- S&P Global Ratings considers the recently proposed energy reform in Mexico as part of the current administration's strategy to strengthen the role of CFE, the state-owned utility company, in the electricity market.
- The reform could affect the credit quality of domestic projects we rate through potentially higher energy prices, the new dispatch order, curtailment risk, and modified contracts.
- Although if the reform passes, CFE will be first in the dispatch order, we think it could weaken the company's operating margins and credit metrics.
Overview Of The Proposed Reform
On March 2, Mexico's Congress approved a reform of the country's electric law that includes the following main points:
- Prioritizing state-owned utility Comision Federal De Electricidad's (CFE; foreign currency: BBB/Negative/--; local currency: BBB+/Negative/--) power plants in the dispatch order for the Mexican electricity system, displacing renewables and private power plants.
- The new dispatch order would be: (1): CFE's hydro power plants, (2): CFE's other power plants (nuclear, thermo, combined-cycle, and geothermic), (3): combined-cycle plants under the independent power producers (PIE, Productores Independientes de Energía) regime, (4): combined-cycle plants under the PIE regime, (5): solar and wind power plants from private companies, and (6): combined-cycle power plants from private companies.
- Permits for new power plants to be aligned with the National Electric System's planning criteria.
- Issuance of Clean Energy Certificates (CELs) won't depend on the owner or the initial date of operations of power plants.
- Eliminating the requirement for CFE Suministros Básicos, a subsidiary of CFE, to acquire energy through long-term auctions.
- The regulator will review or renegotiate self-supply agreements if it deems it necessary.
- The regulator may review the legality and profitability of power purchase agreements (PPAs) under the PIE regime.
In our view, this bill is part of the current administration's strategy to strengthen CFE's role in the electricity market and for CFE to become the main driver of the government's energy policy. While many uncertainties remain about how these modifications will actually be implemented, S&P Global Ratings outlines some of the risks to our rated portfolio and the country's electricity market that we think could arise from the law. According to the proposed reform, the operator and regulator of the system have six months to publish and establish the set of operating rules according to the premises of the reform, so if the bill passes, further information will be forthcoming.
Factors That Could Affect Credit Quality Of Rated Projects
Power prices could spike in the short term
We think energy prices could rise because less efficient power plants from CFE will be ahead of renewables and privately-owned combined-cycle power plants in the dispatch order, which would increase the marginal costs.
Location could increase or mitigate the risks to projects
The proposed new dispatch order in the system could affect our rated portfolio in different ways. Increasing curtailment risk could pose obstacles, although this risk would depend on the characteristics of the nodes where projects are located, which include energy supply and demand, CFE's capacity, and grid congestion.
We also think location could have implications for prices. It could negatively or even positively affect renewable projects that are able to dispatch right after CFE and could therefore benefit from higher merchant prices.
The government may modify PPAs
As stated in the proposed reform, self-supply agreements and PIE regimes--such as for Desarrollos Eólicos Mexicanos de Oaxaca 1 (Demex, mxBBB+/Stable), CE Oaxaca Dos, S. de R.L. de C.V. (BBB/Negative), CE Oaxaca Cuatro, S. de R.L. de C.V. (BBB/Negative), and Mexico Generadora de Energia, S. de R.L. (MGE, BBB+/Stable)--may be subject to revision and renegotiation of their respective terms and conditions. These contracts were signed before the 2014 energy reform. However, this part of the reform wouldn't affect projects contracted under the current energy reform regime, such as Ciclo Combinado Tierra Mojada (FEL Energy VI; BBB-/Stable).
Nonetheless, our base-case scenario doesn't assume that the government would terminate PPAs or legacy contracts unilaterally and without any sort of economic or financial compensation.
Counterparty risk will remain a main factor in our credit assessment of projects.
In our view, the credit quality of the counterparties for rated power projects continues to be one of the main factors for our ratings. These projects tend to have PPAs in a take-or-pay format in which the client or the counterparty buys almost all the project's energy output under a fixed price, making the creditworthiness of the counterparty an important factor for a project's repayment capacity.
Grupo Bimbo S.A.B. de C.V.
CE Oaxaca Dos, S. de R.L. de C.V.
|Foreign currency: BBB/Negative/-- Local currency: BBB+/Negative/-- mxAAA/Stable/--|
CE Oaxaca Cuatro, S. de R.L. de C.V.
|BBB/Negative||CFE||Foreign currency: BBB/Negative/-- Local currency: BBB+/Negative/-- mxAAA/Stable/--|
Mexico Generadora de Energia, S. de R.L.
Grupo Mexico S.A.B. de C.V.
|FEL Energy VI||BBB-/Stable||CFE||Foreign currency: BBB/Negative/-- Local currency: BBB+/Negative/-- mxAAA/Stable/--|
Energy reform risks for rated projects
We think the Demex, CE Oaxaca Dos, and CE Oaxaca Cuatro projects are more exposed to negative factors from the energy reform because their PPAs' terms and conditions could be subject to revision and they're exposed to additional curtailment risk from the new dispatch order. We view FEL Energy VI as less exposed versus those projects because it isn't exposed to contract renegotiation. However, the new dispatch order could hamper its results, although this is partially mitigated by the capacity payments it receives under its PPAs. FEL Energy VI also will have about 30% exposure to the merchant market starting in 2023. Finally, we believe MGE's self-supply agreement could be subject to revision. However, its contractual framework would be a mitigating factor because it's secured by the capacity charges that are not tied to operating performance, capacity, dispatch, commodity prices, interconnections, or transmission.
Given the uncertainty about how the government will implement the reform, we rank the projects that we rate based on the number of changes that could affect each project.
|Energy Reform Risks For Rated Projects|
|Rating||Contract regime||Factors to look for||Risk|
|Demex||mxBBB+/Stable||- PPA for 90% of the output - Self-supply regime||- Contract revision - Curtailment risk||Moderate|
|CE Oaxaca II||BBB/Negative||- PPA for 100% of the output - PIE regime||- Contract revision - Curtailment risk||Moderate|
|CE Oaxaca IV||BBB/Negative||- PPA for 100% of the output - PIE regime||- Contract revision - Curtailment risk||Moderate|
|Low to moderate risk|
|México Generadora de Energía||BBB+/Stable||- PPA for 100% of the output - Self-supply regime||- Contract revision||Low to moderate|
|FEL Energy VI||BBB-/Stable||- PPA for 70% with CFE - PPAs for 30% with various private companies - 30% exposure to merchant starting in 2023 - Under new regime||- Merchant revenues from new dispatch order||Low to moderate|
|Factors To Consider For Rated Projects|
|Demex||CE Oaxaca II||CE Oaxaca IV||MGE||FEL Energy VI|
|Change in dispatch order||May impact||May impact||May impact||N/A||May impact|
|Additional requirements for new power plants||N/A||N/A||N/A||N/A||N/A|
|Participation of older plants in the CELs market||N/A||N/A||N/A||N/A||N/A|
|CFE Suministrador not obliged to get energy under long-term auctions||N/A||N/A||N/A||N/A||N/A|
|Revision of self-supply agreements||May impact||N/A||N/A||May impact||N/A|
|Revision of IPP agreements||N/A||May impact||May impact||N/A||N/A|
Proposed Bill Could Hurt CFE's Operating Margins
In our view, if the legislation is implemented as is, although CFE may benefit from higher dispatch factors for its power plants, its operating margins could decrease because it would dispatch its less efficient plants more often. Moreover, CFE's metrics could worsen if electricity rates limit the company's ability to pass through costs, and consequently, its operations could suffer. Given CFE's large debt burden, this could add another obstacle to its expansion plans.
Nonetheless, we think that CFE will continue to play a critical role for the Mexican government and we expect the strong relationship between the sovereign and the company to remain and even tighten. Considering these factors, we align our rating on CFE with that on the sovereign and expect this not to change. An example of the link between the two is the transfers the company receives from the federal government to cover subsidies from the low-consumption sector. Transfers were about MXN70 billion in 2020 and we expect them to be similar in the next 12-24 months.
Prospects For Reform Approval Remain Unclear
The proposed bill isn't President Andrés Manuel López Obrador's administration's first attempt to propose changes to the country's electricity law. In April and May of last year, the Centro Nacional de Control de Energía (CENACE; entity responsible for ensuring the electricity system functions correctly) and the Ministry of Energy (SENER) released two agreements to regulate the electricity supply in the Mexican grid. However, the government suspended the agreements after a series of legal disputes with private investors.
As of today, although Congress approved the electricity reform, it was suspended by several local courts. In our opinion, the legislation could face additional legal challenges not only on the domestic front but also internationally because the new scheme would favor CFE above foreign investments, which could create inconsistencies with international trade agreements such as the United States-Mexico-Canada Agreement.
We'll monitor the application, if any, of this reform and analyze its possible implications to credit quality once there is more certainty about how it will be implemented and align with other agreements and policies in terms of regulation.
S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
This report does not constitute a rating action.
|Primary Credit Analyst:||Daniel Castineyra, Mexico City + 52(55)5081-4497;|
|Secondary Contacts:||Julyana Yokota, Sao Paulo + 55 11 3039 9731;|
|Candela Macchi, Buenos Aires + 54 11 4891 2110;|
|Additional Contacts:||Marcelo Schwarz, CFA, Sao Paulo + 55 11 3039 9782;|
|Juan Barbosa, Mexico City (54) 114-891-2108;|
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