Institutional Investing, M&As Among Top Trends in Energy Finance

Q: What sets Clifford Chance apart in Mexico’s energy sector?

A: Clifford Chance is an international law firm with more than 36 offices across 23 jurisdictions. We are a leader in infrastructure and energy projects worldwide. Our international network allows us to replicate successful structures from across the globe and apply them in Mexico and Latin America. We are one of the few law firms capable of assembling a team comprising senior, midlevel and junior Spanish speakers, who are trained in both the common and civil law systems and are adept with the issues that are most common in transactions structured in civil law jurisdictions but governed under international law. Our personnel understand both local culture and nuances, as well as international best practices. We view cultural fluency as an essential quality to achieving success with our clients and pride ourselves in bringing this knowledge to the table.

Our presence in the Mexican market goes back to the 1990s, when the original unbundling of the sector occurred through the Pidiregas. At that time, we were one of the first participants when the electricity market opened up and we were involved in the financing of the first Pidiregas projects. We were first movers again with the self-supply projects in the early 2000s and, recently, during the last wave of auction, bilateral and merchant projects.

Q: In your view, what are some important trends happening in Mexico’s electricity sector?

A: The Mexican electricity market gradually is maturing. Six years ago, we were talking about the Energy Reform, five years ago about secondary regulation, four years ago about energy auctions and now, about system congestion and how integration technologies can facilitate the expansion of renewable energies. Without doubt, the Mexican electricity market has taken important steps in recent years, and as in any other developing market, it has encountered challenges, risk and counterbalances.

In terms of local trends, we are observing three categories: technology, transactional and dispute trends. In regard to technology, following the global movements in other markets, the Mexican market has an important interest in distributed generation and electricity storage. Both technologies, if properly regulated and implemented, can help reduce Mexico’s grid congestion and losses. On the transactional front, we are seeing an important trend in the development of merchant projects in regions with attractive nodal prices. We are actually working on the development and financing of a portfolio of merchant projects, where the finance structuring tends to deviate from a traditional structure of relying on corporate guarantees, strong reserves, aggressive debt to equity ratios and/or cash sweeps. Two years ago, the market was assessing the feasibility of merchant projects and now this is a reality.

Also, due to the attractive interest rates in the market and restructuring strategies of certain companies, consistent with what we are seeing globally, we have seen several refinancing efforts in Mexico in the past nine months, some through traditional project finance structures and others through project bond structures, such as 4(a)(2) private placements or 144A/Reg S offerings. Traditionally, commercial and multilateral banks would finance larger scale projects. Now, we are seeing an important participation of institutional investors, such as insurance companies and pension funds, given that they like projects with long-term contacts and stable cash flows. Take-out creditors tend to assume different risks. For instance, they do not face construction risk, rather they still encounter performance or offtake credit-associated risks.

Importantly, and in line with the market practice, in the last 12-months we have seen a wave of mergers and acquisitions across project portfolios. Most of the projects that signed Power Purchase Agreements (PPAs) and achieved financial close three or four years ago have achieved commercial operation. Now, certain sponsors with portfolios of operating assets are implementing their divestment strategy. On the other hand, some private equity funds are seeing the regulatory uncertainty as a market opportunity to buy attractive assets with solid PPAs.

Lastly, in regard to the dispute trends, there are two clear influences. The first relates to substantial completion-related disputes; for instance, whether the EPC contractor achieved substantial completion through the underlying EPC contract or monetary disputes in respect of delayed liquidated damages payable by the EPC contractor. The second trend concerns the assessment of the resources and protections that foreign investors have with respect to the measures that the Mexican government has recently adopted and that could affect energy generation companies. Mexico has entered approximately 4 Bilateral Investment Treaties (BITs) and certain BITs provide for protection against non-equitable treatment and coverage against breach of specific undertakings by the host government.

Q: What is Mexico lacking when it comes to boosting its renewable energy potential?

Globally, the energy industry and many other industries are changing rapidly. Power systems are experiencing significant changes. Various governments and players around the world are discussing how to maximize the use of renewable energy and reduce the cost of the integration technologies. Broadly speaking, the global debate relates to the three Ds: Decarbonization, Decentralization and Digitization (and more recently, market leaders are talking about "Disruption on the demand side" as the fourth D). The world is shifting from a fossil-based system to a low carbon system and from a supply narrative to a consumer narrative. Energy transition is one of the most important challenges of the 21st century and everyone is asking, "How can we deliver reliable, clean and affordable energy, and how can we humanize the energy transition?"

Governments around the world are dealing with what the World Energy Council calls the Energy Trilemma: decarbonizing the energy matrix, ensuring that energy is affordable for consumers and securing supply. An effective transition should balance three important things: society, environment and economics.

Even though the auctions have been halted, Mexico’s electricity demand is enormous. In addition to Mexico’s access to Waha’s natural gas, one of the cheapest in the world, the country benefits from a large and diverse base of resources that could offer one of the most competitive energy costs in the world. In my view, to meet its energy potential, including its 35 percent clean energy commitments by 2024, the Mexican government has to continue fostering competition across the energy sector by investing in transmission-related infrastructure, encouraging investment from the private sector and engaging in a proactive dialogue with the private sphere as well.

Also, integration technologies such as Li-ion batteries, CCS, green hydrogen and smart grids play an important role in the renewable energy potential. Although prices of some integration technologies have declined, policy efforts, including tax policies and financial incentives, the regulatory environment and public’s perception of the industry will be critical to progress in Mexico.

For instance, regarding green hydrogen, unlike the efforts made by Mexico to study carbon capture and storage technologies, the debate regarding the benefits of green hydrogen has not yet taken off in the country. In Mexico, considered one of the most dynamic countries in the world with respect to the generation of electricity from renewable sources, green hydrogen could be used within existing renewable energy systems to store excess energy during peak generation periods and supply energy during low production periods, potentially solving or reducing substantially intermittency-related issues.

The electricity industry law considers clean energy to be the generation of electricity through green hydrogen and fuel cells, and therefore, based on the Sector Program issued by the Ministry of Energy in July 2020, it is expected that debate and discussion about the production and use of green hydrogen will begin soon, as it has in Chile and Uruguay. Despite the recent changes to Mexico’s energy policy, green hydrogen could potentially be a solution for Mexico’s commitment to generate 35 percent of its electricity from clean sources by 2024.

There is a significant opportunity for Mexico. Given that green hydrogen may be traded as a global commodity in the near future, it remains to be seen whether the Mexican government would be interested in exploring potential exports to countries such as Germany, Japan, South Korea and Singapore. Countries with an important renewable potential, such as Morocco, Saudi Arabia, Turkey, Ukraine, Egypt, Australia and Chile, are starting to position themselves as the green hydrogen exporting countries.

Clifford Chance is one of the world’s leading law firms, with expertise in capital markets, corporate, finance, risk management and real estate. The firm has a strong focus on energy and infrastructure in emerging and established markets.