Power Sector Reform Pays Off

Speeches Shim

Competitive procurement deploys clean energy capacity efficiently, creates market opportunities for investors, and improves the lives of communities suffering from high energy costs and unreliable service.

The renewable energy industry has quickly become one of the most vibrant sectors of the global economy, with clean energy investment totaling more than $334 billion in 2017 and unprecedented levels of new renewable energy deployment underway.

And yet, another paradigm shift is already emerging. As an increasing number of countries turn to reverse auctions as a means of procuring independently produced power, news headlines declaring record low energy prices have become a regular occurrence. The frequency of these headlines highlights the power of competitive procurement to efficiently deploy clean energy capacity, create market opportunity for investors, and improve the lives of disadvantaged communities suffering from high energy costs and unreliable service.

Access to affordable and reliable energy services is fundamental to ending extreme poverty, improving health, increasing productivity, enhancing competitiveness and promoting economic growth.

Innovating Opportunities

Over the past five years, innovations in technology and investment vehicles have continued to drive down the cost of clean power generation. In many low and middle-income countries around the world, governments have passed these cost savings along to consumers. Meanwhile, many have also begun to transition away from the old fixed-tariff incentive model to more competitive procurement practices, such as reverse auctions. In reverse auctions, energy producers compete with one another to offer the energy buyer the lowest price in an open and transparent process. These reforms have further reduced energy costs for consumers and are driving an unprecedented spike in clean energy growth, along with new opportunity for U.S. and other international energy developers. Lower prices are making clean energy more affordable and accessible than ever before, allowing for greater socio-economic development in countries deploying these reforms.

However, despite a dramatic decline in the price of clean energy and an incredible increase by 222 million in people who have gained access to electricity in recent years, 1.2 billion people worldwide still lack access to affordable energy. Many more suffer from poor service quality, including frequent and long power outages. Energy costs remain a major burden on the world’s poor, with as much as 30 percent of a family’s annual income going to pay for energy services which are often of poor quality. Access to affordable and reliable energy services is fundamental to ending extreme poverty, improving health, increasing productivity, enhancing competitiveness and promoting economic growth.

Advancing Competitive Frameworks

The U.S. Agency for International Development (USAID) recognizes the value of supporting a competitive framework to stimulate new capacity, remove barriers to growth, build investor confidence in the system, and foster renewable energy deployment. For over 50 years, USAID has helped partner country governments advance utility commercialization and pivotal energy sector reform agendas by providing technical assistance and leveraging the immense expertise of U.S. utilities and regulatory commissions. USAID’s sector reform work also plays a crucial role in helping countries overcome barriers to private investment. Auctions drive down prices, but sector reform enables auctions to take place. By adopting best practices on competitive procurement and auction design, developing countries have driven electricity prices lower through competition, while enhancing transparency and creating a level playing field on which international developers (including those from the U.S.) can compete.

Reverse auctions play a pivotal role here because they serve as an excellent price discovery mechanism by which governments can determine the lowest price that developers are willing to accept for a given project. This has resulted in consistently lower prices than previous methods. Reverse auctions also require that government agencies devote resources to advance planning and consultation and that key stakeholders come together to institute the technical, legal, and regulatory processes needed for stable and efficient energy markets. For example, ensuring that adequate transmission is available to interconnect new projects, and that the electrical grid is ready to integrate variable renewable sources, is not only essential to successful auctions, but to a healthy energy sector overall.

Nowhere have these impacts been clearer than in Mexico where unprecedented levels of private investment have begun to flow into the energy sector.

Energizing Reform in Mexico

Mexico’s 2012 climate change law affirmed the country’s intent to increase clean energy generation. As part of its 2013 Constitutional Reform, Mexico undertook a major restructuring of its power sector, resulting in some of the most competitive renewable energy prices worldwide. The reform focused on the following objectives:

  • Attract investments to modernize the energy sector
  • Reduce energy costs
  • Increase national energy security

Power market reforms, designed to drive efficiency and create accountability are extraordinarily long and complex processes, rather than discrete events. Mexico’s Constitutional Reform and new sector framework are drivers of change across the energy value chain. Power generation is transitioning to a decentralized, fully competitive market, in which an independent system operator now runs the wholesale electricity market, open grid access is guaranteed to all market participants, and public-private partnerships or private entities are allowed to participate in the development and operation of new transmission lines.

More than $1 billion in energy projects awarded to U.S. firms

Reverse auctions lie at the heart of Mexico’s reforms and are viewed as the global standard for the procurement of energy generation in both developed and developing countries. Bidders in Mexico’s technology-neutral energy auctions currently bid in the following categories: firm generation capacity, clean energy, and clean energy certificates (these are tradable certificates granted to generation companies that produce clean energy, in which one certificate equals a MWh of clean energy). The first three long-term auctions, one held in 2016 and two held in 2017, have resulted in progressively lower prices. The first auction averaged USD 47.78 per MWh, the second USD 33.70 per MWh, and third USD 20.57 per MWh. Moreover, the third auction set a new world record for low cost wind generation with a price of USD 17.70 per MWh. Total investment in the auctions will be roughly USD 9 billion, with investors from 12 countries, and more than $1 billion in energy projects awarded to U.S. firms.

Following Best Practices

The Mexico auctions follow a trend of best practice auction design in Latin America. Argentina, Brazil, Chile, and Peru have all held successful auctions in recent years. The low prices obtained in Mexico’s auctions are the result of a confluence of factors, including a transparent competitive tender process; a robust legal, financial and technical pre-qualification process; and guarantees to protect participants from known and potential liabilities. The auction design also addressed the thorny issue of foreign exchange risk, a key element in attracting the interest of diverse international players such as utilities, private equity funds and turbine manufacturers, by allowing bidders to index their offers in either USD or Mexican pesos. This design feature made it easier to obtain funding and increased project bankability in comparison with more restrictive local financing options.

Some analysts have questioned whether projects will actually get built at these low prices, arguing that auctions are forcing overly aggressive bids. Underbidding may simply reflect an opportunity cost to enter a new market, or could be a bidder’s attempt to negotiate additional remuneration at a later date after winning the auction. Bid winners do assume risk regarding land rights and suitability, interconnection capacity and costs, and environmental impact. The depreciation of the peso and an increase in the cost of capital may also put the completion of solar and wind projects at risk. However, data from the first two auctions is encouraging: within a year and a half of the first auction, 60 percent of projects are already permitted and 16 percent have secured financing and/or begun construction.

Scaling Responsibly

Of course, as the pace of renewable energy development quickens, the possibility of social, economic and political conflicts of interest also increases. As solar and wind developers clamor for access to develop projects in the locations with the greatest resource potential, winners and losers will emerge. Rigorous consultation with affected local communities and respect for indigenous people’s rights to free, prior, and informed consent will be imperative to scaling renewable energy responsibly. Inadequate consultations and failure to address community concerns will not only erode the social and economic development potential of such projects but risk protests, project delays, and financial and legal penalties for developers. Human rights, respect for traditional cultures and practices, and the equitable distribution of social benefits across all stakeholders must be considered throughout the design phase of future global energy auctions if their dual potential for market growth and poverty alleviation is to be fully realized.

Transparency, and the establishment of clear rules, foster competition by reducing the risks and costs of participation.

As the auction design process continues to evolve in Mexico in 2018, new market studies will assess specific locations and technologies, including energy storage. Storage is a critical component to enable effective variable renewable energy integration. For example, a large battery system in the Baja Peninsula could potentially enhance solar self-consumption and defer a costly transmission network upgrade. Decreasing cost trends among commercially deployed battery storage technologies are projected to continue over the next five years. Grid modernization efforts will continue to create myriad business opportunities for software and engineering firms, solar and wind generation equipment manufacturers, and electric utilities exploring new business models. Energy storage deployments in emerging markets are expected to grow 40 percent annually over the coming decade, resulting in about 80 gigawatts of new storage capacity.

Today, more global capacity from renewables is added annually than capacity from all fossil fuels combined. As demand for clean energy continues to escalate in the decades ahead, the impressive outcomes seen in the Mexican energy market can, and likely will, be repeated in other emerging markets, with variations in policy innovation and auction design. One of the key design elements of the Mexican auctions, which can be applied in future global auctions, is the emphasis on transparency and the establishment of clear rules that foster competition by reducing the risks and costs of participation.

Kristen Madler

Kristen Madler serves as USAID’s Clean Energy Coordinator where she manages the Energy Utility Partnership Program with the United States Energy Association (USEA), an association of public and private energy related organizations, corporations and academic institutions across all energy sectors. The program supports executive exchanges between U.S. and developing country utilities to share best practices on topics such as the integration of variable renewable energy.

Cover photo: Presidencia de la República Mexicana (CC BY 2.0)