Mexico, Cuba: Next Hot Spots for Energy?

Fortnightly Magazine - July 15 2000


Both look overseas for project developers, but some U.S. firms worry they'll miss out.

With its electric grid primed for privatization, Mexico stands ready to open the door to an estimated $25 billion in new investment in its energy infrastructure. Companies from the United States, Canada, France, and Spain, among others, all appear eager to enter the market.

Cuba, too, is attracting attention, especially among U.S. firms with global affiliates.

Yet U.S. investors worry they'll miss out on some opportunities. And not just in Cuba-for the obvious reasons-but in Mexico as well, since private capital may find itself at a disadvantage when bidding against public sector competitors to win contracts.

Part of the attraction of investing in Mexico's electric generation capacity is the generally strong economic state of the nation, expected to grow 5 percent this year in gross domestic product. But since the advent of the North American Free Trade Agreement in the early 1990s, Mexico's regulatory regime has become far more transparent to global commerce, making entry for U.S. companies particularly attractive. While there still are limits on the private sector participation in distribution and transmission, the needs for generation are profound.

Mexico's federal energy ministry, the Secretaria de Energia, late last year adjusted its prior 10-year forecast for electrical capacity needs by the year 2007, adding 8,554 megawatts to the previously estimated requirement of 13,189 MW of new power, for a revised total of 21,743 MW. The projected new capacity will add to the current generating capacity in Mexico of 35,603 MW.

"This may translate into about 10 projects more than the 10 already planned as of September 1999," says Arturo Dessommes, a trade specialist at the U.S. Embassy, in Mexico City. Some 75 percent of the new capacity planned for the next few years will be sited in the country's industrialized Northeast and Northwest regions, where the export assembly maquiladora factories are most heavily concentrated.

Plans already are in the works by the Mexican federal electric utility (CFE, or Comision Federal de Electricidad, which serves most of the country) to spend $9.3 billion this year to improve the nation's electric grid capability. Public coffers will chip in $2.1 billion to build new generating capacity, with $473 million going to upgrade transmission lines.

Yet the balance of the required new investment in generation-close to $4 billion a year through the end of the next presidential term, which will end in January 2007-will have to come primarily from private-sector companies. And while the demand is great for new generating capacity in Mexico, the terms of new concessions are not always attractive.

Bidding, Finance, and Other Investment Obstacles

In Mexico, the CFE tends to set the winning criteria for concessions on the lowest cost for delivered energy. Thus foreign government-subsidized entities like France's Electricitie de France-one-third owned by the French government-have a perceived advantage over purely private sector competitors in being willing to take a lower rate of return on a project in order to get a foot in the door.

"The last few concessions that have been awarded have been difficult to finance," says Rocio Calzada, director of finances at AES Mexico, a unit of the U.S. power producer AES Corp. According to Calzada, the deals have required the participation of multilateral banks like the Inter-American Development Bank and the use of suppliers' credits. And she sees other difficulties.

"There are obstacles to private sector investment in Mexican power because domestic bank credit is very costly, and trade finance is more costly than [foreign] government credits, which some competitors have access to," says Calzada. "Nonetheless, since Standard & Poors increased Mexico's [sovereign debt] rating, costs have been reduced a bit," she says. "We are a constant bidder in new projects, but at times the interest rates are so high that we can't offer a competitive bid."

AES won the first independent power project bid circulated by the federal regulatory agency, Comision Reguladora de Energia, or CRE, in February 1997, with an associated investment of $213 million. That project involved the construction of the 532-MW AES Merida III project, located at Merida, the capital of Yucatan state. CRE has granted seven other IPP permits since then, with a cumulative investment expectation of $1.8 billion for the addition of 3,528 MW of new generating capacity. Among other developers are Spain's Union Fenosa and Iberdrola, France's EDF, Japan's Mitsubishi, Canada's TransAlta, and InterGen, from the United States.

The most recent of these awards was the 28-Year build-own-operate award of the 275-MW Campeche unit, worth some $200 million, to TransAlta, of Calgary, in Alberta province. The combined-cycle Campeche unit will be located in the city of Palizada, and begin operation in 2003. CFE will purchase the power generated by the plant for 25 years, while state-owned oil company Petroleos Mexicanos, or Pemex, will supply natural gas under a long-term contract.

The CRE called for bids by June 15 for the first two of five remaining power plant projects open to independent power producers and scheduled for the concession process this year, with a cumulative capacity of 2,925 MW. The projects will involve 25-year build-own-operate schemes. The first is for a 900-MW electricity generating project composed of two 450-MW units, called the 19 CC Tuxpan III and IV, in Veracruz State. The second is also a 900-MW project composed of two 450-MW units, called the 15 CC Altamira III and IV, in Tamaulipas State. Both projects are scheduled to be online during the second quarter of 2003.

Other projects also were expected to be opened up for bidding this year for a 225-MW plant at Chihuahua; a 450-MW plant in Laguna; a 450-MW plant in Rio Bravo; and two 450 MW plants in Altamira.

North American companies are among those who will be pursuing these next few projects. "We're going to continue to be involved in Mexico and look at opportunities as they come up," says Dawn Farrell, the executive vice president of independent power projects for TransAlta, in Calgary. "We'll probably look at investing between $500 million and $750 million by the time it's over," she says. "We'd like to have two or three more of the $250 million Campeche-sized projects."

TransAlta bid the proposed electricity cost for the plant at a fraction over 0.29 Mexican pesos per kilowatt-hour to win.

Farrell, too, notes that the lowest-cost kilowatt-hour criteria for winning new plant awards in Mexico presents a challenge for bidders, but also for Mexico itself, competing with other countries for increasingly scarce energy investment dollars.

"My sense is that for Mexico it is a great benefit if there are some subsidized power developers in the world that want to subsidize the cost of power in Mexico," she says.

Beyond the Embargo

Canada, France set up shop early in Cuba.

During the 1990s, as Cuba lost financial support from the Soviet Union and struggled to rid its dependence on oil, brownouts were common during the day at the best hotels ringing the central plaza of Havana. But now that 43 percent of the island's electrical generation comes from domestically produced energy, brownouts are less common. By the end of 2000, when Cuba expects to produce 70 percent of its total energy consumption, the brownouts may become a phenomenon of the past.

Nevertheless, U.S. companies still are barred from investing in the domestic economy of Cuba, thanks to the 38-year-old U.S. economic embargo of trade with the island. But the gradual thawing of U.S.-Cuban trade relations might mean that restrictions on infrastructure will be lifted before long, since the U.S. government has already loosened restrictions on telecommunications services and travel. In the meantime, Canadian and French power companies are stepping in to get established in the market.

HEIGHTENED U.S. INTEREST. "There has been a marked increase in interest by U.S. power generation companies toward Cuba during the last eight months," says John Kavulich, president of the U.S.-Cuba Trade & Economic Council Inc., of New York. "One of the focuses has been on the situation in which many of the U.S.-based power generating companies have global affiliates and global agreements, so that they are finding they are doing business with companies which have direct or indirect dealings in Cuba," he says.

One U.S. utility that took a pro-Cuba business stance-at least for a while-is Tampa Electric Co.'s TECO Power Services unit. TECO does business in a number of countries in Central America and the Caribbean. A TECO official was quoted late last year as saying that U.S. companies were "missing out" on opportunities in Cuba while foreign competitors were moving in.

CANADIAN VENTURES. One of the leading foreign investors in Cuba is Toronto-based Sherritt International, which has a subsidiary, Sherritt Power Corp., with growing investments in the nation. Sherritt Power and the state-owned electric utility, Union Electrica, formed the Energas joint venture to develop natural gas feedstocks and new electrical generating capacity. The venture is operating two gas-fired plants with a total output of 151 MW, says Patrice Merrin Best, the chief operating officer of Sherritt International. One project is located in Varadero, a beach resort outside of Havana. The other is in Boca del Jaruco, about 40 miles west of Havana, where the company is recovering associated gas from oil production facilities.

"Cuba used to flare the gas," notes Best. "Now it's looking like there is quite a bit of gas there."

Best adds that Sherritt "will be adding another 75-MW combined cycle plant in the fall of 2000 that is scheduled to come online in 2001, which will bring our capacity to a total of 226 MW, with a corresponding investment of about $170 million." She adds that her company was "considering an additional 141-MW unit at Boca del Jaruco, which has not been decided on yet." Although the Sherritt Power facilities are "throwing off cash," the capital-intensive investments will not yield a positive cash flow until the end of this year, she projects.

INFRASTRUCTURE NEEDS. According to calculations by the Center for Studies on the Cuban Economy, in Havana, Cuba had a total of 4,345 MW of generating capacity at the beginning of 1999. Of that total, only 3,219 MW were connected to the grid, with the remainder spread out among Energas, tourist resorts, the sugar ministry, and the basic industry ministry.

Apart from the need for new generating capacity, Cuba is also faced with the daunting task of modernizing its aging thermal-based generation base in a cost-effective manner. Union Electrica hopes to increase its generating efficiency by 20 percent to 30 percent to help bridge the gap between demand and capacity, according to CubaNews. If demand is not relaxed through conservation and rising electricity prices, Union Electrica may be faced with the construction of a new $100 million thermal power plant. French companies are helping with the modernization program, says Best.

As Cuba produces more of its own oil through joint ventures with foreign companies, the island's feedstock should increasingly shift from oil to gas.

"The Cubans are bumping up their focus toward developing natural gas-based power and even hydro," says Kavulich. "In 1999 Cuba had $1 billion worth of fuel imports, so they are aggressively working to develop their import substitution plan." -C.T.

Over the last two years, Mexico's federal electrical agencies have raised the price of power to help provide more realistic returns to investors, she notes. "But there is no question that Mexico will have to [continue to] raise prices for power, or the investment money will flow somewhere else."

One way Mexico mitigates risk for power plant investors is to offer long-term power-purchase agreements through the federal utility, CFE.

In the case of the 545-MW Baijo project in San Luis de la Paz, in the state of Guanajuato, InterGen secured a contract from CFE, which agreed to buy 80 percent of the power generated by the $245 million project, scheduled to come online in 2001. The remainder of the power would be sold on a merchant basis. Financing for the project included direct and syndicated loans totaling $136 million from the Inter-American Development Bank, a $240 million Ex-Im Bank guarantee, and a Citibank loan to Mexican partner Aztec Energy. Construction of the project is being carried out by Bechtel International and GE Power Systems. (InterGen is owned jointly by Bechtel Enterprises Holdings Inc. and Shell Generating Ltd.)

CRE also is issuing permits for smaller generating capacity to domestic and international producers, with these projects typically under 30 MW. El Gallo, a $15 million, 30-MW hydroelectric project, for example, was scheduled to start up at the beginning of the second quarter in Guerrero state on the Cutzamala River, through the development of Hidroelectricidad Mexhidro S.A., or Mexhidro. While the Mexican generator plans to serve a domestically owned steel company and a foam company, it notes that it also has plans to approach Chrysler, Ford, GM, and a host of other multinational companies with offers of power. CRE indicates that the El Gallo plant is one of more than 100 such small generators permitted thus far, with associated investments of some $2.5 billion.

Mexico's opening electric sector also may mean an increase in exports and imports of power and natural gas crossing the U.S. border.

For example, a subsidiary of American Electric Power Co., Energia de Mexicali, will build a 258-MW plant at Mexicali, near the U.S. border, to export electricity by March of next year to Southern California, where Integral Energy Services Inc. will market the power.

In the other direction, the U.S. utility El Paso Electric was contracted to begin supplying 80 MW of electricity into the Mexican grid in June, with plans to increase the supply to 100 MW until October 2001. The power would be generated from El Paso assets in Texas, Arizona, and New Mexico. In fact, one analyst suggested that the Mexican government would permit the winning bidder on a Mexican project solicitation to build the power plant in the United States if the developer would agree to sign an exclusive 25-year power purchase agreement to export the electricity back to Mexico.

The Politics of Reform

Before he leaves office at the end of calendar year 2000, Mexican President Ernesto Zedillo apparently intends to set up initiatives that would at least begin opening up the electric distribution and transmission sectors, as well. Embassy specialist Dessommes explains the move.

"In February, President Zedillo launched an initiative to open up private capital investment in distribution and commercialization of electricity. At the same time the Mexico City area utility, LyFC, and CFE, the national utility serving all areas outside the capital region, will most likely undergo a deep restructuring process to allow for this transcendental transformation.

Dessommes notes that the changes Zedillo has in mind will require amendment of the Mexican constitution.

"The reform proposed has an intermediate term [two-year] objective to be implemented, which means that the current administration will not participate in any divestiture of the electric industry assets," he says. "Instead, the ground work will be laid down to allow for the creation of an energy market."

Dessommes adds that reform in the wires sector may not mean the end of federal involvement. "Some clear-cut definitions are set as premises: The government will retain control of the transmission network by the creation of a specific para-state company."

Such a move would facilitate the later sale on the open market of a portion of the equity of the transmission company, as has occurred in other Latin American countries.


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