Mexico recently enacted a Renewable Energy Law that provides welcomes changes to a legal framework designed to promote economically viable renewable power. This article provides an overview of the types of renewable resources currently existing in México, the difficulties in implementing renewable energy projects, the Law and its potential impact on the Mexican renewable power industry.

Mexico possesses large untapped renewable energy resources. Studies have determined that Mexico has national wind resources sufficient to generate in excess of 40,000MW. The wind conditions in the State of Oaxaca are among the best in the world and have the potential to generate 8,800MW. Baja California, Yucatan and Quintana Roo benefit from wind conditions that could potentially generate 274MW, 352MW and 157MW, respectively.

With respect to solar resources, the desert regions of northern Mexico have one of the highest potentials in the world, with an average solar radiation coverage of 5kW per hour per square metre.

As a region with considerable volcanic activity (specifically within the country's Volcanic Belt), Mexico is the world's third largest producer of electricity from geothermal sources. The geothermal resources located in the northern and south central regions alone have the potential to generate roughly 2,400MW.

In the hydroelectric sector, large-scale facilities currently generate roughly 21% of the country's installed capacity, but such projects are difficult to implement and are capital intensive. Small-scale hydroelectric plants producing 10MW or less have the potential to generate approximately 3,250MW.

Notwithstanding the resources available for renewable energy development, Mexico's total installed capacity from renewable sources, primarily from geothermal and wind resources, but including hydro plants of less than 30MW, is just 3% of total installed capacity. (See table below.)

Difficulties in implementation

Mexico has underperformed in the development and implementation of renewables projects due in part to the legal framework governing its electric power industry, technical deficiencies in the transmission system and the uncertainties regarding land ownership.

The electric power industry remains largely state-controlled with limited participation from the private sector. Under the Mexican Constitution, the provision of electricity is considered to be a public service and is controlled by the state-owned electricity utility the Comisión Federal de Electricidad (CFE). Private sector participation in electricity generation has been restricted to self-supply of electricity, electricity sales to the CFE via a power purchaser agreement (PPA) under the independent power production (IPP) scheme, cogeneration and the exportation of electricity.

The CFE is charged with planning for, constructing and operating generation, transmission and distribution assets. Under Article 36-bis of the Electricity Law, the CFE is obligated to obtain electricity at the lowest cost available. So the CFE has not been able to add renewable energy projects to its generation portfolio, since the cost of electricity from renewable sources has historically been much higher than the cost of electricity obtained from large hydroelectric facilities conventional fossil fuel power plants.

As a result of the restrictions placed on the CFE's ability to add new generation capacity, private renewable energy developers have entered the market and are currently developing renewable energy projects under the self supply regime as permitted by the Electricity Law. Under the self-supply regulations, a private company or group of companies is permitted to build, own and operate a generation asset serving multiple clients who are also the owners. Each of the project owners listed in the self-supply permit is entitled to consume the amount of electricity allotted to it in the self-supply permit. Self-supply projects must enter into interconnection agreement and transmission agreements with the CFE.

Self-supply projects are typically driven by the cost savings enjoyed by the offtakers, since the cost of electricity for industrial and commercial customers is very expensive as compared to the cost of electricity derived from a renewable energy project. The current regulations also allow self-suppliers to bank surplus energy monthly, allowing an amount equal to the surplus to be delivered to an off-taker during periods when electricity production is lower than actual consumption. Most of the wind projects under development in Oaxaca are being developed as self-supply projects serving large industrial offtakers.

Notwithstanding their favourable economics, self-supply projects have seen their fair share of obstacles. The main technical difficulty is the lack of transmission capacity from remote areas where such projects are located to urban load centres. To address this problem, the CFE has recently awarded a contract for the construction of two 425km, 400kV transmission lines and related substations in the states of Oaxaca and Veracruz. It is anticipated that the new transmission lines will come into service by the end of 2010.

The other main problem encountered by developers relates to the use of communal land known as ejidos and the ongoing relationship with rural communities. Approximately 47% of all real property in Mexico is owned or controlled by ejidos, which have their own legal identity and cumbersome decision-making processes. These collectively-owned and administered parcels of land tend to be located in rural areas where most renewable power projects (particularly wind projects) are being developed. Proving land ownership can be a challenge due to the antiquated real property registration system that exists in many rural areas of Mexico. It is not uncommon for project developers to go through a lengthy due diligence process only to discover that the purported owner of the land did not have legal title. To complicate matters further, title insurance is not widely available in Mexico.

Current Mexican law allows an ejido to lease its real property to third parties for up to 30 years, provided that the lease agreement is approved by all of the members of the ejido. Negotiating lease agreements with ejidos can be a complicated and time-consuming process. The ejido must comply with its internal regulations in forming contracts with third parties or its actions will not be legally binding. Project developers should have a firm understanding of the regulations to avoid entering into unenforceable lease agreements.

Assuming that the ejido and the project developer are able to execute and valid and enforceable lease agreement, project developers are routinely faced with requests to increase the rent payable to the ejido or to provide additional social services to the ejido that were not contemplated in the original lease. Disagreements commonly result in protests by members of the ejido and the blocking of access to project site until the dispute is resolved. Consequently, the lack of contractual certainty has played a significant role in delaying the implementation of renewable energy projects.

The new law

The Law came into effect on 28 November 2008 and represents the first step in creating a comprehensive legal framework for developing renewable energy projects in Mexico. The two main objectives of the Law are to establish a comprehensive strategy to promote the generation of electricity from renewable sources and to create the instruments for financing the transition to renewable energy.

The Law only applies to electricity that is generated from renewable sources, including wind, sunlight, water, geothermal steam or fluid, ocean currents and waves and biomass, and sold to the CFE and the other state-owned electricity distribution company Compañia de Luz y Fueza del Centro (LFC). Large hydroelectric projects (greater than 30 megawatts) and nuclear plants are neither helped nor affected by the new statute.

The Energy Ministry is required to develop a national renewable energy strategy and to establish a fund to provide financial assistance during the transition to renewable energy. The idea behind this is to give the CFE advance warning of the additions to the transmission grid that will be needed to move renewable energy from remote locations where wind is best or geothermal reservoirs are located to urban population centres. In executing this objective, the Energy Ministry is empowered to enter into agreements with state and municipal governments to facilitate access to areas with high concentrations of renewable resources, to establish new guidelines for land use and to simplify the permitting process for renewable energy projects.

The government is expected to set a specific minimum national content requirement for renewable energy projects and to coordinate with the Treasury to establish appropriate tax incentives.

The Energy Regulatory Commission (Comisión Reguladora de Energía, or CRE) will set tariffs or the prices that may be charged for renewable energy. Owners of renewable energy facilities operating under a self-supply permit will be allowed to sell any excess electricity to the CFE at a tariff to be determined by the CRE.

The government is determined to involve communities in planning for projects. Project developers are supposed to leave room for public participation in the planning stages and to earmark any income earned from the projects for regular lease payments to local communities and for implementation of social development programs.

Financing the transition

The transition to renewable energy is to be supported by a fund that will be administered by a technical committee appointed by the Energy Ministry. For the 2009, 2010 and 2011 fiscal years, the Mexican government has allocated Ps3 billion ($220 million) for the fund, which will be subject to adjustment for inflation. The minimum amount of public money designated for renewable energy projects will be determined no later than 30 June 2009 and will be reviewed and updated every three years during the budget authorisation process in the Mexican Congress.

The fund will be used to provide financial support for the transition to renewable energy. It is expected to engage in direct lending on preferential terms and provide loan guarantees. It may make grants in extraordinary circumstances for projects with significant environmental or socioeconomic benefits. The exact parameters for the type and amount of financial support the fund will provide will be established in the regulations associated with the Law.

The Mexican government also plans to design and implement policy measures to allow it to better benefit from carbon trading. Renewable energy projects located in Mexico are eligible for tradable credits under the clean development mechanism (CDM) of the Kyoto protocol. Mexico has the potential of being a world leader in the development of CDM projects since it is one of the more industrialized, non-Annex I countries with myriad opportunities to implement emission reduction projects. The Law permits the CFE to act as an intermediary between renewable energy projects and the purchasers of carbon credits in international markets. It is still unclear whether the CFE intends to reserve the income derived from the commercialisation of carbon credits for the benefit of the Mexican treasury or allow project developers to retain the rights to sell carbon credits. The regulations should provide more guidance as to how the CFE will approach carbon credits.

Details of the tariff structure, potential subsidies for renewable energy projects, tax incentives and a model power purchase agreement are expected to take form in the next 12 months. The Energy Ministry must establish the fund immediately as it will shortly receive Ps3 billion. It has six months to submit a renewable energy strategy to the president and eight months to publish regulations implementing the Law.

A green revolution?

The enactment of the Law is an important first step in the development of a sustainable renewable energy industry in Mexico. However, it is not certain that the Law will set in motion a green revolution in Mexico. Due to the nature of the Mexican legislative process, the Law only establishes the broad policy objectives related to renewable power and provides the executive branch of government the authorisations necessary to devise and implement a strategy for adding renewable energy assets to its energy portfolio and to establish the regulations related to the renewable power sector. Consequently, information regarding the tariff structure, tax incentives and other financial support to be provided by the fund will not be revealed until the regulations are approved and published during the third quarter of 2009.

The Law does address both the economic issues and land use issues that have deterred renewable power development in the past. Under the Law, the CRE is authorised to determine the maximum tariffs payable by the CFE to renewable energy generators for both capacity and associated energy. In so doing, it has the discretion to take into account the type of renewable technology to be used and the geographic location of the projects.

Furthermore, the fund is authorised to issue guarantees and provide other types of financial support to projects that are approved by the fund's technical committee and are consistent with the national renewable energy strategy. The Energy Ministry, and the Treasury are tasked with devising appropriate tax incentives for renewable energy projects.

The often contentious issue of land is also being addressed. The Ministry of Energy is empowered to enter into agreement with state and municipal governments to facilitate access to areas with renewable sources of energy and to devise new regulations regarding land use for renewable projects. This provision indicates that the federal government is aware of the problems currently faced by renewable energy developers but stops short of federalizing the issue by authorising the expropriation of land for renewable energy projects. Instead, the Ministry of Energy will have to engage in consultations with other governmental entities in order to develop a consensus on how to accommodate the stated objectives of the Law while respecting the rights of land owners. Given the social and political nature of land issues affecting ejidos, a compromise permitting renewable energy developers to purchase and own the real property for their projects may be difficult to obtain.

When published, the regulations will provide considerably more detail regarding the nature and extent of the subsidies to be provided to renewable energy projects as well as greater guidance with respect to the use of land.

*J. Anthony Girolami is counsel in the Mexico City office of Chadbourne & Parke. He is reachable at agirolami@chadbourne.com