How Will the Clearing House Impact Mexico's Electricity Market?Wed, 02/21/2018 - 22:51
Unlocking a country’s entire electricity sector to private initiative is not something done overnight. Mexico’s authorities and private players alike are riding the steep slopes of the sector’s learning curves. Each step brings all parties involved closer to their objectives, and the longterm electricity auctions are a testament to this process. In the third installment of the auctions, CENACE introduced the Clearing House, a mechanism allowing private players to purchase power, energy and CELs parallel to CFE, effectively ending the single off-taker scheme of the previous two auctions and cementing the base of a competitive market.
In the first and second auctions, CFE was the sole purchaser and virtually absorbed a measurable off-taker’s risk. Starting with the third auction, the Clearing House will represent a pool of purchasers per auction. Clifford Chance applauds the authorities’ design efforts when structuring the electricity auctions. We understand that some banks were involved in the structuring of the Clearing House, which is a strong sign that the government took into consideration certain bankability issues, which the banks would likely raise during the financing of the projects. We have no doubt this model will be replicated in other countries in the coming years. The success of the upcoming auctions will be largely based on the independent performance of CENACE, which will manage the risk of buyers’ nonpayment, the guarantees and the reserve funds.
The Mexican market at the moment is at an early development stage where all the transactions are and will remain on a bilateral level for some time, making it mostly a demonstrative market. Once there is enough liquidity and the processes are standardized, the market will integrate the Clearing House for the business associations to include more participants. There are still plenty of challenges and details to be addressed that will shape the Mexican market. These include the midterm auction, financial transmission rights and other final details that will allow for the regulatory pieces to start working correctly.
In the short term, in all likelihood it will not have a significant impact. Mexico’s renewable energy scene is seeing an increased number of private energy traders and suppliers but the total volume they can purchase in the market at the moment is not significant enough for the Clearing House to have an impact. We are anticipating that the energy percentage that other suppliers besides basic supply will purchase through the house will be relatively low, although it will keep growing over time. In the long term, as the energy volume increases, the impact will be consequential and will be reflected in the final consumer price through increased volume and number of private suppliers offering energy
Long-Term Contracts (LTCs) are fundamental to the financing of projects, at least during this stage of the reform. As the market evolves and generates a track record for prices, project financing entities will have a reference, making it easier for merchant projects to attract funding. So far, the most relevant LTCs materialized during the long-term electricity auctions or the pipeline tenders organized by CFE. Now, we are already seeing incentives for developing a more diversified market in the third long-term electricity auction, where CFE will no longer be the sole load-serving entity allowed to participate as a potential buyer. Private load-serving entities and qualified user market participants will be allowed to make purchase offers through the Clearing House.
The Clearing House is proof of how auction design continues to be perfected, integrating an increasing number of positive elements and players. The Argentinian auctions, in which we also participated, allowed fixed quotas per technology – solar, wind, cogeneration – fostering competition among same-technology projects. We believe this approach to be coherent both with the objective of reducing energy costs and the necessity of maintaining a balanced energy matrix. Conversely, pricebased auctions would not solve intermittency problems if solar power achieves a predominant footprint in the mix. Storage and redistribution technologies have yet to become cost-effective for solar power to avoid providing excess supply at certain hours, while projects under equal terms can compete for logistics and production efficiencies, load factor and other characteristics that set them apart.
Due to their complexity, the bidding rounds have involved a steep learning curve but the changes have certainly been for the better. We are quite pleased that the auctions are based on clean technologies. Some of the most important aspects where we have seen improvement is in the fluidity of communication with CENACE, the support desk that was launched and the new, much clearer regulatory framework. Regarding the launching of the Clearing House, we have yet to see how this will affect the development of the contracts but hopefully it will be positive, and make the warranties clearer and more robust for other participants besides CFE.
CENACE’s Clearing House, introduced during the third long-term electricity auction, is a positive step forward. The single off-taker scheme used in the previous auctions, whereby a maximum price was imposed and savings were expected to be generated from there is equivalent to forcing private suppliers to reduce their profit margins. The first midterm electricity auction is a valuable complement to the Clearing House mechanism since it addresses the issue of signing long-term bilateral contracts. At KPMG we doubt anyone knows how the market will evolve in such an extensive period of time, especially when technology costs like solar are drastically decreasing. A project’s viability is greatly assisted by shortening terms to three years.