Mon, Nov 19, 2018

Mexico’s new president and the power sector: Sunshine or storms?

EnergySource by David Livingston

Americas Energy Markets & Governance Latin America Mexico Renewables & Advanced Energy

The incoming President of Mexico, Andrés Manuel López Obrador (commonly referred to as “AMLO”) will enter office with many tailwinds in his favor, including significant public support for his stated focus on promoting social inclusion and combating corruption, the growing dividends of a largely successful set of energy reforms introduced by the outgoing Peña Nieto administration, and the historical weakness of the main opposition parties, the Partido Acción Nacional (PAN) and the Partido Revolucionario Institucional (PRI). It should be a time for Mexico to be seizing manifold opportunities for its underdeveloped power sector, including cheap US natural gas to the north and abundant renewable energy opportunities at home.

To this end, AMLO has made remarks, both during the campaign and after his election, that signal a recognition of the challenges facing the power sector and the need for continued commitment to its modernization. Mexico’s current clean energy generation, as a share of its total energy production, lags behind the Latin American average. AMLO has emphasized the importance of updating the country’s generation fleet and grid, and has particularly honed in on hydropower as a priority technology.

However, three major storms, some precipitated by AMLO himself, are clouding the outlook for power sector investments in Mexico.

First, the populist leftist leader has unsettled the macroeconomic environment by cancelling a much-needed $13 billion new airport for Mexico City, which was already financed and partially complete, and proposing hastily considered new banking laws. The Peso fell to a five-month low as a result, making any dollar-denominated debt used for power sector projects more challenging to service. A weakening and/or volatile peso also complicates the economics of natural gas generation in Mexico, planned or extant, that is dependant upon importing natural gas (priced in dollars) from the United States as fuel.

Second, though the United States-Mexico-Canada Agreement (USMCA), the putative successor trade agreement to NAFTA, will be signed Canada, Mexico, and the US before AMLO takes office, it is very likely that the Congressional vote on the agreement does not take place until January, when a new Democratic House is in place. The new incoming chairman of the House Ways & Means Committee, which oversees trade policy, recently indicated that changes would be needed to USMCA before it could receive sufficient Democratic votes for passage, with the environmental chapter of USMCA one of the most likely flashpoints. AMLO’s party, Morena, is home to factions with mixed feelings on USMCA, and so any turbulence passing the agreement in the United States may also lead to additional risks in terms of the Mexican politics on the agreement. All of this uncertainty, needless to say, is unwelcome news to Mexican renewable developers that are still seeking greater clarity on how they will benefit, if at all, from new investor protections in USMCA.

Third, there is growing unease with some of the personnel decisions being made for key energy positions, and particularly their possession of the requisite level of knowledge and commitment necessary to carry on further reform of the power sector. Key policymakers include the incoming energy minister, Rocío Nahle, who has been primarily focused on her proposal to build new oil refineries in Mexico as an import substitution strategy, as well as Manuel Bartlett, who will serve as chief executive of the Comisión Federal de Electricidad (CFE), the state utility. Bartlett has a long and controversial history in Mexican politics stemming from a disputed 1988 election, and in general has had a strong anti-privatization stance for much of his career. Bartlett, as well as his new deputy, Carlos Andrés Morales Mar, have so far said many of the right things, including their priority on not cutting off foreign investment and not hastily cutting power prices until grid reform can support such reductions. But these positive remarks are oftentimes mixed with contrasting comments that disparage the role of private investors, particularly foreign ones, in Mexico’s energy sector. It also remains to be seen how AMLO and his key energy leadership will navigate disputes between local communities and clean energy developers, as has been the case with planned wind farms in Oaxaca.

The key takeaway here is that in AMLO’s administration, as much if not more than any other, personnel will be policy. The incoming government is at this point less a cohesive mural than a diverse mosaic, with various different factions and interests jostling for power and influence within the Morena party and the broad ruling coalition. The chief of staff, Alfonso Romo, is a businessman with an excellent sense of what markets will—and will not—endure, as well as good connections to the business community. The putative deputy chief of staff, Lázaro Cárdenas Batel, is also a unique character, having lived for several years in Washington, DC before returning to Mexico, but also maintaining strong links with the populist left in Mexico. Cardenas is also the grandson of the Mexican president who first nationalized Petróleos Mexicanos (PEMEX), now one of the largest companies in all of Latin America. These two figures, as well as their influence and longevity, will be key to determining whether the more positive aspects of AMLO’s goals and aspirations will be met with equally constructive policy choices.

The recent experience with the proposed banking laws is instructive; after the market reacted strongly to what was broadly construed as a hastily prepared proposal, AMLO himself hedged to calm the market, clarifying that no changes would be made for the next three years. But only days later, key Morena members in the Senate broke from this compromise and insisted upon imposition of new regulations, driving a further drop in the Mexican stock market and the peso. The headache of many investors, whether in the power sector or otherwise, is less a frustration with a new direction of travel set by a democratically-elected government than with uncertainty over who exactly is running the show and where the incoming President will ultimately end up on numerous key issues.

The forecast is not all gloom; there are bright spots on the horizon, as well. The national energy regulator recently formalized a legal change that will open up more transactive energy models, including catalyzing further build-out of electric vehicle charging infrastructure. The regulator is also working on a framework for battery storage. Considering Mexico’s prolific potential for intermittent wind and solar power, a clear framework for storage could help incentivize ‘solar plus storage’ and ‘wind plus storage’ auctions in the future, with very competitive prices for these already demonstrated in 2018 auctions north of the border in Colorado and Nevada.

The outlook for Mexico’s power sector, in particular for renewables and natural gas, is clearly positive over the long term. There is widespread recognition of the underlying challenges, namely an aging grid, excessively high technical and non-technical losses, and a lack of competition. Beyond Mexico’s borders, there are positive developments that Mexico can draw upon, including the rapidly falling costs of clean energy and energy storage technologies, as well as abundant natural gas production in the United States, combined with growing pipeline connectivity between Mexico and the US. However, these two realities will not necessarily combine to present a promising investment outlook for Mexico’s power sector if the macroeconomic and policy environment is not conducive to such investment.

It would be ideal if the AMLO administration were to carry forward positive momentum in attracting new technologies and private investment. But, at the very least, it would be useful to have the incoming leadership hew to a certain Hippocratic Oath: first, do no harm. This is not a concession to moneyed interests outside Mexico, but is instead in the best interest of the Mexican people and their promising clean energy future.

David Livingston is deputy director for climate and advanced energy at the Atlantic Council Global Energy Center. You can follow David on Twitter @DLatAC