Strength in PPAs in the Face of Uncertainty
Although Mexico’s electricity market is one of the youngest, it has already gone through various stages: from unhindered opportunity to wavering uncertainty. But for the country’s offtakers and power producers, stability and certainty are crucial for long-term commitments. How are power purchase agreements (PPAs) developing within this framework? MBN’s experts outline the issue.
After Mexico formally liberated its energy market, private companies could suddenly take control of their energy portfolio. With the previous monopoly moved off the table, state-owned utility CFE was no longer the only option for those who had never opted for an investment-heavy but lucrative self-supply scheme. Any entity with a demand over 1MW and willing to register as a qualified user (QU) through CRE could suddenly choose from a myriad of clean and cost-effective energy options in the newly founded electricity market.
Because electricity costs often rank high in companies’ expenses, the lower prices and cleaner energy supply found in the electricity market became immediately attractive. But the options available to offtakers can be somewhat overwhelming. “Companies are often unsure whether they should approach a qualified supplier, install their own power plant or stay in their current scheme,” said Valeria Vázquez, Partner at Deloitte to MBN.
Long-term PPAs, a standard in the US market from which Mexico’s wholesale electricity market (WEM) was modeled after, offer a concise answer to those not sure what to decide. These contracts often involve long periods of around 15 years, which can be intimidating to offtakers. After all, who really knows where they will be after that time, let alone what the wider world will look like? Nevertheless, the clear benefits that PPAs offer can kick such anxieties to the curb.
By locking in energy prices for the long term at a discount, offtakers are protected from future fluctuations. Meanwhile, by going for clean energy, companies can tout their lower CO2 emissions without needing to face the complicated operations related to on-site power generation. Renewable energy might be intermittent but its costs are easy to predict compared to natural gas-fueled projects that are tied to the costs of the raw material, giving another boost to PPAs. For project developers, obtaining the necessary financing for power plants can be nearly impossible without signing PPAs beforehand, meaning that they are also keen on signing these contracts.
Urgency to Decarbonize Grows Regardless of Uncertainty
While it is hard to argue against the benefits a PPA can bring to both sides, Mexico’s liberated market model has been marred by the López Obrador administration’s efforts to backtrack the Energy Reform. Private market participants live in a regulatory limbo, unsure what the future of the market will look like. “Many consumers are interested in the potential savings but at the same time there is still a great deal of fear,” explained Federico Muciño, Founder and Consulting Partner at Epscon.
Outside the Mexican environment, the world does not stand still, either. “Mexico is not an isolated country. It is part of a bigger world. The global energy transition cannot be stopped; it is already a worldwide reality. Many companies in Mexico understand this and even have international and internal energy transition commitments to adhere to. These companies want to achieve their goals, despite the unfavorable regulatory environment,” said Vázquez.
Because of the importance of decarbonization, companies often have corporate sustainability programs that they need to adhere to. An increasing number of leading companies demand that their suppliers implement similar measures, as well. For this reason, Vázquez thinks private companies will continue their efforts to ensure their own clean energy supply: “I do not believe companies will sit with their arms crossed, waiting for something to happen four years from now. The most important effort in this transition will come from the private sector. “
Fortunately for these companies, experts agree that there is no reason to see the WEM as a besieged castle. There is no doubt that the government is doing what it can to bolster CFE, no matter if these measures are unpopular to private industry participants. However, the legal foundation of the market is anchored in Mexico’s Constitution.
Following the 2021 mid-term elections, López Obrador failed to reach the qualified majority in Congress needed to change these laws. What is more, judges have thus far ruled to suspend governmental measures affecting the WEM, such as recent changes to the Electricity Industry Law (LIE), although the final say from the Supreme Court is still pending. “Until the Supreme Court or other competent courts issue their final ruling or resolution, nothing is written in stone,” Vázquez stated. Based on previous suspensions, several legal experts in the energy sector are cautiously optimistic.
Both President López Obrador and Minister of Energy Roció Nahle have displayed their willingness to respect Mexico’s highest judiciary, in word and deed. “I would stress that the regulatory framework of the WEM is functioning well. It has been protected and reinforced by Mexico’s judiciary. After all, the rule of law is still the rule. As long as this is enforced, offtakers have certainty whenever they sign a bilateral agreement,” said Laurent Meulemans, Sales Director at Enerlogix Solutions.
In fact, Meulemans argues that companies should transition to become a QU sooner rather than later. “When you add up all the lost potential savings for such players over the last three years, you see that they left a huge amount of money on the table by not transitioning earlier,” he said. Muciño agrees, pointing toward the large amount of renewable energy added to the market in recent years, which has created a situation of oversupply. “Overall, we do not see this situation of oversupply lasting more than two years, so now is the time for offtakers to enter,” Muciño said.
PPAs Adapt to a New Reality
Convincing offtakers under the current regulatory uncertainty will still take some extra effort from power producers and qualified suppliers, though. “Certainty is very much defined by how the agreement is written and negotiated,” said Meulemans. In general, these negotiations are changing the nature of such agreements, although every situation is unique. “Terms of contracts vary a great deal between companies. Some look to regulatory developments or general uncertainties regarding business and decide that they have no clue as to what might happen next year. As a consequence, they are unwilling to commit for the long term. The uncertainty regarding their own operations drives them toward shorter-term contracts,” said Muciño. While shorter contract terms are often proposed, Muciño does not see many companies settle somewhere in the middle. “In terms of demand, there is little middle ground. Companies either want to go short term or arrange it so that they can see the benefits of longer contracts that range from five to 10 years.”
Looking forward, industry insiders believe the market’s dynamics are unlikely to shift much within the current government term. But with a growing need for decarbonization, PPAs are unlikely to fade into the background. Growing electricity costs might convince more companies to address their energy supply. “Recently, electricity rates have increased substantially. It appears that no matter how the sector develops, rates will continue to increase,” said Ricardo Zúñiga, Country Manager of Capwatt Mexico.
Even though the energy sector’s outlook can be a bit murky, companies continue to strive forward. “The next few years will be difficult but energy projects are long term. In the coming years, we will see the results of these efforts,” concluded Vázquez.