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Analysis

Welcome to the Free Market

Wed, 02/22/2017 - 14:31

Approval of the Energy Reform in late 2013 created great expectations in the local and international markets. But the truth is that little happened in the following two years as most efforts focused on getting the regulations, secondary laws and manuals ready for kick-starting the next phase of Mexico’s energy industry.

2016 was different.

This was the year when the wholesale electricity market started trading, with the first private companies participating as generators, qualified users and qualified suppliers. CENACE held the market’s first long-term power auctions, attracting investments of over US$6.6 billion in new clean energy capacity, while outside the spotlight, the first-ever private contracts without CFE’s involvement were also signed. The state-owned company itself started a restructuring process to become a productive enterprise with independent subsidiaries and affiliates.

“We need to erase the image of CFE as one huge company, which is no longer the case. CFE is now a corporation formed by different companies independent from each other. We have already observed competition among CFE’s subsidiaries to keep the best employees on their side. For us, that is a good sign that the unbundling process is moving forward for real,” says Derek Woodhouse, Partner at Woodhouse Lorente Ludlow, a firm that participated in the preparation of CFE’s separation guidelines.

These historic advances, however, do not mean the work is over. The novelty of the market and the surrounding regulations as well as the still missing manuals and guidelines have wrapped the industry in uncertainty. Many project developers, investors and off-takers are waiting to see how pioneering companies perform before diving into the new environment. Now, the greatest challenge for Mexican regulators is to complete the regulatory framework, with the manuals for Social Impact Assessments and Distributed Generation at the top of the industry’s Most Wanted list. Also on that list: enhancing market trust and understanding of existent rules while gaining a firmer grasp of the new dynamics. In the case of the private sector, companies must learn to cope with a wider variety of options and price fluctuations in the newly free market.

“Mexican companies are not used to the price volatility that comes with liberalized markets. They were used to having the same price per unit of natural gas and electricity in all the regions they operated in for long periods. However, this situation was not a reflection of the market’s dynamism. Price fluctuation will now be present as in any other market, but it will not be related to the government in office; it will be a response to market conditions. Companies need to be aware of this and adapt their strategies to the new environment to remain competitive,” says Guillermo García Alcocer, President of CRE.

A NEW ERA

The first megawatts in the new-look wholesale electricity market (MEM) began trading for first time on Jan. 26, 2016, ushering in a new era for the sector. CENACE launched the short-term market pilot in the Baja California system, isolated from the national grid, with CFE participating as the only generator and supplier. Three days later CENACE introduced the MEM to the national electricity system where it registered sales offers for around 32.36GW from CFE and Generadora Fénix. Although some private qualified suppliers were registered in the market, only CFE presented purchase offers.

The opening of the MEM unleashed the potential for new business models in the electricity industry. Private companies have already taken note of these opportunities and by the end of 2016 CRE had awarded market participation permits to 269 generators, eight qualified suppliers, nine qualified users and one basic supplier. The numbers might not look impressive but considering Mexico has never had a market of this kind before, having been under an iron-fisted monopoly for 78 years, it is a big step toward creating a robust MEM, a milestone the government plans to reach during 2017.

Few people will argue that the long-term power auctions were the major events for the MEM in 2016, with the first of these held in March. News of the prices per megawatt-hour and the scale of the projects tendered in the Mexican power auctions sent shockwaves across the world, thrusting Mexico’s energy market under a global industry spotlight. “If you want to know the true price of renewable energy in America —free from subsidies and mandates— look to Mexico,” says Steven Chu, former US Energy Secretary and Nobel Prize winner, in an interview with Forbes. Other big names also took a favorable view of Mexico’s new market. Enel Green Power, Jinko Solar, ACCIONA Energía, Engie and SunPower were some of the well-known project developers that placed big bets on the market.

As a result of the auctions 41 new clean power plants will be built in Mexico in the next three years, accounting for around 5GW of additional installed capacity, almost fivefold the clean energy capacity built from 2014 to 2015, which went from 18.1 to 19.3GW. The majority of these projects will be solar parks. This technology won 54 percent of the energy tendered in the first auction and 45 percent of the second. The prices bid per megawatt-hour of solar energy broke global records in the first edition with average prices of US$40.5/MWh, drawing the attention of solar companies worldwide. Prices were even lower in the second auction.

“The results of the first bidding round were extremely surprising for solar energy companies, including Jinko Solar, which expected wind energy to get most of the megawatts tendered. In the past, the LCOE of wind farms used to be lower than solar parks, making the first tender’s results a turning point for the industry. The use of innovative business models was crucial for lowering the costs of solar energy and we feel proud to have helped our clients with the development of competitive proposals for the tender by providing high-quality technology at accessible prices,” says Alberto Cuter, General Manager Latin America of Jinko Solar.

The high number of rooftops available in Mexico has attracted major solar companies, including California pioneer Solar City. Their focus is on the residential and commercial markets while national players have also been incentivized to step up their game to capitalize on the segment. Distributed generation is expected to eventually enjoy big gains according to many industry players but the uncertainty over the rules for these systems stalled growth in 2016. Clarity is on the way, however, after CRE published the first draft for the interconnection manuals to be reviewed by industry stakeholders in the first half of 2016 and the final regulations were published in early December. Now the hope is that many more business models will be possible under the new scheme, including the possibility to sell energy and CELs to the MEM through an accredited supplier.

In addition to the new schemes available in the MEM, the Electricity Industry Law allows legacy projects to continue operating and offering services, creating a business line for companies looking for an anchor to the past framework’s benefits. The deadline to receive legacy interconnection contracts was December 2016. All legacy projects not complying with the requirements of the law, which included having the financing process completed, lost their right to remain under the previous regulations. The door is now closed for new legacy projects to be introduced to the market but those companies that received permits can maintain their projects’ status for up to 20 years. Contrary to the oil and gas industry, the old and the new will coexist in the electricity sector, at least in the medium term.

RENEWABLE QUESTIONS

The unprecedented growth in renewable energy capacity that will be added in the next three years has raised questions about the stability of the power network due to the intermittent nature of these sources. Some companies are betting on energy storage technologies as the right path for the future but although cost-effective solutions are available for large-scale applications, traditional, fossil-fueled power plants will continue supplying the system’s baseload.

“In Mexico, investing in combined-cycle made sense as the country is expected to have a reliable and cheap inflow of natural gas for a long period. Moreover, combined-cycle provides the advantage of being a baseload technology, with the flexibility to dispatch energy whenever needed, acting as a complement for intermittent technologies, such as solar and wind. In the near future, we expect to see a growing number of efficient combined-cycle power plants providing the country’s baseload, as well as an increasing share of renewables being connected to the grid,” says Ramón Moreno, Chief Technical Officer of Mitsui & Co. Power Americas, the second largest private operator in Mexico.

Mexico and particularly CFE have undergone an ambitious campaign to substitute old and inefficient power plants with natural gas-based combined-cycle facilities. The transitioning state enterprise had plans to revamp seven power plants accounting for 4.5GW capacity altogether. By January 2016, it had already completed the conversion of La Central de Manzanillo in Colima, Puerto Libertad in Sonora, Emilio Portes Gil in Tamaulipas and Francisco Pérez Ríos in Hidalgo. The company has also promoted the construction of new combined-cycle power plants, tendering five of these projects in 2015, which will be built by five different companies, and one more in April 2016: Topolobambo II, awarded to Spain’s Iberdrola. The tenders for Topolobambo III and San Luis Potosi combined-cycle plants are pending.

CFE has also invested in natural gas pipelines to accompany its strategy to substitute coal and fuel oil with natural gas in its facilities, having at the start of 2015 four pipelines in operation with a total length of 1,300km. In 2016, CFE tendered four more pipelines included in the country’s fiveyear expansion plan: South of Texas-Tuxpan, La LagunaAguascalientes, Tula-Villa de Reyes and Villa de Reyes– Aguascalientes-Guadalajara. The pipeline connecting Veracruz with Texas is a highly anticipated project because it will be the first underwater pipeline transporting natural gas in Mexico and is expected to increase the system’s capacity by 2,600 million cfd, supplying gas mainly to CFE’s power plants in Tamaulipas and Veracruz.

The efforts of CFE together with PEMEX and the private sector have solved the natural gas shortages that Mexico experienced in 2012 and early 2013. PEMEX emitted the last critical alert to warn the industry to ration its natural gas usage in mid-2013. Even with rising demand, companies have little to worry about now as US$16 billion are being invested in Mexico to add 10,000km to the National Pipelines System, an 85 percent increase compared to 2012 levels.

The Energy Reform was also received with open arms by the private sector as it freed the way to participate in commercialization activities and provided open access to the National Pipelines System and the possibility to reserve firm capacity through open seasons. CENAGAS finally took ownership of the system and is in charge of administrating and awarding the capacity reserve contracts. To promote competitiveness in the market, PEMEX will give up 70 percent of the natural gas volume associated with its commercialization activities over a four-year period. Entering the commercialization business seemed to appeal to private companies. By July 2016, CRE had already awarded 60 natural gas trader licenses. The Mexican government hopes that by increasing competitiveness, prices will fall and critical alerts will remain in the past.

SETTING GOALS

Having more power production makes no sense without sufficient infrastructure to deliver it to the final user. Similar to CFE’s gas pipeline tenders, the company’s call for building transmission and distribution assets attracted the industry’s attention. Working for CFE used to be the only way to participate in electricity transmission projects. But that has changed, at least partially. Although the new law states that electricity transmission and distribution are strategical areas and therefore remain under the government’s control, it also allows for the private sector to invest and participate in transmission projects.

For transmission lines the new scheme works similarly to a highway concession where electrons are vehicles, roads are transmission cables and the toll rates, financial transmission rights. Under this system, CFE will award projects to private companies through a tendering process although the system planning will be CENACE’s purview. The winning company will be in charge of building, operating and maintaining these assets during an established period of time, after which ownership will pass to the government. The first of these tenders will be held in the first quarter of 2017. The new line will connect Oaxaca with the Valley of Mexico using High Direct Current Voltage (HVDC) technology, a first for Mexico, and will have a capacity of 3GW.

Major electrical companies have already expressed interest in participating in this tender. If successful, the next two big transmission lines in CENACE’s plans —from Sonora to Baja California and from Tamaulipas to Baja California— will be among the most anticipated events in the Mexican electricity industry.

“The existing power grid already has the capacity to absorb a significant number of renewables but it is necessary to strengthen the grid to prepare for the future so there are many infrastructure projects being developed and contemplated in PRODESEN 2016-2030. These three lines will incorporate technology that has not been previously used in Mexico, the HVDC lines, bringing both a leap in technology and in regulations for contracts for financial regulation for renewable energy,” says César Hernández, Deputy Minister of Electricity.

To ensure end users get all the electricity they need at the most competitive costs, CFE has also invested heavily in reducing power losses in the grid, both technical and nontechnical. CFE has made use of public tenders to partner with private companies with expertise in smart metering and power control. The arrival of cutting-edge technologies to the Mexican power network has already proven useful as CFE has decreased power losses from 16 percent in 2012 to 13.1 percent in 2015, reducing associated economic losses by MX$9.75 billion. CFE is now looking to reduce the losses to 10 percent by 2018, bringing the country closer to the Organization for Economic Cooperation and Development (OECD) standard, currently set at 6 percent.

Private companies across different sectors are also looking at new solutions to optimize energy production and usage. The Internet of Things (IoT) and smart metering technologies are slowly digitalizing the Mexican manufacturing and power industries, making it easier to identify critical areas and act on them. Most of the new market participants already see efficiency solutions as an added value for their clients, in addition to competitive electricity supply. In the latest Energy Transition Strategy to Promote the Use of Cleaner Technologies and Fuels, Mexico made official its goals to reduce energy intensity by 1.9 percent between 2016 and 2030 and 3.7 percent between 2031 and 2050. This is the first time Mexico has defined targets in this area.

Accessible financing is expected to be among the main challenges to improving efficiency but international and national development banks are already implementing initiatives to give Mexican companies easier access to efficient equipment. Given that transportation is the sector with the poorest efficiency levels, the government has plans to electrify its entire vehicle fleet by 2050, which will bring new dynamics to power production and supply.

In the same document the government established a target of 50 percent clean energy production by 2050. Judging by 2016’s results, that might be achieved even earlier.