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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 Roselln CIDE, DIW Berlin and Universidad Panamericana USC Mexicos Studies Chair 2017 34th USAEE/IAEE North American Conference October 23-26, 2016 Tulsa, Oklahoma, USA 3/35 Outline 1. New industry and institutional structure 2. Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration 3. Implications for policy making in Mexico

4/35 Outline 1. New industry and institutional structure 2. Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration 3. Implications for policy making in Mexico 5/35 6/35 Vertientes Energy de la Reforma Diagnosis: Tariffs Average CFE tariff was 25% superior to the average tariffs in USA. Without subsidies, the difference was of 73% Average rates, first quarter 2013 (cents/ kWh) 400 Subsidi oSubsidy

Mexico Mxico USA EE.UU. +149% 350 +123% +134% 300 250 Real Rate +69% +73% 200 Subsidized Rate

+84% 150 +25% -24% 100 50 0 Residential High Consumption Comercial Public Services Industrial Residential Agriculture

Source: Energy Information Administration EIA (USA) USA Tariffs converted to pesos considering 12.64 MXP/USD, daily average from the first trimester of 2013. Average 7/35 Vertientes la Reforma Diagnosis:deCFE CFEs assets are rapidly declining; reaching negative net assets in 2014. Net patrimony of CFE (Billion Pesos) 416 381 355 175.98 143 155.54 109

129.95 74 2008 2009 2010 2011 Old Finance Rules Source: CFE Financial Statements; Finance Division 2012 of CFE 2012 2013 2014 -11 2015

New Finance Rules 8/35 Public Service Vertientes de laStructure Reforma Pre-Reform Industry CFE Dispatch Self Supply PIEs 9/35 New Industry Structure Generation

System Control and Electric Market Short Term Transactions Retailing Consumption Unregulated Supply Subsidiary A Qualified Users Spot Market Subsidiary B Basic Service Users Subsidiary C Private Parties

Long Term Contracts Auctions and Contracts Transmission Regulated Supply and Contracts Distribution 10/35 CFEs Transformation Horizontal Unbundling Generation Subsidiaries Vertical Unbundling

Australia Argentina Brasil Mxico Francia Lituania 1 Affiliate for CIL Subsidiary for PPA 98.00 23.00 171.00 90.90 193.40 N/A (76.30) (151.30) (3.30) (83.40) 19.10

N/A (43.78%) (86.80%) 1 Transmission Subsidiary (1.89%) (47.85%) 10.96% N/A 61.00 49.00 120.00 121.50 126.00 N/A (62.60) (74.60) (3.60) (2.10) 2.40

N/A (35.92%) (42.80%) (2.07%) (1.20%) 1.38% N/A Private Participation is allowed 1 Distribution Subsidiary 1 Subsidiary for Basic Service Supply 1 Affiliate for Qualified Supply Unbundling for: Promoting Competition. Reducing barriers to entry.

Increase operational efficiency and reduce costs. Guaranteeing economical viability of CFE in the long run. Vertientes de la Reforma Power Market Instruments Market Energy and Ancillary Services Capacity Clean Energy Certificates Financial Transmission Rights Periodicity Market Type

Daily, Hourly Cost Based Yearly Unrestricted offers with administered price caps According to CRE Requirements Yearly (monthly in second stage) Unrestricted offers Unrestricted offers 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. 12/35 Vertientes la Reforma Neutral EnergydePlanning Before Now POISE PRODESEN CFE SENER Indicative generation (Stakeholders) Proposes SENER

CENACE Authorizes Transmission CFE CRE Executes Opinion SENER Publishes G Market T CFE + Regulated Private Participants D

CFE + Private Participants 13/35 FTRs:de la Reforma Vertientes General Characteristics 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. 14/35

Clean Energy Potential in Mexico Wind Resources Solar Resources Geothermal Resources Mexico has sufficient resources to exceed its goals of 35% nonfossil generation in 2024, 40% in 2035 and 50% in 2050. Portfolio standard will assure that they can be developed. Renewable Energy Potential Wind Geothermal Solar Mini Hydro Total Installed Capacity 2 semester 2014 (MW) Actual Generation Year 2013 (% of total GWh)

1900 823 64 419 3206 1.38% 2.04% 0.01% 0.54% 3.97% Actual Generation Actual Generation Actual Generation + Proven Resources + Proven Resources + Proven Resources +Probable Resources +Probable Resources +Possible Resources 5.30% 2.22% 0.65%

1.72% 9.89% 5.30% 22.52% 0.65% 9.48% 37.95% 34.80% 40.03% 2,189.40% 24.35% 2,288.59% 15/35 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. Expansion in Mexico should become more aggressive. Demand Growth vs. Transmission Expansion

85% growth 70 65 60 Demand 55 Transmissio n 50 200 180 160 18% growth 140 45 40

35 120 100 15/35 Transmission (c-km) Transmission in US and Canada expands faster than demand growth. Demand (GW ) Planning: Expansion plan will be proposed by an independent entity with a mandate to promote open access (CENACE). Pre-Reform Reform New Institutional Framework Generation

Control/Dispatch Transmission Distribution Final Rates Expansion Plan Expansion Plan Dispatch Rules Generator Interconnection Generation Modality Approve Expansion Plan Marketing Participate in Final Rates Reliability Standards Approve Expansion Plan

Participate in Final Rates Permits Operation of Short and Long Term Markets System Operation Planning and Interconnection Studies Requirements for Clean Energy Initial Market Rules Approve expansion plan Minimum consumption to be Qualified User Contracting Requirements

Reliability Standards Regulated Tariffs Svc. Quality Requirements Administer CECs Market Monitor Supervision of Interconnection Final Rates (Basic Service) 17 Implementation plan 2014 2015 Aug Electricity Market

Transmission and Distribution Electric Industry Clean Energy CENACE . Sep Oct Nov Dec Jan Feb Mar Apr May Jun Model Contracts

Creation Decree Regulated Rates National Electric System Development Program Fund Creation Bylaws Sep Oct Nov Dec Resolution Program Responsibility:

Legal Separation Resolution Basic Service Auctions Resolution Clean Energy Requirements Certification Rules Restructuring of CFE Bylaws Terms of Separation CFE Clean Energy Guidelines

Aug Electric Market Operation Resolution First Market Rules Universal Service Jul Operation Resolution SENER CRE 18/35

Outline 1. New industry and institutional structure 2. Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration 3. Implications for policy making in Mexico 19/35 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 CFEs plants Arms length separation Merit order pricing under CFE plants regulation 20/35 Market Design Liberalization of Generation Markets Spot, one-day ahead, long-term capacity and

bilateral generation markets IPPs, self-supply, cogeneration old schemes and the new electricity market Existence of IPPs with long-term contracts of energy sales to CFE Basic Services auctions and CECs 21/35 Market Design Vertical Integration Open access enforcement Access pricing Auctions of transmission and distribution projects Prelude of future privatization? 22/35 Market Design ISOs and regulatory capture ISOs corporate governance and regulation (CENACE) Structure of incentives for the ISO Is CENACE a profit-maximizing or welfaremaximizing dispatch entity? Really independent?

CFE capturing the regulator (CRE)? 23/35 Market Design Distribution CFEs basic-service to (captive) consumers Cross subsidies Role of private marketers (suministradores) 24/35 Outline 1. New industry and institutional structure 2. Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration 3. Implications for policy making in Mexico 25/35 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 26/35 Kunz, F., K. Neuhoff and J. Roselln (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. No FTR allocation Full FTR allocation Average change in surplus of demand in the high wind winter week under production-based allocation approach 27/35 28/35

29/35 Outline 1. New industry and institutional structure 2. Critical issues Market design Nodal prices, FTRs and subsidies Transmission and renewable integration 3. Implications for policy making in Mexico 30/35 Transmission Expansion Optimal regulation of the transmission network The Prodesens planning process: stages Does Prodesen converge to welfare optimality? Auctions of transmission projects Transmission CREs 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? 31/35 32/35 Nodal-price developments in Mexico (2015-2023) 33/35 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 34/35

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 35/33 Outline 1. New industry and institutional structure 2. Critical issues: Market design Nodal prices, FTRs and subsidies Transmission expansion and renewable integration 3. Implications for policy making in Mexico 36/35 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 37/35 public-policy making: CEPG

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