Form 20-F
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, 2017

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)

Avenida Barbacena, 1200, Belo Horizonte, M.G., 30190-131

(Address of principal executive offices)

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

 

Title of each class:    Name of exchange on which registered:

 

  

 

Preferred Shares, R$5.00 par value    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    New York Stock Exchange*
American Depositary Shares, each representing 1 Common Share, without par value    New York Stock Exchange


Table of Contents

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:

487,614,213 Common Shares

971,138,388 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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 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 ☒

 

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

 

 

 

 


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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

   39

Item 4A.

  

Unresolved Staff Comments

   102

Item 5.

  

Operating and Financial Review and Prospects

   102

Item 6.

  

Directors, Senior Managers and Employees

   135

Item 7.

  

Major Shareholders and Related Party Transactions

   147

Item 8.

  

Financial Information

   151

Item 9.

  

Offer and Listing

   161

Item 10.

  

Additional Information

   166

Item 11.

  

Quantitative and Qualitative Disclosures about Market Risk

   183

Item 12.

  

Description of Securities Other than Equity Securities

   185

PART II

     

Item 13.

  

Defaults, Dividend Arrears and Delinquencies

   187

Item 14.

  

Material Modifications to the Rights of Security Holders and Use of Proceeds

   187

Item 15.

  

Controls and Procedures

   187

Item 16A.

  

Audit Committee Financial Expert

   192

Item 16B.

  

Code of Ethics

   192

Item 16C.

  

Principal Accountant Fees and Services

   192

Item 16D.

  

Exemptions from the Listing Standards for Audit Committees

   193

Item 16E.

  

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

   193

Item 16F.

  

Change in Registrant’s Certifying Accountant

   193

Item 16G.

  

Corporate Governance

   194

Item 16H.

  

Mine Safety Disclosure

   195

Item 17.

  

Financial Statements

   195

Item 18.

  

Financial Statements

   195

Item 19.

  

Exhibits

   196

 

 

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PRESENTATION OF FINANCIAL INFORMATION

Companhia Energética de Minas Gerais – CEMIG is a sociedade por ações, de economia mista (a state-controlled mixed capital company) 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$” are to Brazilian reais (plural) and the Brazilian real (singular), the official currency of Brazil, and references to “U.S. dollars,” “dollars” or “US$” 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 (or “IFRS”), as issued by the International Accounting Standards Board (“IASB”). For purposes of this annual report, we prepared the consolidated statements of financial position as of December 31, 2017 and 2016 and the related consolidated statements of income and comprehensive income, changes in equity and cash flows for the years ended December 31, 2017, 2016 and 2015, in reais in accordance with IFRS, as issued by the IASB.

Ernst & Young Auditores Independentes S.S. (“EY”) audited our consolidated financial statements as of December 31, 2017. Deloitte Touche Tohmatsu Auditores Independentes (“Deloitte Touche Tohmatsu”) audited our consolidated financial statements as of December 31, 2016 and 2015; EY and Deloitte Touche Tohmatsu did not audit the financial statements of Madeira Energia S.A. and Norte Energia S.A. as of December 31, 2017, 2016 and 2015, which are investments of the Company accounted for under the equity method. The financial statements of Madeira Energia S.A. and Norte Energia S.A. were audited by PricewaterhouseCoopers Auditores Independentes, whose reports related to the financial statements of Madeira Energia S.A. as of December 31, 2017, 2016 and 2015 and to the financial statements of Norte Energia S.A. as of December 31, 2017, 2016 and 2015, have been presented to EY and Deloitte Touche Tohmatsu and are the sole base for the opinion of EY and Deloitte Touche Tohmatsu on the financial statements of Madeira Energia S.A. and Norte Energia S.A..

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$3.3121 to US$1.00, as certified for customs purposes by the U.S. Federal Reserve Board as of December 29, 2017. 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.

 

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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, 2017 and 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


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FORWARD-LOOKING INFORMATION

This annual report includes certain forward-looking statements, mainly in “Item 3. Key Information,” “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”), the State of Rio de Janeiro ( “Rio de Janeiro”), as well as other states in Brazil;

 

    inflation and fluctuations in exchange rates and in interest rates;

 

    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 anti-corruption investigations in Brazil;

 

    our expectations and estimates concerning future financial performance and financing plans;

 

    our level, or maturity profile, of indebtedness;

 

    the likelihood that we will receive payment in connection with accounts receivable;

 

    our capital expenditure plans;

 

    our ability to satisfactorily serve our customers;

 

    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 or merge into our operations;

 

    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 and Rio de Janeiro;

 

    changes in rainfall and the water levels in the reservoirs used to run our hydroelectrical 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; and

 

    other risk factors identified in “Item 3. Key Information – Risk Factors.”

The forward-looking statements referred to above also include information with respect to our capacity expansion projects that are under way and those that we are currently evaluating. In addition to the above risks and uncertainties, our potential expansion projects involve engineering, construction, regulatory and other significant risks, which may:

 

    delay or prevent successful completion of one or more projects;

 

    increase the costs of projects; and

 

    result in the failure of facilities to operate or generate income in accordance with our expectations.

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. In light of 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


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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

Selected Consolidated Financial Data

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, 2017 and 2016 and for each of the years ended December 31, 2017, 2016 and 2015, 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. Unless indicated otherwise, these U.S. dollar amounts have been translated from reais at R$3.3121 per US$1.00, the exchange rate as of December 29, 2017. The real has historically experienced high volatility. We cannot guarantee that U.S. dollars can or could have been converted into reais, or that reais can or could have been converted into U.S. dollars at the above rate or at any other rate. The selected consolidated financial data as of December 31, 2015, 2014 and 2013 and for each of the years ended December 31, 2014 and 2013 has been derived from our audited consolidated financial statements not included in this annual report on Form 20-F.

Consolidated Statement of Income Data

 

     Year ended December 31,  
     2017     2017     2016     2015     2014     2013  
     (in millions
of US$)(1)
    (in millions of R$ except per share/ADS
data or otherwise indicated)
 

Net operating revenue

    

Energy sales to final customers

     6,171       20,438       20,458       20,319       14,922       12,597  

Revenue from wholesale supply to other concession holders

     985       3,263       2,972       2,207       2,310       2,144  

CVA (compensation for changes in ‘Portion A’ items) and other financial components in tariff increases

     298       988       (1,455     1,704       1,107       —    

Revenue from use of the energy distribution systems (TUSD)

     486       1,611       1,705       1,465       855       1,008  

Transmission concession revenue

     112       371       312       261       557       404  

Transmission indemnity revenue

     113       373       751       101       420       21  

Generation indemnity revenue

     82       272       —         —         —         —    

Adjustment to expectation of cash flow from indemnifiable Financial asset of the distribution concession

     3       9       8       576       55       —    

Revenue from financial updating of the Concession Grant Fee

     96       317       300       —         —         —    

Construction revenue

     338       1,119       1,193       1,252       941       975  

Energy transactions on the CCEE

     260       860       161       2,425       2,348       1,193  

Supply of gas

     531       1,759       1,444       1,667       422       —    

Other operating revenues

     448       1,483       1,421       1,440       1,284       1,047  

Deductions from revenue

     (3,367     (11,151     (10,497     (11,549     (5,626     (4,762

Total net operating revenue

     6,556       21,712       18,773       21,868       19,595       14,627  

 

 

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     Year ended December 31,  
     2017     2017     2016     2015     2014     2013  
     (in millions
of US$)(1)
    (in millions of R$ except per share/ADS
data or otherwise indicated)
 

Operating costs and expenses

            

Energy purchased for resale

     (3,297     (10,919     (8,273     (9,542     (7,428     (5,207

Charges for use of the national grid

     (354     (1,174     (947     (999     (744     (575

Depreciation and amortization

     (257     (850     (834     (835     (801     (824

Personnel

     (491     (1,627     (1,643     (1,435     (1,252     (1,284

Gas purchased for resale

     (323     (1,071     (877     (1,051     (254     —    

Outsourced services

     (294     (974     (867     (899     (953     (917

Post-retirement obligations

     69       229       (345     (156     (212     (176

Materials

     (18     (61     (58     (154     (381     (123

Operating provisions, net

     (258     (854     (704     (1,402     (581     (305

Employee’ and managers’ profit sharing

     (2     (5     (7     (137     (249     (221

Infrastructure construction costs

     (338     (1,119     (1,193     (1,252     (942     (975

Other operating expenses, net

     (119     (393     (155     (426     (651     (624

Total operating costs and expenses

     (5,682     (18,818     (15,903     (18,288     (14,448     (11,231

Share of (loss) profit, net, of associates and joint ventures

     (76     (252     (302     393       210       764  

Gain on acquisition of control of investee

     —         —         —         —         281       —    

Gain on disposal of equity investment

     —         —         —         —         —         284  

Unrealized gain on disposal of investment

     —         —         —         —         —         (81

Impairment loss on Investments

     —         —         (763     —         —         —    

Fair value gain on shareholding transaction

     —         —         —         729       —         —    

Income before finance income (expenses) and taxes

     798       2,642       1,805       4,702       5,638       4,363  

Finance income (expenses), net

     (301     (996     (1,437     (1,340     (1,159     (309

Income before income tax and social contribution tax

     497       1,646       368       3,362       4,479       4,054  

Income taxes expense

     (194     (644     (34     (893     (1,342     (950

Net income for the year

     303       1,002       334       2,469       3,137       3,104  

Other comprehensive income (loss)

     (91     (302     (553     (307     (41     213  

Comprehensive income

     212       700       (219     2,162       3,096       3,317  

Basic earnings:

            

Per common share

     0.11       0.37       0.10       1.96       2.49       2.47  

Per preferred share

     0.25       0.84       0.35       1.96       2.49       2.47  

Per ADS common share

     0.11       0.37       0.10       1.96       2.49       2.47  

Per ADS preferred share

     0.25       0.84       0.35       1.96       2.49       2.47  

Diluted earnings:

            

Per common share

     0.11       0.37       0.07       1.96       2.49       2.47  

Per preferred share

     0.25       0.84       0.32       1.96       2.49       2.47  

Per ADS common share

     0.11       0.37       0.07       1.96       2.49       2.47  

Per ADS preferred share

     0.25       0.84       0.32       1.96       2.49       2.47  

 

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Statement of Financial Position Data

 

     Year ended December 31,  
     2017     2017     2016     2015      2014      2013  
     (in millions
of US$)(1)
    (in millions of R$ except per share/ADS
data or otherwise indicated)
 

Assets

              

Current assets

     2,578       8,537       8,285       9,377        6,554        6,669  

Property, plant and equipment, net

     834       2,762       3,775       3,940        5,544        5,817  

Intangible assets

     3,368       11,156       10,820       10,275        3,379        2,004  

Concession financial assets

     1,994       6,605       4,971       2,660        7,475        5,841  

Other assets

     3,979       13,180       14,185       14,605        12,048        9,483  

Total assets

     12,753       42,240       42,036       40,857        35,000        29,814  

Liabilities

              

Current loans financing and debentures

     716       2,371       4,837       6,300        5,291        2,238  

Other current liabilities

     1,899       6,292       6,610       6,774        4,832        3,684  

Total current liabilities

     2,615       8,663       11,447       13,074        10,123        5,922  

Non-current loans financing and debentures

     3,631       12,027       10,342       8,866        8,218        7,219  

Non-current post-retirement obligation

     1,194       3,954       4,043       3,086        2,478        2,311  

Other non-current liabilities

     986       3,266       3,270       2,843        2,896        1,724  

Total non-current liabilities

     5,811       19,247       17,655       14,795        13,592        11,254  

Share capital

     1,900       6,294       6,294       6,294        6,294        6,294  

Capital reserves

     581       1,925       1,925       1,925        1,925        1,925  

Profit reserves

     1,730       5,729       5,200       4,663        2,594        3,840  

Equity valuation reserve

     (252     (837     (489     102        468        579  

Subscription of shares to be capitalized

     367       1,215       —         —          —          —    

Equity attributable to non-controlling interests

     1       4       4       4        4        —    

Total equity

     4,327       14,330       12,934       12,988        11,285        12,638  

Total liabilities and equity

     12,753       42,240       42,036       40,857        35,000        29,814  

Other data

 

     2017      2016      2015      2014      2013  

Outstanding shares basic:

              

Common (3)

     487,614,144        420,764,639        420,764,639        420,764,639        420,764,639  

Preferred (3)

     970,577,739        837,516,297        837,516,297        837,516,297        837,516,297  

Dividends per share

              

Common

     R$0.03        —          R$0.50        R$0.63        R$1.28  

Preferred

     R$0.50        R$0.50        R$0.50        R$0.63        R$1.28  

Dividends per ADS common

     R$0.03        —          R$0.50        R$0.63        R$1.28  

Dividends per ADS preferred

     R$0.50        R$0.50        R$0.50        R$0.63        R$1.28  

Dividends per share (2)

              

Common

     US$0.01        —          US$0.13        US$0.24        US$0.48  

Preferred

     US$0.15        US$0.15        US$0.13        US$0.24        US$0.48  

Dividends per ADS (2) common

     US$0.01        —          US$0.13        US$0.24        US$0.48  

Dividends per ADS (2) preferred

     US$0.15        US$0.15        US$0.13        US$0.24        US$0.48  

 

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     2017      2016      2015      2014      2013  

Outstanding shares—diluted:

              

Common (3)

     487,614,144        420,764,639        420,764,639        420,764,639        420,764,639  

Preferred (3)

     970,577,739        837,516,297        837,516,297        837,516,297        837,516,297  

Dividends per share diluted

              

Common

     R$0.03        —          R$0.50        R$0.63        R$1.28  

Preferred

     R$0.50        R$0.50        R$0.50        R$0.63        R$1.28  

Dividends per ADS diluted common

     R$0.03        —          R$0.50        R$0.63        R$1.28  

Dividends per ADS diluted Preferrend

     R$0.50        R$0.50        R$0.50        R$0.63        R$1.28  

Dividends per share diluted (2)

              

Common

     US$0.01        —          US$0.13        US$0.24        US$0.48  

Preferred

     US$0.15        US$0.15        US$0.13        US$0.24        US$0.48  

Dividends per ADS diluted common (2)

     US$0.01        —          US$0.13        US$0.24        US$0.48  

Dividends per ADS diluted preferred (2)

     US$0.15        US$0.15        US$0.13        US$0.24        US$0.48  

 

(1) Converted at R$3.3121 /US$, the exchange rate on December 29, 2017. 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) For the year ended December 31, 2017 was included new shares issued through capital increase. Please See “Item 4. Information on the Company”

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”.

 

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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  

2013

     1.9480        2.4464        2.1570        2.3608  

2014

     2.1940        2.7306        2.3498        2.6563  

2015

     2.5644        4.1638        3.3360        3.9593  

2016

     3.4112        4.1299        3.4839        3.2532  

2017

     3.0557        3.3823        3.1916        3.3121  

 

     Reais per US$1.00  

Month

   Low      High      Average      Period end  

November 2017

     3.2055        3.3132        3.2629        3.2843  

December 2017

     3.2338        3.3396        3.2950        3.3121  

January 2018

     3.1470        3.2620        3.2115        3.1782  

February 2018

     3.1718        3.3083        3.2507        3.2428  

March 2018

     3.2191        3.3370        3.2790        3.3045  

April 2018 (through April 27, 2018)

     3.3149        3.5090        3.4051        3.4685  

 

Source: U.S. Federal Reserve Board.

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

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 received by us 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.

On September 22, 2004, while the rules established by Law No. 9,074 of July 7, 1995 were still in force, we requested a 20 years extension from ANEEL of the concessions to the Emborcação and Nova Ponte hydroelectrical plants. On January 14, 2007, ANEEL approved the required extension as of July 24, 2005.The related concession contract was amended on October 22, 2008, to reflect these extensions.

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, at the option of the concession authority.

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 are: Três Marias, Salto Grande, Itutinga, Volta Grande, Camargos, Peti, Piau, Gafanhoto, Tronqueiras, Joasal, Martins, Cajuru, Paciência, Marmelos, Dona Rita, Sumidouro, Poquim and Anil.

 

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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 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’: 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 PM 579, the Company understands 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, our subsidiary CEMIG Geração e Transmissão S.A. (“CEMIG GT”) has filed for a judicial order of mandamus (Writ of Mandamus No. 20,432/DF) 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 Hydroelectrical 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.

On September 3, 2013 the Company was awarded an interim judgment that entitled it to continue commercial operation of the Jaguara plant until a judgment was issued by the courts on the writ of mandamus. On May 27, 2015 there was a decision on the matter, denying CEMIG GT’s request. Prior to the publishing of this decision, which would have prevented the filing of the appropriate appeal, CEMIG GT appealed to the Federal Supreme Court (Supremo Tribunal Federal, or STF) for a provisional remedy with interim injunction requesting a permission to continue operating and managing the power plant. The interim injunction was granted on December 21, 2015. The Action for Provisional Remedy itself has not yet been judged. With the publication of the result of the judgment on February 15, 2016, Cemig GT filed an Ordinary Appeal to the STF on March 1, 2016. On March 21, 2017, the interim remedy given in the Action for Provisional Remedy referred to above was revoked by the Reporting Justice.On November 21, 2017, the 2nd Panel of the STF ruled that the application for mandamus should be dismissed, but this is not a final decision as it requires a full panel to decide. As soon as the full panel judgment is published, the Company will assess the possibility of appeal.

Considering that the São Simão Hydroelectrical Plant (‘the São Simão Plant’) concession of Cemig GT will expire shortly, Cemig GT filed an order of mandamus against an act of the MME, in order to ensure its right to extend the concession of this plant, under Clause 4 of Generation Concession Contract No. 007/1997, obeying the original bases of this contract, which were prior to Law 12,783/13. On December 19, 2014 the Superior Court of Justice (Superior Tribunal de Justiça, or “STJ”) granted Cemig GT an interim relief which allowed it to continue in control of the commercial operations of the São Simão Plant. This decision was reviewed, and overturned, by the Reporting Justice on June 30, 2015. The judgment of the merit of this action has not begun. The Reporting Justice, considering the STF decision on the interim relief of the Jaguara Plant, on December 21, 2015, served notice on Cemig GT to make a statement on the suspension of this order of mandamus relating to the São Simão Plant. On 09/08/2016, Cemig GT, stated its interest in the suspension, but requested an interim remedy with the same outcome that was employed in the case of the Jaguara Plant was granted, i.e. keeping Cemig GT as holder of the concession of the São Simão Plant, on the same terms as the Jaguara Plant, obeying the original bases of the Generation Concession Contract No. 007/1997, prior to Law 12,783/2013. On 08/03/2017, the injunction was granted by the Reporting Justice to allow CEMIG GT to retain ownership of the São Simão concession, under the initial bases of Concession Contract No. 007/1997, until the conclusion of the judgment. On March 28, 2017, that interim injunction was revoked. On December 13, 2017, the First Section of the STJ ruled to deny Cemig’s request. CEMIG GT appealed again to the Federal Supreme Court (Supremo Tribunal Federal, or STF). As of the date of this report, there has been no judgment on the merits of this action.

On December 21, 2016, Cemig GT filed an application for mandamus, requesting interim relief, against an act practiced by the Mining and Energy Minister that was unlawful and violated the plaintiff’s net and certain right – with the objective of obtaining extension of the period of concession of the Miranda Hydroelectrical Power Plant, on the basis of Clause 4 of the Generation Concession Contract No. 007/1997. Cemig GT was granted an interim remedy to continue commercial operation of the Miranda Plant until a final judgment would be given on this application for mandamus. In response to a motion for revision of judgment brought by the Federal Government against the internal appeal, the Reporting Justice revoked this interim remedy on March 29, 2017. As of the date of this report, there has been no judgment on the merits of this action.

 

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On February 21, 2017, Cemig GT made a renewal request to the MME, renewing its administrative application for extension, for a term of 20 (twenty) years, of the concessions of the Jaguara, São Simão and Miranda hydroelectrical plants pursuant to Clause 4 of Generation Concession Contract No. 007 of 1997. In this renewal request, which reaffirms the Company’s interests in these plants, Cemig GT also made an alternative request, in the event the application is denied, for the concession of these hydroelectrical plants to be transferred/granted to one of its subsidiaries, for the purposes specified by Paragraph 1-C of Article 8 of Law 12,783/13 (as amended by Law 13,360 of November 17, 2016), which enables the Federal Government to grant a power generation concession for 30 years when associated with transfer of control of a legal entity providing this service which is under direct or indirect control of a State, the Federal District or a municipality.

On September 27, 2017, the Brazilian Federal Government auctioned the concessions of the São Simão, Jaguara, Miranda and Volta Grande hydroelectrical 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 was a third party unrelated to CEMIG. Ownership of these concessions would be transferred from CEMIG to the winning bidders on December 30, 2017.

CEMIG GT understands that it complied with the requirements to maintain the concessions of the São Simão, Jaguara and Miranda power plants, which were each subject to automatic renewals. Several legal actions, public acts and negotiation meetings were held with MME e ANEEL in order to seek a solution to the litigation that has extended since 2012. In the case of Volta Grande, CEMIG GT has also worked intensively to negotiate renewal terms for that concession. Despite the outcome of the auction, CEMIG GT plans to continue to assert its rights with respect to this concession in court. Following the legal actions in progress in the STF and the STJ, cases were brought in the administrative and the judicial sphere related to the indemnity to which the Company is entitled.

On August 3, 2017, the MME established the amounts of the indemnity owed to CEMIG GT for investments made in the São Simão and Miranda power plants. The total amount of the indemnity has been calculated at R$1.028 billion, of which R$243.59 million relates to the residual value the São Simão plant and R$784.15 million relates to the indemnity for the Miranda plant. These amounts are as of September 2015 and December 2016, respectively, and are to be adjusted by the IPCA inflation index and by the Selic rate. However, payment is conditional on budgetary and financial availability of public funds and is subject to administrative and judicial challenges and there can be no assurance as to when such amounts will be paid.

Our initial estimates indicate that these amounts are insufficient to cover Cemig’s investment, therefore on August 17, 2017 we filed a hierarchy appeal that has not yet been judged. On November 27, 2017 Cemig GT filed a Prior Provisional Remedy in order to obtain an order for the Federal Government to disclose the basis for calculation of the indemnity for Jaguara, Miranda, São Simão and Volta Grande Hydroelectrical Power Plants, and also immediately deposit the non-contested portion of the indemnity, which had been set at R$1.028 billion.On November 29, 2017 the application for this remedy was denied and Cemig GT filed an Interlocutory Appeal that is currently pending judgment. Additionally, on January 17, 2018 Cemig amended the writ: (i) to file additional support for the disclosure of the calculation; (ii) applying for declaration of nullity of Article 1, §§1 and 2, and Article 2, of the Mining and Energy Ministry Order No. 291/2017, and consequent payment of indemnity to include all the investments made by Cemig GT in the concession; and (iii) requesting immediate payment of the non-contested amount.

Regarding transmission activities, on December 4, 2012, the Company signed the second amendment to Transmission Concession Agreement No. 006/1997, extending the concession for 30 years as of January 1, 2013. The concession extension resulted in a reduction of the Permitted Annual Revenue (Receita Anual Permitida, or RAP), which decreased from R$ 485 million (in June 2012) to R$ 296 million (in June 2016). The Brazilian Government has compensated us for the reduction of the RAP of part of those concessions, but the assets in operation before the year of 2000 have not been compensated yet. In our view, Law 12,783/13 states that the Federal Government is required to compensate us, using the IPCA index as basis, RAP reductions of assets operating before 2000 within a 30 year period. According to Brazilian Mining and Energy Ministry Ordinance No. 120/2016, as of July 2017, the transmission companies that extended their concession agreements will have their assets not yet compensated included in the Regulatory Remuneration Base and will also receive the recovery of past revenues from those assets.

With respect to extension of the energy distribution concession, CEMIG Distribuição S.A. (“CEMIG D”), as per Decree No. 7,805/12 and Decree No. 8,461/15, accepted the extension of its concession contracts, and signed the Fifth Amendment to its Concession Contract in December 2015 (the “Fifth Amendment”). This extends the concession for a further 30 years from January 1, 2016, but requires compliance with even more rigid rules related to the quality of service provided and the economic and financial sustainability of the Company over the 30 years of the concession.

 

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In light of 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 the new provisions established by PA 579 (and subsequent Law No. 12,783/13) and amendments made to it by Law No. 13,203/15 and Law No. 13,360/16, 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.”

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.

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 and its subsidiaries.

Delays in the implementation and construction of new energy undertakings can trigger the imposition of regulatory penalties by ANEEL, which, under ANEEL’s Resolution No. 63 of May 12, 2004, 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.

 

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Rules under the Fifth Amendment to the distribution concession contract came into effect as from 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 shareholders’ equity may be limited until compliance is resumed. Furthermore, in the first five years, non-compliance with a target for two consecutive years, or with any one of the targets in the fifth year will result in legal termination of the concession. The imposition of fines or penalties or the early termination or annulment by ANEEL of our concession agreements or any failure to receive sufficient indemnification for investments we have made, may have a material adverse effect on our business, financial condition and results of operations.

We are subject to extensive and uncertain governmental legislation and regulation, 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 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 in 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, compensation 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 and, in particular, the energy industry. As part of the restructuring of the industry, 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.

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. Also, we cannot guarantee that measures taken in the future by the Brazilian 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 have regularly implemented changes in tax policies that have affected 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.

We are subject to certain restrictions on our ability to make capital investments and acquisitions and raise funds from third parties, which might prevent us from entering into new contracts for financing of our operations, or for the re-financing of our existing obligations, and which may adversely affect our business, results of operations and financial condition.

Our by-laws require us to maintain certain financial indicators, related to factors including debt and investments, within certain limits, and this could affect our operational flexibility. In 2015, 2016 and 2017, certain limits and financial ratios specified in our bylaws were exceeded, and corresponding waivers were granted pursuant to the relevant approvals given by our shareholders at the General Shareholders’ Meetings for 2015, 2016 and 2017.

 

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In relation to investments, our by-laws state that we may use up to 40.0% of our annual EBITDA (earnings before interest, income taxes, depreciation and amortization) each fiscal year on capital investments and acquisitions. This restriction could indirectly affect our investment capacity. 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 are currently governed by Law No.8,666/1993 (“the Tenders Law”) and from June 30, 2018 will be governed by Law No. 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, state-controlled companies, in some cases, must comply with certain requirements to use funds extended by local commercial banks, such as (i) in the case of Brazilian federal banks, use the proceeds for refinancing of financial obligations undertaken with entities of the Brazilian financial system; or (ii) in transactions guaranteed by receivables.

Further, we are subject to certain contractual conditions under our existing debt instruments, and we may enter into new loans that contain 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, Eurobonds on international market and loans from Caixa Econômica Federal and Banco do Brasil.

We have approximately R$8.3 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 our results of operation.”

If, for example, we breach a financial covenant under the Eurobonds, we would have an interest increase, or even suffer early maturity of some of our debts. Similarly, if the Company violates a covenant under our debenture issuance, the debenture holders may anticipate 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. The anticipation of the maturities of our debts could have a material adverse effect on our financial situation, and may also trigger cross-default clauses in other financial instruments.

In the event of a default and acceleration of the maturities, our assets and cash flow might be insufficient to repay amounts due, or to comply with the servicing of such debts. 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 might face difficulties in delivering the results described in the business plans of the companies that it has acquired, or those which may be acquired in the future, which could have a material adverse effect on our business, financial condition and results of operations.

The Company might not realize the results expected from our acquisitions. 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; and (v) legal claims made against the acquired business that were unknown at the moment of its acquisition. 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.

A reduction in our credit risk rating or in Brazil’s sovereign credit ratings could adversely affect the availability of new financings 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.

 

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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’s controlling shareholder, the State of Minas Gerais.

The rating agencies began a review of Brazilian sovereign credit risk in September 2015 that culminated in the loss of the country’s investment-grade rating with the three principal agencies. They referenced the worsened credit scenario and the growing deterioration of Brazilian debt indicators, taking into account the environment of low growth and the challenging political situation. As a result, the trading prices of Brazilian debt and other Brazilian securities were affected. We believe that a continuation of the present recession in Brazil could cause further ratings reductions.

In the last years, the three main rating agencies have downgraded CEMIG Holding, CEMIG D and CEMIG GT’s ratings following the macroeconomic deterioration in Brazil and as a result of the increasing leverage of CEMIG, due to the pressure on its cash flow. More recently, Standard & Poor`s upgraded each Company to brBBB (national scale) keeping the rating B in the global scale. Currently, Fitch classifies each company as BBB-(bra) (national scale) e B (global scale) and Moody’s classifies each company as B2.br (national scale) e B3 (global scale).

If our ratings are downgraded due to any external factors, 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 financings could be adversely affected. Also, further reductions in Brazilian sovereign ratings could adversely affect 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 further reductions in our ratings or Brazil’s sovereign ratings could adversely affect our operating and financial results, and our access to future financings.

Disruptions in the operation of, or deterioration of the quality of, our services, or those of our subsidiaries, could have an adverse effect on our business, financial condition and results of operations.

The operation of complex energy generation, transmission and distribution networks and systems involves various risks, operational difficulties and unexpected interruptions, caused by accidents, damage to failure of equipment or processes, performance below planned levels of availability and efficiency of assets, or disasters (such as explosions, fires, natural phenomena, floods, landslides, sabotage, terrorism, vandalism or other similar events). In the event of this occurrence, the insurance coverage for Operational Risks may be insufficient to fully repay costs and losses incurred as a result of damage caused to assets, or interruptions of services. Also, operational decisions taken by an entity responsible for the operation of the national grid, or actions or decisions taken by authorities responsible for regulation of the power industry, or for the environment or for issues that affect the energy generation, transmission and distribution businesses could have an adverse effect on the functioning and profitability of the operations of the Company’s generation, transmission and distribution systems.

The revenues that the Company and its subsidiaries generate from establishing, operating and maintaining facilities are, directly or indirectly, correlated with the availability of equipment and assets, and to the quality of the services (continuity, and compliance with the regulatory requirements). Under our concession agreements, the Company and its subsidiaries are subject to: (i) a reduction of their “Portion B” allocation due to increase of the component Q in the formula for the “X Factor” at the time of the tariff review for the distributors; (ii) reduction of the Permitted Annual Revenue (RAP) of the Transmission Companies, due to non-availability of transmission lines and substation equipment; and (iii) impacts on the revenue of the generation companies arising from the Availability Factor (Fator de Disponibilidade, or FID), and from reduction of the guarantee offtake levels of the plants. The hydroelectrical plants share the hydrological risk, and based on the applicable regulations and on the level of the guarantees offered previously by agents, to the extent that the plants do not meet the necessary production levels, on average agents will have to acquire the equivalent of the shortfall in volume of power at the spot price (Preço de Liquidação de Diferenças – Differences Settlement Price, or PLD), which tends to be highly volatile.

The generation agents are exposed to financial risks, since there may be differences in the financial accounting of the contracts in the sub-markets of the CCE, depending on: (a) the location of the plant, which determines the PLD used in the accounting procedure for the vendors; and (b) the location of consumption of the contract, which will determine the PLD used in the accounting procedure for the consuming agent. If there is a difference between the PLD of the sub-markets, the agents will be subject to these differences.

Penalties and payments of offsetting or other compensation are applicable, depending on the scope, severity and duration of the unavailability of service or equipment. Thus, stoppages in our generation, transmission or distribution facilities, substations or networks, may have a material adverse effect on our business, financial situation and operational results.

 

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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 our cash flow from operations in recent years has not been sufficient to fund our capital expenditures, debt service and payment of dividends, our debt has significantly increased since 2012. Our total loans, financing and debentures (including interest) decreased by 5%, to R$ 14,398 million on December 31, 2017 from R$ 15,179 million on December 31, 2016 and R$ 15,167 million on December 31, 2015. At present, 42% of our existing loans, financing and debentures—totaling R$ 6,084 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, and may continue to rely upon, a combination of cash flows provided by its operations, 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 impact its cost of financing, also making it more difficult or costly to refinance maturing obligations. If, for any reason, the Company were faced with continued 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, as its cash flow from operations is currently insufficient to fund such both planned capital expenditures and all of its debt service obligations. A reduction in the Company’s capital expenditure program or the sale of assets could significantly and adversely affect its results of operations.

In the context of lengthening the amortization schedule, CEMIG GT prepared itself along 2017 to tap the international debt capital market through a seven-year bond issuance of US$1 billion. The issuance was priced in December with a 9.25% coupon and 9.5% yield and the proceeds were used to repay existing short-term debt. The bonds will pay interests semiannualy and the principal will fall due in December 2024, with the possibility of a call from December 2023 on. The issuance was hedged by a coupon swap and a call spread on the principal, in order to protect the company against foreign exchange volatility.

In addition, in December 2017, Cemig concluded the re-profiling of its debt, representing up to R$3.4 billion, by negotiating a bank debt refinancing with its main creditors in order to refinance short and medium term indebtedness of CEMIG GT and CEMIG D and, then, to balance CEMIG’s short and medium term cash flows. The debt re-profiling involved the amortization schedules of existing debt maturities, ranging from 2017 through 2020, into facilities with a principal amortization grace period in 2018 and final maturities in 2022.

Our divestment program depends on external factors that could impede its successful implementation.

Among other initiatives, in 2017, a divestment program which contemplates the sale of R$ 8,046 million in assets in the 2017 and 2018 was publicly informed, which targets at least 50% of the divestment (by value) by the end of 2018. This program is intended to contribute to the balancing of our financial profile by reducing net indebtedness in the short term. External factors, such as regulatory changes, exchange rate fluctuations, the deterioration of Brazilian and global economic conditions and the Brazilian political crisis, among others, may adversely affect our ability to sell our assets or reduce sales price of such assets.

Any difficulty in successfully implementing our divestment program could have a material adverse effect on our business, results of operations and financial condition, including exposing us and the Company to liquidity constraints in the near and medium term. In addition, while the sale of assets will allow us to reduce our total indebtedness and improve our short-term liquidity position, such sales will also result in a decrease in our cash flows from operations, which could have a material adverse effect on our long-term operating growth prospects and consequently our results of operations in the medium and long term.

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, to a large extent, on successful, cost-effective and timely implementation of our strategic planning. The following are some of the factors that could negatively affect this implementation:

 

    Inability to generate cash flow, or obtain the future financings, 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;

 

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    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 commitments;

 

    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; and

 

    Substantial changes in economic, regulatory, hydrological or other conditions.

The occurrence of the above factors, separately or in the aggregate, 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, because 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 as a result of change in the political agents of the Executive Branch of government due to the electoral process, as occurred with most of our executive officers, including the CEO and CFO in December 2014, and also 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 and minority investees might negatively affect our strategies, operational results and financial situation.

We own equity in and do business through various subsidiaries and minority investees, including companies with significant assets in energy generation, transmission and distribution. The future development of our subsidiaries and minority investees, such as Transmissora Aliança de Energia Elétrica S.A. (“TAESA”), Light S.A. (“Light”), Renova Energia S.A. (“Renova”) and Aliança Geração de Energia S.A. (“Aliança”), could have a significant impact on our operational results. The Company’s ability to meet its financial obligations is correlated, in part, to the cash flow and the profits of these subsidiaries, 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 equity paid to the Company, which could have a material adverse effect on our results of operations and financial position.

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

Furthermore, the Company does not control the management of some of its minority investees and their management practices might not to be aligned with those of the Company.

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.

New investments and acquisitions will require additional capital, which might not be available to us on acceptable terms.

We will need funds to finance acquisitions and investments. However, we cannot guarantee that we will have our own funds or that we will be able to raise such funds in a timely manner and in the necessary amounts, or at competitive rates (by issuance of debt securities, or incurrence of loans). If we are unable to obtain funds as planned, we may be unable to meet our acquisition commitments, and our investment program could suffer delays or significant changes, which could adversely affect our business, financial condition, results of operations and future prospects.

 

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Delays in the expansion of facilities, in new investments or in capitalizations in our generation, transmission and distribution companies could adversely affect our business, results of operations and financial condition.

We are currently engaged in the construction and expansion of plants, transmission lines, distribution lines, distribution networks and substations, and also studying other potential expansion projects. Our capacity to conclude projects, within deadlines and on budget, without adverse economic effects, is subject to various risks. For instance, we may encounter the following:

 

    Various problems in the phase of planning and construction of expansion projects or new investments, such as stoppages, delays by suppliers in materials and services, delays in tender processes, embargos on work, unexpected geological and meteorological conditions, political and environmental uncertainties, the liquidity of our partners, contractors and subcontractors;

 

    Regulatory or legal challenges that delay the start date of operations of expansion projects;

 

    New assets might operate below the planned capacity, or the costs of their operation/installation might be greater than planned;

 

    Difficulty of obtaining adequate working capital to finance the expansion projects; and

 

    Environmental demands and claims by local communities during construction of generation plants, transmission lines, distribution lines, distribution networks and substations; and, possibility of failure to comply with the “Duração Equivalente de Interrupção por Unidade Consumidora”—DEC (outages duration) target, resulting in risk of loss of the concession, since the contract provides that non-compliance with the targets for quality indicators for 2 consecutive years, or in the fifth year, will result in opening of a process of expiration of the concession.

If we face any of these problems or other problems related to the new investments or to the expansion of our generation, transmission or distribution capacity, we might suffer increases of costs, or, perhaps, lower profitability than originally expected for the projects.

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

On December 31, 2017, the total of our past-due receivables owed by customers, traders and power transport concession holders was approximately R$ 1,038 million (R$961.5million in 2016), corresponding to 4.78% of our consolidated net revenue in 2017 (5.12% in 2016). We have recorded in 2017 a provision for doubtful receivables in the amount of R$ 568 million (R$660 million in 2016). The possibility exists that we might be unable to collect amounts payable by 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 provision that we have made could cause an adverse effect on our business, operational 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 does not succeed in successfully controlling energy loss, its business, operations, profit and financial situation could be substantially and adversely affected.

A distribution company’s energy losses comprise two types of losses: technical losses and non-technical (commercial) losses. Technical losses are inherent in the process of transmission and transformation of electric power, and occur in the lines and equipment of the energy system. Non-technical losses comprise power 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, 2017, using a 12 month window was 14.24%. This percentage is in relation to the total energy injected into the distribution system (the total volume of losses was 7,113 GWh). Of that percentage, 8.98% comprised technical losses, and 5.26% comprised non-technical losses. This result was 0.78 percentage points higher than the result for December 2016, and above the regulatory target set by ANEEL for 2017 (10.84%).

In our view, the adverse macroeconomic scenario that Brazil has gone through in recent years, with high unemployment, and the changes in the energy sector resulting from Provisional Act 579 (converted into Law No. 12,783 of 2013), which affected the cash flow and situation of the distribution company and resulted in successive tariff increases, in our view led to an increase in fraud against the energy supply in Cemig’s concession area, beginning in 2014.

 

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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 on the basis of a benchmarking model that compares the social-economic complexity of each concession in relation to cost involved in combating the illegal use of the power supply. 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 medium term, and this could affect the Company’s financial situation and operational results, since the portion of a distribution company’s power losses that exceeds the regulatory cap cannot be passed through to the client 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.

Wherever there are dams, 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 hydroelectrical 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.

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 also 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 in the event that 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 measures in an amount to be decided by the environmental agencies, 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 operational 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.

 

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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 operational 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.

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

The prices of energy purchase contracts signed by energy distribution concession holders such as CEMIG D are linked to certain variables that are not under their control, such as hydrological conditions and dispatching of thermoelectric plants. Although any increases in costs for purchasing of energy arising from adverse hydrological conditions and from higher than forecast dispatching of the thermal plants are passed through to the energy distribution concession holders in the form of tariff increases at the time of the distribution concession holders’ tariff adjustments, this situation could result in mismatches of cash flow, with an adverse impact on CEMIG’s financial situation.

In recent years, the Brazilian Federal Government and ANEEL have created mechanisms to reduce the mismatch in the distributors’ cash flow arising from the increase in prices for purchase of energy.

In 2013, funds from the Energy Development Account (Conta de Desenvolvimento Energético, or CDE) were used to reduce this effect; and in 2014 a series of bank loans, in the name of the Energy Trading Exchange (Câmara de Comercialização de Energia Elétrica, or CCEE), were employed, passed through to the distributors in the account referred to as the ACR Account. As from 2015, these costs began to be incorporated into the energy tariffs paid by customers. In 2015, there was also an extraordinary review of tariffs to compensate the increased costs of higher contributions to the CDE, and of energy purchased from Itaipu, among other factors. Finally, as from January 2015, the “tariff flag” system was finally put in place on a permanent basis. This system increases the tariff for the final customer when the generation system is undergoing adverse hydrological conditions, and thus transfers part of the costs to these customers more rapidly. The “Red Flag” was in force for the whole of the year 2015; this is the highest rate, indicating higher energy acquisition costs for the distributors and constantly higher charges for the customer. Even with this mechanism in place there is a risk of the increase in purchase prices being so great that the Company’s cash position is pressured until the next tariff adjustment. The recovery of higher costs of purchase of energy by passing through to tariffs takes place gradually, over the 12 months between price adjustments.

Starting in 2014, the Brazilian Federal Government undertook another round of funding support transactions, with funds from the CDE. These amounts refer to the subsidies to certain customers (users of irrigation, water service utilities, rural customers, and other users) that had been withdrawn from the tariff adjustment when Law No 12,783/2013 was put into effect. These funds were granted by the Brazilian Federal Government, among other sources, and paid through Eletrobras. We note that a delay in these payments could cause problems of mismatch in the cash flow of CEMIG D.

The current economic downturn in Brazil contributed to several factors resulting in the increase in rates charged from regulated customers, and the migration of customers to the free market. This could lead to a revenue decrease and possible financial exposure due to an energy inventory greater than 5% of demand. In order to mitigate these effects, distributors can assign contracts for the purchase of energy provided by existing generation facilities through the Surpluses and Deficits Compensation Mechanism (Mecanismo de Compensação de Sobras e Déficits, or MCSD), which is available to distributors who have deficits and generators with delay on their initial operations. If, after using this mechanism, distributors still have an excessive inventory of more than 5% of current consumption, such excess can be sold in the spot market, which can result in a loss for the distributor if the spot price is lower than the costs of the purchase contracts. This loss cannot be passed on to the customer and is bared by the concessionaire. Such losses could have a material adverse effect on our business and results from operations.

In 2016 the New Energy MCSD was created, which allows the termination of new energy contracts between distributors in order to compensate for surpluses and deficits. If there is more surplus than deficit, the mechanism also allows the generators to offer reduction of the contracts to the distributors in order to compensate for the surplus. The reduction is then effected in descending order of price and there is no financial compensation for the reduction. In addition to the New Energy MCSD, Resolution No. 711/2016 was also published, which allows bilateral negotiation of contracts between generators and distributors, enabling partial or full reduction of Regulated Market Energy Sale Contracts (CCEARs). This mechanism provides financial compensation to the stakeholders if the reduced contract is priced above the PMIX (average price of the distributor’s portfolio), such compensation to the stakeholder is limited to a 36-month period. If the contract has a price lower than the PMIX, the loss must be reimbursed from the stakeholder to the customer.

 

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There has been an increase in the volume of distributed generation, mainly solar, in the area served by CEMIG D. The amounts involved are not yet significant for CEMIG D’s market, but they are being monitored, and in the future they might cause a material adverse effect on our business, operational results or financial condition.

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

Hydroelectrical generation is predominant in Brazil. The advantages of hydroelectrical power have also been widely publicized: 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 the 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. 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 operation of the Brazilian energy system is coordinated by the National Energy System Operator (Operador Nacional do Sistema, or “ONS”). Its primary function is to achieve optimal operation of the resources available, minimizing operational 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 hydroelectrical plants and increase thermal generation, which results in higher costs for the hydroelectrical generating agents, as happened in 2014. In the distribution companies, 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 distribution companies. Also, in extreme cases of scarcity of power due to adverse hydrological situations, the system might undergo rationing, which could result principally in reduction of cash flow.

The Energy Reallocation Mechanism (Mecanismo de Realocação de Energia, or 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 power 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.

In 2015, the Federal Government proposed a system of voluntary renegotiation relating to hydrological risk. This process allows the generation company to pass on to customers its costs and revenues related to hydrological risk, in exchange for payment of a ‘risk premium’, while also receiving indemnity for the losses suffered in 2015 through, among other measures, an extension of their generation concessions (or permissions, depending on the case) for up to 15 years.

To be able to participate in the renegotiation, the companies had to waive and withdraw all the claims that they had filed and all the applications for injunction that they had made, and also waive any other rights that they might have in relation to those actions.

In the free market, the system did not receive the same acceptance, 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$7.4 billion in the short-term market (as of January, 2018). 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.

 

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Any substantial seasonal variation in the monthly flows and in the total of flows over the year could limit hydroelectrical 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.

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 distribution companies. 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 3MW or more: they are allowed to choose their energy supplier. 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, operational 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 clients referred to as “Special Customers”, which are those with contracted demand between 500kW and 3MW. Special Customers are eligible to participate in the Free Market provided they buy energy from incentive-bearing alternative sources, such as Small Hydroelectrical plants, biomass plants or wind farms. 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 clients 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 clients may cause purchase or sale exposures to spot prices, which can have an adverse impact on our business, operational results and/or financial situation. Market variations, such as variations of prices for signature of new contracts, and of volumes consumed by our clients in accordance with flexibilities previously contracted, can lead to spot market positions, which can potentially have a negative financial impact on our results.

The MRE aims to reduce the exposure of generators of hydroelectrical power, such as our generation companies, to the uncertainties of hydrology. It functions as a pool of hydroelectrical 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 hydroelectrical plants by 20% or more.

In 2015, the Brazilian Federal Government proposed a system of voluntary renegotiation relating to hydrological risk. This process enabled the generating companies to transfer their costs and revenues related to hydrological risk to customers in exchange for the payment of a “risk premium” to be deposited in the so-called tariff band deposit account (the tariff band surcharges are deposited in such account and transfers to the distribution concessionaires are made from this account as well) 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, hydroelectrical 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 with a postponement of the risk premium. If the remaining concession/authorization period is insufficient (i.e. not long enough to amortize the regulatory asset), then generators would have a concession/authorization extension (limited to 15 years).

 

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In the free market, the system was not favorable enough to gain acceptance: even with the payment of the risk premium, generation companies would have been required to continue assuming the hydrological risk at moments of critical hydrology. In this environment, the system required contracting of reserve power, which has very high prices, for mitigation of the hydrological risk.

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 determination of the PLD is done through the results of the optimization models of the operation of the national grid used by the ONS and by the CCEE. The models depend on entry data revised by the ONS at each period of four months, and monthly, and weekly. In this system there is the possibility of errors being made in entry of data into the model, which can lead to an unexpected change in the PLD and possible subsequent re-publication of it, in accordance with ANEEL Resolution No. 568/2013. The alteration of these models, errors in entry of data and re-publications of the PLD constitute a risk for the trading business, causing uncertainty in the market, reducing liquidity, and resulting in financial losses with the unexpected variation in the price.

The anticorruption investigations currently in progress in Brazil, which have had large-scale public exposure, might have adverse effects on the perception of the country, on us and 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 may represent potential risks to the social and economic outlooks for Brazil.

Among the Brazilian companies involved in these investigations are companies in the oil and gas, energy and infrastructure sectors, which are being submitted to investigations due to accusations of corruption by the Brazilian Securities Commission (Comissão de Valores Mobniliários or 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). Some issues raised have included Norte Energia S.A., holder of the concession to build and operate the Belo Monte Hydroelectrical Plant, on the Xingu River, in the state of Pará, Brazil, in which CEMIG GT is a minority shareholder through Aliança Norte and Amazônia Energia S.A., with an interest of 11.74%. In an on-going internal investigation by Norte Energia S.A., the estimated amount of losses have already been provisioned in our financial statements. We cannot guarantee, however, that further amounts of provisioning will not be necessary as a result of further investigations based on the same accusations.

Investigations and other legal measures are in progress, conducted by the Federal Public Attorneys’ Office, which involve other indirect shareholders of Madeira Energia S.A. and certain executives of those other indirect shareholders. The Company has direct and indirect investments, of 10% and 8.13% respectively, in Madeira Energia S.A. (which holds an investment in Santo Antônio Energia S.A.), of R$ 1,117 at December 31, 2017 (R$ 1,321 at December 31, 2016). In this context, the Federal Public Attorneys have started investigations into irregularities involving contractors and suppliers of Mesa and of its other shareholders. These investigations are in progress. In response to allegations of possible illegal activities, the investee and its other shareholders have started an independent internal investigation. At the present moment there is no way of determining the results of these investigations, or the developments arising from them, which may at some time in the future have consequences for the investee.

On January 19, 2018, Renova, a company in which Cemig has a direct interest of 36.23% and indirect interest of 6.8%, responded to a formal statement by the Civil Police of Minas Gerais State received in November 2017, relating to the investigation being carried out by that Police Force into certain injections of capital made by the controlling shareholders of Renova, and injections of capital made by it in certain projects under development in previous years. As a consequence of this matter, the governance bodies of Renova requested the opening of an internal investigation on this subject, which is being conducted by an independent company. The work of the internal investigation is in progress, and it is not at present possible to measure any effects of this investigation, nor any impacts on the financial statements of Renova, of the Company, or of its subsidiary Cemig GT for the year ended December 31, 2017.

We have not been notified and are not aware of any on-going investigation by the SEC or the DOJ involving us. Also, we cannot guarantee that CEMIG Holding or companies of the CEMIG Group will not become the subject of court actions, criminal or civil, based on these or new anticorruption investigations, in the ambit of the applicable jurisdiction either of the United States or of Brazil, if any additional illegal acts come to light.

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

 

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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 affiliated companies, such as special-purpose companies and joint ventures, in which we do not have shareholding 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.

Certain members and former members of our management are parties in administrative and judicial proceedings and ongoing corruption investigations.

Brazilian authorities have been conducting anticorruption investigations in a number of governmental areas, including partnerships and equity interests held by Brazilian Governmental entities in the private sector. These investigations have resulted in administrative, civil and criminal proceedings against the individuals under investigation.

Members of our management who have worked for the Brazilian Government and the government of Minas Gerais are parties to judicial and administrative proceedings being conducted by the competent authorities. 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 members of our management will not impose limitations or restraints on the performance of the members of our management who are party to these proceedings. In addition, we cannot assure you that these limitations will not adversely affect us and our reputation.

In addition, we have not hired any third party to conduct an internal investigation as we are not aware of wrongdoing in connection with our operations. If new allegations arise and we decide to conduct an internal investigation, any findings under such internal investigation could have an adverse effect for the Company and for 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.

During the year 2017, Cemig lost four of its most important hydroelectrical power plants, due to the termination of their concession contracts. It represented a reduction of 2,922 MW in Cemig´s installed capacity. At present, taking into account projects and companies that are jointly controlled, Cemig has more than 66 hydroelectrical power plants, with 5,319.63 MW and representing 94% of our installed capacity.

 

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Water is the main raw material for CEMIG’s production of energy, and 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 hydroelectrical power essentially require 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 2015, 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 also 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 also the effects of flood events occurring due to excess of rains. 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 Holding and has full powers to decide on all business relating to the Company’s objects as stated in the bylaws, 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 the members of our Board of Directors 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 any dividends.

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: (i) laws and regulations of the Brazilian energy sector, such as Law No. 10,848/04 (on trading in energy), regulations by ANEEL; (ii) 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 Brazilian Securities Commission (Comissão de Valores Mobiliários, or CVM); (iii) laws and regulations that apply to Brazilian companies with majority state-owned shareholdings, such as Law No. 8,666/93 (the “Tenders Law”) and Law No. 13,303/2016 (the “State Companies Law”); and (iv) laws and regulations that apply to Brazilian companies that have securities traded on the U.S. capital markets, such as the Sarbanes-Oxley Act of 2002, the Foreign Corrupt Practices Act (FCPA), and regulations of the U.S. Securities and Exchange Commission (SEC), among others.

Furthermore, in recent years, 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 clients, which increases its exposure to risks of fraud and administrative impropriety.

 

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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 COSO (Committee of Sponsoring Organizations of the Treadway Commission). 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, our processes of governance, risk management and compliance 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.

We might also be unable completely to prevent accounting errors in our financial reports and to prevent the occurrence of material weaknesses in the future. Our management identified a material weakness in our internal control over financial reporting in 2017. For more information on the material weaknesses identified by our management, see:“ Item 15—Controls and Procedures—Management’s Annual Report on Internal Control over Financial Reporting

Furthermore, we might be incapable of reporting the results of our operations, and other material information, with precision and timeliness in future periods, and/or successfully remedying the material weakness identified, and/or filing the documentation and information required by the authorities, including the SEC and the CVM. Non-compliance with laws and regulations, and other rules; accounting errors with material weaknesses; and not presenting precise and timely information as required by public authorities all are risks that might result in penalties, loss of licenses, damages to our reputation, or significant financial losses.

If our efforts to remediate the material weakness 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. There is also a risk that there could be accounting errors in our financial reporting, and we cannot be certain that in the future additional material weaknesses will not exist or otherwise will not be discovered. Any of these occurrences could adversely affect our and the Company’s business, results of operations and financial condition.

Cyber-attacks, or violation of the security of our data such as might lead to an interruption of our operations, or a leak of confidential information either of the Company, or of our clients, 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 various proprietary information and sensitive or confidential data relating to our operations. We may be subject to breaches of the information technology systems we use for these purposes. Experienced computer programmers and 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 programmers and 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.

In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the system.

The costs we may incur to eliminate or address the foregoing security problems and security vulnerabilities before or after a cyber 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 clients that may impede our critical functions.

In addition, breaches of our security measures and the dissemination of proprietary information or sensitive or confidential data about us or our customers or other third parties could expose us, our clients or other third parties affected to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation, or otherwise harm our business. In addition, we rely in certain limited capacities on third-party data management providers whose potential security problems and security vulnerabilities could have similar effects on us.

 

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

It is possible that we may experience shortages of qualified personnel. In the last two years we have been carrying out a voluntary severance incentive program open to all of our employees which have enabled us to reduce our headcount by approximately 25%. This reduction allowed us to adapt to the reference levels of the market indicated by a Strategic Planning study, the objective of which was to make it possible to achieve optimal human resource efficiency level demanded by the concession contracts. Our success depends on our ability to continue to successfully train our personnel so they can assume qualified senior positions in the future. We cannot assure you that we will be able to properly train, qualify or retain skilled personnel, 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.

Instability of inflation rates and interest rates could adversely affect our results of operations and financial condition.

Brazil has historically experienced high rates of inflation, particularly prior to 1995. Inflation, as well as government efforts to combat inflation, had significant negative effects on the Brazilian economy. More recently, inflation rates were 2.95% in 2017, 6.29% in 2016, 10.67% in 2015, 6.41% in 2014, and 5.91% in 2013, as measured by the Amplified National Customer Price Index (Índice Nacional de Preços ao Consumidor Amplo, or IPCA), compiled by IBGE (Brazilian Institute of Geography and Statistics).

The Brazilian Government may introduce policies to reduce inflationary pressures, such as maintaining a tight monetary policy with high real interest rates, which could have the effect of reducing the overall performance of the Brazilian economy. Some of these policies may have an effect on our ability to access foreign capital or reduce our ability to execute our future business and management plans.

We are also exposed to losses linked to fluctuations in domestic interest rates and inflation rates, due to the existence of assets and liabilities indexed to the variations in the Selic and CDI rates, and the IPCA and IGP-M inflation index.

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 financial assets of our concessions.

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. Dividends can be paid out from the net income accrued in each fiscal year or from the accumulated profits of previous years, or from accumulated profit reserves. 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.

Under our by-laws, we must pay our shareholders a mandatory annual dividend equal to at least 50% of our net income for the preceding fiscal year, based on our financial statements (which are prepared in accordance with IFRS and the accounting practices adopted in Brazil), and holders of preferred shares have priority in the allocation of the minimum mandatory dividend for the period in question. Our by-laws also require that the mandatory annual dividend we pay to holders of our preferred shares must be equal to at least the greater of (a) 10% of the par value of our shares, or (b) 3% of the value of the portion of shareholders’ equity represented by our shares. If in a given fiscal year we do not have net income, or our net income is insufficient, our management may recommend at the Annual Shareholders’ Meeting that the payment of the mandatory dividend should not be made in respect of that year. However, there is also a guarantee given by the government of the State of Minas Gerais, our controlling shareholder, that a minimum annual dividend of 6% will in any event be payable to all holders of common shares and preferred shares issued up to August 5, 2004 (other than public and governmental holders) in the event that mandatory distributions have not been made in a given fiscal year.

 

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ANEEL has discretion to establish the rates that distribution companies 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: (i) the Annual Adjustment; (ii) the Periodic Review; and (iii) the Extraordinary Review. The purpose of the Annual Adjustment (Reajuste Anual) 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; and establish a factor based on economies of scale, which will be taken into account in the subsequent annual tariff adjustments. 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 equilibrium, we cannot guarantee that ANEEL will set tariffs that do remunerate us adequately in relation to the investments made or the operational costs incurred by reason of the concession, and this might have a material adverse effect on our business, financial situation and operational results.

ANEEL has discretion in setting the Permitted Annual Revenue (Receita Annual 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.

The RAP that we receive through our transmission companies is determined by ANEEL, on behalf of the Federal Government. The concession contracts provide for two mechanisms for the adjustment of revenues: (i) the annual tariff adjustments; and (ii) 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 previously took place every four years, but Law No. 12,783/2013 changed the tariff review period to five years. Our last tariff review was in July, 2009, and the next is due for July 2018, as stated in our Concession Contract. However, the rules for the tariff review are being discussed between ANEEL and the society, including the transmission companies, and they are not finished. This review may be postponed to July 2019, with retroactive effects. During the periodic tariff review, the investments made by a concession holder in the period and the operational costs of the concession are analyzed by ANEEL, taking into account only investments that it deems to be prudent, and operational costs that it assesses as having been efficient, using a benchmarking methodology developed by employing an efficiency model which compares the data of the various transmission companies in Brazil. Thus, the tariff review mechanism is subject to some extent to the discretionary power of ANEEL, since it may omit to include investments that have been made, and could recognize operational costs as being lower than those actually incurred. This could result in an adverse effect on our business, results of operations and financial condition.

The concessions for some of our transmission assets were extended for a further 30 years, under Law No. 12,783/13, and this resulted in an adjustment of the RAP of those concessions, reducing the revenue that we will receive from them. The Federal Government has compensated the Company for the reduction of a portion of the remuneration, and reduction of the RAP, of part of these concessions, but the assets in operation before the year 2000 have not yet been compensated. Under Law No. 12,783/13, compensation is to be received for reduction of the RAP of the assets that were in operation before the year 2000, paid over a period of 30 years, with monetary updating by the IPCA inflation index. On April 20, 2016, the Mining and Energy Ministry issued its Ministerial Order 120, determining that the amounts ratified by ANEEL in relation to the assets specified in Article 15, §2, of Law No. 12,783/13, should now become a part of the Regulatory Remuneration Base of the transmission concession holders, and that the cost of capital should be added to the related Permitted Annual Revenue. In this context, Public Hearing No. 068/2016 was held with the aim of establishing the procedures for inclusion of this RAP into the Revenue of the transmission companies.

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 operational costs incurred by reason of the concession, which may have a material adverse effect on our business, financial condition and results of operations.

 

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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. These proportions are established by the number of votes 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 includes provisions for risks in a total amount of R$ 678 million, as of December 31, 2017, for actions in which the chances of loss have been assessed as “probable” (i.e., more likely than not).

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.

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.

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.

 

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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, and unexpected geological conditions, changes in the regulatory environment, environmental and climatic risks, and other natural phenomena. Also, we and our subsidiaries might be considered to be responsible for losses and damages caused to third parties as a result of failures to provide generation, transmission and/or distribution service.

CEMIG 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 will 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 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 impact our ability to achieve our long-term objectives.

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

A substantial portion of our and the Company’s assets is tied to the provision of public services. These assets are not available for liquidation in the event of our bankruptcy nor can they 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 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 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.

There are uncertainties about the methodology and parameters to be adopted by the regulatory authorities in the first Tariff Review cycle to be applied to Gasmig.

Gasmig obtained the concession for distribution of piped gas in the state of Minas Gerais for 30 years from the date of publication of State Law No. 11,021, of January 11, 1993, with the possibility of extension provided certain requirements are met. On December 26, 2014 the Second Amendment to the respective Concession Contract was signed and the period of the concession was extended until January 10, 2053.

Under the Concession Contract, Gasmig will continue its natural gas distribution activities until the end of the concession, being compensated through tariffs paid by the users of distribution services.

The Minas Gerais State Economic, Scientific, Technological and Higher Education Development Department (SEDECTES), an entity of the Minas Gerais State government, responsible for the regulation of distribution of piped gas, was expected to make its first review of Gasmig’s tariff in 2017. The review process took longer than planned, and is now expected to be completed in 2018. The process of review of the tariffs is intended to determine the regulatory remuneration required from 2018 to 2022. The methodology used will determine the maximum margins to be applied by Gasmig from 2018 to 2022, in accordance with expectations of investments, costs, volumes and other variables of the business. This review will be the subject to public consultation before the end of first half 2018. After the public consultation, there will be a final decision by the regulator’ on the regulatory compensation rate, which might cause a change in the profit margin for gas distribution and could have a material adverse effect our business and results of operations.

 

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

Excluding the thermoelectric generation sector, the volumes of sales are sustained by the large-scale industrial market, which represents 93.5% of the volume of gas sold to this sector in 2017. Gasmig’s largest clients are in steel, metallurgy, mining and and paper pulp – which provided an aggregate 73.5% of the non-thermoelectric consumption volume in 2017.

After three successive years of heavy falls in production, Brazilian industry is now on a recovery trend: over the course of 2017, the index of production, according to industrial production volume figures from IBGE (the Monthly Industrial Survey – Physical Production, or PIM-PF), improved on a month to month basis comparing same months of 2016, and the country’s total industrial production rose 2.5% over the prior year.

Even with the positive recent figures, industry has recovered only part of the losses it has suffered in the last three years, and is still 13.8% below the maximum level of production it reached in June 2013.

In 2017, the volume sold by Gasmig to the industrial sector, including steel, metallurgy and mining companies, was 12.8% higher than in 2016, mainly due to operational adjustments in some of its principal clients. In the event of reversal of expectations and an adverse economic scenario, continuity of the structure of the market served by Gasmig could have a negative effect on Gasmig’s business, operational results and financial situation.

The existence in Brazil of a sole supplier of natural gas affects competitiveness.

In January 2017 Gasmig and Petrobras signed the Seventh Amendment to their Additional Supply Contract, adjusting the contracted quantity, the price of gas, and other matters. The price of gas acquired from Petrobras follows a variation defined by a contractual formula, and is adjusted in accordance with the price of oil. In the period from November 2016 to November 2017, the average price of acquisition for the market, excluding thermoelectric generation plants, was increased by approximately 30.5%.

Since the second half of 2016, Petrobras has been decreasing its presence in the natural gas supply chain. In 2017, it sold part of its transportation pipeline to Canadian Brookfield Infrastructure Partners, although it retained the operation of the gas transportation system.

The Brazilian Government has launched the “Gás para Crescer” (Gas to Grow) initiative, which aims changes in the regulatory environment of Natural Gas Industry preparing for a less massive Petrobras participation. National Congress is expected to analize the “Gás para Crescer” proposals bill from 2018 onwards. This initiative did not show solid results yet, but Petrobras is expected not to be the only Brazilian Market natural gas supplier at the end of Gasmig’s contract in 2021.In 2017, Petrobras also reviewed its policy of prices in energy sources that compete with natural gas. The price of LPG (liquefied petroleum gas) and fuel oil underwent many variations during the year, resulting in increases of 32.4%, and 23.0% in the respective prices by December 31, 2017. The prices of these energy products also vary in accordance with the oil price, which would result in gas maintaining its competitiveness.

However, Petrobras is entitled to, at any time, review the price policy of its products, which can change the market demand, since price drives customers choice between natural gas and competing fuels, usually LPG, gas oil and/or fuel oil. If this happens, Petrobras could cause a positive or negative impact on the demand for natural gas, directly impacting Gasmig’s operational results and financial situation.

The regulatory agency responsible for piped gas distribution is controlled by the Minas Gerais State Government, the interests of which might conflict with those of economic equilibrium of the concession.

The Brazilian Federal Constitution establishes that it is the function of the States to exploit local piped gas services, directly or through concession. Gasmig is indirectly controlled by the State of Minas Gerais, through the majority shareholding position held by CEMIG Holding in Gasmig. The Minas Gerais Economic, Scientific, Technological and Higher Education Development Department (SEDECTES) is a body of the state government, and in Minas Gerais it exercises the function of regulator of piped gas distribution services. SEDECTES is also responsible for promoting sustainable development in the State of Minas Gerais.

The Government of the State of Minas Gerais, as indirect controlling shareholder of Gasmig and, at the same time, regulator of the public service, through SEDECTES, has the authority to direct efforts and investments of the Company in accordance with its own political, economic or social interests and these could have a negative impact on the economic equilibrium of the concession.

 

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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 Brazilian economy today continues to be subject to the effects of the process of impeachment against former President Dilma Rousseff. On August 31, 2016, after a judgment by the Senate, Dilma Rousseff, until then President, was formally impeached. The Vice-President, Michel Temer, assumed the position of President of Brazil until the next presidential election, which is set for 2018, with the next presidential term commencing on January 1, 2019. 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. The Public Attorneys’ Office filed charges of participation in a criminal organization and obstructing justice against President Temer and others from his party. President Temer denied the accusations, and Congress voted to set aside the accusations against him.

Further, Brazilian markets have experienced a high level of volatility due to the uncertainties derived from the on-going “Operação Lava Jato” investigation, and other similar investigations, which are 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.

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;

 

    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 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 also 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.

 

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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 29, 2017, the exchange rate between the Real and the US dollar was R$ 3.3121 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.

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 operational costs, since we have payment obligations under financing contracts and import contracts indexed to exchange rate variations. Also, depreciation of the Real could cause inflationary pressure that might result in abrupt increases in the inflation rate, which would increase our operational 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 2015, 2016 and 2017 was, respectively, 10.67%, 6.29% and 2.95%. No assurance can be given that inflation will remain at these levels, especially at the level of 2017.

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.

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.

 

 

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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 also 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.

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 2017, 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$ 3.16 trillion, and average daily trading volume of approximately R$ 7.44 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(main brazilian stock exchange) by the Brazilian Corporate Law, Federal Law No. 13,303/16 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.

 

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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 Amendment No. 18/2014. 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.

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.

 

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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 (R$). Under Brazilian exchange control limitations, an obligation in Brazil to pay amounts denominated in a currency other than Reais (R$) 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.

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.

 

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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.

 

Item 4. Information on the Company

Organizational and Historical Background

CEMIG started its activities on May 22, 1952 in Minas Gerais, Brazil as a sociedade por ações de economia mista (a state-controlled mixed capital company) with indefinite duration, pursuant to Minas Gerais State Law No. 828 of December 14, 1951 and its implementing regulation, Minas Gerais State Decree No. 3,710 of February 20, 1952. The Company’s full legal name is Companhia Energética de Minas Gerais – CEMIG, headquartered at Avenida Barbacena, 1200, Belo Horizonte, Minas Gerais, Brazil.

In order to comply with legal and regulatory provisions pursuant to the required unbundling of its vertically integrated businesses, in 2004, CEMIG incorporated two wholly-owned subsidiaries: CEMIG Geração e Transmissão S.A., referred to as CEMIG GT, and CEMIG Distribuição S.A., referred to as CEMIG D, which were established to carry on the business of energy generation and transmission, and distribution, respectively.

Several major companies decided to be headquartered in Minas Gerais—such as Mannesmann, a steel company producing seamless tubes—due to the guarantee given by the state government that CEMIG would be able to supply their energy requirements. At that time, Mannesmann’s energy needs was equal to half of the entire consumption of the State of Minas Gerais.

The first three hydroelectrical power plants built by CEMIG were commissioned in the 1950s- Tronqueiras, Itutinga and Salto Grande.

In 1960, CEMIG commenced its energy transmission and distribution operations. During the same period the “Canambra” consortium was formed, by a group of Canadian, American and Brazilian technical experts, who between 1963 and 1966, identified and evaluated the hydroelectrical potential of the State of Minas Gerais. This study, which was aligned with the concept of sustainable development—it revolutionized the focus of construction of power plants in Brazil, and defined which projects could be developed to supply future electric power needs.

In the 1970s, CEMIG took over responsibility for the distribution of energy in the region of the city of Belo Horizonte, incorporated Companhia Força e Luz de Minas Gerais, and embarked on the construction of more major power plants. In 1978, CEMIG commissioned the São Simão hydroelectrical power plant, at that time its largest plant. In this decade, the State of Minas Gerais saw major progress in transmission with the construction of 6,000 km of power lines .

In the 1980s a partnership between CEMIG, Eletrobrás (Centrais Elétricas Brasileiras S.A.) 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 hydroelectrical power plant, on the Paranaíba River, started operation in 1982. At that time, it was the Company’s second largest power plant, and together with the São Simão plant it tripled the Company’s generation capacity. In 1983, CEMIG established its Ecological Program Coordination Management Unit, which is responsible for the planning and development of an environmental protection policy. This enabled the research of alternative energy sources, such as wind power and solar generation, biomass and natural gas, which became a focus of the Company’s research projects.

The subsidiary Gasmig (Companhia de Gás de Minas Gerais), was established in 1986, for purposes of distributing natural gas. On September 18, 1986, CEMIG changed its corporate name from Centrais Elétricas de Minas Gerais to Companhia Energética de Minas Gerais – CEMIG to reflect the expansion of its area of operation, including multiple sources of power. By the end of the 1980s, CEMIG was distributing energy to 96% of the State of Minas Gerais, according to ANEEL (Agência Nacional de Energia Elétrica), the Brazilian regulatory agency.

 

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In the 1990s, despite the economic crisis, CEMIG, according to its records, served approximately 5 million customers. At that time, CEMIG added 237,000 new connections to the energy supply in a single year, a record in its history. Also in the 1990s, CEMIG began to build hydroelectrical plants in partnership with the private sector. It was through this structure, for example, that Igarapava hydroelectrical power plant, in the ‘Triângulo Mineiro’ region, was built. Igarapava was commissioned in 1998.

In 2000, CEMIG was included in the Dow Jones Sustainability Index for the first time and it’s been part of this index since then. CEMIG sees this as confirmation of its dedication to the balance between the three pillars of corporate sustainability: economic, environmental and social. The year 2000 was also marked by the simultaneous construction of three hydroelectrical plants (Porto Estrela, Queimado and Funil) and the number of CEMIG’s customers growing to more than 5 million for the first time in its history.

In 2001, CEMIG inaugurated Porto Estrela Hydroelectrical Power Plant, started the construction of Aimorés Hydroelectrical Power Plant and the feasibility process for Irapé Hydroelectrical Power Plant. In the same year, CEMIG’s ADRs representing its common and preferred shares were upgraded to Level 2 on the New York Stock Exchange.

In 2002, according to its records, the number of CEMIG’s customers exceeded 6 million for the first time. And it was also the year when the construction of the Irapé Hydroelectrical Power Plant, in the Valley of the Jequitinhonha River, and Barreiro Thermoelectric Plant, started, and Funil Hydroelectrical Power Plant was inaugurated. In that year, CEMIG’s shares began being traded on the Latibex segment of the Madrid Stock Exchange.

In 2003, CEMIG began simultaneous construction of several hydroelectrical power plants, as part of an effort to avoid power rationing, and established several centers of excellence and research—focusing on climatology, thermoelectric generation, energy efficiency and renewable power sources.

The year 2004 CEMIG had some major challenges: the new Brazilian regulatory framework came into force—its main requirement being the ‘unbundling’ of CEMIG’s distribution, generation and transmission activities. In 2005, as a consequence of this ‘unbundling’, CEMIG operated as a holding company, with two wholly-owned subsidiaries: CEMIG Distribuição S.A. and CEMIG Geração e Transmissão S.A..

In 2005, CEMIG inaugurated Aimorés Hydroelectrical Power Plant.

In 2006, CEMIG connected in its grid a further 230,000 new customers, and its investment in protecting the environment totaled R$60 million. The Irapé and Capim Branco I hydroelectrical power plants were inaugurated in July, and in that same year 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 2007, CEMIG inaugurated Capim Branco II Hydroelectrical Plant, in the Araguari River.

In 2008, CEMIG acquired a shareholding in wind farms in the northern Brazilian state of Ceará, with total potential generating capacity of approximately 100MW. In addition, CEMIG initiated its participation in the UHE Santo Antônio generation project at the Madeira River.

In April 2009, CEMIG 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 December 2009, CEMIG signed a share purchase agreement to acquire up to 13.03% of Andrade Gutierrez Concessões S.A. equity interest in Light. This acquisition was completed in 2010, starting the process of building its position within the controlling shareholding group of Light.

2009 was the tenth year in which CEMIG was included in the worldwide Dow Jones Sustainability Index, and in that year it was elected as the world leader in sustainability among utilities. It continues to be the only company in the energy sector of Latin America that has been included in the “DJSI World” since the inception of that index.

 

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In 2010, CEMIG formed a partnership with Light for the development of smart grid technology – with a view to increasing operational efficiency, and reducing commercial losses. Also in 2010 – for the second year running – CEMIG was rated Prime (B–) by Oekom Research, a German agency that issues sustainability ratings. In the same year CEMIG GT signed a contract with Light for the acquisition of 49% of the share capital of Lightger S.A., a special-purpose company (“SPC”) holding the authorization for the commercial operation of the Paracambi Small Hydroelectrical Power Plant.

In 2011, CEMIG 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 9.77% stake in Norte Energia S.A. (“NESA”), the owner of the concession for the construction and operation of Belo Monte Hydroelectrical 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 hydroelectrical power plants (“SHPs”) and wind farms for over a decade.

In 2012, CEMIG concluded the consolidation of its investments in the transmission sector, by transfering the assets of this sector to TAESA. This same year, CEMIG was selected for the eighth consecutive year to be included in the ISE Corporate Sustainability Index (“Índice de Sustentabilidade Empresarial”) of B3.

The following describes some activities of CEMIG, subsidiaries, jointly-controlled entities and associates during 2013, which includes the acquisition of significant power generation and transmission assets:

 

    Parati made a public offering to acquire shares for cancellation of the listed company registration of Redentor Energia S.A. and for its delisting from the Novo Mercado, a special listing segment of B3. Redentor Energia left the Novo Mercado listing segment, but continues to be traded in the standard listing segment of B3;

 

    CEMIG GT signed a share purchase agreement with Petrobras (Petróleo Brasileiro S.A.) and Joelpa (tag along) for the acquisition of 49% and 2%, respectively, of the common share of Brasil PCH; and an investment agreement with Renova, RR Participações S.A., Light Energia S.A. (“Light Energia”) and a new company Chipley (jointly owned by CEMIG GT and Renova), governing the admission of CEMIG GT into the controlling shareholding block of Renova, and the assignment of the Brasil PCH Share Purchase Agreement to Chipley;

 

    CEMIG Capim Branco Energia S.A. completed the acquisition from Suzano Group of a 30.30% holding in the SPC Epícares Empreendimentos e Participações Ltda., corresponding to an additional equity interest of 5.42% in the Capim Branco Energia Consortium;

 

    Madeira Energia S.A. (“MESA”) received cash injections from its shareholders, and credit lines, loans and financings with a long-term profile;

 

    Gasmig invested to expand its distribution network, and increased its presence in the compressed natural gas (GNC) and in the residential distribution market segments;

 

    Acquisition by Empresa Amazonense de Transmissão de Energia (“EATE”) of the equity interest held by Orteng Equipamentos e Sistemas S.A. (“Orteng”) in Transmineiras (a group of three concessionaires made up of Companhia Transleste de Transmissão, Companhia Transirapé de Transmissão and Companhia Transudeste de Transmissão);

 

    Transfer of control of TAESA from CEMIG GT to CEMIG (the holding company). The holders of the debentures of the second and third issuances of CEMIG GT agreed with the reduction of the share capital of CEMIG GT as a result of the transfer of shares in TAESA to CEMIG (the holding company), in accordance with the consent given by ANEEL;

 

    TAESA won Lot ‘A’ (a 500kV energy line) in ANEEL Auction No. 013/2013, and subsequently created Mariana Transmissora de Energia Elétrica S.A.;

 

    Negotiation to create the company Aliança Geração de Energia S.A. (“Aliança”), to be the platform for consolidation of generation assets held by CEMIG GT and Vale S.A. (“Vale”) in a generation consortium, and investments in future energy generation projects.

 

    Negotiation for the acquisition by CEMIG GT of 49% of Aliança Norte Energia Participações S.A. (formed in 2015), which owns a 9% interest in NESA belonging to Vale.

 

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The following describes certain activities relating to CEMIG, subsidiaries, jointly-controlled entities and associates during 2014:

 

    Inclusion of four special-purpose companies operating in hydroelectrical generation, created for the purpose, in Guanhães Energia S.A., with 100% equity interest;

 

    Formation of CEMIG Overseas S.L., with head office in Spain, a wholly-owned subsidiary of CEMIG (the holding company);

 

    Inclusion in Light Energia of the wholly-owned subsidiary Lajes Energia S.A.;

 

    Acquisition of the equity interest in MESA which was held by Andrade Gutierrez Participações S.A. and, subsequently, by SAAG Investimentos S.A (“SAAG”). In the second half of 2014, CEMIG GT acquired an indirect interest in MESA through the vehicles Fundo de Investimentos em Participações Malbec, Parma Participações S.A., and Fundo de Investimentos em Participações Melbourne (“FIP Melbourne”). FIP Melbourne acquired an 83% interest in SAAG Investimentos S.A., which owns a 12.4% interest in MESA, which owns 100% of Santo Antônio Energia S.A. (“SAESA”). On December 31, 2017, CEMIG’s total indirect interest in SAESA is at 18.13%;

 

    Creation by Renova of 17 special-purpose companies operating in wind generation to participate in auctions of wind power generation and the commercialization of energy on the free market;

 

    Inclusion in Light S.A. of its 50.10% shareholding interest in the SPE Energia Olímpica, the objects of which are building and implementation of the Vila Olímpica substation and two 138-kV underground lines;

 

    Disposal of the whole of Light’s equity interest in CR Zongshen E-Power Fabricadora de Veículos S.A.;

 

    Acquisition of the 40% equity interest in Companhia de Gás de Minas Gerais, belonging to Gaspetro, increasing CEMIG’s interest to 99.57% of the total of Gasmig;

 

    Inclusion of the Renova Moinhos de Vento Consortium in Renova, with 99.99% equity stake;

 

    Acquisition by CEMIG GT of a 49.9% interest in Retiro Baixo Energética S.A. from Orteng (24.4%) and Arcadis (25.5%). Retiro Baixo Energética S.A. holds the concession to operate the Retiro Baixo hydroelectrical plant, with installed generation capacity of 83.7 MW, until August 2041;

 

    Addition of the SLT Project Consortium in CEMIG GT, with a 33.33% interest. Its objectives are to manage and negotiate the contracting of legal, environmental, technical and any other external consultants necessary for the preparation of studies to ascertain the attractiveness of the São Luiz do Tapajós hydroelectrical plant, in the State of Pará;

 

    Addition of CEMIG GT in the controlling block of Renova, with 27.37% of the total share capital and 36.62% of the voting shares, through a capital increase of 87,186,035 nominal common shares without par value;

 

    Change in the equity interest in Empresa Regional de Transmissão de Energia S.A—ERTE (TAESA);

 

    Establishment of two sub-holding companies by Renova, named Diamantina Eólica Participações S.A. and Alto Sertão Participações S.A., with a 99.99% equity interest in each company. The purpose of such companies is to hold equity interests in other companies in the area of energy generation and trading, and sales of energy;

 

    CEMIG GT exited the Cosama Consortium;

 

    Divestment by CEMIG Geração e Transmissão of its 40.00% interest in Chipley SP Participações and increase in the percentage equity interest held by Renova in Chipley to 99.99%; and

 

    Formation of the company Aliança, to be a platform for consolidation of generation assets held by CEMIG GT and Vale in generation consortia and investments in future energy generation projects.

The following describe certain activities relating to CEMIG, subsidiaries, jointly-controlled entities and associates during 2015:

Renova Group:

 

    Transfer of the SPE Ventos de São Cristóvão Energias Renováveis S.A. from Renova Energia S.A. to Centrais Eólicas Bela Vista XIV S.A.;

 

 

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    Restructuring of Renova, which included: (i) acquisition of a 11.36% equity interest in TerraForm Global Inc., with the corporate purpose of acquiring, from SunEdison or third parties, assets connected to the generation of clean energy; (ii) creation of three subholdings of TerraForm Global Inc.: (1) TerraForm Global BV, (2) Other Holdings and (3) TERP GLB Brasil; (iii) transfer of Nova Renova Energia, alongside Bahia Eólica Participações S.A. and the 5 wind generating SPEs, in which Renova had an ownership interest to TERP GLB Brasil; (iv) transfer of Salvador Holding S.A., in which Renova had an ownership interest in to TERP GLB Brasil; (v) transfer of Salvador Eólica Participações S.A., alongside the other 9 wind generating SPEs, in which Nova Renova Energia had an ownership interest to Salvador Holding S.A.; (vi) transfer of Renova Eólica Participações S.A., alongside 15 wind generating SPEs in which Nova Renova Energia had an ownership interest to Nova Energia Holding S.A.; (vii) transfer of Diamantina Eólica Participações S.A., in which Renova had an ownership interest to Alto Sertão Participações S.A.; (viii) transfer of the 24 wind generating SPEs in which Renova had an interest to Diamantina Eólica Participações S.A.

Aliança Geração de Energia S.A. (“Aliança”):

 

    Conclusion of the transaction of association between Vale and CEMIG GT to form Aliança. 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 SPCs: Central Eólica Garrote Ltda., Central Eólica Santo Inácio III Ltda., Central Eólica Santo Inácio IV Ltda. and Central Eólica São Raimundo Ltda.

CEMIG Geração e Transmissão S.A.:

 

    Merger of CEMIG Capim Branco Energia S.A. into CEMIG GT, and consequently the cancellation of its registration with the Brazilian Federal Revenue Service;

 

    Acquisition by CEMIG GT, from Vale, of Vale’s 49% stake in Aliança Norte Energia Participações S.A., which holds a 9.00% interest in NESA (which owns the concessions of Belo Monte)—corresponding to an indirect holding of 4.41% in NESA;

 

    Winding up of the Aimorés and Funil consortia, and the consequent cancellation of their registration with the National Registry of Legal Entities (CNPJ) of the Federal Revenue Service;

 

    EBL Companhia de Eficiência Energética S.A., that had a 33% equity interest in Light Esco Prestação de Serviço S.A was excluded;

 

    Parati made a public tender offer seeking to acquire all of the outstanding shares of Redentor Energia S.A. (“Redentor”) and delist Redentor’s shares from B3. As a result, Parati became the owner of 99.79% of Redentor’s equity interest; and

 

    CEMIG GT won the concession for Lot D in ANEEL’s Auction No. 012/2015, for placement of concessions for hydroelectrical plants under a regime of allocation of generating capacity and physical offtake guarantees. Lot D is comprised of 13 plants that previously owned by CEMIG, and additional five plants which were owned by Furnas Centrais Elétricas S.A. The hydroelectrical plants CEMIG previously owned are: Três Marias, Salto Grande, Itutinga, Camargos, Marmelos, Joasal, Paciência, Piau, Tronqueiras, Peti, Cajuru, Gafanhoto and Martins. The plants Furnas previously owned are: Coronel Domiciano, Dona Rita, Sinceridade, Neblina and Ervália. The aggregate installed generation capacity of these 18 plants is 699.57 MW.

The following describe certain activities relating to CEMIG, subsidiaries, jointly-controlled entities and associates during 2016:

Concession Contracts for 18 Generation Plants

On January 5, 2016, CEMIG GT signed the concession contracts for operation of 18 generation plants (699.57 MW total installed generation capacity), acquired by CEMIG GT for R$ 2.216 billion, as a result of ANEEL Auction No. 012/2015.

 

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Exchange of Debentures owned by AGC Energia for Shares Issued by CEMIG

On March 3, 2016, BNDES Participações (“BNDESPar”) exchanged the totality of its debentures in the Non-convertible Permanent Asset-guaranteed Exchangeable Shareholders’ Debentures of the First Series issued by AGC Energia, for 54,342,992 common shares and 16,718,797 preferred shares issued by CEMIG and previously owned by AGC Energia. After the exchange, the equity interest held by BNDESPar in CEMIG—which on March 2, 2016 comprised no common shares and 1.13% of the preferred shares—increased to 12.9% of CEMIG’s common shares and 3.13% of CEMIG’s preferred shares. This increased the interest of BNDESPar in the total equity of CEMIG from 0.75%, before the exchange, to 6.4% immediately thereafter.

Investment Agreement for Subscription of Capital in Ativas signed by Cemig Telecom

On August 25, 2016, CEMIG Telecomunicações S.A.(“CEMIG Telecom”) signed an Investment Agreement with Sonda Procwork Outsourcing Informática Ltda., a company of the Chilean group Sonda S.A. (‘Sonda’), for the subscription of capital in Ativas Data Center S.A. (‘Ativas’), in partnership with Ativas Participações S.A. (‘Ativas Participações’), a company controlled by the Asamar Group.

Sonda, has subscribed capital totaling R$ 114 million, and now holds an equity interest of 60% in Ativas, while CEMIG Telecom holds 19.6% and Ativas Participações holds 20.4%.

Sale of Interest in Transchile

On September 12, 2016, CEMIG signed a share purchase agreement for sale of the whole of its interest in Transchile Charrúa Transmisión S.A.—corresponding to 49% of the share capital—to Ferrovial Transco Chile SpA., a company controlled by Ferrovial S.A., for US$ 57 million, the amount to be adjusted at the closing. This transaction was concluded on October 6, 2016.

Miranda Hydroelectrical Plant

On December 22, 2016, the Superior Court of Justice (STJ) granted an interim injunction to CEMIG GT maintaining CEMIG GT in control of the Miranda Hydroelectrical Plant, in Minas Gerais, on the initial basis stated in Concession Contract No. 007/97, until conclusion of judgment on the application for mandamus filed by CEMIG GT. In response to a motion for revision of judgment brought by the Federal Government against the Internal Appeal, the Reporting Justice revoked this interim remedy on March 29, 2017.

Renova Group

On February 2, 2016, the Board of Directors of Renova approved an increase in the capital of Renova in which we will take part through the Parent Company’s wholly-owned subsidiary CEMIG GT, which has approved allocation of up to R$ 240 million.

On April 1, 2016, Renova terminated the purchase and sale of shares for the sale of the ESPRA project (“ESPRA Agreement”) owned by Renova to Terraform Global, Inc. (“Terraform Global”) by an agreement between the parties, upon a break-up fee payment in the amount of US$10 million to Renova. In this way, the ESPRA projects (three small hydroelectrical plants (SHPs) contracted under PROINFA, with 41.8MW installed capacity), would remain within Renova and return to compose Renova’s portfolio of operational assets.

On June 14, 2016, the Board of Directors of Renova approved cancellation of the power purchase agreement entered into between Renova Comercializadora de Energia S.A. (“Renova Trading”) and CEMIG GT for supply by 25 wind farms in the region of Jacobina, in the Brazilian state of Bahia, with 676.2 MW of installed capacity, for operational startup on January 1, 2019. The Board of Directors of Renova approved an advance payment of R$ 118 million for contracted future energy supply under the agreement between Renova Trading and CEMIG GT. The agreement, signed in 2013, provides for the parties to make earlier or later payments for the power supply that is the subject of the agreement.

CEMIG increased its capital of Renova, through the Parent Company’s wholly-owned subsidiary CEMIG GT, in the amount of up to R$240 million. Such capital increase was ratified on June 21, 2016, in the total amount of R$280 million (R$ 240 million by CEMIG and R$ 40 million by Light Energia S.A.), by means of a issuance of 42,042,219 common shares and 165 preferred shares, subscribed and paid up for the issuance price of R$6.66 per share (common or preferred) and R$19.98 per unit.

 

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Investment in Renova – Loss on impairment of assets available for sale

Put options contract

On September 18, 2015, a contract was signed providing Renova the option to sell to SunEdison, Inc. (‘SunEdison’), on or after March 31, 2016, up to 7,000,000 shares in TerraForm Global.

The exercise price of this option was R$ 50.48 per share, while SunEdison, at its own discretion, has the right to pay US$15.00 per share rather than R$ 50.48. The contract also gave SunEdison an option to buy 7 million shares on the same terms.

In the first half of 2016 Renova recognized a loss of R$111 million, resulting in the change in the fair value of the option, considering the credit risk. In addition, it recognized a loss of R$63 million relating to the expiration of the option, and commenced an arbitration proceeding seeking, among other items, indemnity for losses. On May 26, 2017, Renova and Terraform Global signed an agreement for the parties to terminate arbitration proceedings, upon compensation to Renova of US$15.0 million.

Investment in TerraForm Global – pricing of the shares

Renova also recognized a loss, in the first half of 2016, of R$272 million, reflecting the negative volatility in the share price of TerraForm in the period, in which Renova had an equity interest of 11.65%, valued on the basis of the market price of the shares.

The figures above refer to the impact on Renova’s interim financial statements. The effect on CEMIG was proportional to its interest at the time of 34.2%, in Renova, valued by the equity method, in the amount of R$93 million.

Advances to Renova under Power Purchase Agreement

On September 6, 2016, the Renova Board of Directors approved an advance payment of R$118 million by CEMIG to Renova for future contracted energy supply under the Power Purchase Agreement between Renova Comercializadora de Energia S.A. and CEMIG GT, which was signed in 2013.

The agreement provided for the parties to elect to make advance payments for power. The payments were meant to be primarily allocated to the Alto Sertão III project, and also to meet other needs of Renova. The amount due would be settled by delivery of power supply, in the amounts specified in such agreement, starting in May 2021.

In June 2016 CEMIG GT made an advance payment to Renova Comercializadora de Energia S.A. of R$94 million under the Power Purchase Agreement, and at that time signed an agreement placing a security interest on 100% of the shares in Enerbrás S.A. and 100% of the shares in the specific-purpose companies of Phase B of the Alto Sertão III Project on behalf of CEMIG GT. An option was also granted to CEMIG GT to purchase 100% of the shares of Enerbrás S.A..

A Call Option Agreement has been signed which will enable CEMIG GT to convert the total amount advanced into a shareholding interest in Alto Sertão Participações S.A. (“Alto Sertão”), the controlling shareholder of the companies that comprise Phase A of the Alto Sertão III project; up to a limit of 49.9% of the shares in Alto Sertão, and also an agreement placing a security interest upon 100% of the shares in Bahia Holding S.A. and 49% of the shares in Ventos de São Cristóvão Energias Renováveis S.A., which holds certain of Renova’s wind power projects. Exercise of the call option is conditional upon prior approval by the BNDES. Settlement of the share option transactions referred to above will require the prior approval of BNDES, Banco do Brasil S.A. – where applicable, ANEEL, and the Brazilian Monopolies Authority (CADE).

 

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Adjustment for impairment in value of investments

In 2016, CEMIG posted an adjustment for a reduction in value of investments of R$ 763 million related to its investment in Renova. Renova incurred losses totaling R $1,101 million for the year ended December 31, 2016, had negative working capital of R$ 3,211 million as of December 31, 2016 and presented negative cash flow generation. The main reasons for these negative financials are: (i) energy purchases Renova was forced to make to comply with previous commitments because of a delay in certain wind farms becoming operational; (ii) substantial investments Renova made in the construction of the Alto Sertão III wind farm; (iii) a delay in obtaining BNDES long-term financing; (iv) Renova’s failure to meet certain covenants and obtain creditors’ approval in 2016, which resulted in certain long-term debt being reclassified as current liabilities and (v) losses resulting from its Terraform operation. In addition, currently Renova is late on certain payments and in negotiation with creditors under several contracts. As a result, Renova’s management has been taking various measures to rebalance its liquidity and cash generation structure such as selling assets, decreasing administrative and operational structure and administrative costs, increasing shareholders’ commitment of financial support, entering into long-term financing with the BNDES, starting cash flow equalization projects and seeking the consent of creditors to reclassify certain current debts as noncurrent liabilities.

Increase in Capital of Renova

CEMIG GT increased its stake in Renova in the amount of R$56 million through a capital increase that was ratified on June 21, 2017, in the total amount of R$112.8 million by means of a issuance of 50,888,993 common shares and 5,492,938 preferred shares, subscribed and paid up to the issuance price of R$2.00 per share (common or preferred) and R$6.00 per unit.

Sale of Alto Sertão III Wind Farm Complex by Renova

On November 12, 2017, Renova received a binding proposal from Brookfield for primary investment of R$ 1.4 billion in Renova, at a price of R$ 6 per unit. The offer further includes an earn-out of up to R$ 1.00 per unit, for any amount that Renova receives in the future as adjustment to the sale price of the Alto Sertão II Wind Power Complex. The proposal also specifies conditions precedent that are usual in this type of transaction. This proposal was accepted by Renova’s board of directors on November 24, 2017.

On February 23, 2018, Renova received a new binding proposal from Brookfield replacing the previous offer for primary capitalization (November 12, 2017 proposal). This new proposal provided for the acquisition of all assets of the Alto Sertão III Complex (the “ASIII Complex”), in addition to certain other wind projects under development with total planned generating capacity of approximately 1.1 GW. The value proposed for the ASIII Complex was R$ 650 million, to be paid upon the completion of the transaction (the “Price”). The Price would be subject to regular post-closing adjustments and to an earn-out mechanism that may increase the Price up to additional R$ 150 million.

On February 27, 2018, the board of directors of Renova accepted Brookfield’s February 23, 2018 binding offer for the acquisition of ASIII Complex and additional wind power projects under development. Renovas’s board of directors also approved to grant Brookfiled an exclusivity term of up to 60 days for the negotiation and execution of the transaction documents. The exclusivity term has ended, but negotiation between Renova, its shareholders an Brookfield is still continue and final completion of the transaction will take place after agreement is reached and consideration and approval by the governance bodies of Renova and of its controlling shareholders, and after all conditions precedent are met.

 

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TAESA

On April 13, 2016, TAESA was the winning bidder of Branch ‘P’ in Auction No. 013/2015 of Public Power Transmission Lines auction promoted by the Brazilian Energy Regulatory Agency (“ANEEL”). Branch ‘P’ comprises 90 km of transmission lines and two substations in Tocantins state. ANEEL granted TAESA the right to explore the concessions for 30 years. TAESA did not offer a discount for Lot ‘P’ RAP defined by ANEEL at the auction notice, granting an initial revenue of R$ 56 million.

On August 31, 2016, the Board of Directors of CEMIG authorized monetization of up to 40,702,230 units in TAESA corresponding to 40,702,230 common shares and 81,404,460 preferred shares in TAESA, owned by CEMIG.

On October 24, 2016, TAESA settled its restricted offering (“Restricted Offering”) of 65,702,230 units (each unit being evidenced by Certificados de Depósito de Ações, each of which represented one outstanding ação ordinária (common share) and two outstanding ações preferenciais (preferred shares)) (“Units”) offered and sold by Fundo de Investimento em Participações Coliseu (“FIP Coliseu”) and CEMIG. The Restricted Offering was a secondary offering, with restricted placement efforts of 65,702,230 units held by the Selling Shareholders, being 25,000,000 units held by FIP Coliseu and 40,702,230 units held by CEMIG, at a price per Unit of R$19.65.

On December 27, 2016, TAESA received the notice sent by Fundo de Investimento em Participações Coliseu and Fundo de Investimento em Ações Taurus (jointly, “Sellers”), informing that a Share Purchase Agreement was executed with Interconexión Eléctrica S.A. E.S.P. (“Agreement” and “Buyer”, respectively) for the sale of the totality of their equity interests bound to the block of control of TAESA, representing, jointly, 26.03% of the common shares and 14.88% of the total capital share of TAESA, for the total amount of R$1,055,932,217.19.

Changes in the Shareholders’ Agreement of Parati

In 2016, there has been a corporate simplification with regard to CEMIG´s indirect investment on Light, such as FIP Redentor termination, incorporation of Redentor Energia SA. by Rio Minas Energia Participações S.A. (“RME”), Parati’s total break-up, whereby CEMIG, Santander (Brasil) S.A., BV Financeira S.A., BB—Banco de Investimento S.A. and Banco BTG Pactual became direct shareholders of RME and Luce Empreendimentos e Participações S.A. (“Lepsa”), bearing same rights, obligations and equity then held by Parati. CEMIG has also acquired Banco BTG Pactual S.A.’s equity shareholdings of RME and Lepsa in 2016. Legal instruments have been signed to formalize the related alterations to the rights and obligations relating to the Put Option granted by CEMIG to the Direct Shareholders on shares in Parati, with the result that the said rights and obligations now apply, instead, to the shares in RME and Lepsa, since these two companies received the whole of the body of assets and liabilities that were split off as a result of the 100% split of their controlling and sole shareholder, Parati.

In November of 2017, the Company entered into certain amendments to the shareholders’ agreement of RME, one of successors of Parati. The principal change arising from these amendments is to postpone the exercise of the put option on the RME common shares for November 23, 2018.

In essence, the obligations of the put option remained as follows:

 

  1) The maturity of the put option granted in 2011 by CEMIG in favor of the unit holders of FIP Redentor, initially scheduled to be exercised on May 31, 2016 was postponed and divided into three separate exercise dates:

 

  a) First option exercise window: up to, and including, September 23, 2016, only with respect to preferred shares, up to a limit of 153,634,195 preferred shares in RME e Lepsa, representing 14.30% of the total shares in Light held by the other direct shareholders. With respect to shares put within this exercise window, CEMIG paid by November 30, 2016.

 

  b) Second option exercise window: up to, and including, September 23, 2017, and not restricted to preferred shares in RME and Lepsa, and may include the totality of the common shares in Lepsa, representing 5.49% of the total shares in Light held by the other direct shareholders, regardless of the exercise of the put option in the first payment window. With respect to shares put within this exercise window, CEMIG paid by November 30, 2017.

 

  c) Third option exercise window: up to, and including, September 23, 2018, only with respect to common shares in RME, regardless of the exercise of the put option in the first or second payment window. With respect to shares put within this exercise window, CEMIG must make payment by November 30, 2018.

 

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  2) New provisions were included to provide for the possibility of acceleration of the put option exercise window in case CEMIG fails to comply with certain clauses of the shareholders’ agreement, allowing any direct shareholders to present to CEMIG a notice of acceleration of the put option, at which moment the option shall be considered exercised by all the direct shareholders, over the totality of their shares.

 

  3) To guarantee the full payment of the put option, on May 31, 2016 CEMIG offered the holders of the put option: Units directly held by CEMIG in TAESA, representing 55,234,637 ordinary shares and 110,469,274 preferred shares, and as a further guarantee, 26.06% (53,152,298 shares) that CEMIG directly holds in Light.

 

  4) The put option may be exercised by the direct shareholders of RME.

The following describe certain activities relating to CEMIG, subsidiaries, jointly-controlled entities and associates during 2017:

Light Put Option Amortization and Reprofiling

On September 15, 2017, CEMIG received Notices of Intention to Exercise Put Options, under the “Second Exercise Window”, from BB–Banco de Investimento S.A. (“BB-BI”), BV Financeira S.A. – Crédito, Financiamento e Investimento (“BV Financeira”), and Banco Santander (Brasil) S.A. (“Santander”) (jointly, the “Shareholder Banks”), giving notice of irrevocable decision to exercise their right to sell the totality of their holdings of common and preferred shares (the “Shares Subject of the Put Option”), comprising the totality of their equity interests, in Lepsa and RME (jointly, “the Companies”) This put option was exercised under Clauses 6.1.4 and 6.3 of the Shareholders’ Agreements of the Companies (“Put Options—Second Exercise Window”), signed on October 31, 2016, and as amended, by CEMIG and the Shareholder Banks, with the Companies as consenting parties (“the Lepsa Shareholders’ Agreement” and “the RME Shareholders’ Agreement”). The acquisition of the shares, by CEMIG took place on November 30, 2017.

There have been negotiations with the Shareholder Banks in order to postpone for 12 months (to November 2018) the closing date of the put option, which would allow CEMIG to divest from its interests in Light. CEMIG proceeded with a block trade of part of its interest in TAESA by November 24, 2017 and deposited the funds in an escrow account it maintains with the proceeds of a previous sale of TAESA’s shares. CEMIG paid R$1,016 million of the put option on November 30, 2017 buying preferred shares of RME and common shares and preferred shares of Lepsa.

The 12-month extension with the Shareholder Banks was negotiated to postpone to November 30, 2018 in relation to common shares of RME. The basis for the negotiation of this postponement is the fact that if the put option on the common shares is exercised, Light could potentially become a state-controlled company, since CEMIG would then hold, directly and indirectly, 52.12% of Light’s capital share. This would lead to the acceleration of several of Light’s financing agreements that have cross-default clauses, and it would result in a sharp fall in the share price of Light, which would have a material adverse effect on CEMIG. See more details in note 30 in our consolidated financial statements.

Decision on disposal of holding in Light

On June 21, 2017, the Board of Directors of CEMIG decided to begin the process to sell its entire interest in the share capital of Light S.A. (“Light”), and on July 14, 2017 RME and Lepsa made formal decisions to start the process to sell their entire interest in Light. This formalized the joint decision of CEMIG, RME and Lepsa to dispose of the totality of the controlling shareholding block of Light, which comprises an aggregate holding of 52.12% of the share capital of Light.

CEMIG has received non-binding proposals related to its process of disinvestment, as a result of the first phase of access to the documents and information contained in the data room made available to potential investors in relation to the Light group. CEMIG is analyzing these proposals for possible selection for inclusion in the next phase. If a selection is made, conclusion of the disinvestment process will also be subject to: a phase of due diligence, including technical visits; submission of binding proposals; negotiations; final approvals for signature of definitive agreements for the transaction referred to; and approvals of conditions precedent that are usual in this type of transaction.

 

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Sale of Alto Sertão II Wind Farm Complex by Renova

On August 3, 2017, CEMIG GT’s affiliate Renova completed the sale to AES Tietê Energia (“AES Tietê”) of Renova’s entire equity interest in Nova Energia Holding S.A. (“Nova Energia”), which, through Renova Eólica Participações S.A. (“Renova Eólica”), owns the Alto Sertão II Wind Farm Complex (the “Complex”). The base value of the acquisition (“the Acquisition Price”) is R$ 600 million, and AES Tietê has also assumed the debt of the Alto Sertão II Complex, which totaled R$ 1.15 billion at December 31, 2016. The Acquisition Price will be adjusted based on certain variations in working capital and net debt of the Complex. It may also be increased by up to R$ 100 million under earn-out clauses, depending on the performance of the Complex as measured over a period of five years from the completion of the transaction. A tranche totaling R$364.6 million of the Acquisition Price has been allocated to extraordinary amortization of the debentures of Renova’s Third Issue of Nonconvertible Debentures (Unsecured, with Additional Asset Guarantee, for Public Distribution, in a Single Series, with Restricted Distribution Efforts), settling the whole of the outstanding balance of principal and remuneratory interest owed by Renova under that issue.

Disposal of TerraForm Global Inc. shares

On May 26, 2017, Renova entered into a Share Purchase Agreement and sold its equity interests in TerraForm Global Inc. to Orion US Holding 1 L.P., a vehicle of Brookfield Asset Management. The price for the acquisition was US$92.8 million paid to Renova in cash upon completion of the transaction, after certain conditions precedent have been met. Also on the same date, Renova and Terraform Global signed an agreement for the parties to terminate certain arbitration proceedings, upon payment of compensation to Renova of US$15.0 million. The transaction closed on July 3, 2017.

Renova’s management has stated that the transaction is aligned with its new directional strategy, the goals of which are the (i) restoration of the balance of its capital structure; and (ii) sustainability of the business in the long term.

Investment in Renova

Renova is late on certain payments and is in negotiation with creditors under several contracts. As a result, Renova’s management has been taking various measures to rebalance its liquidity and cash generation structure such as selling assets, decreasing administrative and operational structure and administrative costs, and increasing shareholders’ commitment of financial support.

Sale of Coliseu’s interest in TAESA

On June 13, 2017, CEMIG’s affiliate TAESA received a notification from ISA Investimentos e Participações do Brasil S.A. (“ISA Brasil”) in relation to disposal of common shares in TAESA held by Fundo de Investimento em Participações Coliseu and Fundo de Investimento em Ações Taurus, under the share purchase agreement signed on December 27, 2016 between the vendors and Interconexión Eléctrica S.A. E.S.P. (“the Purchaser”).

In accordance with the terms of the purchase agreement the vendors sold in the aggregate 153,775,790 common shares, representing 26.03% of the voting share and 14.88% of the total capital of TAESA. These shares were transferred to ISA Brasil (an investment vehicle of the Purchaser) on June 13, 2017 for approximately R$1 billion. ISA Brasil is now subject to the Shareholders’ Agreement of TAESA.

 

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Transfer of transmission companies to TAESA

On July 13, 2017, CEMIG GT signed an agreement regarding an equity restructuring involving the transfer to TAESA of the equity interests held by CEMIG in the following public energy transmission concession holders (referred to jointly as “the Transmineiras Companies”): Companhia Transleste de Transmissão S.A. (“Transleste”), Companhia Transudeste de Transmissão S.A. (“Transudeste”) and Companhia Transirapé de Transmissão S.A. (“Transirapé”).

The initial value of the transaction is approximately R$ 76 million, to be paid on the date of closing. This amount will be subject to adjustment for: (i) accumulated variation of the IPCA inflation index as from January 1, 2017, inclusive, up to the day immediately prior to the date of signature of the agreement; and (ii) accumulated variation resulting from application of 100% of the CDI rate, from the date of signature, inclusive, up to the day immediately prior to the date of closing and is subject to discounting of any amounts of dividends and/or interest on equity declared as from January 1, 2017 (inclusive) by the Transmineiras Companies in favor of CEMIG GT, whether paid or not, up to the date of closing, duly updated by the accumulated variation of the IPCA inflation index from the date of the payment to the day immediately prior to the date of closing.

Under the terms of the agreement, a further tranche with a maximum value of R$ 11.7 million may be divided between TAESA and CEMIG GT if the Transmineiras Companies obtain a favorable judgment in certain legal proceedings that are in progress. This amount will be updated by the accumulated variation resulting from application of 100% of the CDI rate from January 1, 2017, inclusive, to the day immediately prior to the day of payment.

Following approval by the Brazilian monopolies authority CADE (Conselho Administrativo de Defesa Econômica), Aneel (the Brazilian energy regulator), and the financing banks, on November 30, 2017, Cemig has concluded the shareholding restructuring involving transfer to Transmissora Aliança de Energia Elétrica S.A. of the shareholdings held by Cemig in the following transmission concession holders: Companhia Transleste de Transmissão S.A., Companhia Transudeste de Transmissão S.A. and Companhia Transirapé de Transmissão S.A.. The amount received by Cemig in this Transaction was R$ 56 million– this being the amount resulting from monetary updating by: (i) the accumulated variation of the IPCA inflation index from January 1, 2017, inclusive, to the day immediately prior to the signature of the final closing document for the Transaction; and (ii) accumulated variation of 100% (one hundred per cent) of the CDI rate from date of signature, inclusive, to the day immediately prior to date of closing, and after discounting of: any amounts of dividends and/or Interest on Equity declared as from January 1, 2017 (inclusive) by the Transmineiras Companies in favor of Cemig, whether paid or not, up to the date of closing of the Transaction, with monetary updating by the IPCA from the date of payment to the business day immediately prior to the closing date.

TAESA – Columbia Consortium

On April 24, 2017, the Columbia Consortium formed by TAESA and CTEEP won the bid for Branch 1 of the Transmission Auction No. 5/2016, carried out by ANEEL by offering R$267 million of Annual Allowable Revenue (RAP). The project, which will require a R$1,936 million investment, will comprise (i) 525 kV Guaíra—Sarandi transmission lines, extending them 266.3 kilometers; (ii) Foz do Iguaçu – Guaíra transmission lines, extending them 173 kilometers; (iii) Londrina – Sarandi transmission lines, extending them 75.5 kilometers; and (iv) the 230 kV Sarandi—Paranavaí Norte line, extending it 85 kilometers, plus constructing and operating three substations (Guaíra, Sarandi and Paranavaí Norte), located in Paraná. The deadline for execution of the work is 60 months and the commercial operation start is scheduled for August, 2022.

Cemig sold 34 million Taesa Units

On November 24, 2017, Cemig has sold, by auction on the B3 exchange (‘the Auction’) 34,000,000 Units in Transmissora Aliança de Energia Elétrica S.A. (‘Taesa’) (TAEE11), for R$ 21.10 per Unit. This reduces Cemig’s equity interest in Taesa from 31.54% to 21.68%. Cemig now owns 218,369,999 common shares equivalent to 36.97% of Taesa’s total common shares and 5,646,184 preferred shares 1.28% of Taesa’s total preferred shares. The controlling shareholding block of Taesa remains unchanged, since the shares sold were not bound by the Shareholders’ Agreement. The proceeds from the sale will be held in an escrow account to execute the Company’s commitments in relation to the put option granted by Cemig to the shareholders of Rio Minas Energia Participações S.A. (‘RME’) and Luce Empreendimentos e Participações S.A. (‘Lepsa’).

 

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Offer for Interest in Santo Antônio Power Plant

On June 26, 2017, CEMIG received from State Power Investment Overseas Co., Ltd of China (“SPIC Overseas”) an offer for purchase of the equity interests held by CEMIG GT and SAAG Investimentos S.A. (“SAAG”) in Madeira Energia S.A. (“Mesa”), holder of the concession to operate the Santo Antônio Hydroelectrical Power Plant.

Starting from this proposal, the parties entered into a negotiation process aiming at achieving a common ground regarding the valuation of Mesa and the purchase price of the shares. This negotiation process has been temporarily suspended at the end of July 2017 and was resumed on March 2018.

CEMIG’s Bank Debt Refinancing

In 2017, Cemig entered into negotiations with its main creditors aiming at a Bank Debt Refinancing, representing up to R$3.4 billion of debt, in order to refinance short and medium term indebtedness of CEMIG GT and CEMIG D and, then, to balance CEMIG’s short and medium term cash flows. The reprofiling involved the amortization schedules of existing debt maturities, ranging from 2017 through 2020, into facilities with a principal amortization grace period in 2018 and final maturities in 2022.

In December, CEMIG D concluded the reprofiling by means of a local notes issuance in the amount of R$1,575 million and ammendments in debt agreements entered into with Banco do Brasil (R$500 million) and Caixa Econômica Federal – CEF (R$625 million). As to CEMIG GT, there were ammendments in debt agreements entered into with Banco do Brasil (R$741 million). In aggregate, the bank debt reprofiling reached, approximately, R$3.4 billion. The new debt of CEMIG D will pay interests of 146.5% of CDI (local interest rate), whereas the new debt of CEMIG GT will cost 140% of CDI. The amortization of principal will begin in 2019, with monthly payments in the following annual distribution: 33.36% in 2019 and 2020, and 33.28% in 2021 for CEMIG GT and 6.75% in 2019, 13.50% in 2020, 27% in 2021, 11.25% and a balloon of 41.50% in 2022 for CEMIG D.

The Bank Debt Refinancing did not involve a principal reduction and the new facilities were senior secured indebtedness. The collateral for CEMIG GT’s Bank Debt Refinancing is comprised of cash sweep on CEMIG GT’s asset sales (35% of every asset sale), pledges on dividends earned from some of CEMIG and CEMIG GT’s subsidiaries and pledge on receivables (R$125 million per month for the life of the new debt facility). The collateral for CEMIG D’s Bank Debt Refinancing is comprised of cash sweep on CEMIG Holding’s asset sales (35% of every asset sale) and pledge on receivables (R$400 million per month for the life of the new debt facility).

Cemig’s Capital Increase

On October 26, 2017, Cemig’s Extraordinary General Meeting of Shareholders authorized an increase of the Company’s share capital through the issuance of new shares that were available only for subscription by the Company’s existing shareholders, with the following terms and conditions (the “Capital Increase”):

 

  1. Amount of the Capital Increase: up to R$ 1 billion through the issuance of up to 199,910,947 new shares each with nominal value of R$ 5.00, for an issue price of R$ 6.57, for both common and preferred shares. The difference between the issue price (R$ 6.57) and the nominal price (R$ 5.00) is to be allocated to the capital reserve account;

 

  2. New shares: up to 199,910,947 new nominal shares (up to 66,849,505 nominal common shares and up to 133,061,422 nominal preferred shares). 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.

 

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  3. Subscription of the new shares: the Capital Increase was implemented through a private subscription and Cemig’s shareholders were eligible to exercise their preemptive rights in proportion equity holdings, at the ratio of 15.89% of the number of shares of each type that they held at the close of market on October 25, 2017.

 

  4. Preemptive right exercise term: the preemptive right for the subscription of the new shares were exercised by the shareholders between October 30, 2017 to November 29, 2017.

 

  5. Remaining shares: Not all the newly issued shares have been subscribed, shareholders were eligible to subscribe the remaining sharesmay do so at the same price and on the same conditions.

On March 21, 2018, all the Remaining Shares have been sold through a public auction, resulting in proceeds from the Capital Increase of R$ 1.3 billion. On April 23, 2018, the Extraordinary General Meeting of Shareholders approved the Capital Increase and, the resulting amendment of Cemig’s Bylaws to reflect the new amount of the Company’s s share capital: in the aggregate amount of R$ 7,294 million, represented by 487,614,213 common shares and 971,138,388 preferred shares.

Cemig did not register the Capital Increase with the U.S. Securities and Exchange Commission (SEC). Citibank, as the Depositary Bank for the ADRs, sold the corresponding preemptive rights only in the Brazilian market and, on December 13, 2017, Citibank made a distribution of the net proceeds arising from such sale (gross revenue from the sales, less charges and expenses), in US dollars, to the holders of the ADRs.

The merger of Cemig Telecomunicações S.A. by Cemig

On January 12, 2018 in a meeting, Cemig’s Board of Directors decided to submit a proposal to an Extraordinary General Meeting of Shareholders that Cemig should merge its wholly-owned subsidiary Cemig Telecomunicações S.A. The merger will provide gains from optimization of assets and synergies, and reduce financial, operational and administrative costs through concentration of existing administrative structures, while improving options for use of available funds.

An Extraordinary General Meeting of Shareholders of Cemig, and an Extraordinary General Meeting of Shareholders of Cemig Telecomunicações S.A., both held on February 28, 2018, have approved and authorized the signature of the Protocol of Merger and Justification establishing the terms and conditions governing the merger of CemigTelecom by Cemig.

The merger of Cemig Telecomunicações S.A. by Cemig was completed on March 31, 2018.

Since this is a merger of a wholly-owned subsidiary, there was no capital increase nor issue of new shares by Cemig. The shares in the subsidiary were canceled, on the Merger Date, and the necessary accounting records made.

Auction of Former CEMIG GT Generation Concessions and Indemnification

Under Concession Contract 007/1997 the concessions of the Jaguara, São Simão, Miranda and Volta Grande hydroelectrical plants had expiration dates in August 2013, January 2015, December 2016 and February 2017, respectively.

Believing that Cemig had the right to renewal of the concessions of these three plants, based on the original terms of the Concession Contract, the Company filed administrative and court proceedings requiring their extension for the related renewal periods. These applications, however, were rejected by the Mining and Energy Ministry, on the view that the request was made out of time in relation to the deadlines and/or rules set by Law 12783/13.

In March 2017 the interim judgments that had maintained the Company in possession and operation of the concession of the Jaguara and Miranda plants on the basis of the original Concession Contract 007/1997 were revoked. Cemig GT remained in control of the asset, and recognized the sales revenue from energy, and the operational costs, of these plants up to the date of the revocation of those interim judgments. From that date onward, the subsidiary ceased to recognize the expenses of depreciation on the plants, 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. As ordered by Mining and Energy Ministry Order 432/2015, the São Simão plant was being operated under the Quotas Regime since September 2015.

 

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In spite of the fact that there were court proceedings still pending, involving the São Simão, Jaguara and Miranda plants, on September 27, 2017 the Federal Government auctioned the concessions for the São Simão, Jaguara, Miranda and Volta Grande plants – which have total generation capacity of 2,922 MW – for a total of R$ 12,130,784. 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 of Assisted Operation was formalized, maintaining the Company as the party responsible for provision of energy generation service from the plants up to the following dates:

 

    Volta Grande plant: Until November 30, 2017.

 

    Jaguara and Miranda plants: Until December 28, 2017.

 

    São Simão plant: Until May 9, 2018.

Annual Generation Revenue (Receita Anual de Geração, or RAG) of these plants was recognized in the amount of R$ 462, million, in 2017 (R$ 319 million in 2016).

On August 3, 2017 Mining and Energy Ministry Order 291/17 established the values of indemnity, to Cemig GT, for the investments made in the São Simão and Miranda plants that have not been amortized up to the end of the contract. The total amount of the indemnity is R$ 1,027,751, of which R$ 243,599 relates to indemnity for the São Simão Plant, and R$ 784,152 is indemnity for the Miranda Plant – these figures being expressed in December 2015 and February 2016 currency, respectively. The amounts will be updated, pro rata die, by the IPCA (Expanded Customer Price) index, up to the date of signature of the Concession Contract by whichever party wins the tender for the concession of the Plants, by the Selic reference rate for federal securities, as from the date of signature of the Concession Contract up to the date of actual payment of the indemnity.

The balances not yet amortized of the concessions of the São Simão and Miranda Plants, in relation to their Basic Plans, were adjusted to reflect the matters defined in Ministerial Order 291/17, and as a result revenue of R$ 271,607 was recognized (more details in Notes 4, 15 and 26). Additionally, the Company transferred the balances referred to Concession Financial Assets.

The Company is discussing, with the Mining and Energy Ministry, the criteria used for deciding the amount published in Ministerial Order 291/17, and also the date of payment, since that Order establishes that the payment of the indemnity must be made, by the Federal Government, on or before December 31, 2018, provided that there is budget and financial availability.

On December 31, 2017, investments made after the Jaguara, São Simão and Miranda plants came into operation, in the amounts of R$ 174,203, R$ 2,920 and R$ 22,546, respectively, are classified in Concession Financial assets, and the decision on the final amounts to be indemnified is in a process of discussion with Aneel.

 

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Companies incorporated in Brazil described below are our major subsidiaries and affiliates and jointly-controled companies. Jointly controlled companies and affiliates are recorded under the equity method:

 

LOGO

CEMIG Holding’s main subsidiaries and jointly-controlled investees 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;

 

    Transmissora Aliança de Energia Elétrica S.A. (“TAESA”) – jointly-controlled entity, with ownership of 36,97% of the voting share and 21,68% of the total stock: construction, operation and maintenance of energy transmission facilities in 18 states of Brazil;

 

    Light S.A. (“Light”) – Jointly-controlled entity, with a direct holding of 26.06% and an indirect holding of 22.8% of total share, totaling 48.86%: energy generation, transmission, trading and distribution, and other related services; direct or indirect holding of interests in companies operating in these areas;

 

    Renova Energia S.A. (“Renova”) – jointly-controlled entity, with direct ownership of 36,23% of the total capital and 45,83% of the voting share. Listed company operating in development, construction and operation of plants generating power from renewable sources—wind power, small hydroelectrical plants (SHPs), and solar energy; sales and trading of energy, and related activities. Renova owns Latin America’s largest wind complex, in the central region of the state of Bahia;

 

    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.

 

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Long-Term Strategic Plan

Our vision and goal to consolidate our position as the largest group in the Brazilian energy sector in this decade, with a presence in the natural gas industry, and becoming a world leader in sustainability, admired by clients and recognized for our strength and performance was undergoing a review process.

The ongoing review signals an ambition to be a leader in the electric power industry in sustainable value creation through increased productivity and healthy growth by 2020.

In order to pursue our ambition and to follow our Long Term Strategic Plan, we have the following goals:

 

    Strive to be a national leader in the markets we operate;

 

    Strive for operational efficiency in asset management;

 

    Be one of the most attractive companies for investors;

 

    Be a benchmark in corporate management and governance;

 

    Be innovative in the search for technological solutions for our business; and

 

    Be a benchmark in social, economic and environmental sustainability.

Capital Expenditures

Capital expenditures for the years ended December 31, 2017, 2016 and 2015 in millions of reais, were as follows:

 

     Year ended December 31,  
     2017      2016      2015  

Distribution network

     1,083        1,460        885  

Power Generation (1)

     308        3,133        577  

Transmission network (2)

     25        54        146  

Others

     104        219        105  
  

 

 

    

 

 

    

 

 

 

Total capital expenditures (3)

     1,520        4,866        1,713  

 

 

(1) Includes additions in generation financial assets in the amount of R$ 2,217 million in 2016.
(2) Includes additions in transmission financial assets in the amount of R$25 million and R$54 million in 2017 and 2016.
(3) The capital expenditures are presented in our Consolidated Statement of Cash Flow on account lines related to Financial Assets, Acquisition of equity investees, capital increase on investees, PP&E, acquisition of subsidiaries – Gasmig and intangible assets.

In 2018, we plan to make capital investments in relation to our fixed assets in the amount of approximately R$ 1,226 million, corresponding to our basic program (programs with tariff coverage). We expect to allocate these expenditures primarily to the expansion of our distribution system. We will also allocate R$ 167million for injection of capital into subsidiaries in 2018, to meet specific capital needs.

The amounts planned for 2018 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.

We expect to fund our capital expenditures in 2018 mainly from the cash flow from operations and, to a lesser extent, through financing. We expect to finance our expansion and projects from commercial bank loans through debt rollover and from the issuance of promissory notes and debentures in the local market.

Business Overview

General

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

 

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CEMIG

We are engaged in transactions to buy and sell energy through our subsidiaries. The total volume of energy resourced in December 31, 2017 was 82,479GWH or 2.1 % more than in 2016 and in 2016 was 80,774 GWH or 3.6 % less than in 2015. The amount of energy produced by us in 2017 was 6,606 GWh or 30.0% less than the 9,461 GWh produced in 2016, which was 35% less than 2015. The amount of energy purchased by us in 2017 was 75,873 GWh or 6.4% less more than the 71,313 GWh purchased in 2016, which was 3 % more than in 2015. These figures include 6,230 GWh purchased from Itaipu in 2017 and 5,921 GWh in 2016, and through the Energy Trading Chamber (Câmara de Comercialização de Energia Elétrica, or CCEE) and from other companies, we purchased 69,632 GWh in 2017and 65,392 GWh in 2016.

The energy traded in 2017 totaled 82,479 GWh, an amount 2.1% higher than 2016. 49.0% of that volume (40,146GWh) was traded to final customers, both captive and free.

Total losses of energy in the core and distribution networks in 2017 totaled 7,121GWh, which corresponds to 9.0% of total resources, and 5.9% more than the 6,723 GWh loss in 2016.

The table below shows the breakdown of resources and power requirements by CEMIG traded in the last three years:

CEMIG’S ELECTRIC ENERGY BALANCE

 

(GWh)    2017      2016      2015  
     (in GWh)  

RESOURCES

     82,479        80,774        83,750  

Energy generated by CEMIG

     5,708        8,852        14,068  

Energy generated by Sá Carvalho

     214        238        207  

Energy generated by Horizontes

     64        69        62  

Energy generated by CEMIG PCH

     94        94.2        63.2  

Energy generated by Rosal Energia

     128        134        97  

Energy generated by SPE

     398        —          —    

Energy bought from Itaipu

     6,230        5,921        6,190  

Energy bought from CCEE and other companies

     69,643        65,392        62,896  

REQUIREMENTS

     82,479        80,744        83,750  

Energy delivered to final customers

     40,147        45,322        48,710  

Energy delivered to auto-producers

     —          —          10  

Energy delivered by Ipatinga

     —          —          —    

Energy delivered by Barreiro

     —          8        63  

Energy delivered by Cachoeirao

     —          133        131  

Energy delivered by Sá Carvalho

     461        473        472  

Energy delivered by Horizontes

     79        76        76  

Energy delivered by CEMIG PCH

     65        82        82  

Energy delivered by Rosal Energia

     213        202        201  

Energy delivered by SPEs

     788        

Energy delivered to the CCEE and other companies

     33,605        27,754        27,543  

Losses (1)

     7,121        6,723        6,461  

 

(1) Discounting the losses attributed to generation (124 GWh in 2017) and the internal consumption of the generating plants.

Generation

The electric power generation business consists of the generation of energy through the use of renewable energy sources (water, wind, sun and biomass), or non-renewable sources (fossil and nuclear fuels).

According to ANEEL, as of December 31, 2017, we were the fourth largest energy generation group in Brazil, by total installed capacity. As of that date, we were generating energy at over 80 hydroelectrical plants (small hydroelectric power plants (“PCH”) and hydroelectric power plants (“UHE”), thermoelectric plants, wind and solar plants, with total installed capacity of over 5,600 MW, with plants present in 10 states of Brazil. The vast majority of our capacity is generated at hydroelectrical plants (96.0% of installed capacity), with the remaining being generated by thermal and wind plants. Our top five power plants accounted for over 57.4% of our installed energy generation capacity in 2017 are:

 

 

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Rank
(Installed
Capacity)
  

Generation Power Plant

  

CEMIG Group
Company
Holding Stake

  

Restricted /
Unrestricted
Group in This
Offering

   Installed
Capacity
(MW)
     Start of
Comm.
Operations
     Expiration of
Concession or
Authorization
    

Type of
Power
Plant

   CEMIG´s
Stake
 

1

  

Emborcação

  

CEMIG GT

  

Restricted

     1,192.0        1982        23/07/2025      UHE      100%  

2

  

Santo Antônio

  

SAESA

  

Unrestricted

     646.9        2012        12/06/2043      UHE      18.13%  

3

  

Nova Ponte

  

CEMIG GT

  

Restricted

     510.0        1994        23/07/2025      UHE      100%  

4

  

Belo Monte

  

Norte Energia

  

Unrestricted

     497.97        2016        26/08/2045      UHE      12.77%  

5

  

Irapé

  

CEMIG GT

  

Restricted

     399.0        2006        28/02/2035      UHE      100%  
  

Sub-Total: Top 5

           3,245.87              
  

Total (All Plants):

           5,650.53              

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 500 kW from alternative energy sources, such as wind, biomass or small hydroelectrical plants). Its revenue depends directly on the availability of its assets. The transmission network comprises energy transmission lines and substations with voltage of 230kV or more, and is part of the Brazilian Grid regulated by ANEEL and operated by the ONS. See “The Brazilian Power Industry.” On December 31, 2017, CEMIG GT and other CEMIG transmission networks had approximately 4,150miles of lines, as follows:

 

Classification

  

CEMIG GT

  

Other CEMIG Group Companies (proportional

to CEMIG’s stake in the relevant concession)

> 525kv Lines

      59 miles

500kv Lines

   1,355 miles    674 miles

440kv Lines

      68 miles

345kv Lines

   1,231 miles    31 miles

230kv Lines

   478 miles    263 miles

220kv Lines

     

Total

   3,064 miles    1,095 miles

Distribution

Within the CEMIG Group, energy distribution activities are conducted by a wholly owned subsidiary, CEMIG Distribution (“CEMIG D”), in addition to Light S.A. (“Light”), in which CEMIG has a 48.86% direct and indirect interest.

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 market (Ambiente de Contratação Regulada-ACR, the “Regulated 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 352,614 square miles, or 96.7% of the territory of the State of Minas Gerais. On December 31, 2017, CEMIG D’s energy system comprised 329,114 miles of distribution lines, through which it supplied 25,091 GWh to 8,346 million regulated customers and transported 17,738 GWh to 994 free customers that use our distribution networks. The total volume of energy distributed was 42,829 GWh, of which 44.4% was distributed to regulated and free industrial customers, 14.6% to regulated and free commercial customers, 23.4% to regulated residential customers, and 17.6% to other regulated customers.

Other Businesses

While our main business consists of the generation, transmission and distribution of energy, we also engage in the following businesses: (i) telecommunications; (ii) energy solutions consulting business for both Brazilian and international clients, through our subsidiary Efficientia S.A. (iii) exploitation of natural gas, through five consortia; (iv) 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. and CEMIG Comercializadora de Energia Incentivada S.A.; (v) acquisition, transport and distribution of gas and its subproducts and derivatives through Companhia de Gás de Minas Gerais (Gasmig); and (vi) 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.

 

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Table of Contents

Revenue Sources

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

 

     Year ended December 31,  
     2017     2016     2015  

Energy sales to final customers

     20,439       20,458       20,319  

Revenue from wholesale supply to other concession holders

     3,263       2,972       2,207  

CVA (compensation for changes in ‘Portion A’ items ) and other financial components in tariff increases

     988       (1,455     1,704  

Revenue from use of the energy distribution systems – TUSD

     1,611       1,705       1,465  

Revenue from use of the concession transmission system

     371       312       261  

Transmission indemnity revenues

     373       751       101  

Generation indemnity revenue

     271      

Adjustment to expectation of cash flow from the indemnifiable financial asset of the distribution concession

     9       8       576  

Revenue from financial adjusting of the Concession Grant Fee

     317       300       —    

Construction revenues

     1,118       1,193       1,252  

Transactions with energy on the CCEE

     860       161       2,425  

Supply of gas

     1,759       1,444       1,667  

Other operating revenues

     1,484       1,421       1,440  

Deductions from revenue

     (11,151     (10,497     (11,549
  

 

 

   

 

 

   

 

 

 

Total net operating revenues

     21,712       18,773       21,868  
  

 

 

   

 

 

   

 

 

 

Power Generation and Trading

Overview

CEMIG’s top five power plants (excluding the São Simão, Jaguara, Miranda and Volta Grande power plants) accounted for over 57% of its installed energy generation capacity as of the date of the 2017 annual report.

On September 27, 2017, the Brazilian Federal Government auctioned to third parties the concessions of four of CEMIG’s top ten power plants (São Simão, Jaguara, Miranda and Volta Grande power plants) with a total capacity of 2,922 MW. The following table shows CEMIG’s top five power plants as of the date of this annual report:.

 

Rank
(Installed
Capacity)
  

Generation Power Plant

  

CEMIG Group
Company
Holding Stake

  

Restricted /
Unrestricted
Group in This
Offering

   Installed
Capacity
(MW)(1)
     Start of
Comm.
Operations
     Expiration of
Concession or
Authorization
    

Type of
Power
Plant

   CEMIG´s
Equity
Stake
 
1   

Emborcação

  

CEMIG GT

  

Restricted

     1,192.0        1982        7/23/2025      UHE      100
2   

Santo Antônio

  

SAESA

  

Unrestricted

     646.9        2012        6/12/2043      UHE      18
3   

Nova Ponte

  

CEMIG GT

  

Restricted

     510.0        1994        7/23/2025      UHE      100
4   

Belo Monte

  

Norte Energia

  

Unrestricted

     497.97        2016        8/26/2045      UHE      13
5   

Irapé

  

CEMIG GT

  

Restricted

     399.0        2006        2/28/2035      UHE      100

CEMIG’s market consists of sales of energy to:

 

  (i) Regulated customers in CEMIG’s concession area in the State of Minas Gerais;

 

  (ii) Free customers both in the State of Minas Gerais and other States of Brazil, through the Free Market;

 

  (iii) Other agents of the energy sector – traders, generators and independent power producers, also in the Free Market;

 

  (iv) Distributors in the Regulated Market; and

 

  (v) CCEE (eliminating transactions between companies of the CEMIG Group).

 

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The following charts show the breakdown of CEMIG GT’s energy commercialization and energy sources and breakdown of energy sales for the periods shown:

 

LOGO

The total volume of transactions in energy in 2017 was 82,479 GWh, an increase of 2.1% in comparison to the 80,774 GWh in 2016.

Generation Assets

As noted above, on September 27, 2017, the Brazilian Federal Government auctioned to third parties the concessions of four of CEMIG’s power plants with a total capacity of 2,922 MW: São Simão, Jaguara, Miranda and Volta Grande. As a result, as of the date of this annual report, the subsidiaries and jointly-controlled subsidiaries of CEMIG Holding operated more than 80 plants, totaling 5,650 MW (exluding the São Simão, Jaguara, Miranda and Volta Grande power plants).

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 Holding GT owns 100% of the equity: 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.. There companies were incorporated by CEMIG GT in 2016 to hold the concession contracts for 18 hydroelectrical plants won in the auction the year before. The total installed generation capacity secured to CEMIG GT’s portfolio was 699 MW.

The generation companies in which CEMIG GT has jointly 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 hydroelectrical plants and the following generation consortia: Porto Estrela, Igarapava, Capim Branco and Candonga. In addition to the hydroelectrical plants in operation, there are four wind plants, which will compose the Complexo Eólico Santo Inácio in northeastern Brazil, in implementation phase. The company has installed hydro capacity of 1,158 MW in operation, among other generation projects, and will be responsible for investments in future projects of energy generation.

 

    Aliança Norte Energia Participações S.A. (49.9%) – Together with Vale (50.1%), the company holds participation of 9% of Norte Energia S.A., corresponding to an indirect equity interest of 4.41% and representing an installed capacity of 495 MW.

 

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    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., holder of the concession to operate the Belo Monte hydroelectrical plant, on the Xingu river, in the State of Pará, representing an installed capacity of 818 MW directly held by CEMIG GT.

 

    Renova (45.83% of voting share, 36.23% of total capital) – This company is the group’s vehicle for growth in generation from alternative generation and the group’s Small Hydroelectrical Plants (SHPs). At the end of 2017 Renova had generation supply contracts totaling 622,8 MW of generation capacity, of which 190,2 MW were already in commercial operation. CEMIG also has an indirect interest in Renova through Light (21.72% of voting share, 17.17% of total capital).

 

    Baguari Energia S.A. (69.39%) – The company operates the Baguari Hydroelectrical 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 hydroelectrical 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 38.5 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.

 

    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.

 

    Madeira Energia S.A (“MESA”) (10%) – 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 8.13% and takes place through the following companies: SAAG, FIP Melbourne (31.94%), Parma (56.75%) and FIP Malbec (49.92%).

 

    Central Eólica Praias de Parajuru S.A. (49%) – A beach-located wind plantat Beberibe, in the state of Ceará, in Northern Brazil. The other 51% is held by Energimp S.A..

 

    Central Eólica Praias do Morgado S.A. (49%) – Also located on a Northern Brazilian beach, this wind plant is at Acaraú, in Ceará state. The other 51% is held by Energimp S.A.

 

    Central Eólica Volta do Rio S.A. (49%) – This is the third of a group of three beach-located wind plants in Ceará, and is also in the municipality of Acaraú. The other 51% is held by Energimp S.A..

CEMIG Holding also has equity interests in jointly-controlled entities that operate generation assets. These include:

 

    Light (26.06%) – Owns 25.5% of Amazônia Energia Participações S.A, 51% of Lightger S.A., 100% of Itaocara Energia Ltda. Light Energia has investments in several jointly-controlled entities – for example 51% of Guanhães Energia S.A.; 21.72% of the voting share and 17.17% of the total share, of Renova; and 100% of Lajes Energia S.A., São Judas Tadeu and Fontainha. Light has a total installed generation capacity of 1013 MW, and an assured energy of 684 average MW, including proportional stake in associates.

In addition, CEMIG GT has the following interests in consortium, as of December 31, 2017:

 

    Queimado Hydroelectrical Power Plant – We hold an 82.5% interest in this enterprise and our partner in this project is CEB Participações S.A. (“CEBPar”), a subsidiary of Companhia Energética de Brasília (“CEB”), a state-controlled energy company, which owns 17.5% equity interest in the plant.

 

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CEMIG GT has jointly control in the following company with plants under construction:

 

    Guanhães Energia S.A. (49%) – This company owns 100% of PCH Dores de Guanhães S.A., PCH Senhora do Porto S.A., PCH Jacaré S.A. and PCH Fortuna II S.A. These companies are responsible for construction and commercial operation of four SHPs. Light owns the remaining 51% equity interest in Guanhães Energia S.A..

 

    Usina Hidrelétrica Itaocara S.A. (49%) – Independent power producer, formed to build and operate the Itaocara I hydroelectrical plant. Itaocara Energy Ltd. (100% owned by Light) owns the remaining 51%. On July 5, 2016, the concession contract (Concession Contract No. 01/2015) of Itaocara I hydroelectrical plant was transferred from the Consortium UHE Itaocara to Usina Hidrelétrica Itaocara S.A..

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

 

    CEMIG PCH S.A. – Independent power producer, operating the Pai Joaquim small hydroelectrical 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 hydroelectrical 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 hydroelectrical power plant.

 

    Barreiro S.A. Thermal Power Plant – An independent power producer which operated the 12.9 MW Barreiro thermoelectric plant, on the premises of the metal products company V&M do Brasil S.A. (“Vallourec & Mannesmann”), in Belo Horizonte, Minas Gerais. UTE Barreiro ended its production of energy in the second semester of 2016 and, by the end of the year, it was sold to Vallourec & Mannesmann.

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

 

    Central Eólica Praia do Morgado S.A., Central Eólica Praia de Parajuru S.A and Central Eólica Volta do Rio (49%)—Wind farms located in the State of Ceará with a total installed capacity of 99.6 MW.

 

    Renova (45.83% of voting share and 36.23% of total capital) –CEMIG Holding also has indirect participation in Renova through Light which has 21.72% of voting share and 17.17% of total capital.

 

    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, has started its commercial operation in December of 2017 and have an installed capacity of 98.7 MW.

Expansion of Generation Capacity

We are involved in the construction of hydroelectrical plants – Belo Monte and 4 SHPs: Dores de Guanhães, Senhora do Porto, Fortuna II and Jacaré. These plants will increase our total installed hydroelectrical generation capacity by 821,4MW (proportional stake) over the coming six years.

Guanhães Projetct: Guanhães Energia S.A. is a jointly-controlled company, with Light Energia owning the remaining 51%, 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 construction and 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. They will have an aggregate installed capacity of 44 MW.    Construction was halted on December 2015 due to delays in implementantion of the project which resulted in the termination of the contract with the construction consortium. In November 2017, the construction was resumed, with the first generation unit expected to start operating on May 2018 and the last one on February 2019. As of December 31, 2017 CEMIG GT had subscribed capital totaling R$189 million in the project, in proportion to its 49% interest in this enterprise.

 

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Belo Monte Project: Norte Energia S.A. (NESA) is a special-purpose company which holds the concession to build, operate and maintain the Belo Monte hydroelectrical plant, located on the Xingu River, in the Amazon Region, in the North of Brazil. Cemig GT has an indirect interest in NESA of 11.74% through Amazônia Energia S.A. and Aliança Norte Energia Participações S.A., shareholders of Norte Energia S.A.. NESA will still require significant funds to complete the electromechanical assembly of the remaining 10 generation units, in addition to funds to cover organizational, development and pre-operational costs for the completion of the plant. According to estimates, these costs will be repayed by revenues from future operations. When fully completed—scheduled for 2020, it will have a total capacity of 11,233 MW and will be one of the largest hydroelectrical power plants in the world.

In addition, in January 2017, Madeira Energia S.A. (MESA) announced that Santo Antonio Hydroeletrict Plant has become fully operational. MESA is a privately held company, created to construct and operate the Santo Antônio Hydroelectrical Plant on the Madeira River in the municipality of Porto Velho, Rondônia. The plant began operating in March 2012. CEMIG GT owns 10% of MESA, and has an indirect ownership of 8.13%. On December 31, 2017 the total value of the fixed net assets representing the proportion of CEMIG GT’s holdings in this indirectly-held subsidiary was R$ 3,785 million. At the end of 2017 the Santo Antônio plant had 50 rotors in operation, representing capacity to generate approximately 3,568 MW.

Also, on April 30, 2015 the Consortium UHE Itaocara (“Consortium”), in which CEMIG GT has 49% and Itaocara Energia Ltda., a SPC owned by Light, has 51%, won the concession of Itaocara I, a 150-MW hydroelectrical plant, to be constructed on the Paraíba do Sul River, between the municipalities of Itaocara and Aperibé, in the State of Rio de Janeiro. The energy of this power plant is to be delivered on January 1, 2020 and the concession period is 35 years. On July 5, 2016, ANEEL transferred the concession of Itaocara I power plant from the Consortium to Usina Hidrelétrica Itaocara S.A., a special purpose company held by CEMIG GT (49%) and Itaocara Energia Ltda (51%). Due to the worsening of Brazilian macroeconomic conditions in recent years, construction has not started yet and the project is currently being reevaluated.

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 distribution companies. 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

   2017      2016      2015  

500 kV

     1,355        1,355        1,355  

345 kV

     1,231        1,228        1,228  

230 kV

     478        478        478  
  

 

 

    

 

 

    

 

 

 

Total

     3,064        3,061        3,061  

 

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

Substations

   2017      2016      2015  

Number of transmission substations (2)

     38        37        37  

MVA

     17,615        17,573        17,168  

 

(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 show 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

   2017      2016      2015  

>525 kV

     59        86        117  

500 kV

     674        856        1,289  

440 kV

     68        98        136  

345 kV

     31        66        67  

230 kV

     263        486        518  

220 kV

     —          —          62  
  

 

 

    

 

 

    

 

 

 

Total

     1,095        1,592        2,189  

 

Subsidiaries and Affiliates of CEMIG – Transmission

Company

  

Number of transmission substations

TAESA

   40 (7 private and shared 33)

ATE III

   4 (1 private and shared 3)

EATE

   5 (1 private and shared 4)

Lumitrans

   2 shared

EBTE

   7 (2 private and shared 5)

ERTE

   3 (1 private and shared 2)

STC

   4 (2 private and shared 2)

ENTE

   3 shared

ECTE

   2 shared

ETSE

   2 private

ETEP

   2 shared

ESDE

   1 private

São Gotardo

   1 shared

Brasnorte

   4 (2 private and shared 2)

ETAU

   4 (2 private and shared 2)

Transleste

   2 (1 private and shared 1)

Transirapé

   2 (1 private and shared 1)

Transudeste

   2 shared

Centroeste

   2 shared

Transmission assets

LT2 345 kV The Furnas–Pimenta Transmission Line (Companhia de Transmissão Centroeste de Minas) – 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 hydroelectrical 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.

 

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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 Coliseu (22%), a private investment fund. 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. In 2013, TAESA incorporated several companies into the group, in which it had 100% interest and where the merger would provide economic gains and simplify the shareholding structure.

This table shows the percentage holdings in the transmission companies as of December 31, 2017:

 

Subsidiary and affiliate transmission companies

   % equity
interest(Direct and Indirect)
 
     CEMIG      TAESA  

TAESA

     21.68        —    

ATE III

     21.68        100.00  

EATE

     10.84        49.98  

Lumitrans

     8.67        39.98  

EBTE

     16.15        74.49  

ERTE

     10.84        49.99  

STC

     8.67        39.98  

ENTE

     10.84        49.99  

ECTE

     4.14        19.09  

ETSE

     4.14        19.09  

ETEP

     10.84        49.98  

ESDE

     10.84        49.98  

São Gotardo

     21.68        100.00  

Brasnorte

     8.38        38.66  

ETAU

     11.40        52.58  

Mariana

     21.68        100  

Transleste

     6.50        30.00  

Transirapé

     6.40        29.50  

Transudeste

     6.29        29.00  

Centroeste

     51.00        —    

Miracema

     21.68        100.00  

Janaúba

     21.68        100.00  

Aimorés

     10.84        50.00  

Paraguaçu

     10.84        50.00  

The Itabirito 2–Vespasiano 2 Transmission Line – TAESA was awarded this concession (Lot ‘A’) at ANEEL Auction No. 013/2013 in December 2013 – to build, operate and maintain the 52-mile, 500-kV Itabirito 2–Vespasiano 2 transmission line, in Minas Gerais. Annual Permitted Revenue (RAP) is R$11 million. The project construction is scheduled for completion in 2018.

In April 2017, TAESA, as part of the Consortium Columbia (50% Taesa – 50% CTEEP), was the winning bidder of Branch 1 in Auction 005/2016 of Public Power Transmission Lines auction promoted by ANEEL. Branch 1 comprises 600 dual circuit kms totaling 1200 kms in Parana State. ANEEL granted TAESA the right to explore the concessions for 30 years. RAP is R$ 267.3 million.

 

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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.

In 2017, we invested approximately R$983 million in the construction and acquisition of the property, plant and equipment needed to expand and to 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

   2017      2016      2015  

161 kV

     30.12        28.84        28.84  

138 kV

     7,879.51        7,635.47        7,138.14  

69 kV

     2,228.23        2,250.22        2,218.76  

34.5 kV + Others

     606.59        522.13        511.67  
  

 

 

    

 

 

    

 

 

 

Total

     10,744.45        10,436.66        9,897.40  

 

     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

   2017      2016      2015  

Overhead urban distribution lines

     65,734.68        61,969.21        59,834.20  

Underground urban distribution lines

     1,530.63        1,351.94        750.30  

Overhead rural distribution lines

     251,925.70        241,325.01        237,223.60  
  

 

 

    

 

 

    

 

 

 

Total

     319,191.01        304,646.16        297,818.10  

 

     Step-down transformation capacity (1)
of distribution substations
 
     As of December 31,  
     2017      2016      2015  

Number of substations

     404        393        388  

MVA

     10,585.91        10,279.18        10,099.18  

 

(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 next five years is based on projections of market growth. In the next five years, we anticipate an increase of approximately 942,000 new urban customers and approximately 35,000 rural customers. In order to accommodate this growth, we expect that we will need to add 230,785 medium-voltage poles, 1,292 miles of distribution lines and 53 step-down substations, adding 1,076 MVA to our distribution network.

 

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Purchase of Electric Power

During the year ended December 31, 2017, we purchased 6,230 GWh of energy from Itaipu, which represented approximately 16% of the energy we sold to final users, and 632 GWh (1.6%) of energy from PROINFA. We also purchased 1,076 GWh under Nuclear Energy Quota Contracts (Contratos de Cotas de Energia Nuclear, or “CCENs”) (2.7%) and 8,242 GWh of energy under Assured Energy Quota Contracts (Contratos de Cota de Garantia Física, or “CCGFs”) (21%). In addition to this compulsory purchase, we have two other types of supply arrangements: (i) purchases through public auctions, which accounted for approximately 21% of the energy purchased for resale during the year ended December 31, 2017; and (ii) long-term agreements existing prior to the New Industry Model Law, which represented approximately 2% of the energy purchased in 2017.

Itaipu — Itaipu is one of the largest operational hydroelectrical plants in the world, with an installed capacity of 14,000 MW. Centrais Elétricas Brasileiras S.A., or Eletrobrás, a holding company controlled by the Federal Government, owns a 50% interest in Itaipu, while the remaining 50% is owned by the government of Paraguay. 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 distribution companies 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 2,012/2015 which set 9.82% as the percentage of Itaipu’s power production bestowed upon CCEE that CEMIG D would have to purchase in 2016. For 2017, Resolution No. 2,178/2016 set it at 10.39% and for 2018, it was set at 10.09% 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 distribution companies for the following year, as guidance for the five subsequent years. Based on this, the distribution companies 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. 12,111/2009 and ANEEL Resolution No 530/2012 between distributors and Electronuclear for the energy produced by the Angra I and Angra II plants.

CCGFs: Decree No. 7,805/2012 regulated Provisional Act No. 579/2012 and created contractual arrangements governing contracting of energy and power from the plants whose concessions were extended under Law No. 12,783/2013.

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. The following table gives the amounts of energy contracted, and average original tariff and prices related to the CCEAR contracts for energy acquired by CEMIG. See “The Brazilian Power Industry” for more information on CCEEs and CCEARs.

 

Average Tariff (R$/MWh)

   Energy Contracted
(MW—average per year)
   Term of
the Contract

138.85

       61.23        2010 to 2039

134.67

       431.17        2010 to 2039

120.86

       24.71        2010 to 2024

137.44

       23.24        2010 to 2024

128.42

       63.89        2010 to 2024

129.14

       56.57        2011 to 2040

128.37

       126.34        2011 to 2025

  78.87

       122.83        2011 to 2025

  77.97

       457.75        2012 to 2041

102.00

       52.76        2012 to 2026

  80.10

       336.40        2012 to 2041

262.00

       27.00        2015 to 2044

270.81

       69.03        2014 to 2044

 

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Average Tariff (R$/MWh)

   Energy Contracted
(MW—average per year)
   Term of
the Contract

  99.48

       46.80        2014 to 2033

  67.31

       136.73        2015 to 2044

129.70

       25.09        2015 to 2044

     121

       15.68        2016 to 2035

133.29

       32.13        2018 to 2047

117.51

       16.27        2018 to 2037

135.58

       19.30        2018 to 2047

  96.28

       16.41        2018 to 2037

119.03

       2.62        2018 to 2042

121.00

       15.68        2017 to 2046

129.96

       32.13        2017 to 2036

161.89

       3.20        2019 to 2048

205.19

       311.11        2019 to 2043

136.00

       56.06        2019 to 2038

183.66

       4.94        2020 to 2049

278.46

       23.21        2020 to 2044

205.01

       0.535        2018 to 2047

212.75

       0.701        2018 to 2037

181.14

       3.843        2018 to 2037

219.20

       6.81        2023 to 2052

168.35

       188.51        2023 to 2046

108.28

       66.08        2023 to 2042

138.85

       61.23        2010 to 2039

134.67

       431.17        2010 to 2039

120.86

       24.71        2010 to 2024

137.44

       23.24        2010 to 2024

128.42

       63.89        2010 to 2024

129.14

       56.57        2011 to 2040

“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 ending December 31, 2017 CEMIG D didn’t enter into new 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 remaining shares are owned by the Municipality of Belo Horizonte.

On August 25, 2004, CEMIG, Gasmig, Gaspetro and Petrobras signed an Association Agreement, later amended on November 5, 2004, December 14, 2004 and August 15, 2007, for the implementation of a plan to develop the natural gas market in the State of Minas Gerais. The plan provided for (i) the expansion of the existing gas pipeline network, under the responsibility of Petrobras, (ii) the expansion of the natural gas distribution network, under the responsibility of Gasmig, and (iii) the acquisition by Gaspetro of equity in Gasmig.

On October 10, 2014, a share purchase agreement was signed for acquisition by CEMIG of Gaspetro’s 40% interest in Gasmig (previously approved by the Boards of Directors of CEMIG and Petrobras), for R$570.93 million. This amount was the result of monetary update of R$600 million by the IGP–M inflation index, after discounting of the dividends paid, over the period from the base-date of the agreement to the closing of the transaction. The acquisition was completed after approval by the CADE and consent from the concession authority, the State of Minas Gerais.

 

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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.

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. In 2017, Gasmig supplied approximately 3.6 million cubic meters of natural gas per day to 31,355 customers in thirty five cities: 105 large and medium-sized industrial plants, 591 small industrial plants and commercial customers, 44 retail distribution stations supplying vehicle natural gas (“VNG”) to vehicles, two fired power generation plants, four co-generation projects, four distributors of compressed natural gas (“CNG”), and 30,605 homes. In 2017, Gasmig distributed approximately 5.5% of all natural gas distributed in Brazil.

Currently, Gasmig serves the following regions of the State of Minas Gerais: (i) Greater Belo Horizonte (Metropolitan Region), (ii) the Rio Doce region (Vale do Aço), (iii) the South of Minas region (Sul de Minas region), (iv) Zona da Mata region (in the southeast of the State), and (v) the Campos das Vertentes region – in all of them supplying the industrial, commercial, automotive, residential, co-generation markets, and thermoelectric power plants.

For distribution to the market other than thermoelectric energy generation, Gasmig has an Additional Supply Contract (Contrato de Suprimento Adicional, or “CSA”) with Petrobras, signed on December 15, 2004, in effect until 2021 for 2.8 million m³/day. There was previously another gas supply contract for the non-thermoelectric market, referred to as the ‘Contrato Convencional’ (or “Contract Agreement”), signed on July 6, 1994, which was terminated in 2013. The remaining balance of quantity of gas paid for under that contract was received during the year 2014.

Gasmig has contracts of 1.6 million m³/day, in effect until 2022, to supply two thermal plants.

The tariffs consist of a full pass-through of the cost of the acquisition of the gas, plus the distribution cost (margin) and taxes.

Capital expenditures in 2015 and 2016, totaling R$118 million, were focused on expansion and densification of the existing networks, with a focus on serving the residential market. In 2017, capital expenditures totaled R$53.6 million and maintained a focus on serving the residential market, and 49 kilometers were added to our natural gas network.

Many energy-intensive industries, such as cement, steel, ferro-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 that are densely industrialized. The first phase of service to the Vale do Aço region was completed in 2006. Also in 2006, Gasmig began to provide service to the South of Minas Gerais region through a local network supplied with liquefied natural gas (“LNG”). In 2009, after Petrobras completed the gas pipelines that transport gas from Paulínia, State of São Paulo, to Jacutinga, State of Minas Gerais, the local networks were connected to the national gas transport network. In 2010, the second phase of providing service to the Vale do Aço region was completed.

In 2013, Gasmig began distributing natural gas to residential and small commercial customers in the municipalities of Nova Lima, Belo Horizonte and Poços de Caldas.

Through a structuring project in 2013, Gasmig began to serve the municipalities of Governador Valadares and Itabira, from a facility to supply compressed natural gas (“CNG”) in the municipality of Ipatinga. In 2014, Gasmig began to service the municipality of Pouso Alegre through another structured project supplied with LNG.

In 2017, Gasmig registered an expense acquisition of gas of R$1,070 million compared to an expense of R$877 million in 2016, an increase of 22.1%. This increase is a result of larger consumption of thermal plants and large industrial clients.

Natural Gas Exploration

CEMIG, in partnership with other companies, won in the 10th Brazilian Round, promoted by the National Agency of Oil, Natural Gas and Biofuels (Agência Nacional do Petróleo, Gás Natural e Biocombustíveis, or “ANP) –, in December 2008, the concession rights for natural gas exploration in four blocks in the São Francisco Basin, one block in the Recôncavo Basin, and one block in the Potiguar Basin, located in the states of Minas Gerais, Bahia and Rio Grande do Norte, respectively.

 

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Block POT-T-603 in the Potiguar Basin was given back to ANP after the conclusion of all planned activities, which demonstrated the absence of hydrocarbon that could be commercially produced.

CEMIG has a stake in the following consortia:

 

    Blocks SF-T-104 and SF-T-114 (São Francisco Basin): CEMIG (24.5%), Codemig (24.5%) and Imetame (51%);

 

    Blocks SF-T-120 and SF-T-127 (São Francisco Basin): CEMIG (24.5%), Codemig (24.5%), Cemes (51%), being the last company formed by Imetame, Sipet and Orteng; and

 

    Block REC-T-163 (Recôncavo Basin): CEMIG (24.5%), Codemig (24.5%) and Imetame (51%).

These consortia were included by Cemig as assets that are part of the Disinvestment Program, according to the Relevant Event announced by the Company on June 1st, 2017.

Telecommunications, Internet and Data Traffic

On January 12, 2018 meeting, Cemig’s Board of Directors decided to submit a proposal to an Extraordinary General Meeting of Shareholders that Cemig should merger its wholly-owned subsidiary Cemig Telecomunicações S.A. (“CEMIG Telecom”). The merger will provide gains from optimization of assets and synergies, and reduce financial, operational and administrative costs through concentration of existing administrative structures, while improving options for use of available funds.

An Extraordinary General Meeting of Shareholders of Cemig, and an Extraordinary General Meeting of Shareholders of Cemig Telecomunicações S.A., both held on February 28, 2018, have approved and authorized the signature of the Protocol of Merger and Justification establishing the terms and conditions governing merger of CemigTelecom by Cemig which was completed on March 31, 2018.

Since this is a merger of a wholly-owned subsidiary, there was no capital increase nor issuance of new shares by Cemig. The shares in the subsidiary were canceled, on the merger date, and the necessary accounting records made.

CEMIG Telecom offers an optical network for transport of telecommunications services in the State of Minas Gerais using CEMIG’s energy transmission and distribution infrastructure.

It was constituted on January 13, 1999, in partnership with AES Força Empreendimentos Ltda., a member of the AES Corporation Group, and at that time was named Empresa de Infovias S.A. Its purpose is to provide services in the area of telecommunications, through an integrated system comprising fiber optic cables, and electronic and associated equipment, for transmission, broadcasting and reception of symbols, characters, written signals, images, sound and information of any type, and also to provide telecoms services in the wholesale market, selling specialized circuits, to internet service providers and other telecommunications companies, data centers, broadband, corporate market, etc.

CEMIG Telecom’s core business is providing telecommunications services in the operator segment, and provide specialized services to the corporate market, providing network and Internet access connectivity solutions. It provides the largest optical network for telecommunications transport services in Minas Gerais, with a presence in more than 90 cities of the State. Also, in its expansion project, it makes optical network services available in the metropolitan regions of Salvador, Recife, Goiânia and Fortaleza, and has presence in the cities of São Paulo e Rio de Janeiro.

CEMIG Telecom has a strong internet structure with different internet traffic exits, and is connected to the largest PTTs or IXs (Internet Exchange) nationwide, exchanging traffic with various companies. It also has a direct connection via PNI (Private Network Interconnect) with Google, Facebook, Valve Software (Games) and Riot Games and hosts some Content Delivery Network (CDNs) within its structure. In addition, CEMIG Telecom has connectivity with the main cloud service providers in São Paulo to complete its telecommunications services range.

CEMIG Telecom has a 19.6% interest in the joint venture Ativas. Management and principal decisions are shared with an investor partner, governed by a shareholders’ agreement.

 

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The corporate purpose of Ativas is to provide of Information and Communication Technology (“ITC”) infrastructure services. These comprise physical hosting of IT environments, database and site backup, storage, professional information security and availability services, ITC consultancy, connectivity and sale of access and Internet bandwidth. The construction of the data center, classified in category “Tier III” (by the Uptime Institute), to serve large and medium-sized corporations, was concluded in January 2011.

Consulting and Other Services

Efficientia S.A., created as a wholly-owned subsidiary of CEMIG in 2002, created and implemented its own business model, launching an implementation of projects based on performance contracts, with reflects an innovative approach to the implementation of projects in the Brazilian market. The principal source of revenue for Efficientia has been the implementation of energy efficiency projects through performance contracts.

In 2017, a relevant project was concluded: the biomass-burning cogeneration plant at the company Bem Brasil in Araxá, Minas Gerais. This plant has a generation capacity of 7,500 kW and an output capacity of 54,000 MWh/yr. The construction cost of R$42 million, was financed by the Energy Eficiency Program of CEMIG D.

The photovoltaic solar generation projects developed by Efficientia are also characterized as investments in distributed generation. Photovoltaic generation systems were completed in the following clients in 2017:

 

    Condominium Village I and Village II: development and implementation of a photovoltaic plant, for planned generation of 1,018 MWh/year; invested amounted R$ 6.1million and was completed in 2017.

 

    Algar Telecom: development and implementation of one photovoltaic solar plant, for generation of 49.8 MWh / year; investment amounted R$ 875 thousand and was completed in 2017.

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 the 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., ESCEE Empresa de Serviços de Comercialização de Energia Elétrica S.A. (“ESCEE”) and CCEI CEMIG Comercializadora de Energia Incentivada S.A. (“CCEI”).

Energy Losses – CEMIG Holding

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.

As presented on the table CEMIG’s Electric Energy Balance (on page 59), the total energy losses recorded by CEMIG in the year of 2017 was 7,121 GWh, an increase of 5.90% in comparison to 2016. The CCEE apportioned losses in the national grid totaling 508 GWh to CEMIG D. Other energy losses, totaling 6.613 GWh, include technical and non-technical losses in the local distribution system.

Technical losses were approximately 63.06% of the total losses related to CEMIG D for the year ended December 31, 2017. Losses in distribution are inevitable as a result 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 the purpose of 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 36.95% of CEMIG D’s total energy losses in 2017 and it was caused by customer fraud, illegal connections to the distribution network, 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 distribution companies can be partially comparable, taking into account the social complexities in the concession area and the effectiveness of efforts to prevent losses.

 

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At the end of 2017, 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 10.83 and 5.43 respectively. In 2016, the figures with respect to CEMIG D for SAIDI and SAIFI were 11.73 and 5.63, respectively. At the end of 2017, the SAIDI and SAIFI for Light were 9.14 and 5.26, respectively, compared to 11.70 and 6.47 in 2016.

For the year ended December 31, 2017, Light’s total losses amounted to 8,004GWh, or 21.92% of the total load, a reduction of 4.2% compared December 31, 2016.

In 2016 the strategy for preventing non-technical losses (commercial losses) was remodeled. In the light of macroeconomic conditions and a new diagnosis of the causes and locations of the losses, activities were intensified in medium and high-income districts, through management measures aiming to recover and include larger volumes of energy per client, and reduce expense per megawatt-hour recovered. This expense was reduced in 2017 by 28.3% in comparison with 2016. Previously, loss remediation efforts were capex-intensive, and the areas with the highest rates indices were in districts and communities with lower income and higher rates of violent crime. The Company launched an advertising campaign against theft of energy, directed to the A, B and C income groups, on television, radio stations and outdoor billboards. This campaign offered fraudulent customers the opportunity to regularize their consumption with special terms. The internal channel was also reformulated to enable employees to report irregularities. One of the program’s principal actions was the Operations Groups, which concentrated on the ‘Possible Areas’ and on clients selected by Light’s Intelligence Center. These actions now take place more than once a week, and involve more than 700 professionals including field teams, legal staff and cooperation with the civil and military police.

Customers and Billing – CEMIG Holding

Customer base

The CEMIG Group sells energy through the companies CEMIG D, CEMIG GT and other wholly-owned subsidiaries – Horizontes Energia, Sá Carvalho, Termelétrica de Barreiro, 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.

This market comprises sales of energy to:

 

  (i) regulated customers in CEMIG’s concession area in the State of Minas Gerais;

 

  (ii) free customers both in the State of Minas Gerais and other states of Brazil, through the Free Market;

 

  (iii) other participants of the energy sector – traders, generators and independent power producers, also in the Free Market; and

 

  (iv) distributors, in the Regulated Market.

In 2017 we sold a total of 55,277 GWh, or 0.6% less than in 2016.

Sales of energy to final customers plus our own consumption totaled 42,499 GWh, or 1.4% less than in 2016.

Sales to distributors, traders, other generating companies and independent power producers in 2017 totaled 12,778 GWh – or 2.2% more than in 2016.

In December 2017, CEMIG Group invoiced 8,347,484 customers – a growth of 1.1% in the customer base in the year since December 2016. Of these, 8,347,100 are final customers, including CEMIG’s own consumption; and 383 are other agents in the Brazilian energy sector.

 

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Sales to Final Customers

Residential

The residential customer category accounted for 18.1% of CEMIG’s energy sales in 2017, totaling 10,008 GWh – or 0.9% more than in 2016 and average monthly consumption per customer in 2017 was 123.8 kWh/month, or 0.6% less than in 2016 (124.6 kWh/month);

This lower consumption by the residential customer category was the result of the following factors:

 

  a) Lower temperatures than in the previous year, in most of the months of 2017, resulting in less use by customers of air conditioners and ventilators in homes

 

  b) The billing calendar in 2017 had 2.6 less days than in 2016 (364.2 days, compared to 366.8 days in 2016).

 

  c) High level of unemployment.

Industrial

Energy billed to regulated and free industrial clients in the State of Minas Gerais and other states was 32.1% of the total volume of energy traded by us in 2017, at 17,761 GWh, or 8.9% less than in 2016.

This decline is the result of an 18.3% reduction in the captive market, and a 7.1% reduction in the Free Market. Both segments were affected by the trends in productive activities and a result of the uncertainties in the Brazilian and also international, political and economic scenarios.

Also, in the captive segment there is the effect of customers migrating to the Free Market.

Commercial and Services

Energy sold to regulated and free clients in this category in Minas Gerais and other states was 13.6% of the total volume of energy traded by us in 2017, at 7,507 GWh, 14.2% higher than in 2016.

This reflects a reduction of 8% in the volume billed to regulated customers of CEMIG D, and an increase of 161.7% in the volume billed by CEMIG GT and its wholly-owned subsidiaries to free clients in Minas Gerais and other Brazilian states.

The lower consumption in the regulated market reflects several factors, including migration of regulated clients to the Free Market.

The increased consumption in the Free Market is associated with the increase of 166 in the number of new billed customers in 2017. The incentive energy comes from alternative sources of generation such as biomass, solar, wind and SHPs (small hydropower plants). The incentive comes in the form of a discount on the use tariff of the distribution system—TUSD - for the special free customers (those whose contracted demand is between 500 kW and 3,000 kW). Each energy source has a different percentage of discount on the TUSD.

Rural

Energy used by the rural customer category, at 3,651 GWh, was 2.1% more than in 2016, and was 6.6% of the total traded by us in 2017.

 

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The increase in consumption is a result of the increase of 11,515 customers and by the low volume of rainfall during part of the humid period.

Other customer categories

Supply to other categories – government, public lighting, public services, and our own consumption – totaled 3,534 GWh in 2017, or 1.3% more than in 2016.

Sales in the Free Market

In 2017, total sales of energy in the Free Market were 10,416 GWh, or 3.3% more than in 2016.

Sales and trading transactions in energy with other agents of the energy sector in the Free Market often results from taking previously-created selling opportunities, which lead to short-term sales contracts, which in 2017 were sold at higher prices than those practiced in 2016.

Sales in the Regulated Market

Sales in the Regulated Market in 2017 totaled 2,362 GWh, or 2.6% less than in 2016.

The tables below show the CEMIG Group’s market in more detail, itemizing transactions in 2017 compared to 2016:

 

Type of Sale

   2017      2016      Variation YoY  
   Customers      Energy      Customers      Energy      Customers      Energy  
   Amount      Participacion      Amount      Participacion      Amount      Participacion      Amount      Participacion      Variation      Variation  
   ( u n )      (%)      ( GWh )      (%)      ( u n )      (%)      ( GWh )      (%)      (%)      (%)  

Traded Energy

     8,347,484        100.00        55,277        100.00        8,260,336        100.00        55,592        100.00        1,06        -0,57  

Sales to final customers

     8,346,349        99.99        42,463        76.82        8,259,504        99.99        43,047        77.43        1,05        -1,36  

Residential

     6,765,201        81.04        10,008        18.11        6,691,673        81.01        9,916        17.84        1,10        0,93  

Industrial

     74,497        0.89        17,761        32.13        75,139        0.91        19,495        35.07        -0,85        -8,89  

Captive

     73.833        0.88        2,611        4.72        74,535        0.90        3,195        5.75        -0,94        -18,29  

Free

     664        0.01        15,150        27.41        604        0.01        16,300        29.32        9,93        -7,05  

Comercial

     718,520        8.61        7,508        13.58        716,968        8.68        6,573        11.82        0,22        14,21  

Captive

     717,988        8.60        5,253        9.50        716,602        8.68        5,712        10.27        0,19        -8,03  

Free

     532        0.01        2,255        4.08        366        0.00        861        1.55        45,36        161,75  

Rural

     705,542        8.45        3,652        6.61        694,026        8.40        3,575        6.43        1,66        2,15  

Captive

     705,541        8.45        3,648        6.60        694,026        8.40        3,575        6.43        1,66        2,04  

Free

     1        0.00        4        0.01        0        0        0        0        0,00        0,00  

Other Categories

     82,590        0.99        3,534        6.39        81,698        0.99        3,488        6.27        1,09        1,31  

Own Consuption

     751        0.01        37        0.07        750        0.01        37        0.07        0,13        0,91  

Wholesale sales

     383        0.00        12,777        23.11        82        0.00        12,508        22.50        367,07        2,15  

Contracts in Regulated Market

     46        0.00        2,362        4.27        45        0.00        2,425        4.36        2,22        -2,61  

Free and bilateral contracts

     337        0.00        10,415        18.84        37        0.00        10,083        18.14        810,81        3,29  

 

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This table shows the CEMIG Group’s sales to the Industrial user category as a whole in 2017, by sector of activity:

 

Sector of activity

   Volume invoiced, (GWh)      %  

Metallurgy

     4,248        24  

Mining

     2,363        13  

Non metallic minerals

     1,685        9  

Foods

     1,816        10  

Chemicals

     1,057        6  

Machinery and equipment

     990        6  

Automotive

     918        5  

Textile

     745        4  

Plastic Products

     924        5  

Other sectors

     3,016        17  
  

 

 

    

 

 

 

Total, industrial customers

     17,762        100  

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

 

Client

  

Activity

Usiminas

   Metallurgy and Mining

Dow Corning

   Metallurgy

CSN

   Metallurgy

ArcellorMittal

   Metallurgy

Vallourec

   Metallurgy

Saint Gobain

   Chemicals, Non metallic mining

Anglo American

   Metallurgy

Fiat

   Automotive

International Paper do Brasil

   Paper and cellulose

Kinross Brasil

   Mining

Billing

Our billing and payment procedures for energy distribution vary depending on the voltage of supply. Our large-scale clients, that have direct connections to our transmission network, are billed within five days after the reading of their consumption and receipt of invoices by email. The payment due date is five days after receiving the invoice.

Other clients that acquire eletricity at medium voltage (2.3kV or more) approximately 13,800 customers are charged within two business days of the reading of their consumption and they have payment due at least on five business days from delivery of the invoices. This group of customers receives invoices both printed and by email. At present, 84% of the customers in this voltage band have automatic consumption reading.

Our low-voltage clients are billed within five business days from the reading of their consumption, for payment within five business days from delivery of the bill, or 10 business days after delivery of the bill in the case of public sector institutions. The invoices are prepared on the basis of the meter reading or estimated consumption.

We are in the process of implementing an immediate billing mode for low-voltage customers, with printing of invoices simultaneous with meter reading. We used this billing system with approximately 6,600,000 clients in 2016 and 7,500,000 customers in 2017.

 

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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 shows quarterly figures of energy billed by the CEMIG Group to final users, regulated customers and free customers from 2015 to 2017, in MWh:

 

Year

   First Quarter      Second Quarter      Third Quarter      Fourth Quarter  

2017

     10,364        10,712        10,607        10,817  

2016

     10,580        10,778        10,845        10,942  

2015

     11,661        11,326        11,315        11,703  

Competition

Contracts with Free Customers

On December 31, 2017 CEMIG GT had a portfolio of contracts with 1,176 industrial and commercial free customers. Out of this total, 590 customers were located outside of the State of Minas Gerais, amounting to 40.02% of the total volume of energy sold by CEMIG GT in 2017.

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 clients. 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.

Raw Materials

Fluvial water is the main raw material used by CEMIG for hydroelectrical generation of energy. As of December 31, 2017, 82 of CEMIG’s 102 plants use this source and provide 95% of our generation.

The cost of the water may be considered as nil, since water is a natural resource that comes from rivers and rain.

In a smaller proportion, the Company also produces energy from wind (also with a nil cost) and in thermoelectric plants, burning fuel oil (the cost varies with the price of oil on the international market).

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. A violator of Law No. 9,605/1998, the Law on Environmental Crime (Lei de Crimes Ambientais), may be subject to administrative and criminal sanctions, and will have an obligation to repair and/or provide compensation for environmental damages, Federal Decree No. 6,514/2008 specifies the penalties applicable to each type of environmental infraction, setting fines that vary between a minimum of R$50.00 and a maximum of R$50 million, as well as suspension of operations. Criminal sanctions applicable to legal entities may include fines and restriction of rights, whereas, for individuals, they may include imprisonment, which can be imposed against executive officers and employees of companies that commit environmental crimes.

 

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We believe that we are in compliance with the relevant 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 2017, trees were the cause of 36,248 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 has an initiative 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 stablish conditions, restrictions and environmental control measures that should be complied by entities and individuals to install, expand and operate enterprises or activities that use environmental resources or have potential to cause damage to the environment.

Brazilian law requires that licenses be obtained for several activities, including construction, installation, expansion and operation of any facility that utilizes environmental resources, causes environmental degradation, or pollutes or has the potential to cause environmental degradation or pollution or to harm historical, cultural and archaeological heritage.

Failure to obtain and comply with the requirements of an environmental license to construct, implement, operate, expand or enlarge an enterprise 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.

Each license is valid for a specific term, provided that the license must be renewed upon its expiration. Pursuant to Complementary Law No. 140, of December 8, 2011, the request for the renewal of an environmental license must be filed 120 days before its expiration date, so that it remains valid until the renewed license is issued.

The environmental licensing may be approved at the Federal, State and Municipality levels, depending on specific rules. IBAMA – Brazilian Institute for Environment and Natural Renewable Resources, which is the environmental federal authority, has jurisdiction to license projects that cause national and regional impact, activities in indigenous lands, in territorial waters, on the continental shelf and exclusive economic zone, in addition to nuclear activity. The environmental state authorities have jurisdiction to license projects whose impacts do not surpass the territorial limits of the state, located in territorial spaces protected by state dominion, or whose jurisdiction has been delegated by the Federal Government by agreement or other proper legal instrument. Municipalities, on its turn, may issue environmental licenses for activities that cause local environmental impact, pursuant to certain rules.

 

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We have projects licensed under both the Federal and State levels.    

Environmental Operating Licensing

Resolution No. 1, enacted on January 23, 1986, issued by the National Environmental Council (Conselho Nacional do Meio Ambiente, or “CONAMA”), requires that environmental impact assessment studies be undertaken, and a corresponding environmental impact assessment report be prepared, for all major energy generation facilities built in Brazil after February 17, 1986. Pursuant to CONAMA Resolution No. 6. of September 16, 1987 facilities built prior to that year do not require these studies, but must obtain an environmental operating licenses, which can be acquired by filing a form containing specific information regarding the facility in question. Obtaining the operating licenses for the projects which began operations before February 1986, under CONAMA Resolution No. 6. of September 16, 1987, requires the presentation to the competent environmental body of an environmental report containing the characteristics of the project, the environmental impacts of the construction and operation, and also the mitigating and compensatory measures adopted or that are in the process of being adopted by the organization carrying out the project.

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. 2,163-41/2001), which allows project operators to enter into agreements with the relevant environmental regulators in order to comply with Federal Law No. 9,605/1998. Accordingly, we have been negotiating with (i) IBAMA; and (ii) the Regional Environmental Management Units (“Suprams), which is environmental authority of 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 State of Minas Gerais, which are subject to the environmental licensing under State level, we have agreed with Supram and IBAMA to bring us into compliance on a gradual basis.

For those facilities of CEMIG GT that started operations before February 1986, although we have not yet obtained an operating license, we have prepared the required environmental assessments, filed applications before the appropriate environmental bodies, and submitted them for analysis.

To manage compliance with the conditional requirements, we use the Environmental Requirements Non-compliance Risk Reduction Index (Índice de Redução do Risco de Não Cumprimento das Condicionantes Ambientais, or “IRDC”).

In 2017, 6 licenses and authorizations for regularization of projects of CEMIG D were obtained, in the following categories: 3 Environmental Operating Authorizations (Autorizações Ambientais de Funcionamento, or “AAFs”) and 3 Authorizing Documents for Environmental Interventions (Documentos Autorizativos para Intervenção Ambiental, or “DAIAs”). All the above projects have been regularized in the Suprams spread out over the State of Minas Gerais.

Distribution of natural gas by Gasmig through pipelines the state of Minas Gerais is also subject to environmental control. All licenses necessary for the regular operation of Gasmig’s activities have been issued by the environmental authority of State of Minas Gerais (Secretaria de Estado de Meio Ambiente e Desenvolvimento Sustentável – SEMAD).

Environmental licenses and authorizations issued by relevant Municipality, State and Federal bodies usually impose conditions relating to environmental impacts inherent to our activities, which must be complied 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 (Reserva Legal) 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. As a general rule, 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 hydroelectrical power potential, in which projects for electric power generation, or energy substations or transmission or distribution lines are operating.

 

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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 hydroelectrical 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.

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 legally classified as Permanent Preservation Area (Área de Preservação Permanente 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. Preservation of APPs is mandatory, being the intervention allowed in specific situations..

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 12,651/2012 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 to 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.

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.

 

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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 Minas Gerais State Forests Institute (Instituto Estadual de Florestas, or “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 hydroelectrical plants can create a risk for fish that inhabit rivers, due to various changes in the aquatic environment caused by the use of dams. One of our environmental area’s principal activities is to ensure that environmental accidents involving the native fish population do not take place at our hydroelectrical power plants. Further, to mitigate the impacts caused by the operation of our plants, CEMIG has developed a methodology for evaluating the risk of fish mortality at the plants. We also carry 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 spite of these efforts, an incident occurred in 2007, at the Três Marias hydroelectrical power plant, resulting in the death of approximately 17 tons of fish, as estimated by the Environmental Police (8.2 tons, by our estimate). The volume of dead fish was not measured. As a result of the event, the Minas Gerais State Forests Institute imposed two fines, totaling approximately R$5.5 million, and on April 8, 2010, CEMIG and the Public Attorneys’ Office of Minas Gerais state signed a Conduct Adjustment Commitment (Termo de Ajuste de Conduta, or “TAC”), for R$6.8 million in compensatory measures to be used for environmental improvements in the area affected by the Três Marias power plant, in Três Marias, Minas Gerais. Both these financial commitments have now been settled, and the environmental improvements in the affected area, such as automation of the fish protection grids, are being implemented.

In this context, in June 2007 we created the Fish Alive (“Peixe Vivo”) program 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 hydroelectrical plants. The adoption of scientific criteria for decision-making, establishment of partnerships with other institutions and modification of practices adopted as a result of the information generated, are the principles that guide the work of the Peixe Vivo team. Also, publication of the resulting information to society is important – ensuring transparency of the program, and creating opportunities for the community to express its concerns and suggestions.

On average, over the period 2007 to 2017 CEMIG spent R$6.4 million per year in activities and research projects in relation to the Peixe Vivo program. We invested a further R$6.6 million in physical barriers to prevent fish from entering the draft tube at Três Marias Hydroelectrical Power Plant.

In spite of all the advances in fish management achieved by the Peixe Vivo program, there are still major challenges to be studied and understood. In 2012, an estimated 1.8 tons of fish died in an occurrence at the Três Marias hydroelectrical plant. The cause of death is still unknown, and the event was not expected – there was no precedent for the particular circumstances of this accident. However, with the adoption of measures to control this environmental incident, and as a result of our prompt reporting to the environmental authorities, the fine that we were charged for the accident, a total of R$50,000, was reduced by 45%, as provided by law due to immediate communication of the damage or danger to the environmental authority, and collaboration with the environmental bodies in solving the problems arising from our conduct. The fine imposed in 2012 (per kilogram of fish killed) was one fortieth of the fine applied by IEF in the 2007 accident. The Peixe Vivo program studied the circumstances of the accident to decide optimum forms of control to avoid similar occurrences.

 

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In 2017, the Peixe Vivo Program completed its 10th anniversary and as a celebration CEMIG organized the 5th Seminar on Conservation of Fish in Minas Gerais and the 1st Workshop on dam removal, an event held in the Auditorium of the Center for Educational Activities of the Federal University of Minas Gerais (“UFMG”). The event was promoted by CEMIG in partnership with UFMG, Federal University of Lavras, Southamptom University, Fapemig, ANEEL R&D Program and sponsored by Aliança Energia, Cemig Geração Três Marias, Retiro Baixo Energética, UHE Baguari Consortium and Queimado Hydroelectrical Power Plant. There were 211 atendants of which: (i) 44% were from research institutions; (ii) 27% were representatives of companies in the energy sector; (iii) 13% were from environmental agencies; (iv) 11% were from consulting firms; and (v) 6% were from foundations. The Peixe Vivo program runs 7 scientific projects in partnership with research institutions, involving more than 80 students and researchers.

These partnerships, which have been operating since 2007, have resulted in more than 364 technical publications up to today’s date, and have also 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. The Program’s website has been redesigned and a list with these publications was made available for the project and can be accessed at: www.cemig.com.br/peixevivo.

Considering the 10 year duration of the Program, Peixe Vivo’s performance within the Company was very satisfactory in environmental, social and economic aspects, guaranteeing a return on investment in projects and technological innovations. It is noteworthy that the team has been contacted by other companies of the Electric Sector to present and discuss the work they develop so these companies can implement similar initatives.

Urban Occupation of Rights of Way and Reservoir Banks

Gas Pipelines — Our piped natural gas distribution networks are underground, crossing 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 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 can be conveniently located on the Company’s 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 2017, due to the effectiveness of the preventive actions adopted by GASMIG, there was a very low frequency of damage caused by third parties. At all times there was reduced volume dispersed due to low operating pressure of damaged nets and short response in containment of leaks.

Transmission Lines — We have easements for our transmission and distribution networks over land with approximately 16,756 miles in length. A significant portion of such land is occupied by unauthorized construction, including 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 removal of these occupants or improvements that would make it possible to maintain our energy system safely and efficiently. The Committee for the Equation and Prevention of Human Occupation under Transmission and Distribution Lines was created to mitigate these risks by monitoring and recording invasions and by taking action to prevent invasions on the paths of the transmission and subtransmission 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; education of communities about the risks of accidents involving electric shocks arising from the invasion of sites and the building of homes; creation of community vegetable gardens; and removal of occupation of the transmission line pathways through agreements with local residents and other authorities, and/or through court actions.

 

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Reservoir Areas — We have implemented safety measures to protect our energy generation facilities against invasions, using observation posts and mobile patrols to control the banks of reservoirs. Electronic security systems to monitor the generation power plant installations are also planned. Any invaders found inside the facilities are detained and taken to police stations, where police complaints are filed. There are signs on the banks of the reservoirs of our hydroelectrical generation facilities, indicating ownership. Periodic inspections by the mobile patrol units operating on the reservoir areas report any invaders of reservoir banks. We frequently have to take legal action to recover possession of invaded areas. Due to the vast area and number of reservoirs, we are continually subject to new trespasses and occupation of the banks of the reservoirs by unauthorized construction. However, we are making our best efforts to prevent these invasions, and prevent any environmental damage to APPs, around the reservoirs. To patrol the reservoir areas, we have driven approximately 113,752 miles in vehicles, spent 895 hours navigating on reservoirs and waterways and made over 17,915 surveys. We have recently added one more inspection post for monitoring reservoir banks.

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 in various stages of development registered in the United Nations Framework Convention on Climate Change (UNFCCC), which includes seven SHPs with a capacity of 116 MW and two hydroelectrical 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 (PCBs), — At CEMIG, most of the large equipment contaminated with PCBs was removed from the electrical system and sent for incineration. Since then, the remaining mass of PCB identified has been progressively eliminated. Brazilian law prohibited the sale of PCBs since 1981, but allows its use in equipment that are still in operation. The Stockholm Convention (EC), of which Brazil is a signatory and which was ratified by Decree No. 5472/2005, requires operation of equipment contaminated with PCBs to be removed by 2025 and finally disposed of by 2028.

Operational Technologies – CEMIG Holding

We continue to invest in automated monitoring and control equipment in connection with our strategy of increasing efficiency and further modernizing and automating our generation, distribution and transmission grids.

CEMIG has developed and completed a project to migrate its main data center to a company specialized in providing services of this nature, 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 our head office in Belo Horizonte, is the nerve center of our operations. It coordinates the operations of our entire energy and energy system, in real time, providing operational integration of the generation and transmission of energy. It also operates the interconnection with other generation, transmission and distribution companies. The supervision and control executed by the COS now extends to more than 50 high and extra high voltage substations, more than 20 major generating power plants, 15 SHPs,1 Wind Farm and 1 Solar Power Plant .

Through its activities, the COS permanently guarantees the security, continuity and quality of our supply of energy. 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.

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. The COD is responsible for the supervision and control of 404 distribution substations, 318,497 miles of medium voltage distribution lines, and 10,751 miles of sub-transmission lines and 8.3 million customers and operates in 774 municipalities of Minas Gerais.

 

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We provided an average of 12,516 operating services in the field a day in 2017. The COD is certified according to ISO Quality Standard 9001: 2000. 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.

Geographic Information System

The Atlantis Project aims to modernize and unify Cemig’s system of geoprocessing of distribution lines and networks. The new system enables management of resources with a geospatial vision, planning of utilities, records of electrical equipment, planning and analysis of electrical networks, and also assist in compliance with the Normative Resolutions of the regulator, ANEEL. The Atlantis Project will customize the Geographic Information System (GIS), applied to the management of power lines, substations and distribution networks. This GIS will enable us to give support to the processes of registry and design, as well as supporting the following corporate processes: collection of invoices, commercial client customer care and support, protection of revenues, operation, maintenance, materials planning and supplies, property services and management of assets. The Atlantis project was started in 2015 and part of the solution was deployed in August of 2017. The remaining deployment steps will be concluded in the second half of 2018

In another initiative, known as “Portais Geográficos da Cemig”, the new geographic portals created in 2017 made it possible to integrate information on events in Cemig’s energy system with meteorological information (meteorological radar and satellite images, electrical discharges, and forest fires), and information on the generation, transmission and distribution assets, and even the location of vehicles and service teams. The result of this integration was the improvement in the planning of actions, and a gain in speed and precision, reducing the time taken to activate teams, and consequently the time to service of clients.

Internal Telecommunications Network

We believe we have one of the largest telecommunication networks of all the Brazilian energy utility companies. Made up of high performance microwave links provided by more than 344 communication stations, and an optical system of approximately 1,747 miles of optical fiber, it provides for a mix of telecom solutions from telephonic to corporate networks – and also monitoring, protection and control of substations, generation plants, transmission and distribution lines, dispatching of field teams to carry out mission-critical technical services and commercial contacts, lightning and storm prediction and hydro meteorological system to operate reservoirs.

Our robust data network also contains the communications facilities that share the site with more than 300 substations, 39 generation plants and 172 transmission and distribution lines. For support for supervision and control of the medium-voltage distribution system, a radio communication system is in place, installed in approximately 300 key terminals and more than 1,610 vehicle mobile terminals connected by satellite and Cellular Solution. The corporate data network serves more than 240 offices and units within the State of Minas Gerais.

The Telecoms Network Management Center, in Belo Horizonte, monitors and operates the telecoms infrastructure of CEMIG GT and CEMIG D, operating 24 hours x 7 days per week to guarantee continuity for perfect functioning of the telecoms services, aiming to meet the requirements for operational performance and service quality specified in operational agreements and concession contracts, regulations of ANEEL, ANATEL, the Brazilian National Water Agency (“ANA”) as well as the procedures of the ONS.

Corporate Data Network

Our corporate data network has 278 sites in 162 cities of Minas Gerais linked by an infrastructure which includes microwave links, optical fibers and wire cable, 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 topologies of the network employ security resources such as firewalls, intrusion prevention system (IPS), access control, antivirus and antispam systems, which are continually updated to protect against unauthorized access, in accordance with ISO 27002. A system of event logs makes it possible to investigate adverse events, and also provides a historical record base to meet legal requirements.

 

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The networks and security operations center, at the Company’s head office, in Belo Horizonte, monitors, operates and manages the whole of network and security infrastructure in real time (24 hours x 7 days week), maintaining confidentiality, integrity and availability of the data throughout the whole network.

IT Governance Program

Our Information Technology Governance Program aims to continually align IT with our business, adding value by applying information technology, appropriate resource management, risk management and compliance with legal, regulatory and Sarbanes-Oxley requirements.

Our information technology Project Management Office has been responsible since 2008 for ensuring that management of information technology projects is systematic, using dedicated software methodology, processes and tools.

Considering the central role of Information Technology Governance in our business, a dedicated management unit was created in 2009 to concentrate, plan and implement all the actions that are specific to information technology governance, including results arising from corporate strategy, strategic IT planning, legal and regulatory compliance, quality management, budget and financial management, services management and project management.

Customer Relationship Channels

We have six 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 up to 250,000 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 the website www.cemig.com.br, which offers all of our 16 types of service; (iv) via SMS; (v) via the social networks Facebook (CEMIG. ATENDE) and Twitter (@ CEMIG_ATENDE); (vi) smartphone application “CEMIG Atende” which offers 16 types of service and Telegram Messenger application which offers 5 types of services.

Commercial Management System

We have established and consolidated an efficient customer care system (“CCS”), based on our SAP CCS/CRM platform which is totally integrated into our ERP and BI that support our decision-making processes. The CCS serves approximately 8 million customers who receive supply at high, medium and low voltage. It is a competitive tool, adding safety, quality and productivity to CEMIG’s business processes, and adapts itself with great efficiency and speed to legal, regulatory and market changes and requirements.

Maintenance and Repair Systems

The 10,751 miles of high voltage distribution lines in CEMIG D’s network, operating at from 34.5kV to 161kV, are supported by approximately 55,035 structures, mainly made of metal.

The network of CEMIG GT has 3,063 miles of high voltage transmission lines, operating from 230kV to 500kV 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 infra-red cameras, allowing for simultaneous visual and thermographic (infra-red) 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.

 

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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. In 2015, CEMIG GT acquired 37 extra structures to be used in case of emergency. CEMIG has a well-trained and equipped team to provide support whenever necessary.

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

Information Security Management

Information security, a permanent Company concern, 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.

Management Tools

The SAM (Maintenance Accompaniment System) has been developed as a solution for maintenance and monitoring of the transmission facilities of the national grid, serving the requirement for integration with the National Energy System Operator (Operador Nacional do Sistema Elétrico, or ONS).

Among the initiatives in Governance, Risk and Compliance, an SAP solution module has been put in place for control of processes, with a focus on meeting requirements of internal audit activities. There has also been evolution of access control modules, ensuring segregation of functions.

Property, Plant, and Equipment; Intangible Assets and Concession Financial Assets

Our main assets are our power generation plants, transmission and distribution infrastructure described on Item 4. Our net book value of total property, plant and equipment and intangible assets, including our investment in certain consortia that operate energy generation projects, including projects under construction, was R$13,918 million on December 31, 2017.

Generation facilities represented 18.10% of this net book value, intangible assets represented 81.90%, of this net book value, (distribution facilities in intangible assets represented 81.90%, and other intangible, including our gas distribution system represented 15.56% and other miscellaneous property and equipment, including transmission and telecommunication facilities, represented 2.54%.

The average annual depreciation rates applied to these facilities were: 3.24% for hydroelectrical generation facilities, 8.91% for administration facilities, 4.61% for telecommunication facilities and 4.07% for thermoelectric facilities.

Apart from our distribution network, no single one of our assets produced more than 10% of our total revenues in 2017. Our infrastructure are in general 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.

The Brazilian Power Industry

General

In the Brazilian energy sector, generation, transmission and distribution activities have been 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 have been privatized, in an effort to increase efficiency and competition. The Fernando Henrique Cardoso president of Brazil during 1995–2002 aimed to privatize the state-controlled part of the energy sector, but the Luis Inácio Lula da Silva president of Brazil during 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”.

 

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Significant changes have been implemented during Dilma Rousseff’s administration (i.e. from 2011 through 2016), by means of Provisional Act No. 579/2012, converted into Law No. 12,783/2013, establishing new rules for renewal of concessions, including rebidding for hydroelectrical power generation concessions.

Subsequently, under the administration of Michel Temer (2016–present), other changes have been introduced in the sector by Provisional Act No. 735/2016, 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. Also 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.

The New Industry Model

The primary objective of the New Industry Model was to secure energy supply and reasonableness of rates. To secure energy 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 the construction of new hydroelectrical and thermal power plants in a way that mantains the best balance possible between the security of the supply and the reasonableness of rates. To achieve reasonable rates, the New Industry Model Law requires that all purchases of energy by distributors are made through a public bid, based on lowest price criteria, and that the execution of the agreement is carried out through the Regulated Market. Auctions are categorized into two types: (i) auctions for supply coming from new plants, aiming at the expansion of the system; and (ii) auctions for power generated by existing plants, seeking to meet the existing demand.

The New Industry Model created two environments for the purchase and sale of energy: (i) the Regulated Market, in which distribution companies 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 Mining and Energy Ministry, (or “MME”). Two entities have been created to structure the sector’s new framework: (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) the Electric Power Trading Chamber (Câmara de Comercialização de Energia Elétrica, or 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 have exempted contracts executed prior to the enactment of the law, in order to provide regulatory stability to transactions carried out before its enactment.

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 also compulsory procurement volumes. As a consequence, 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 Federal Government, which buys all the energy credits from Eletrobrás.

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 distribution companies 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.

 

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The Regulated Market

In the Regulated Market, distribution companies 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 distribution companies 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 distribution companies, 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 hydroelectrical 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.

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 MW at a voltage equal to or higher than 69kV or at any voltage level if their supply began after July 1995. Starting in 2019, customers whose supply began before 1995 may also migrate to Free Market pursuant to Law No. 13,360/2016. In addition, customers with contracted demand of 500kW 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 Distributors

Distributors 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.

 

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Contracts Executed Prior to the New Industry Model Law

Under the New Industry Model Law, contracts executed by distribution companies 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.

Reduction of the Level of Contracted Energy

Decree No. 5,163/2004, which regulates trading in energy under the New Industry Model Law, allows distribution companies to reduce their CCEARs: (1) to compensate for the exit of potentially free customers from the regulated market, pursuant to a specific declaration delivered to the Mining and Energy Ministry, (2) by up to 4.0% per year of the initial contracted amount due to market deviations from their estimated market projections, at the distribution company’s discretion, starting two years after the initial energy demand was declared; and (3) in the event of increases in the amounts of energy acquired under contracts entered into before March16, 2004 (date of publication of Law No. 10,848/2004). This reduction may be made only with CCEARs of existing power plants.

The circumstances in which the level of contracted energy may be reduced must be stated in CCEARs, and distribution companies may make such reductions at their own sole discretion, in compliance with the provisions described above, and ANEEL regulations.

ANEEL regulations require any reduction of the level of contracted energy under the CCEARs of existing energy to be preceded by the Mechanism of Compensation of Surplus and Deficits (MCSD), by means of which distribution companies that have contracted energy in excess of their demand may assign a portion of their CCEARs to distribution companies that have contracted less energy than needed to meet their customers’ demand.

In 2016, a New Energy MCSD was created, which allows the transfer of new energy contracts between distributors in order to compensate for surpluses and deficits. If there is more surplus than deficit, the mechanism also allows the generators to offer reduction of the contracts to the distributors in order to compensate this surplus. The reduction is then effected in descending order of price and there is no financial compensation for the reduction.

In addition to the New Energy MCSD, Resolution No. 711/2016 was also published, which allows bilateral negotiation of contracts between generators and distributors, enabling partial or full reduction of contracted energy under CCEARs. This mechanism provides financial compensation if the reduced contract is priced above the average price of the distributor’s portfolio (PMIX). Such compensation is limited to a 36-month period. If the CCEAR has a price lower than the PMIX, the loss must be reimbursed to the customer.

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 average value of acquisition in energy purchased in generation supply auctions carried out in the years ‘A–N’, weighted by the acquired quantities, calculated for all distribution companies, and creates an incentive for distribution companies to contract for their expected energy demands in the A–5 and A-6 auctions, where prices are expected to be lower than in A–3 e A-4 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. 5,163/2004 establishes the following limitations on the ability of distribution companies to pass through costs to customers:

 

    No pass-through of costs for energy purchases that exceed 105% of regulatory demand.

 

    100% pass-through of the costs of acquisition of energy in the ‘A–5’ and ‘A–6’ auctions.

 

    Limited pass-through of costs for energy purchases made in an A–3 and A-4 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.

 

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    Energy purchases from existing facilities in the “A-1” auction are limited to 0.5% of distribution companies’ 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. Ministério de Minas e Energia ( “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 8,379/2014, was 1.0%, except for 2008 and 2009) and pass-through of costs are limited to the estimated average future marginal cost of the power delivery submarket, which is also limited to the minimum and maximum spot prices (PLDs) for the supply periods of the contracts negotiated, calculated on the basis of the Monthly Operation Plan (PMO) of the National Energy System Operator (ONS) and the five-month moving average 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.

Tariffs

Electric energy tariffs in Brazil are set by ANEEL, which has the authority to adjust and review tariffs in accordance with applicable concession contracts and regulations. Each distribution company’s concession contract provides for an annual tariff. In general, “Portion A costs” are fully passed through to customers. “Portion A costs” are the portion of the tariff calculation formula which provides for the recovery of certain costs that are not within the control of the distribution company. “Portion 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 tariff adjustment includes components such as the inter-year variation of Portion A costs (“CVA”) and other financial adjustments, which compensate for changes in the company’s costs up or down that could not be previously taken into account in the tariff 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 are mainly held: (i)to ensure necessary revenues to cover efficient operational 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, and on labor costs. 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 operational costs during the five-year period between the tariff reviews, to reach the level defined for the previous year of the review cycle.

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 rate of 7.50% after tax, compared to the rate of 11.25% applied in the previous cycle. This rate of return is applicable to the investments made by CEMIG D until the next tariff cycle, which will be held starting in 05/28/2018. After that, the new rate of return calculated by the regulator is 8.09% after tax.

 

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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. It also included two additional components abovementioned: XQ and Xt. The components of the X factor, determined in the 2013 review, for the period 2013/2018, were: Xt = 0.68%, and Xpd=1.15%. On each review an XQ is calculated and added to the previous values.

ANEEL has also issued regulations governing access to the distribution and transmission facilities, and establishing TUSD; and the TUST. The tariff 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 separated part of the variable energy costs of distributors, which were previously agreed to be applied in 2016, and created an additional fee that would be passed on to customers through their energy bills. This system became 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, at a ratio of R$2.50 per 100 kWh (or fractions thereof). If conditions are even less favorable, the system will indicate a red flag and there will be an additional fee imposed on customers proportional to the consumption rate of R$4.50 per 100 kWh (or fractions thereof). During 2016 there were red flags in January and February, yellow in March and November and green in the other months. In 2017 there were green flags in January, February and July, yellow in March, July and September, and red (level 1) in April, May, August and December and red (level 2) in October and November. From January to October 2017 the values for the flags per 100 kWh were: the yellow flag fixed at R$ 2.00; the red flag level 1was set at R$ 3.00 and the red flag level 2 was set at R$ 3.50. As of November 2017 the values per 100 kWh were readjusted to: the yellow flag fixed at R$ 1.00; the red flag level 1 was set at R$ 3.00 per 100 kWhand the red flag level 2 was set at R$ 5.00 per 100 kWh.

ANEEL, when determining tariff adjustment applicable to energy distributors, estimates the costs considering a favorable scenario for electricity generation.

Land Acquisition

The concessions granted to CEMIG by the Federal Government do not include a grant of the land upon which the power plants are located. In general, energy utilities in Brazil have to negotiate with the owner of each property to obtain the land required for operation. However, in the event that a concessionaire is unable to obtain the required land amicably, such land may be condemned for the concessionaire’s use through specific legislation. In cases of governmental condemnation, the concessionaires may have to participate in negotiations relating to the amount of compensation with landowners and the resettlement of communities to other locations. We make all efforts to negotiate with the communities before taking legal action.

The Brazilian Electric Power System – Operational Overview

Brazil’s power production and transmission is a large-scale hydroelectrical and thermal system made up predominantly of hydroelectrical 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 a potential hydroelectrical power generation of approximately to 247,997 MW, of which only 44% has been developed or is under construction, according to Eletrobrás studies compiled in December 2016.

 

 

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Power Generation by Source:

 

LOGO

 

Source: Empresa de Pesquisa Energética – (EPE) and International Energy Agency – (IEA)

By December 2017, Brazil had an installed capacity in the interconnected power system of 166.26 GW, approximately 60.47% of which is hydroelectrical, according to the Matriz de Energia Elétrica available at the Banco de Informações de Geração “BIG”, published by ANEEL. This installed capacity includes half of the installed capacity of Itaipu – a total of 14,000MW owned equally by Brazil and Paraguay. There are approximately 84,228 miles of transmission lines in operation at 230 kV or above in Brazil.

Approximately 31% of Brazil’s installed generating capacity and 45% of Brazil’s high voltage transmission lines are operated by Eletrobrás, a company owned by the Federal Government. Eletrobrás has historically been responsible for implementing energy policy, and conservation and environmental management programs. The remaining high-voltage transmission lines are owned by state-controlled or local electric power companies. Distribution is conducted by approximately 60 state or local utilities, a majority of which have 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 Federal Government or indirectly through the granting of concessions, permissions or authorizations. Since 1995, the Federal Government has taken a number of measures to restructure the power industry. In general, these measures 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 Federal Government has taken the following measures:

 

    The Brazilian Constitution was amended in 1995 to authorize foreign investment in power generation. Prior to this amendment, all generation concessions were held by a Brazilian individual, an entity controlled by Brazilian individuals, by the Federal Government or by 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:

 

    determined that all concessions for the provision of energy-related services must be granted through public bidding processes;

 

    gradually 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;

 

    provided 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;

 

    granted free customers and energy suppliers open access to the distribution and transmission grids;

 

 

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    eliminated the need for a concession to construct and operate power projects with capacity from 1 MW to 30 MW, or Small Hydroelectrical plants, (SHPs), which was amended on May 28, 2009 by Law No. 11,943 and further by Law No. 13,360/2016, 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:

 

    Established 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.

 

    Established 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 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 Federal Government issued Provisional Measure No. 579, enacted as Law No. 12,783, related to the extension of the concessions granted prior to Law No. 9,074 of July 7, 1995, aiming to decrease the sector’s charges and achieving more reasonable tariffs. This legislation changed the rules applicable to certain concessions, and implemented new bidding process rules for certain utilities, and adjustments to tariffs.

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

On June 22, 2016, the Federal Government issued Provisional Act No. 735, 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 August 22, 2017 the Federal Government issued Decree No. 9,143, which modified the auctions for contracting power supply in the regulated environment, creating new auctions described as ‘A–4’, ‘A–6’, and possibly ‘A–7’. At the same time adjustments were made to the limits for pass-through to, and contracting of, distributors.

Rationing and Extraordinary Tariffs Increases

Rationing of energy; government measures to compensate energy concession holders.

In late 2000 and early 2001, low levels of rainfall, significant growth in demand for energy, and Brazil’s significant dependence on energy generated from hydroelectrical sources resulted in an abnormal fall in levels at several of the reservoirs used by Brazil’s largest hydroelectrical generation plants. In May 2001, the Brazilian Federal Government announced a group of measures requiring reduction in consumption of energy in response to those conditions (“Brazilian Energy Rationing Plan”). Under this plan, energy distribution and generation companies (such as CEMIG) were compensated for the losses of revenue resulting from the rationing imposed by the Federal Government – either due to lower volume of sales, or reduction in energy selling prices, or purchases of energy within CCEE. This compensation was given in the form of the right to charge extraordinary increases in energy rates to customers for a future period, which averaged 74 months, and ended in March 2008.

However, the New Industry Model (its main purpose being to guarantee the supply of energy) created auctions for the Regulated Market, in which it is possible to buy energy from new plants to seek security of supply. Since the New Industry Model was introduced, approximately 47,000MW of capacity have been placed in these auctions, for installation between 2008 and 2017.

Out of this amount, a total of 5.97 MW was contracted in “Reserve Auctions” – that is to say, this power capacity is not committed to any contract, or to any minimum supply.

 

 

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In the rainy season of late 2012 and early 2013, there was much less rainfall than expected in Brazil’s Southeastern region (November to March), and in this situation the thermoelectric plants were activated to generate complementary supply to meet the system’s energy consumption needs. During this period, the principal strategy of ONS was to preserve storage capacity at the reservoirs of hydroelectrical plants and to ensure supply of the system’s energy needs over the whole of the year 2013. This resulted in a high level of expenses on thermoelectric generation, and a sustained increase in the spot market price – which averaged R$121.29/MWh in July 2013.

Once again, in the rainy season of late 2013 and early 2014, rainfall in the Southeast was lower than the expected averages, an all-time low. This placed the system in a state of alert during the whole of 2014, concentrating the efforts of the operators on how to maintain the capacity of the system to supply consumption needs. ONS continued to dispatch all the thermal plants, and introduced some flexibility to hydroelectrical restrictions so as to maintain the levels of storage and meet demand. Over the year, the spot price reached the regulatory limit, with the spot price rising to R$822/MWh for several months. Its average in the year was R$688/MWh. At the end of 2014, the levels of storage once again reached their lowest level, putting great pressure on the ONS to guarantee full operation of the system.

In order to maintain the requisite supply during 2015, the ONS continued to utilize the full capacity of thermoelectric plants, as there was no improvement in hydrology during the rainy season. In order to avoid possible rationing, the Brazilian Federal Government revised the applicable tariffs by removing subsidies and passing the cost of thermoelectric generation directly to customers, resulting in an increase in the cost of energy by 50%. The effect of the increase in energy prices, along with the poor performance of the economy led to a drop in energy consumption of 1.3% compared to 2014. With lower power consumption, additional thermal utilization and the improvement in the hydrology of the second half of 2015, the Brazilian energy system met the demand and there was no need for rationing. Once again, we ended the year with low levels of water storage in reservoirs.

In the spot market, the spot price closed December 31, 2015, with a yearly average of R$287.20/MWh. The price cap for 2015 was R$388.48/MWh.

With the drop in energy consumption and increased rainfall, close to the historical average in the rainy season, pressure on the operation of the system was relieved in 2016, which enabled the gradual shutdown of the thermal plants that were operating due to energy security. However, the northern and northeastern regions contined to have shortages and recorded historically low rainfall. As a result, some thermal plants in that region remained in operation. In 2016, the average spot price was R$ 93.98 / MWh with a ceiling of R$ 422.56 / MWh.

In 2017, as in 2015, the system experienced low flows during the dry period, which prevented the principal reservoirs to recover. At the end of April, storage in the national grid system was close to 40% of its maximum capacity. In this scenario of low storage and low flows, prices were high, which increased dispatching of the thermoelectric plants. The northeastern region which continued to have shortages of rainfall. In 2017, the average spot price (PLD) in the system was R$ 324.17/MWh, with a ceiling of R$ 533.82/MWh.

Conflicts of interest between CEMIG and other users of water.

The operation of reservoirs for generation of energy by CEMIG requires 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 operational 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 hydroelectrical plants.

 

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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 hydroelectrical 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 agreements 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, 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.

On September 22, 2004, while the rules established by Law No. 9,074, enacted on July 7, 1995, were still in effect, CEMIG requested from ANEEL an extension for 20 years of the concessions of the Emborcação and Nova Ponte Hydroelectrical plants. On January 14, 2007, the Federal Government approved the extension of these concessions for a period of 20 years from July 24, 2005, until July 24, 2025. The related concession contract was amended on October 22, 2008, to reflect the extension granted to CEMIG.

On September 11, 2012, the Federal Government issued Provisional Act No. 579 of 2012 (“PA 579”), which was converted into No. 12,783 of January 11, 2013, governing the extension of concessions granted before Law No. 9,074/1995. Under PA 579, concessions granted before Law No. 9,074/1995 could be extended for a single time, for a period of up to 30 years.

On December 4, 2012, CEMIG signed the second amendment to transmission contract No. 006/1997, 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, which will reduce the revenue which we will receive arising from those concessions. The Brazilian Government has compensated us for the reduction of the RAP in part but the assets in operation before the year of 2000 have not yet been compensated. 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. 120/2016, which determined that recognition of the amounts owed would take place as from the tariff adjustment process of 2017.

Also on December 4, 2012, CEMIG chose not to accept the extension of the generation concessions that expired in the years 2013 to 2017, namely Três Marias, Salto Grande, Itutinga, Volta Grande, Camargos, Peti, Piau, Gafanhoto, Tronqueiras, Joasal, Martins, Cajuru, Paciência, Marmelos, Dona Rita, Sumidouro, Poquim and Anil. In relation to the power plants that had their first extension of the related concessions after the issuance of PA 579, namely Jaguara, São Simão and Miranda, CEMIG believes that Generation Concession Contract No. 007/1997 enables CEMIG to extend these concessions for an additional 20 years, until 2033, 2035 and 2036, respectively, without restrictions.

 

 

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CEMIG GT applied for an order of mandamus against an MME action at the STJ (Superior Tribunal de Justiça)with the objective of ensuring CEMIG GT’s right to an extension of the period of the concession of the Jaguara hydroelectrical plant, under Clause 4 of Concession Contract No. 007/1997, obeying the original bases of this contract, which were prior to Law No. 12,783/2013. CEMIG GT was granted an interim injunction to continue commercial operation of the Jaguara hydroelectrical plant until a final judgment is rendered on this application for mandamus. Judgment was then given on this Action, refusing the applications made by CEMIG GT. Prior to the implementation of the outcome of this trial, which would result in the government taking over the UHE, CEMIG GT applied to the STF for a Provisional Remedy with interim injunction permitting it to continue operating and managing the plant. Although this judgment has not yet been published, which prevents filing of the appropriate appeal, the Company did apply to the STF for a provisional remedy with an interim injunction to permit it to continue operating and managing the plant. The interim injunction was granted. Judgment has not yet been given in this action for provisional remedy. With the publication of the result of the writ of mandamus, CEMIG GT filed an ordinary appeal to the STF on March 1, 2016. On March 21, 2017, the interim injunction granted in the case of the provisional remedy cited above was then revoked by the Reporting Justice. On November 21, 2017, the 2nd Panel of the STF ruled that the application for mandamus should not proceed. The Company believes that this is not a final decision, and for this reason, now that the full judgment has been published, the Company is evaluating the possible lines of appeal. The chance of loss in this action has been classified as ‘probable’, in view of the judgment given in Ordinary Appeal 34.203/STF. The case has several particular elements: the singular nature of Concession Contract No. 007/1997; the unprecedented nature of the subject matter; and the fact that the action will be a leading case in consideration of extension of concessions by the Brazilian Courts

CEMIG GT applied for an order of mandamus against an act of the Mining and Energy Minister with the objective of ensuring its right to extend the period of its concession for the São Simão Hydroelectrical Plant, under Clause 4 of Concession Contract No. 007/1997, in accordance with the original terms of this contract, which were prior to Law Nº 12,783/2013. The interim relief originally obtained by CEMIG GT, empowering it to continue in control of the commercial operation of the São Simão Plant until judgment is given in the application for mandamus, was reviewed and overturned by the Reporting Justice. The Reporting Justice, in view of the STF, having granted interim relief in the action on the Jaguara Hydroelectrical Plant – the legal subject matter of which is similar to that of the mandamus case on the São Simão Hydroelectrical Plant, served notice on CEMIG GT to make a statement on the suspension of this order of mandamus relating to the São Simão Plant. CEMIG GT stated its interest in the suspension, but requested granting of the interim remedy with the same outcome that was employed in the case of the Jaguara Plant, i.e. keeping CEMIG GT as holder of the concession of the São Simão Plant, on the same conditions as the Jaguara Plant, that is to say obeying the original bases in Concession Contract 007/1997, prior to Law 12,783/2013. An injunction was granted by the Reporting Justice to allow the Company to retain ownership of the São Simão Plant concession, pursuant to the initial bases of Concession Contract No. 007/1997, until the conclusion of the judgment. On March 28, 2017 that interim injunction was revoked. On December 13, 2017, the First Section of the Higher Appeal Court (STJ) ruled to reject Cemig’s applications. The Company is currently assessing lines of appeal. The chance of loss in this action has been classed as ‘probable’, due to the judgment given against the Company in Ordinary Appeal 34.203/STF, which was filed in the case of the mandamus on the Jaguara hydroelectrical plant (see above) – since both cases have the same issues and facts to be considered, and in the last analysis will be heard and judged by the same court body. CEMIG GT filed an application to the STJ for mandamus, requesting interim relief, against an MME action that was illegal and violated certain right of the plaintiff, with the objective of obtaining extension of the period of concession of the Miranda Hydroelectrical Plant on the basis of Clause 4 of Concession Contract 007/1997. CEMIG GT was granted an interim injunction to continue in commercial operation of the Miranda Hydroelectrical Plant until final judgment on this application for mandamus. In response to a motion for revision of judgment brought by the Federal Government against the Internal Appeal, the Reporting Justice revoked this interim remedy on March 29, 2017. There is as yet no judgment on the merit of this action. The chance of loss in this action was classified as probable due to the judgment given against the Company in Ordinary Appeal 34.203/STF, which was filed in the case of the mandamus proceedings relating to the Jaguara hydroelectrical plant (see above) – since both cases have the same issues and facts to be considered, and in the last analysis will be heard and judged by the same court body. In addition to the Mandamus mentined above, on February 21, 2017, CEMIG GT made a renewed request to MME, reiterating its administrative application for extension, for 20 (twenty) years, of the concessions of the Jaguara, São Simão and Miranda hydroelectrical plants in the terms specified by Clause 4 of Concession Contract No. 007/1997. In this new request, which restates and underlines the Company’s interests in these plants, CEMIG GT also made a subsidiary request, for the concession of these hydroelectrical plants to be transferred/granted to one of its subsidiaries, for the purposes specified by Paragraph 1-C of Article 8 of Law 12,783/2013 (included in that law by Law No. 13360 of November 17, 2006), which enables the Federal Government to grant a power generation concession for 30 years when associated with transfer of control of a legal entity providing this service which is under direct or indirect control of a State, the Federal District or a municipality. The presentation of the subsidiary request does not result in any waiver by CEMIG GT of its right to guaranteed extension of the concessions as specified in Clause 4 of Concession Contract 007/1997; such right is the subject of the legal actions that it currently has in progress against the Federal Government.

 

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On September 27, 2017 the Brazilian Federal Government auctioned the concessions for the São Simão, Jaguara, Miranda and Volta Grande hydroelectrical plants, the concessions for which had been previously held by Cemig GT. These plants have aggregate generation capacity of 2,922 MW, and the price of the sale was R$ 12.13 billion. In each case the winning bidder of the concessions was a third party not related to Cemig GT.

Cemig GT worked intensely to maintain the concessions of the São Simão, Jaguara and Miranda plants and despite of the result of the auction, Cemig GT will continue to fight for its rights to be recognized by the courts. As well as the legal actions in progress in the Federal Supreme Court (STF) and in the Higher Appeal Court (STJ), cases were brought in the administrative and the judicial sphere related to the indemnity to which Cemig GT is entitled.

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 Remedy, 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 the Jaguara, Miranda, São Simão and Volta Grande hydroelectrical plants, and also immediately deposit the non-contested portion of the indemnity, which had been set at R$ 1.027 million. In this case, the application for interim remedy 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.

In the years 2014 and 2015, Brazil experienced a severe drought culminating in further alterations to the regulatory framework, established by Provisional Act No. 688/2015, which was converted into Law No. 13,203/2015. This law, among other measures, significantly altered Law No. 12,783/2013, creating a mechanism of voluntary renegotiation of hydrological risks, since they affect the hydroelectrical generation companies, and changing the rules for bidding for certain hydroelectrical generation concessions. Subsequently, in 2016, other changes were introduced to the sector by Provisional Act No. 735/2016, enacted as Law No. 13,360/2016 which, among other measures, changed Chapter III of Law No. 12,783/2013, which relates to bidding for energy generation, transmission and distribution concessions.

The documents for Generation Auction No. 12/2015 on October 7, 2015, included two new regulatory provisions for the concessions renewal of existing power plants. The first provision granted an additional revenue to the concession holder in order to assure the power plant´s fast and cost effective renovations and reforms. This additional revenue is called “GAG Melhorias”, it was three times higher than the market expected. More on this issue can be found on the auction documents. The second provision was stipulated by Law No. 13,203/2015. The concession holder could avoid the risk of a severe drought (which implies in thermoelectric generation, therefore, higher costs) by paying a reasonable prize to the customers who would take that risk. As a result this law improved the projections of the concession´s cash flow and reduced the revenue loss due to thermoelectric complementation. CEMIG Holding’s Board of Directors authorized our participation in Generation Auction No. 12/2015, and CEMIG GT was successful at this auction, held at B3 on November 25, 2015. CEMIG won concessions for Lot ’D’ – which comprises the concessions for 18 hydroelectrical power 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 term 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 to handle the 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).

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, accepted 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.

 

 

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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 a total of five non-consecutive years, will result in forfeiture (caducidade) of the concession.

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 governed by the MME, and the majority of its members are officials from 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.

Mining and Energy Ministry – MME

The MME is the Federal Government’s primary regulator of the power industry. Following the adoption of the New Industry Model Law, the 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.

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 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.

Energy 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 chairman of the board of directors.

 

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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.

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.

Incentives for Alternative Sources of Power

In 2000, a federal decree created the Thermoelectric Priority Program (Programa Prioritário de Termeletricidade, or “PPT”), for the purpose of diversifying the Brazilian energy matrix and decreasing its strong dependency on hydroelectrical plants.

In 2002, the PROINFA Program was established by the Federal Government to create certain incentives for development of alternative sources of energy, such as wind energy projects, SHPs and biomass projects.

Law No. 9,427/96, as amended by Law No. 10,762/03, Law No. 13,097/15 and Law No. 13,360/16, further established that hydroelectrical plants with an installed capacity of 1MW or less, generation plants classified as a SHP, and those with qualifying solar, wind, biomass or cogeneration sources, with capacity injected into the grid no higher than 30 MW, used for independent production or self-production, will have the right to a discount of at least 50% on the rates for use of the transmission and distribution systems, charged on production and consumption of the energy sold. This legal provision was regulated by ANEEL through its Resolution Nos. 077/2004, 247/2006 and 271/2007.

The government also held two alternative energy generation auctions and four back-up regulated auctions for contracting power from wind energy projects, SHP projects, or biomass projects.

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.

 

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The 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 make contributions 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 Federal Government.

Since January 2013, the Global Reversion Fund has not been charged to: (i) any distribution companies; (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 hydroelectrical 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. The CCC was managed by Eletrobrás and as of May 2017, it has been managed by CCEE pursuant to Law No. 13,360/2016.

Charge for the Use of Water Resources

With the exception of Small Hydroelectrical plants, all hydroelectrical 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 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. Since May 2017 the CDE has been managed by CCEE pursuant to Law No. 13,360/2016.

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 operational 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.

 

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The Regulated Market Account

Contracts held by distribution companies 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 distribution companies 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 distribution companies. The Regulated Market Account was established in 2014 to cover the exposure that distribution companies 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 distribution companies 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 distribution companies, 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 previously explained, raised the energy cost in the spot market to its highest level, causing the financial exposure of the distribution companies to reach billions of reais. Since the cost of the distribution companies’ 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 distribution companies to balance their exposure so no new loan was necessary.

To deal with this, the Government created the Regulated Market Account, by Decree No. 8,221/2014 enacted on January 1, 2014, regulated by ANEEL Resolution No. 612/2004, 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 distribution companies, as determined by Decree No. 8,221/2014 and ANEEL Resolution No. 612/2014. In 2014 and 2015, R$21 billion was raised by this account and passed through to the distribution companies.

The ANEEL Resolution No. 1863/2015 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 of 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 hydroelectrical power by mandating that all hydroelectrical 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.

 

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In 2014, Brazil was subject to very adverse hydrological conditions, which resulted in a lower level of hydroelectrical 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.

During 2015, the low values of GSFs along with high spot prices again left producers of hydroelectrical 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, hydroelectrical 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, the voluntary negotiation, in general, was deemed inefficient by generation companies.

Consequently, acceptance of the mechanism by the regulated market was, approximately 90%. However, it was not accepted by the free market.

In 2017, the average GSF stood at 0.815. As in prior years, low demand, lower hydroelectrical generation and higher generation by the thermal, wind and solar plants impacted the GSF.

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, distribution companies of the South, South-East and Midwest parts of the grid pay specific charges for transmission of energy generated at Itaipu. All these rates and charges are set by ANEEL. The following is a summary of each rate or charge:

TUSD

TUSD is paid to a distribution company by generation companies, other distribution companies 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.

 

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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 distribution companies, and free customers, also pay a fee for exclusive transmission connections to some transmission companies. The fee is set by the regulator for a 12-month period and it is paid monthly through the issuance of invoices.

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 distribution companies into: (1) costs that are beyond the control of the distributor, or “Portion A” costs; and (2) costs that are under the control of the distributor, or “Portion B” costs. The rate adjustment is based on a formula that takes into account the division of costs between the two categories.

Portion 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 distribution companies, and the ONS).

Portion 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.

In general, Portion A costs are fully passed through to customers. Portion B costs, however, are adjusted for inflation in accordance with the IPCA inflation index adjusted by the X Factor. Energy distribution companies, according to their concession contracts, are also entitled to periodic reviews. These reviews mainly aim: (i) to ensure necessary revenues to cover efficient Portion B operational costs and adequate compensation for investments deemed essential for the services within the scope of each company’s concession; and (2) 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.

 

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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, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015, 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 reais.

Basis of Measurement

The consolidated financial statements have been prepared based on historical cost, with the exception of the following material items recorded in the statement of financial position:     

 

    Derivative financial assets measured at fair value through profit or loss

 

    Financial assets held for trading measured at fair value.

 

    Concession financial assets measured by the New Replacement Value (“VNR”), equivalent to fair value.

 

    Financial liabilities related to put options, measured at fair value through the Black-Scholes-Merton model.

New accounting standards and interpretations

The following standards that were effective on or after January 1, 2017:

 

    Amendments to IAS 12, Income Taxes – Recognition of deferred tax assets for unrealized losses.

 

    Disclosure Initiative (Amendments to IAS 7, Statement of cash flows), require entities to provide disclosure of changes in their liabilities arising from financing activities, including both changes arising from cash flows and non-cash changes (such as foreign exchange gains or losses)

The application of these amendments had no significant impact on the amounts recognized in the consolidated financial statements.

Standards issued but not yet effective on December 31, 2017

Effective starting January 1, 2018:

 

    Amendments to IFRS 10 and IAS 28 – Sale or contribution of assets between an investor and its associate or joint venture: Deal with situations that involve sale or contribution of assets between an investor and its associate or joint venture.

The Company does not expect significant impacts on its financial statements as a result of adoption of these amendments.

 

    IFRS 9 – Financial instruments

In July 2014, the IASB issued the final version of IFRS 9 Financial Instruments that replaces IAS 39 Financial Instruments: Recognition and Measurement and all previous versions of IFRS 9. IFRS 9 brings together all three aspects of the accounting for financial instruments project: classification and measurement, impairment and hedge accounting. IFRS 9 is effective for annual periods beginning on or after 1 January 2018, with early application permitted. Except for hedge accounting, retrospective application is required but providing comparative information is not compulsory. For hedge accounting, the requirements are generally applied prospectively, with some limited exceptions.

The Company made an assessment of the potential effects of adoption of IFRS 9 and does not expect significant impacts on its financial statements, except as to the impairment of accounts receivable from customers.

 

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Classification and measurement

The Company expects to continue measuring at fair value all financial assets that are currently measured at fair value. For financial assets currently classified in accordance with IAS 39 as loans and receivables (the objective of the business model of which in accordance with IFRS 9 is to raise contractual cash flows, representing only payments of principal and interest), the Company has concluded that these financial instruments comply with the criteria for measurement and classification under the amortized cost. For this reason, no change in the method of measurement of these instruments is expected.

Impairment

IFRS 9 requires the Company to record expected losses on all its financial assets instead of an incurred losses approach.

The provisions for expected losses will be measured based on the losses expected in the next 12 months, as a function of 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. The Company have adopted, in its analyses, a simplified approach, considering that the balance of its accounts receivable from clients do not have a significant financing component, and have calculated the expectation of loss considering the historic average of non-collection over the total billed in each month (based on the last 12 months of billing), segregated by type of client and projected for the next 12 months, taking into account the aging of receivables, including those not yet due. The estimated loss for the past due balances of customers who renegotiated their debt has been calculated based on the maturity date of the original invoice, with the new terms negotiated not being taken into account. For the balances that are more than 12 months past due, expectation of total loss was assumed.

The Company estimates that the adoption of this new pronouncement will have an impact, mainly, on the expected losses from its receivables doubtful accounts. The estimated effects at January 1, 2018 arising from adoption of IFRS 9, resulted in an increase in the provision for doubtful accounts and a corresponding effect in Equity, as follows:

 

     Jan. 1, 2018  

Customers and Traders; Transport of energy

     195  
  

 

 

 
     195  
  

 

 

 

 

    IFRS 15– Revenue from contracts with customers

IFRS 15 – Revenue from contracts with clients was issued in May 2014, and amended in April 2016, and establishes a five-step model to account for revenues arising from contracts with customers. Under IFRS 15, revenue is recognized at an amount which reflects the consideration to which an entity expects to be entitled in exchange for transfering goods or services to a customer. This new pronouncement will supersede all current requirements for recognition of revenue under the IFRS. Additionally, IFRS 15 establishes requirements for more detailed presentation and disclosure than the standards currently in effect.

Either a full retrospective application or a modified restrospective application is required for annual periods starting January 1, 2018. The Company plans to adopt the new standard on the requierd effective date using the modified retrospective method.

The Company performed a preliminary assessment application of the five steps for recognition and measurement of revenue, as required by IFRS 15:

 

    Identify the contracts signed with its customers;

 

    Identify the performance obligations in each type of contract;

 

    Determine the price of each type of transaction;

 

    Allocate the price and to the performance obligations contained in the contract; and

 

    Recognize the revenue when (or to the extent that) the entity satisfies each performance obligation of the contract.

 

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The Company expects no material impacts in the adoption of the new standard, except for reclassification of the penalties for performance indicators, from operating expenses to an account reducing revenue for availability of the energy network. Below is a detailed analysis of Revenues from contracts with customers: