Impacts and Consequences of LIE Reform

On March 9, 2021, the Ministry of Energy (SENER) published an amendment to the LIE (LIE Reform) that was previously approved by both Chambers. The document establishes significant changes to the original LIE’s fundamentals. Among these changes, the most relevant is that which modified the economic dispatch, which is the tool that guarantees the lowest cost to produce energy while the availability, continuity and security principles are observed, to make it an “administrative” dispatch.

Even though the LIE Reform doesn't establish a specific dispatch, it does prioritize the dispatch from CFE. Based on the reform project, as well as documents from the Congress, the resulting dispatch under the LIE Reform should be as follows:

1. CFE’s hydropower generators
2. Independent Power Producers (IPP-Offtake Agreements with CFE)
3. The rest of CFE-owned generators
4. Private renewable generators
5. The rest of the private generation in the system

The economic dispatch is the term used to describe the co-optimization of the electric system to guarantee the demand of electricity by dispatching power generators at the lowest cost possible. The Mexican Independent System Operator (CENACE) performs the co-optimization[1] based in the cost of generating electricity for any given hour. The result of co-optimizing the sell and buy offers to meet the demand yields the hourly Local Marginal Price (LMP). It does so by arranging the generation offers from the cheapest to the most expensive until demand is satisfied. The changes in the LIE Reform change the variable (generation cost) used by the algorithm to solve the economic dispatch to a given “administrative” rank.

To understand some of the implications of theses changes, Northland Power Energia’s (NPE) team modeled these changes on its market simulation tool to answer one of the main questions arising from these changes: What are the economical, technical, and environmental effects of the new dispatch in the LIE Reform?[2] 

The NPE market simulation tool and the vast experience that the team has, enables NPE to model and forecast many variables in different scenarios. The tool uses a co-optimization algorithm, allowing NPE to have the same approach that CENACE uses to produce the daily LMP, generation dispatch, CO2 emissions, transmission congestion, system’s demand, among many other results.

The simulation’s results show troubling consequences, particularly in the LMP and dammed hydropower generation. For most regions in the Mexican system, LMPs retain the near-zero value given the modifications in the generation offers to enforce the new dispatch under the current market rules.

In generation, results successfully show an increase of the desired power plants’ generation. Private renewables and combined cycle generators are pushed beyond the system demand and only generate when the demand is significantly high or when the hydropower has reached the maximum generation limit. The dominating technologies are CFE’s gas-based combined cycles, thermal (today running on high sulfur, heavy fuel oil - HSFO), hydropower and coal, respectively. This trend is maintained until 2025 when the lack of new generation additions and the increase in demand brings private generators back into the regular dispatch.

While the generation priority is met, it comes at a heavy toll. Because of the LMP depreciation mentioned before, the income of generation is devastated while the costs remain of a similar magnitude. This leads to staggering system losses of more than US$10 billion per year, most coming from fossil fuel technologies.

Regarding the dammed hydropower, in Mexico, water is a scarce resource; therefore, the Mexican National Water Commission (CONAGUA) imposes water quotas to secure water for agriculture and human consumption. The quotas have monthly maximum and minimum values to guarantee everyday water availability and secure it throughout the year. The new dispatch forces hydropower generation to reach the quotas’ maximum limit in most of the simulated months. The simulation results show a key confirmation: hydropower is being dispatched for energy instead of ancillary services.

This creates reliability issues as most of the dammed hydropower in Mexico is typically used as stand-by generation to quickly respond to changes in demand or generation unavailability.

For CENACE, it will become a major challenge to maintain the system reliability given the new dispatch. System reliability results are more qualitative than quantitative given the current regulation and the information available. Modeling system reliability requires high-resolution information like outages, fuel constraints, ramp rates, generation minimum down time, as well as other necessary information. More in-depth modeling on ancillary services will be addressed in further contributions considering the hydropower usage and generation outages.

In terms of the environmental aspect, the CO2 emissions in the simulation increased from 109 megatons in 2020 to 146 megatons in 2021 given the “administrative” dispatch. This represents an increase of 33 percent. The main driver for such increase is the emissions from HSFO, coal and less efficient generators that are dispatched as baseload, resulting in higher amounts of fuel burned to produce a MWh. The high amounts of CO2 emissions are maintained throughout the simulation period 2021-2025, implying that Mexico will be far from meeting the Paris agreement target in 2024 adopted at COP 21.

The new dispatch does not seem to be an enabling policy to tackle the ongoing climate crisis. The science is very clear about the origin and cause of climate change. This is particularly important as Mexico is among the countries with the highest increase in average temperatures, as well as the ongoing drought. This will have serious consequences for the country’s livelihood and economic activities.

Even though low LMPs are beneficial for qualified users, the generation revenue losses translate into an economic aggrievance for Mexico. This comes at a moment of great economic stress caused by COVID-19. Additionally, these changes result in great environmental detriments at a moment when global efforts are moving toward decarbonization. For Mexico, this is also acknowledged by the qualified users, who are demanding even more renewable energy solutions.

[1] Mathematically, it gives a result where demand is met by generators with the cheapest dispatch arrangement possible, considering the transmission and generation constraints. 

[2] The full report is available at https://tinyurl.com/rwdps7fj