Diversifying the Power Producer Base

There are still challenges to overcome before financing institutions can more effectively deal with the risks of a project under the PPA format, Marian Aguirre, Energy Finance Vice President of BANCOMEXT, told the Mexico Energy Forum 2018 in Mexico City on Wednesday. “There is a tendency toward tariff differentiation and we need to better understand how tariffs are composed to improve our understanding of the structure of tariffs and private PPAs.”

On the other hand, although the structuration of tariffs has attracted the participation of companies and constituted a success in terms of energy policy, Jose Aguilar, Principal at ViveEnergía, pointed out that the auction structure must change to underpin the process. “The challenge is making projects bankable,” said Aguirre. “What makes these projects feasible is that they are long term.”

The two business leaders were part of the panel “Diversifying the Power Producer Base: Auctions, Project Development and Financing” at the Hotel Sheraton Maria Isabel. The group, which also included Óscar Silva, Head of Global Strategy Group at KPMG in Mexcio, who acted as moderator, Ernesto García, Project Finance Manager of EDF Énergies Nouvelles Mexico; and Salomón Amkie, Vice President Head of Power and Utilities at Citibanamex, reflected on the perspective of developers and banking institutions regarding the current and future situation resulting from the Energy Reform.

The main topics addressed in the panel were the record low prices achieved in the last energy auction, merchant risks and how financing institutions react to these and the likelihood of the Energy Reform being set back by the next government.

“We see sponsors with an appetite to enter Mexico and that is driving the prices of PPAs down as competition in the sector grows,” says Aguirre. “In the long term, we expect a trend toward price equilibrium.”

All panelists agreed that the energy prices resulting from auctions, which fell from US$30 and US$40 per KW/h in the first round to US$17 and US$20 in the last round, offer new challenges for both developers and financing institutions. “Pricing in the market is creating consumption,” said Aguilar. “The gap between prices will close in the future but we need to come up with a structure to cater to clients’ needs and harness the financial offering that exists in the market.” Aguirre pointed out that it is difficult to predict energy prices in one or two years, so longer terms are impossible.

On the merchant risks that banks would have to absorb to finance some projects, all panelists concurred that there are several challenges for commercial banks to engage in financing energy developments. As Amkie put it, “financing projects with long-term maturation periods will always be complicated for banks and the tendency points to PPAs of between three and seven years.” He expects that PPAs will increasingly become short-term products because project bonds with 16-year merchant tails are difficult. Elaborating on this perspective, Aguirre said the bankability of projects with PPAs is key because if PPAs are not renewed banks would absorb a merchant-like risk. Looking ahead, she expects commercial banks to soon engage in generation projects but underlines that inasmuch as the banking sector does not finance such projects, development banks will be there to open the market. Amkie underlined that before a commercial bank such as Citibanamex could offer a hedge in that area, it would need to see a historic record of some years as well as transparency and liquidity in energy prices.

Given the fact that one of the presidential candidates competing in the 2018 elections has promised to set the Energy Reform back, the likelihood of this process happening is a key topic for the industry. On this, all panelists agree that such an outcome was highly unlikely. “The opening of the market is a trend that cannot be drawn back,” says García. Similarly, Aguilar pointed to the market advantages that the reform has generated. “Auctions have worked,” he says. “Pricing signals are correct, it is a good public policy and it would be too expensive to step back.” According to Aguirre, it is unlikely that there will be changes regardless of the candidate who wins. “There has always been continuity through government changes despite the leanings of the winning party or individual,” she said.

While García said that refining the reform in terms of regulation is the main challenge ahead for the industry, Amkie concluded the panel by stating that the opening of a market the size of Mexico does not happen often, which has attracted developers and investors. “There is a great potential for growth that attracts investment,” he said.