WITH LUCK

Mexico 2014 | ENERGY | FOCUS: ELECTRICITY REFORM

Mexico is on the verge of game changing progress in its electricity reform.

Although the reform of Pemex has dominated coverage of President Nieto's reform agenda, the electricity sector in Mexico has been in sore need of sweeping changes for decades. In July 2014, after more than a year of talks, protests, inflamed tempers, and promises, Mexico's senate passed key bills that broke the monopolies that both PEMEX and CFE had over the hydrocarbon and electricity sectors, respectively. In both cases, these moves were long overdue, but for most Mexicans and many Mexican companies the CFE reform is what they will feel immediately in their wallets.

For decades the CFE has been like the rest of Mexico's state run enterprises. Powerful and long-established unions, who make it very difficult to streamline operations and provide electricity at acceptable costs to consumers, dominated the operation and decision-making. Efforts to change the sector have been fraught. In 2009 former president Felipe Calderón ordered police to shut down the nation's second largest electricity company, Luz y Fuerza del Centro (LyFC), after it cost the government $23 billion to operate over the course of his administration, the same amount as a massive nationwide poverty program. At the time, the leader of the union swore to fight back.

Those were dark times for Mexico. In 2009 it was one of the worst performers in Latin America, partly because of the looming inefficiency of its energy sector. Just a handful of examples among many are that Mexico's grid experiences losses of 18%, over twice the OECD average of 7%, and tariffs on most consumers are twice what they are the United States. The citizens who are best subsidized are those in the top 10% of incomes, who receive twice the subsidization of those in the lowest 10%. These issues, combined with common electricity pirating, aging power stations, and some of the world's best wind resources (located on the Oaxacan coast) lying untapped by the public or private sector, paint a startling portrait.

The reforms will liberalize the electricity sector and force the CFE to compete with private producers and behave like a profit seeking company. The specifics of the changes to the CFE have not yet been defined, but should be clear by early 2015. However, one important organizational change from the current system is that a third, decentralized public body that operates and manages the nation's electrical networks and how consumers access them, will be created. Under the former system the CFE made requests to the Ministry of Energy for resources. Private producers had to consult with the same ministry, which was also tasked with the hydrocarbon sector and other responsibilities and often produced long lead times.

This somewhat simple change, along with several administrative modernizations that emphasize transparency, competition, and efficiency within the organization, should have effects that ripple throughout the sector and promote the wider objectives of the reform. Among those legislated objectives are: more natural gas plants to drive demand for natural gas exploration and production, as well as to eliminate current fuel-oil plants which are dirty and inefficient; and 35% of electricity to be generated from non-oil sources by 2024, up from an already impressive 20%. The reforms are also expected to clear the way for private investment into the Mexican electricity and generation sector, while maintaining government control, but not all of the legislation has been passed or made public as of mid-2014.

Expected laws include changes to the self-supply system in which private producers arrange with companies to supply electricity on long-term contracts. The current structure discourages changes to those arrangements, such as additional consumers, and therefore hinders efficiency in the private sector. A review of the tariff policy is another likely discussion lawmakers will entertain, as it has frequently been the target of criticism and could be better directed to generating revenue for the CFE, while reliving costs for those most in need.

The CFE will also gain the right to sell natural gas to private sector users, which will promote small-scale generation and re-sale to the grid. It plans to build up to seven new gas-fired power plants to replace the aforementioned older and more expensive fuel oil plants. It will also be responsible for long-term gas contracts that will promote the construction of new gas pipelines, and $2.2 billion worth of such projects have already been announced, as have a further $600 million in electricity infrastructure projects.

Mexican companies will be supplied with cheaper, more reliable, and cleaner electricity with savings reflected in their margins. In some energy intensive sectors, costs may drop by as much as half over the coming years. The electricity reforms in Mexico may yet prove to be one of the most positive changes to the country in years.