"Mexican Energy Sector Restructuring: New Opportunities for Renewables"

by Skadden, Arps, Slate, Meagher & Flom LLP

Skadden, Arps, Slate, Meagher & Flom LLP

The ongoing effort to restructure the power sector in Mexico, together with Mexico’s strong policy on combating climate change, have created compelling opportunities for investors in renewable energy projects that likely will persist this year.  As Mexico continues to transition its electricity sector from a vertically integrated, state-owned and -controlled structure to an unbundled one with private and public ownership, investors will be required to bear more market and investment risks than before. However, these risks are familiar to investors in other mature electricity markets and do not represent insurmountable obstacles to capitalizing on new Mexican renewable energy opportunities.

Electricity Sector Restructuring

The “Secretaría de Energía,” or Energy Ministry (SENER), is overseeing the restructuring of the electricity sector pursuant to the August 2014 “Ley de la Industria Eléctrica” (Electric Industry Law) and related legislation (Reform Legislation). The intention of the reform is to lower prices by shifting to a more competitive market and promoting renewable energy generation.

Prior to the Reform Legislation, the “Comisión Federal de Electricidad,” or Federal Electricity Commission (CFE), was the state-owned enterprise responsible for operating the electricity sector. CFE controlled power purchasing, planning and transmission and was the primary generator that owned most of the total installed capacity and electricity production in the country. Opportunities existed for private entities to participate in generation but were mostly limited.

Under the new regime and for the near term, CFE continues as the primary retail supplier of electricity, but it has become a holding company with separate generation, transmission, distribution, supply and marketing subsidiaries that operate semi-independently. As a result, parties doing business with CFE must look to the specific credit profile and assets of the CFE entity with which they are contracting, and such parties can no longer rely on the asset and credit profile of the consolidated/integrated energy company. In addition, system operations have been transferred to the “Centro Nacional de Control de Energía,” or National Energy Control Center (CENACE). This independent system operator (ISO) for the new wholesale power market plays a similar role to that performed by ISOs in the U.S., with responsibility for ensuring access to the grid, operating the system in a reliable manner and assuring availability of sufficient supplies to meet customer demand. This year, CENACE will introduce new market components, including the real-time wholesale market, the balancing capacity market and financial transmission rights. With these changes, the electricity sector will transition to a structure akin to markets such as the California ISO, which will be very familiar to independent power producers and financiers in the U.S. electricity market.

Power Contract Auctions

The Mexican government made an aggressive commitment to renewable energy with the 2012 General Law on Climate Change, requiring 35 percent of electricity production to come from renewable sources by 2024. A key component of that commitment is power supply solicitations in which CENACE auctions long-term (15-year) power contracts with CFE to renewable energy generators.

Two auctions have been held to date. At the first, 11 winning bids were selected for wind and solar projects totaling 1,720 megawatts (MW) of generating capacity with an average bid price of US$41.80 per megawatt-hour (MWh). The winning bids in the second auction represented 2,871 MW with an average bid price of US$33.47 per MWh. Each auction received bids from approximately 60 to 70 local and international prospective suppliers. A third auction is planned for April 2017.

The CENACE auctions are governed by the “Bases de Licitación de la Subasta de Largo Plazo,” or Bid Rules for Long-Term Auction, which are published before each auction. Pursuant to these rules, bidders must provide a detailed construction schedule with specific milestones, including a fixed commercial operation date, certify their technical expertise and identify their contractor, among other details. The rules include a form of non-negotiable power purchase agreement (PPA) that winning bidders must execute with CFE. The new PPA contains terms that generally have been included in project financings in the U.S. and elsewhere but not some of the protections that benefited generators in previous power purchase agreements with CFE in Mexico.

New Terms of Agreement

The new PPA between a CFE subsidiary and the generator has a 15-year term that runs from the fixed commercial operation date. However, the uncertainty around pricing in the new wholesale electricity market is hampering developers’ efforts to secure long-term financing extending into the period following expiration of the 15-year PPA. Under the PPA, the CFE counterparty makes payments in accordance with the actual amount of energy delivered each month and performs year-end reconciliations that aggregate the monthly amounts delivered to determine compliance with contracted quantities. Because ownership was a material consideration in securing the bid, there are some limitations on changes to generator ownership. However, CFE’s restructuring and the new regime present credit, curtailment, construction and operational risks that were mitigated under the old regime.

CFE Credit Risk

Under the old regime, CFE’s obligations were guaranteed by the government. Given this guarantee and CFE’s formidable balance sheet, it enjoyed a favorable international credit rating that made the former PPA with CFE an attractive and bankable contract for investors and lenders alike. Under the new regime, while the government continues to own the CFE counterparty, it no longer guarantees the subsidiary’s obligations. In addition, the CFE counterparty’s balance sheet reflects the fact that it owns only a subset of the assets that its predecessor entity held, and it must be responsible for its respective share of long-term liabilities and obligations.

Anticipating concerns about credit, the Reform Legislation requires the CFE counterparty to post a guarantee equivalent to one year of its contractual obligations. It is unclear whether the government would ultimately backstop CFE through an implied guarantee if the market assigns a high-risk premium to project financings under the new arrangements. Also, in the event that a CFE counterparty default causes generator termination, the CFE counterparty must fund the full amount of the contract into a trust in order to cover the difference between spot market and contract prices. However, the CFE counterparty’s contractual obligation does not eliminate the risk that the CFE counterparty may fail to comply with this funding obligation, either because it lacks the necessary financial resources or for other reasons.

The Reform Legislation contemplates further restructuring CFE, which could result in a CFE counterparty no longer being a subsidiary or affiliate of CFE. In that scenario, the CFE counterparty would be required to increase its posted guarantee, but the generator would still take the risk that the CFE counterparty might not post the requisite guarantee.

Curtailment Risk

Generators also are subject to certain curtailment risks under the new PPA. To be accepted and remain active in the market, generators must acquire and maintain their status as a market participant, which includes executing a market participant agreement with CENACE. Both this agreement and the new PPA require that the generator abide by CENACE’s operational instructions. While the regulations governing CENACE indicate that dispatch decisions will be based on impartial criteria, the process for determining dispatch and curtailment priorities is not plainly defined, and it is unclear what factors might affect these decisions beyond reliability.

Under the new PPA, generators that are instructed not to deliver energy by CENACE are not compensated, and generators are allowed to terminate the agreement only after six months of curtailment. This change is a significant departure from the former PPA with CFE, where CFE generally was required to pay in the event of curtailment.

Construction and Operational Risks

Similar to the curtailment risk, projects developed under the new PPA will be subject to other construction and operational risks. For construction, generators are responsible for strictly meeting the schedule set forth in the auction bid rules and annexed to the PPA. While certain extraordinary events, such as civil disturbance or the occurrence of a force majeure, allow for a schedule delay, project holdups due to other factors will result in the developer incurring penalties per milestone missed. Furthermore, the CFE counterparty can terminate the PPA if commercial operation is not reached within 12 months of the fixed commercial operation date.

In addition, the PPA does not provide compensation in the event of project delays or other missed milestones resulting from government actions or inactions. For delays brought on by issues such as permitting or an inability to interconnect on time because of grid construction, the fixed commercial operation date may be delayed with no penalty to the generator; however, the generator is not compensated for the delay. The generator has the right to terminate the agreement after six months of delays due to government actions that affect the project schedule.


The restructuring of the electricity sector and Mexico’s commitment to renewable energy present investors with attractive, long-term opportunities in renewable energy projects. However, changes to the market structure and regime remove important investment protections afforded to project owners under the previous regime. Investors will need to undertake careful diligence of curtailment and other risks that might not have been a focus previously.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.