How Did Mexico Unlock Its Wind Energy Potential?

How Did Mexico Unlock Its Wind Energy Potential?

How Did Mexico Unlock its Wind Energy Potential?

While it is true that the Mexico’s Energy Reform created a new landscape for clean energy, renewables arrived in Mexico years before. Geothermal and hydro plants for example are as old as fossil fuel plants, and wind energy has been in Mexico for more than ten years, commissioning the first large scale farms in 2007.

 

When wind energy arrived in Mexico developers had two options to generate energy: Independent Power Producers (IPP) and Self-Supply Generators (SSG). However, the Energy Regulatory Commission (CRE) was establishing the drivers to facilitate the entry of wind into the energy matrix.

Mexico needed to expand installed capacity and reduce its dependence on fossil fuels. CRE established three regulatory instruments to attract renewable energy investors: Energy Banking, Wheeling Agreements, and Open Season.

Wheeling and “banking” instruments played a fundamental part in the deployment of renewable generation projects in Mexico. The main strength of these structures is that they enable renewables to compete against conventional generation, without involving additional costs to consumers.

In 2017 wind generation was 1,976,434 MWh, 12x more than in 2010 and around 44x more than in 2006, the year in which wheeling agreements and energy banking entered into force. These instruments, along with the open season process, was the driver for the successful development of renewables in Mexico. We expect the industry to enjoy a compound annual growth rate of 5% to 8% over the next three to five years.

 

What is “Energy Banking”?

The concept of “energy banking” was introduced in 2006, six years after the introduction of interconnection contracts. These contracts allowed renewable energy plants over 0.5 MW to connect to the grid with discounts for 50-70%.

Energy Banking means that a renewable energy plant can earn credits for the surplus generated under favorable weather conditions. During times with high wind speeds, a wind farm can virtually “bank” its surplus energy as credits, and trade them later.

Generators can sell the “banked” energy when they are unable to meet the agreed amount. Sales are executed at peak hours, or any other times within 12 months. The price is set at 85% of the spot price at the time of the transaction.

This benefits wind farms since they generate a lot of energy at certain times, and significantly less at other times of the day. This concept also provides developers with smoother cash flows, and an ability to bid more aggressively on energy supply deals.

 

Wheeling Agreements Support Projects in Remote Areas

Wheeling Agreements allow IPPs to use the grid to transport their electricity to remote load centers by benefiting renewable generators with favorable fees for “postage stamp system”. Typically, the postage stamp system used in transmission charges consumers based on level of voltage, energy transported, and distance.

However, with wheeling agreements, issued in 2004, renewable power plants were exempted from the distance fee, required to pay only for voltage and energy. Renewable generators could “wheel” energy to any load center at a reasonable price. This was a powerful incentive since wind farms were located in remote areas far from their load centers. The fee for distance was a great barrier when considering new projects.

 

Open Season Drove Development of New Transmission Infrastructure

Wheeling Agreements and Energy Banking incentivized the creation of a third instrument known as “Open Season”. This drove the development of new transmission infrastructure. The new infrastructure was reserved to dispatch future renewable energy facilities unable to serve 100% of their capacity.

Open season required strong commitment and coordination between CRE and renewable energy developers. Transmission lines were built at a loss, but connected new renewable energy projects which supported the industry.

The first open season was for about 2,000 MW of wind power from The Istmo of Tehuantepec in the southern region of Mexico. The second open season was in Tamaulipas in the north of Mexico. Only developers who applied to Wheeling Agreement and Energy Banking before the reforms can continue utilizing these incentives.

 

Mitigation of Project Risks Related to Distance and Variability

New developers should enter the market because these three initiatives de-risk projects and provide visibility for investors. They also mitigate the impacts of the two biggest concerns related to wind energy: distance and variability.

We expect relatively higher IRRs going forward as developers utilize more data/analytics. We also expect more value creation as developers benefit from the lessons of earlier projects. Please contact Latam Energy Advisors to learn more about the drivers impacting renewable energy across the region.