Mexico’s decision to suspend renewables auctions is bad news for Mexican electricity consumers and bad news for the environment.
Mexican President Andrés Manuel López Obrador (“AMLO”) has only been in office for 8 months, but he has already made several highly questionable decisions on energy policy. I’m particularly discouraged by the recent step backward on renewables.
After several successful rounds of renewables auctions under the previous administration, AMLO abruptly reversed course, canceling future auctions. Instead, AMLO is putting his support behind fossil fuels. For example, earlier this month he ordered a new natural gas combined cycle plant to be built in the Yucatan.
This is part of a broader move to pull back from Mexico’s energy reforms and return control of the sector to state-owned companies like CFE, the state-owned electric utility. AMLOs decision means moving forward there will be fewer private companies building renewables in Mexico, and more CFE-owned projects. CFE director general says, “Why should we buy power, if we can produce it?”
I see why some would find this “energy sovereignty” idea appealing, but this decision to suspend renewables auctions is a deep mistake. Cancelling renewables auctions is bad for Mexican electricity consumers, bad for the environment, and bad for the country’s long-run commitment to markets.
The Auctions Were Working
AMLO cancelled what would have been Mexico’s fourth renewables auction. The first three auctions were very successful, by just about any metric. During the third auction in November 2017, the average winning bids were 2.1 cents per kilowatt hour. These are shockingly low prices – among the lowest prices for renewables ever observed anywhere in the world.
It is hard to believe that CFE, or any state-owned company, is going to be able to replicate these low costs. Renewables auctions have now been held in 48 countries, and they have proven remarkably effective at delivering rock-bottom prices.
Why? Competition. I spoke with one of the developers from the third auction, and he described how hard his company worked to submit a low bid. The auction forces companies to seek out the best locations with the most cost-effective technologies.
The auctions were not perfect. For example, I’ve heard that the most recent auction could have done a better job weighing locational factors. But this could have been addressed by refining the auction design, not moving away from markets altogether.
AMLO is wrong, moreover, if he thinks these companies are getting rich. There has been so much competition in recent Mexican auctions that profit margins are razor thin. There is also “winner’s curse” and related phenomenon which mean that the winners may actually be losing money.
Bad for Electricity Consumers
AMLO’s decision means Mexican electricity customers will pay higher prices. CFE cannot simply stand still. Electricity consumption in Mexico is growing at 3%+ per year, so Mexico needs to be continually adding generation capacity.
CFE wants to build this capacity itself. But economists have long pointed out that state-owned companies have less incentive than privately-owned companies to minimize costs, and many studies show that as markets become more competitive they become more efficient and higher performing.
There is also the very real possibility that CFE will fail to get new plants built at all. Blackouts are currently rare in Mexico, but this could change as growing electricity demand puts strain on the system. The first three renewables auctions yielded contracts for 7 gigawatts of wind and solar, and projects from the first two auctions are already coming online. It will not be easy for CFE to keep up this level of investment.
Bad for the Environment
But probably the biggest loser is the environment. Mexico had a goal of getting 35 percent of its electricity from clean sources by 2024, but AMLO’s decision puts this goal out of reach.
Rather than private companies building renewables, AMLO has said that the CFE will prioritize modernization of the country’s existing power plants, primarily coal and natural gas. This means more emissions of carbon dioxide, more emissions of local pollutants, and more of all the negative externalities that go along with fossil fuels.
Bad for Markets
Mexico has long been regarded as more risky than more free-market oriented countries like Chile. Cancelling the renewables auctions came as a big surprise to developers, and puts a serious chill on investor interest moving forward.
It takes a substantial commitment of resources to participate in these renewables auctions, and at some point, companies are going to give up on Mexico. Frankly, even if Mexico gets the auctions going again, it is not going to be the same. AMLO’s willingness to change the rules of the game, and his attacks on independent energy regulatory agencies raise serious questions about the long-run commitment to markets.
In the end, it is hard not to be discouraged by these developments. Any way you look at, AMLO’s decision makes Mexico worse off. I’m afraid this one is going to hurt for a long time.
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Suggested citation: Davis, Lucas. “Mexico Goes Backward on Renewables”, Energy Institute Blog, UC Berkeley, August 12, 2019, https://energyathaas.wordpress.com/2019/08/12/mexico-goes-backward-on-renewables/
Lucas Davis is the Jeffrey A. Jacobs Distinguished Professor in Business and Technology at the Haas School of Business at the University of California, Berkeley. He is Faculty Director of the Energy Institute at Haas, a coeditor at the American Economic Journal: Economic Policy, and a Faculty Research Fellow at the National Bureau of Economic Research. He received a BA from Amherst College and a PhD in Economics from the University of Wisconsin. Prior to joining Haas in 2009, he was an assistant professor of Economics at the University of Michigan. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.