Call for Papers – Economics of Energy & Environmental Policy

11 Editions since its first volume in 2012

Reforming the Mexican Electricity Market: Design and Regulatory Issues   Juan Rosellón CIDE, DIW Berlin and Universidad Panamericana USC Mexico’s Studies Chair 2017 34th USAEE/IAEE North American Conference October 23-26, 2016 Tulsa, Oklahoma, USA

Outline New industry and institutional structure Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration Implications for policy making in Mexico

Outline New industry and institutional structure Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration Implications for policy making in Mexico

Diagnosis: Energy Tariffs Vertientes de la Reforma Average CFE tariff was 25% superior to the average tariffs in USA. Without subsidies, the difference was of 73% Source: Energy Information Administration – EIA (USA) USA Tariffs converted to pesos considering 12.64 MXP/USD, daily average from the first trimester of 2013.

Diagnosis: CFE Vertientes de la Reforma CFE’s assets are rapidly declining; reaching negative net assets in 2014. Source: CFE Financial Statements; Finance Division 2012 of CFE

Pre-Reform Industry Structure Vertientes de la Reforma Public Service CFE Dispatch PIEs Self Supply

New Industry Structure Generation System Control and Electric Market Retailing Consumption Short Term Transactions Unregulated Supply Qualified Users Subsidiary “A” Spot Market Subsidiary “B” Basic Service Users Subsidiary “C” Private Parties Long Term Contracts Regulated Supply Auctions and Contracts and Contracts Transmission Distribution

Generation Subsidiaries 1 Transmission Subsidiary CFE´s Transformation Horizontal Unbundling Unbundling for: Promoting Competition. Reducing barriers to entry. Increase operational efficiency and reduce costs. Guaranteeing economical viability of CFE in the long run. Vertical Unbundling Generation Subsidiaries Subsidiary for PPA 1 Affiliate for CIL 1 Transmission Subsidiary Private Participation is allowed 1 Distribution Subsidiary 1 Subsidiary for Basic Service Supply 1 Affiliate for Qualified Supply

Power Market Instruments Vertientes de la Reforma Market Periodicity Market Type Energy and Ancillary Services Daily, Hourly Cost Based Capacity Yearly Unrestricted offers with administered price caps Clean Energy Certificates According to CRE Requirements Unrestricted offers Financial Transmission Rights Yearly (monthly in second stage) Auctions and Long Term Contracts CRE will set the requirements for all suppliers to contract forward energy and associated products. Basic Service Retailers may only contract forward through auctions operated by CENACE. All market participants can participate in the auctions.

Neutral Energy Planning Vertientes de la Reforma Before Now POISE PRODESEN CFE SENER Proposes Indicative generation (Stakeholders) SENER CENACE Authorizes Transmission CFE CRE Executes Opinion SENER Publishes G T D Market CFE + Regulated Private Participants CFE + Private Participants

FTRs: General Characteristics Vertientes de la Reforma Objectives Allow market participants to reduce exposure to congestion prices. Assure that generators face correct signals to build and operate plants. Preserve legacy rights. Avoid restricting efficient dispatch. Features Allocation process for Grandfathered FTRs. General auctions for new FTRs. Special FTR mechanism linked to new construction. CENACE will only award FTRs up to the capacity of the network.

Renewable Energy Potential Clean Energy Potential in Mexico Solar Resources Wind Resources Geothermal Resources Mexico has sufficient resources to exceed its goals of 35% non- fossil generation in 2024, 40% in 2035 and 50% in 2050. Portfolio standard will assure that they can be developed. Renewable Energy Potential Installed Capacity 2° semester 2014 (MW)   Actual Generation Year 2013 (% of total GWh) + Proven Resources +Probable Resources +Possible Resources Wind 1900 1.38% 5.30% 34.80% Geothermal 823 2.04% 2.22% 22.52% 40.03% Solar 64 0.01% 0.65% 2,189.40% Mini Hydro 419 0.54% 1.72% 9.48% 24.35% Total 3206 3.97% 9.89% 37.95% 2,288.59%

Opportunities for Transmission Investment Existing Program: In the 15 year plan, CFE has included 19.3 billion USD of transmission projects including 19,555 circuit-km of lines. Planning: Expansion plan will be proposed by an independent entity with a mandate to promote open access (CENACE). Transmission in US and Canada expands faster than demand growth. Expansion in Mexico should become more aggressive.

New Institutional Framework Generation Control/Dispatch Transmission Distribution Marketing Final Rates Expansion Plan Expansion Plan Generator Interconnection Dispatch Rules Pre-Reform Generation “Modality” Participate in Final Rates Reliability Standards Approve Expansion Plan Approve Expansion Plan Participate in Final Rates Permits Operation of Short and Long Term Markets System Operation Planning and Interconnection Studies Reform Requirements for Clean Energy Initial Market Rules Minimum consumption to be Qualified User Approve expansion plan Contracting Requirements Reliability Standards Regulated Tariffs Svc. Quality Requirements Administer CEC’s Market Monitor Supervision of Interconnection Final Rates (Basic Service)

Implementation plan Electricity Market Transmission and Distribution 2014 2015 Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Electricity Market CENACE . Creation Decree Model Contracts Electric Market Operation Resolution Certification First Market Rules Rules Transmission and Distribution Regulated Rates Resolution Universal Service Fund Creation National Electric System Development Program Program Electric Industry Bylaws Restructuring of CFE Bylaws Legal Separation Terms of Separation CFE Resolution Clean Energy Clean Energy Guidelines Basic Service Auctions Resolution Operation Clean Energy Requirements Resolution Responsibility: SENER CRE

Outline New industry and institutional structure Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration Implications for policy making in Mexico

Liberalization of Generation Markets Market Design Liberalization of Generation Markets Horizontal integration in generation markets under a dominant incumbent (CFE) How to accomplish a level-playing-field to allow fair competition? Potential collusion of CFE’s plants Arms’ length separation Merit order pricing under CFE plants’ regulation

Liberalization of Generation Markets Market Design Liberalization of Generation Markets Spot, one-day ahead, long-term capacity and bilateral generation markets IPP’s, self-supply, cogeneration old schemes and the new electricity market Existence of IPPs with long-term contracts of energy sales to CFE Basic Service’s auctions and CECs

Market Design Vertical Integration Open access enforcement Access pricing Auctions of transmission and distribution projects Prelude of future privatization?

ISO’s and regulatory capture Market Design ISO’s and regulatory capture ISO’s corporate governance and regulation (CENACE) Structure of incentives for the ISO Is CENACE a profit-maximizing or welfare-maximizing dispatch entity? Really independent? CFE capturing the regulator (CRE)?

Market Design Distribution CFE’s basic-service to (captive) consumers Cross subsidies Role of private marketers (suministradores)

Outline New industry and institutional structure Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration Implications for policy making in Mexico

Nodal prices, FTR Auctions and Subsidies Transition to nodal prices starting from a confusing regressive subsidy scheme Free allocations of FTRs to smooth out revenue or cost shocks (distributive efficiency) Grandfathered FTRs (legados) FTR auctions? Lump-sum subsidies in a now progressive scheme Subsidies carried out by the finance ministry (Hacienda) and not by the Energy authorities

Kunz, F. , K. Neuhoff and J. Rosellón (2014) Kunz, F., K. Neuhoff and J. Rosellón (2014). "FTR Allocations to Ease Transition to Nodal Pricing: An Application to the German Power System," Discussion Papers of DIW Berlin 1418, German Institute for Economic Research.

Outline New industry and institutional structure Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration Implications for policy making in Mexico

Transmission Expansion Optimal regulation of the transmission network The Prodesen’s planning process: stages Does Prodesen converge to welfare optimality? Auctions of transmission projects Transmission CRE’s tariff regulation Application of an incentive mechanism to promote the efficient regulation of the operation and expansion of the Mexican networks? Is there room for incentive transmission-tariff regulation?

Nodal-price developments in Mexico (2015-2023)

Transmission Expansion and Renewable Integration Time resolution, and supply and demand fluctuations of a renewable integration process Hourly time resolution to substantially increase the applicability of regulatory mechanisms Price-cap incentive HRV regulation is still superior to cost-plus regulation

Transmission Expansion and Renewable Integration Rationality of transmission investment under a dynamic process of renewable generation integration. Transmission investment under gradual substitution of conventional energy (e.g., coal or fuel oil) with renewables (wind, solar or geothermal energy) Diverse developments of the technological mix in the generation park that implies different network congestion scenarios

Outline New industry and institutional structure Critical issues: Market design Nodal prices, FTRs and subsidies Transmission expansion and renewable integration Implications for policy making in Mexico

Implications for Policy Making in Mexico Analysis of allocative, productive and distributive efficiencies in the electricity sector. Increase in economic welfare. Efficient integration of renewable energies into transmission networks (with consequent reduction of greenhouse emissions). Efficient expansion of transmission networks. Nodal-price systems and financial hedging mechanisms that grant adequate property rights which incent efficient investments Research results with potential to be applied in actual public-policy making: CEPG