Energy Reform Highlights and the New Operating Framework

In the first session, entitled “Energy Reform highlights and the New Operating Framework”, the discussion revolved around the supervision of the implementation of the Energy Reform, the role of regulators, and the corresponding changes that would have to take place in the industry. Guillermo Zuñiga, one of CRE’s Commissioners, praised two aspects of the process. “The Energy Reform was very clear and PEMEX has been open about implementing the Energy Reform,” he said, although adding that PEMEX could not have reacted in any other way. Zuñiga also talked about how the broad spectrum of the reform would force a matching increase in competence from the private sector. “We need to define the level of competence this will create in Mexico, which SENER and the National Hydrocarbons Commission (CNH) have been working on,” he said. In comparing the 2013 Energy Reform to its 2008 predecessor, Zuñiga said the first one set out to create incentives for companies. The 2013 version changed the entire energy structure of Mexico, it removes the monopolies and makes PEMEX work with new organizations and prove its competence in the market.

Next to him, Oscar Roldán, the Director General of Hydrocarbons for CNH, was enthusiastic about the broad range of tools the Reform offers the state. “The state can now use any kind of tool to define the best contract for the drilling and extraction of oil, and the transfer of oil to the state,” he says. To seize this moment, he called on SENER to come with a long-term strategy that would create a match between all of Mexico’s resources so that they could be used properly. To Roldán’s mind, any doubts about the management of the types of contracts offered up by the reform would be defined by the secondary laws. Despite the opening up of the market to the private sector, he insisted it was vital that the state stay on top of all exploration activities that are happening within Mexico’s borders.

A note of caution was struck by Miriam Grunstein, a professor in legal studies at CIDE. She expressed concern that the Reform might lead to overlap between different regulators, and about CNH being granted perhaps too much freedom. To Grunstein, a lack of clarity remains in the administration of joint contracts, a worrying fact since they deal with drilling and exploration, areas that were previously the unique right of the state. She cautioned that any murkiness would create problems down the line as it would be left to the courts to analyze the legal issues surrounding the contracts, allowing magistrates to have the final say on these contracts’ implementation.

The second panel, tackling “Energy Transition & Climate Change,” revolved mainly around finding the best ways to ensure the development of energy efficient equipment and renewable energy projects for the long-term. For Sergio Villalón Antuñano, Country Manager for Phillips, the harnessing of new technologies hinges on having the right incentives in place to ensure users can become familiar with them. “We would consider financing programs for the market to help more investments come to these efficient technologies. We could also have aggressive planning to bring alternative energies to communities that have no access to energy.”

Efraín Villanueva Arcos, Director General of Sustainability at SENER, echoed Roldán by saying a two-year long assessment of all energy sources was needed to really understand how Mexico can best integrate natural gas with renewable energies. He predicts that this consolidation would allow energies like geothermal to be fully exploited by the private sector, while helping the advance of tidal power. “We are creating the right conditions for this. Research centers are moving ahead with technological development so they can help these energies mature and bring them to market faster,” he said.

The President of AMDEE (Mexican Wind Energy Association), Adrián Escofet, picked up on the theme of collaboration between energy sources, saying this was essential for Mexico’s “ambitious but achievable” renewable energy goals. He provided the example of the Isthmus de Tehuantepec, Mexico’s wind energy capital that could be coupled with nearby hydro resources to provide a variety of projects that could help meet the 2024 targets. For this to happen, Escofet also said that the public sector cannot go it alone. “Everybody has to work together. For years, a monopoly anchored all the rules of the game. There must be a realignment of all the institutions and all the players to reassess the market.”

The third panel turned to one of the pressing issues facing the Mexican energy sector, how to integrate natural gas in the energy mix. Moderator David Enriquez, Partner of Goodrich Riquelme Asociados, said that the US has had the most runaway success in developing its natural gas market, and challenged his panelists for how Mexico could so the same.

Edgar Rangel Germán, Commissioner at the CNH, laid out the current reality of Mexico’s natural gas market. “The production of natural gas in Latin America still lags behind growth in Europe or China. So what should we do to take it to the next level? Growth has not kept up with demand here. We turned to imports but Mexico has enough resources to meet its own needs. It is one of the few lucky countries in this position,” he explained. He said the array of contracts that exist under the new constitutional framework, and the ability to combine them into a variety of projects, shows the new potential to develop natural gas. As CNH will be in charge of licensing and assigning these contracts, and managing their implementation, it is seeking to learn lessons from other regulators. In 2014, Mexico will host the annual International Regulators’ Forum, from which CNH hopes to learn a lot, especially on how to best pass regulation for the exploitation of Mexico’s shale gas reserves.

Marco Cota-Valdivia, Director General of Hydrocarbons of SENER, sought to provide more clarity about the future regulatory framework surrounding natural gas. Interestingly, he suggested the federal government would account for regional particularities. “We are building secondary laws that understand that, for the exploration of gas, Mexico will develop more strongly at a regional level. On the financial side, the federal government is making an action play that will take many years to develop.” The competitiveness in the market that the Energy Reform aims to implement depends on CENAGAS, said Cota-Valdivia. CENAGAS is a new federal body that will be in charge of building pipelines and ensuring widespread access to gas, but it will operate independently from the government. Cota-Valdivia also said that CENAGAS would seek to ensure there are no conflicts of interest in the gas market, much as CENACE will be doing in the electricity sector.

Eduardo Andrade, Corporate Director of Iberdrola Latin America, advised that CENAGAS should adopt a similar structure to CENACE. “The secondary laws will dictate how this is done. Coordination should be made with CENACE to see how it operates and how it can serve as a model.”

Luis Miguel Labardini, Partner of Marcos y Asociados law firm, suggested another example to learn from. “The US has regulated natural gas for 50 years. It has 580,000km of ducts while Mexico has 9,000. There, the owner of the service also owns the resources and could sell it. That creates an alignment between the state as a tax collector, the interests of the owner as a royalty collector and the oil and gas companies as service providers,” said Labardini. “Mexico will not do this but we must find a new mechanism to align all these interests, or it will not be successful. We could duplicate the cost structure from the US, as this is the only way investment will come here.”

Rogelio Gasca Neri, an independent consultant, former Director General of CFE and counselor to Pemex, emphasized how exploiting its shale gas would transform Mexico’s positioning. He equated this potential to that of natural gas in the US, saying that shale gas could help Mexican export to the US, provided the right infrastructure and regulation were in place.

The fourth panel, titled “Renewable energy opportunities after the reforms,” saw panelists engage in a vigorous debate about the advantages and disadvantages brought about by the implementation of the Energy Reform.

Hector Martínez Vivas, CEO of Next Energy, adroitly linked the good with the bad. “One advantage is the independence being given to the power sector as part of the process. But this brings a disadvantage as it has led to mistakes being made by companies and CFE, such as a huge lack of training for personnel. Another advantage is that the level of competition has risen, but small companies that have been in the market for a long time are being eaten by the big fish,” he said. He gave the example where Next Energy was bidding on a government project at its home in Nuevo Leon, but was muscled out by the ambassadors of Italy and China personally lobbying for their companies. “As we are only regular civilians, we did not have this level of access,” he quipped. “But the good outweighs the bad.”

Arturo Vaca Durán, Vice President of Energy and Technology at Peñoles, said that the company had been an early believe in self-supply and renewable projects. “After the Energy Reform, such projects will have less administration hoops to jump through while more legal certainty will be provided.” He echoed earlier panelists in saying that technological advances would change the game as much as the Reform itself, giving the example of solar technology prices keeping on dropping.

Derek Woodhouse, Partner at Woodhouse Lorente Ludlow, took a slightly less enthusiastic tone. As a lawyer, he said he was compelled to read the small print and that it was rare for a reform to have 21 transitory acts. He said that for the 2024 targets to be achieved, the government would have to give major support to renewable energy projects. “Obligations should be imposed on the productive companies of the state that will take over the market. These companies should celebrate long term contracts to green energy producers. There is no other option. It does not matter if gas is cheaper, the government has the obligation to create the opportunities for renewables to fill those gaps.”

Néstor Lorenzo Díaz Ramírez, Director of Technological Development at CONACYT, ensured that that support would be found. “The state will support companies that could work on sustainability topics. CONACYT and SENER have worked to support public institutions so that they can strengthen their fiscal and HR infrastructure in the area of renewable energy,” he explained. He pointed to the country’s Sustainability Fund that is used to support projects that deal with the efficient use of alternative energies and the development of clean energies. He also explained that about hundreds of millions of pesos had been poured into creating development centers for renewable energies.

The fifth panel also tackled a sensitive topic, the integration of intermittent renewable resources into the grid. The first speaker, CRE Commissioner Noé Navarrete, chastised those who saw the impact of the Energy Reform as mainly affecting with CFE or CENACE. “We have to consider the entire market, the role of the major players has changed, forcing them to be more competitive. Work on the grid is not just about the transmission lines. A variety of costs is attached to a range of aspects, including gauges, readers, smart grid technology. Now the Energy Reform has passed, many of those costs can be affected by intermittent renewable energy,” he stated. He continued by saying that the quality of energy depends on the quantity and the frequency of that energy. One major challenge will be how CENACE fares in dispatching energy, while accounting for the costs of renewable energy but adhering to environmental goals at the same time. He continued, “renewable energies must be developed for the specific region they are in. Using wind in Oaxaca is not the same as using wind in Coahuila or Baja California. We have to take these differences into account before a project begins.”

Héctor Olea, President and CEO of Gauss Energía, was more focused on the grid code, or the daily interconnection with CFE. “When the interests of private projects align with CFE, collaboration can go very smoothly. But with the Energy Reform, some aspects that we must pay attention to might fall by the wayside.” On PV, he said companies had been closing the gap with CFE to ensure integration, but that negotiations would continue until the grid code is settled for all renewable energies. “Although everyone is focused on the implementation of the Energy Reform, we have to remember that surrounding regulations have to be more developed to give an optimal result.”

Alejo López stated that even though integrating intermittent renewables to the grid poses a technical challenge - mostly to the grid operators, there are significant success cases in the United States and Europe of regions with a high-degree of solar and wind grid penetration. Mexico can benefit from those best practices while implementing a protocol that best fits the country grid. Also, wind and solar are clearly intermittent due to their nature, but so are hydro, nuclear and thermal. Hydro is subject to weather patterns that have proven extremely erratic and challenging in many places. Nuclear and thermal are usually thought as baseline power, but when they are taken offline due to unplanned repairs, this also creates a significant power void that operators need to fill with other technologies during prolonged periods of time.

The final panel of the day sought to explore a concept that will not cease to trouble developers in the future, “minimizing risk and maximizing stability.” The moderator Francisco Acuña, CEO of InTrust Global, brought up an interesting subject for discussion, maximizing profits from the right social engagement with communities. He spoke of his INDI Fund, the first equity fund that brings private capital to renewable projects under indigenous communities. “80% of Mexico is made up of agricultural or indigenous areas, but these ejidos produce only 3.9% of GDP. The potential for growth this is huge.” He spoke of several studies done across Latin and North America that have looked at where the potential for business lies within these communities. “This can help increase bankability by working among those communities. We work with more or less sophisticated communities that have already formed the idea and want a project.”

Manuel Ortiz Monasterio, Director General of Environmental Resources Management (ERM), encouraged people not to forget the basics when dealing with ejidos. “We all know of many projects that were stopped because developers did not involve all the shareholders, and did not spend time to explain the full benefits. This is not optional, it is not about giving the leaders some money but about fully understanding the environmental impact and developing a community program that is aligned with their needs.”

Enrique Nieto, Director of Sustainable Projects of NAFINSA, demanded attention by laying out the vision of banks in the matter. Although NAFINSA first started to help renewable projects grow in Mexico with the addition of fellow development banks from the US, Germany, France and other countries, the impact of their model is still felt today in the stance of commercial lenders. Environmental impact assessments, social licenses and community planning are now essential for developers seeking loans, and these factors have even become enshrined in the Equator Principles.

José Pablo Fernández, Director General of Grupo Dragón, added that training opportunities for locals was also not to be sniffed at. “Mexico has many well-trained people from the minute a project starts, you can rely on a larger group to help you when it enters operation. There is no easy solution but involving the community and making them part of the business works well. They receive training, they get better pay, understand the project better and accept the projects.”

Luis Vera, Partner at Vera & Carvajal, capped the conversation by recommending that companies stop treating community relations as a single project, highlighting the differences among all the ejidos. “Not all communities are the same, some love projects and others hate them. We have been working on social licenses recently. It is good to hear what communities want to do, how developers can make a town or a community feel like a project is theirs,” he said. He added that doing requires a wholesale change in mindset among developers and a new commitment, beyond meeting the social involvement demanded by lenders. “Developers need to understand how they will become part of the very communities they are involved. They must become part of these communities.”

The Mexico Energy Forum also marks the launch of Mexico Energy & Sustainability Review 2014, which is the first publication that provides a comprehensive overview of the latest developments, main trends, and investment opportunities in the Mexican energy and sustainability markets. This annual publication is based on interviews with over 200 business and political leaders who drive Mexico’s energy and sustainability future, and who are invited guests to the Mexico Energy Forum. Mexico Energy & Sustainability Review 2014 is destined to serve as an essential decision making tool at this time of change and unprecedented opportunity, and will be the official present for all participants in the Mexico Energy Forum.