Moving targets

For some time now, Mexico has been working to thoroughly diversify its energy matrix. One of the objectives of this endeavor is to move away from fossil fuels and increase the amount of renewable energy in its energy matrix. The reasons for these actions are twofold: (i) reduce CO2 emissions; and (ii) energy security. Historically, Mexico generated most of its electricity through power plants fed mainly by fuel oil and other petroleum by-products. The latter proved to be expensive, inefficient and not in accordance with international best practices. In addition, it created a great degree of energy insecurity. 

According to the Mexican government1, as of 2014, the energy generation matrix of Mexico was as follows:
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As a consequence of the actions undertaken by the Mexican government, CO2 emissions have been reduced and the price of electric energy has decreased as well, although this may also be a consequence of low prices of petroleum by-products, caused by a drop in the price of oil. 

Even though the effort to increase the amount of renewable energy has paid off partially, the Mexican government has ambitious goals. On 24 December 2015, the Energy Transition Law (the Law – Ley de Transición Energética) was published in the Federal Official Gazzete of the Federal Government of Mexico (Diario Oficial de la Federación). The Law has as an overall purpose to regulate the “sustainable enjoyment of energy, the obligations associated with clean energy and the reduction of pollutants by the electric energy industry”. In general, the Law provides guidelines to achieve the latter objectives. However, the Law does establish a clean energy participation (CEP) target for the years 2018, 2021 and 20242, as follows:
(graph)

In addition to its national clean energy target, Mexico has certain international obligations to reduce its greenhouse gases under the Conference of the Parties 21 (i.e., 2015 Paris Climate Conference). Amongst others, Mexico undertakes to unconditionally reduce greenhouse gases by 22 percent by 2030 and further reduce them by 36 percent, subject to the condition of having proper financing and technology. 

The national and international targets set by Mexico are aggressive. It is yet to be seen if the instruments created by the Mexican government will allow Mexico to meet the aforementioned targets.

ENERGY REFORM AND RENEWABLE ENERGY 

On 20 December 2013, the Mexican Federal Congress passed constitutional amendments that paved the way for a complete overhaul of the Mexican energy industry, both in the oil & gas and in the electric energy sectors. This article will focus on the electricity sector, with an emphasis on renewable energy. 

As way of background, before the constitutional reform, the electricity sector was dominated by the state. Generation, transmission and distribution were considered public services and only the state could provide such services. The state conducted such activities through a state owned entity – Comisión Federal de Electricidad or Federal Electricity Commission (CFE). Only in limited circumstances could a private party generate and sell electric energy. 

These circumstances where: (i) generation with the sole purpose to sell the electric energy to CFE; or (ii) generate and sell electric energy to the shareholders / equity holders of the generator (Self-Supply Power Projects – SSPP). Under SSPP, private generators entered into competition with CFE for large off-takers. As a consequence of CFE being inefficient, SSPP projects developed price formulas through which the off-taker ended up paying less to the SSPP project than to the CFE. 

In this context, renewable projects before the reform where highly attractive in Mexico. Even though Mexico did not have incentives as other countries had, CFE’s higher price allowed renewable developers to offer competitive prices to large off-takers (the pricing formula was usually very simple – a discount over CFE official tariff). This model worked well under a closely-held market. However, the energy reform modified the market and its assumptions.
The purpose of the constitutional reform was to move away from the state controlled model and liberalise the market. Under the new market structure, generation will not be considered as a public service (only transmission and distribution will), creating a wholesale electricity market (WEM) and industry players. Under the new structure, the WEM will be the “virtual” venue where electric energy, power and ancillary services and products (wheeling rights, clean energy certificates, etc) will be commercialised. 

Consequently, legislative and policy instruments have been issued to implement the same. In 2014, the Law of the Electric Industry (the EI Law – Ley de la Industria Eléctrica) and its regulations were published. These documents included a new instrument for the Mexican electricity market, which ought to increase clean energy participation in the Mexican energy matrix. This instrument is a clean energy certificate (CEC). CEC’s will be issued in favor of generators that produce clean4 energy. They will be traded in the WEM, or through bilateral transactions. The WEM Basis5 establishes in more detail the procedure for trading CEC’s in the WEM. 

Under the applicable regulation, suppliers, qualified users that participate in the WEM and other players will have to meet a clean energy obligation, which implies that the aforementioned market participants will need to meet a determinate percentage of clean energy consumption per year. Under the EI Law, the Executive has freedom to determine the clean energy obligation percentage that will need to be met by the applicable subjects. Consequently, the Ministry of Energy will set each year the applicable clean energy obligation percentage. For 2016 and 2017, the clean energy obligation percentage has been set at zero and for 2018 it has been set at 5 percent.

CONCLUSION 

The Mexican electricity market is new. The overhaul that occurred as a consequence of the constitutional reform is complex and investors are expectant as to the ability of the Mexican government to implement the new market structure successfully. The Mexican energy regulator (Comisión Reguladora de Energía) has been vested with new powers, enabling it to be a proper referee of the industry, with a new government-backed independent grid operator created to ensure open access to transmission and distribution networks and an efficient operation of the electricity market. However, it is yet to be seen how this new structure will operate and function. 

In the renewable energy realm, the horizon is filled with uncertainties. The prior regime (before the energy reform) provided a fair amount of certainty, with the underlying risks and market assumptions known by sponsors, developers and lenders. The risk profile in these types of projects was acceptable.

Now, renewable producers will face direct competition against cheaper energy sources, such as natural gas. Incentives exist, but they are limited. The clean energy obligation will help. However, the political risk of this incentive is perceived as high. An incentive such as this one is seen as an artificial creation of demand, which is not the preference of renewable developers, especially when the demand will be created by the Executive by setting the percentage of the clean energy obligation each year.

Even though an obligation exists in the Law to meet CEP targets, there are no real consequences for the government in case they are not met. Experience shows that CEP has increased in the last couple of years. But with said increase presented under different market and regulatory circumstances, it is yet to be seen how the renewable industry will develop under the new energy framework. 

Other incentives for the renewable industry exist – such as accelerated depreciation for renewable equipment and net metering type of arrangements – but these are only relevant in case the market has appetite for renewable projects.