Mexico Tees Up PPA Auctions

Mexico Tees Up PPA Auctions

November 12, 2015

Mexico will issue the first request for proposals and bidding guidelines on November 11 to bid on 15-year contracts to sell capacity and electricity from clean energy sources and on 20-year contracts for clean energy certificates, known as CELs.

The contracts will be awarded in an auction expected in the second quarter of 2016.

Clean energy sources are wind, solar, geothermal, hydro, and other forms of renewable energy plus nuclear, certain biofuels and efficient cogeneration, among others.

A separate request for proposals and bidding guidelines will follow in the third quarter of 2016 for an auction that will be open to all power suppliers to bid for three-year contracts to sell capacity and electricity from any sources.

Anyone interested in participating in the auctions will be required to post commitment guaranties, but will not need a permit to participate in the auctions and, in the case of a generator, it is not required to have built its power plant before the bid is submitted.

Anyone operating in the wholesale power market will have to post a separate performance guaranty.

New Market Rules

Mexico released long-awaited rules for operation of the new wholesale power market in September.

The new rules govern sales of electricity, capacity, ancillary services, financial transmission rights and clean energy certificates, among other products, and auctions will award medium- and long-term contracts.

There will be separate short-term markets for wholesale electricity, capacity, clean energy certificates and financial transmission rights.

Electricity may be sold wholesale initially into a day-ahead market (mercado del día en adelanto) or a real-time market (mercado de tiempo real). In the second phase of market evolution, an hour-ahead market (mercado de hora en adelanto) will be added.

Sales in the short-term market of energy and ancillary services will be based on locational marginal prices and ancillary services zonal prices. Virtual offers for power trading will not be permitted until the second phase of the market. Generating units assigned to the day-ahead market will not be subject to economic curtailment in its initial phase, but may be curtailed after the market moves into the second phase; however, they will be entitled to receive an income sufficiency guaranty.

For projects located outside of Mexico selling power into the Mexican market, only cross-border energy import and export transactions with fixed programming will be accepted in the initial phase of the day-ahead market, but after the market moves into the second phase, cross-border energy import and export transactions with fixed or dispatchable programming will be accepted in both the day-ahead market and the hour-ahead market.

In terms of pricing, all charges in the initial phase of the real-time market will be based on hourly measurement data, while in the second phase, charges will be calculated and paid for based on each dispatch interval.

The short-term capacity market will be for sales of capacity in annual increments and will focus on transactions to allocate capacity that was not allocated to, or covered by, purchase agreements (contratos de cobertura eléctrica). The capacity market will match offtakers and any other entities acquiring power (entidades responsables de carga) that were unable to sign contracts for their actual capacity requirements in the previous year, as well as generators that did not satisfy their contractual obligations during the same period of time, with offtakers who came up short or with generators that have excess capacity.

 The independent grid operator — CENACE — will operate a market for clean energy certificates where all offtakers can purchase CELs to satisfy their statutory purchase requirements. Briefly, Mexico is requiring certain market participants, including registered consumers with aggregate load points above a threshold set by the department of energy (two megawatts as of August 2015 and one megawatt as of August 2016), power suppliers and holders of grandfathered generation permits (that is, permits issued prior to publication of the new electric industry law) with load points with power consumption not entirely sourced from clean energy generators, to purchase, beginning on January 1, 2018, CELs representing at least 5% of their aggregate power consumption.

CENACE will also run auctions to allocate financial transmission rights, which are the marginal congestion component of locational marginal prices. These auctions will take place in the day-ahead market. Financial transmission rights do not grant a physical right to use the grid, but rather transfer the costs of congestion from one party to another. Basically, the holder of financial transmission rights is entitled to a portion of the income (or costs) resulting from the difference between marginal prices in the system. Financial transmission rights may be sold in the market for cash.

Upcoming Auctions

The main goal of the upcoming auction for 15-year contracts for energy and capacity and 20-year contracts for CELs, is for the state utility, CFE, to satisfy its requirements for any or all of the three products. Thus, most contracts awarded through the auction will be entered into with a CFE subsidiary as an offtaker.

After the first auction, participation will be broadened and private offtakers will also be permitted to participate, but the utility’s requirements will always have priority.

While bidders will not have to have a generation permit in hand when bidding, the permit will be required before the bidder can perform any contract it is awarded. Power plants operating under legacy permits will not be permitted to participate in the auctions, except where the power to be offered in the auction is generated by expansion capacity under a new generation permit.

The 15- and 20-year contract terms are meant to help generators finance projects, especially renewable energy projects given that, other than these long-term contracts and the sale of CELs, there are basically no tax or other type of incentives in place for the development of renewable power projects.

A key issue will be what the contracts awarded in these auctions say. The forms of contracts will be part of the package of bidding guidelines. This remains an item of concern for lenders and developers alike. Several lenders have said that they would like to see terms similar to those included in the CFE legacy contracts for independent power projects (including lender step-in rights and payment by CFE of all due obligations upon a CFE default, among other provisions). Lenders are familiar with these provisions and have relied on them to finance projects for the past two decades.

Pricing under contracts for the sale of power from clean energy sources will be based on the zones — called “generation zones” — where the offering power plants are located, thus transferring to the buyers the risk of congestion. Contracts for intermittent power sources, like wind and solar, will include hourly adjustments to take into account the value of energy based on the time of the day and month of the year during which it is produced. CENACE is expected to issue a table as part of the bidding guidelines for the clean energy auction, with the projected hourly adjustments for a 24-hour period, for each month of each year of the 15-year contract term. These adjustments will take into account seasonality. The table, once issued, will not be modified going forward.

Existing participants in the Mexican market and new entrants have eagerly awaited the publication of the request for proposals for the long-term auctions.

Winning bidders who are awarded contracts will have to have their projects in commercial operation by January 1 of the third calendar year following the date of the RFP, except that if the bids were received in the calendar year following the RFP, then the commercial operations deadline will be two years after bids were submitted. For example, for an RFP issued in November 2015, if bids are received by December 31, 2015, then commercial operations must begin no later than January 1, 2018. However, if bids are received in 2016, then commercial operations start by the two-year anniversary of the bid date. The rules allow bidders to select a different date for starting commercial operations that may be up to one year prior to, or two years after, the statutory commercial operations date.

Long-term auctions will take place annually or more frequently should a need arise or should SENER (the energy department) or the CFE request an interim auction from CENACE.

There are prequalification requirements for all interested parties and minimum offer requirements for all bids. Capacity offers must be for a minimum 5% of the capacity demand in the auction or, if less, 10 megawatts. An offer for CELs must be for a minimum of 5% of the aggregate demand in the auction or, if less, 20,000 CELs per year. Offers may be for bundled services. Offers for clean energy must identify the power plant units that will generate the power and the percentage of total output from the plant.

Bidders must specify whether they wish for payments to be indexed in Mexican pesos or US dollars, in which case the new rules provide both inflation and currency exchange adjustment mechanisms, but all payments will be in Mexican pesos.

Moving to the follow-on auction in late 2016 for three-year contracts that will be open to all generators, the energy or capacity offered must be available starting January 1 of the year after the auction took place. Offers for energy will be based on the zones where the load points are located, thereby passing to the sellers the risk of congestion, and will be required to indicate whether the offer is for base, intermediate or peak energy blocks. Offers for capacity will have to indicate a fixed annual capacity offered in a particular zone where the power plant is located, called a “capacity zone.”

The auctions for three-year contracts — called “medium-term auctions” — will take place annually or more frequently should a need arise or should SENER or the CFE request it from CENACE.

Guaranties

Anyone participating in any of the auctions must provide a commitment guaranty. For long-term auctions, the guaranty is a flat amount for all participants, plus a flat amount for each sale offer, plus an amount for each megawatt of capacity offered per year, plus an amount for each megawatt hour of clean energy offered per year, plus an amount for each CEL offered per year.

All amounts will be expressed as Mexican investment units or UDIs (unidades de inversión). The Mexican central bank publishes the UDI value in pesos for each day of the month in the official gazette. On the 10th day of each month, the central bank publishes the value of the UDI corresponding to days 11 through 25 of the relevant month and on the 25th day of each month, it publishes the value corresponding to the 26th day of that month through to the 10th day of the next month. The published value of the UDI for November 11, 2015 is 5.34 pesos.

If a power plant bidding in an auction is already in operation when the bid is submitted or has all the permits and equipment necessary for construction in time to meet the commercial operations deadline, then a smaller guaranty may be required. Commitment guaranties will be released after the auction or, if the bidder was a awarded a contract, once the contract is signed.

Wholesale market participants will also be required to post a performance guaranty in favor of CENACE to operate in the market. The amount of the performance guaranty will vary from one participant to the next. It will be based on the aggregate estimated potential liability of the participant in the market. The amounts will be updated by CENACE at least every 15 minutes. The government has released a “Market Manual for Performance Guaranties” that includes formulas for calculating the amounts. Market participants’ operations will be suspended immediately if the estimated potential liability exceeds the guaranteed amount.

Since the enactment of the new electric industry law in August 2014 and the restructuring of the Mexican power market, one of the key questions has been the creditworthiness of the CFE subsidiaries that will become market participants, including the subsidiary that will be the sole supplier of basic electricity services and thus the main offtaker under contracts awarded through medium and long-term auctions. The new wholesale market rules allow these entities to provide a guaranty from their parent — the CFE — that will make the CFE jointly and severally liable for their obligations as market participants, and to deliver a surety from the federal government for obligations owed to CENACE.

Private market participants will be able to post stand-by letters of credit as guaranties. The LCs may be issued by financial institutions that are on an approved list drawn up by CENACE and that have an agreement in place with CENACE that will allow quick and efficient drawing of funds. Market participants will also be permitted to post cash or financial instruments issued by the Mexican government.

A market participant may reduce the amount of its performance guaranty after a year based on its creditworthiness and its track record of performing.

Financial Transmission Rights

Financial transmission rights — or FTRs — will be available under three different scenarios.

Grandfathered FTRs (DFT legados) will be directly assigned, at no cost, to parties to grandfathered interconnection contracts, parties to transmission rights agreements and basic service suppliers. Parties to grandfathered interconnection contracts will be assigned FTRs so long as they have elected to migrate to an interconnection agreement under the new regime. If a party to a grandfathered interconnection contract chooses not to migrate, then the FTRs it would have received will be assigned instead to a unit of CFE that will serve as an intermediary (generador de intermediación) that will manage the FTRs on behalf of the party to the contract. The amount and term of FTRs assigned will be determined on a case-by-case basis, but the term may not go beyond the year 2035.

After all the grandfathered FTRs have been assigned, CENACE will auction FTRs for the remaining transmission capacity. During the first phase of the market, FTRs will only be available through annual auctions and for a period of one year. During the second phase of the market, auctions will award FTRs for three-year periods based on seasonality. There will also be monthly auctions to assign FTRs for the immediately following month and the remainder of the year.

Finally, if a market participant or a party to a grandfathered interconnection contract pays to expand transmission or distribution networks that are not included in the government’s expansion and modernization plans, then it will be entitled to FTRs that will be valid starting when the expanded network is put in service and for a period of 30 years.