AES TIETE expansion plan in Brazil Case Solution
What are the strategic challenges AES Tiete is facing in early 2014? Why is AES pursuing the gas-fire power plant in Brazil?
AES bought Tiete in 1999 with the obligation to invest in generation expansion in the state of the Sao Paulo by adding 15% increase in capacity within 8 years but due to regulatory environment company unable to meet its obligation.
Furthermore, AES Tiete was facing increased rigorousness of the hydrological in year 2014 with a greater reduction on the reserves in Brazil hydroelectric as well as it acuired costly base thermal generation.
Moreover, the issues included limitation in generating the hydroelectric, shortages in water, rising the energy costs generated through the system. By locking at the figure 3 of the case study, it seems that the revenues have declined and costs are increasing
Therefore, they now decided to develop plans including the development of 500MW natural gas (thermo plant) to meet the demand in Brazil. The CEO stated that the company would be able to expand through acquisition, along with new projects and the wind solar power segment.
(b) Considering the base-case assumptions, should AES bid at the price of BRL50/MWh? What is the minimum price AES could bid and still meet its investment return target?
The project generates revenue for the company in two different streams first through capacity stream and second from variable cost stream. Majority of the capacity revenue in the total revenue of the project is the a sensitive factor. Currently, the base case plan of the project indicates that at 50 bid price, the company can generate around net present value of the project of $48.5 Million but in case the company offers 40 BRL/ MWh, then this would not be a value generating project as it would lead to a negative NPV. Through the base case calculation, it is identified that the company can raise return on interment of 13% from the energy project. Although the case does not specifies the required rate of return on investment however, 47 BRL/MWH is the minimum price where the company can earn around 9% in terms of return on investment.
Calculate the bidding price under the optimistic and pessimistic scenarios in which AES would be able to have same level of returns. Do you believe that AES should still pursue this power plant?
Under the optimistic plan, the calculation indicates that the project can generate up to net present value of around $53.3 million which seems to be a healthy profitability for the company. The returns are reasonable but the likelihood of such cases happening is very low therefore, the company should focus on base case analysis due to its higher probability. Apart from optimistic plan, the pessimistic plan indicates that the project would generate the positive NPV of $7 million, which provides clear basis for taking the decision by the company. The AES Corporation should proceed with the project as the negative perspective of the project generates good returns. The company has no option to reduce the bidding price from 50 BRL/MWh in pessimistic plan as the small reduction will turn the NPV negative. However, in optimistic plan, the company can offer 45.5 BRL/MWh, which would generate the same return as the pessimistic plan.
The major proportion of the projects expenses is related to the regulatory compliance cost which can be reduced by the company through recruit qualified advocates and they will assist the company to avoid non-compliances which in turn reduces cost. In addition to this, the company can renegotiate on its fixed cost like reduction in rental expenses, etc. Operational efficiencies are key to the success and in case of AES, the company should adopt the procedures, which would reduce the consumption of Gas Btu while converting it into MWh.
High bargaining power of Supplier:
This case indicates that the supplier or distributor of natural gas has the monopolistic powers in the Brazilian economy. The supplier can put pressure on the company to raise prices for their supplies, which in turn, would increase the operational cost of AES.
The company should negotiate better terms with the supplier and not create that contract, which would provide higher benefits to the supplier as well as balance would be maintained.
The natural gas prices based on demand and supply and fluctuation in the international market prices will directly affect the Brazilian prices which might affect the company......................
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