Mexico: Prepare to Launch
Is it still hurry up and wait or is the race to build new power projects finally underway in Mexico? New power market rules are expected in final form soon. The country revamped its electricity sector to great fanfare at the end of 2013. Raquel Bierzwinsky, a partner in the Chadbourne New York and Mexico City offices, and Sean McCoy, an international counsel in the Chadbourne Mexico City office, talked to Keith Martin about the potential opportunities in Mexico at the Chadbourne global energy & finance conference in June.
MR. MARTIN: Many of us in this audience have been following Mexico. We know the constitution was amended in late 2013 to open up the power sector to private competition. We also know that implementing legislation was finally enacted last year, but that is not enough because you still need guidelines to implement the implementing legislation. Sean McCoy, when are those guidelines expected?
MR. McCOY: This July, hopefully.
MR. MARTIN: You have a draft of them that came out in February, I believe.
MR. McCOY: Yes. A draft was issued in February by the Ministry of Energy and was published for public comment in an effort to improve the rules. The idea is to publish an official version after revising them to take into account the public comments.
MR. MARTIN: Let’s review the new opportunities that will be created for independent generators. I know you have written a fair amount about this over the last two years. I have pulled some of this out of your writings. Let me see if I have this straight. Independent generators will be able to sell electricity, but only at wholesale and basically to the CFE, the national utility. Is that correct, or can they also make retail sales?
MS. BIERZWINSKY: They will be able to make retail sales. The new legislation allows independent power producers to enter into bilateral power purchase agreements to sell electricity. The key point is that specific categories of consumers will be able to enter into PPAs. Consumers must have at least a minimum load before they can purchase from the market directly or enter bilateral PPAs. Beginning in August of this year, the minimum load is two megawatts. It will drop to one megawatt next year and, thereafter, the Ministry of Energy will determine whether that goes down further.
MR. MARTIN: So if a factory has at least a two-megawatt load, as of this August, it can enter into a direct contract with an independent generator to buy electricity. If it has at least a one-megawatt load, it can do so, but must wait until August 2016.
MS. BIERZWINSKY: That is correct.
MR. MARTIN: Are there any restrictions on the contract terms or can they be whatever the parties negotiate?
MS. BIERZWINSKY: They can be whatever the parties negotiate.
MR. MARTIN: What about the electricity price? Can it be whatever the parties work out?
MS. BIERZWINSKY: Yes, more or less whatever the parties work out on price. I think that the model will continue to be similar to what we have seen in the past, which will be based off the market price with perhaps some discount.
MR. MARTIN: There will also still be the option to sell electricity directly to the CFE. CENACE – the national independent system operator — plans to hold a capacity auction later this year. Sean McCoy, when is the auction expected? How much capacity do you expect to be up for auction?
MR. McCOY: The auctions are planned for October. How much capacity is not clear. Details remain to be worked out, but it is clear that CFE needs to replace 10,000 megawatts of existing capacity. The new generation will be mainly set up in central Mexico, which is one of the main industrial areas in the country. Basically, that is the main area in which new generating facilities are expected to be built.
MR. MARTIN: So 10,000 megawatts in total are expected to be auctioned, but some small increment of that will be this fall, perhaps in October. Do we know how long the power contracts with CFE will run?
MS. BIERZWINSKY: There are two options. There is a medium-term contract for gas-fired power plants, which right now under the rules is three years but we expect the final rules to set it at five years, and then there is a 10-year contract. We have heard from a lot of renewable energy developers in Mexico that they are not content with just 10-year PPAs. Obviously there is no fuel risk for them, so they would like to go to at least to 15 or 20 years, if possible.
MR. MARTIN: What if one wanted to build a merchant power plant? Is there a national power pool where this electricity can be sold?
MS. BIERZWINSKY: Yes. That is part of what is new in Mexico. There was no national power pool until the new legislation was enacted, so now there will be one. There is a newly-created independent system operator that will run a wholesale electricity market. That market will start operating for day-ahead sales on December 31, 2015 and for same-day sales on January 1, 2016.
MR. MARTIN: How confident are you the government will stick to these timelines?
MR. McCOY: That is the key question. The government is rethinking how fast it makes sense to implement the reforms, but it has stuck to all of its deadlines to date, and I believe the wholesale power pool will start operating next year as scheduled.
MS. BIERZWINSKY: I am pretty certain the government will stick to the timeline.
MR. MARTIN: So a high degree of confidence from both of you. Will private intermediaries be able to trade electricity?
MR. McCOY: Yes. That is the basic idea. Before the energy reform, there was only a state utility company, CFE. Now the idea is to increase the pool of suppliers in order to lower electricity rates.
MS. BIERZWINSKY: I think that is one of the great opportunities in the new market because no one has the experience or the technology currently to do this in Mexico. We have discussed this a lot internally. Whoever has that experience and can go to Mexico and do that successfully right now — not wait several years until the market is fully developed — will do well. If you are interested and able, I think this is the right time to offer those services in Mexico.
MR. MARTIN: The national grid will remain in government hands under a new agency called CENACE.
MR. McCOY: Yes.
MR. MARTIN: All independent generators will have to have an interconnection agreement with CENACE. How easy will it be to get such interconnection agreements?
MR. McCOY: The government published the rules for interconnection criteria last week. These rules cover both power plants and offtakers seeking to interconnect. The idea is to reduce the period of time by reducing from 20 to 10 the number of steps that will be required. The basic principle is open access to the grid.
MR. MARTIN: Will people connecting have to pay for network upgrades to the grid to accommodate the additional electricity?
MR. McCOY: Yes.
MR. MARTIN: Clean energy certificates, called CELs, will be handed out to generators who use clean energy sources. These can be bought and sold. Who needs them? Will the CFE have to turn in a certain number of them at the end of each year?
MS. BIERZWINSKY: The way the government has structured this is that offtakers who are able to purchase electricity directly from the electricity market will be obligated to purchase a certain percentage of clean energy certificates based on their aggregate loads. Thus, the independent generators who are issued the certificates will be able to sell them to offtakers or sell them in a market that is expected to develop for them.
The program has been designed this way to meet the Mexican policy goal of having at least 35% of electricity in Mexico produced from clean energy sources by 2024. The scope of what qualifies as clean energy is still being worked out. Renewables obviously qualify, but there is also talk of adding natural gas and possibly clean coal power plants.
MR. MARTIN: The certificates will be handed out starting when, and will they be given solely to new generators who come on line after that date?
MS. BIERZWINSKY: The certificates will be handed out starting on January 1, 2018. They will be issued to generators that come on line after the enactment of the laws last year and to existing generators that have built additional capacity based on clean energy sources.
MR. MARTIN: Here is my last question, and then we will let the audience ask some. We had a discussion earlier this morning about the potential for rooftop solar in Africa. The outlook there is a mixed bag at least until the regulatory regimes settle. What is the outlook for rooftop solar in Mexico, and has rooftop solar already taken hold?
MR. McCOY: It is a huge opportunity in Mexico. Obviously the country has lots of sunlight. It has taken a couple years for the utility-scale solar market to develop, and that market was set to boom until the reference price on offer from the CFE fell dramatically to a point where new projects are becoming harder to build. Rooftop solar will get the best traction with retail customers who pay the high-end tariffs for electricity. We have many industrial parks in this category with rooftops that are suitable for solar equipment.
MR. MARTIN: What is the business model in Mexico for rooftop solar? Is it third-party ownership where solar company retains ownership of the equipment and sells electricity to the owner of the building or leases the equipment to the owner of the building?
MS. BIERZWINSKY: This is still fairly new in Mexico, Keith. We are still working out the business model. The business model we have seen to date is the solar company retains ownership of the system — for example, we have seen this approach used for systems put on Walmart stores and carports — but it is not as well developed as here in the US or in other places.
MR. MARTIN: We have time for a few audience questions.
MR. DANIELS: Ed Daniels with Panda Power Funds. You mentioned the possibility of winning a power contract with a five-year term with the CFE in the October auction for gas-fired power plants. Do you know what the forward start is? Will the contract term start in 2017 or will it start further out?
MR. McCOY: The target is to have such contracts start in 2018.
MR. HUNT: Chris Hunt from Riverstone Holdings. I understand there is a prior system of grandfathered power purchase agreements for wind and solar generators and that there is actually quite a large number of such contracts representing potentially billions of dollars of grandfathered projects. Do you see those projects going forward or could the rules change such that many of those projects may not get built?
MS. BIERZWINSKY: There was a rush to apply for permits before the new law was enacted in August 2014. There are about 15,000 megawatts worth of applications. I do not see them all going forward. There is a specific requirement in the new law for grandfathered permits that requires those projects to have at least 30% of total project costs invested by December 31, 2016. Anyone who fails to reach this threshold will have his permit revoked.
MR. McCOY: Some of the developers are already struggling to reach the 30% target. A new trend we are seeing is for other developers to acquire the rights to these grandfathered projects in order to interconnect and bid into the CENACE auction expected in October.
MS. BIERZWINSKY: We have a very active M&A market currently in these projects. Some of the target entities either have applied for or already have grandfathered permits for what we call self-supply, meaning they are authorized to supply electricity to a group of offtakers directly under a contract with a term of 20 years.
MR. COOK: Ben Cook with SolarCity. You talked about the business model behind the meter for residential and commercial customers. You said rooftop solar will get the most traction with customers who pay the highest tariffs. I would be interested in your views about the rate-setting process and how political changes might affect it. How likely is the current rate structure to remain place in the medium to longer term?
MR. McCOY: That’s the rub because certain tariffs will be subject to political change as recently happened when tariffs dropped by 30%. However, the DAC — the acronym in Spanish for the domestic high consumption tariff — will remain a regulated tariff. Although this tariff is set by the government, it is least likely to change, because the government understands that manipulating it will disturb the open market rates. I foresee a really stable DAC tariff, and that is huge.