Making sense of Mexico’s renewable energy auctions

Summary: As Mexico prepares for its 2017 auctions, the winners of the first two in 2016 merit a closer look — especially in light of heightened economic uncertainty in the country. These auctions have proven to be the most sophisticated in the region.

Carlos St JamesAbout the AuthorCarlos St. James is a leading advisor to energy investors and developers in emerging markets since 2005. He co-founded and presided over the Argentine Renewable Energies Chamber from 2005-2011; has been a board member of the Latin American & Caribbean Council on Renewable Energy since 2010; and publishes the Latin American Energy Review in his free time.

He will speak at this year’s LAC-CORE Finance Summit to be held in June 13-15, 2017 in Miami, Florida. A must attend event!

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In 2016 Mexico established itself as perhaps the most desirable renewable energy market in Latin America. What’s more, its two auctions – free of tax incentives and subsidies – left no doubt to the world that renewable energy is viable and can compete head-on with any technology or fuel source.

CENACE, the independent grid operator, is the organizer and coordinator of the auctions. It matches buyers and sellers, offering 15 year power purchase agreements (PPAs) for energy and 20 year contracts for clean energy certificates – while allowing bidders to offer multiple combinations that include installed capacity, energy and the certificates. Last year 5.5 gigawatts of new renewable energy projects were approved at very attractive terms: average pricing was $53 per megawatt-hour (MWh) in the first auction and fell to $37/MWh in the second.

Geographic variances in prices

As with any large market, supply/demand imbalances create differential pricing in different regions. In Mexico (click on maps and charts to enlarge them) the southeastern state of Yucatan and the southern tip of Baja California Sur in the west have the highest energy costs (see below, in red and orange). Northwestern states like Sonora tend to have far lower prices (in blue).

Mexico electricity pricing during daytime, nighttime and average, by region, in USD. Source: SENER, Mexican Secretariat of Energy

Auction regulators established incentives to favor investment in states with higher energy costs, establishing pricing adjustments that became very important in the first auction, last April (A1). This was so successful that it was dubbed the “Yucatan Auction” because so many winning bids were located there.

Clean Energy Certificates

Beginning 2018, major power consumers will be required to buy five percent of their electricity consumption from either PPAs with clean power suppliers or through the purchase of clean energy certificates (Certificados de Energia Limpia, or “CELs”). Most bidders used combinations of these two in making their offers.

The First Auction

Prices were capped at about $75/MWh for energy plus CELs, and at about $8,200/MW for capacity. The former proved too high, the latter too low; the auction corrected this. A1 resulted in 17 winners committing 2085 megawatts (MW) of new installed capacity. To the government’s surprise it was heavily solar over wind (81% solar to 19% wind).

Why was solar so prevalent? For three reasons. Mexico currently has a mere 66 MW of solar PV operational – amazingly low for a country with such good solar radiation – while, in contrast, Central America already has exactly ten times more, a grouping of six countries where financing and topography is considerably more complex. Mexico’s current transmission grid contains existing renewable energy installed capacity (3870 MW wind; 66 MW solar; 873 MW geothermal).

But the fact remains solar pricing proved more attractive: Enel, for example, ended up winning more than a third of A1 because it bid solar prices of about $35/MWh. A second reason is that price adjustments favored states like Yucatan and Baja California Sur, which have comparatively better solar radiation than wind resources. And third, there were already a large number of solar developed projects ready to bid: a lot of pent-up solar supply.

In the first round the only buyer was the Comisión Federal de Electricidad (CFE), the government-owned utility.

Installed Capacity

None of the winning bids included offers for Capacity: the maximum price established by the government was about $8,200/MW capacity, a woefully low figure that doesn’t take into account the roughly $1 million cost per MW to build. (This changed dramatically in the second auction.)

Summary of the winners in Mexico’s 2016 first power auctions. Sources: many, but primarily government sites. And with a tip of the hat to clients and local friends who always make time to share insights

The final winners of A1 appear in the above chart (click to enlarge; there’s good info). The 2085 MW total was broken down into 1691 MW of solar PV at an average price of $50.86/MWh, plus another 394 MW of wind at an average price of $58.96/MWh.

Note the effect of the geographic adjustments discussed earlier — a key factor of A1 success. Perhaps the biggest overall win was pulled off by the Tizimin wind project (see #17 on the chart), which won with a $66.86/MWh bid. But because the project was located in Yucatan its bid was made more competitive with a $21.98/MWh adjustment on paper which placed it among the winners (remember, the average winning bid for wind was almost $20/MWh lower). Conversely, Acciona’s 168 MW El Cortijo project bid $42.81/MWh but was penalized (just on paper) more than six dollars/MWh – and barely made it into the winner’s circle despite being priced 37% lower than Tizimin’s.

And on the solar side we have a situation whereby Enel’s 330 MW Villanueva solar PV project won with a bid of $35.66/MWh even after a location penalty, while Sunpower/Vega’s 500 MW Ticul 1 project won with a $56.25/MWh bid because it benefitted from a $22/MWh price adjustment for being in Yucatan.

But perhaps the hardest win to witness was the Sol de Insurgentes 23 MW solar project (see #7) because — in retrospect — it appears to have left a lot of money on the table. It benefitted from a whopping $34.28/MWh adjustment for being located in energy-hungry Baja California Sur and could have bid $20/MWh higher and still been the lowest price in post-adjustment A1. But hindsight is 20/20, and the fact is, Baja California Sur has a complicated setup unlike any other part of the country.

The 997 MW of projects approved in Yucatan state in A1 still have a number of hurdles to overcome. Environmental impact studies may find challenges at a number of levels: it is hurricane country; the topography is rocky; jungles are prevalent and so flora & fauna may be affected by some of these projects. Importantly, it is also the heart of Mayan civilization and they may encounter cultural and anthropological resistance.

The Second Auction

If the first auction was referred to as “La ronda Yucatan”, the second one (A2) held last fall has been dubbed “La subasta de los arrepentidos” (the Repentant’s Auction) by local wits: prices got squeezed considerably just as Trump was elected and economic uncertainty increased.

A2 added more layers of sophistication. Capacity was now priced more attractively and so there were three true variables to contend with (versus only two in A1). Not only that, bidders accepted the challenge and made complex offers that in some case were either/or, complementary, and some even tied to future sequential projects. Also, whereas in A1 the government was the only buyer, A2 was now a true brokering mechanism of matching private sector buyers and sellers. This is especially appealing as developers normally have a hard time getting commitments longer than five years from corporates, and these auctions came with 15 year PPAs.

But what if one of the parties in this matchmaking process is deemed less than attractive by the other party? The government has thought of this eventuality too: the poetically named Cámara de Compensación (Compensation Chamber) takes care of this, with CENACE as a clearing house between buyer and seller to ensure a good marriage.

The significant geographic adjustments seen in A1 all but disappeared in A2.

Capacity price ceilings were blown off their hinges for A2 and suddenly the market took a closer look. Average prices bid were $32,258/MW (versus no one bid in A1 when the ceiling was much lower.)

3463 MW of new capacity was won in A2. Forty-five percent (1573 MW) were solar projects and 26% (898 MW) were wind; the rest were combined cycle, geothermal and small hydro. Average wind prices dropped 35% from the first auction to $38.36/MWh and solar prices dropped 29% to $36.12/MWh. (And bear in mind that the MXN/USD exchange rate had already begun to suffer; it was about 17.3 pesos/dollar in A1 and a little over 18 in A2.)

Summary of winners in Mexico’s 2016 second power auctions. Sources: many, but primarily government sites. And with a tip of the hat to clients and local friends who always make time to share insights

The fact that a geothermal facility could lock in prices at under $50/MWh deserves far more global attention than has been given. And as a baseload provider, it also offered up its entire 25 MW capacity at $45,000/MW.

There was no time for drama in A2; it was all about sharpening pencils. Among the solar projects, the Middle East-owned Fotowatio Renewable Ventures (FRV) provided the absolute lowest price at under $30/MWh for the 300 MW Potosi Solar project. On the wind side, Enel provided the lowest price at about $34/MWh for the 100 MW Salitrillos project.

Conclusion

MXN/USD exchange rate in 2016. Source: xe.com

The new U.S. government has thrown a wrench into Mexico’s economic outlook. As seen on just one indicator, exchange rates, between the time of the original A1 bids in April 2016 until today, the peso has dropped some 15%. Some investors have decided to postpone participation while this plays out.

The jury is still out on the possible long term “efecto Trump”. But the fact remains that cost of capital has changed in Mexico in recent months, while PPAs are hardwired. Projects with tighter pricing from the second auction are at greater risk.

Yet our firm has seen variations of this heartache throughout the region and the sky has yet to fall. Early last year the Peruvian tenders rocked the region with what seemed impossibly low pricing at that time; Chile continues to attract financing despite essentially working off a spot market; while Argentina’s auctions were overbid even as banks made clear they weren’t lending.

Mexico will find ways to get these projects built. This, too, shall pass.

© Latin American Energy Review 2017

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