Mexican Renewable Energy Powers Up

Investors that can manage the risks will find major opportunities in Mexico’s emerging renewable energy sector, writes Lourdes Pintado, Control Risks Associate Analyst, Mexico…

Mexico made global headlines with its flagship 2013 energy reform. But while most of the attention was on state oil giant Pemex one of the most exciting subplots was the opportunities for renewable energy companies as Mexico’s wholesale power market opens up. Emerging investment opportunities and favourable regulations have attracted private-sector interest and companies that manage the risks can fully harness this potential.

Government drive

Investment opportunities in Mexico’s nascent renewable energy sector are being created by the government’s enhanced commitment to diversify its energy matrix away from fossil fuels. The government launched two of the country’s first long-term power auctions this year, with 61 of a total of 74 contracts being awarded to solar and wind energy companies to provide public power utility, the National Electricity Commission (CFE), with electric power and clean energy certificates (CELs) from 2018. The remaining 13 contracts were awarded to companies focusing on combined-cycle, hydroelectric and geothermic technologies. The government estimates that the 74 contracts will attract up to $6.6bn in investment over the next four years. As a result of these power auctions, wind and solar plants are set to operate in 16 of the country’s 32 states. More auctions will be held as early as next year, while the government is in the process of easing further barriers.

"More auctions will be held as early as next year…"

Another testament of the government’s commitment to develop clean energy sources is the Energy Transition Law, approved in 2015, which mandates that the country’s share of clean energy sources must increase to 25% by 2018 and to 35% by 2024. In a country where many laws are not implemented, either fully or in part, it is encouraging that the government has already shown the will and capacity to implement this law in particular, and the energy reform more generally. Two important government actions include improving the bidding terms for the second auction – so as to avoid some of the technical glitches that occurred in the first auction – and the decision to increase investment opportunities in the second auction. The government has also worked to ensure that energy sector bidding processes meet international standards and are not subject to vested interests – as many other bidding processes in Mexico are.

Nonetheless, some setbacks and delays in implementation are likely to ensue. Delays in the implementation of the CFE’s restructuring process, which will essentially break the company’s monopoly in the power generation and commercialisation segments, are already evident. In September, the deadline for the CFE to fulfil the legal constitution of the ten separate subsidiaries and affiliated companies, a key part of its restructuring process, was extended from July to the end of October. And while the CFE’s union agreed to cut its pension benefits in May, represented a first step in the right direction, this does not mean that union members will facilitate subsequent stages of the restructuring process. However, any delays and setbacks will be more down to inherent complexities of the liberalisation processes rather than a lack of political will to push the process forward.

Reforming Mexico

Of course Mexico is still far from being the land of milk and honey for renewable energy projects, and there are several risks relating to social, security and corruption issues. As infrastructure projects in general have been expanding into remote areas, activism by community landowners, indigenous and environmental groups has been on the rise. In the state of Oaxaca, for instance, opposition from indigenous communities has delayed the construction of a wind plant, while a local community has attempted to extort a solar project. Furthermore, while social and environmental impact assessments are a mandatory pre-requisite for wind and solar energy projects, the rules regulating these processes are still unclear. Uncertainty also affects the regulations concerning prior consent for cases where an indigenous community lives near a project. As a result of this lack of legal clarity, consultation processes have increasingly ended up in court. According to the Mexican Academy of Energy Law (AMDE), there are currently 20 projects in the energy sector that are on hold due to issues related to social impact assessments.

To compound this, Mexico’s security environment continues to be corroded by unrelenting turf wars between organised criminal groups to control drug trafficking routes, as well as a myriad of illicit activities. The government’s strategy to break up these groups hasn’t worked. On one hand, some organised criminal groups have fragmented into a number of local cells, which have consequently diversified from narcotics trafficking into new crimes such as kidnapping, extortion and fuel theft. On the other hand, violence related to organised crime is on the rise again, after a steady year-on-year reduction since the unprecedented levels reached in 2011. In this context, several regions of the country where solar and wind energy projects are set to be installed experience frequent shootouts and murders related to organised crime and have high extortion and kidnapping levels. Although these groups are not known to specifically target renewable energy projects, their entrenched presence affects the logistical operations of renewable energy projects, as enhanced security measures are required to reduce the threat of incidental exposure to violence.

Finally, corruption remains a pervasive issue across all levels and branches of government. Bribes and kickback requests in exchange for issuing permits and licences are a frequent occurrence. In this regard, the recent approval of the National Anti-corruption System (SNA), which introduces stronger mechanisms to prevent, investigate and sanction corrupt practices by public officials, private companies and individuals, has improved the long-term prospects for anti-corruption enforcement. However, the prospect for the next four-to-six years remains challenging, as full implementation of the SNA will be a protracted process. Renewable energy projects operating under a zero tolerance of corruption policy are therefore likely to, at the very least, incur some delays.

Keep positive

In the midst of this, there is good news: risks can be managed. While this is not an easy task; undertaking a stakeholder mapping from the outset to identify the local agents that could support or oppose the project, and following this with a comprehensive community engagement strategy for the project’s life cycle, can significantly reduce exposure to social risks. The key is not to underestimate the importance of the first contact with local stakeholders, which should be conducted in a culturally and socially appropriate manner, and should be followed with regular communication channels for local stakeholders to voice their concerns and be informed. To overcome security and corruption risks, there also are effective mechanisms that investors and companies can put in place. A thorough approach to risk management can assist investors and operators of renewable energy projects to better monitor and assess returns and build operational delays into their timetables. Mexico’s renewable sector will reward international investors; it is just a question of managing the risk.