Mexico is running out of time to hit its ambitious goal of generating 30% of its power from clean sources by 2020. However, the 2013 energy reforms are starting to materialize, and we are witnessing a fundamental transformation of the Mexican power markets. Although many projects have been slow to hit meaningful milestones, 2017 looks to be the year when real progress will start to take hold.
The reforms affect everything from the day-ahead markets to transmission access rights and long and midterm wholesale power auctions.
The increased competition, innovation, industrialization and efficiency are creating opportunities for new participants to satisfy the growing demand for power in Mexico.
Interest in the wind and solar space in Mexico grew exponentially in 2016, and the trend is expected to continue in the short and medium terms. Projects are starting to move toward the finish line. That is not to say there are no hurdles to project development. Low power prices, transmission constraints and landowner issues persist.
In December 2013, Mexico enacted major constitutional reforms that completely transformed the energy landscape for the country by effectively ending state monopolies in power generation (among other things). Implementing legislation and regulations has created a legal regime that opens the door to increased foreign direct investment and has the potential to create a market-based system for power generation and sales. The most important laws, regulations and market participants are briefly described as follows:
Ley de la Industria Electrica (LIE). The so-called “Power Industry Law” established the new market model for the generation and commercialization of power. Even though the LIE opened the power sector to private participants, it reserved certain strategic functions for the government, including planning, regulation, control, transmission and distribution.
The LIE empowered two regulatory entities: the Comision Reguladora de Energia (CRE), in charge of regulating and supervising the energy industry; and the Centro Nacional de Control de Energia (CENACE), in charge of operating and maintaining the national power grid and the wholesale power market. The LIE also provided for the creation of the Certificados de Energias Limpias (CELs), or clean energy certificates, to promote the development of clean energy resources. In particular, one of the most important components of the new power market scheme in Mexico is the wholesale power market, whereby private parties can compete in the generation and commercialization of power. The wholesale power market is regulated by the CRE and operated/managed by CENACE, and it provides power generators and marketers with access to the national power grid through power auctions.
Ley de la Comision Federal de Electricidad (CFE). The “CFE Law” was modified to allow the CFE, Mexico’s state-owned power utility company, to establish a corporate structure that promotes efficiency, profitability and value creation.
Basically, the changes to the CFE Law were enacted to allow the CFE to adapt and compete in the new power market. Although some matters are still reserved for the state, as will be mentioned, the CFE has been charged with becoming a “productive enterprise,” concentrating on developing a commercially viable system capable of meeting growing demand for power.
Ley de Transicion Energetica (LTE). Mexico’s “Energy Transition Law” created guidelines to promote the development of sustainable energies, which primarily consist of a set of specific minimum clean energy generation goals to be achieved by 2018 (25% of power from clean energy), 2021 (30% of power from clean energy) and 2024 (35% of power from clean energy).
The LTE is a comprehensive legislation that will drive the energy policy in Mexico to ultimately reduce carbon emissions, promote the sustainable use of clean energy resources and increase energy efficiency. As part of this regulatory framework, the Mexican government created various plans, strategies and programs to promote the sustainable development of clean energy sources, including, among others, the National Development Plan, the Special Energy Transition Program, the Program for the Development of the National Power Grid, the National Program for the Sustainable Utilization of Energy, and the Guidelines for the wholesale power market, which provide clear financial and tax incentives to private power generators and marketers.
Notwithstanding these changes, wind power has one of the bright spots in the Mexican power industry, and multiple incentives have been implemented to spur development. The LIE, in particular, grandfathered certain favorable incentives for power projects approved before the energy reforms were enacted, allowing such projects to retain two attractive benefits: energy banking, which allows renewable projects to generate and dispatch power to the grid at any time and receive credit regardless of whether the power was taken by the off-takers; and postage stamp wheeling, which gives renewable power projects, frequently located in remote areas with limited grid access, the ability to pay a flat fee per megawatt of wheeled electricity, regardless of the location of the load points. Even though these grandfathered provisions granted important incentives to private investors, the changes brought by the energy reforms focus on promoting power development and a reduced reliance on fuel-oil-fired facilities.
The wind market
Wind power has been the fastest-growing clean energy sector in Mexico over the last five years and has become the second most important source of alternative power. Wind energy has also significantly outperformed all forms of renewable energy. At the end of 2015, Mexico had 32 producing wind power projects, which generated 8,745 GWh, a 36.08% increase year to year. Before the energy reforms in Mexico, power generation was subject to the CFE monopoly; however, small/medium power producers are now forecasted to generate 51.9% of the additional wind power by 2030.
2016 was an important year for wind energy in Mexico. In January, CENACE and the CRE opened the wholesale power market. Although there were some issues with the implementation, and purchasers were limited to the CFE and major industrial consumers, by the end of the year, the market seemed to have been functioning, and developers and third parties now have access to real-time sales information, demand, dispatch and scheduling. The system is similar to many independent system operators in the U.S. and provides for daily scheduling and dispatch of power over five regions throughout Mexico. In the first long-term wholesale power auction, wind power generation won rights to power purchase agreements (PPAs) linked to 394 MW of capacity – around 20% of the total 5.4 GWh annual allocation, at an average price of $55/MWh. Wind energy saw even better results in the second long-term wholesale power auction, in which 43% of the 8.9 TWh annual power supply and 41% of the associated CELs were awarded for wind power generation projects. According to auction estimates by the Energy Ministry, the second auction will equate to $4 billion in new projects in Mexico.
Several factors contributed to the aforementioned results, including increasing growth of power demand in Mexico, ambitious environmental goals, regional economic development, and certain tax and financial incentives provided by the local and federal governments. Some of the most enticing stimuli include accelerated depreciation (allowing investments in machinery and equipment for the energy production derived from renewable energy to be fully depreciated in a 12-month period), government loans, CELs, custom exemptions for imported equipment, and government grants for research and development of clean energy sources and technologies. In particular, CELs are considered one of the most innovative and important incentives in the Mexican model, as they allow parties to confirm their compliance with Mexico’s renewable energy targets, while simultaneously providing Mexico with an accelerated disposition of clean energy technologies.
Ultimately, the CEL scheme is expected to make Mexico more competitive in the global market as it seeks to diversify its domestic energy production, thereby increasing Mexico’s energy efficiency and enhancing its energy security.
Although development conditions were historically favorable in Mexico, the reforms from 2013 may yield mixed results for wind power in the short and medium terms. Solar power was the big winner in the first two wholesale auctions, driving prices per megawatt generated down to close to $34/MWh. Key utility-scale developers dominated the markets with substantial percentages, providing increasing pressure for smaller developers, many of which will likely look to other markets until pricing improves.
Further, the extreme devaluation of the peso versus the dollar will have material impacts on the overall profitability of projects. Key project components will have to be purchased in U.S. dollars and imported into Mexico. The fate of the North American Free Trade Agreement is unknown, and even if minimal tariffs are applied, purchasing in U.S. dollars for payment in Mexican pesos denominated PPAs could further limit returns in the near term.
Notwithstanding the hurdles the market faces, the Mexican government believes up to 35% of power can come from clean energy sources by 2024. In the short term, wind power capacity is scheduled to triple as new wind farms come online and additional capacity is auctioned. In the long term, wind power is poised to become a major element of the energy mix in Mexico, reaching 47,365.6 GWh by 2030 – a 350.2% increase over the next 15 years.
Wind developers hoping to access the market also believe that wind power will grow at an accelerated pace in Mexico and materially contribute to reaching Mexico’s ambitious energy transition goals. Developers are starting to focus on the less transmission-constrained areas, such as Oaxaca. We are also starting to see large landowners get involved in wind development, in some cases partnering with large foreign project developers, in order to avoid complications and delays that arise when dealing with agrarian communities.
Steve Otillar and John J. Marciano III are partners, and Eduardo Canales and Patrick Moneypenny are associates at law firm Akin Gump Strauss Hauer & Feld. They can be reached at email@example.com, firstname.lastname@example.org, email@example.com, and firstname.lastname@example.org.