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Reform of the Electricity Paradigm in Mexico: The Importance of Perspective

Politics, as with almost everything else, is all about perspective. Perspective is often used as a verb to describe spatial relationships in a photograph or by an astronomer to define the size of objects in space. The word is designed to remind us that we need to be aware of the relative nature of things. Without perspective, we wouldn’t know what is large or small, heavy or light, fast or slow, expensive or cheap, or even up or down. Al Gore, former Vice President of the United States and Nobel Prize winner, used to have an image of the Earth in his office with the South Hemisphere on top of the map — making the point that even one’s perspective of our planet in the cosmos depends upon from where the analysis is conducted.

Such is the case in Mexico regarding the recent reform of the laws governing Mexico’s energy sector. 

President Pena Nieto clearly advanced his bright political legacy by forging a coalition among a cantankerous, contorted and often chaotic group within the government to change Articles 25, 27, and 28 of Mexico’s Constitution and concomitantly pass supporting statutory and regulatory revisions. But the reform's real impact on the national electricity utility and consumers throughout the Republic depends, of course, upon one’s perspective.

From a political perspective, the reform is clearly positive movement towards the acceptance of the simple (and yet often elusive) premise that competition, in this case, albeit limited only to the generation of electricity in Mexico, is a good thing; and, by inference, that the heavy hand of government control over the generation of electricity is not.  That message is clear.

Through competition, Mexico hopes to accelerate the expansion of its electrical transmission networks and natural gas pipelines, which will the improve distribution supply quality, increase sources of fuel through bi-lateral agreements with the United States, and allow consumers to consider a wider range of opportunities to meet their consumption needs. By choosing to burn less coal and heavy fuel oils to produce electricity while encouraging the development of hydro, wind and solar energy projects, these reforms are expected to lead Mexico along a path towards attaining sorely needed environmental and subsequent health benefits.  And by decentralizing the Comisión Federal de Electricidad (CFE), one of the oldest and largest state owned utilities in the world — clearly the most important element of the reform as they relate to electricity — Mexico’s consumers should be in a better position to benefit from lower electricity rates driven by market forces and new technologies.   Of course, these utopian benefits (lower rates, cleaner air, a modernized infrastructure, etc.) will need to be achieved within a system whereby the CFE will remain in complete control of the distribution and transmission of electricity in Mexico.   

Taking a pragmatic perspective, Mexico’s CFE is burdened with a staggering financial obligation to its own pensioners; faces the reality that it must bring online at least 55,000 MW of new capacity within the next 15 years to meet consumer demand; and deals with an infrastructure that wastes almost one out of every five kWh of electricity produced with system-wide transmission line density of 730 km/TWh (four times larger than that in the United States). These reforms do not go far enough to make a real change in the rates paid by residential, commercial, industrial and municipal users or allow the CFE to become self-reliant or even profitable.

Consumers also pay above “market” rates that subsidize the electricity used by others in the system. From the specific perspective of residential consumers in Mexico, presently the CFE has more than 40 different rates that vary according to geographic location and usage level.  All others are subsidized, with the exception of high consumption residential users that pay the equivalent of about US 32 cents/kWh, which represents approximately 2 percent of the total residential users, according to a recent report issued by PricewaterhouseCoopers.  That’s right.  Right now, the rates charged to almost all of the country’s residential users are subsidized.  And to compound this economic paradox, the subsidy system is applied according to the amount of kWhs consumed, generating an unequitable and perhaps unintentional application whereby the more affluent users (at least those consuming and able to pay for more electricity) receive more than double the subsidy, per capita, than those using the least amount of electricity — undoubtedly the poor and elderly.

Will these reforms seed growth in residential “roof top” use, such as was the case in Germany and more recently in the United States, or increase the coordination and alignment of residential users into groups under “self-provider” permits offered by the Comisión Reguladora de Energía?  Until credit facilities by private or publicly supported financial institutions become available to the average Mexican (or even some of them), the answer is, sadly, self-apparent.  As such, without such additional contributors to the support the more open electricity generation market, the only group of residential users able to take advantage of the reforms by installing roof top systems or forming “self-provider” groups are the very rich — the same group that the CFE needs most to continue to contribute to their now definable bottom line.  Expressed less elegantly, if the rich people take themselves “off grid” the CFE’s ability to balance its own accounts is weakened.   Further, as the reforms birth the new CFE with an interest in being financially self-reliant — untethered to and thus unprotected by the federal government’s strong credit rating will the national utility eliminate subsidies and raise residential rates for an overwhelming majority of Mexicans?  

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What about corporate and industrial users in Mexico under other Tariffs (HM, OM and Tariff 2)?  While dozens of companies and large industrial users in Mexico such as FEMSA (Coca Cola), Bimbo, Grupo Mexico, Wal-Mart, and P&G are already enjoying the benefits of lower cost electricity produced by independent developers or themselves — what will be the result of these reforms for other corporations?  In the short term, most likely, not much if anything will change.  Those companies in Mexico that seek to develop their own projects will do so, and others that fear change and uncertainty will not.  For corporate and industrial users the question is whether they want to guarantee themselves electricity at a fixed, pre-determined rate or hope, thus wagering, that competition in and by itself will lower rates in the future.  And if rates were to lower in the future, when would they decrease and at what amount?

The CFE had already established itself as an innovator by creating its virtual “energy bank” for developers and allowing them to deliver electricity through a national transmission and distribution network at a low cost.  While the reforms generally broadened preferences given to renewable energy developers, they did not, of course go so far as to offer Feed-in-Tariffs or special tax subsidies to spur investment — the same poisonous Voodoo economics used to destroy renewable project developments in Italy, Spain, Germany and the United States.  In Mexico, the market was open to developers before the reforms and it is open, albeit more slightly more publicly, today — as a result of the reforms.  Over the last ten years, the CFE’s Tariffs for such corporate and industrial users have, predictably, increased.  Nothing in these reforms would suggest a change in their upward trajectory. 

Then what about the municipalities in Mexico that pay for their electricity via CFE’s Tariff 5 and 5A?  As a result of these reforms will more developers come forward to invest in projects to generate electricity for them?  No. In fact, while it is true that rates paid for electricity by Mexico’s municipalities have steadily (and not coincidently) increased every year at almost exactly the same amount, for reasons that relate more to their credit worthiness and the political theater that surrounds the issuance of PPAs signed by Mayors and City Councils that serve terms of no more than three years — "hell no."  To developers, the risks and profit margins are the same today as they were before the reform. 

There is a chasmic difference between reforms that merely embrace competition and further the chance that developers will invest their capital into power generation in Mexico (which is the case here), and reforms that provide specific incentives to developers, create investment funds (using state and private equity capital) to expand and construct modern transmission lines and power stations in the most critical areas, etc.), and focus on advancing a specific innovation or technology (as was the case in China relating to the development of solar panels).  

So while there may be few tangible results defined by lower utility rates for residential, corporate, industrial and municipal users of electricity, for developers of energy projects looking around the globe to invest their capital in profitable, market based systems, the reform’s move towards competition offers a slightly brighter — although not particularly different — perspective.   

As such a developer, we welcome and celebrate even the slightest change of brightness in the perspective in Mexico.

Lead image: Mexico senate via Shutterstock

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Don Walter is a lawyer, former Director of Policy and Research for the Republican party in Washington, DC, and is currently developing solar energy projects in Mexico and throughout Latin America.

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