Mexico Goes Verde

Mexico Goes Verde

November 01, 2008

Mexico adopted a new renewable energy law in late October that is the first step in creating a comprehensive legal framework for developing renewable energy projects in Mexico and that will open up new opportunities for renewable energy developers and technology suppliers. The new law is expected to take effect in November.

Potential Market

Mexico has the good fortune of possessing many renewable energy resources that remain largely untapped. A 2003 study by the US National Renewable Energy Laboratory concluded that Mexico has national wind resources sufficient to generate more than 40,000 megawatts of electricity. The wind conditions in the Tehuantepec Isthmus of Oaxaca are among the best in the world with the potential to generate 8,800 megawatts. Baja California, Yucatan and the Mayan Riviera of the State of Quintana Roo benefit from wind conditions that could potentially generate 274 megawatts, 352 megawatts and 157 megawatts, respectively.

With respect to solar resources, Mexico has one of the highest potentials in the world with an average solar insolation of 5 kWh/m2. The areas with the most solar potential are mainly in the north of the country and include large portions of the states of Baja California, Sonora, Chihuahua, Zacatecas and Durango.

As a region with volcanic activity, Mexico also has considerable geothermal resources with the potential to generate approximately 2,400 megawatts. Primary geothermal sources are located in Baja California, Sonora, Michoacán and Puebla.

Mexico has a long tradition of converting its hydraulic resources into electricity through the implementation of large-scale hydroelectric plants. Currently, approximately 21% of the country’s installed capacity comes from hydro power. While large-scale hydroelectric facilities are difficult to implement and are capital intensive, small scale hydroelectric plants producing 10 megawatts or less are a viable option given Mexico’s numerous hydraulic resources. It is estimated that small hydro projects have the potential to generate approximately 3,250 megawatts.

Notwithstanding the existing resources available for renewable energy development, Mexico continues to rely heavily on conventional plants fueled by fossil fuels and coal. The total installed capacity from renewable sources today in Mexico is just 3%, not counting hydroelectricity.

Existing Legal Framework

The Mexican electricity sector is state controlled. The generation, transmission, distribution and sale of electricity to the general public are the responsibility of the Federal Electricity Commission or “CFE”. In 1992, the national electricity law was modified to allow private parties to generate power. Private entities are allowed to participate in four types of activities related to the electricity sector. They are self-supply of electricity also known as inside-the-fence projects, projects that sell their output to the CFE under long-term power purchase agreements, cogeneration facilities and production of electricity for export to neighboring countries.

Most renewable energy projects developed to date have been either constructed and operated by the CFE or by private companies either as inside-the-fence facilities or with long-term output contracts with the CFE.

An independent generator may be able to enter into a 20-year power purchase agreement with the CFE. Such contracts are awarded through a competitive bidding process. The CFE is currently in the process of tendering for a 100-megawatt wind project in Oaxaca.

With respect to the self-supply or inside-the-fence regime, a project developer is permitted to build a power plant serving multiple offtakers who collectively own the power plant. Self suppliers must obtain a permit from the Energy Regulatory Commission, called the “CRE,” prior to commencing construction. Each of the project owners listed in the self-supply permit is entitled to take the share of electricity specified in the permit. The developer must enter into a separate interconnection and transmission contract with the CFE to connect the project to the grid.

The New Law

The two main objectives of the new law are to establish a comprehensive plan to promote the generation of electricity from renewable sources and to create the instruments for financing the transition to renewable energy.

The new law only applies to electricity that is generated from renewable sources, including wind, sunlight, water, geothermal steam or fluid, ocean currents and waves and biomass, and sold to the state-owned electricity distribution companies, the CFE and Compañia de Luz y Fueza del Centro (LFC). Large hydroelectric projects (greater than 30 megawatts) and nuclear plants are neither helped nor affected by the new statute.

The Energy Ministry is required to develop a national renewable energy plan and to establish a trust fund to provide financial assistance during the transition to renewable energy. The idea behind the plan is to give the CFE advance warning of the additions to the transmission grid that will be needed to move renewable energy from remote locations where wind is best or geothermal reservoirs are located to urban population centers.

The government is expected to set a specific minimum national content requirement for renewable energy projects and to coordinate with the Treasury to establish appropriate tax incentives.

The Energy Regulatory Commission will set tariffs or the prices that may be charged for renewable energy. The tariffs will be fixed over the term of each power purchase agreement, subject to adjustments for inflation and indexation methods formulated by CRE, and may not exceed 10% of the maximum tariff paid by the CFE to independent power producers for electricity from fossil fuels. Owners of renewable energy facilities operating under a self-supply permit will be allowed to sell any excess electricity to the CFE at a tariff to be determined by the CRE.

The government is determined to involve communities in planning for projects. Project developers are supposed to leave room for public participation in the planning stages and to earmark any income earned from the projects for regular lease payments to local communities and for implementation of social development programs.

Financing the Transition

The transition to renewable energy is to be supported by a trust fund that will be administered by a technical committee appointed by the Energy Ministry. The Energy Ministry is required to deposit a portion of its annual budget into the trust. Other funding for the trust may come from any carbon taxes imposed by the federal government, contributions by state and municipal governments, donations from international agencies, voluntary donations from citizens and proceeds from selling renewable energy bonds.

The trust will be used to support generation projects, rural electrification projects, the construction of transmission and interconnection infrastructure and biofuels plants. The trust is expected to engage in direct lending on preferential terms and provide loan guarantees. It may make grants in extraordinary circumstances for projects with significant environmental or socioeconomic benefits.

The Mexican government also plans to fund the trust through the sale of carbon credits and perhaps other strategies that are part of a broader effect to reduce greenhouse gas emissions. Renewable energy projects in Mexico are eligible for benefits under the “clean development mechanism” of the Kyoto protocol. The projects qualify for carbon credits that can be sold in international markets. It is possible that some of the proceeds from such sales may be channeled into the trust.

Details of the tariff structure, potential subsidies for renewable energy projects, tax incentives and a model power purchase agreement are expected to take form in the next 12 months. The Energy Ministry must establish the trust fund immediately. It has six months to submit a renewable energy plan to the president. It has eight months to publish regulations implementing the new law.

For centuries, the sun, wind and earth have played an important role in the daily life of Mexico. Aztec mythology is filled with references to Huitzilopochtli, the god of the sun, Ehecatl, the god of the winds, and Chantico, the goddess of volcanos, who, along with other deities, were responsible for creating and maintaining the life force of the Aztec universe. Modern-day Mexico is looking once again to these resources to produce energy of a different sort with the assistance of modern technology.