In the Dark

SAO PAULO, Brazil — The last one out of Brazil need not shut off the lights. Most have been off for some time, along with the air conditioning, elevators, escalators and some automotive production lines. The country, with 20 million cars on the road at a medium age of 10 years, is ranked eleventh in global light vehicle output.

Indeed, California-style rolling blackouts are becoming all too familiar to South America's largest and most populous country of 170 million, which is 97% dependent on hydroelectric power. Two years of drought have reduced water levels to 70% below what is considered satisfactory. While total installed electrical capacity stands at 73,000 megawatts (MW), current demand is 80,000 MW and in five years is expected to exceed 100,000 MW.

The federal government announced in May that if energy consumption was not reduced quickly — 20% for residences, commerce and office buildings; 35% in public street illumination; and 15% for industrial energy — planned blackouts would be enforced. Participants at Brazil's recent Automec 2001 found out the hard way just how critical the situation is. About 65,000 visitors annually attend the region's largest and most important exhibition for aftermarket and automotive suppliers.

No one expected the power to fail in the cavernous exhibition hall in the first hour of opening day, leaving frustrated executives to deliver important speeches in the dark and others to suffer computer meltdowns. Although electricity eventually was restored to a good number of the 1,030 exhibits, many remained in shadows.

More worrisome are the line stoppages and production cuts by Renault SA, Ford Motor Co., Fiat Auto SpA, Honda Motor Co. Ltd., Toyota Motor Corp. and DaimlerChrysler AG due to the energy crisis and the slowing of Brazil's economy. Volkswagen AG is the latest to succumb, halting production at its Sao Bernardo do Campo plant from July 30-Aug. 8, sending workers home on paid leave.

Most everyone blames Brazil President Fernando Henrique Cardoso for not seeking alternative modes of energy before now, such as nuclear and solar energy. Plus Brazil still lacks suitable transmission lines to enable it to purchase more power from neighboring Argentina, Paraguay and Venezuela — home to some of the largest hydroelectric dams in the world.

With the lights out, crime on the already mean streets of Sao Paulo has taken on new significance. Automobile accidents have increased after dark because no one is willing to sit at a traffic light. There are some 19 million people living in the metropolitan area — the majority of them very poor, some desperate enough to rob motorists at gunpoint or kidnap for ransom. Many of the captains of industry here, both native and expatriates, drive armor-plated cars.

The kidnappings rarely are made public. One recent incident, however, made it into Japan's Kyoto News, which reported that the head of Suzuki Motor Corp.'s Brazilian operation in late May was kidnapped by three men while on his way home from a golf course. He was released after a $29,500 ransom was paid.

Volker J. Barth, president of Delphi Automotive Systems Inc.'s South American operations and vice president of Brazil's Society of Automotive Engineers, who himself has been robbed three times, estimates that Brazil needs to invest some $20 million in order to generate its own energy. Delphi, with nine manufacturing facilities in Brazil and two in Argentina, two technical centers and two joint ventures and employing more than 7,000 people, expects to produce $500 million in revenue for the year.

Mr. Barth predicts, however, that an ongoing energy crisis could force local automakers to cut production by 20%, which would increase demand and thereby trigger inflation that would in turn cripple buying power. Thus creating a vicious cycle that Brazil is all too familiar with, having clawed its way back from a whopping 929% inflation in 1994 to 5% so far this year, albeit nudging up as interest rates shoot past 18%.

The problem is particularly frustrating for Tier I suppliers such as Delphi, which more and more are finding themselves squeezed. As the economy contracts, automakers are reluctant to increase the price of passenger cars, while demanding 5% cost cuts from major suppliers. At the same time, local parts makers are passing on increased costs of their materials.

Considering 70% of Brazil's market is the 1L “popular car,” with 90% local content, a rise in material costs constitutes a substantial drain on profits. Plus, with the local currency devaluation, Brazilian companies would rather export commodities such as steel, rubber and plastics than supply local industry, causing in-country prices to escalate.

Nevertheless, localization is a means of promoting domestic suppliers while reducing inventories, increasing flexibility, avoiding taxes and cutting logistics costs. “It takes 30 days to get parts here (from overseas),” complains Fernanda Pereira, head of purchasing for Delphi South America.

“Our problem is that we don't have enough raw materials,” she says. “We import on average 42% of our components. Our local suppliers say there's a price increase, no discussion. If we don't agree, we have to pay a penalty. When we go to the OEMs, they say, ‘That's your problem.’ We are the middle of the sandwich.”

As the Brazilian currency, the real, continues to slide — from R1.85 to the U.S. dollar last year to its current R2.47 — importation costs soar because they must be paid in U.S. dollars. “We can't constantly absorb increased costs,” says Sandra McCulloch, Delphi's executive director, marketing and sales and managing director for Delphi Harrison Thermal SA.

On the other hand, she says, focusing on exports creates a natural hedge. Being paid in U.S. dollars constitutes a windfall, especially with labor cheaper in Brazil. Automakers and major suppliers say for now they are getting by on exports. Suppliers last year exported $4 billion in auto parts — the largest allocation to the U.S. — while imports accounted for $4.2 billion. This year, they expect to import $4.3 billion and export $4.7 billion, a gain of $400 million.

Some 20% of Brazilian-made cars are exported, with volumes in the first quarter rising to 77,431 units, up 7.4% over the same period last year. While most go to neighboring Mercosur trade pact partners, sales to Mexico last year generated $505 million. South Africa bought $36 million in vehicles, with sales up in this year's first quarter by 63% over same period last year. There now are plans to target India.

On the down side, a recent study by a Brazilian think tank found the power crunch is taking a toll on the country's trade balance, with a $1.6 billion deficit projected by year's end. Economists also fear energy rationing, and its consequences could shrink Brazil's economic growth to less than 3% from the expected 4.5%. Another study foresees 800,000 people losing their jobs if electricity supply continues to fall. The auto industry currently employs about 175,000.

That's more cause for worry, say suppliers. Which is why Brazil's automotive supplier association, Sindipecas — made up of 25 major companies that include, in addition to Delphi, such global giants as Robert Bosch GmbH, Dana Corp., Visteon Corp., Siemens AG and Denso Corp. — meets weekly to discuss common problems and ways in which to approach the OEMs.

About 60% of supplier products go to OEMs, 20% to aftermarket and 20% to export. Suppliers say they would like to be less dependent on automakers. “It's not a comfortable situation,” says Sindipecas President Paulo Butori. “We sell to OEMs at a very low price. Where we could be selling to different markets, we have to feed the OEMs.”

But the region's potential is worth it. “We have 350 million people in South America, with 10 persons to every one car,” says Delphi's Mr. Barth, whose company has launched a pilot project here to establish its brand in the lucrative consumer aftermarket electronics sector. “Easily, we have 4 million to 5 million potential car buyers per year. But it will take time.”

How successful Delphi and other suppliers are in convincing OEMs to work toward cost solutions likely will depend on how effective automakers are at finding suitable measures to relieve energy consumption. General Motors Corp., for example, is transferring activities from one Brazilian location to another to take advantage of the proximity of natural gas supplies, plus it's reducing energy in foundries and offices.

Ford, whose operations have been 88% dependent on electricity, is spending millions to install natural gas lines to its plants. By 2002, the automaker plans to use natural gas for 25% of its energy needs.

Volkswagen's Taubate plant, which builds the Gol, has reduced energy expense by 10% through the use of natural gas. The German automaker also is using its own wells at its Sao Bernardo do Campo factory in place of city water. The Anchieta plant in Sao Paulo has achieved an 8% to 12% short-term reduction of power by shutting down elevators and turning off lights in stairwells, bathrooms and in manufacturing areas where robots are at work.

Carlos Alberto Salin, VW Brazil's vice president of manufacturing, says the automaker's long-term solution includes switching to gas for foundry heat treatment, which it will import from Bolivia, and perhaps importing gasoline generators to keep production from being interrupted by blackouts. “There have to be tax incentives, predictable prices,” Mr. Salin says. “You don't invest millions without knowing you get it back.”

Automakers and suppliers have formed a taskforce to meet with the Brazilian government over such issues. Despite the problems, Anfavea — which includes VW, GM, Fiat Auto, Ford, Honda, Toyota, Renault, PSA Peugeot/Citroen and DaimlerChrysler — is sticking to its output forecast of 1.9 million units in 2001, second only to the 2.07 million cars, vans and trucks produced in 1997. The country last year built 1.67 million vehicles.

The lingering question now is whether the economy will burn out before the lights come back on.