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$2.6bn of investments spark official launch of electricity market

Article - July 4, 2016

Following a landmark electricity auction which signaled the start of Mexico’s commercialization of its energy sector, a second auction is penciled in for later this year, with the country planning to add 20GW of clean energy to its portfolio over the next 15 years

Mexico held its first ever electricity auction in March 2016, raising $2.6 billion from 11 clean energy developers including Enel Green Power, SunPower Systems, Alten Renewable Energy and Recurrent Energy. The auction marked the launch of the country’s electricity market following the government’s 2013 decision to allow the entrance of private companies in the sector, officially ending a long-running state monopoly on power.

Speaking after the event, Comisión Federal de Electricidad (Federal Electricity Commission, CFE) CEO Enrique Ochoa Reza commented, “For the first time in Mexico, an electricity market has been established where the generation and commercialization of energy are open to free competition.”

The winning companies will generate and sell 2,085 MW of clean power to the state-owned CFE in 18 new projects. The majority of these are solar, which represented 1,691 of the MW contracted. Wind power will account for the remaining 394 MW. Sales of power to CFE, which were contracted for a 15-year period, will begin in 2018.

The first long-term public tender since its energy reform attracted a total of 227 bids were made by 69 companies is a good sign of things to come, and proved that there is strong international interest in the opening of the electricity sector. The 11 successful bundles of wind and solar projects averaged a price of $41.80 MW per hour (MW/h).

The biggest winner of the day was Italy’s Enel Green Power, which walked away with a contract for the construction of three solar projects (representing an investment of $1 billion) that will account for nearly 1 gigawatt (GW) in installed capacity. In a press announcement, the company’s CEO Francesco Venturini said, “Mexico is a pivotal market for all serious players in this field due to its huge potential in clean energy and stable regulatory framework.”

Still, the auction met just 84% of CFE’s demand, and a second auction is penciled in for later this year.  Mexico wants to add 20GW of clean energy to its portfolio over the next 15 years. As President Enrique Peña Nieto stated, “The goal is that by 2024, the electricity network functions with at least 35% clean energy and with 50% by 2050, while today the percentage is 21%.”

Mr. Reza said that the first auction was a clear step towards this goal.

Liberalization and economic competitiveness

The 2013 Energy Reform is revolutionizing Mexico’s energy sector after 77 years of monopoly by CFE and Pemex, when private investment was subjected to considerable restrictions and electricity costs remained high. Now, the government hopes that opening the sector to competition will lower costs, and a new era of competitive advantage for Mexican industry.

The timing is right. Mexico’s economically active population is expected to grow from its current 87 million people to 98.9 million by 2020. By 2050, this figure is predicted to exceed 114 million. This is a demographic that represents a one-shot opportunity for the country to create the conditions that will allow this productivity to flourish.

“What is being created is an innovation ecosystem, based on investment incentives in the technology development and in the training of highly specialized human resources,” said President Peña Nieto.

Not surprisingly, the energy reform has radically changed the private investment landscape in the sector. Indeed, energy has witnessed the greatest structural changes of any sector in terms of opening up opportunities for new business. Last year, it underwent a deep regulatory overhaul with the passing of a 1,000 pages of new legislation. An additional 3,000 to 4,000 pages of secondary regulation is now being enacted.

In brief, these changes represent a transformation at the sector’s most basic level, going far beyond its mere regulation. Formerly, power trading between private parties was only possible under the narrow conditions of self-supply, cogeneration, or through independent energy production or small-scale production with CFE.

Contrarily, the fundamentals of the new electricity market have been designed with a laser-like focus on increasing operational efficiency. Now, the entire market, including the medium and long-term auctions, as well as ways of trading power and associated products will be carried out according to competitive processes that guarantee the highest levels of efficiency and transparency, and which are open and non-discriminatory.

The model is based on best international practice, and is similar to that used in many parts of the United States. Energy, related services, power, transmission rights, and clean energy certificates will quantify their opportunity costs instantly and independently for the National Electricity System, and in this way, tariffs for each power zone will be determined. Consequently, cost will decide each and every operation, with the aim of reducing electricity tariffs for end users, who are, after all, the beneficiaries at the center of the energy reform.

In comparison with other structural reforms that were delayed or partially implemented, the energy reform has not only been formalized at the constitutional level, but its secondary laws were drafted within the established time limit and all legislation has been enacted on time or even ahead of schedule. The complete overhaul of CFE from public entity to a state-owned competitive company is also underway, including the introduction of new regulations that will allow it to partner with private sector companies.

“Mexico has understood clean energy to be all of the traditional sources, like wind, solar, thermal and hydro. It has also included nuclear as a non-CO2 emission source, though the country has but one nuclear plant with 1000MW. The auction held this year was specifically for clean energy producers so it’s clear that the mechanisms for developing clean energy are being implemented”

ENRIQUE ALBA, CEO, Iberdrola Mexico

At the end of the day, the goal of opening the electricity market is to allow the entrance of private companies who will bring greater technological know-how to the task of modernizing the network, while increasing competition and efficiency in the sector. The government hopes that lower tariffs will boost the well being of the general population and the competitiveness of the country’s industrial players, some of whom are currently paying electricity tariffs more than 135% higher than those of their counterparts in the United States.

“Two years ago, Mexico had an electricity tariff exceeding $100 MWh,” says Enrique Alba, CEO of Iberdrola México. “The measures that the government and CFE have taken, such as the conversion of combustible plants to natural gas, the reduction in the use of fuel oil – which is a much more expensive fuel – the implementation of an aggressive gasification campaign throughout the country through pipelines which has significantly boosted the output of combined-cycle plants here, along with the energy reform itself, have been a catalyst for the operational startup of a number of new private projects. Today, rates are at $55 MW/h, which is cheaper than in some U.S. states and not too much higher than Texas, one of the cheapest states because it has so much gas.”

Consequently, Mr. Alba says, the energy reform is already bearing fruit in terms of lowering the cost of electricity. “Obviously, in order for this to be sustainable over time, the entire reform, which is now just in its first phases, must be implemented. But as it stands today, electrical power in Mexico is at a rate that is similar to many European countries, and cheaper than in some U.S. states. We have definitely seen very rapid results over the last two years in electricity tariffs,” he comments.

Next up, transmission

Following a second generation auction this year, tenders will be announced for the construction of 1,230 kilometers of direct-current, high-voltage transmission line that will connect the Isthmus of Tehuantepec in the midwest to central Mexico. This auction, the first to be held for transmission, will represent the launch of a massive modernization of the country’s lines that will include intelligent network technology. The Isthmus of Tehuantepec line is expected to boost capacity in Mexico’s industrial center while supporting the wind power potential of the Isthmus.

“In terms of transmission lines, there are two bits of very good news,” explains CFE chief Mr. Reza. “CFE announced last year that we will participate in the Fibra E [financing mechanism] with transmission assets. One of the characteristics of Fibra E is that is must be done through assets that are already constructed and which have a constant and proven economic flow. Our transmission lines comply with this requirement because they unite consumption with generation, and economic flow is predictable due to CFE regulated tariffs. This means that transmission falls under the Fibra and can be opened to the market.”

Fibra E is a financing tool for infrastructure projects introduced in Mexico last year. It is based on the master limited partnerships (MLPs) traded in the United States since the early 1980s. By grouping together qualifying assets that generate stable cash flows, U.S. MLPs allow companies to raise capital at a lower cost than that of more traditional sources of financing. The mechanism typically allows higher-than-average yields for investors. Under this scheme, the government is expecting an investment of $19.9 billion in the transmission sector between now and 2028.  

“CFE has proposed 10 billion pesos in transmission networks under Fibra E,” adds Mr. Reza. “What will we do with these revenues? We will invest them in additional transmission lines, with licensing processes for the private sector. This new transmission infrastructure,  constructed with Fibra E funds, will then be included in a new Fibra round so that a virtuous financial and operational cycle is created that will allow us to strengthen the entire transmission network.”

For the transmission line tenders, CFE expects to use a licensing process very similar to that used with the gas pipeline expansion, which has been popular with both national and international bidders. “The licensing process used for this line will be a new one for CFE in transmission lines, and we expect it to be the model we will continue to use as we move forward,” says Mr. Reza. “The licensing mechanism, along with Fibra E, will allow us to fulfill our commitment to continue strengthening the transmission network within our budgetary restrictions.”

Certifiably Clean

Promoting environmental protection and fostering the use of clean energies is also an important aim underlying the electricity sector’s overhaul as was evidenced by the electricity auction earlier this year. The auction was a further step in what has been a constant effort in recent years by the government to raise its clean energy production. Over the last few years, Mexico’s renewable energy generation has been growing at a rate of 50% annually. Between 2012 and 2015, more than 2,700MW were added, primarily from wind power sources. Today, Mexico boasts 16,500MW of renewable energy generation capacity, which represents just under a quarter of its total installed capacity. The creation of the country’s green certificate program is meant to guarantee this trend continues and deepens.  

“Mexico has created a medium and long-term electricity auction scheme that will include clean energy certificates to guarantee that a percentage of the electricity that large users consume comes from environmentally friendly sources,” said President Enrique Peña Nieto.

“The licensing process used for this line will be a new one for CFE in transmission lines, and we expect it to be the model we will continue to use as we move forward”

Enrique Ochoa Reza, CEO, CFE

The Clean Energy Certificates stipulate minimum compulsory percentages or quantities of renewable energy for energy producers, suppliers and qualified users like industrial groups and companies with an electricity demand in excess of 5MW. An instrument used successfully in other parts of the world such as the U.K. (where renewable energy production tripled after their introduction in 2002), the Clean Energy Certificates act to create a market in which participants can buy and sell certificates. If they do not meet their minimum percentage, they must purchase the number of certificates that allow them to do so or face fines.

Mr. Alba of Iberdrola Mexico says the environmental goals of the energy reform are significant and highly ambitious, and in line with those of most European countries, as well as the most demanding international protocols. “Mexico has understood clean energy to be all of the traditional sources, like wind, solar, thermal and hydro. It has also included nuclear as a non-CO2 emission source, though the country has but one nuclear plant with 1000MW. The auction held this year was specifically for clean energy producers so it’s clear that the mechanisms for developing clean energy are being implemented.”