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PA OPINION

Challenges and opportunities of participating in Mexico’s new wholesale and resale electricity markets

During the 2018 Energy Mexico conference, I had the opportunity to present on the topic of “The New Architecture of the Mexican Electricity Market: Opportunities and Challenges for the Private Sector.” I focused my remarks on a few key areas including:

  • The current status of private sector participation
  • Issues in signing up qualified retail customers
  • Challenges to financing merchant generation
  • Lessons learned from deregulated electricity markets in other countries.

What follows is a summary of my remarks.

Overview

While some market participants are disappointed by the pace of deregulation, the time frame for the creation of the new market is rapid compared to the development of many other competitive electricity markets around the world. Lessons from other markets highlight both the interest of large load customers in leaving the incumbent utility and the potential financial challenges for suppliers.

Pace of deregulation

There is the potential for significant opportunities to participate in Mexico’s wholesale electricity market and to sell electricity to retail customers. While many of these opportunities are currently limited, the deregulated market is evolving rapidly. For example:

  • Figure 1 illustrates the number of generators registered in the market. However, these independent generators do not have a significant presence with respect to the amount of generation dispatched.
  • There are a number of qualified suppliers and registered qualified users but they represent a very small share of the approximately 30-35 percent of The Comisión Federal de Electricidad’s (CFE)—the state electric utility of Mexico—load that is entitled to switch to a qualified supplier.
  • As a result of the first three long-term auctions there is almost 1,800 MW and 20,000 GWH per year under contract primarily to CFE. In many ways, the contracts under the long-term auction are a variation on the old scheme where CFE conducted competitive procurements to purchase energy and capacity under long-term PPAs.

Figure 1: Market participants as of the end of 2017

Competing against CFE and the Basic Supply Rates

The five CFE generation companies that have been assigned legacy CFE assets have a mix of high and low cost generators. Most of these assets have been, and still are, contracted to CFE in its role as the basic supplier. As a potential competitor in the retail market, it is the supply assigned to the commercial and industrial Basic Supply that is critical. This mix is shown in Figure 2. For the next three years the fixed cost of the generation rate incorporates a number of high cost assets that will be recovered from non domestic customers. Many of these customers may choose alternative suppliers. Higher prices for Basic Supply, at least in the short run, will encourage customers to look at alternative suppliers. In the next decade, the Basic Supplier will not be responsible for recovering the fixed costs of the older inefficient and expensive thermal power plants. This should make the contracted generation mix more competitive with the private sector that will be entering the market with new generation.

Figure 2: Assignment of legacy generation to non-domestic basic supply customers

Retail opportunities

Figure 3 shows that the size of the market for customers with demands over 1 MW. This represents 25 - 30 percent of the retail market. When Qualified Users includes customers who can aggregate their loads to over 1 MW, the market is over one-third of retail sales. There are a number of challenges to capturing this large potential market including:

  • Forecasting the CFE Basic Supply generation costs: Up until December 2017 the CRE had not published the methodology and rates for the generation and associated administrative costs that make up the total tariff.
  • Customer expectations: The long-term auction has been published and the auction prices for energy are in the range of half of what wholesale electricity costs. This can create unrealistic customer expectations for low cost electricity.
  • Customer education: It takes time for customers to understand how the new market works, what services are supplied by CFE, and what services are supplied by the Qualified Supplier. In addition, the structure of the tariffs is also complex.
  • Risk aversion: Many potential customers are risk adverse and not willing to sign long-term contracts for electricity. This creates challenges for suppliers looking to finance new generation.

Figure 3: Size of the retail market

Challenges to financing new generation

There are different challenges for financing new generation associated with contracts awarded in the long term auctions and new generation without those contracts. The largest challenge for long-term auction winners that need project finance is the low prices bid for energy and CELs. The small margins create challenges to obtain capital in the financial markets. Merchant generation without long term contracts has different challenges, including:

  • Most retail customers are not willing to make a long-term commitment to buy energy so investors need to absorb market risk and must evaluate the pricing risk of the long-term value of energy and capacity.
  • Persistence of relatively high energy prices. The wholesale market prices are currently relatively high compared to the cost of generation with new efficient combined cycle plants as well as wind and solar power projects. There are differences in opinions regarding expectations for how rapidly margins will decline as new efficient generation enters the market and natural gas availability increases.
  • Financial tools used to manage that risk are only starting to develop in the market. These tools include counter-parties that are willing to sell hedges so that power plant developers can have more certainty on cash flow available to pay debt service.

Lessons learned

The time frame for the creation of the new competitive electric market is rapid compared to the development of many other competitive markets around the world. It is important to consider experiences in other markets. For example:

  • Figure 4 shows that it took years for the number of suppliers to grow significantly in Europe.
  • In the U.S. the number of suppliers is decreasing as there is market concentration. However, at the same time the migration of large consumers of electricity from the utility to competitive suppliers was very rapid. In many of the U.S. markets where customers can choose their suppliers, over 90 percent of the customers with peak demand over 1 MW have switched from the basic service offered by their utility.
  • While SENER and the CRE have made a significant effort to learn from other markets and create a market that works for Mexico, it is unrealistic to assume that the market rules will not change.
  • Niche players will find significant opportunities for specialized suppliers who offer energy management services in conjunction with selling electricity. Niche players will also find opportunities to build solar energy projects to serve small groups of customers.

Figure 4: 2017 pace of market entry in Europe

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