October 8, 2019

There Is, In Fact, Life After Mexico’s Electricity Auctions

By José María Lujambio

At the end of January of this year, Mexico’s National Energy Control Center (“CENACE” for its acronym in Spanish) decided to cancel the fourth long-term auction that would have allowed CFE Basic Services Suppliers and other interested suppliers to acquire electricity, capacity and clean energy certificates (“CEL,” for its acronym in Spanish) at the wholesale level. This decision hit the national energy sector, particularly those companies that develop power plants, like a bucket of cold water.

 

The decision was directed by the Secretary of Energy and motivated by the current prevailing ideological rejection by the new Mexican federal administration of the generation of electricity by private companies, particularly foreign companies. It did not matter that the Electric Industry Law explicitly provides that auctions organized by CENACE are the only means by which basic suppliers may enter into electricity hedge contracts. Nor did it seem to matter that lower prices were obtained in each of the three prior auctions, owing primarily to fierce competition. This was particularly true in the third auction, in which an average unit price of $20.57 dollars was achieved for the package of electricity and CEL, with a minimum of $17.70 dollars, which broke the prior world record low price. The government also ignored the fact that the more than 60 power plants with assigned contracts will create up to 200,000 direct and indirect jobs and approximately $60 billion dollars in investments over the next 15 years.

 

In the midst of this landscape, and after a few perplexing months of uncertainty, the electricity industry has reacted with creativity and optimism. The fact that the Mexican government has sought not to organize the electricity auctions, which it is obligated to hold, has not prevented other players from organizing similar competitive processes. Demand will continue to grow as the economy grows, and generation companies are still eager to meet such demand, despite all that has taken place recently.

 

For example, consultants from Bravos Energía, who are the talented former public servants who designed the wholesale electricity market during the prior administration, have put on the table a long-term electricity “contest” so that various load serving entities can acquire electricity, capacity and CEL by means of contracts for 5, 10 or 15 years. Their proposal features the participation of a clearinghouse, as well as interesting ideas to address the risks of congestion and deviations in renewable generation.  The contest was announced in June, at an event where more than 200 people attended. Organizers and stakeholders agree that one of the challenges will be to convince a significant number of qualified end users to take advantage of the supply that results from this contest.

 

In recent years, energy trading giant Vitol has shown interest in becoming a major player in the Mexican electricity market through its active participation in organizations such as the Energy Traders Association (“ACE,” by its Spanish acronym) and by recruiting high-level local talent.  Earlier this month, Vitol held an event to present its long-term “private procurement process,” with the support of the EY consulting firm. Expectations are that the confidence inspired by this large company’s actions will encourage developers to try to sell their products by means of this new mechanism, and that Vitol, as a non-supply marketer, will consolidate itself as a major supply aggregator that brings liquidity to the market and uses contracts with independent qualified suppliers to serve end users.

 

Additionally, despite enormous challenges in achieving agreements negotiated directly and freely between generators and suppliers, there have already been several instances of successful negotiations.  Undoubtedly, the struggle is to balance the generators’ and the suppliers’ needs for long-term contracts, with the end users’ preference not to commit for a long time period, as well as mitigating credit risks of all parties involved. 

 

Finally, several companies are exploring the opportunities of isolated supply and its sister figure, local generation, to develop projects that can, based on their scale, continue to meet their desired returns, without having to go through the market. These “behind-the-fence” or “behind-the-meter” solutions result in what could be compared to a marriage between the generator and the end user, with the advantages and disadvantages that such a relationship involves.

 

One hopes that the government will soon reconsider and understand that no corruption has occurred in prior electricity auctions and that if some projects resulting from such procedures have not been able to materialize, the rules can be perfected so that only the most serious and advanced projects win.  CFE cannot afford to discard an instrument that allows it to achieve cheap and clean energy, which is exactly what the people of Mexico desire. Meanwhile, as you can see from the discussion above, life goes on after the auctions, especially for those parties who in good faith desire to invest in Mexico’s growing electricity sector.