Jorge Sandoval
Goodrich, Riquelme y Asociados
View from the Top

Solid Regulation: the Road to Competitiveness

Wed, 02/22/2017 - 09:32

Q: How does Mexico’s energy regulatory framework stack up against international standards?

A: The government has done admirable work in preparing and applying the Energy Reform, developing a legal framework to transit from a monopoly to a liberalized market. However, the Wholesale Electricity Market (MEM) created as a result of this reform is extremely complex and the government also has established tight deadlines that are difficult for private participants to comply with. The basis of the legal framework is adequate but the rules are constantly shifting, which brings uncertainty to the market. This, combined with the vast amount of information that new players must process, has delayed the inclusion of private participants in the electricity sector. The MEM began operations in January but only CFE participated as a generator and qualified supplier.

Q: How has the reform made renewable energy projects attractive to international investors?

A: The Energy Reform is promoting major changes in the country to eradicate monopolies in the oil and gas and electricity sectors. Particularly in the electricity industry, generation, transmission, distribution and supply used to be carried out exclusively by CFE. In the case of electricity generation private entities could participate under certain regimes such as self-supply, cogeneration or the smallproducer scheme but these were the only ways in which private companies could generate and consume their own energy and it did not allow them to trade electricity. Now the country has a liberalized market in which CFE remains the main player, which makes the market’s structure even more complex.

Although CFE has already split its business units, in practice it might take years to end its monopoly over the market. It is also important to highlight that the purpose of the electricity reform is not to promote clean energies but to reduce prices. The Mexican market is based on the Pennsylvania, Jersey, Maryland (PJM) model, which corresponds to a pricing market. At the moment, the only available incentives for renewables are Clean Energy Certificates (CELs) and the distributed generation plan, which includes net metering but is only applicable for projects under 0.5 MW. The MEM includes another mechanism to incentivize participation of renewable energy projects in the market: auctions that allow companies to sign long-term PPAs for selling CELs, capacity and clean energy.

Q: What are the potential benefits and disadvantages that long-term contracts offer to renewable energy developers?

A: The government established special auctions to sign longterm PPAs for energy, capacity and CELs to provide more financial certainty to renewable energy project developers. The government first established a 10-year period for the PPAs that was insufficient for this purpose and it was later decided that the contract length would be extended to 15 years, an improvement despite the fact that a 20-year time frame would have been more appropriate for energy projects. Long-term auctions also provide a solid opportunity for renewables to enter the market and participate in energy generation and supply. To understand the exact benefits this scheme will bring to renewable projects we would have to evaluate the periodicity of the auctions and the evolution of prices, which are not favorable for some renewable technologies. CFE has reported its highest financial losses in years and we expect that at some point electricity prices will be readjusted to avoid bankruptcy at the state-owned company and boost private participation in the market. Otherwise, Mexico will continue to have a monopoly within a liberalized market.

Q: What encouraged the prevalence of M&As in the country’s electricity sector?

A: The guarantees required to take part in the wholesale electricity market are significant. It is also difficult to have the financial and technical capabilities to participate. Companies are now more willing to merge to complement financial capacities with technological assets and vice versa as a strategy to participate in the auctions organized by CENACE. In the past few months, we have seen an increase in M&A cases in our practice and we have represented a significant number of companies in this process, especially for the latest long-term power auctions. We represented solar company ILIOSS, which has been acquired by SolarCity, the largest solar company in the US.

After the acquisition went through we kept in contact with SolarCity/Ilioss and we know the company plans to invest about US$1 million in Mexico. We also are helping them to develop their business in the country.

Q: How are PPPs helping boost renewables and what challenges did you face establishing one in Sinaloa?

A: This project is related to a 25-year PPP contract between a solar energy producer and the government of Sinaloa. The main challenge was to obtain the majority approval of the state congress, a requirement of Sinaloa’s legal framework for PPPs. The project won approval and was carried out under the old self-supply scheme, with all its benefits included. We believe that PPP is one of the key elements to boost the use of renewables in Mexico, particularly considering the high energy consumption of municipalities. Unfortunately, the new energy framework does not allow municipalities to participate as qualified users, which excludes a considerable number of projects.

Q: How have the processes changed for obtaining permits, licenses or authorizations for renewable energy projects?

A: Companies are only required to obtain a generation permit when their power facilities have a capacity equal to or higher than 0.5MW. In such cases renewable energy developers do not need to pay the generation permit fees introduced as an incentive for these types of technologies. We have lobbied CENACE to lower the costs of interconnection feasibility studies as it charges smallscale companies about MXN$800,000 for these. This is excessively high and represents a considerable barrier for small and medium-sized energy projects in the country. CENACE has been open to listening to our comments and it is analyzing the possibility of decreasing its fees. From a tax perspective there also are incentives for renewables, such as tax-free purchasing or accelerated depreciation of renewable energy equipment.

Q: What are the main challenges facing the Mexican energy industry in the coming years?

A: The country is not accustomed to a liberalized market and the old energy trading schemes have deep roots in the national mindset. The main challenges are to develop the market and incentivize private entities to participate. Otherwise Mexico will not achieve its climate change and clean energy targets, as CFE alone is not capable of this. Without competition the country will face enormous challenges in offering low-cost and efficient energy, which is the key objective of the Energy Reform.

Another challenge is to transform Mexico into a competitive country for the private sector and eliminate the current monopoly. The complete transformation of the market is expected to take up to 20 years because it is not possible to eliminate a monopoly in a short period. But we are confident that the country has the foundations to grow in the right direction and that the government is working hard to understand the needs of the private sector and include its concerns in the new electricity market. To help with this transition, we are creating a dialogue between the private sector and the authorities to ease the negotiations and we are making our voice heard to ensure that Mexico becomes more competitive in the coming years.

The country has great potential to develop renewable energy, not only natural gas-based projects. The MEM lacks certain instruments that would be desirable but it is a fairly competitive market. In general, the work performed by the authorities in the last 18 months is admirable and they are open to listening to the industry to continue improving the framework.