Existing Challenges in Mexico’s Power MarketBy Carlos Ramos Miranda | Tue, 12/15/2020 - 09:00
Among the goals of the Energy Reform that was enacted in late 2013 by the federal government was to allow for a liberalized electric sector by transitioning from a vertically integrated state monopoly market to a structured free market with respect to the generation and sale of power. Since the enactment of the related laws, the power sector has been swiftly adjusting to the new legal regime and market structure, with promising opportunities to invest in the sector (both in combined cycle-based projects and renewables). Recent shifts in the overall energy policy, however, have had a substantial negative impact on the investment in power and other associated projects. The end result is a halt in new projects being developed, and investors analyzing options to better protect their investments in Mexico.
The Mexican government’s energy policy has aimed to undermine the Energy Reform in order to artificially support the growth and dominance of government-owned entities, such as the Federal Electricity Commission (CFE). Since late 2019, the Mexican government has implemented regulatory and policy actions that effectively modify the legal and regulatory framework of the electricity industry without actually amending the law or regulations. The purpose is to shift the balance of the industry to the government, through CFE. The government is attempting to limit the space in which private parties operate by allowing CFE to fill these gaps, particularly in power generation. Consequently, the Ministry of Energy (SENER) and the Energy Regulatory Commission (CRE) have issued policies, or taken or omitted to take action, to foster CFE as a dominant player in the market.
Policies implemented, which in many cases have been delayed and on occasion prevented though court actions, have a cumulative negative impact in the sector. In this article, we briefly explore such actions or omissions of the current administration and their impact.
EXTENSION OF TERM FOR CFE VESTING CONTRACTS AND DELAYS IN POWER PURCHASE AUCTIONS
Importantly, a crucial aspect of the energy reform included the implementation of a new wholesale electricity market (WEM). The WEM was designed as a market whereby electricity, power, and ancillary services would be commercialized to facilitate and guarantee open access to such a market in an organized, competitive, and non-discriminatory fashion. The Energy Reform envisioned a transition from a state monopoly to a multiplayer regime that required several transitory mechanisms be implemented to ensure a swift transition; particularly, that CFE could be better positioned to act as a player in the new competitive market.
In addition, existing participants in the market were allowed to maintain their status prior to the reform, such as self-supplied producers. These players are expected to, within a period of time, migrate to the new legal structure.
CFE was spun off into several new entities that would participate in the different sectors of the electricity market, including two new subsidiaries: CFE Suministrador de Servicios Básicos (CFE SSB), an entity created for purposes of providing basic services in the sector, and CFE Suministrador de Servicios Calificados (CFE SSC), whose purpose is to provide qualified services in the sector.
CFE SSB’s basic-use customers, mainly residential users and low-consumption commercial users, would have access to better power prices as secured by CFE under specific auctions. Consequently, the expectation was that, because of a higher participation of agents in the WEM, electricity rates would gradually decrease. Under this new structure, the Electric Industry Law (LIE) mandated that basic services suppliers (i.e. CFE SSB) should execute power purchase agreements (PPAs) only through auctions, whereby CFE SSB would secure the best available prices in the market. CFE SSB would, in turn, supply basic services at the lowest available prices resulting from these auctions.
The Energy Reform would take time to be fully implemented, so there was a need to generate efficiencies in CFE’s cost structure, particularly at CFE SSB. Transitory articles to the LIE allowed CFE SSB to enter into PPAs without an auction process in those cases where such purchase was made from existing CFE-owned power plants considered among the most efficient (these contracts are known as “vesting contracts”). Such power purchase agreements were subject to specific conditions issued by SENER in 2017, and restricted the term during which such PPAs would be effective. The idea was to allow CFE SSB sufficient time to enter into PPAs with third parties through the auction mechanism, while still being able to secure power to be sold to end customers in the meantime.
SENER also amended the 2017 resolution extending the term of such power purchase agreements, and the types of CFE-owned centrals allowed to sell power to CFE SSB. The result is that auctions for cheaper power are not required in the near term, thus impacting the price of power sold by CFE SSB to basic users, as it is not certain that CFE SSB will be able to fetch attractive prices as it would otherwise secure through the now canceled auctions. CRE followed by validating such amendments, thus delaying the full implementation of the Energy Reform as envisioned in 2013. For basic services customers, this may mean more expensive power to satisfy their consumption or higher government subsidies. Furthermore, it deters private investment in new, efficient and clean power plants that, among others, would allow Mexico to meet its national and international CO2 reduction goals and to decrease the cost of electricity.
By extending the 2017 resolution, the regulator is in fact nullifying the expected results of the Energy Reform for an indefinite time. This is also consistent with the Ministry of Energy’s cancelation of long- and medium-term electricity auctions, which in essence also displaces more efficient power generators that participate in the WEM.
Under this scenario, to the extent CFE SSB only purchases power from less efficient CFE-owned centrals, the WEM may be artificially disrupted, dis-incentivizing new generators from participating in the WPM.
CHANGES IN THE RULES FOR ISSUANCE OF CLEAN ENERGY CERTIFICATES
Under the reform, new power generation plants that came into operation from August 2014 were eligible to receive clean energy certificates (CELs), which could be sold in the market to obligated subjects (load-serving entities, non-renewable Legacy Generators and consumers that consume electricity through “isolated supply”). Under the reform, obligated subjects are required to acquire CELs equivalent to a percentage of the consumption of the loads they represent, or their consumption, depending on the obligated subject. Old CFE plants were eligible to receive CELs to the extent major overhauls were implemented in order to make them more efficient. SENER has eliminated the aforementioned requirements for old CFE plants to be eligible to receive clean energy certificates. SENER is seeking, with said elimination, that old CFE plants become eligible to receive CELs, improving its position in the market and lowering the price of the clean energy certificates. The private industry has secured several stays from federal courts, and thus, the SENER modification is currently suspended pending judgment on the matter.
CURTAILING THE OPERATION OF SOLAR, WIND POWER PLANTS
Pre-operational tests of new renewable-power plants were halted, under the excuse that the COVID-19-related reduction in the demand for power has effectively put at risk the integrity of the transmission grid, under the pretense that renewable power, by nature, is not fully reliable, and the natural changes in power can cause damage to the grid. Consequently, without pre-operational testing, new power plants cannot commence commercial operations, thus delaying additional supply of power, which reduces prices in the spot market. These measures have also been challenged and the issue is pending rulings in the federal courts.
CHANGES TO MARKET RULES
SENER has also tried to change the market rules, through the issuance of a public policy document called “SENER Reliability Policy,” introducing uncertainty to the dispatch of power and the development of intermittent power projects, among others. Under new policies issued in May 2020, SENER wants CFE power plants to be ranked ahead of other privately owned power plants for dispatch of energy. Again, these changes are based on the pretense that clean energy dispatch is not constant and sometimes uncertain. Consequently, instead of dispatching the cheapest energy first, the market receives more expensive (and less clean) energy. This preference for CFE power being dispatched actually distorts the market. SENER seeks to do this by eliminating the principle of economic dispatch and by allowing CFE power plants to provide reliable ancillary services, seeking to satisfy demand through these ancillary services and not by electric energy traded in the WEM. Like in the aforementioned cases, the private industry has also secured judicial stays to avoid this changes to apply.
CHANGES TO RULES APPLICABLE TO GRANDFATHERED GENERATION PROJECTS
Transmission rates applicable to self-supply power generation plants (grandfathered under the regime prior to the Energy Reform) and to renewable-power plants have been significantly increased. Since grandfathered projects play within a different legal regime, which implies restrictions as to their ability to sell power in the spot market, such grandfathered projects enjoyed specific benefits with respect to transmission rates. Under an argument of leveling the playing field for all players, and to avoid an alleged subsidy to these agents, CRE authorized CFE to significantly increase transmission costs to grandfathered projects. This increase significantly impacts the economics of such projects, since long-term PPAs were negotiated and agreed to under the assumption that transmission costs (among others) would be increased at a rate consistent with previous years, at least within a certain period of time.
Tariff rate increases have also been challenged by affected grandfathered projects and resolutions are pending in federal courts. So far, judicial stays have been secured.
In addition, CRE has taken the position that grandfathered self-supply projects, mainly those where the generator can only supply power to its partners, cannot change their ownership structure. Consequently, self-supply permit holders are now prohibited from adding new shareholders to whom they supply the power they generate.
DELAYS IN ISSUING NEW PERMITS
CRE has effectively and publicly taken the position that it will delay issuing new permits either for power generation or associated power market activities that require the issuance of permits. The end result is fewer players in the market, thus restricting the options and ability to secure more and cheaper energy in the WEM.
Even though some of the changes described in this article have not been fully implemented as a consequence of judicial stays and judgments secured by private participants, as a whole, they have a material adverse effect on the power sector overall and prove to be a deterrent for new project development. The main challenge for market participants is pursuing business opportunities in a regulatory and political environment of uncertainty, knowing the government will favor state-owned entities, even if it represents higher prices to consumers overall.
A scenario of constant changes in policies, contradictions, and deterrent of investments will delay much-needed development of new sources of cheap energy, a solid and efficient market operation and competition, which results in losses across the whole productivity chain. Investors that have been affected are analyzing the option of bringing investment and challenges to free trade treaties, while most projected investments have been suspended.
While there is room from improvement and leveling the playing field for all participants, policies need to be clear, transparent, and require additional certainty for all such participants.