This article first appeared in Mexico Energy Review 2017.
Q: How has PA Consulting helped private and state-owned companies during the transition to an open market?
A: PA Consulting has been working with CFE and PEMEX to restructure several aspects of their former business divisions. Our work with the government has mostly focused on tariffs, product pricing systems and the transition from a vertically integrated monopoly to an open system, developing strategies to thrive in this competitive environment. In the private sector we have collaborated mostly with international power companies, most of which already have generation projects in Mexico through CFE contracts and want to understand the attractiveness of participating in the new competitive market. PA Consulting also works with industrial off- takers, mainly manufacturers, to improve their processes and become more competitive. We have done some work for the government on domestic content issues, which is a new requirement established by the Energy Reform for foreign companies.
Q: What are the positive and negative aspects of the Reform that international companies are looking at?
A: Energy companies experience highly competitive situations in the US and Europe and face difficulties putting capital to work for good economic returns, partly because of the low-interest rate environment globally. Mexico’s market liberalization provided untapped opportunities for these companies, which see in the country a large investment potential. The Reform’s novelty has brought uncertainties but international companies are working hard to understand the market, which is not always an easy task. The main priority for them is to determine whether or not it is worth it to make large capital investments in Mexico’s energy sector. In the past five years, the competition to win long-term contracts with CFE had become fiercer but offered low returns on investment (ROI). Companies are now analyzing if the conditions have changed under the new legal framework.
Q: How can you help private companies successfully enter the electricity market here?
A: Our focus is on identifying our clients’ main competitors and forecasting what their next move will be, for instance, which region they are targeting for their project’s next location to participate in the power auctions. Price forecasting is the main concern for clients that are not interested in the tenders but prefer selling electricity to large industrial customers through PPAs. They want to know what prices they can get in the wholesale market as well as the potential transmission congestion costs so they can design an optimal business strategy. We help these clients understand market issues, providing future pricing forecasts as well as mapping potential customers. We also support companies developing financial models to determine if they can see an economic return on their investments.
Q: What strategies should companies consider if they want to succeed in the power auctions?
A: It is important to understand the tendering process if you want to build a successful proposal. The prices tendered in CFE’s power auction were low on average but US$45 per MW/h is not the final price that the company will get. If a tender’s winner produces power in peak hours it will receive higher prices per megawatt-hour. It is important to keep in mind that the companies’ returns will be influenced by different factors. Other elements also have the power to tip the balance toward a specific proposal besides price. Location is a critical aspect that can make the difference between a winning and losing proposal. Companies might not get a higher price for locating in a region with constraints but their proposal could be treated more favorably. Another component of a successful proposal is a diversified revenue stream. A company building a 100MW wind farm might only need to sell 80MW to CFE and the rest on the open market or to private off-takers. We can help companies define these strategies and look for potential purchasers that fit their projects’ characteristics.
Q: To what extent do your clients consider transmission and distribution investment attractive?
A: Many of our clients have expressed interest in investing in transmission infrastructure because they perceive fewer risks than in power generation but they have a hard time understanding CFE’s process for establishing investment partnerships in transmission and distribution. We support our clients to access CFE’s investment opportunities, whether it is by participating in a competitive tender or by establishing business relations with the state-owned company. We also help companies understand how transmission tariffs will work so they can determine if they will see an attractive ROI within a certain period. In the US there are two business models, which can take up to 20 years to materialize, for companies investing in transmission infrastructure that are not electric utilities. The big question for Mexico is how long it will take private companies to participate in these projects and recover their initial investments.
Q: How do you deal with the uncertainties in Mexican markets when building your clients’ business models?
A: We have a model of Mexico’s market based on the 52 transmission regions defined by CENACE. This model dispatches generation on an hourly basis to meet the hourly forecasted load. We analyze the power flows through Mexico’s different regions, identifying where the demand is and the loads are, which allow us to forecast in which nodes there will be congestion. The other side is the transmission costs, which we can also forecast to analyze their impact on estimated production rates.
Q: Should companies prepare for disruptive technologies such as increased distributed generation and energy storage?
A: We have already included disruptive technologies in our forecasting models. We expect to see an increasing number of distributed generation projects from commercial customers like Walmart, which has plenty of capital and rooftop space for solar panels. Having more distributed generation will definitely impact the market’s functioning, bringing negative and positive elements such as mitigating congestion. We do not expect to see similar growth in energy storage technologies in the short term. As long as net metering can be done and energy rates are relatively low, energy storage for distributed projects is not economically viable. As a utility resource, however, it will become increasingly important in Mexico, especially considering the country’s ambitious clean energy generation goals. Nonetheless, energy storage is still expensive even in the US and Europe, which makes it a questionable use of resources for Mexico. Energy efficiency will become more important in the coming years. Energy companies will start to see the same kind of competition that now exists in the US, where it is hard to maintain healthy balance sheets just by selling electricity, so we expect companies in Mexico to soon start including other types of services and process improvements to complement their businesses’ competitive advantages.
Q: Which market schemes are most attractive to international companies?
A: Private companies willing to enter the Mexican market are mostly looking to sign PPAs with CFE. As long as CFE is interested in establishing long-term contracts for 15-20 years, there will be a lot of interest from foreign renewable energy companies, particularly as these ease financing. Without long-term contracting conditions, investors and financial institutions would be hard-pressed to finance renewable energy projects.
Q: What do you think will be your most popular service for clients in the energy sector?
A: Forecasting energy prices and defining the market potential will be our primary services in the coming years. We also have clients looking at opportunities in natural gas pipeline investment but the big question is whether a market exists for projects outside CFE’s power auctions. Uncertainties in electricity tariffs make it difficult to forecast the potential of the retail electricity market. We know that CRE is working hard to clarify these processes. Once this barrier is overcome we expect to see increasing participation in the wholesale electricity market. In the US the majority of qualified users shifted to the open market instead of buying directly from a utility and we expect to see a similar pattern in Mexico.
It is difficult to say when the market will consolidate but it will depend on CRE and the Ministry of Energy’s decisions regarding legacy CFE generation projects. CFE holds projects of around 50GW in the country, which makes it difficult for other companies to compete. Once there is more transparency about CFE’s new role, it will be easier to measure the market potential for others. We hope this process takes no more than another year or two. Some clients are frustrated by the market uncertainty and the perceived slow pace of development but Mexico has done an incredible job when compared with other countries, which took much longer to set up a functioning market. We are amazed by Mexico’s achievements during the past two years, and we foresee it will take only a couple of years more to have a mature market in place.
Jim Heidell is an energy expert at PA Consulting Group