Reforms, liberalisation open Mexico's energy sector to private investment and emphasise clean, sustainable energy

Historically, Mexico is an energy powerhouse, one of the world’s most important crude oil producers, and highly dependent on those exports for economic growth, foreign currency and government revenues. At 5.2% of GDP in 2015, however, oil and gas extraction account for a smaller share of the national economy than at any time in recent history, down from about twice that level in the mid-nineties.

A number of factors are at play here, including a decade of declines in oil production, low oil prices and relatively stronger growth in other sectors, notably manufacturing. At the same time the reduction in oil revenues coupled with a boost to government coffers as a result of significant 2014 tax reforms mean that the country is less fiscally dependent on the energy sector than at any time in decades. In 2015 oil accounted for just 13% of total government revenues, down from 37.6% as recently as 2012 and below the previous low of 14.2% in 2002.

As for foreign currency, fuels accounted for only 6% of merchandise exports in 2015, according to the World Bank, down from 17.4% as recently as 2008. In fact, Mexico became a net importer of hydrocarbons in mid-2015, with a negative balance of -0.9% of GDP for the whole year, which the IMF at that time projected would deteriorate further to -1.1% and -1.5% of GDP in 2016 and 2017, respectively. By 2016 Mexico depended on imports for more than a third of its natural gas, half of its fuel and more than 70% of its petrochemicals needs.

Sector Shake-Up

Mexico’s energy sector has been undergoing a profound paradigm shift since a reform programme, launched in 2013, put an end to state monopolies in most sub-sectors and began the process of opening the production and distribution of oil, gas, petrochemicals and electricity to private investment. In parallel, the entire legal, regulatory and institutional framework is being transformed to oversee new market mechanisms. Ernesto Marcos Giacoman, president of energy consulting firm Marcos y Asociados, told OBG, “These reforms are fundamental to the long-term success of the sector. The next government needs to continue the implementation and make efforts to streamline the regulatory framework to ensure investment keeps flowing.”

The fruits of these efforts became more apparent in 2016, when a number of notable developments took place, including two successful long-term electricity supply auctions and a deepwater oil and gas auction for exploration and production in December 2016 (see analysis). A significant challenge going forward will be to ensure that infrastructure is of sufficient quantity and quality for the entire country to benefit from the reform efforts.

Oil Production Decline

From peak crude oil production of 3.5m barrels per day (bpd) in 2004, Mexico’s output has been in steady decline ever since, reaching 2.1m bpd in 2016. Despite the opening up of the country’s hydrocarbons reserves to exploration and exploitation by private companies through successive licensing rounds, these projects are not yet at the production stage, meaning nearly 100% of national oil and gas production is still in the hands of state-owned Petróleos Mexicanos (Pemex). The drop in oil production has seen Pemex move from being the third-biggest oil producer in the world in 2004 to the eighth-biggest by 2015.

Pemex still has some 22.2bn barrels of proved, probable and possible – 3P – reserves, despite the farming out of oil reserves, but has faced increasing challenges in exploiting them, as production from older and easier-to-extract wells continues to decline while financial circumstances have meant that Pemex has had to scale back the investment needed to bring new production on-line. The Cantarell field is a key example of the current production decline. Discovered in 1976 the field is still one of the largest in the world, and is by far the largest in Mexico in terms of cumulative production to date. In 2004 the Cantarell field alone accounted for 2.1m bpd of production, but this had declined to about 200,000 bpd by 2016, according to data provided by Pemex.

While production at the national oil producer’s other fields has increased by more than half since 2004, this has not been enough to prevent an overall decline. For Pemex to boost production, it will need to invest in new technologies, such as enhanced oil recovery, to improve extraction at older fields, including Cantarell, while also stepping up investment in exploration and production at new locations. This is something that can be helped by the continuing liberalisation of the sector, as oil recovery will be enhanced by the technology international companies bring on board, boosting production levels.

Pemex is targeting oil production of 1.94m bpd in 2017, using its naturally occurring decline in production to participate in the first agreement on production levels between members and non-members of the Organisation of Petroleum Exporting Countries since 2001, but without instigating significant operational change. In fact, the natural production decline is likely to be greater than the 100,000-bpd reduction Mexico signed up to as part of the agreement.

Risks & Restructuring

Net losses and debts have been mounting at Pemex since 2010. In 2015 the firm’s net losses more than doubled from the previous year to reach $45bn, as sales fell from $118bn to $74bn over the same period. By the end of June 2016 the producer’s net financial position had deteriorated to a loss of $80bn. With sovereign debt also increasing rapidly in recent years, there is limited scope for public finances to continue shouldering the burden without putting its sovereign rating at risk. Losses of $10bn reported in third quarter of 2016 further underlined the urgency of the situation.

In the face of these challenges, Pemex has already put in place a wide-ranging austerity programme, shedding senior corporate positions and rationalising its future pension liabilities.

The company’s financial difficulties have undermined its ability to invest in productive assets and exploration and production, which further harms its ability to generate future revenues. Capital expenditure by Pemex has decreased from a high of $20.5bn in 2014 to just $8.7bn in 2015, with only a marginal increase to $9.4bn forecast for 2017. This is in line with reductions in investment by many leading international oil companies in light of the prevailing low oil prices. In total, Pemex has made a budget adjustment of MXN100bn ($6bn), or about 20% .

Aside from the challenges posed by restructuring, the company is also tackling a sustained loss in revenue due to organised crime. According to local press reports, which cited a recent study by independent energy security consultant Dwight Dyer, between 2012 and 2016 fuel theft cost Pemex a total of MXN97m ($5.8m). Furthermore, it is estimated that the producer loses up to 900,000 barrels every three months in this fashion. Putting a stop to systematic criminal activity will require a coordinated effort by local and federal authorities as well as improved security mechanisms from designers and constructors to assure safe and efficient transport of fuel.

New Business Plan

With its sights set on a return to profitability and strategic reorganisation, in November 2016 Pemex launched a business plan for the 2017-21 period. The company expects a recovery in production to begin in 2018 and is targeting production of just over 2m bpd in that year, rising to 2.2m bpd by 2021. Pemex is aiming for a financial surplus in 2017, its first since 2012, assuming average oil prices of $48 per barrel and production of 1.94m bpd. It is expected that achieving this will put the company’s net consolidated debt on a downward trajectory.

Farmouts

Given Pemex’s challenging financial position and recent cutbacks in capital expenditures, it will increasingly need to partner with private firms to raise the financing required to meet its goals and benefit from the know-how of its partners in areas of non-conventional extraction like deepwater and shale, where it does not yet have much experience.

The first such partnership, or farmout arrangement, undertaken by the national producer was announced as part of the fourth phase of the first licensing round in December 2016 (see analysis). The deal will see Pemex team up with Australia’s BHP Billiton to develop the Trion deepwater field in the Gulf of Mexico. Trion, discovered in 2012, is expected to contain around 485m barrels of reserves and will cost around $11bn to develop and $7.5bn in capital expenditure, according to local media reports. BHP’s winning bid, at $624m, earned it a 60% stake in the project.

The Trion field is seen as important both as a price reference point for future deals and as a first step towards an ambitious farmout programme that could ultimately total several hundred contracts. For the 2017-18 period alone, as covered by Pemex’s new business plan, some 167 fields or assignments are expected. The company expects these arrangements to help increase production by approximately 15% compared to what has been envisaged, with the resulting additional revenues to be shared between Pemex and the federal government.

Finance Models

Another source of funding for Pemex’s capital investment programme could be the monetisation of its more mature assets through a new type of investment trust called fideicomiso de inversión en energía e infraestructura, or FIBRA E, modelled on those commonly seen in the real estate sector. By developing investment trusts in energy and infrastructure the sector could free up resources for higher risk but potentially lucrative exploration and production activities in newer fields (see analysis).

Private Interest Upstream

Starting in 2017 and gaining momentum in 2018 will be the first production of oil and gas by private firms subsequent to the awarding of contracts in the first three phases of licensing Round 1, which began in 2015. The fields likely to produce oil first in this category are those onshore fields awarded in the third phase, followed by the shallow-water fields from the first and second phase. The deepwater reserves allocated in the fourth phase are more speculative in nature, with production not likely before the mid-2020s.

Oil Refining

Mexico’s oil refining capacity stands at approximately 1.6bn bpd, all operated by Pemex, but its capacity utilisation has been in steady decline since the early stages of 2010, falling as low as 50% by August of 2016. This is the result of years of underinvestment in both new and existing refineries. In December 2015 Pemex announced a $23bn, three-year plan to upgrade its existing refineries, but these have yet to have a positive significant impact on either capacity or utilisation rates.

Strong Trade Links

With domestic refining on the wane, imports of petrol and other refined products have increased significantly, with imports of petrol from the US reaching a new peak of over 400,000 bpd by late 2016. In spite of potential political challenges in 2017 a close trading relationship between the two countries is expected to continue, according to Ivan Sandrea, CEO of Sierra Oil and Gas, who told OBG, “There is such interconnectivity and self reliance between the two neighbours in terms of energy trade, it will be against common interest to reduce energy trade or affect the economics of projects. Mexico’s import need is highly beneficial to the US, as the strong demand captures excess supply from the US; similarly, refineries in the US are reliant on certain crudes produced by Mexico.” As such, Mexico now accounts for more than half of US petrol exports. Because refineries across the border in the US are far more efficient, many analysts believe that it makes sense to keep importing rather than to make the heavy investments needed to further expand refining capacity. However, this would mean that the cost of retail petrol would become increasingly dependent on the exchange rate as well as transport costs.

Downstream

Over the course of 2017 Mexico is progressively liberalising its retail markets for combustibles, starting with regions near the US border – which are more saturated with distributors, and where infrastructure is more developed – and moving south. It is expected that almost all regions will have competitive markets by the end of 2017.

In line with the energy reform and in response to a stronger US dollar, authorities announced in late December 2016 that national reference prices for petrol were to be increased by 20%, thereby aligning them more closely with international petrol market prices. This sudden hike in January 2017 sparked a wave of protests known as gasolinazo, with blockaded highways and looting seen across the country. Moreover, from February 2017 references began to be updated on a fortnightly basis, and subsequently daily.

One major challenge to the successful implementation of these price liberalisation efforts will be to ensure sufficient infrastructure is put in place over the longer term. Gas stations in areas of relatively low saturation will be important to maintain competition in local markets, while there is likely to be demand for new pipelines for the transport of combustibles since this is a far more efficient mode than the road-based tankers that currently predominate.

As an initial step to encourage competition, from 2017 Pemex will be required to allow other operators to bid for the spare capacity in its pipeline network, as part of the so-called temporada abierta (open season). Towards the end of 2016 there were indications of strong appetite among potential players in downstream segments as more than 400 import permits had been sought, equivalent to around twice the annual consumption needs (see analysis).

The Role Of Gas

Gas has become an increasingly important feature of Mexico’s energy mix in recent years, even as domestic production has fallen, a trend that is expected to continue over the medium term. Gas has been in demand by the country’s energy-hungry manufacturing sector and particularly by the Federal Electricity Commission (Comisión Federal de Electricidad, CFE), the state-owned electric utility, which has been switching from fuel oil to gas-fired, combined-cycle plants for electricity generation. In fact, fuel oil is being phased out completely for this purpose by 2020. With production in decline, imports have been playing an increasingly important role in gas consumption through liquefied natural gas (LNG) and, in particular, less costly shale gas piped directly from the Eagle Ford region of Texas in the US. This shift requires substantial increases in investment in new pipeline infrastructure (see analysis).

Petrochemicals

Oil and gas are the feedstock of the petrochemicals industry, which produces plastics, industrial chemicals and other derived products. Despite being a big producer of oil and gas, Mexico has a large and growing negative trade balance in petrochemicals, reaching $14.7bn in 2015. While the sector has been at least partly open to private investment since 1992, it has been stagnant for much of the past two decades. However, market observers think this could be about to change, as a recovery in oil production and improved access to inexpensive, imported natural gas leads to better feedstock availability, while the switch to cheaper gas-fired and renewable electricity generation can reduce the cost of the sector’s other most important input.

An important milestone project in this regard was the Etileno XXI plant, built in Veracruz state on the east coast by a consortium led by the Brazilian firm Braskem in partnership with Mexico’s Idesa Group. This $5.2bn project to supply more than 1.1m tonnes of polyethylene per year to the local market, was the first major private sector petrochemicals investment since the 1990s and, according to the International Finance Corporation, which part-financed the plant, it is the sector’s biggest ever project-financing transaction in the Americas. The plant opened in April 2016, with Pemex awarded the 20-year contract to supply it with ethane. However, concerns have arisen during 2016 that there is insufficient ethane to meet the needs of all existing and planned projects in the country.

Growing Electricity Demand

Electricity consumption in Mexico reached 288,232 GWh in 2015, up 2.9% from the previous year, while gross generation was 309,553 GWh, up 2.7%, according to an “Energy Alert” report by professional services firm EY. Demand for power is expected to grow steadily at a rate of about 3.7% per year over the medium term, while the latest “Mexico Energy Outlook” report from the International Energy Agency (IEA) published in October 2016 projects that total energy demand will increase by 85% by 2040.

According to data provided to EY by the Ministry of Energy, 55.1% of Mexico’s gross generation in 2015 was operated by CFE, 28.8% by independent power producers, 7.8% was self-supplied and 5.1% was accounted for by cogeneration. A total of 71.7% of the country’s generation capacity comes from conventional sources, while the remaining 28.3% is supplied by clean energy. However, due to the intermittent nature of many sources of renewable energy, conventional sources accounted for 80% of generation in 2015, with renewables accounting for the remaining 20%.

The share of renewables in generation is expected to double to 41% by 2030, as the absolute amount of power generated from conventional sources is forecast to increase only modestly during this period. Overall, increased demand coupled with the necessity of replacing plants approaching the end of their lifespan means that in addition to the current total installed capacity of 70 GW, the country will require another 120 GW by 2040, according to the IEA.

As well as increasing moves towards renewable energy sources, an important shift is under way within Mexico’s conventional power generation mix, as the government aims to effectively phase out oil-fired plants completely by 2020. Much of this shift involves changing over to natural gas-fired plants, utilising cleaner and cheaper fuel.

This transition has accelerated dramatically in recent years, as the shale revolution in the US has served to drive down prices while Mexico has invested significant funds in expanding its pipeline network in order to import gas directly from the US rather than, for example, importing Peruvian LNG through its terminal at the Port of Manzanillo on the Pacific coast, as it has done in the past.

Wide Supply

Electricity supply is generally available, with the national grid covering nearly 98.5% of the country. There are no generalised structural problems with blackouts or brownouts, for example, although the relative isolation of Baja California, which operates on a different grid to the rest of the country, leads to much higher electricity prices in that region, as well as occasional supply shortages. The authorities are looking to micro-generation projects to fill the remaining gaps in the national grid, as this is seen as a more efficient option than connecting very isolated small communities to the grid itself. To this end, a MXN12bn ($723.2m) Universal Electric Service Fund was established in 2016 to develop local grids and install solar panels in communities. The target is to cover 99.8% of the population by 2021 by bringing power to an extra 1.5m homes over this period.

Cross-Border Trade In Electricity

The Mexican grid is integrated across its northern border with the US, and Belize and Guatemala to the south. This facilitates a small amount of cross-border trade in electricity. For example, Mexico imports some of its power needs directly from Texas, while it is a net exporter to California and Belize. With the development of renewable power sources in the south of the country, as well as the necessary accompanying transmission infrastructure, discussions are under way about ramping up exports to the country’s southern neighbours from its current level of around 50 MW to approximately 150 MW.

Prices On The Rise

Traditionally, retail electricity prices were set by the Ministry of Finance and Public Credit (Secretaría de Hacienda y Crédito Público, SHCP). From early 2017, however, pricing will be determined in the first instance by the Energy Regulatory Commission (Comisión Reguladora de Energía, CRE), based on the cost of generation and transmission. SHCP will then decide on the level of subsidies, which will determine the price that CFE and smaller distributors charge to consumers. The authorities aim to phase out subsidies, except for the most marginalised of populations, over a number of years. This move could result in accelerated price increases for commercial and household consumers during 2017. Already, the price of natural gas has risen significantly, with year-on-year costs growing by a total of 77% in December 2016. The price of imported coal also increased by around 73% in the same period.

In addition, the authorities’ increase in the reference cost of combustibles by 20% in January 2017 will add further to generation costs. For example, from January 1, 2017 CFE increased prices for industrial consumers by 3.2% to 4.5% and for commercial consumers by 2.6% to 3.4%, although the price at which the majority of households get their electricity increased by only 2.4%. Prices also differ significantly across Mexico’s regions, with average electricity costs often double the national average in the isolated state of Baja California and 1.5 times the national average in the Yucatán Peninsula.

Wholesale Market

When the wholesale power market opened at the beginning of 2016 electricity was trading at an average price of $19.21 per MWh and ranged between $48 per MWh and $60 per MWh in the majority of locations during the first six months of operation. In regions of the country bordering the US, where imports of electricity are possible, prices during the first half of 2016 were comparable to those in the US, at an estimated $23 per MWh. Meanwhile, prices in Baja and Yucatán continue to trade significantly higher, given their isolation from the national grid and lack of available options for generating or importing electricity at a low cost.

Taking Stock Of Reform

Speaking at the launch of the IEA’s most recent “Energy Outlook” report for Mexico, published in October 2016, Fatih Birol, the organisation’s executive director said, “This is not a reform, it is a revolution on an unprecedented scale. This transformation touches every sector of the Mexican energy industry and goes well beyond.”

The IEA’s report compared its forecasts for the country’s energy sector up to 2040 to a scenario in which the reforms had not taken place. The organisation estimates that without reform, oil production in 2040 would have amounted to just 2.3m bpd, compared to their current projection of 3.4m bpd. This is largely due to the extra capital expected to become available for upstream investment over the coming two decades on the back of reforms already implemented, without which production from deepwater oil fields, in particular, would be far lower. In dollar terms, the reforms are estimated to generate an extra $260bn in upstream investment and an extra $650bn in oil production up to 2040.

In the power sector, without the reforms there would also be less investment in clean energy than is now expected to take place. This would have meant the target of 41% clean energy by 2035 would be missed, while CO emissions from the power sector would be 20% higher by 2040. In addition, electricity prices for industrial users would be 14% higher by 2040 if the energy reform had not been implemented, while the cost of generating and delivering power to residential clients would be 16% higher, implying an extra $50bn in subsidies by 2040.

Meanwhile, estimates of the economic impact of the energy reforms on the wider economy have varied, but are nonetheless significantly positive. For example, an IMF working paper, which was published in February 2015, measured the reform’s impact on the country’s manufacturing sector through changing energy prices and found that reduced electricity tariffs would have a particularly positive impact. The IMF paper estimated that the overall impact of the reform would see a 3.6% increase in manufacturing output and a 0.6% increase in GDP.

The economic impact would be significantly greater if increased service sector output and technology spillovers from higher foreign direct investment in the oil and gas sector were also taken into account. For its part, the IEA estimated that GDP would be around $100bn – or 4% – lower by 2040 without the energy reform, implying a cumulative loss of GDP of $1trn over that period.

Reacting to the publication of the IEA’s report, Pedro Joaquín Coldwell, the minister of energy, asserted that it “motivates us to continue in the path traced by the energy reform and to double our efforts. The challenge for Mexico is to turn into reality the positive predictions.” Clearly, the implementation of such a revolutionary reform will not be without its challenges – as evidenced notably in early 2017 by widespread public protests at the increase in the price of combustibles ahead of market liberalisation – but the country’s current administration, led by President Enrique Peña Nieto, has been praised for advancing so far in such a short space of time.

Cfe Restructuring

To adapt to the new competitive market landscape CFE is undergoing significant restructuring. What was for seven decades a vertically and horizontally integrated state monopoly is now being unbundled into independent companies responsible for generation, transmission, distribution and commercialisation. For the purposes of generation, it is also being split horizontally into six companies along regional and functional lines. All subsidiaries will remain under the control of a central holding company. The unbundling process is expected to be finalised sometime during 2017.

Tackling Climate Change

Building on a non-binding pledge made at the COP15 UN Conference on Climate Change in Copenhagen in 2009, in 2012 Mexico adopted its climate change law, targeting a 50% reduction in carbon emissions by 2050 and an interim 30% reduction by 2020. Mexico was one of the first countries to sign up for the Paris Agreement at COP21 in 2015, ratifying it in September 2016. Under the agreement, the country is committed to reducing greenhouse gas emissions by 22% and black carbon emissions by 51% by 2030 compared to usual levels. It also targets a peak for net emissions in 2026, and a reduction of 40% in emissions per unit of GDP between the years 2013 and 2030.

A carbon tax was introduced in 2014 applying to the use of fossil fuels. With an initial price of $3.50 per tonne of CO , it targeted raising $1bn in revenues. However, the CRE still considers that insufficient activity has taken place to ascertain whether the measure has been a success. In November 2016 the country launched a pilot carbon-pricing programme, with up to 60 companies volunteering to participate. The programme is being run on a trial basis for 12 months, with a view to establishing a national market for carbon emissions in 2018.

Other recent and planned measures that will contribute towards the planned carbon emission reduction targets include the liberalisation of petrol and diesel prices and the phasing out of subsidies on electricity and combustibles.

Renewables

Domestically, the authorities are targeting a long-term goal of 50% clean energy generation by 2050, while interim targets were written into the 2015 Energy Transition Law that would see clean energy account for 25% of total power generation by 2018, 30% by 2021 and 35% by 2024.

Given installed renewable capacity of 19.3 GW in 2015, this implies that up to 29 GW of renewable capacity will need to be installed by 2024, with the government having set an interim target of 9.5 GW by 2018. Meanwhile, according to the IEA, more than half of the 120 GW in new power generation capacity expected to be installed by 2040 will be accounted for by renewables. This represents an ambitious acceleration in the country’s shift to clean energy.

Although Mexico’s energy market was closed for eight decades, with prices for consumers still subsidised, the shift to renewables is coming about largely through the application of market mechanisms. “Many countries that lead the way in renewables, such as Spain, have created very successful domestic markets in green energy,” Jonathan Davis Arzac, chairman of Macquarie Infrastructure and Real Assets, told OBG. “However, they are largely government-led and heavily subsidised. Here in Mexico the sector has grown organically without the need for government help and financial incentives.” While the governments of the US, Canada and Mexico have created the North American Climate, Clean Energy and Environment Partnership in July 2016 to collectively strive for 50% clean power generation by 2050, some claim Mexico’s economic status still constitutes a significant barrier to the adoption of clean energy. Ricardo Cardiel, CEO of power generation business development firm Latin American Rainmakers, told OBG, “The initial cost of implementing green energy is the primary obstacle to increasing its uptake. Mexico is still an emerging market, so green energy isn’t a top priority for many companies or individuals. Tariffs play a fundamental role in the dynamics of the energy market. International investment funds are seeing Mexico as a potential place to go, that’s the positive of this stage.”

Clean Energy Auctions

The first two long-term power supply auctions, which took place in 2016 (see analysis), proved highly successful, with competitive bidding driving down prices per MWh for clean energy to a low of $33.50 in the second auction, held in September 2016. The auctions generated investment from 23 national and international companies, and with the third auction scheduled for October 16, 2017 expectations are high for the government to secure $6.6bn of investment in the sector by 2019, according to local media reports. These are among the most competitive prices for renewable power in the world and signal a strong appetite by investors to enter the market as well as a significant reduction in the cost of renewable technologies. The auctions were dominated by solar photovoltaic and wind projects proposed by private companies, while CFE also proposed a small-scale geothermal project. In a conversation with OBG, Felipe Salazar, director-general at renewable energy company Alten Energías Renovables – one of the successful bidders – explained that, “In terms of geography, Mexico has a wide variety of opportunities for the development of solar and wind power projects. The lack of investment previously from CFE followed by the liberalisation of the sector means that the time is now ripe for investment. For instance, there is a substantial level of interest in the Bajío region, with its extensive infrastructure, cool climate and high altitude making it ideal for the use of solar panels.”

Geothermal

Given the country’s large geothermal reserves, this source can be expected to play an increasingly important role in generation over the longer term, building on its share in the energy mix of 2% in 2015. In fact, Mexico has the fourth-largest geothermal reserves in the world – after the US, the Philippines and Indonesia – and is already the fourth-largest producer. Passage of the Geothermal Energy Law in 2015 has fostered a 50% increase in the number of geothermal concessions to six, while a further 15 permits were at the survey stage and six more requests were in the pipeline as of June 2016.

September 2016 also saw the publication of a manual for distributed generation systems; small renewable energy projects of less than 0.5 MW, involving an entity that is both producer and consumer.

The government has signalled its intention to begin to shift from a net-metering to a net-billing system, which essentially means that small-scale producers, rather than having their surplus energy virtually stored in the grid for later use, will be equipped with two meters – one for consumption and one for production. This will allow them to sell surplus energy to CFE on an ongoing basis. This development is expected to be of particular benefit to larger generators and is expected to lead to double-digit growth in total installed capacity from around 85 MW in 2016.

Connectivity

In the medium term, an important challenge facing the authorities is to develop infrastructure to transmit renewable power from its source to large population centres, while reducing transmission losses (see analysis). José Pablo Fernández, CEO of green energy firm Grupo Dragón, explained the importance of implementing new technologies to improve transmission efficiency. “Smart metering can have a big impact on the way we use energy in Mexico. Around 15% of energy is wasted during the transmission process, a percentage that must aim to fall below 5% in order to gain competitiveness and reliability of service,” he told OBG.

Given the remote locations of Mexico’s renewable power sources, such infrastructure developments – whether in generation or transmission – will also need to be sensitive to the concerns of local indigenous populations, such as the Mayans in the Yucatán Peninsula. Other challenges include a need for further improvements in the legal and regulatory framework – such as certification – as well as a need to ensure small operators can access the finance they need for up-front capital investment.

Some claim that potential reforms also need to stretch to changes in human capital legislation. “The labour legal framework needs to be reformed in order to reduce uncertainty for companies investing in training of personnel,” Juan Carlos Hernández, general manager of Industrias Energéticas, an engineering and power services provider, told OBG. “Since there is no rule preventing workers from leaving the company after being trained, a number of firms are experiencing high turnovers of trained people. Stronger laws committing both employer and employee should help to increase the number of skilled workers while boosting productivity levels.”

Nuclear Potential

Mexico has two nuclear reactors, which together provide 1.6 GW of capacity, approximately 4% of the country’s total, according to the World Nuclear Association. In 2010 CFE was exploring the possibility of constructing up to 10 new nuclear plants, as part of its efforts to achieve carbon-free power generation targets. This could have seen up to a quarter of Mexican energy supplied from nuclear sources by 2028, but these plans were postponed given the low prevailing price of gas at the time, and were put on hold indefinitely in the wake of the disaster that struck Fukushima in Japan in 2011.

Evolving Regulations

Changes wrought by Mexico’s energy reform since 2013 have necessitated a step change in the country’s regulatory architecture. “The energy reform has totally transformed the structure of the sector, from an entirely integrated value chain operated exclusively by Pemex to the possibility of private participation in every activity,” Alejandra Palacios, president of the Federal Economic Competition Commission, told OBG. “There are two sides of this coin – the laws and the practice. A major part of the transition until today has been the changes in laws and regulations, but now we are entering the stage of the temporada abierta, with Pemex compelled to share its infrastructure with third parties.”

Efforts are under way to promote transparency in the sector. For example, meetings of the CRE are now recorded and made public, while its commissioners are prohibited from meeting external actors in that capacity. The CRE is also working to establish more open communications, including consultations with stakeholders on a more formalised basis. At a more technical level, in 2016 the CRE published the Código de Red, or Network Code, setting out detailed specifications for all participants in the power market for grid interconnections and other operations.

However, achieving best practice in terms of transparency still remains a long way off. “Transparency is still a work in progress in Mexico. Having readily available information is naturally a long way off compared to more mature markets like the US or UK,” David Fatzinger, vice-president and general manager for Latin America at power generation firm Intergen, told OBG. “This has serious implications on investment decisions.” Fatzinger added, “One of the greatest challenges in particular lies in the planning process. Finding a right of way for a project is a long and complex process. Most are not contiguous and applications can last years.”

However, other industry professionals see the development of transparency in Mexico in more relative terms. “Considering the young regulatory framework, the focus on transparency since the start of the energy reform has been one of the great successes of the entire process,” Carlos Morales Gil, CEO of oil and gas company Petrobal, told OBG.

Outlook

While the opening weeks of 2017 were dominated by popular opposition to the increase in retail prices for petrol and diesel, this is unlikely to derail the government’s broader energy reform agenda, which is now well entrenched. While the increase in global oil prices and the decline in value of the Mexican peso in the second half of 2016 and into early 2017 will cause further knock-on increases in prices facing consumers of both combustibles and electricity, the same phenomena should give a boost to the energy sector more generally. Rising crude oil prices could also help Pemex meet its financial targets for 2017 in addition to alleviating some of the budget pressures on government. They will also underpin continued success in the licensing rounds for oil and gas exploration, as the investment appetite of international energy companies begins to recover following the slowdown experienced in recent years.

 

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The Report: Mexico 2017

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