The Itaipú case: All you need to know

Paraguay and Brazil's 14GW Itaipú shared hydroelectric dam on the Paraná river, one of the largest generators in the world, has found itself in the midst of a huge controversy in recent weeks.

It all began on July 24, when the president of Paraguayan state-run power company Ande, Pedro Ferreira, was forced to resign from his post after he refused to ratify an agreement between Ande and Brasil's state-run electric company Eletrobras that had been signed by Paraguay's ambassador to Brazil, Hugo Saguier Caballero, and Brazil's foreign minister Pedro Miguel da Costa e Silva in May.

What local media described as a secret agreement covered the sales of the extra volume of energy produced by Itaipú to Eletrobras, which would cost Paraguay around US$300mn extra over the next three years, according to legislators from the country.

A scandal then emerged, bringing down the new head of Ande, Alcides Jiménez, Paraguay's foreign minister Luis Castiglioni, Saguier Caballero and the Paraguayan director of Itaipú, José Alderete. At its peak, the scandal seemed to be on the verge of bringing Paraguay's President Mario Abdo Benítez to an early end.

Tensions faded when authorities announced they were canceling the deal, with Brazilian ambassador Carlos Alberto Magalhães recognizing a decision by the Paraguayan state to unilaterally end the agreement.

Several analysts consulted by BNamericas agree that it is difficult to explain why the Paraguayan government would sign an agreement which includes such unfavorable terms for the country. The lack of a reasonable public explanation was so stark that it led a portion of the ruling party – the Honor Colorado movement – to briefly support impeachment proceedings against the president.

Why did Paraguay sign the deal?

According to Caio Pizzetta Torres, political risk analyst at Control Risks, a possible explanation may lie in the fact that the original agreement, which set the framework for how Itaipú’s energy is split and sold, expires in 2023, by which time it will have to be renegotiated by the two governments.

The agreement could thus be seen as “a sign of diplomatic goodwill towards the Brazilian government” to try and gain an advantage in the upcoming negotiations, Torres told BNamericas.

However, if this was the objective, it backfired. “The Brazilian position in this situation is quite comfortable to be honest,” Torres said. The fact that President Jair Bolsonaro's government quickly agreed to backpedal on the agreement and help save Abdo's presidency will now give it the upper hand in the negotiations. “Brazilian diplomacy will certainly not forget this gesture going forward,” Torres said.

Manuel Ferreira, president of economic consulting firm MF and a former finance minister of Paraguay under previous president Federico Franco, told BNamericas that Brazil is applying heavy pressure on Paraguayan authorities to roll back a deal agreed by both countries in 2009.

“There's a sort of consensus in Brazil that the country has financed Paraguay’s growth in the last 15 years” through the favorable Itaipú deal, Ferreiro said. But he argues that most of Paraguay's growth has actually come from the country’s agribusiness sector and not the industrial sector, and the majority of growth in energy demand has been residential. 

How could a single power plant hold so much sway over a country? The history of Itaipú is unique in the fact that seldom has a country relied so heavily on a single generator. It is thus unlikely that this will be the last time the dam spells trouble for Paraguay in its relationship with its much larger neighbor. But the dam itself takes a backstage role in an unstable political situation in which the ruling Colorado party is struggling to keep its coalition in check.

Instability within Paraguay's government

The Colorado party is split into two main factions: Colorado Añetete, the faction of Abdo, and Honor Colorado, led by former president Cartes. “The alliance that holds the government together is very fragile and based on a power-sharing agreement,” said Torres of Control Risks. As Honor Colorado felt the secret deal was unjustifiable, it turned against the president and decided to support impeachment.

“You could also argue that the members of Honor Colorado saw an opportunity to undermine the government and maybe increase their influence over the president, which is probably what's going to happen going forward. So, it's likely that Mario Abdo will be much more dependent on political agreements with this other faction within his own party.”

Mariano Machado, a senior political analyst at Verisk Maplecroft, concurs. “The inherent tension that exists within the Colorado party has proven to have immediate political consequences,” he told BNamericas, “forcing the president to let go of key aides.”

For this reason, Maplecroft expects volatility to persist in the ruling coalition and believes that it could increase if former Cartes can enter congress, a process that has so far been impeded by concerns that the constitution bars a former president from becoming an active senator.

Maplecroft's corruption risk index for Paraguay.

The history of Itaipú

In order to understand the scandal fully, we must first recap the history of the dam itself. Itaipú was agreed upon in 1973 and completed in 1984, when both countries were ruled by military dictatorships, under a binational operating framework.

However, on the Paraguayan side the deal was always deemed to be lopsided, as Paraguay had to give up territory and displace native communities as a consequence of the huge reservoir created behind the US$20bn dam.

Itaipu's generation far exceeds Paraguay’s energy needs. As an example, national demand usually hovers around 2,500-3,500GWh a month, while the plant's production (which is split 50-50 between the two countries) was close to 8,000GWh per month last year. And Paraguay does not have the infrastructure in place to draw all of its energy from a single source. This means a significant part of the Paraguayan share of around 4,000MWh is instead sold back to Eletrobras by Ande. The price and terms of these energy sales are the origins of the controversy.

The original agreement, signed after the dam’s construction, specified a framework for determining costs that set two price brackets. The first is for the minimum energy the dam can produce under any scenario, known as “guaranteed energy.” Since this power will be sold no matter what, the deal adds the permanent costs associated with the plant’s operation to this price, including its rolling debt. This makes for a final price of around US$44/MWh. When the threshold is passed, the rest of the energy – the surplus – is sold at a price of US$6/MWh, just enough to recover the royalty costs for the use of the river.

Under the original agreement, each country had access to 50% of the guaranteed energy and 50% of the surplus. But the deal was renegotiated by former Brazilian president Luiz Inácio Lula da Silva and his Paraguayan counterpart Fernando Lugo in 2009. The new framework establishes that Brazil will buy most of its consumption from the guaranteed (and most expensive) portion.

For the share of the guaranteed energy that belongs to Paraguay, Brazil pays US$44/MWh to Itaipú plus an additional export fee of around US$9/MWh to the Paraguayan government. This allows Paraguay to buy most of its consumption from the surplus allotment, which means the energy it draws is much cheaper. That agreement took payments from Brazil to Paraguay from US$120mn to around US$360mn each year.

A breakdown of Itaipú's US$44MWh guaranteed energy price.

The deal was compensation from the Brazilian side for the fact the country suspended its payments to the dam in the 1990s during its domestic economic turmoil. This meant Itaipú had to acquire more debt, which was then refinanced with payments until 2022, said Ferreiro. But the new debt was shared by both countries equally, a decision Paraguayans see as unfair.

On the Brazilian side, in contrast, the fact that Brazil has been paying a higher price for Itaipú’s power is sometimes decried as subsidizing Paraguay’s development. After President Jair Bolsonaro took office in January, the Lula deal quickly came under fire from the new administration.

The "secret" agreement between both countries that sparked the current controversy was the cancellation of the terms offered by Lula and a return to the original terms set when the dam was built, in which each country gets 50% of the guaranteed energy and 50% of the surplus production.

This would mean up to US$200mn less in payments from Brazil to Paraguay and potential economic troubles for Ande. This, in turn, could mean higher household bills and more power outages, an issue that has already been plaguing Paraguay in recent years.

The 2023 renegotiation

According to Ferreiro, the fact that Itaipú’s debt will be paid off in 2022 will mean the energy generated by the plant will be much cheaper from that point onward. Total costs for the operation would fall from about US$3.5bn annually to approximately US$1.5bn. This means the cost of guaranteed energy will go down from US$44/MWh to about US$17-18/MWh.

While the Brazilian position is very clear – it wants cheaper energy – the Paraguayan position is less so. It is estimated the country would have to invest around US$3bn in transmission and distribution infrastructure but it still couldn't use its entire share due to a lack of demand.

Paraguay's generation and demand.

Therefore, part of the new agreement that Paraguay may try to push is to allow for the country to sell its share of the energy directly in the Brazilian market or to other offtakers in the region (Argentina, Uruguay, Chile) at a higher price. The current treaty only allows for this if Eletrobras turns down the offer to buy Paraguay’s portion, which never happens.

Another option for Paraguay would be to maintain the energy costs of Itaipú at US$44/MWh and turn the portion currently allocated to debt into royalties that each country can keep. This could help the country bolster its public finances, Ferreira said.

Whatever position the country takes in the coming years, one thing is clear: negotiating with a country as big as Brazil, and especially with the Bolsonaro administration, will be no easy task.