the deadlines of the SC.

CEMIG has been maintaining its historical good practices in order to avoid further contamination.

 

Operational Technologies – CEMIG

CEMIG invests in automated monitoring and control equipment, in connection with the strategy of increasing efficiency and further modernizing the generation, distribution and transmission grids. CEMIG keeps developing and implementing new systems, with the purpose of optimizing its internal activities and increasing the availability of its infrastructure and applications that support CEMIG’s business.

 

Load Dispatch Center

CEMIG’s System Operation Center (Centro de Operação do Sistema, or ‘COS’), located at the head office in Belo Horizonte, is the nerve center of the transmission and generation operations. With a modern control room, it coordinates the operations of the entire energy system, in Real time, providing operational integration of the generation and transmission of power. It also operates the interconnections with other generation, transmission and distribution companies. The supervision and control executed by the COS now extends to 51 extra high voltage substations, 16 major generating power plants, 15 minor generating power plants and 1 wind farm.

Through its activities, the COS permanently guarantees the security, continuity and quality of the energy supply to its clients and to the system. The activities of the COS are supported by up-to-date telecommunications, automation and information technology resources, and executed by highly qualified personnel. The COS has a Quality Management System, with ISO 9001:2015 certification.

81 

Distribution Operation Center

Our distribution network is managed by a Distribution Operation Center (Centro de Operações de Distribuição, or ‘COD’), located in Belo Horizonte. The COD monitors and coordinates our distribution network operations in Real time. They are responsible for the supervision and control of 414 distribution substations, 328,252 miles of medium and low voltage distribution lines, and 10,835 miles of sub-transmission lines and 8.71 million customers and operates in 774 municipalities of Minas Gerais.

We provided an average of 15,158 operating services in the field a day in 2020. There are various systems in use to automate and support the COD’s processes, including trouble call, field crew management, distribution substation supervision and control, restoration of power, emergency switching, network disconnection, and inspection. Technologies, including a Geographic Information System and Satellite Data Communication Helpline, to reduce customer service restoration time and provide better customer service. These are devices, installed along our distribution network, that sense and interrupt fault currents, and automatically restore service after momentary outages, improving operational performance and reducing restoration time and costs.

 

Geoscience Information System

The Atlantis Project aims at modernizing and unifying CEMIG’s system of geoprocessing of distribution lines and networks. The new system enables management of resources with a geospatial vision, allows the planning of expansions, records electrical equipment to the analysis of electrical networks, and assists in compliance with ANEEL’s normative resolutions.

The Geographic Information System (‘GIS’) will enable us to give support to the processes of registry and design, as well as supporting the following corporate processes: network expansion and maintenance, protection of revenues, planning and supplies, property services and management of assets through full integration with the Enterprise Resource Planning (‘ERP’) system, besides supporting the operations.

Additionally, it provides support to engineering through integration with the electrical and mechanical calculations system that offers network analysis and suitable network sizing. The Atlantis project began in 2015 and part of the solution was deployed in August 2017. Since this time, the system is used by CEMIG's high, medium and low voltage asset registration teams.

In 2019, we´ve implemented the reconciliation of the grid registration units with the elements registered in SAP/ERP, the consultation module and the electrical calculation module.

In 2020 the system was fully deployed.

There are another IT solutions based in GIS technologies, such as, geographic panels with data available in tabular and map views, automation panels for distribution's operations, system to management, inspection and security of dams and integrations to permit access to simple map views.

 

Internal Telecommunications Network

CEMIG’s telecommunications network is composed of high-performance microwave links provided by more than 376 communication stations, and an optical system of approximately 1,161 miles of optical fiber providing a mix of telecommunications. Our robust data network also contains communications facilities that share the site with more than 418 substations, 44-generation plants and 172 high and extra high voltage transmission and distribution lines.

The solutions provided range from corporate telephonic and corporate networks to mission critical telecommunications grid dedicated to monitoring, protection and control of generation plants, substations, transmission and distribution lines, dispatching of field crews to carry out technical and commercial services, lightning and storm prediction and hydro meteorological system to operate reservoirs.

82 

In order to support supervision and control of the medium-voltage mission critical distribution system, a proprietary radio communication system is in place, installed in approximately 1,023 reclosers and 77 automated switches. Other 12,087 reclosers are monitored and controlled utilizing third part solution; begin 11,187 supported by cellular solution and 910 by satellite media.

Commercial and technical service dispatch are supported by 1,200 vehicle mobile terminals connected by a hybrid satellite and Cellular Solution and 400 handhelds equipped with cellular solution.

Approximately 39,118 energy meters are equipped with cellular solution and dedicated to revenue protection. Additionally, more than 5,000 meters utilizing RF Mesh and PLC solution are installed in low voltage customers and medium voltage transformers at Sete Lagoas region constituting a complete proof-of-concept of Advanced Metering Infrastructure (‘AMI’).

The corporate data network serves more than 230 offices and units within the concession area.

The Telecommunications Network Operation monitors and operates the infrastructure 24 hours x 7 days a week to guarantee continuity and reliability, according to Brazilian regulations and in compliance with ANEEL regulations, National Grid Operator (‘ONS’) operational procedures and other specific regulations.

 

Corporate Data Network

Our corporate data network services 377 units in 275 cities of Minas Gerais linked by an infrastructure, which includes microwave links, optical fibers and metal cables, owned either by ourselves or by contracted operators. The architecture is in line with market standards, using state-of-the-art equipment, which is monitored, operated and managed using the latest technological solutions.

The physical and logical network topologies employ security resources such as firewalls, intrusion prevention system (IPS), access control, antivirus and antispam systems, which are continuously updated to protect against unauthorized access, in accordance with ISO 27002. A security information and event management system (SIEM) makes it possible to investigate adverse events, while also providing a historical record base to meet legal requirements.

The Network and Security Operations Centers (‘NOC’ and ‘SOC’), at the Company’s head office, in Belo Horizonte, monitors, operates and manages the whole network and security infrastructure in Real time (24 hours per day, 7 days a week), maintaining confidentiality, integrity and availability of the data throughout the whole network.

 

Information Security Management

Information security, a permanent concern of ours, is ensured by a management system based on the Brazilian Standard (‘ABNT’) NBR ISO/IEC 27001:2013, which is aligned with best market practices. Our information security management system includes processes for policy, risk, communication, information classification and information security management and control. In addition, recurring actions for improvement in processes, communication, awareness and training strengthen our information security practices.

CEMIG maintains an ongoing safety awareness program for its employees through annual campaigns.

 

IT Governance Program

Our Information & Technology Governance program seeks alignment with the business, adding value through the application of the appropriate management of resources and risks, constantly monitoring performance and compliance, ensuring adherence to legal, regulatory and compliance requirements that are continuously audited. In order to execute corporate strategy and objectives, the company aligns interests and goals with control objectives and with governance and management processes, translating business opportunities and needs into results with compliance and within the appropriate levels of risk. To support this governance

83 

program and ensure that the strategy is implemented, the processes employed by the IT department are directly related to the control objectives and are based on IT service management (‘ITIL’) best practices.

 

Commercial Management System

We have established and consolidated an efficient customer service system, based on SAP CCS (‘Customer Care Solution’)/ CRM (‘Customer Relationship Management’) platform, fully integrated with the Business Intelligence (‘BI’) database, which supports our customer service processes.

The employees use CCS/CRM to manage and serve approximately 9 million customers who receive high, medium and low voltage energy supply. Both corporate tools offer security, quality and productivity to our processes of energy distribution with efficiency in accordance with the regulatory and Market requirements.

In 2019, we configured a new solution based in Salesforce software to improve the efficiency and reliability of energy trading and trading actions related for the use of distribution system assets. We aim improvements in controls over energy sales processes, greater traceability of information, management of customer portfolios with mapping of new opportunities, use of mobile devices such as tablets and smartphones and greater agility for customer billing.

The Salesforce solution was increased by the deployment of a portal accessed by specific customers. This portal offers an interface so that customers can make their requests and claims regarding energy quality.

During 2020, due to the emergencies caused by the Covid-19 pandemic, we implemented several adjustments focusing the automation and availability of our customer system and offering services by the internet and mobile app.

 

Management Tools

In 2019, we started a project to install new IT products to improve engineering processes, based on the Cyme Platform (‘CYME’), provided by Cooper Power Systems.

The CYME platform is an expert system that includes complex electrical calculations for the planning and study of distribution networks. In the case of CEMIG, which has an extensive and integrated distribution network and a significant level of complexity, the activities for implementing the technology solution are even more challenging and demanding, requiring considerable effort to complete the steps.

The project continued in 2020, although affected by pandemic. Interfaces and integrations were developed and customized to connect to Geographic Information System (‘GIS’) GE Smallworld, Outage Management System (‘OMS’) application, Advanced Metering Infrastructure (‘AMI’) and other systems. The CymDIS application that performs electric calculations based on our electric network was also delivered.

New mobile solution for collection of readings and simultaneous printing of invoices in the field: Since August 2020, we have readers using the new application "SGL Collector" (SGL is a reading management system) on smartphones. The new solution provides benefits of an application with a more intuitive graphical interface that makes it easy for the reader to learn and perform activities, associated with handling smaller, lighter equipment and with lower costs compared to the PDAs previously used. The installation and updating of versions of the application on the readers' smartphones is done remotely and centrally, through a UEM (‘Unified Endpoint Management’) platform that guarantees all the security and integrity of the equipment and applications used by the field teams in the execution of the activities throughout CEMIG's concession area.

 

84 

 

Customer Relationship Channels

We have nine major channels of service to our Minas Gerais customers. Customer service contact, whether of an emergency nature or to deal with, service requests, can be made via: (i) our call center, which can handle an average of 40,000 daily calls, and also operates with an efficient electronic service through Interactive Voice Response (‘IVR’, or Unidade de Resposta Audível); (ii) in person at branches in the 774 municipalities of our concession; (iii) through our Virtual Branch, on our website, which offers 46 types of service; (iv) via SMS; (v) via the social networks Facebook, WhatsApp and Twitter; (vi) smartphone application ‘CEMIG Atende’ which offers 7 types of service and Telegram Messenger application which offers 12 types of services.

 

Maintenance and Repair Systems

The 10,835 miles of high voltage distribution lines in CEMIG D’s network, operating at from 34.5 kV to 230 kV, are supported by approximately 53,151 structures, mainly made of metal.

The network of CEMIG GT has 3,062 miles of high voltage transmission lines, operating at from 230 kV to 500 kV, supported by approximately 11,754 structures.

The majority of the service interruptions to our distribution and transmission lines are the result of lightning, farm surface fires, vandalism, wind, and corrosion.

The entire high voltage transmission line system of CEMIG D is inspected once a year by helicopter, using a ‘Gimbal’ gyro-stabilized system with conventional and infrared cameras, allowing for simultaneous visual and thermographic (infrared) inspections. Land-based inspections are also made at intervals of between one and three years, depending on the characteristics of the line, such as time in operation, number of outages, type of structure, and the line’s importance to the energy system as a whole.

All the extra high voltage transmission lines of CEMIG GT are inspected twice a year by helicopter. Land-based inspections are made every two years to inspect the supporting structures. Line pathways are inspected annually, aiming to keep the areas free of vegetation that could lead to surface fires.

We use modern modular aluminum structures to minimize the impact of emergencies involving fallen structures. Most of our maintenance work on transmission lines is done using live-wire methods. We have a well-trained staff and special vehicles and tools to support live- and dead-wire work.

Our set of spare equipment (transformers, breakers, arresters, etc.) and mobile substations are of great importance in prompt reestablishment of power to our customers in the event of emergencies involving failed substations.

 

Property, Plant, and Equipment and Intangible Assets

Our main assets are our power generation plants, transmission and distribution infrastructure. Our net book value of total property, plant and equipment and intangible assets, including our investment in certain consortium that operate energy generation projects, including projects under construction, was R$14,217 million on December 31, 2020.

Generation facilities represented 16.93% of this net book value, intangible assets represented 83.07%, of this net book value, distribution facilities in intangible assets represented 77.96%, and other intangible, including our gas distribution system represented 15.35% and other miscellaneous property and equipment, including transmission and telecommunication facilities, represented 6.69%.

The average annual depreciation rates applied to these facilities were: 2.96% for hydroelectric generation facilities, 6.19% for administration facilities, and 4.94% for wind facilities.

Apart from our distribution and generation network, no single one of our assets produced more than 10% of our total revenues in 2020. Our infrastructure is adequate for our present needs and suitable for their intended purposes. We have rights of way for our distribution lines, which are our assets and do not revert to the landowner upon expiration of our concessions.

85 

The Brazilian Energy Industry

General

In the Brazilian energy sector, generation, transmission and distribution activities were traditionally conducted by a small number of companies that had always been owned by either the Federal Government or the governments of individual states. Since the 1990s, several state-controlled companies were privatized, in an effort to increase efficiency and competition. The Fernando Henrique Cardoso administration (1995 – 2002) aimed to privatize the state-controlled part of the energy sector, but the Luis Inácio Lula da Silva administration (2003 – 2010) ended this process and implemented a ‘New Industry Model’ for the Brazilian energy sector, expressed in Law No. 10,848, enacted on March 15, 2004, referred to as the ‘New Industry Model Law’.

Significant changes were implemented during Dilma Rousseff’s administration (2011 – 2016), by means of Provisional Act No. 579/12, converted into Law No. 12,783/13, establishing new rules for renewal of concessions, including rebidding for hydroelectric power generation concessions.

Subsequently, under the administration of Michel Temer (2016–2018), other changes were introduced in the sector by Provisional Act 735/16, enacted as Law No. 13,360/16, including a change of the bidding rules for energy generation, transmission and distribution concessions as well as addressing the renegotiation of hydrological risk. In addition, in 2017, a series of public consultations, which discussed proposals for modernization, and expansion of the Free Market in electric power supply with the industry (Public Consultation No. 33) began.

During the first year under Jair Bolsonaro (2019 – present), the government proceeded with the studies proposed by public consultation n. 33, holding several workshops and meetings with agents to study the following topics: separation of energy contracts into capacity and energy contracts, pricing, definition of price limits and reduction of the spot price time base.

Main Regulatory Authorities

National Energy Policy Council – CNPE

In August 1997, the CNPE was created to advise the Brazilian president regarding the development and creation of the national energy policy. CNPE is presided over by the MME, and the majority of its members are officials of the Federal Government. CNPE was created to optimize the use of Brazil’s energy resources and to assure the supply of energy to the country.

Ministry of Mines and Energy – MME

The MME is the Brazilian Federal Government’s primary regulator of the power industry. Following the adoption of the New Industry Model Law, the Brazilian Federal Government, acting primarily through the MME, undertook certain duties that were previously under the responsibility of ANEEL, including the drafting of guidelines governing the granting of concessions and the issuance of directives governing the bidding process for concessions related to public services and public assets.

86 

National Electric Energy Agency – ANEEL

The Brazilian power industry is regulated by ANEEL, an independent federal regulatory agency. After enactment of the New Industry Model Law, ANEEL’s primary responsibility is to regulate and supervise the power industry in line with the policy issued by MME and to respond to matters which are delegated to it by the Brazilian Federal Government.

 

National System Operator – ONS

The ONS was created in 1998 as a non-profit private entity comprising free customers, energy utilities engaged in the generation, transmission and distribution of energy, and other private participants such as importers and exporters. The New Industry Model Law granted the Brazilian Federal Government the power to appoint three directors of the ONS, including the Director-general. The primary role of the ONS is to coordinate and control the generation and transmission operations in the interconnected power system, subject to ANEEL’s regulation and supervision.

 

Brazilian Electric Power Trading Chamber– CCEE

One of the main roles of the CCEE is to run public auctions in the regulated market, including the auction of existing energy and new energy. Additionally, the CCEE is responsible, among other things, for: (1) registering all the power purchase agreements within the Regulated Market (CCEARs), and the agreements within the Free Market, and (2) accounting for and settling short-term transactions.

Under the New Industry Model Law, the price of energy in the spot market, known as the Differences Settlement Price (Preço de Liquidação de Diferenças, or ‘PLD’), takes into account factors similar to the ones used to determine the Wholesale Energy Market spot prices prior to the New Industry Model Law. Among these factors, the variation of the PLD will mainly vary according to the balance between the market supply and demand for energy, as well as the impact that any variation on this balance may have on the optimal use of the energy generation resources by the ONS.

The members of the CCEE are generators, distributors, trading agents and free customers, and its board of directors comprises four members appointed by these agents and one appointed by the MME, who is the chairperson of the board of directors.

 

Energy Research Company – EPE

The Brazilian Federal Government created EPE by a decree enacted on August 16, 2004. It is a state-owned company, responsible for carrying out strategic research on the energy industry – including energy, oil, gas, coal and renewable energy sources. EPE is responsible for: (i) studying projections for the Brazilian energy matrix; (ii) preparing and publishing the national energy balance; (iii) identifying and quantifying energy resources; and (iv) obtaining the required environmental licenses for new generation concessionaires. EPE’s research supports the MME in its policymaking role in the domestic energy industry. EPE is also responsible for approving the technical qualification of new energy projects to be included in the related auctions.

 

Energy Sector Monitoring Committee – CMSE

Decree No. 5,175 enacted on August 9, 2004, established the Energy Sector Monitoring Committee, or CMSE, which acts under the direction of the MME. The CMSE is responsible for monitoring and permanently evaluating the continuity and security of energy supply conditions and for indicating necessary steps to correct identified problems.

 

87 

Permanent Commission for Analysis of Methodologies and Computation Programs of the Electric Sector – CPAMP

Ordinance No. 47, enacted on February 19, 2008, created the Permanent Committee for Analysis of Methodologies and Computation Programs of the Electric Sector (‘CPAMP’), with the purpose of guaranteeing coherence and integration of the methodologies and computational programs used by MME, EPE, ONS and CCEE.

 

Ownership Limitations

On November 10, 2009, ANEEL issued Resolution No. 378, requiring it to notify the Economic Law Secretariat of the Ministry of Justice (‘SDE’) if it identifies any act that may cause unfair competition or may result in significant market control (under Article 54 of Law 8,884 enacted on June 11, 1994). After the notification, SDE must inform CADE. On November 30, 2011, Law No. 8,884 was revoked and replaced by Law No. 12,529, which terminated the SDE and replaced it with the Competition General Management Unit (‘Superintendência Geral’). Such unit, if necessary, will require ANEEL to analyze any such events, upon which CADE will decide if there should be any sanctions applied. Under Articles 37 and 45 of Law No. 12,529, these may vary from pecuniary penalties to dissolution or other disposition of the offending company.

 

The New Industry Model

The primary objective of the New Industry Model was to guarantee security of supply and reasonableness of rates. In terms of ensuring security of supply, the New Industry Model Law (a) requires distributors to contract their entire energy production, and to be responsible for making realistic projections of demand requirements; and (b) aims to arrange for the construction of new hydroelectric and thermal plants to be decided in ways that best balance security of supply and reasonableness of rates. To achieve reasonable rates, the New Industry Model Law requires that all purchases of energy by distributors to be by auction, based on lowest price criteria, and that contracting be carried out through the Regulated Market. Auctions are categorized into two types: (i) auctions for supply from new plants, aimed at expansion of the system; and (ii) auctions for power generated by existing plants, aiming to meet existing demand.

The New Industry Model created two environments for the purchase and sale of energy: (i) the Regulated Market, in which distributors purchase through public auctions all of the power they need to supply their customers; and (ii) the Free Market, to include all purchases of energy by non-regulated entities, such as free customers and trading companies. Distributors are allowed to operate only in the Regulated Market, whereas generators may operate in both, maintaining their competitive characteristics.

Requirements for expansion of the sector are evaluated by the Federal Government through the MME. Two entities were created to provide structure for the sector: (i) the Energy Research Company (Empresa de Pesquisa Energética or ‘EPE’), a state-controlled company responsible for planning expansion of generation and transmission; and (ii) CCEE, a private entity responsible for the accounting and settlement of short-term (spot) energy transactions. CCEE is also responsible, through delegation by ANEEL, for organizing and conducting Regulated Market public power auctions, in which the distributors purchase energy.

The New Industry Model eliminated self-dealing, forcing distributors to purchase energy at the lowest available price rather than from related parties. The New Industry Model exempted contracts executed prior to the enactment of the law, in order to provide regulatory stability to transactions carried out before it was enacted.

Several categories of power supply are not subject to the requirement for public auction via the Regulated Market: (1) certain low capacity generation projects located near consumption points (such as certain co-generation plants and SHPs); (2) plants qualified under the PROINFA program; (3) power from Itaipu and, as from January 1, 2013, from Angra I and II; (4) power purchase agreements entered into before the New Industry Model Law; and (5) concessions extended by Law No. 12,783. The rates at which the energy generated by Itaipu is traded are denominated in U.S. dollars and established by ANEEL pursuant to a treaty between Brazil and Paraguay, and there are compulsory procurement volumes. Consequently, the price of energy from Itaipu rises or falls according to the U.S. Dollar/Real exchange rate. Changes in the price of Itaipu-generated energy are, however, neutralized by the Brazilian Federal Government, which buys all the energy credits from Eletrobrás.

88 

The New Industry Model Law is currently being challenged on constitutional grounds before the Brazilian Federal Supreme Court. The Brazilian Federal Government moved to dismiss the actions, arguing that the constitutional challenges were moot because they relate to a provisional act that had already been converted into law. To date, the Brazilian Supreme Court has not reached a final decision upon the merits of this action and we do not know when such a decision may be reached. Thus, the New Industry Model Law is currently in force. Regardless of the Supreme Court’s final decision, certain portions of the New Industry Model Law related to restrictions on distributors performing activities unrelated to the distribution of energy, including sale of energy by distributors to free customers and the elimination of agreements between related parties, are expected to remain in full force and effect.

 

Coexistence of Two Energy Trading Environments

Under the New Industry Model Law, energy purchase and sale transactions are carried out in two different market segments: (1) the Regulated Market, in which distributors buy all their power supply needs through public bids; and (2) the Free Market, for all purchases of energy by non-regulated entities such as free customers, energy traders and energy importers.

 

The Regulated Market

In the Regulated Market, distributors purchase energy for their regulated customers through public auctions regulated by ANEEL and conducted by the CCEE.

Energy purchases take place through two types of bilateral contracts: (i) Energy Agreements (Contrato de Quantidade de Energia) and (ii) Capacity Agreements (Contratos de Disponibilidade de Energia). Under an Energy Agreement, a generator commits to supply a certain amount of energy and assumes the risk that energy supply could be adversely affected by hydrological conditions and low reservoir levels, among other conditions, that could interrupt the supply of energy, in which case the generator will be required to purchase the energy from third parties to meet its supply commitments. Under a Capacity Agreement, a generator commits to make a certain amount of capacity available to the Regulated Market. In this case, the revenue of the generator is guaranteed under the contractual conditions and the distributor assumes the hydrological risk. However, if there are additional costs to the distributors, these are passed on to customers. Together, these agreements comprise the power purchase agreements (Contratos de Comercialização de Energia no Ambiente Regulado, or ‘CCEARs’) in the Regulated Market.

The regulations under the New Industry Model Law establish that distributors that contract less than 100% of their total demand, accounted in the CCEE, will be subject to penalties. There are mechanisms to reduce the possibility of penalties, such as participation in the MCSD mechanism (‘Mechanism of compensation of surpluses and deficits’), which allows for the managing of surpluses and deficits among distributors, or purchase of supply in auctions during the year. Any remaining shortfall from 100% of total demand may be purchased at the spot market. If a company contracts more than 105% of its total demand, it would be subject to price risk if it sells that supply in the spot market in the future. To reduce this price risk, a company may reduce its purchase contracts made at ‘existing source’ auctions by up to 4% each year, by bilateral negotiation through Regulation 711, through MCSD ‘New Energy contracts’, and through loss of customers that have opted to become free customers (and are thus supplied by generators directly).

With the renewal of the hydroelectric power plant concessions, Contracts for the Physical Accounts Security (‘CCGF’) were created. These contracts take into account 90% of the energy generated by the plants whose concessions were renewed in order to mitigate the hydrological risk. The execution of CCGF is mandatory and each distributor received an amount according to the assessment made by ANEEL.

89 

The Free Market

In the Free Market, energy is traded by power generators. The Free Market also includes certain grandfathered existing bilateral contracts between generators and distributors until the expiration of their current terms. Upon expiration, new contracts would have to be executed under the New Industry Model Law.

Potentially free customers are those whose energy demand exceeds 3 (three) MW at a voltage equal to or higher than 69kV or at any voltage level if their supply began after July 1995. Since January 2019, customers whose supply began before 1995 were also able to migrate to the Free Market pursuant to Law No. 13,360/16. In July 2019, the restriction to be a free customer will be reduced to 2.5 MW and in January 2020 to 2 MW (Ministerial Order 514/2018). On December 12, 2019, Ministerial Order no. 465/2019 reduced the restriction to be free consumer to 1.5 MW in January 2021, to 1.0 MW in January 2022 and to 0.5 MW in January 2023. This order also gave ANEEL and CCEE a dead line (January 2022) to finish and present regulatory measures necessary to allow the free market to be opened for consumers with a load below 0.5 MW, including the regulated energy trader and proposed opening schedule beginning January 1, 2024.

Until the total opening, customers with contracted demand of 500 kW or more may be serviced by suppliers other than their local distribution company if they purchase from certain alternative energy sources, such as SHPs, wind or biomass of a certain size.

Once a customer has opted for the Free Market, it may only return to the regulated system after giving its regional distributor five years’ notice. The distributor may reduce this term at its discretion. The aim of the extended notice period is to ensure that, if necessary, the distributor is able to purchase additional energy to supply the re-entry of free customers into the Regulated Market. Moreover, distributors may also reduce the amount of energy purchased according to the volume of energy that they will no longer distribute to free customers. State-owned generators may also sell energy to free customers, but unlike private-sector generators, they are obliged to do so through an auction process.

 

Restricted Activities for Distribution companies

Distribution companies in the Brazilian Interconnected Grid (Sistema Interligado Nacional, or ‘SIN’) are not permitted to: (1) operate in the business of the generation or transmission of energy; (2) sell energy to free customers, except for those in their concession area and under the same conditions and rates as regulated customers in the Regulated Market; (3) directly or indirectly hold any interest in any other company, except entities incorporated for raising, investment and management of funds necessary for the distributor (or its parent company or related companies or partnerships); or (4) engage in activities that are unrelated to their respective concessions, except for those permitted by law or in the concession agreement.

 

Contracts Executed Prior to the New Industry Model Law

Under the New Industry Model Law, contracts executed by distributors and approved by ANEEL before the enactment of that law will not be amended to reflect any extension of their terms or change in prices or volumes of energy already contracted.

 

Limitations on Pass-Through

The New Industry Model also limits the pass-through of costs of energy to final customers. The Annual Reference Value corresponds to the weighted average of the energy prices in ‘A - 5’ and ‘A - 3’ auctions, calculated for all distributors, and creates an incentive for distributors to contract for their expected energy demands in the A - 5 auctions, where prices are expected to be lower than in A - 3 auctions. The Annual Reference Value is applied in the first three years of power purchase agreements from new power generation projects. After the fourth year, the energy acquisition costs from these projects will be allowed to be passed through in full. Decree No. 5,163/04 establishes the following limitations on the ability of distributors to pass through costs to customers:

90 
·No pass-through of costs for energy purchases that exceed 105% of regulatory demand;
·Limited pass-through of costs for energy purchases made in an A–3 auction, if the volume of the acquired energy exceeds 2.0% of the demand found in A–5 auctions;
·Limited pass-through of energy acquisition costs from new energy generation projects if the volume re-contracted through CCEARs of existing generation facilities is below a ‘Contracting Limit’ defined by Decree No. 5,163;
·Energy purchases from existing facilities in the ‘A - 1’ auction are limited to 0.5% of distributors’ demand, frustrated purchases in previous A - 1 auctions, involuntary exposure to regulated customer demand, plus the ‘replacement’, defined as the amount of energy needed to replace the power from power purchase agreements that expire in the current year (A - 1), according to ANEEL Resolution No. 450/2011. If the acquired energy in the A - 1 auction exceeds the limit, the pass-through to final customers of costs of the excess portion is limited to 70.0% of the average value of such acquisition costs of energy generated by existing generation facilities. MME will establish the maximum acquisition price for energy generated by existing projects;
·Energy purchases in ‘market adjustment’ auctions are limited to 5.0% of a distribution concession holder’s total demand (the previous limit, modified by Decree 8,379/14, was 1.0%, except for 2008 and 2009) and pass-through of costs is limited to Annual Reference Value;
·If distributors fail to comply with the obligation to fully contract their demand, the pass-through of the costs from energy acquired in the short-term market will be the equivalent to the lower of the PLD or the Annual Reference Value.

 

Rationing under the New Industry Model Law

The New Industry Model Law establishes that, in a situation in which the Federal Government decrees a compulsory reduction in the consumption of energy in a certain region, all energy quantity agreements in the regulated market, registered within the CCEE in which the buyer is located, shall have their volumes adjusted in the same proportion to the required reduction of consumption.

 

Rates

Electric energy rates in Brazil are set by ANEEL, which has the authority to adjust and review rates in accordance with applicable concession contracts and regulations. Each distribution company’s concession contract provides for an annual rate. In general, ‘Parcel A costs’ are fully passed through to customers. ‘Parcel A costs’ are the portion of the rate calculation formula which provides for the recovery of certain costs that are not within the control of the distribution company. ‘Parcel B costs’, which are costs that are under the control of the distributors, are adjusted for inflation in accordance with IPCA index. The average annual rate adjustment includes components such as the inter-year variation of Parcel A costs (‘CVA’) and other financial adjustments, which compensate for changes in the company’s costs, upward or downward, that could not be previously taken into account in the rate charged in the previous period.

Distribution concessionaires are also entitled to periodic reviews. Our concession agreements establish a five-year period between periodic reviews. These reviews mainly aim: (i) to ensure necessary revenues to cover efficient operating costs, determined by the regulator, and adequate return for investments deemed essential for the services within the scope of each company’s concession; and (ii) to determine the ‘X factor’, which is calculated based on the average productivity gains from increases in scale. The X factor is a result of three components: a productivity factor representing those productivity gains (Xpd); the quality factor XQ, which punishes or rewards the distribution company depending on the quality of the service provided, and the factor Xt, which has the objective of reducing or increasing the regulatory operating costs during the five-year period between the rates reviews, to reach the level defined for the efficient operating cost determined by the regulator.

91 

In 2011, ANEEL concluded the Public Hearing No. 040/2010, in which it dealt with the methodology for the third periodic review. To calculate the rate of return, ANEEL used the methodology of Weighted Average Cost of Capital (‘WACC’), which resulted in a yearly rate of 7.50% after tax, compared to the rate of 11.25% applied in the previous cycle. This rate of return was applicable to the investments made by CEMIG D until the next tariff cycle, which was conducted in 2018. After that, the new rate of return calculated by the regulator is 8.09% after tax.

ANEEL also changed the methodology used to calculate the X Factor: from a method based on discounted cash flow to the Total Factor Productivity (‘TFP’) method, which consists of defining potential productivity gains for each company based on average productivity gains in the later years. It also included the other two components, as mentioned above: XQ and Xt. The components of the X factor, determined in the 2018 review, for the period 2018/2023, were: Xt = -1.33%, which is applicable on each annual readjustment, Xpd and XQ which are defined ex-post and added to the previous value based, respectively, on the productivity gains from the last year and from changes in the quality of services provided.

ANEEL has also issued regulations governing access to the distribution and transmission facilities, and establishing TUSD and the TUST. The rates to be paid by distribution companies, generators and free customers for use of the interconnected power system are reviewed annually. The review of the TUST takes into account the RAP of transmission concessionaires under their concession contracts For more detailed information on the rate-setting structure, see ‘Rates for the Use of the Distribution and Transmission Systems.’

In 2015, ANEEL created an additional fee that would be passed on to customers through their energy bills. This system is known as ‘tariff flags.’ The system provides customers with a system disclosing the Real costs of energy generation. The system is a simple one: the colors of flags (green, yellow or red) indicate whether, based on the conditions of energy generation, the cost of energy to customers will increase or decrease. When the system provides a green flag, the hydrological conditions for power generation are favorable and there should be no additional fee included in the customers’ rate. If the conditions are somewhat less favorable, the system will indicate a yellow flag and there will be additional charges proportional to consumption. If conditions are even less favorable, the system will indicate a red flag, which has two levels.

In 2019, the additional charges remain the same as 2018 until July when the additional charges corresponding to each flag were adjusted as follows: the yellow flag was set to R$1.50 per 100 kWh, the red flag level 1 was set to R$4.00 per 100 kWh and the red flag level 2 was set to R$6.00 per 100 kWh. Those additional charges were adjusted again in November 1st when the additional charges corresponding to each flag were adjusted as follows: the yellow flag was set to R$1.343 per 100 kWh, the red flag level 1 was set to R$4.169 per 100 kWh and the red flag level 2 was set to R$6.243 per 100 kWh. During 2020, due to the Covid 19 pandemic, the tariff flags were suspended from June/2020 until November/2020 (ANEEL’s dispatch nº 1,511/2020). ANEEL’s Dispatch nº 3,364/2020 restored the tariff flags on December/2020 there was a red flag level 2 in December, a yellow flag in January and a green flags in all other months.

 

Acquisition of land

The concessions granted to CEMIG by the Federal Government assign to the concessionaire the acquisition of the lands in which the plants and substations will be implanted. Energy companies in Brazil have to negotiate with each property owner to obtain the land needed for the implementation of the entity. However, in the event that a concessionaire is unable to obtain the necessary land amicably, these lands may be acquired for use by the concessionaire through specific legislation. In cases of acquisition, through legal proceedings, the concessionaires may have to participate in negotiations regarding the value of compensation to owners and the resettlement of communities in legal proceedings. The Company makes every effort to negotiate with the owners and affected communities before taking legal action.

92 

 

The Brazilian Electric Power System – Operational Overview

Brazil’s energy production and transmission is a large-scale hydroelectric and thermal system made up predominantly of hydroelectric power stations, with many separate owners. The Brazilian Interconnected Grid connects companies in the Southern, Southeastern, Center-West, and Northeastern Regions and part of the Northern Region of Brazil. Approximately 2% of the country’s energy production capacity is not connected to the Brazilian Grid, in small isolated systems located mainly in the Amazon region. Brazil’s abundant hydrological resources are managed through storage reservoirs. It is estimated that Brazil has hydroelectric power generation potential of close to 246,241 MW, of which only 44% has been developed or is under construction, according to Eletrobrás studies compiled in December 2018.

 

Source: Banco de Informações de Geração (SIGA ANEEL – 16/02/2021)

 

By April 2021, Brazil had an installed capacity in the interconnected power system of 175.35 GW, approximately 51% of which is hydroelectric, according to the ‘Matriz de Energia Elétrica’ (Eletric Power Matrix) available at the Sistemas de Informação de Geração – ‘SIGA’, published by ANEEL. This installed capacity includes half of the installed capacity of Itaipu – a total of 14,000 MW owned equally by Brazil and Paraguay.

Eletrobrás, a company owned by the Federal Government, operate approximately 30% of Brazil’s installed generating capacity and 49% of Brazil’s high voltage transmission lines. Eletrobrás has historically been responsible for implementing energy policy, and conservation and environmental management programs. State-controlled or local electric power companies own the remaining high-voltage transmission lines. Distribution is conducted by approximately 60 state or local utilities, a majority of which has been privatized by the Federal Government or state governments.

 

Historical Background

The Brazilian Constitution provides that the development, use and sale of energy may be undertaken directly by the Brazilian Federal Government or indirectly through the granting of concessions, permissions or authorizations. Since 1995, the Brazilian Federal Government has taken a number of measures to restructure the power industry. In general, these have aimed to increase the role of private investment and eliminate restrictions on foreign investment, thus increasing overall competition in the power industry.

In particular, the Brazilian Federal Government has taken the following measures:

93 
·The Brazilian Constitution was amended in 1995 to authorize foreign investment in power generation. Prior to this amendment, all generation concessions were held either by a Brazilian individual, or by an entity controlled by Brazilian individuals, or by the Brazilian Federal Government or a state government;
·The Federal Government enacted Law No.8,987 on February 13, 1995, or the Concessions Law, and Law No.9,074 on July 7, 1995, or the Power Concessions Law, that together:
orequired that all concessions for the provision of energy-related services be granted through public bidding processes;
ogradually allowed certain energy customers with significant demand (generally greater than 3 MW), referred to as free customers, to purchase energy directly from suppliers holding a concession, permission or authorization;
oprovided for the creation of generation entities, or Independent Power Producers, which, by means of a concession, permission or authorization, may generate and sell all or part of their energy to free customers, distribution concessionaires and trading agents, among others;
ogranted free customers and energy suppliers open access to the distribution and transmission grids;
oeliminated the need for a concession to construct and operate power projects with capacity from 1 MW to 30 MW, or Small Hydroelectric plants, (SHPs), which was amended on May 28, 2009 by Law No. 11,943 and further by Law No. 13,360/16, raising the limit from 30 MW to 50 MW, regardless of being characterized as an SHP or not;

 

The current regulator, ANEEL, and the Conselho Nacional de Política Energética (National Energy Policy Council, or ‘CNPE’), were created in 1997.

 

In 1998, the Federal Government enacted Law No. 9,648 (‘Power Industry Law’), to overhaul the basic structure of the energy industry, providing as follows:

·Establishment of a self-regulated body responsible for operation of the short-term energy market, or Wholesale Energy Market, replacing the prior system of regulated generation prices and supply contracts;
·Creation of the ONS a non-profit, private entity responsible for the operational management of the generation and transmission activities of the interconnected power system;
·Establishment of public bidding processes for concessions for construction and operation of power plants and transmission facilities, in addition to the bidding process requirements under the Concessions Law and the Power Concessions Law, On March 15, 2004, the Brazilian Federal Government enacted Law No. 10,848, (or the ‘New Industry Model Law’), in an effort to further restructure the power industry, with the ultimate goal of providing customers with security of supply combined with fair rates. On July 30, 2004, the Brazilian Federal Government published Decree No. 5,163, governing trading rules under the New Industry Model Law, as well as the granting of authorizations and concessions for energy generation projects. These include rules relating to auction procedures, the form of power purchase agreements and the method of passing costs through to final customers.

 

On September 12, 2013, the Brazilian Federal Government issued Provisional Measure No. 579, enacted as Law No. 12,783, related to the extension of the concessions granted prior to Law 9,074, aiming to decrease the sector’s charges and achieving tariffs that are more reasonable. This legislation changed the rules applicable to certain concessions, and implemented new bidding process rules utilities, and adjustments to tariffs.

On August 18, 2015, the Brazilian Federal Government published Provisional Act No. 688, which was converted into Law No. 13,203, on December 8, 2015, which created the mechanism of voluntary re-negotiation of hydrological risks affecting the hydroelectric generation companies. In the same law, the government changed the bidding process rules concessions too.

94 

In June 22, 2016, the Brazilian Federal Government issued Provisional Act No. 735, which was converted into Law No. 13,360, enacted on November 17, 2016, which, among other measures, altered Chapter III of Law 12,783, governing competitive bids for energy generation, transmission and distribution concessions.

On July 2017, the MME organized two public consultation proceedings with the purpose of gathering contributions from sectorial agents to improve the national electric energy sector and update its regulatory framework.

On February 9, 2018, the MME submitted for analysis by the Brazilian President a draft bill including several proposed changes to the industry regulation. Among other issues addressed by the MME in the draft of the bill, we highlight:

·Divestment of hydro power plants. In case of divestment of hydro power plants, the new concession would be granted by means of payment of compensation to the government and it would not be subject to the quota regime established by Law No. 12,783/2013 (for generation concessions renewed in accordance with Law No. 12,783/2013, the energy produced by the power plant must be sold to all distributors in Brazil according to a quota system);
·Expansion of the free market. The consumption requirement for the characterization of free customers would be reduced. Currently, free customers must have an energy load of 3MW. Between 2020 and 2024, the load criteria qualifying the free customer would vary from 2 MW to 300kW. By 2026, there would not be a minimum energy load required, as long as the free customer is connected to tension equal or higher than 2,3kV;
·Incentives for renewable energy. MME’s proposal tends to reduce incentives granted to renewable energies through discount over connection tariffs. Such discount may be subject to certain conditions;
·Hydrological risk. The hydrological risk of differences in power production due to a hydrological scenario would exclude: (i) generation in disregard of the merit order which means dispatching energy to the grid in disregard of the ascending price raking for energy generation, (ii) anticipation of delivery of firm energy to the system of relevant power plants, and (iii) restriction to the supply of energy to the grid due to delay in the transmission system; and
·Separation between energy consumption and firm energy. A timeline for implementation of the legislative model that separates the charges for firm energy added to the grid and energy consumption.

 

Furthermore, it is under analysis in Congress the Bill of Law nº 622/2015, which establishes a deadline, defined in 2017, for the application of discounts not lower than 50% in tariffs for use of the transmission and distribution systems (TUST and TUSD) for projects using alternative energy sources such as solar, wind, biomass and qualified cogeneration, as stated in Article 26 and paragraphs of Law 9,427/1996. In its status, the bill states that such discounts will stay valid for current grants, even if extended, and for future grants up to December 31, 2027. The bill also imposes on the Federal Government the obligation to create a market mechanism to encourage investments in low-carbon energy sources, to be implemented on January 1, 2027.Currently, Bill of Law nº 622/2015 is in the Infrastructural Services Commission, awaiting appointment of a rapporteur.

The publication of Law 14.052/2020 and Resolution 895/2020, proposed the reimbursement of agents holding the concession of hydraulic plants in the MRE of the effects: (i) generation in disregard of the merit order which means dispatching energy to the grid in disregard of the ascending price ranking for energy generation, (ii) anticipation of delivery of firm energy to the system of relevant power plants, and (iii) restriction to the supply of energy to the grid due to delay in the transmission system. These effects will be calculated retroactively from 2012 to 2020, updated and remunerated at the ANEEL rate of 9.63%. The amount will then be paid through extension of the plants' concession. With this new agreement, injunctions are expected to be withdrawn and market deficits to be settled. In this way, the liquidity of the market in the short term and the default in the CCEE should return to their historical values.

95 

 

Rationing and Extraordinary Rate Increases

Conflicts of interest between CEMIG and other users of water

The operation of reservoirs for generation of energy by CEMIG requires it to assess the multiple uses of water by other users of the relevant river basin, and this in turn requires it to consider the applicability of a number of factors, including environmental factors, irrigation, waterways and bridges. In periods of severe drought, such as the one beginning in 2013, CEMIG was actively involved in monitoring and forecasting the levels of reservoirs and in maintaining a dialogue with public authorities, civil society and users. While CEMIG engages other essential users and takes into account societal interests with respect to its water use, competing interests with respect to the use of water could, subject to certain minimum limits established by law, affect the use of water in our operations, which in turn could affect our operating results or financial condition. Potential conflicts between CEMIG and other users are monitored through CEMIG’s active participation in River Basin Committees, and also in the related Technical Boards and Working Groups, where users of water, organized civil society and public authorities are represented. CEMIG participates in 5 River Basin Committees of rivers under federal control, and 20 River Basin Committees of rivers under local State control. CEMIG also monitors news published in various media outlets, receives comments and complaints during the periods of floods or drought, and acts to resolve any conflicts with communities living in the river basins where it has hydroelectric plants.

For new projects, CEMIG prepares a socio-environmental impact study, and carries out public hearings with all interested parties, where suggestions in assessing any potential conflicts are analyzed. When the project is operational, a Plan for Environmental Conservation and Use of the Artificial Reservoir Surroundings (‘Plano Ambiental de Conservação e Uso do Entorno de Reservatório Artificial’) is prepared with the participation of stakeholders. This plan is intended to govern conservation, recovery, use and environmental protection of the reservoir and its surrounding area in a balanced way, complying with the applicable legislation, the needs of the project and the demands of society.

CEMIG also conducts a program called Proximidade (‘Proximity’), which coordinates activities aimed at improving the relationship with affected communities. Through this program, CEMIG hosts public meetings that cover topics such as the operational and security procedures in its hydroelectric plants; climate conditions; and environmental aspects. CEMIG also provides opportunities for the public to take guided tours of plant facilities. By means of the Proximidade program, CEMIG also receives comments and complaints from the affected population and establishes partnerships with local community leaders, public entities, the local media and other actors responsible for safety and flood, including Civil Defense associations, the Fire Brigade and the Military Police.

Finally, CEMIG uses a risk management system to analyze scenarios and estimate the degree of financial exposure to risks, considering the probability of each event, and its impact. In the scenarios related to potential conflicts with other users, CEMIG also evaluates the effects arising from prolonged droughts, which may lead to an increase in competition for water between the energy sector and other users, and also the risks arising from consequences of floods due to excessive rain.

 

Concessions

We conduct the majority of our activities in generation, transmission and distribution of energy through concession contracts executed with the Brazilian Federal Government. The Brazilian Constitution requires that all concessions for public services must be subject to competitive tenders. In 1995, in an effort to implement these provisions of the Constitution, the Federal Government instituted certain laws and regulations, referred to collectively as the Concessions Law, which governs the procedures for competitive tenders in the energy sector.

96 

Transmission:

On December 4, 2012, CEMIG signed the second amendment to transmission contract No. 006/97, which extended the concessions under such contract for 30 years, in accordance with PA 579, beginning on January 1, 2013. This resulted in an adjustment to the RAP from these concessions, reducing the revenue from those concessions. The Brazilian Federal Government has compensated us for the reduction of the RAP in part, but we have not yet been compensated for the assets in operation before 2000. In accordance with Law No. 12,783, we are required to be compensated for the reduction of the RAP of the assets in operation before 2000, over a period of 30 years, the amounts being adjusted by the IPCA inflation index. This compensation was addressed by Mining and Energy Ministry Order No. 120/16, which determined that recognition of the amounts owed would take place as from the tariff adjustment process of 2017.

The amounts payable of the indemnities corresponding to the portions of investments linked to revertible goods not amortized or depreciated, recognized by MME in Ministerial Order 291/2017, were impugned in the administrative sphere (still awaiting decision – a hierarchy appeal), and, in the judiciary. CEMIG GT applied for a Prior Provisional Decision, on November 27, 2016, with the objective of obtaining an order for the Federal Government to exhibit the documentation that supported its calculation of the indemnity for reversion of the assets of Jaguara, Miranda, São Simão and Volta Grande hydroelectric plants. The Federal Government immediately deposit the non-contested portion of the indemnity, which had been set at R$1,028 million. In this case, the application for interim decision was refused and CEMIG GT filed an Interlocutory Appeal (currently pending judgment). Additionally, on January 17, 2018, CEMIG amended the writ: (i) to reiterate the need for exhibition of documents; (ii) applying for declaration of nullity of Article 1, §1 and 2, and Article 2, of Mining and Energy Ministry Order 291/2017, and consequent payment of indemnity to include all the investments made by CEMIG GT in the concessions referred to; and (iii) requesting immediate payment of the non-contested amount.

 

Generation contracts:

In the years 2014 and 2015, Brazil experienced a severe drought culminating in further alterations to the regulatory framework, established by Provisional Act No. 688/15 and later converted into Law No. 13,203/15. This law, among other measures, significantly altered Law No. 12,783/13, creating a mechanism of voluntary renegotiation of hydrological risks, since they affect the hydroelectric generation companies, and changing the rules for bidding for certain hydroelectric generation concessions. Subsequently, in 2016, other changes were introduced to the sector by Provisional Act No. 735/16, enacted as Law No. 13,360/16, which, among other measures, changed Chapter III of Law No. 12,783/13, which relates to bidding for energy generation, transmission and distribution concessions.

Following publication of the tender documents for Generation Auction No. 12/15 on October 7, 2015, which included the new regulatory provisions for renewal of concessions of existing plants stipulated by Law No. 13,203/15, CEMIG’s Board of Directors authorized our participation in Generation Auction No. 12/2015, and CEMIG GT was successful at this auction, held at the B3 on November 25, 2015. CEMIG won concessions for Lot ’D’ – which comprises the concessions for 18 hydroelectric plants: Três Marias, Salto Grande, Itutinga, Camargos, Cajuru, Gafanhoto, Martins, Marmelos, Joasal, Paciência, Piau, Coronel Domiciano, Tronqueiras, Peti, Dona Rita, Sinceridade, Neblina and Ervália. The total installed capacity of these plants is 699.5 MW, and their guaranteed basic offtake is 420.2 MW average.

These concession contracts have a period of 30 years beginning in January 2016 and expiring in January 2046 and, during the first half of 2016, were assigned by CEMIG GT to 7 wholly-owned subsidiaries created for commercial operation of these concessions (CEMIG Geração Camargos, CEMIG Geração Itutinga, CEMIG Geração Três Marias, CEMIG Geração Volta Grande, CEMIG Geração Leste, CEMIG Geração Oeste and CEMIG Geração Sul).

On September 9, 2020, the Law 14,052 was issued, changing the Law 13,203/2015 and establishing new conditions for renegotiation of hydrological risk in relation to the portion of costs incurred due to the GSF, borne by the holders of hydroelectric plants participating in the MRE between 2012 and 2017, when there was a serious crisis in water sources.

97 

The aim of this new law is to compensate the holders of hydroelectric plants participating in the MRE for non-hydrological risks caused by:

(i)        Generation ventures classified as structural, related to bringing forward of physical guarantee of the plants;

(ii) The restrictions on start of operation of the transmission facilities necessary for outflow of the generation output of structural projects; and

(iii) Generation outside the merit order system, and importation.

 

This compensation will take the form, of extension of the grant of concession or authorization to operate, limited to 7 years, calculated on the basis of the parameters applied by ANEEL.

On December 1, 2020, ANEEL issued its Normative Resolution 895, which established the methodology for calculation of the compensation, and the procedures for renegotiation of hydrological risk. To be eligible for the compensations under Law 14,052, the holders of hydroelectric plants participating in the MRE are required to:

(i)        Cease any legal actions which claimed exemption from, or mitigation of hydrological risks related to the MRE;

(ii) Relinquish any claims and/or further legal actions in relation to exemptions from or mitigation of hydrological risks related to the MRE; and

(iii) Not to have renegotiated hydrological risk under Law 13,203/2015.

 

On March 2, 2021 the CCEE sent to ANEEL the calculations for the concessions extensions in the Free Market (ACL) that have opted to accept the conditions proposed by ANEEL Normative Resolution 895/2020 and Law 14,052/2020. The Company’s management is awaiting ratification and publication by ANEEL of its extensions of the concession grants, for subsequent submission to the Company’s governance bodies for approval. Thus, no impact arising from this subject has been recorded in the financial statements at December 31, 2020.

 

Based on the preliminary data supplied by CCEE to ANEEL, the Company’s plants will have the right to the following periods of extension:

 

Power plant

Physical Guarantee

(average MW)

Preliminary expectation of Concession extension

(months)

Emboração

500

23

Nova Ponte

270

25

Sá Carvalho

56

22

Rosal

29

46

Others (1)

399

-

     

(1)Includes 11 power plants, of which 7 are owned by CEMIG GT, 1 is owned by CEMIG PCH and 3 are owned by Horizontes. The average concession extension in months varies between 1 and 84 months.

98 

With the approval of Law 14,120/2021, the right to reimbursement for the generation plants of Lot D was recognized, enabling the CCEE to make a new calculation, including these plants, indicating the right to their concession extension by the allowed maximum (seven years). Official confirmation of these amounts is pending regulations to be issued by ANEEL.

 

Distribution contracts:

In relation to the extension of the distribution concession contracts, CEMIG D, in accordance with Decree No. 7,805/2012 and Decree No. 8,461/2015, indicated acceptance of the extension of its concession contracts, and signed the Fifth Amendment to its Concession Contract in December 2015. This amendment guarantees extension of the foregoing concessions for an additional 30 years, from January 1, 2016 until January 2, 2046. The new amendment also requires CEMIG’s compliance with more stringent rules regarding service quality and with respect to CEMIG’s economic and financial sustainability, which must be met during the full 30 years of the concession.

Such compliance will be annually assessed by ANEEL, and if there is non-compliance, the concessionaire may be obliged to arrange for capital contributions by its controlling shareholders. Non-compliance for two consecutive years, or for five non-consecutive years, will result in forfeiture of the concession.

 

Regulatory Charges

Global Reversion Fund and Public Use Fund – RGR and UBP

In certain circumstances, power companies are compensated for assets used in connection with a concession if this concession is eventually revoked or is not renewed. In 1971, the Brazilian Congress created a Global Reversion Fund (Reserva Global de Reversão, or ‘RGR’), designed to provide funds for such compensation. In February 1999, ANEEL revised the assessment of a fee requiring all distributors, transmission companies and certain generators operating under public service regimes to make monthly contributions to the RGR at an annual rate equal to 2.5% of the company’s fixed assets in service, but not to exceed 3.0% of total operating revenues in any year. In recent years, the RGR has been used mainly to finance generation and distribution projects.

The Brazilian Federal Government has imposed a fee on IPPs reliant on hydrological resources, except for SHPs and generators under the public services regime, similar to the fee levied on public-industry companies in connection with the RGR. IPPs are required to contribute to the Public Use Fund (Fundo de Uso de Bem Público, or ‘UBP’), according to the rules of the corresponding public bidding process for the granting of concessions. Until December 31, 2002, Eletrobrás received the UBP payments. Since then they have been paid directly to the Brazilian Federal Government.

Since January 2013, the Global Reversion Fund has not been charged to: (i) any distributors; (ii) any transmission or generation utilities whose concessions have been extended under Law No. 12,783; or (iii) any transmission utilities that started their bidding procedure on or after September 12, 2012.

 

Fuel Consumption Account – CCC

The Fuel Consumption Account (Conta de Consumo de Combustível, or ‘CCC’), was created in 1973 to generate financial reserves to cover the high costs associated with the use of thermoelectric energy plants, especially in the Northern Region of Brazil, due to the higher operating costs of thermoelectric plants compared to hydroelectric plants. All energy companies were required to contribute annually to the CCC. Annual contributions were calculated on the basis of estimates of the cost of fuel needed by the thermoelectric energy plants in the following year. The CCC was then used to reimburse generators operating thermoelectric plants for a substantial portion of their fuel costs. Starting in 2013, CCC's expenditures are included in the annual budget of the CDE. Eletrobrás managed the CCC and, as of May 2017, it has been managed by CCEE pursuant to Law No. 13,360/2016.

99 

Charge for the Use of Water Resources

With the exception of Small Hydroelectric Plants, all hydroelectric utilities in Brazil must pay fees to Brazilian states and municipalities for the use of hydrological resources. The amounts are based on the amount of energy generated by each utility and are paid to the states and municipalities where the plant or the plant’s reservoir is located.

 

Energy Development Account – CDE

In 2002, the Brazilian Federal Government created the CDE to be in effect for 25 years, funded by: (i) annual payments made by concessionaires for the use of public assets; (ii) penalties and fines imposed by ANEEL; and, (iii) since 2003, the annual fees to be paid by agents offering energy to final customers, by means of a charge to be added to the rates for the use of the transmission and distribution system. The amounts are adjusted annually. The CDE was created to support: (1) development of energy production throughout the country; (2) production of energy from alternative sources; and (3) universalization of energy services throughout Brazil. With the enactment of Law No. 12,783/2013, these fees were used to contribute to reduction of energy rates. The CDE is managed by CCEE.

Under the New Industry Model Law, failure to pay the contribution to the RGR, the PROINFA Program, the CDE or any payments for purchases of energy in the regulated market prevents the defaulting party from receiving a rate readjustment (except for an extraordinary review), or receiving resources arising from the RGR or CDE.

 

ANEEL Inspection Charge – TFSEE

The Energy Services Inspection Charge, is an annual tax charged by ANEEL for its administrative and operating costs. It is calculated according to the Tariff Regulation Procedure (Procedimento de Regulação Tarifária, or ‘Proret’) – (Subsection 5.5: Energy Services Inspection Charge) based on the type of service provided (including independent production), and is proportional to the size of the concession, permission or authorization. It is limited to 0.4% of the annual economic benefit, considering the installed capacity, earned by the concessionaire, permit holder or authorized party and must be paid directly to ANEEL in 12 monthly installments.

 

The Regulated Market Account

Contracts held by distributors for a total supply of approximately 8,600 MW expired in December 2012. These contracts had been executed in the first auctions of energy from existing supply sources in 2005, and the energy should have been re-contracted in a further auction, but the Brazilian Federal Government did not hold the auction in 2012, because it expected that, with the renewal of the concession contracts this supply would come from Assured Energy Quota Contracts. However, the energy supply that was renewed was lower than expected and the distributors were under-contracted by 2,000 MW in 2014 and by 2,500 MW in 2015. By 2016, the decrease of consumption of energy resulted in a balance between the power purchase agreements and the demand from distributors. The Regulated Market Account was established in 2014 to cover the exposure that distributors could have as a result of under-contracted amounts. By 2015, the lower consumption of energy eliminated the under-contracted shortfall and resulted in a more regular contracting level. Thus, the Regulated Market Account was not needed to cover the exposure of distributors during 2015.

This situation was further exacerbated by the fact that certain power plants did enter into operation when expected, and by the low level of contracting in the auctions held in 2013 and 2014. The result was that the total level of under contracting in 2014 was 3,500 MW. In this scenario the only option for the distributors, in a situation of under contracting, was to purchase the required supply in the spot market.

The hydrological situation of the system in 2013 and 2014, as explained above, raised the energy cost in the spot market to its highest level, causing the financial exposure of the distributors to reach billions of Reais.

100 

Since the cost of the distributors’ exposure is passed through to customers only in the following year, this gap caused a problem in the companies’ cash flow. By 2015, the new price cap was lower than in 2014 and the ‘tariff flags’ mechanism helped the distributors to balance their exposure so no new loan was necessary.

To deal with this, the government created the Regulated Market Account, by Decree No. 8,221/14 enacted on January 1, 2014, regulated by ANEEL Resolution No. 612/04, which created an account to be managed by the CCEE, aiming to cover part or all of the costs resulting from the involuntary exposure to the spot market and of the dispatching of the thermal plants related to the availability contracts in the regulated market. To cover these costs, CCEE obtained a financing from a group of private and public institutions. These funds were then passed to the distributors, as determined by Decree No. 8,221/14 and ANEEL Resolution No. 612/2014. In 2014 and 2015, R$21 billion was raised by this account and passed through to the distributors.

The ANEEL Resolution No. 1,863/15 defined the charges to be applied on the energy customers and the Resolution No. 2004/2015 later updated those charges. These loans were charged by means of the payment through CDE, and were inserted in the energy rates after the Annual Tariff Adjustment of each distribution company proportionally to their captive markets. Initially CEMIG D had 59 months to pay the loan, and in December 2015, that period was updated to 47 months.

 

Energy Reallocation Mechanism

The Energy Reallocation Mechanism (Mecanismo de Realocação de Energia, or ‘MRE’), attempts to mitigate the risks involved in the generation of hydroelectric power by mandating that all hydroelectric power generators share the hydrological risks within the Brazilian grid. Under Brazilian law, the revenue from sales by generators does not depend on the amount of energy they in fact generate, but on the ‘Guaranteed Energy’ or ‘Assured Energy’ of each plant, indicated in each concession agreement.

Any imbalances between the power actually generated and the Assured Energy is covered by the MRE. In other words, the MRE reallocates the energy, transferring a surplus from those who generated in excess of their Assured Energy to those who generated less than their Assured Energy. The volume of energy actually generated by the plant, either more or less than the Assured Energy, is priced pursuant to an ‘Energy Optimization Rate,’ which covers the operation and maintenance costs of the plant. This additional revenue or expense is accounted for on a monthly basis by each generator.

The MRE is efficient in mitigating the risks of individual plants that have adverse hydrological conditions in a river basin, but it does not succeed in mitigating this risk when low hydrological levels affect the whole grid, or large regions of it. In extreme situations, even with the MRE, the aggregate generation of the whole system will not attain the levels of the total Assured Energy, and hydrological generators may be exposed to the spot market. In these situations, the shortage in hydro resources will be compensated by greater use of thermal generation, and spot prices will be higher.

In 2014, Brazil was subject to very adverse hydrological conditions, which resulted in a lower level of hydroelectric generation, and on the full utilization of thermoelectric plants of the system, as noted above. This led the plants of the MRE to generate at levels below their physical guarantee levels, causing an exposure for the generation companies to the short-term market. The proportion of the exposure is calculated by the ratio between the energy generated by all the plants of the MRE and the total of all the physical guarantees. This ratio is called the Generation Scaling Factor (‘GSF’) (Fator de ajuste da energia). In 2014, the GSF was 0.91, which indicates that the generation companies had their physical guarantee reduced by 9% in that year. In 2015, this exposure continued to occur, despite of a slightly better hydrology, but with the continued thermal dispatch and lower energy consumption the GSF closed the year at 0.84.

101 

During 2015, the low values of GSFs along with high spot prices again left producers of hydroelectric generation with high financial exposure. Thus, starting in March 2015, generators began to obtain court injunctions to prevent such exposure. Such injunctions claimed that the GSF’s calculation methodology was incorrect and that it caused undue exposure to producers. From March to September, there was an exponential increase in the number of injunctions issued, which led to a paralysis of the market. In order to address this situation, the Brazilian Federal Government proposed (by means of Provisional Act No. 688) the renegotiation of the hydrological risk, enabling generators with Free Market contracts to transfer the exposure to customers in exchange for a risk’s premium payment to be deposited in the so-called tariff band deposit account (the tariff band surcharges are deposited in such account and transferred to the distribution concessionaires) and would be indemnified for the losses suffered in 2015 by means of, among other measures, an extension of their power generation grants (concessions or authorizations, as the case may be) for up to 15 years. In other words, hydroelectric power plants would recover the costs incurred with GSF deficits retroactively to January 2015, and such recovery would form a ‘regulatory asset,’ which would be amortized over the term of the concession/authorization. If the remaining concession/authorization period is insufficient (i.e. not long enough to amortize the regulatory asset), generating companies would have a concession/authorization extension (limited to 15 years). To be able to use the mechanism the companies have to waive all claims filed and all injunctions obtained, as well as waive any further rights they would have in connection with any such legal action. This mechanism enabled plants with contracts signed in the regulated market and the free market to renegotiate them. However, the system and mechanism for renegotiating are different in the two markets. In both, this mechanism functions as a hedge, in which the generators bear the high cost of reserve of energy, and they receive the amount stipulated by the spot market price for their generation.

In the Free Market, the system did not have the same acceptance levels that were present in the regulated market, since the value of the risk premium was too high and, in order to hedge their GSF exposure, the generation companies would have to acquire reserve energy contracts. For these reasons, and considering that there are other alternatives available in the free market to mitigate the hydrological risks, generation companies deemed the voluntary negotiation inefficient. Consequently, acceptance of the mechanism by the regulated market was, approximately 90%. However, it was not accepted by the free market.

In 2020, the average GSF stood at 0.83 still impacted by a hydrological condition below the historical average and lower reservoir levels. The chart below presents the average price and GSF for the periods shown:

 

Charges for Use of the Distribution and Transmission Systems

ANEEL oversees rate regulations that govern access to the distribution and transmission systems and establish rates: (i) TUSD and (ii) TUST. Additionally, distributors of the South, Southeast and Midwest parts of the grid pay specific charges for transmission of energy generated at Itaipu Hydro Plant. All these rates and charges are set by ANEEL. The following is a summary of each rate or charge:

 

102 

TUSD

The TUSD is paid to a distribution company by generation companies, other distributors and customers, for the use of the distribution system to which they are connected. It is adjusted annually according to an inflation index, the variation in transmission costs, and regulatory charges. This adjustment is passed to customers of the distribution network in the Annual Rate Adjustment or Reviews.

Law 9,427/96 defines the application of discounts not lower than 50% in tariffs for use of the distribution and transmission systems (TUSD and TUST) for projects using alternative energy sources such as solar, wind, biomass and qualified cogeneration, as stated in his Article 26 and paragraphs.

 

TUST

The TUST is paid by generators, distributors and free customers, for the use of the basic transmission grid to which they are connected. It is adjusted annually according to an inflation index and taking into account any adjustment to the annual revenue of the transmission companies. According to criteria established by ANEEL, owners of the different parts of the transmission grid were required to transfer the coordination of their facilities to the ONS in return for receiving regulated payments from the transmission system users. Generation and distributors, and free customers, also pay a fee for exclusive transmission connections to some transmission companies. The regulator sets the fee for a 12-month period and it is paid monthly through the issuance of invoices.

As mentioned above, this tariff may suffer changes regarding the application of discounts for generators using the low-carbon energy sources defined in Article 26 and paragraphs of Law 9,427/1996.

 

Distribution rates

Distribution rates are subject to review by ANEEL, which has the authority to adjust and review rates in response to changes in energy purchase costs, charges payments or transmissions payments, or other factors related to market conditions. ANEEL divides the costs of all distributors into: (1) costs that are beyond the control of the distributor, or ‘Parcel A’ costs; and (2) costs that are under the control of the distributor, or ‘Parcel B’ costs. The rate adjustment is based on a formula that takes into account the division of costs between the two categories.

 

Parcel A costs include, among others, the following:

·Regulatory Charges (CDE, TFSEE and PROINFA);
·Costs of energy purchased for resale (CCEARs, power from Itaipu, and bilateral agreements); and
·Transmission charges (National grid, the Transmission Frontier grid, transport of energy from Itaipu, use of network for connection to other transmission companies, use of networks of other distributors, and the ONS).

 

Parcel B costs are those that are within the utility’s control, and include:

·Return on investment;
·Taxes;
·Regulatory default;
·Depreciation costs; and
·Costs of operation of the distribution system.

 

103 

In general, Parcel A costs are fully passed through to customers. Parcel B costs; however, are adjusted for inflation in accordance with the IPCA inflation index adjusted by the X Factor. Energy distributors, according to their concession contracts, are also entitled to periodic reviews. These reviews mainly aim: (i) to ensure necessary revenues to cover efficient Parcel B operating costs and adequate compensation for investments deemed essential for the services within the scope of each company’s concession; and (ii) to determine the X factor.

The X factor is used to adjust the proportion of the change in the IPCA index that is used in the annual adjustments and to share the company’s productivity gains with final customers.

In addition, distribution concessionaires are entitled to an extraordinary review of rates, on a case-by-case basis, in the event of unusual circumstances, to ensure their financial balance and compensate them for unpredictable costs, including taxes that significantly change their cost structure.

 

 

Item 4A.Unresolved Staff Comments

Not Applicable.

 

 

Item 5.Operating and Financial Review and Prospects

You should read the information contained in this section together with our consolidated financial statements as of December 31, 2020, 2019 and January 1, 2019 and for the years ended December 31, 2020, 2019 and 2018, contained elsewhere in this annual report. The following discussion is based on our consolidated financial statements, which have been prepared in accordance with IFRS and presented in million of Reais.

Our consolidated financial statements for the years ended December 31, 2019 and the opening balance as of January 1, 2019 have been restated to reflect the application of change in accounting policy disclosed in note 2.8 of our annual consolidated financial statements.

 

Basis of Preparation

Statement of compliance

The financial statements of the Company have been prepared in accordance with International Financial Reporting Standards (‘IFRS’) as issued by the International Accounting Standards Board (‘IASB’).

Company’s management certifies that all relevant and material information in the financial statements is being disclosed, which is used by management in its administration of the Company.

As part of its normal operations, the Company receives written comments and/ or requests from local regulators (i.e. ANEEL and CVM) regarding some of the information reported by the Company on its quarterly and annual reports, as well as on its regulatory financial statements filled locally in Brazil. The Company responds to such requests timely and its management believes that these comments and/ or requests would not have a material impact on the current or previously issued financial statements.

On April 30, 2021, the Company’s Audit Committee authorized the issuance of the consolidated financial statements as of December 31, 2020, 2019 and January 1, 2019 and for the years ended December 31, 2020, 2019 and 2018.

 

104 

Basis of measurement

The consolidated financial statements were prepared on a historical cost basis, except in the case of certain financial instruments and assets as held for sale, which are measured at fair value and fair value less costs to sell, in accordance with the standards applicable, as detailed in Note 31 and 32, respectively.

 

Functional currency and presentation currency

The consolidated financial statements are presented in Reais, which is the functional currency of the Company and its subsidiaries, joint ventures and affiliates, and all amounts are rounded to the nearest million, except when otherwise indicated.

Transactions in foreign currency were converted to Reais at the exchange rate as of the transaction date. Balances of monetary assets and liabilities denominated in foreign currency are translated to Reais at the exchange rates at the reporting date. Foreign exchange gains and losses resulting from the settlement or translation of assets and liabilities denominated in foreign currency are recorded in finance income and costs in the consolidated statement of income.

 

Use of estimates and judgments

Preparation of the consolidated financial statements requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, revenues and expenses. Uncertainties about these assumptions and estimates could result in outcomes that could require a material adjustment to the carrying amount of assets or liabilities affected in future periods.

Estimates and assumptions are periodically reviewed, using as a reference both historical experience and any significant change in scenarios that could affect the Company’s financial position or results of operations. Revisions in relation to accounting estimates are recognized in the period in which the estimates are reviewed, and in any future periods affected.

The main estimates and judgments that have a significant effect on the amounts recognized in the financial statements are as follows:

·Adjustments for loss on doubtful accounts – Note 8 to the Financial Statements;
·Deferred income tax and social contribution tax – Note 10 to the Financial Statements;
·Financial assets and liabilities of the concession – Note 14 to the Financial Statements;
·Concession contract assets – Note 15 to the Financial Statements;
·Investments – Note 16 to the Financial Statements;
·Property, plant and equipment (‘PP&E’) and useful life of assets – Note 17 to the Financial Statements;
·Intangible assets and useful life of assets – Note 18 to the Financial Statements;
·Leasing transaction – Note 19 to the Financial Statements;
·Amounts to be refunded to customers – Note 21 to the Financial Statements;
·Employee post-employment obligations –Note 24 to the Financial Statements;
·Provisions – Note 25 to the Financial Statements;
·Unbilled revenue – Note 27 to the Financial Statements;
·Financial instruments measurement and fair value measurement – Note 31 to the Financial Statements;
·Assets held for sale measurement – Note 32 to the Financial Statements.

 

105 

The settlement of the transactions involving those estimates may result in amounts that are significantly different from those recorded in the financial statements due to the uncertainty inherent to the estimation process. The Company reviews its significant estimates at least annually.

 

The main new accounting standards and interpretations

 

a)New accounting standards, interpretation or amendments of accounting standards, applied for the first time in 2020

 

The new accounting standards, interpretation or amendments of accounting standards, applied for the first time in 2020 had no impact on the consolidated financial statements of the Company. (See Note 2 of the financial statements).

 

b)Standards issued but not yet effective

The new and amended standards and interpretations that are issued, but not yet effective, up to the date of issuance of the Company’s financial statements are disclosed in the financial statements. The Company intends to adopt these new and amended standards and interpretations, if applicable, when they become effective. (See Note 2 of the financial statement).

 

Summary of significant accounting policies

The significant accounting policies described in the financial statements have been applied consistently to all the periods presented in the consolidated financial statements, except for the practices, which were applied prospectively as from 2020, in accordance with the standards and regulations previously described in this section. (See Note 2 of the financial statement)

The main accounting policies relating to the Company´s present operations that require judgment and the use of specific valuation criteria are the following:

 

Financial instruments

Financial instruments are classified, at initial recognition, as subsequently measured at amortized cost, fair value through other comprehensive income (‘OCI’), and fair value through profit or loss, depending on the financial asset’s contractual cash flow characteristics and the Company’s business model for managing them.

 

Fair value through profit or loss: this includes the concession financial assets related to distribution segment infrastructure. The financial assets related to energy distribution infrastruture are measured at the expected New Replacement Value (Valor Novo de Reposição, or ‘VNR’), as defined in the concession agreement, which represent the fair value of the residual value of the infrastructure as of the balance sheet date. The financial assets related to gas distribution infrastruture are measured based on the fair value of the indemnity established in the concession contract. The Company recognizes a financial asset resulting from a concession contract when it has an unconditional contractual right to receive cash or another financial asset from, or under the direction of the grantor for the services of construction and maintenance of the infrastructure.

This category also includes cash equivalents, marketable securities not classified at amortized cost, derivative financial instruments and indemnities receivable from the generation assets.

Cash and cash-equivalents comprise cash at banks and on hand and short-term highly liquid deposits, subject to an insignificant risk of changes in value, maintained to carry out the Company’s short-term cash management. The disclosures about the main assumptions used in fair value measurement are summarized in the respective notes.

106 

 

Derivative financial instruments (Swap transactions and call spread): The Company maintains derivative instruments to manage its exposure to the risks of changes in foreign currency exchange rates (US dollar). Derivative instruments are recognized initially at their fair value and the related transaction costs are recognized in the Statement of income when they are incurred. After initial recognition, derivatives are measured at fair value and changes in fair value are recorded in the Consolidated Statement of Income.

 

Derivative financial instruments (Put options) – The options to sell to CEMIG GT units of the FIP Melbourne and FIP Malbec funds (‘the SAAG PUT’) were measured at fair value using the Black-Scholes-Merton (BSM) method, using as reference the related put options obtained by the BSM model valued on its exercise date. See note 31 to the Financial Statements for further details.

 

Amortized cost: This includes accounts receivables from customers, traders and power transport concession holders; accounts receivable from Minas Gerais State; restricted cash; escrow deposits in litigation; marketable debt securities with the intention of holding them until maturity and the terms of their contracts originate known cash flows that constitute exclusively payments of principal and interest; concession financial assets related to generation concession grant fee; accounts receivable from related parties; suppliers; loans and debentures; debt agreed with the pension fund (‘Forluz’); concessions payable; the Minas Gerais State PRCT Tax Amnesty Program; advances from customers; assets and liabilities related to the CVA account and Other financial components in tariff adjustments; the low-income subsidy; reimbursement of tariff subsidies; and other credits.

Amortized cost is calculated by taking into account any discount or premium on acquisition and fees or costs that are an integral part of the effective interest rate (‘EIR’).

Gains and losses are recognized in profit or loss when the asset is derecognized, modified or impaired.

 

Receivables from customers, traders and power transport concession holders

Accounts receivable from customers, traders and power transport concession holders are initially recognized at the sales value and subsequently measured at amortized cost. These receivables are stated including sales tax and net of withholding taxes, which are recognized as recoverable taxes.

In order to estimate future losses on receivables, the Company adopted a simplified approach, considered that the accounts receivable from customers do not have significant financial components, and calculated the expected loss considering the historical average of non-collection over the total billed in each month (based on the last 24 months of billing), segregated by type of customer and projected for the next 12 months, taking into account the age of maturity of invoices, including those not yet due and unbilled.

The Annual Permitted Revenue (‘RAP’) is the consideration received as revenue from the investment in the national grid as well as the construction or upgrades, operation and maintenance services. The revenue from the energy transmission concession contracts is recognized when the performance obligation is satisfied. The contract asset is transferred to the financial asset, falling within the scope of IFRS 9, after the issuance of the credit notice, monthly issued by ONS, authorizing RAP billing, which is when the right to consideration is unconditional. The revenue is recognized at the transaction price and the assets are subsequently measured at amortized cost, using the effective interest method, adjusted by impairment losses, when applicable, and recognizing the deferred taxes. As required by IFRS 9 – Financial Instruments, the financial asset carrying amount is analyzed and, when applicable, a loss allowance for expected credit losses is recognized.

107 

The expected losses for overdue accounts of customers that renegotiated their debt is measured based on the maturity date of the original invoice, despite the new terms negotiated. Expected losses are fully recognized for accounts overdue for more than 12 months.

Expected losses for invoices unbilled, not yet due or less than 12 months past due are measured according to the potential default events, or losses of credit expected for the whole life of a financial instrument, if the credit risk has significantly increased since its initial recognition.

For large customers, the provision for doubtful receivables is recorded based on estimates by Management, in an amount sufficient to cover probable losses. The main criteria used by the Company are: (i) customers with significant open balances, the receivable balance is analyzed based on the debt history, negotiations in progress, and asset guarantees; and (ii) for large customers, an individual analysis of the debtors and the initiatives in progress to realize the receivables.

 

Concession assets

Energy and Gas Distribution segment: Concession infrastructure under construction are initially recorded as contract assets, in accordance with IFRS 15 and IFRIC 12, considering that the Company is entitled to consideration for performance completed to date, and, only when the construction phases ends, has the right to charge for the services provided to customers or receive an indemnity at the end of the concession period for assets not yet amortized. In accordance with IFRS 15 and IFRIC 12, construction revenues equivalent to new infrastructure are initially recorded as contract assets, measured at construction cost plus margin (which, for the construction business, is deemed as zero). Construction cost include borrowing costs.

The portion of the infrastructure to be amortized during the concession period is recorded as an intangible asset, as provided for in IFRIC 12 – Concession contracts, and is subsequently measured at cost less amortization. The amortization rates reflect the expected pattern of their consumption and are measured based on the asset carrying amount using the straight-line method, using the rates based on the expected useful life of the energy distribution assets that are used by the Regulator during the tariff process.

The Company recognizes a financial asset for the residual value of the infrastructure at the end of the concession, representing an unconditional right to receive cash or another financial asset directly from the grantor. This portion is subsequently measured at the estimated fair value, which represents the New Replacement Value (Valor Novo de reposição, or VNR), based on the Regulatory Remuneration Base of Assets ratified by the regulator (‘ANEEL’) in the tariff processes.

 

Transmission segment: When construction is finalized, concession infrastructure assets remains as contract asset, considering the existence of performance obligations during the concession period, represented by the network construction, operation and maintenance, as there is no unconditional right to receive the consideration for the construction service unless the company operates and maintains the infrastructure. The contract asset is reclassified as a financial asset (accounts receivable) only after the performance obligation to operate and maintain the infrastructure is satisfied, since from that point nothing more than the passage of time is necessary for the consideration to be received. The costs related to the infrastructure construction are recognized as incurred in the statement of income. The construction or upgrade services revenues are recognized in accordance with the stage of completion of the construction service, based on the costs actually incurred, including construction margin.

The margin added to the performance obligation related to the construction and improvements is based on Company’s expectations regarding its projects profitability.

When adjusting the amount of consideration for the concession contract asset financing component, the Company uses the discount rate which reflects the Company’s estimation of the financing of the transmission infrastructure investments. This reflects the rate that discounts the nominal amount of the consideration to the price that the customer would pay in cash for the goods or services when (or as) they transfer to the customer. The interest rates implicit in the contract are defined at the beginning of the investments and take into account the credit risk of the counterparties.

108 

When the tariff set is changed at the time of the periodic tariff reviews, the contract asset is remeasured, discounting the future revenue (RAPs) using the contract original discount rate, implicit in the contract. The amount remeasured is confronted to the carrying amount and the difference is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) at the date of the contract modification (the adjustment to revenue is made on a cumulative catch-up basis).

Consideration monthly received is allocated to revenue related to the operation and maintenance service and to the collection of the contract asset related to the construction service based on their relative fair value. Costs of expansion and upgrades of the infrastructure are recorded as contract assets.

 

Financial portion of remuneration and depreciation unpaid since the extensions of concessionsin in accordance with Law 12,783/2013: corresponding to the portion of remuneration and depreciation unpaid from the date of the extension of the concessions until it was incorporated into the Assets Remuneration Base (January 1, 2013 until June 30, 2017), to be paid over a period of eight years through the RAP.

The amounts to be received are subject to the applicable regulatory rules in the tariff process, including the mechanisms that monitor and measure efficiency. In this new context, the unconditional right to consideration depends on the satisfaction of the performance obligation to operate and maintain, and is, thus, characterized as a contractual asset.

 

Generation segment: The concession fee right paid for the concession contracts granted by ANEEL in November 2015 are classified as a financial asset, at amortized cost, as it represents an unconditional right to receive cash, adjusted by the IPCA index, and remuneratory interest, during the period of the concession.

 

Impairment

In assessing impairment of financial assets, the Company uses historical trends of the probability of default, timing of recovery and the amounts of loss incurred, adjusted to reflect management’s judgment as to whether current economic and credit conditions are such that the actual losses are likely to be greater or less than suggested by historical trends.

Additionally, management revises, annually, the carrying amount of non-financial assets, for the purpose of assessing if there is any indication, such as events or changes in the economic, operational or technological conditions that an asset may be impaired. If any indication exists, or when annual impairment testing of an asset is required, the Company estimates the asset´s recoverable amount. The recoverable amount of an asset or cash generating unit is defined as the higher between its value in use and its fair value less costs to sell. When the carrying amount of an asset or cash generating unit exceeds its recoverable amount, an impairment loss is recognized, adjusting the carrying amount of the asset or cash generating unit to its recoverable amount.

 

Employee benefits

The liability recorded in the consolidated statement of financial position related the Company’s retirement benefit pension plan obligations, is the greater of: (a) the amount to be paid in accordance with the terms of the pension plan for amortization of the actuarial obligations, and (b) the present value of the actuarial obligation, as calculated by a qualified actuary, less the fair value of the plan’s assets, and adjusted for unrecognized actuarial gains and losses. Expenses related to the debt agreed upon with the pension trust fund were recorded in finance income (expenses), because they represent financial interest and inflation adjustment. Other expenses related to the pension fund were recorded as operating expenses.

109 

The Company offers post-employment healthcare benefits to its employees as well as life insurance for active and retired employees. The expected costs of these benefits are accrued over the period of employment using the same accounting methodology that is used for defined benefit pension plans. These obligations are measured annually by a qualified independent actuary.

Actuarial gains and losses arising as a result of changes in actuarial assumptions are recognized in other comprehensive income.

Short-term benefits to employees: Employees’ profit sharing as determined in the Company’s by-laws are recorded in accordance with the collective agreement established with the employees’ union and recorded in employees’ and managers’ profit sharing in the statement of income.

 

Income tax and social contribution tax

The income tax and social contribution tax expenses represents the total amount of current and deferred taxes, which are presented separately in the financial statements. The Company is subject to the regular tax regime ‘Lucro Real’. However, its subsidiaries that can benefit from the favorable tax regime, according to tax law, analyze the payable tax projection for the next year, in order to determine the tax regime that reduces its taxes payment.

Deferred and current tax related to items recognized directly in equity or in other comprehensive income (OCI) are recognized directly in equity.

Periodically, in accordance with IFRIC 23, the Company and its subsidiaries evaluate positions taken in the tax returns with respect to situations in which applicable tax regulations are subject to interpretation and establishes provisions where appropriate.

 

Current

Current income tax assets and liabilities are measured at the amount expected to be recovered from or paid to the taxation authorities. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted at the reporting date.

Advances, or tax credits, are presented as current or non-current assets, in accordance with the expected date of their realization at the balance sheet date, when the tax amounts are duly calculated and offset against advances made.

 

Deferred

Deferred tax is recognized for temporary differences between the carrying amount of an asset or liability in the statement of financial position and its tax base at the reporting date.

Deferred tax liabilities are recognized for all the inter-temporal tax differences. Deferred tax assets are recognized for all the temporary differences deductible, to the extent that it is probable that future taxable profit will be available for the temporary differences to be offset, except:

·When the deferred tax (asset or liability) arises from the initial recognition of goodwill or an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting profit nor taxable profit or loss;
·In respect of taxable temporary differences associated with investments in subsidiaries, associates and interests in joint arrangements, when the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future;
·In respect of deductible temporary differences associated with investments in subsidiaries, associates and interests in joint arrangements, deferred tax assets are recognized only to the extent that it is probable that the temporary differences will reverse in the foreseeable future and taxable profit will be available against which the temporary differences can be utilized;
110 

·Theses taxes are measured at the tax rates that are expected to apply in the year when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted at the reporting date.

 

Deferred income tax and social contribution tax assets are reviewed at the reporting date, and are reduced to the extent that their realization is no longer probable.

 

The Company offsets deferred tax assets and deferred tax liabilities if and only if it has a legally enforceable right to set off current tax assets and current tax liabilities and the deferred tax assets and deferred tax liabilities relate to income taxes levied by the same taxation authority on either the same taxable entity.

 

Non-current assets classified as held for sale and discontinued operations

The Company classify non-current assets as held for sale when their carrying amount will be recovered, principally, through a sale transaction rather than through continuous use. This condition is met only when the asset (or group of assets) is available for immediate sale in its current condition subject only to usual and customary terms for the sale of the asset (or group of assets) and its sale is considered highly probable. Management must be committed to the sale which is expected to be completed within one year from the date of classification. Assets held for sale are measured at the lower of its carrying amount and fair value less costs to sell. Costs to sell are the incremental costs directly attributable to the disposal of an asset, excluding finance expenses and income tax expenses.

Fixed assets (PP&E) and Intangible assets are not depreciated or amortized as long as they are classified as held for sale. Assets and liabilities classified as held for sale are presented separately as current items in the Statement of financial position.

Dividends received from jointly controlled entities and affiliates, classified as held for sale, are recognized in the Income statement, in view of the discontinuation of measurement by the equity method, under IFRS 5.

A disposal group qualifies as discontinued operation if it is a component of an entity that either has been disposed of, or is classified as held for sale, and:

·Represents a separate major line of business or geographical area of operations;
·Is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations; or
·Is a subsidiary acquired exclusively with a view to resale.

 

Discontinued operations are excluded from the reported profit from continuing operations, and are presented as a single amount, after taxes, based on discontinued operations, in the statement of income.

Additional disclosures are presented in Note 32. All the other notes to the financial statements include amounts for continuing operations, except when otherwise stated.

 

Revenue recognition

In general, revenue from contracts with customers is recognized when the performance obligation is satisfied, at an amount that reflects the consideration to which the Company expects to be entitled in exchange for the goods or services transferred, which must be allocated to that performance obligation. The revenue is recognized only when it is probable that the Company will collect the consideration to which it is entitled in exchange for the goods or services transferred to the customer, considering the customer’s ability and intention to pay that amount of consideration when it is due.

111 

Revenues from the sale of energy are measured based on the energy supplied and the tariffs specified in the terms of the contract or in effect in the market. Revenues from supply of energy to final customers are recorded when the delivery has taken place. The billing is carried out monthly. Unbilled supply of energy, from the period between the last billing and the end of each month, is estimated based on the supply contracted and on the volume of energy delivered but not yet billed.

Historically, the differences between the estimated amounts and the actual revenues recognized are not significant.

Revenues from use of the distribution system (TUSD) received by the Company from other concession holders and other customers that use the distribution network are recognized in the period in which the services are provided. Unbilled retail supply of energy, from the period between the last measured consumption, according to the schedules specified in the concession regulation, and the end of each month, is estimated based on the billing from the previous month or the contractual amount.

The ‘Parcel A’ revenue and other financial components in tariff adjustments are recognized in the Statement of income when the energy acquisition costs effectively incurred are different from those considered by the Grantor to stablishes the energy distribution tariff.

Any adjustment of expected cash flows from the concession financial asset of the energy distribution concession contract is presented as operating revenue, together with the other revenues related to the energy distribution services.

Construction revenue – corresponds to the performance obligation to build the infrastructure, by the investments in concession assets made by the Company in the reporting period. Recognition of this revenue is directly related to the expenditure incurred on the addition of contractual assets.

Revenues from the sale of gas are measured based on the volume of gas sold and the tariffs specified in the terms of the contract. Revenues from supply of gas are recorded when the delivery has taken place, based on the volume measured and billed. The billing is carried out monthly. In addition, unbilled supply of gas, from the period between the last billing and the end of each month, is estimated based on the supply contracted and on the volume of gas delivered but not yet billed. Historically, the differences between the estimated amounts and the actual revenues recognized are not significant and are recorded in the following month.

Revenues from transmission concession services are recognized in the statement of income monthly, and includes:

·Construction revenue corresponds to the performance obligation to build the transmission infrastructure, recognized based on the satisfaction of performance obligation over time. They are measured based on the cost incurred, including PIS/Pasep and Cofins taxes over the total revenues and the profit margin of the project.
·Operation and maintenance revenue corresponds the performance obligation of operation and maintenance specified in the transmission concession contract, after termination of the construction phase. They are recognized when the services are rendered and he invoices for the RAPs are issued.
·Interest revenue in the contract asset recognized, recorded as transmission concession gross revenue in statement income. Revenue corresponds to the significant financing component in the contractual asset, and is recognized by the linear effective interest rate method based on the rate determined at the beginning of the investments, which is not subsequently changed. The average of the implicit rates is 6.68%. The rates are determined for each authorization and are applied on the amount to be received (future cash flow) over the contract duration. This includes financial updating by the inflation index specified for each transmission contract.

 

The services provided include charges for connection and other related services; the revenues are recognized when the services are rendered.

112 

The profit margin on operation and maintenance of transmission infrastructure is determined based on the individual sale price of the service, based on available information on the value of the consideration that the entity expects to have the right to, in exchange for the services promised to the client, in cases where the Company’s transmission subsidiaries have the right, separately, to the remuneration for the activity of operation and maintenance, as per IFRS 15 – Revenue from contracts with clients, and the costs incurred for the provision of services of operation and maintenance.

The Resolution ANEEL 729/2016 regulates the Variable Portion (‘Parcela Variável’ or ‘PV’), which is the pecuniary penalty applied by the grantor as a result of any unavailability’s or operational restrictions on facilities that are part of the National Grid and the surcharge corresponding to the pecuniary bonuses provided to concessionaries as an incentive to improve the transmissions facilities availability. The Company assessed the PV effects, based on historical data, and concluded that recognizing the occasional variable consideration arising from the PV estimated would not result in relevant account information. Therefore, for the both situations described, it is recognized as an adjustment to revenue, either as an increase in or a reduction of operation and maintenance revenue, when it occurs.

 

Leases

As from the IFRS 16 first adoption, on January 01, 2019, the Company assesses at contract inception whether a contract is, or contains, a lease. That is, if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Company applies a single recognition and measurement approach for all leases, except for short-term leases and leases of low-value assets.

When recording a lease operation, the lessee recognizes a liability to make the payments (a leasing liability) and an asset, representing the right to use the subject asset during the period of the leasing (an asset of right to use).

 

Right-of-use assets: Company recognizes right-of-use assets at the commencement date of the lease (i.e., the date the underlying asset is available for use). Right-of-use assets are measured at cost, less any accumulated amortization and impairment losses, and adjusted for any remeasurement of lease liabilities. The cost of right-of-use assets includes the amount of lease liabilities recognized, initial direct costs incurred, and lease payments made at or before the commencement date less any lease incentives received. Right-of-use assets are amortized on a straight-line basis over the shorter of the lease term and the estimated useful lives of the assets; as described in Note 19 to the Financial Statements.

If ownership of the leased asset transfers to the Company at the end of the lease term or the cost reflects the exercise of a purchase option, amortization is calculated using the estimated useful life of the asset.

 

Lease liabilities: At the commencement date of the lease, the Company recognizes lease liabilities measured at the present value of lease payments to be made over the lease term. The lease payments include fixed payments (including in substance fixed payments) less any lease incentives receivable, variable lease payments that depend on an index or a rate, and amounts expected to be paid under residual value guarantees. The lease payments also include the exercise price of a purchase option reasonably certain to be exercised by the Company and payments of penalties for terminating the lease, if the lease term reflects the Company exercising the option to terminate. Variable lease payments that do not depend on an index or a rate are recognized as expenses in the period in which the event or condition that triggers the payment occurs.

113 

In calculating the present value of lease payments, the Company uses its incremental borrowing rate at the lease commencement date because the interest rate implicit in the lease is not readily determinable. After the commencement date, the amount of lease liabilities is increased to reflect the accretion of interest and reduced for the lease payments made. In addition, the carrying amount of lease liabilities is remeasured if there is a modification, a change in the lease term, a change in the lease payments (e.g., changes to future payments resulting from a change in an index or rate used to determine such lease payments) or a change in the assessment of an option to purchase the underlying asset.

The Company recognize separately the expenses of interest on the leasing liability and the expense of depreciation of the asset of the right to use.

 

Short-term leases and leases of low-value assets: The Company applies the short-term lease recognition exemption to its short-term leases. It also applies the lease of low-value assets recognition exemption to leases that are considered to be low value. Lease payments on short-term leases and leases of low value assets are recognized as expense on a straight-line basis over the lease term.

 

Principal Factors Affecting our Financial Performance

Analysis of Energy Sales and Cost of Energy Purchased

Energy rates in Brazil, related to energy distributors’ sales to regulated customers, are set by ANEEL, which has the authority to readjust and review rates in accordance with the applicable provisions of the concession contracts. See “Item 4: The Brazilian Power Industry—Tariffs”.

We charge regulated customers for their actual energy consumption during each 30-day billing period at specified rates. Certain large industrial customers are charged according to the energy capacity contractually made available to them by us, with adjustments to those rates according to consumption during peak demand time, as well as capacity requirements that exceed the contracted amount.

In general, rates on energy that we purchase are determined by reference to the capacity contracted for as well as the volumes actually used.

The following table sets forth the average rate (in Reais per MWh) and volume (by GWh) components of energy sales and purchases for the periods indicated. The term ‘average rate’ refers to revenues for the relevant class of customers divided by the MWh used by such class and does not necessarily reflect actual rates and usage by a specific class of end-users during any particular period.

114 

 

Year ended December 31,

2020

2019 (Restated)

2018

(Restated)

Energy sales:      
Average rate to final customers (R$/ MWh)      
Industrial rate 327.62 320.04 276.61
Residential rate 899.31 917.41 843.28
Commercial rate 580.91 582.62 558.83
Rural rate 581.49 542.26 496.27
Public services rate and others 540.52 548.43 505.74
       
Total sales to final customers (GWh)      
Industrial customers 12,731 14,873 17,689
Residential customers 10,981 10,538 10,267
Commercial customers 8,571 9,335 8,380
Rural customers 3,766 3,795 3,615
Public services and other customers 3,319 3,634 3,571
Average rate (R$/ MWh) 584,18 569,76 501.32
Total revenues (R$million) 23,018 24,052 21,882
       
Sales to concession holders:      
Volume (GWh) 13,907 11,920 11,992
Average rate (R$/ MWh) 241.82 246.90 250.33
Total revenues (R$million) 3,363 2,943 3,002

 

 

Distribution Rates

CEMIG D's periodic tariff review takes place every five years and has the objective of re-evaluating the company's manageable costs, which primarily include the operating costs and the costs of fixed assets that comprise the remuneration and depreciation of these assets. In the tariff review, the regulator applies the methodology for defining efficient operating costs and evaluates the incremental investments made in the asset base since the last review, as well as the write-offs and depreciation of the existing assets, composing a new remuneration base.

On May 15, 2020, in view of the public calamity scenario resulting from the Covid-19 pandemic, CEMIG submitted a request to ANEEL to defer the application of the result of its tariff process until June 30, 2020, in order to mitigate the effects on consumers in its concession area, the tariff that was in force since May 2019 remaining. On June 25, 2020, ANEEL’s Board approved the result of CEMIG's readjustment with an average impact of 4.27%.

On August 5, 2020, CEMIG submitted to ANEEL a proposal for the reversal of R$714 million, for consumers in its concession area, regarding the financial component of reimbursement of Pasep / Cofins, with the objective of complying with contribute to low tariffs at a time when society as a whole was seeking to reduce the impacts of the pandemic. On August 18, 2020, ANEEL approved the readjustment with the insertion of this negative component reducing the average effect of CEMIG D’s 2020 tariff adjustment to zero. Such rate was effective starting on August 19, 2020 and it remains the same until May 27, 2021. Such updating had the following components: (i) an increase of 6.07% due to the Tariff Adjustment Index; (ii) an decrease of 14.31% due to the variation in Parcel A costs (CVA – non-manageable costs); and (iii) a increase of 8.24% related to other financial adjustments. The average annual tariff adjustments of CEMIG D in 2020, 2019 and 2018, and the revisions of their respective components were as follows:

115 

 

 

2020

2019

2018

Average annual/periodic tariff adjustment 0.00% 8.73% 23.19%

Components

     
Tariff adjustment index 6.07% 1.94% 13.30%
Inter-year variation in fixed costs (CVA) -14.31% 15.98% 4.59%
Other financial adjustments 8.24% -9.18% 5.30%

 

Transmission Rates

In January 2013, our transmission concession was renewed for another 30 years in accordance with the rules defined in Law 12,783/2013. At that time, there was an Extraordinary Review and transmission revenue was strictly reduced to the amount necessary to cover operation and maintenance costs, being part of the non-reversible assets indemnified.

In 2017, the capital cost of the reversible assets not yet amortized at the time of renewal of the transmission became part of the Allowed Annual Revenue (‘RAP’) of transmission concessionaires covered by Law 12,783/2013, according to rules defined in MME Administrative Rule no. 120/2016. This revenue consists of two components. One refers to the financial component, which corresponds to the cost of capital of the non-indemnified assets for the period from January 2013 to June 2017. During this period, the transmission company remained without any revenue for the assets made available that had not yet been indemnified. The second component, called the economic component, refers to the cost of capital to be paid to the end of the asset lifespan.

According to Technical Note No. 183/2017, appended to Resolution No. 2,258/2017, which ratified the RAP calculation for the 2017-2018 cycle, the total value of the cost of capital of assets not indemnified for this cycle was R$370.8 million.

Concerning the readjustment processes, the transmission concession agreement provides for a review every five years. The first review after the concession renewal was to occur in July 2018. However, this review occurred only in 2020 with a retroactive effect from July 2018. The methodology for this review was approved by Normative Resolution No. 816/2018, which covers a new criterion for valuation of the asset base and captures other revenues for tariff moderation. A new model for calculating operating costs is being discussed with the regulator. In July 2020, CEMIG GT’s RAP was increased by 15.7%. The main positive variations were observed in the Economic and Financial Component of the Annual Cost of Assets (‘CAA’) of Basic Network of the Existing System (‘BNES’), due to the change of the WACC and the reinclusion of the Ke parameter on the Financial Component, both effects of the Review process of the 2018-2023 cycle. The postponement of the RAP Review of the 2018-2023 cycle (which took place, as expected, in 2020) generated an Adjustment Portion of R$165 million, referring to the positive effects of the review on the revenue of the 2018-2019 and 2019-2020 cycles. This amount will be paid in three installments of R$55 million (June 2020 prices) in the 2020-2021, 2021-2022, and 2022-2023 cycles, adjusted by the IPCA. In CEMIG Itajubá case (concession contract No. 079/2000) there was awarded an adjustment of 6.5%, as the result of an inflation adjustment to the revenue previously approved based on the IGP-M index.

 

Exchange Rates

Substantially all of our revenues and operating expenses are denominated in Reais. However, we have some foreign currency-denominated debt. As a result, in reporting periods when the Real declines against the U.S. dollar or other foreign currencies in which our debt is denominated, our operating results and financial position can be adversely affected even with such foreign currency-denominated debt being hedged. Foreign exchange gain or loss and monetary variation gain or loss may affect our results of operations in periods in which there are wide swings in the value of the Real relative to the U.S. dollar or high inflation. We have a number of financial and other contracts under which we owe, or are entitled to, amounts in respect of monetary variation as measured by an index of price inflation in Brazil.

116 

Impacts of Covid-19

Overview

On March 11, 2020, the World Health Organization characterized Covid-19 as a pandemic, reinforcing the restrictive measures recommendations to prevent the virus dissemination worldwide. These measures are based, mainly, on social distancing, which have been causing major negative impact on entities, affecting their production process, interrupting their supply chains, causing workforce shortages and closing of stores and facilities. The economies around the world are developing measures to handle the economic crisis and reduce any possible effect, especially by their central banks and fiscal authorities.

 

Government measures aimed at Brazilian energy sector

Several measures were implemented by the Brazilian government, specifically aimed at energy sector, which include:

·The provisional normative act. 950/2020 issued on April 8, 2020, which provides for 100% discount in the calculation of social energy tariff (‘Tarifa Social de Energia Elétrica’), from April 1, 2020 to June 30, 2020, applicable to customers included in low-income residential subclass, with energy consumption less than or equal to 220 kWh/month. The act also authorizes the Federal Government to allocate resources to Energy Development Account (CDE), limited to R$900 million, to cover the tariff discounts established.
·Expansion on the limit of total amount of energy that can be declared by energy distributors in the process of the mechanism for the sale of surplus (‘Mecanismo de Venda de Excedentes’ - MVE), during 2020, from 15% to 30%, for the purpose of facilitating contractual reductions.
·Provision of financial resources available in the reserve fund in April 2020, by CCEE, in accordance with ANEEL Dispatch 986/2020, dedicated to reduce future regulatory fees. CEMIG D was granted with R$122 million.
·Under Resolution 878/2020, issued on March 24, 2020, the regulator has implemented some measures in an attempt to maintain the public service of energy supply, which include: prohibiting energy supply suspension due to default of certain categories of customers (residential), for 90 days, extended to July 31, 2020, prioritizing emergency assistance and energy supply to services and activities regarded as essential, drawing up specific contingency plans to assist health care units and hospital services, among others. Under Resolution 879/2020, issued in July 21, 2020, the regulator changed the Resolution 878/2020, as of August, 2020, maintaining the prohibition of energy supply suspension only to low income residential subclass, revoking the provisions applied to the other residential subclasses and related to services and activities regarded as essential.
·Authorization to create the ‘Covid-Account’ under the Decree 10,350/2020 issued on May 18, 2020, as detailed in the following topic.

 

Company’s initiatives

On March 23, 2020, the Company established the Coronavirus Crisis Management Committee (‘Comitê Diretor de Gestão da Crise do Coronavírus’) to ensure its readiness to making decisions because of the fast-changing situation, which became more widespread, complex and systemic.

Also, in line with recommendations to maintain social-distancing measures, the Company has implemented an operational contingency plan and several precautionary measures to keep its employees healthy and safe, including: security and health technicians contacting operational staff on a daily basis; interacting daily with subcontractors Social Service department to monitor the evolution of suspicious cases; changing the schedule to prevent gatherings; restricting national and international travel; suspending technical visits and events at Company&rsq