Lingering Regulatory Concerns Hinder Investment

Q: What are your clients’ main concerns as a result of the Energy Reform?

A: The Energy Reform has imposed challenges not only for private companies but for the authorities as well and we help them to understand this new scenario. The second main concern is regarding minor issues that have prevented private companies from feeling completely comfortable with the new legal framework. This will keep developing over time and will eventually succeed but numerous clients are uneasy about when this will finish evolving. Sometimes new officials also have the challenge of fully understanding the new legal framework, which is new to them as well. We expect that in 2017 many of these issues will be resolved. Thompson & Knight is detecting opportunities in the small print of the legislation and has been able to advise our clients about new opportunities based on our experience in mature power markets.

Q: What main challenges are the regulatory institutions facing?

A: The expertise of all the workers in CRE and CENACE is outstanding but naturally they are understaffed and they are as new to the legal framework as any other company, institution or individual. Even though the institutions enacted the Energy Reform, external advisers were employed to create the guidelines, so even for CENACE and CRE’s employees the documents might present challenges and complexities.

Q: What role have law firms played in the development of the Energy Reform and what will be their continued involvement?

A: Experience and understanding of the previous scheme has been key in understanding the 180-degree change created by the Energy Reform. Other firms believe that because of the novelty of the Reform, understanding past legislation is not necessary, as if it is starting from scratch. But it is impossible to have an adequate grasp of the new framework without knowledge of the role of the authorities in the previous system. Even the legal interpretation of the new guidelines depends on the technical understanding of the previous regime. That is the technical legal role that Thompson & Knight offers our clients, not only reading and trying to interpret complex technical documents and providing a legal perspective. Our longstanding experience with the former regime allows us to complement their perspective. When people hire us they do not just hire a lawyer, they hire a consultant as well. We are attorneys and counselors in the energy industry and we provide an insight regarding the technical and commercial aspects of the reform as much as the legal ones.

Q: Which areas of the framework are the most unclear and how does that affect the perspective of investors?

A: It is not a lack of clarity but rather the novelty which presents the main challenge in the Mexican market. Numerous off-takers in the industry felt quite comfortable with the previous regime due to its transparency and they are hesitant as to whether to continue with that scheme through the legacy contracts or to participate in the market either as a qualified user or as a market participant. With the market liberalization, companies have to debate the best way to cope with the power, capacity and CEL needs. CELs have been the most controversial aspects of the regulatory framework because many industries consider them an imposition which will hinder their competitiveness.

Q: What percentage of companies do you expect will comply with their projects on time and what reasons might hinder others?

A: The prices offered at the power auctions were very low and small companies might find it a burden both to finance and build the projects. Large companies will not have problems complying because they have access either to their own funds or to cheap funding. Additionally, some companies might not be fully aware of the complexities and challenges that the projects they proposed will present. The impression from the first auction was that the requirements were not set properly. They lacked stronger technical requirements for participants, which was surprising because it meant ideas could be submitted as projects and that will be a problem. To pay the costs of transition from an idea to a fully developed project is costly and complex.

Q: What is your perspective on the restructuring of CFE?

A: The strictly legal separation of CFE is a decree but in the market the idea prevails that CFE as a company will have access to information other companies will not, which will give them an advantage in a supposedly competitive market. However, the competition rules in the Electricity Industry Law are well structured to protect the market players from anticompetitive practices. It will be the right of the players to start an investigation through COFECE if any monopolistic situation arises in the future.

CFE has already taken the right steps in appointing very experienced general directors within CFE instead of politicians. Historically in Mexico important positions were awarded to politicians without experience in the sector. The legal separation should be a priority for CFE, with strict rules, sanctions and requirements to ensure compliance. People need to start looking at CFE as a new player driven by the market, competitiveness, excellence and professionalism just as much as any other company. This is a cultural change and it will be a complex process but actions such as hiring capable and open-minded people as directors definitely accelerates the process.

Q: What are the energy sources of the future?

A: Companies are changing their energy matrix. For instance, ACCIONA winning with PV projects in the second auction, Électricité de France, which was at first focused on wind projects, winning a wind and a PV project. We have clients that have developed different technologies because they all offer different advantages and disadvantages, so a combination of all of them creates a more competitive energy matrix. All energy companies will have to consolidate as power companies instead of focusing on a single technology. Renewable energies are just starting but will be developed even more, not only in Mexico but globally as well. Cogeneration still has a very important role due to dispatchability and capacity. Nuclear is not a feasible option in Mexico because it is still an area reserved for the Mexican state. Geothermal will have an important role soon but it will need incentives for funding and exploration, otherwise it will be too expensive to consider.

Q: How will Mexican companies participate in the sector given the presence of international businesses?

A: Mexican companies were very active in the first auctions, both in PEMEX’s bidding rounds and CFE’s power auctions. Opportunities in the generation market had not been as clearly foreseen as those in the oil and gas industry but several Mexican companies are already positioned as qualified suppliers.