By Matt Horsburgh

Plans for the reform of Mexico’s electricity market continue to stall on political opposition. Can a compromise be reached to pave the way for much-needed capacity expansion?


With Mexico’s reform plan not looking clear, Fox will need to appease investors with a set agenda
Click here to enlarge image

In April the Supreme Court of Justice dealt a blow to President Vicente Fox’s plans to open up the power sector to increased private investment when it ruled his legislative proposal on electricity reforms to be unconstitutional. Fox responded by insisting that he would seek opposition party backing on ways in which to try and prize open the electricity sector. Mexico’s much-vaunted efforts to get the ball rolling on liberalization seem to have begun and constitutional reform is the first major obstacle facing the government.

“There is a historical folklore surrounding the energy sector that makes restructuring and private investment politically sensitive,” according to George Baker of Houston-based Mexico Energy Intelligence (MEI). Energy has been jealously guarded by the state ever since the oil industry was nationalized in the 1930s, followed by electricity in 1958.

Nevertheless, for the past four years the issue of electricity sector reform has been moving up the political agenda. The previous administration of Ernesto Zedillo was first to highlight the urgent need to expand capacity and supply in order to meet projected demand and to fuel economic growth. Installed capacity is at just under 38 000 MW which is currently sufficient to ensure supply security although some doubts have been expressed for the medium and long term. Zedillo sent a bill to Congress in 1999 which was shelved as the historic 2000 presidential elections approached in which Fox and his National Action Party (PAN) defeated the once-dominant Institutional Revolutionary Party (PRI).

Reform initiatives

Fox, who sent an initiative to Congress via his PAN in May 2001, immediately revived energy reforms. Two more initiatives followed, one by Fox’s PAN and the other by the Green party. Added to this, were more proposals by both the PRI and the smaller Party of the Democratic Revolution (PRD). These latter two are the only bills still alive in congress. Fox’s was broadly similar to Zedillo’s, whereby generation would be opened to private investment, transmission operated independently and distribution in the hands of a combination of public and private companies.

Click here to enlarge image

“However, under the constitution generation, transmission and distribution are declared to be public services to be formed by the State. Therefore, the court’s ruling came as little surprise. Personally speaking, the specific result [of the court decision] is correct from a legal and constitutional point of view,” says Miguel Quintana, vice president of the Mexican Electric Energy Association. However, he goes on to say that: “It is clear more than ever that we need constitutional reform.”

Quintana agrees with Fox’s argument that current constitutional definitions on energy act as a legal constraint on increased private investment. He said: “The only way to have a proper framework is to amend the constitution, although that remains a matter of intense political negotiation.” Although there has been much talk of reform no real progress has been made. He adds: “There is always this expectation that regulation will happen.”

However, Quintana points out that electricity reform has now become a clear priority. For the first 18 months of the current six-year government term, Fox prioritised legislative activity and debate on the more urgent need to pass a tax reform bill through. With that achieved earlier this year the government has clearly moved on to power sector reforms. “It will require a lot of skill on the part of the executive to convince the PRI to change its position,” says Quintana, adding that it is not unfeasible, given that it was the PRI’s Zedillo who originally put forward similar plans for change.

Electricity reform has entered political debate just at a time when there has been an emergence of opposition politics and more effective legislative debate. Opposition lawmakers, of whom the PRI forms the largest block, are consequently learning how to use congress as an effective means of influence. PRI legislators are blocking Fox: “Not just for the sake of public policy, which they are to some degree but also for the sheer pleasure of opposition,” says Baker. Adding: “Energy has become one of the sources of controversy and allowing private investment in electric power distribution goes against the concept of public service.”

Double language

While the PRI is learning the art of opposition, i.e. getting the right balance between negotiation and obstruction, Fox is also learning the art of government. Following his successful presidential election campaign in 2000 Fox has found difficulty in handling an unruly opposition. Initially chastened by their defeat, the PRI have gained strength as Fox’s popularity has dwindled on his failure to immediately deliver ambitious targets laid out in his election campaign. Furthermore, there have been some lapses in tact that have only served to increase opposition to his plans, including electricity reform.

Click here to enlarge image

For example, lawmakers were ruffled in May by the President’s comments made during a tour of European Union nations. Fox insisted to foreign delegates that the energy sector would be opened up to competition. Congressional representatives pointed out that no specific commitments had been set to debate electricity liberalization. They accused Fox of using double language, one of market friendly sentiment in international business circles and one of conciliation and dialogue when dealing with Congress.

However, there are some signs that Fox is beginning to enter into a spirit of compromise in order to push legislation through. Baker points out that: “His proposal actually doesn’t go quite as far as Zedillo’s proposal,” concluding that this is a practical move designed to minimize opposition. Nevertheless, opposition has remained somewhat intransigent. According to Quintana: “The PRI is trying not to amend the constitution and to maintain state control over all activities of the power sector allowing only small room for private investors.” It would effectively seek to maintain and even impose further current restrictions on private investment.

The PRI’s proposal is unlikely to prevail, unless it can pull together support not just within its fractious ranks but also from other opposition groups. Nevertheless, says Quintana, the PRI has so far managed to successfully argue its case that power should remain in public hands. The PRI wants to give more management to Mexican government-owned utilities. By giving greater autonomy to the Federal Electricity Commission (CFE), Mexico’s monopoly state power firm, to invest income in new facilities, Quintana sees a situation in which even more restrictions will be placed on the power sector, stalling much-needed expansion.

With other international examples of supply problems in other regions whose power sectors are in a state of transition (Brazil and California), opponents of liberalization have been able to sell the idea that the Mexican power industry is working well as it stands. Nevertheless, this raises questions as to the medium and long-term supply. These are the areas the government needs to concentrate on says Quintana. “The government has not made a good publicity campaign to explain why reorganization would be good,” says Quintana. “It needs to let people understand the need for private capital without which the country’s economic prospects and growth expectations will suffer.”

Slowdown

A look at Mexican government energy statistics for the 1990s shows that the reserve margin between highest demand and installed capacity has been narrowing, dropping from 46.8 per cent in 1996 to 24.5 per cent in 2000. The Ministry of Energy reckons that an investment of $50 billion is needed to boost the ability to meet demand requirements over the coming years, an annual $5 billion, in order to double installed capacity (up to 36 000 MW). Growth projections for the economy suggest that at least an extra 21 000 MW will be needed by 2007.

Currently, the power sector is heavily dependent on fossil fuels for generation requirements, accounting for over 50 per cent of the fuel mix. Fossil fuel production has been boosted over the past few years in order to match spiralling demand that accompanied strong economic recovery during the last half of the 1990s. Other sources of generation have also been explored and almost 50 per cent of future expansion plans look set to use combined cycle technology.

A counterweight to the government’s insistence on power reforms is the US economic slowdown. The central argument put forward by advocates of electricity reform in Mexico is that under current growth projections for the industry public sector investment will be insufficient to meet demand. “In the year 2000 the government issued estimates for the next ten years projecting growth in demand to the tune of eight to ten per cent per year,” says Baker. While such figures demand an added level of investment that might only be met through private investment, the global economic downturn has reduced expectations of growth. “The urgency [of reform] is not what it used to be,” says Baker. In political terms, Baker offers the following analogy to describe the electricity sector needs: “Do you need a new car? Or do you want a new car?”

Fox is a keen advocate of energy liberalization but with the need less tangible, he needs to find new ways to convince his detractors. However, Quintana stresses that this is a short-term problem and that with signs of recovery in the US, growth in Mexico will also pick up.

International concerns over the failure to progress on energy reform were highlighted in June when Fitch ratings agency announced the release of a sovereign report on Mexico. It underlined electricity reform and other structural reforms that improve the country’s competitiveness and signal Fox’s ability to build consensus in a divided Congress would be viewed positively in order to pave the way for any future improved rating for the country.

Private investment

Since 1992 there has been a trickle of private investment in the electricity sector following the wake of amendments made to electricity regulations. This included the introduction of independent power projects (IPPs) as well as allowing self-supplying companies to sell excess power to the CFE. “IPPs have been used with success,” says Quintana, “allowing private companies to build and provide power to the CFE.” He cites the fact that there have been ten international public bids won by either foreign firms or a combination of foreign and national companies. There is currently 7800 MW of IPP capacity being constructed or near completion.

Private moves

Under the terms of the 1992 regulatory changes, the CFE opens competitive bids to potential investors. The location and size are pre-determined and the CFE remains the single purchaser under 25-year contracts. Bids initially aroused strong interest, at a time when the IPP programme was seen as the first step towards liberalization. The first foreign firm to enter was AES which was awarded construction of the 532 MW Merida III project in the Yucatan peninsula in February 1997. However, with the regulatory future so uncertain bids have been attracting less and less interest. For example, in 2001 only Electricit

The PRI is currently opposed to increasing the number of IPPs, favouring the idea of boosting state funding to allow government-owned entities to invest in increased capacity. Quintana warns of the impact of the lack of certainty of the future for IPPs. “I do not know of any big IPP contractors who support the current regulatory framework. All of them without exception support a change in regulations. They want a bigger piece of the Mexican market.” Furthermore, despite regulatory restrictions Mexico remains a market with big potential both in terms of domestic supply and exporting. Mexico’s border with the US includes power hungry states, most notably California, whose own supply limitations would make it a natural export market for power producers in Mexico.

If constitutional reform is arguably the most pressing concern for the government, then once achieved, it will be just the beginning of potentially tortuous efforts to open up the sector. Fox would want to see a clear separation of activities between transmission, distribution and generation, including breaking up the CFE. This would inevitably reignite opposition hostility backed up by a still significant and well-mobilized labour movement.