Publish in Perspectives - Wednesday, June 3, 2020
New rules favor Mexican state company CFE and weaken private companies, but its cash flow generation may be insufficient to meet the country's necessary power investments. Here the CFE headquarters in Mexico City. (Photo:Zeratai)
Rising regulatory risk halts Mexican private power investments.
MONTERREY, Mexico – The guidelines announced on May 15th by the Mexican Ministry of Energy (SENER) as a way to preserve grid reliability and safety, may restrict and ultimately undermine private energy investment, strengthening the market share and voice of state-owned utility Comision Federal de Electricidad (CFE, rated BBB-/Stable).
SENER's operation agreement reinforces previous measures announced on April 29th by the Mexican Independent System Operator (CENACE) to suspend pre-operational tests for intermittent power plants and alter the number of must-run units. The agreements are not intended to modify the 2014 Electricity Industry Law (LIE, Ley de la Industria Electrica); however, these actions could destabilize the competitive landscape promoted under the LIE and elevate the regulatory risk for private investment in the country.
Together, these agreements could have negative credit implications for privately-owned electricity generators exposed to dispatch, curtailment, and merchant risk, for both new and existing facilities operating under the current regulatory framework. In addition, SENER's operation agreement introduces new costs to cover novel ancillary services, which will increase backup capacity remuneration and will likely affect renewable power plants. In the next few months, the CENACE and the Energy Regulatory Commission (CRE) will prepare new manuals and procedures to make SENER's policy fully effective. Fitch expects legal actions being taken by the different affected companies to delay the operational entry of these agreements. However, uncertainty around the regulatory framework will retroactively affect existing power plants and may limit private investment in the Mexican power market.
Despite the potential negative credit implications for project finance power assets, Fitch does not anticipate any related rating actions within its corporate finance power generation portfolio. Infraestructura Energetica Nova, S. A. B. de C. V. y Subsidiarias (BBB/Stable) benefits from adequate business diversification and solid capital structure, and Cometa Energia (BBB-/Stable) does not have renewable projects dispatching in the SEN.
Under SENER's new agreement, baseload plants may be required to increase power generation to provide reliable dispatch and protect the grid against intermittent power generation. Because of this, the agreement may favor thermal assets owned mainly by CFE, prioritizing their dispatch over more efficient plants. CENACE will now have discretionary power to dispatch out-of-merit plants arbitrarily or unpredictably, potentially displacing non-CFE generation projects that would otherwise be dispatched, reducing revenues and negatively impacting their credit quality.
The new guidelines also create uncertainty for generators with merchant exposure, as CENACE, in line with SENER's strategy, may designate additional CFE's plants as must-run units. Generally, must-run facilities are necessary to supply voltage control in the system and maintain reliable operations. This situation could either increase spot prices if marginal costs of these plants are declared, or reduce merchant prices if variable costs are assigned outside of the day ahead auctions; generally, the variable cost for must-run units operating at technical minimums doesn't affect spot prices.
Furthermore, CFE, as the owner of the country's transmission lines, will propose SENER to green-light projects that adhere to the government's new policies. The grant of new permits will require a new interconnection feasibility study, considering aspects such as: electricity demand sufficiency, transmission congestion, renewable plants' geographical dispersion, and the amount of reserve capacity. CENACE may reject projects not meeting the listed requirements, restricting the development of new plants in highly congested regions. This situation could challenge the ability of new renewable projects to reach financial closing or force them to extend their commercial operation dates. CFE cash flow generation may be insufficient to meet the country's necessary power investments without incurring additional debt to fund these projects, which could pressure its financial profile.
CENACE's agreement published in April halted pre-operational tests for intermittent power plants. Preventing renewable projects from reaching commercial operations may significantly pressure the assets' financial position as it will delay their commencement of operations and revenue generation. The measure elevates the risk of breaching the terms and conditions under the project agreements since the documents generally have a commercial operation date that may only be adjusted under extraordinary situations, or that may expose the project to additional penalties and costs. Projects unable to declare an extraordinary event, force majeure, or lacking sufficient liquidity during the construction period, may be at risk of not being able to meet debt service payments.
SENER and CENACE stated that these actions intend to preserve the safety and reliability of the National Electric Grid (SEN) in the midst of the falling electricity demand caused by the COVID-19 pandemic. However, grid instability in Mexico precedes this global contingency. In Fitch's view, grid stability issues are more related to insufficient investment in transmission expansion than it is to solar and wind generation. Other countries with higher renewables penetration, such as Chile and the United States, have not had to adjust its economic order dispatch curve or limit the injection of renewable energy during the pandemic despite falling energy demand.
The CRE, the entity that grants non-discriminatory access to the transmission system, has not weighed in on these matters, creating uncertainty in the market. However, the independent antitrust regulator (COFECE) issued a response statement on May 7th strongly criticizing CENACE's actions as they undermine the market's competitiveness, and violates the agreement to provide non-discriminatory, open access to the system. Additionally, Mexican courts have already ruled in favor of several injunctions against CENACE's measures, suspending the action against pre-operative testing for several entities. Fitch expects additional legal challenges will be filed against SENER's new policy.
The new policies are the latest in a series of actions taken since the end of 2018 that have increased uncertainty for private energy entities and might undermine the energy market development and investment in the country. Over the past year, the fourth long-term electricity auction was cancelled; two long-distance transmission lines were abandoned; gas pipeline agreements renegotiation was forced; and the clean energy certificates (CELs) distribution rules were attempted to be adjusted to grant CELs to old state-owned nuclear and hydro energy producers, instead of only to new renewable energy projects.
This article is based on a non-rating action commentary from Fitch Ratings.