Mexico’s growing solar market is gradually opening up to foreign backers as specialist funds work out how to de-risk investments.

DG Energy Capital, a joint venture between Shanghai Ventures and Caaapital [sic], for example, is seeing growing interest from international financiers after developing a low-risk investment fund specifically for the Mexican distributed solar sector.

While utility-scale projects have often been funded off-balance-sheet by international players, the distributed solar sector has seen “a lot of volatility for foreign investors, so you have few foreign investors coming in,” said Franco Capurro, CEO of Caaapital.

"A lot of them want to,” he said. “We’ve been approached by many.”

Are you an international investor eyeing Mexico's solar market? Read on. Better yet, come to GTM's Solar Summit Mexico on February 13-14.

One of the big concerns for foreign investors is currency exchange rate risks and costs.

“When you have an asset that gives you, say, 15 percent IRR [internal rate of return] and you get a hedge for 7 [percent], and you have returns in pesos, then you may as well just finance the auctions with an offtaker that is the government instead of a household,” Capurro said. 

As a result, the distributed solar market has been mostly served by Mexican entities, including boutique banks such as Ve por Más, specialist funds, and the state energy efficiency agency Fideicomiso para el Ahorro de Energía Eléctrica (FIDE), which offers fixed-rate finance.

Larger Mexican banking groups have shown little interest in the distributed solar sector, said Capurro. 

The smaller Mexican banks already involved have tended to finance distributed solar projects through standard fixed-asset loans, frequently with unfavorable rates.

FIDE, in particular, has an onerous financing process. Furthermore, installations tend to be financed on a case-by-case basis, rather than through established lines of credit.

That makes the financing process painful for customers, said Capurro. Unsurprisingly, many early distributed solar installations were paid upfront by owners, which did little to speed the pace of adoption.

As the market matures, the Mexican Banks Association (Asociación de Bancos de México, or ABM) estimates that on-site, distributed energy technologies will see a compound annual growth rate of 121 percent. 

Mexico’s distributed generation market is split into three distinct customer groups: homeowners, small-commercial users and larger industrial customers. Around 90 percent of investors are looking to target the first two groups, Capurro said.

Because solar energy still does not make sense for most households in the country, the residential segment is small, representing less than 1.7 percent of homes in Mexico, according to Capurro, who will be speaking at GTM’s Solar Summit Mexico in Mexico City on February 13 and 14.

These households tend to be affluent and pay upfront in cash, or use five- or 10-year loans with interest rates that can be as high as 25 percent, said Capurro. Some will even pay with credit cards, he said.

Even the cheapest financing deals available to residential customers are unlikely to come with interest rates much below 13.5 percent, though.

Foreign investors targeting the residential segment need to be aware that even though it appears to be a relatively small market, it still encompasses half a million potential customers with a wide range of energy needs.

Residential systems can range from 3.3 to 30 kilowatts in size, Capurro said, making it hard to target the market with a one-size-fits-all financing product.

The small commercial segment can be an easier sell because the customers are more accustomed to obtaining financing and are more likely to have an ongoing relationship with banks.

Small-commercial customers have traditionally compared financing offers with what they can get from their local bank.

In the short term, the small-commercial segment is expected to offer the greatest opportunity for investors in distributed generation because these are users that have historically faced increasing tariffs.

In December, commercial users enjoyed an almost 30 percent cut in electricity tariffs, but this is expected to be short-lived, with high energy prices set to return later this year.

And while the residential sector comprises just 500,000 households, the small-commercial market covers around 4 million businesses.

Large industrial companies, meanwhile, have so far shunned investment in solar because they already enjoy preferential energy tariffs that extend the payback time for PV to 10 years, an untenably long period.

“The economy has never been stable that long,” Capurro said. “It doesn’t make a lot of sense to weaken your balance sheet with an investment like this.”

Despite this reluctance, backing large-scale industrial solar “would be a genius thing to do,” he said, because inflation in Mexican electricity tariffs is expected to run to around 8 percent for the next 10 years. 

While large industrial users may not see much point in investing in solar to save costs, they may want to adopt distributed generation as a hedge against future energy price increases, Capurro believes.

All of this will likely be of interest to foreign investors that have seen utility-scale solar investment returns eroded through the cutthroat price competition seen in Mexico’s auctions. Admittedly, though, taking the risk out of distributed solar investments has not been easy.

DG Energy Capital had a team of around 17 specialists working for a year to come up with a package that would satisfy foreign investors. Part of the mix is the application of rigid bankability standards for installations.

The company’s master services agreement runs to 125 pages, compared to around 60 for a similar document in the U.S. “It’s Mexico, so it’s way more complicated,” Capurro noted.

DG Energy Capital also uses FICO for residential credit scoring and only offers loans to customers with a U.S. bond-level score. For large industrial customers, the fund uses Moody’s and Standard & Poor’s credit ratings.

It also insists on installation standards on par with those seen in the U.S. These standards did not exist previously and had to be created from scratch for the distributed solar segment.

DG Energy Capital is one of just a couple of finance providers offering this level of bankability. But it is already attracting interest from family offices, investment funds, strategic investors and others, said Capurro.

He said it could be up to two years before foreigners make up the bulk of investment in Mexican distributed solar, though.

Alongside the growing availability of custom funds such as DG Energy Capital, foreign investors will likely be encouraged as larger projects start to reach financial close more easily.

José Luis García, chief development officer at Zuma Energía, an independent renewable energy producer with a portfolio of 800 megawatts of wind and solar across four Mexican states, was hopeful that early financing challenges would be resolved soon.

“Solar energy is a relatively new technology in the Mexican market, and if we add that to the complexity of the power-purchase agreements and the auction mechanisms, it is understandable that the first financial closes have taken a while,” he said. “Nevertheless, we hope that once the financial market has understood these particularities, the closes should start happening ever more quickly.”

One challenge that could hamper progress is that panel prices have started to rise, which could hit the profitability of projects and make it harder for them to reach financial close.

Another potential stumbling block for the growth of distributed solar, in particular, is the rise of so-called metered suppliers, or "suministradores tarificados."

These entities are allowed to sell energy from generation assets including PV plants, effectively giving potential distributed generation customers access to solar without having to make any upfront investment.  

Finally, Mexico is facing elections this year, with a high level of uncertainty over who might win.

Left-wing populist Andrés Manuel López Obrador has threatened to abolish Mexico’s latest electricity law, which has liberalized the sector.

It is hard to see how he might do this in practice, short of expropriating freshly privatized entities or failing to honor contracts. “It’s very unlikely to go back,” Capurro stated.

Against this, 2018 has seen the introduction of new rules making it easier to lease rooftops for distributed solar generation. The likely impact of these rules is also unclear.

With so many factors at play, there is one thing foreign investors will be sure to find in Mexico: excitement. 

Interested in Latin America's solar market? Join GTM February 13-14 in Mexico City for an in-depth look at the country's rapidly expanding solar sector.Solar Summit Mexico will leverage GTM Research’s expertise in Mexico to ensure your company is uniquely positioned to capture specific opportunities while appropriately managing regulatory, political and market risks. Find out more here.