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Analysis

The Year in Review

Wed, 02/21/2018 - 17:22

Mexican regulators have pulled all the stops to provide the required regulatory framework that will strengthen every link of the industry’s value chain and guarantee competitive schemes so that all players can compete on a level playing field. For the energy industry, 2017 was about maintaining, and even ramping up, the momentum from the year before
While staying true to its objective of increasing electricity generation through clean energy sources up to 35 percent of the country’s total energy mix by 2024, Mexico has also set an ambitious 100 percent coverage goal through the Universal Electric Service Fund, launched in May 2017. Considered as the social face of the Energy Reform by Minister of Energy Pedro Joaquín Coldwell, the fund is intended to extend CFE’s electricity distribution capacity to the doorstep of remote communities and also to install off-grid systems where extending the grid is not viable. 
The Ministry of Energy published the first tender for offgrid contracts to install more than 10,000 off-grid systems that will impact 898 municipalities across 11 Mexican states and benefit approximately 45,000 habitants, amounting to an investment of US$23 million. The second phase of the fund, announced on Nov. 13, 2017, called for the country’s productive companies of the state and their affiliates to participate in the extension of the public service of electricity distribution by presenting grid extension projects aimed at homes located anywhere between 1 and 12km from the nearest grid.
Capitalizing on the success and learning from the results of the first two long-term electricity auctions, the terms for the third long-term auction, published in May 2017, took Mexico’s energy transition one step further, and expectations were high. Coldwell declared that this third edition could triple Mexico’s electricity production from clean energy sources and continue the low tariff tendency of the previous two editions. Confirming Coldwell’s estimations, the results published on Nov. 22, 2017 produced an average package price for MWh and CELs reached US$20.57. Another US$2.4 billion in investments and 2.7GW of additional installed capacity powered by clean energy are expected. One key feature set apart this third edition: the Clearing House.
Through this innovative instrument, CFE will no longer be the sole purchaser of power, energy and CELs, opening the door to private players after proving their credit worthiness. KPMG’s Energy and Natural Resources Lead Partner Rubén Cruz says the Clearing House is a “positive step toward building up an energy market. The reform’s mandate clearly stipulates reaching a wholesale market with diversified purchasers and suppliers. A single offtaker, instead of creating market conditions, impacts power producer’s margins and value through the former’s purchasing power.” 
While the industry welcomes the Clearing House, some note that these are still early days; it will take time before the true effect of the entity is realized. “Mexico’s renewable energy scene is seeing an increased number of private energy traders and suppliers, but the aggregate volume they can purchase in the market at the moment is not significant enough for the Clearing House to have a decisive and notable impact,” says Eduardo Reyes, Partner Power and Utilities of Strategy&, a PwC company. “We anticipate that the energy percentage that other suppliers, outside of basic supply, will purchase through the chamber will be relatively low, although it will keep growing over time. In the longterm, as the energy volume increases, the impact will be consequential and will be reflected in the final consumer price through increased volume and the number of private suppliers offering energy.”   
The year also saw the country release terms for its first midterm electricity auction, the goal of which is to provide certainty and reduce exposure to price volatility for electricity spot-market players. In August 2017, the Ministry of Energy launched the auction, with the results set to be announced in February 2018. The primary objective of this new instrument is to allow energy suppliers and energy purchasers to participate in contracts with terms no longer than three years. “Private players are hesitant to sign longterm bilateral contracts given that predicting market behavior is complex, while renewable technologies are experiencing a downward slope in costs. Three-year terms provide acceptable risk levels as well as equating tariffs with market tendencies,” says Cruz. In comparison to the longterm electricity auctions, “shorter terms mean different financial schemes. This is where commercial banking feels more comfortable and more likely to participate through mini-perms,” says Marian Aguirre, Energy Finance Deputy Director of Bancomext.
As a testament to Mexico’s commitment to empowering consumers through a liberalized energy market and transitioning to a cleaner energy mix – enshrined in the Energy Reform – the country was admitted as a new member of the OECD’s International Energy Agency (IEA) by a unanimous vote on June 21, 2017. The agency determined Mexico’s energy policy is aligned with the IEA’s shared objectives of following international best practices and designing policies oriented toward sustainability and market competitiveness. 
 

BANKABLE PROJECTS

Making long-term electricity auction projects bankable is one of the biggest challenges posed by the new market. Compartmentalizing risk within the different stages of the project, relying on best practices, integrating innovative financing schemes and reaching financial closure are but a few of the elements that turn project development into a success story. “So far, two strategies have dominated the auction process: either you equate your offer price to your cost structure and see if it sticks, or you take a deeper look at the market, the competitive context and converge accordingly with the value chain to identify the prices that need to be reached,” says Adrián Katzew, Director General of Zuma Energía. “In contrast, the execution phase is highly specialized, working with banks and contractors to close pending contracts and begin project construction. This stage is particularly fulfilling in the sense that we are defining unprecedented financial structures – meeting the requirements of annual energy volume, CELs, alternate markets that used to honor those obligations – and studying their intrinsic risks in relation to our business.” 
Development banking institutions will have a key role to play in ensuring the success of the auction projects, which in turn will send positive signals to the market. “Banobras finances infrastructure projects, NAFIN focuses on production chains and Bancomext fosters foreign trade. Despite specializing in different segments and having different mandates, all three development banking institutions are placing capital in energy projects to respond to the sector’s high financing needs. Put together, we represent a joint portfolio of more than US$2.5 billion dedicated to these projects,” says Aguirre.
Social impact is the other element that project developers need to tackle head on. “Energy projects need to be directly related to social development. Energy projects are by nature long-term investments and are sprouting in different locations, surrounded by different communities. Coherent corporate social responsibility policies are at the core of this necessity. Companies that show resolve in finding ways in which a project can give back and have a positive impact on a community’s quality of life are those that will see their project prosper in the long term,” says Ángel Lárraga, President of AME and Gas Natural Fenosa. 
The success of the long-term electricity auctions will become apparent in 2018 as most of the projects awarded during this auction are set to start operations in the first quarter. Enel Green Power showcased the first tangible success case as its 250MW Villanueva PV park, awarded during the first auction, entered commercial operation in the wholesale electricity market on Dec. 18, 2017 and is now injecting renewable energy into the National Electricity System.
STRONGER AND SMARTER INFRASTRUCTURE Boosting Mexico’s installed capacity to address the expected increase in demand for electricity also requires sturdy and lengthy infrastructure to transmit and distribute it to key consumption points. Controllable demand and automated processes will be at the core of strengthening the grid by avoiding saturation and guaranteeing a seamless supply of electricity. “In 2017, we published the Program for Smart Electricity Grids. We designed a systemic vision to integrate new technologies under specific time frames, mirroring international tendencies. Progressive incorporation of energy storage, controllable electricity demand, electric cars and IoT are contemplated in this program,” says César Hernández, Former Deputy Minister of Electricity at the Ministry of Energy. 
In line with Mexico’s Electricity System Development Program (PRODESEN), the Ministry of Energy developed a new financing model for electric transmission lines where private third parties can participate. The announcement of the first bid for a major transmission line project, parallel to transmission line development on behalf of CFE with private players, was announced in December 2017 to connect Baja California to the rest of the country’s National Electricity System. In its latest 2017-2031 version, PRODESEN is scheduling the construction of 23,772km2 of transmission lines, representing a total investment of US$11.5 billion.
Mexico’s energy authorities are not alone in this effort: “We are backing PRODESEN’s process of developing the country’s electricity network. There is a significant investment forecast in the expansion and digitalization of the network and we are pushing for an automated and smarter network with balanced power loads, as well as providing the equipment for a sturdier grid,” says Alejandro Preinfalk, Vice President of Energy Management for Siemens Mexico.
Another major player in Mexico’s energy scene, Acciona, has stepped up to take on the challenge of building two transmission lines and two power substations, in Sinaloa and Sonora, for the Topolobambo III combined cycle plant, representing a US$24.5 million investment. The project is expected to be finalized by March 2019.
 

DISTRIBUTED GENERATION 2.0

While on-site power generation is an important element of the country’s Energy Reform, Mexico had already experimented in that area prior to 2013, with bidirectional contracts with CFE and regulated by CRE. The scheme stipulated that whenever energy surpluses were produced, CFE stored them in a virtual energy bank for one year to be used at a later date. This initiative was the precursor to creating an appetite for residential and commercial solar systems in Mexico. 
“Distributed Generation 2.0 regulations allow the closing of an interconnection contract with CFE through which you can not only store energy surpluses but also sell them under net billing and net metering schemes,” says Guillermo Zúñiga, Commissioner of CRE. Between 2013 and 2017, according to CRE’s statistics, small and medium-scale interconnection contracts increased from 4,613 to 40,109, respectively. Installed capacity in that period went from 29,131kW to 304,167kW, an impressive tenfold increase.
Although distributed generation in Mexico can now operate within net metering, net billing and wholesale schemes, the final users expected to benefit from these new schemes are still primarily relying on net metering as CRE’s secondary regulations roll out. “Very few contracts have been signed under these schemes. The main issue involves price certainty, as local marginal prices vary on an hourly basis. This fluctuation makes it difficult to design a long-term financial model that aligns with these variations, especially considering that an interconnection contract can span the better part of 25 years,” explains Rodrigo Pantoja, Director General of Greentech Ingeniería Sustentable. “Net billing suffers from similar hurdles. It is difficult to predict at what price the generated electricpower surplus will be sold. Net metering seems to be the most viable option in terms of certainty, especially because the electricity system’s capacity has been increased for inclusion in the net metering model. Previously, domestic high consumption and commercial tariffs were capped at 30kW of electric capacity. Now, those have increased up to 50kW.” 
While the industry feared that CFE’s amparo pertaining to interconnection requests from burgeoning small-scale, renewable powered systems could derail distributed generation’s growth, companies involved in distributed generation and solar power associations were reassured when interacting with CFE regarding this issue. “When CFE acquired legal protection against the interconnection rules published by CRE, ASOLMEX sat down with CFE. Instead of burning bridges, we looked for a way to fix the problem. CFE was not able to handle so many interconnections in such a short time. After those talks, both CFE and the companies involved in distributed generation were ready to keep working together,” says José Zambrano, Director General of Galt Energy.
 

STRENGTHENED REGULATOR

In the first years of the Energy Reform, the Ministry of Energy had a preponderant role in crafting the policies and priorities for Mexico’s electricity industry while CRE transposed the Ministry of Energy’s vision into the regulatory framework. In the case of the electricity auctions, CENACE undertook the design and unfolding of this innovative mechanism to inject clean energy into the country’s power mix, while CRE acted as technical adviser. With the fourth edition of the longterm electricity auction looming on the horizon, CRE will now coordinate the design of the fourth auction, while CENACE will implement it and the Ministry of Energy will act as technical adviser. “We will not change what is working well. CRE’s message to all interested parties is one of continuity and any eventual change will help make auctions more attractive to potential participants. Financial entities are growing accustomed to the auction’s new schemes and are developing project finance mechanisms. We want to maintain their interest in the auctions,” says Guillermo García, President Commissioner of CRE.
CRE will also be responsible for announcing all tariffs pertaining to the electricity industry, the first of which was the Basic Supply Tariff published on Nov. 29, 2017. “Tariff methodologies have already been approved and published. The relevant point is that these tariffs will be based on the monthly electricity generation cycle, while they previously were calculated based on a 1990s methodology that used a fixed power-producing mix where price was solely impacted by fuel price 
variations. This new attribution is historic as tariffs will be determined for the first time by an independent, autonomous regulator, contributing to the market’s development,” García adds. During a ceremonial official act on Dec. 20, 2017, the Ministry of Energy handed to CRE the First Electricity Market Rules package, containing the operative dispositions in accordance with the Electricity Industry Law’s Third Transitory Article. The package includes the Fundamentals for the Wholesale Electricity Market, 27 Market Practice Manuals and one Operative Guide. 
This act signaled the official conclusion of the emission of the First Electricity Market Rules, which integrate global best practices adapted to the country’s specificities to ensure Mexico’s electricity market operates efficiently. From this point on, CRE will be the regulatory body that evaluates and determines the further modifications or updates required as the market evolves.  
 

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