Alfredo Álvarez
Energy Segment Leader
EY
/
Insight

Balancing Market Consolidation and Paradigm Shifts

Wed, 02/21/2018 - 09:49

As Mexico’s electricity market becomes an open platform for private players, the country must rise to the challenge of both planning for the long term and developing an electric system flexible enough to integrate new and often unpredictable technological developments that could make both the grid and power-producing facilities more efficient, says Alfredo Álvarez, Energy Segment Leader at EY.

“We are entering a disruptive phase where it is difficult to make nine-figure, 25-year-long investment decisions, while the world is abruptly changing. Major utility companies are uncertain about what the future holds and how the energy market will operate,” says Álvarez. As renewable energy gains increased prevalence in the global energy mix, utility companies must figure out how to make business profitable under a zero marginal price scheme and how distributed generation is going to impact grid use with the rise in installations of autonomous power systems.

“Financial closing for the long-term electricity auctions’ renewable energy projects will be the industry’s measuring stick. Reaching this phase is extremely complex, which is not something exclusive to Mexico,” Álvarez says. “Technology type — solar, wind, cogeneration — is not so much the reason for this caution as is the absence of a track record that is long enough to justify an investment decision,” he adds. Available cash flows under P90 models, which predict generation levels to exceed 90 percent throughout the year, make a project’s repayment capacity uncertain. “The root of the challenge lies in financial entities being able to transition from financing government-backed CFE and PEMEX projects to developing new financing schemes in an incipient market surrounded by long-term uncertainty,” says Álvarez. Paving the way toward lucrative yields will take a coordinated effort between development and commercial banks to absorb financial risks inherent to renewable energy.

When looking at Mexico’s energy mix, solar and wind take the lead but other sources could emerge as leaders, Álvarez says. “Fifteen years ago, no one doubted that investing in nuclear energy was a great idea. Today, the price variations for natural gas have put it in the front seat as the transition fuel between conventional and renewable energy sources.” The priority is conferring certainty to power producers regarding their mid and long-term incomes. Mexican authorities have to ponder, as the market consolidates among the long and midterm electricity auctions and the upcoming CELs market, if this new structure runs the risk of becoming obsolete. “The backbone of it all is pricing electricity at levels where its marginal value can generate a profitable rate of return, while experiencing and increasing the number of incidences where, thanks to renewable energy and new technologies, its marginal value is zero.” 

To inject liquidity to the market, Mexico’s energy regulatory authorities designed and launched the first midterm electricity auction. “The idea behind these auctions involves creating certainty to alleviate immediate merchant risks. The schemes for the new Mexican electricity market are well-designed and standardized around global best practices,” Álvarez says. Mexico is bringing every piece of the local electricity market puzzle together. “The real question is if these pieces will continue to be relevant in five to 10 years, and how the country will adapt to upcoming technological changes.”

Lack of generation and transmission capacity implies an extra cost to the electricity system. Total transmission costs are calculated based on the transmission cost of a particular node over the total amount of MWh transmitted. As distributed generation progresses, the latter will decrease while the former will increase. “Exponential effects can be anticipated from this progression as it can cause a massive abandonment of the electric grid, jointly with the increased use of batteries,” Álvarez says. He believes electric generation in situ remains costly and inefficient compared to a centralized generation scheme. As new technology developments are integrated into this scheme, there could be a paradigm shift and a new set of opportunities and challenges. “A couple of years ago, installing 1MW of solar power under US$1 million was nearly impossible. Today, you can have it for under US$800,000. Inventive regulation and preparing the grid for the coming fleets of electric cars will be key factors in addressing the country’s electricity challenges.”