Alterations Shake Up 2020’s Renewable Project FinancingBy Cas Biekmann | Mon, 12/14/2020 - 10:46
Soon after the López Obrador administration came into power, the government’s particular views on how energy should be administered brought significant changes to the sector. After the enactment of the Energy Reform in 2014, long-term energy auctions helped to establish utility-scale projects financed by a variety of parties as a strategy for renewable energy development. Now, there are legal uncertainties and the effects of COVID-19 have made progress far more complicated. MBN's experts chime in on what trends are arising in the area of renewable project financing.
From Auctions to a CFE-Centric Market
Long-term auctions (LTAs), beginning in 2015 for the electricity, and oil and gas sectors, were identified by KPMG as crucial mechanisms to support massive energy investments by the Peña Nieto administration. Mexico welcomed many new private players who brought in large amounts of investment and Mexico’s renewable development took off. The levelized cost of energy (LCOE) plummeted, reaching US$20.6/MW. This eventually led to 7,538MW of installed clean energy capacity, according to BNAmericas. With further auctions planned and investors ready to participate, the notion was that utility-scale financing was likely to remain a trend and Mexico would consolidate its position as a top market for private clean energy investments.
Nevertheless, in February 2019, the López Obrador administration officially cancelled the fourth energy auction, after having it postponed at the end of 2018. This cancellation was considered a blow to the private energy industry. In a November 2020 industry update, Zumma Energy Consulting outlined relevant policy events from that point onward. Some of the more notable decisions made in 2019 include alterations to the strict legal separation of CFE in an attempt to change guidelines regarding Clean Energy Certificates (CELs) to make them available to CFE’s older hydropower plants. In 2020, CENACE restricted new renewable interconnections to Mexico’s grid and changed the dispatching of power plants. This was followed by a policy agreement from SENER, proposing to alter the roles of CENACE, CRE and CFE. In June, CFE increased the wheeling rates for older energy projects operating on so-called legacy contracts, slapping an 800 percent increase to said rates. More recently, in October 2020, CRE published a regulation that prevents companies from modifying the end user of their legacy project. In addition, regulatory processes have slowed down greatly in 2020. A global pandemic only added to the difficulties.
Renewable Project Financing on Stand By?
“Maybe too much, too fast,” wrote Ramón Moreno, CEO of Mitsui Power Americas, about the Energy Reform in an MBN Expert Opinion three months ago. “Very rapidly, [the Energy Reform] attracted a significant level of investment to the country but excitement is now in a fast cool-down mode since the current government took power,” he added.
The market is entering a new phase. After all, the old model is currently not feasible, said Mario Pani, Regional Manager Latin America of prominent solar developer BayWa r.e. to MBN. “In light of SENER’s current policy, which is putting up barriers for renewable energy companies, developing solar projects in Mexico is not a viable business. It might be a bold statement but it is true.” Nonetheless, Pani does not really consider leaving Mexico, as there is a growing energy demand, which will double in the next 15 years. “If we were to stop developing projects now, we would not be in a position to capitalize on this opportunity. The company now boasts 1GW of projects in development. Over time, a few of these projects might fall off but we are doubling down on our portfolio. This is a different reaction than some other companies, but we have been quite successful in Mexico and we are happy to invest,” he added. As far as wind energy is concerned, the argument is very similar. Rafael Valdez, Managing Director Latin America and the Caribbean at Envision, also believes that renewable developers might just need to bide their time. “We believe renewables will eventually be recognized by the government and other stakeholders, providing ample future opportunity,” he told MBN.
“Mexico still has very strong long-term fundamentals for sound renewable energy projects. Long term investors understand these fundamentals, which are both on the macro side, like a strong and rising middle class next to the largest economy in the world, and on sector-specific areas, like the vast renewable resources in the country and infrastructure gap. This creates potential demand and opportunities for renewable assets in Mexico,” Salomon Amkie, Director of Banking, Capital Markets and Advisory at Citi, shared with MBN. While market fundamentals are still firmly in place, renewable developers instead need to focus on excellent assets. “Of course, not all assets are created equal, so investors will seek to mitigate any investment risk with better quality of cashflows, nodal relevance and small curtailment risk and, finally, good and knowledgeable management teams with experience in Mexico,” Amkie said.
Amkie commented on the current role of banks that are considered crucial partners for developers and are now interested in alignment. “For several years now, banks have been very active financing energy projects in Mexico. However, the existing environment has shifted priorities and created added due-diligence requirements. Regulatory risk has taken center stage when analyzing projects in Mexico. In particular, development and commercial banks are looking, first, for alignment and relevance of the project to the current administration’s stated energy plans. Second, they look for significant permitting and licensing risk mitigation.” After all, a renewable energy project is considered successful if it manages to operate for over 20 years. Regulatory certainty is therefore of the highest importance. Even if investments can be obtained through new channels, such as Cox Energy’s foray into the Mexican stock market, certainty is still considered key.
New Trends Emerge From Sidelines
Considering Mexico’s energy market, experts agree that the utility-scale trend will return sooner than later. In the meantime, several financing trends are taking effect. Other than looking to temporarily shift attention to elsewhere in Latin America, the Mexican market still offers opportunity in other areas. Managing Director of Balam Fund, Jaime Pérez de Laborda, identified an issue for his investment fund, however. “Our main expertise is utility-scale generation. We have analyzed a number of energy efficiency projects but most do not have the required scale or security of payment. Furthermore, many are related to public institutions, which are facing budget cutbacks. The renewables sector in Mexico is now more focused on communities, small-scale industrial or the residential sector. It is difficult to achieve scale in those areas,” he said.
Indeed, distributed generation (DG) shows particular promise because any project under 0.5MW needs no permits to operate. In this area, various players are trying to figure out where the best opportunities can be found. Unfortunately for wind developers, this means that solar at the moment presents the most opportunities. “In terms of LCOE, wind is very competitive against solar but these numbers are reached through large-scale projects. The unitary costs to implement a turbine are still not at the level of competitiveness that solar can provide, meaning you would need to construct larger wind farms to become profitable. However, we do think distributed wind could be among the opportunities for the future,” said Valdez.
DG opportunities can be found in startups such as Finsolar and Energía Real that look for innovative financing schemes to make solar’s low LCOE attractive in the C&I area, sometimes adding battery storage to the mix. Other companies with larger backing are active in the area as well. “We do not expect CFE will organize tenders for improvements in certain parts of Mexico in terms of grid interconnection. This does not leave much room for anything but DG and storage, which is where we can jump in,” said Julian Willenbrock, General Director of DG-frontrunner Enlight. Even large-scale players like Iberdrola are looking to be players in this market segment, offering to take on most of the costs of the solar installation themselves and then selling the energy back to the client. The so-called Energy-as-a-service (EaaS) business model has attracted an increasing number of solar players. Others, like ForeFront Power, have a unique value proposition based on “small utility-scale projects” of 5 to 10MW, big enough to power major industrial players but not too large to attract major attention.
Nevertheless, for utility-scale renewable developers who stay in their original area of expertizumse, the secondary market still offers an opportunity, as well. “The secondary market, however, could provide us with an interesting opportunity to find assets at good prices,” said Pérez de Laborda, who suggests that selling assets could also be an interesting opportunity for developers. “Sellers will be more inclined to sell and prices might adjust to the current circumstances,” he added, noting that given the current uncertainty, match pricing in M&A deals would be tricky. But tricky does not mean impossible: one recent example of a significant deal is the Chinese energy giant State Power Investment Corporation’s (SPIC), which acquired Mexico’s Zuma Energía, the largest private renewable energy producer in the country. SPIC has the objective to expand further in Latin America and it is also betting on Mexico’s market fundamentals for the long term. For the time being, the name of the game is patience, as investors bide their time and wait for legal certainty the state will eventually provide, along with great business opportunities.