Eduardo Reyes
Partner Power & Utilities
PwC
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View from the Top

A Competitive Energy Market Takes Shape

Wed, 02/22/2017 - 10:04

Q: What would you say are the major advances in electricity this year?

A: The past 12 months have been the most dynamic in the power sector this decade. Driven by the Energy Reform and resulting regulations, the market has changed but not in line with our expectations. Auction developments resulted in 26 companies winning projects amounting to 6GW. This is primarily wind and solar power but also includes geothermal and fossil fuels, representing more than a US$10 billion investment.

Prior to the Energy Reform only a couple of projects in this sector stood out. Too few projects existed to assess how competitive the market in Mexico was and many thought renewable energies were expensive. But resulting opportunities in renewables were surprising. The auctions communicated the real price to the market and now many are aware of Mexico’s competitive advantages in wind and solar generation.

We work closely with the National Solar Energy Association (ASOLMEX), through which we have managed projects, moving them from Europe where solar potential is half that of Mexico. Solar panels are also less expensive in Mexico, making the industry more competitive thanks to the Reform’s scheme. The new availability of attractive bankable contracts with CFE reduced the risk for investors. In the five years leading to the Reform many developers from Europe, the US and Mexico were trying to develop projects here but we lacked the schemes to support them. Now, every project auction has plenty of interested parties bidding, which also drives prices down.

Q: What will motivate companies to participate in the industry as purchasers and not as generators?

A: The nature of the business is distinct. Some companies build power plants and sell electricity and others trade it. This latter group of companies need not invest in the same way, rather purchasing electricity as a commodity and selling it. The Energy Reform allows other companies to enter as purchasers and sell it to final customers with a retail margin, as in any other business. This is the motivation for new entrants. Outside of the newly established auctions, we will see a mix of ways in which companies sign contracts. Some could sign a power purchase agreement (PPA) with other generators beforehand. Auctions tend to result in more competitive prices but contracts are less negotiable. They may stipulate 15-year contracts or strict requirements. If buyers wish to only contract part of the energy or for a shorter period, they would benefit from negotiating directly with the generator.

Q: What are your clients’ main concerns regarding the auctions?

A: Going forward we expect concerns to emerge regarding the sheer size of the auctions and whether continued growth will be sustainable in the long term. All developments are driven by Mexico’s target to reach 35 percent clean energy by 2024. To comply, the auctions are crucial. We expect clients to mostly ask us how big the market will be long-term and how much their competitors will contribute to price drops. Prices are already low and some may fear that they will fall even further, affecting their return on investment (ROI). The winners of the bids are mostly concerned with securing the financing to go ahead with their projects. They are keen to comprehend the certifications necessary and have them in place to comply with their side of the commercial operations, as decided at the auctions.

Q: How does PwC support its clients in the energy industry?

A: In the last year, we have focused on supporting our clients with their bidding strategies. We have advised more than half the auction winners, an illustration of the tremendous success on our part. The auctions are complex, well-defined and efficient for the buyer, so these rules can be difficult to understand. We can advise them in terms of who they are bidding against, clean energy certifications and the price they set to maximize their returns within the rules.

Q: What other investment opportunities do you perceive in the Mexican power sector?

A: The industry can grow a lot in generation but we will ultimately need transmission lines to connect the plants. The transmission grid in cities and industrial regions can benefit from investment, the most recent example of which is in the high-voltage direct current transmission line from Oaxaca to Mexico City. That project also came to fruition within a new contracting scheme and once developed, CFE and the government can replicate the model in many other areas. This leads me to believe that the next big opportunities for investment in hard assets will be in transmission lines. CFE will be relieved of the obligation to put its own money into these lines, opening the possibility for the private sector to share in the investment. Not being restricted to the federal budget is the main advantage. Perhaps in the short-term companies must try to understand the new dynamics of these schemes but I see more advantages than disadvantages to this process.

Q: From PwC and its clients’ perspective, how is CFE’s separation process expected to affect the industry?

A: This is a concern in the sense that, as in any market, the unpredictability of competitors’ actions makes us wary. But the sector has seen enough positive results recently to feel confident. The Ministry of Energy and the regulatory authorities call the shots, which is good for the private sector. CENACE is playing a major role now that CFE is being unbundled. Having well-defined regulations assures us of market transparency. The nature of CFE being so large may mean the process takes longer than we expect. But now that all subsidiaries are in place, they can start operations in January.

Q: How could lower participation in the spot market be boosted to match private participation in long-term auctions?

A: Few projects are intended for the spot market and banks will always ask for long-term contracts to finance projects of this type. Long-term contracts simply are not a reality in the spot market. When the auction's winners come into play in 2018, we will see these projects’ energy surplus being sold into the market in the short term. This will strengthen the market but I see few projects going merchant because banks tend not to finance those types of structures. This could change in time as price visibility increases and banks can draw on the historical data of price developments. Therefore, we predict a few large projects.

Q: How do you expect the CELs market to behave in the near future?

A: The CELs sold in recent auctions will probably be produced from 2018 onward but the biggest player will be CFE. The volume of energy and CELs that CFE is requesting in the auctions precisely matches their requirements so we predict these negotiations will go smoothly. The parties experiencing challenges in this area will be the industrial companies that use electricity from fossil fuel power plants. They will be required to use CELs by 2018. These companies are evaluating the most efficient way to purchase those CELs from auction surplus or other schemes, and have one year to reach a solution.

Q: To what extent are companies approaching PwC asking to capitalize on the distributed generation market?

A: We are working with companies that are developing business cases for solar distributed generation (DG) in their factories, for example. I expect this to become a big market but regulation developments are pending, such as clarifying who will pay for net metering. While this business case will crop up in many conversations because it is working elsewhere, it will not be clear how the process will work until the legal side is finalized.

Q: What developments will stand out in the industry in 2017?

A: The first auction with private companies purchasing electricity will be a major event in the industry, for which we need a clearing house. Suppliers will soon start selling electricity to final consumers, not only CFE, so many companies are preparing their business cases to present to the regulator and CENACE to request development permits. To date few companies are selling energy and this will remain static until the regulations are finalized. They are due to be published in the first quarter of 2017 and approximately 10 players will enter the competition to sell energy to industrial clients. The electricity market is new so we must enhance our services every month. We now assess the capacity market for clients, branching out from energy spot prices. The need for advice on financial transmission rights will increase in the future and we are developing the tools to support our clients with ancillary services to help them move within this increasingly complicated market.