Mexican government officials are quick to boast about their success in capitalizing the country’s electricity sector over the past two years. During that time Mexico has raised $1.4 billion in private investment commitments through international tenders, or the equivalent of about 2,100 megawatts of additional generating capacity, according to the Comisión Federal de Electricidad, the country’s energy regulatory commission.
Just this year, say CFE officials, the government has awarded five independent power production (IPP) contracts and two build-lease-transfer contracts, which equal roughly 2,000 MW, or about $1.3 billion in investment. And officials plan to tender as many as 17 projects by the end of next year in an effort to increase investments in the sector to $3.3 billion.
Though such investment is substantial, the additional capitalization still falls short-significantly short-of enabling the country to meet its future electricity demand.
In February, the government said that at least 13,000 MW of additional generating capacity would be needed in the next six years to keep up with Mexico’s expected 6% annual growth in electricity demand. That would mean generation, transmission and distribution investments equaling $25 billion during that time.
“In general, the reality is that Mexico’s energy needs are growing much faster than the government can finance them,” said Jose Ordoñez, director at Salomon Smith Barney.
Limited Participation
Over the past several years, IPP contracts, as well as build-lease-transfer and build-own-operate contracts, have really been the only source of private investment in Mexico’s electricity sector. But these contracts such as IPPs, which only allow for investment in generation, not in transmission and distribution aren’t enough to keep up with the country’s burgeoning demand.
The numbers speak for themselves: the 13,000 MW of additional generation capacity required is more than a third of today’s 36,000 MW of available capacity.
“If Mexico wants to continue growing, it needs an injection of external funds to fuel the growth and meet the supply,” said Lawson Steele, utilities analyst at Warburg Dillon Read.
According to consulting firm CG/LA Infrastructure, capacity add-ons necessary to meet CG/LA’s baseline demand forecasts total 23,500 MW through 2008-or a necessary average investment in generation of about $1.8 billion per year over the next ten years.
This is a difficult target to meet, especially considering the fact that the share of the public power sector investment devoted to generation dropped from 54% in 1992 to 26% in 1997.
“There has been an average decline (in overall public investment) from roughly $2.1 billion per year in the early 1990s to roughly $1 billion per year in the past four years,” said Mark D. Hoff, director of CG/LA Infrastructure’s power sector. “That shortfall needs to be met, and the only logical source is private investment,” he added.
Key Reforms
That’s exactly the idea behind Mexican President Ernesto Zedillo’s new and significantly controversial proposal that pushes for a structural reform of the country’s electricity sector to allow private sector participation in generation and distribution through long-term concessions.
| George S. Liparidis, Max Yzaguirre, John Hushon. | ||||||
For the past three decades, the two state-owned utility companies, Comisión Federal de Electricidad (CFE) and Luz Fuerza del Centro (LFC), have been responsible for electric power generation, transmission and distribution. CFE supplies power to the whole country, except Mexico City and its surrounding cities, where LFC is a supplier.
Without this reform, in which developers will be able to participate in generation and distribution, Mexico will not be able to fulfill electricity demand, says Zedillo. Most industry analysts agree, saying the reform bill is not an option, but a necessity.
“Electric power is not a luxury item,” said Max Yzaguirre, president and CEO of US energy company Enron’s Mexico division. “It’s something needed for economic growth, public health and well being.”
Added James E. Callahan, president and managing director at BankBoston in Mexico: “Mexico is almost unique in not having privatized its energy sector.”
Increasing the private sector’s participation has enraged many Mexicans. With the bad privatization experience of the Salinas era fresh in their minds, most view electricity as a public service that should be the state’s responsibility. Critics also say the US is the true benefactor of the opening, as it will also help fulfill the US’s limited demand.
Analysts, bankers and industry players in and out of Mexico view the privatization as an inevitable necessity and applaud Zedillo’s initiative. “Bringing competition into a sector in the long run generally leads to improvement and reduction in energy costs, like in Chile and Argentina,” said Salomon’s Ordoñez. “Competition is always good for the market. Added Hoff: “Mexico is behind the curve in its opening to private investors.”
Intense Interest
US energy companies, in particular, are keeping a watchful eye on the government’s next move. Though only willing to talk in hypotheticals, many admit that they would step up their investments in Mexico if the proposal favored competition, transparency and a good regulatory environment.
“If the proposal actually goes through, there will be tremendous appetite on the part of US energy companies,” said Ordoñez. “Mexico is the largest market in Latin America that hasn’t been privatized. It’s a country that is growing rapidly and has significant energy needs, and it’s right next to the US.”
Indeed most US energy companies still envision a Yukon-to-Yucatan integrated energy grid for natural gas and power.
“The (power industry) is undergoing a convergence, where electricity distribution and gas distribution are becoming a single business,” Ordoñez explained. “Companies are trying to participate throughout the value chain of energy.”
Sempra Energy is a case in point. The San Diego-based company, which already has investments in three gas distribution projects and one gas transmission project in Mexico, is one of the handful of US companies-including El Paso Energy International, Intergen, Enron and AES-that recently placed a bid to build a 450-MW generation plant, Monterrey III, in northern Mexico.
The winner, which will be announced in October, will be able to choose whom to buy natural gas from and for the first time will have the option of building a larger plant than that originally requested by the CFE, in order to self-consume the excess energy.
If Sempra wins the bid, Monterrey III would be the company’s first electricity distribution asset in Mexico-precisely an area Sempra would consider investing in, if and when Zedillo’s proposal were passed, says George Liparidis, senior vice president of Sempra Energy International, a subsidiary of Sempra Energy.
In the meantime, “Sempra will continue to invest in gas, which is an area that is already open, and will continue to look at IPPs consistent with our strategy,” said Liparidis.
Sempra also has plans to bid for the Naco-Nogales (225 MW) and Rosarito 10 and 11 (450 MW) IPP projects, scheduled to come to the auction block in September and November, respectively.
Enron is another US energy company that is keen on becoming a critical piece in the Canada-US-Mexico energy puzzle. “That’s why our Mexico business is part of our North American operation,” said Yzaguirre, the head of Enron de Mexico.
Enron de Mexico will continue to pursue investments primarily in the merchant as well as the asset development side of the business, which includes electric power and natural gas. “As both (power and gas sectors) open (up), they will converge into one market, and we will be involved on both sides of it,” said Yzaguirre.
Enron, which has no spending goal and no cap on investments in Mexico, is willing to make “very significant” investments in the country if conditions are favorable, says Yzaguirre. Without providing specific figures, he said, “We are prepared to take the necessary steps and investments to develop natural gas and infrastructure projects (in the country) and expand and finance activity in this market.”
Sempra has a similar attitude. Sempra’s Liparidis said he is certain that the company would at least double its current $150 million committed in the country in the next few years, depending on how the market opens up. “Sempra has a long-term view of Mexico,” he said. “We are going to be in Mexico. The issue is how big our investment will be.”
Big Potential
That is precisely the question everyone is asking. Though most officials were hesitant to give specific numbers, the initial interest expressed by energy companies indicates they are prepared to pour substantial resources into developing the Mexican market.
John D. Hushon, president of El Paso Energy International, said the company’s net equity investment in Mexico could easily double in the next five years depending on the conditions of the proposal.
“El Paso is investing in terms of equity something between $500 million and $1 billion worldwide, and Mexico is one of our most important markets,” said Hushon. “I would be very surprised if our commitment to Mexico is limited to $100 million in the next five years.”
Most of El Paso’s investment would be in the wholesale generation of electricity and long-haul transportation of natural gas, the company’s core business, with gas pipeline transmission being a top priority.
“Almost all the fuel for the northern tier in Mexico, in the foreseeable future, will come from the US,” said Hushon. “We have available fuels just north of the border that we can transport south.”
El Paso Energy International already owns 40% of the Samalayuca pipeline, a 45-mile pipeline-22 miles in the US and 23 miles in Mexico-which transports gas to the 700-MW Samalayuca power plant. It was also awarded licenses to build natural gas distribution systems in three different Mexican cities.
The Europeans
Though US energy companies are enthusiastic about a freer electricity market in Mexico, analysts predict that becoming a top contender there will not be easy, especially with increased competition from non-US players.
The presence of large European energy companies can already be felt, said CG/LA’s Hoff. “Some European companies are competitively bidding in IPP projects, getting their foot in the door, even though the economics aren’t that great and margins are low-extremely low in most cases,” he said.
In other words, European bidders tend to accept lower rates of return than US private energy companies. Most of the large European energy companies are still state-owned and capital rich. In addition, they are inclined to place greater value on market share than US companies, instead of viewing the purchase as a discounted cash flow. Meanwhile, US companies typically have greater management pressures for high returns.
As Tom Smith, president of PSEG Americas, a subsidiary of New Jersey-based Public Service Enterprise Group, explains: “Big European companies with lots of capital, such as Iberdrola and EDF, sometimes do crazy things in going after properties in Latin America,” he said. “They don’t have the same profit motives as private US energy companies. They will pay prices that look insane to us.”
Eletricite de France and Union Fenosa have been particularly active in Mexico. These two companies have been awarded three of the five IPP tenders already underway.
Japanese companies Mitsubishi Corp. and Nissho Iwai haven’t stayed away either. In May Mitsubishi won the contract to build and operate a 495-MW plant in Mexico’s southern state of Veracruz, outbidding Iberdrola, among other companies. Meanwhile, Nissho Iwai has won two of the six build-lease-transfer contracts awarded in Mexico since 1997.
Proposal
Though the prospects are promising, the consequences of the proposal for Mexico is still anyone’s guess.
The only thing that is certain is that it will be a daunting task which will involve amending the constitution, writing new laws and regulations and, of course, ultimately getting congressional approval.
While the government will attempt to push the proposal through Congress in September, most observers do not expect the proposal to pass before the end of the year, or even before Zedillo’s term is up in 2000.
“It looks as if it will go into Congress this fall, but it’s anyone’s guess if and when it will pass,” said Hoff.
While critics say the timing of the proposal is awkward, considering it’s Zedillo’s last year in office, Enron’s Yzaguirre says the debate is quite timely. “The situation that currently exists has made it a very opportune moment to have public policy debate on how the country is going to (fill this demand),” he said.
Political bickering is at the heart of the proposal’s knots.
Nevertheless, as Hoff points out, the consequences will be “tremendous and far reaching.”
Opportunities for Banks
While energy companies will obviously be the most interested parties in Mexico’s electricity reform, the change will also create opportunities for suppliers, engineering firms and banks, according to James E. Callahan, president and managing director at BankBoston in Mexico.
“Banks will be interested in financing this private sector investment, but the rules have to be clear and credible,” said Callahan. “The regulatory framework must be well-designed.”
If this is the case, it is feasible that the traditional transfer payment role that exists today in Mexico’s local banking sector may be converted to credit transactions, according to Robert Chandler, acting CEO of Banorte. “But it is difficult to project beyond that with whom we would be doing what and under what terms,” he added.
Though the Monterrey-based bank doesn’t have a business strategy developed around this issue, Chandler did say Banorte is interested in following the development “if and when the players begin to line up and profile themselves.”
The reform proposal would undoubtedly create significant opportunity in the capital market, said Jose Ordoñez, a director at Salomon Smith Barney. “There will be several companies in the private sector that will be looking to raise capital to finance this growth.”
Other sectors that may benefit are Mexican construction firms. Companies such as Empresas ICA, Tribasa, and Bufete, which are already actively investing in Mexico’s power market, are likely to form, or have already formed, strategic alliances with foreign firms specializing in electricity generation, said Hoff.
Those alliances would also help banks, says Carlos Perezalonso, senior equity analyst, cement and construction for Latin America at ABN AMRO in Mexico. “In order to construct new electric plants, international firms will have to subcontract work to local Mexican construction firms,” he explained. “And these local firms will need to get some financing.”