The northern border region of Mexico is leading the way with considerable growth in ‘self-generation’ projects in recent years, for both private and public sector organizations. Here, Scott D. Storment and Arturo Nuñez explain the reasons behind the growth and look at some of the financing issues involved.

The northern border region of Mexico has experienced precipitous growth since the mid-1990s following the passage of the North American Free Trade Agreement (NAFTA). With that growth, energy costs and consumption have increased dramatically.

The market for developing alternative sources of cleaner and more affordable energy for the public and private sector is growing. The financing requirements for these types of projects are developing with their own unique variables and challenges. The goals of achieving economic and environmental sustainability are becoming equally important for many non-traditional players in the Mexico energy arena.

Self-generation projects in the border region

NADB has been working actively to develop and finance clean energy projects since 2002. Since then it has participated in a challenging market transition in Mexico. Electricity has been primarily provided by the Comisión Federal de Electricidad (CFE), but is now also being supplied by private developers pursuing small-scale ‘self-generation’ projects in partnership with the public and private sectors. That transition is being propelled by ever increasing energy costs, greater electricity availability and reliability, and interest in developing cleaner electricity generation options (especially as these relate to greenhouse gas reductions).


A self-generation project is being implemented at this dairy in Delicias, Chihauha
Click here to enlarge image

Under the Public Electricity Service Law 1992, the primary electricity generation source and provider of electricity transmission is the state. However, there are certain provisions for allowing limited electricity generation for self-supply and cogeneration.1 One unique feature of self-generation projects is that the ultimate consumer of the electricity has to be a shareholder in the power production company. In order to meet the legal requirements, this does not necessarily have to be an investor but must at least be a nominal shareholder.

These types of projects are becoming more attractive in the US–Mexico border region due to increasing CFE electricity costs and the interest in accessing potential revenues from the sale of carbon credits produced from electricity generation sources that achieve reductions in greenhouse gas emissions.

NADB is working in two sectors on financing self-generation projects for public and private sector electrical consumption. Each sector is pursuing these projects for different reasons, but the end result for both is that self-generation projects (on-site and off-site) are becoming much more popular and viable.

The public sector focus is primarily consumption related to public street lighting and other municipal power uses. Municipalities in Mexico pay some of the country’s highest electricity prices for public street lighting, averaging in the range of 14–16 cents per kWh. This cost item in a municipal budget is burdensome fiscally and can be reduced when considering a self-generation arrangement. The cost savings can then be allocated to other social needs in the community. The primary sources of self-generation for municipal-based projects tend to be wind energy and landfill gas-to-energy projects.

The private sector players where self-generation is beginning to grow in popularity are related to ‘concentrated animal feeding operations’ (or CAFOs). There are hundreds of CAFOs made up of pig farms, dairies and poultry operations within the 300-km border zone and the interest in generating electricity for self-consumption is growing acutely. Unlike the municipal sector, the agricultural sector experiences a more highly subsidized electricity price, which averages near 4 cents per kWh.2 The sector’s incentive to pursue self-generation is not driven as much by the cost of electricity because it is creating an asset out of a waste management liability. However, permanent capture of the cost of electricity at this point is advantageous to the CAFO. Electricity prices are increasing annually due to the removal of tariff subsidies and rising CFE production costs.

By using anaerobic digesters to treat their animal wastes, the CAFOs create methane which is captured for use as a ‘free’ fuel source to cogenerate electricity and heat for use in their buildings (milking parlours, pig barns). The incumbent methane reductions are then packaged and sold as carbon credits under the auspices of the Clean Development Mechanism (CDM) of the Kyoto Protocol. Methane, on a molecular basis, has an atmospheric warming multiplier of 21 times that of a molecule of carbon dioxide; thus, the multiplier translates into greater economic value per tonne of methane destroyed and sold as a carbon credit. This revenue source can be quite lucrative for developers partnering with CAFOs and for the CAFOs themselves if they develop their own cogeneration/methane reduction projects.

There is also a growing market opportunity for self-generation projects in the industrial sector, especially with combined heat and power (CHP) projects. There is definite activity in heavy industry, where major companies such as Vitro (glass) and Cemex (cement) are using petroleum coke and waste tyres as alternative fuel sources for their furnaces. Utilizing waste products as a fuel source for the production of thermal resources and to generate electricity is a growing trend in Mexico. Although it is not clear at this stage how prevalent this practice will become in the next few years, it demonstrates the search for cheaper sources of energy by large industrial players in Mexico.

Another area that appears to have real opportunity for growth is the recovery of waste heat from industrial processes coupled with using that thermal resource for the production of electricity or using it in an industrial process for its thermal value. As natural gas and electricity prices continue to rocket in Mexico, this approach to maximizing energy use and reuse is becoming more focused in heavy industry. Steel mills, metal fabrication facilities, mining operations, ceramic factories and other energy-intensive industries are seeing the upside of implementing waste heat recovery projects. Industry is driven by economic necessity to reduce energy costs, but also is motivated by an environmental awareness of the need to begin reducing the corporate carbon footprint. NADB is beginning to explore these types of projects and is hoping to see this area as a growth opportunity for our lending activities.

NADB has developed, or is in the process of developing, financing packages for the following self-generation and/or cogeneration projects:

  • Large dairy in the State of Chihuahua – finance an anaerobic digester to treat animal wastes, create methane for use a fuel source, utilize the waste heat for dairy operations, and install an 800 kW electrical generator for self-generation purposes on-site. This project is being developed and owned exclusively by the dairy.
  • Regional wind energy project near Monterrey, Nuevo Leon – co-finance a 20 MW wind energy project that will produce electricity for public street lighting in seven municipalities in the Monterrey region. This project is being developed as a self-generation project where the municipalities are minor shareholders in the project company and the sole purchasers of the electricity generated.
  • Large municipal landfill gas-to-energy project in northern Mexico – finance electrical generators that will use biogas (methane) being pumped from the closed landfill cells. The project will produce 6.4 MW of electricity to be used locally for public street lighting. Waste heat from the generators is introduced to reverse chillers and reused for self-cooling purposes in the generators. This project is being developed as a self-generation project with the local municipality being a minor shareholder in the project company.

NADB views the opportunity to finance self-generation projects as a priority in achieving its mission of improving the environment of the US–Mexico border region. As a result, it works to identify companies and developers that are seeking reasonable terms and affordable pricing for project debt financing. NADB sees its role partly as a catalyst in assisting the development of these types of projects in northern Mexico and indirectly for the rest of the country.

NADB approach to financing self-generation projects

The growing market for clean energy self-generation projects in northern Mexico is a priority financing target for NADB. Since it is a binational, government-owned development bank, it is motivated to support and finance these types of investments. However, NADB has a clear incentive and fiduciary responsibility to minimize project risk to the greatest extent possible. In its due diligence process when analysing a project proposal, the primary areas where project risk enters the analysis are as follows:

  • Financial analysis – are the cash flow projections secure enough and able to provide a reasonable assurance of repayment for a NADB loan?
  • Technical assessment – are the project technology and operational capacity of the client sufficient to meet the power performance projections?
  • Legal/regulatory analysis – are the project business structure, contracts and regulatory permits solid enough to anchor the overall financing transaction?

In Mexico, the technical and legal/regulatory variables are the most important factors in financing an energy project, especially with renewable energy self-generation projects. Municipalities and small companies such as CAFOs had not previously been in the power generation business. Despite the economic benefits expected from a self-generation project, this is a gamble for these entities. The technical and legal realities of this new business activity are challenging and present considerable project risk for any investor or financing institution.

Cash flows from generated revenues are related directly to the accuracy of the power performance projections and the capacity of the client to operate and manage the power generation assets during the term of the financing. If the technical aspects of the project are not well-developed and comprehensively analysed, it is highly likely that power projections will be lower than estimated. This will impact the project revenues and threaten the client’s ability to cover the outstanding debt service payments on a loan. Accurate power performance projections underpin the entire financial strength of the project. NADB puts considerable effort and resources into looking at this component of all self-generation projects in Mexico.

Additionally, NADB is concerned with the long-term sustainability of the project beyond the life of its loan. It works with any client to assist in providing the technical and managerial resources necessary to enhance project longevity, investment profitability and successful operations.

Ultimately though, a self-generation project is only as strong as the business structure and contracts that bind the entire transaction. NADB works closely with clients to understand:

  • the legal architecture of their project
  • the intricacies of their fuel/feedstock purchase and power purchase agreements
  • the contractual relationship between the various parties to the project
  • the quality of the security package they are offering from the project or equity investors to backstop its loan.

In addition, the Mexican regulatory regime through which a self-generation project has to navigate introduces particular risks that are more uncertain and unpredictable than in many other countries in Latin America. The two lead agencies in charge of Mexico’s regulatory processes are the Comisión Reguladora de Energía (CRE) for electrical generation and CFE for transmission. The overall process is in transition to accommodating a more decentralized approach to many types of private investment and electricity generation. The regulatory maturation process is far from complete, but it is moving in the right direction and making headway despite internal political divisions within Mexico on energy reform.

In this climate, regulatory delays or permit denials can cause major problems for an otherwise reasonably well-structured self-generation project. The regulatory risk is not solely the responsibility of the government agencies, but also of the client. Clients must have adequate professional capacity to undertake the collation of information for the permit application and to facilitate the process in a timely manner. Both ends of the process are part of the solution; clients and government agencies must communicate frequently and effectively to ensure a successful outcome – which is a self-generation permit and a successfully implemented project.

In summary

The future of large-scale private investment in Mexico’s electrical generation marketplace is still not clear. One segment of the electricity market that does present interesting and viable opportunities in the northern border of Mexico is self-generation projects (both on-site and off-site) for public and private sector energy consumption. To implement this type of project successfully, not only in the border region but throughout Mexico, a developer must focus on the technical and legal factors that can undermine a project’s power output and, eventually, economic performance.

NADB is a newcomer to the power finance business in general terms, but it has taken the time to understand the most important factors affecting how this new market in Mexico operates and can produce viable projects for financing. NADB considers financing for self-generation projects as an integral piece of its environmental mission and a vital part of its aim to promote ‘green energy’ project investments in Mexico.

Scott D. Storment is Senior Officer (Clean Energy Projects) and Arturo Nuñez is Director of Project Development (New Sectors) with the North American Development Bank (NADB), San Antonio, Texas, USA.
e-mail: sstorment@nadb.org

References

1. Ley de Servicio Público de la Energía Eléctrica, 1992

2. Center for Energy Economics, University of Texas at Austin, and Instituto Tecnológico y de Estudios Superiores de Monterrey. Guide to Electric Power in Mexico. September 2006.

A US–Mexico border development bank

The North American Development Bank (NADB) was created in 1984 under the auspices of NAFTA to address, through financial assistance, environmental issues in the US–Mexico border region. A sister institution to NADB, the Border Environment Cooperation Commission (BECC), was created to certify the environmental, technical and sustainability merits of all projects to be financed by NADB.

Click here to enlarge image

BECC has a strategic role in the NADB process because its project certification has to be completed in order for NADB to provide financing for project. The BECC and NADB processes run in parallel, and the two institutions share a common board of directors where the approval of an environmental certification and project financial package is facilitated simultaneously. This approach heightens the importance of environmental and financial sustainability in all projects considered by BECC and NADB.

The NADB is authorized to serve the public and private sector in the US–Mexico border region, which extends 3380 km (about 2100 miles) from the Gulf of Mexico to the Pacific Ocean. Eligible projects must be located within 100 km (about 62 miles) north of the international boundary in the four US states of Texas, New Mexico, Arizona and California and within 300 km (about 186 miles) south of the border in the six Mexican states of Tamaulipas, Nuevo Leon, Coahuila, Chihuahua, Sonora, and Baja California.

NADB provides project financing to public and private entities involved in developing environmental infrastructure projects in the border region. Potable water supply, wastewater treatment and municipal solid waste management form the core sectors of the Bank’s activities. However, new focus has developed in other areas (e.g. clean and efficient energy, air quality and industrial/hazardous waste) where project sponsors are able to demonstrate tangible environmental benefits for the US–Mexico border region.