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Analysis

Renewables Here to Stay

Wed, 02/21/2018 - 18:13

Rome was not built in a day, and neither will Mexico’s energy market, despite the sense of urgency the private sector has expressed to participate unhindered in promising present and future opportunities brought about by the reform. Several milestones have been reached and should be celebrated

The joint effort of the country’s private and public spheres in unlocking such a complex and sophisticated market in such a short time is commendable. As a new year gets under way, Mexico can already boast 20 percent of its power mix from clean technologies, staying well on course to reach its 35 percent objective for 2024.

With the third edition of the long-term electricity auction, Mexico is looking at 8.8GW of mostly clean installed capacity, set to be up and running by 2020, including solar, wind, cogeneration, combined cycle, hydroelectric and geothermal. The clean promise of the country does not stop there, as other technologies and renewable resources are also proving to be bankable. Wave power, for instance is among the emerging technologies. “Few countries in the world have companies that are strongly committed to wave power technologies,” says Francisco Carrión, CEO of MARERSA. “This is due mainly to costs, which can make ocean wave power too expensive to develop. MARERSA has found a way to solve this, and with our project in Lazaro Cardenas, we are going to become the first company in the world to produce an economically viable project with this technology, on a large scale.”

To gain increased flexibility and liquidity, Mexico’s energy market needs to be able to function in shorter terms than it was used to prior to the Energy Reform and go below the 15 to 20-year contract terms mark of the first three editions of the long-term electricity auctions. Enter the midterm electricity auctions. With this mechanism, similar to its long-term sibling, private players can sign three-year PPAs, which also allow commercial banks to inject capital in the projects as this shorter term is more in line with how they are used to operating. “No one knows how the market will evolve over 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,” says Rubén Cruz, Energy and Natural Resources Lead Partner at KPMG.

POWER INFRASTRUCTURE

Mexico’s power infrastructure has a three-pronged challenge: mitigating energy loss, becoming smart to integrate data-mining practices, crucial for a thriving energy trading subsector, and being sturdy and extended enough to not only absorb the additional GW of capacity set to come online in the near future to avoid power congestions, but also to transmit and distribute it nationwide. The National Electricity System Development Program (PRODESEN) for 2017- 2031 outlines the possibility of the private sector to participate in the financing of electric transmission and distribution projects. The first with major significance is the bid announced by the Ministry of Energy on Dec. 7, 2017, to participate in the interconnection of the Baja California Peninsula, an isolated system, to the rest of the National Electricity System. The project is set to launch a 1,400km circuit line between Mexicali and Hermosillo. “The PRODESEN lists 410 transmission projects that are expected to be developed between 2017 and 2029, offering a wide array of opportunities for the private sector and financial entities,” says Alan Sakar, Project Development and Finance Associate at Clifford Chance.

SOCIAL AND ENVIRONMENTAL IMPACT

According to the US Department of Energy’s (DOE) National Renewable Energy Laboratory, the state of Oaxaca holds the key to 6,600km2 of terrain with good to excellent wind resource, little more than 7 percent of the state’s total extension (91,500 km2). Using a conservative average of 5MW/km2, Oaxaca’s wind blows 33,000MW of potential installed capacity. It is also home to several local communities, each with its own characteristics, traditions and power structures. These communities need to be an active part of the projects developed not only in Oaxaca but across the nation, to ensure the long-term prosperity of the projects.

Mexico’s project developers should become increasingly aware of the Equator Principles, a framework for the financial sector to determine, evaluate and manage a project’s social and environmental risks. Under these principles, companies must showcase their social responsibility policies to obtain financing. Performance Standards on Environmental and Social Responsibility of the World Bank Group’s International Finance Corporation (IFC) are also the norm. In July 2017, Bancomext and KfW, a German development bank, signed a complementary agreement where the social and environmental impacts of renewable energy projects up for financing will be analyzed via Bancomext’s Environmental and Social Management System (SARAS). “Social impact and financial closing are two sides of the same coin that need to be better linked. A project can face an impasse from lacking a good social negotiation and time is the worst enemy of this particular component,” says Alfonso Caso, Director General of ANAF Energy.

Mexico's Energy Mix Targets

While Mexico’s regulatory framework takes social and environmental impact into account, the details of these regulations need to adjust better to Mexico’s reality, both to the benefit of private companies looking to develop utility-scale projects and communities. “Regulations on environmental impact apply to the energy industry as a whole,” says Luis Vera, Founding Member of Vera & Asociados. “Both hydrocarbons and electric energy are under the same legal framework, the LGEEPA, but the evaluation is carried out by two different agencies: ASEA and SEMARNAT. Social impact is regulated by independent rules for each activity but evaluated by one authority: the Ministry of Energy. In the electricity segment, the law states that the social impact studies from private companies must start 90 days prior to their investment decision. But legally, it is difficult to prove at which point an investment decision was made.” Incentivizing corporate social responsibility policies and reaching equilibrium between seamless project development and positive social impact remains a prevailing issue for 2018.

CONTINUITY IS KEY

Mexico is set to hold presidential elections on July 1, 2018. Electoral periods can have an impact in investment and business decisions, particularly when there is no clearcut potential winner and the likelihood of the necessity of a legislative coalition to push forward the executive agenda is rather high. But Mexico’s energy regulators are confident that the process launched in 2013 will keep moving forward, under a constant improvement basis.

“Looking back, the most uncertain period in the country’s recent history was last year’s US presidential elections. One month later, we witnessed the success of Round 1.4, the deepwater chapter, which included participation from major US companies such as ExxonMobil and Chevron. This experience tells us that the business world is above political discourse or alignments. As long as the rules are clear, transparent and foster open participation, business will continue and investments will pour in,” says Guillermo García, President Commissioner of CRE. “Continuity is key for fostering certainty and reliability. CRE’s commissioners have seven-year mandates, outside of political cycles, with phased nominations. Another major component is CRE’s organizational structure. We restructured CRE to provide an ever-improving service. While my predecessor’s commission was completely cross-sectional, we set out to reassemble CRE into business units, with new rules of procedure published in May 2017. This structure has helped develop procedures and protocols that work seamlessly regardless of who is at the helm,” he adds.

Now that Mexico is taking the first steps of its liberalized energy market, the country has set out to gather all the elements of a competitive, modern and renewable electric system, taking head on the challenge of making each link of the industry’s value chain equally strong to keep the industry’s cogs turning.

Mexico must remain alert to the sector’s new technological advancements, as disruptive innovations and new developments emerge to provide more secure, reliable and efficient products and technologies to the benefit of sustainability and electric security. “The backbone of it all is pricing electricity at levels where its marginal value can generate a profitable rate of return, while experiencing and increasing the number of incidences where, thanks to renewable energy and new technologies, its marginal value is zero,” says Alfredo Álvarez, Energy Segment Leader of EY.