Mexico's solar industry shot out of nowhere to become a world leader within the last three years.
Now everyone involved is trying to take a step back and figure out what happens next. The combination of tangible opportunities with abundant unknowns animated GTM's Solar Summit in Mexico City last week, evoking the beginnings of the U.S. solar heyday a decade ago.
By now, the major questions facing the U.S. solar industry have been worked out, and companies are fine-tuning their execution (and responding to unanticipated setbacks, like presidentially imposed import tariffs). In Mexico, however, the open questions abound, and developers, suppliers, government agencies and financiers are racing to decipher the answers and leverage the support needed to keep the growth rolling.
Like guacamole dusted with spiced grasshoppers, there's a lot to chew on here, but these are the key takeaways.
Crazy-low prices are both a joy and a peril
Mexico enjoys the magical combination of a massive solar resource with low cost of labor.
That potential has finally been unleashed by a recent energy system reform that makes it easier for private companies to participate in a grid long dominated by a single state utility. As part of the reform, Mexico has held three annual solar auctions that saw successive plunges in average bid price.
The third round added another nine solar projects totaling 1.7 gigawatts, and now holds the record for cheapest average solar bids in the world.
As companies race to tap this solar gold mine, they benefit from the work that has already been done elsewhere to bring down module costs and streamline project design and delivery. That said, there's still a lot that must be worked out anew within Mexico, which had hardly any capacity even five years ago.
The big question is whether the industry can actually deliver on its rock-bottom bids -- and make money doing so.
The panelists at Solar Summit Mexico brought a healthy dose of skepticism. The auction structures incentivize aggressive bidding to get a piece of the early action; we have yet to see many developers deliver. Indeed, many of the awarded projects have yet to close on financing, an ominous sign as the months and years pass by.
The energy reforms also have opened up a market for bilateral contracts between energy producers and large corporate consumers. Now the aggressive auction pricing puts pressure on the budding commercial solar market to offer comparably cheap deals.
That won't really be possible, because distributed solar is more expensive per unit than utility-scale, and because the policy framework for the commercial offtakers is still being fleshed out.
The onus is on developers to turn their flashy bids into real megawatt-hours. Business model innovation has already begun (see Enel's big flip, discussed below). Developers I spoke to hinted at their own special sauce for making it work, but nobody wanted to talk details with a journalist just yet.
Fighting for financing
The wild west marketplace that could make this market lucrative also deters many sources of financing that could help the industry grow.
The aggressive bidding in the auctions has forced developers to branch out in the hopes of salvaging their margins. Many projects now diversify their revenue among an auction power-purchase agreement, clean energy certificates, and the wholesale markets.
The PPA with utility CFE is considered solid, but the risk associated with the value of the certificates and wholesale markets has financiers worried. The wholesale marketplace offers average prices about three times higher than the recent auction PPAs, so there's considerable profit potential. But the marketplace is still a toddler, so there's no long-term data to examine in order to accurately project revenue into the future.
This creates a great deal of merchant risk, further complicated by the interplay of U.S. natural gas in the northern grid, precisely where most of the solar development is concentrated.
All of this drives up the cost of capital, if it doesn't scare away lenders altogether.
Much of the early financing has been led by development banks and multilaterals, whose missions empower them to take more risk than commercial banks for projects that serve a social goal. Even these institutions, though, have limits to how much of their portfolio they can dedicate to a risky emerging industry.
If they can help the industry build up a bit more of a track record, commercial banks and foreign investors may come in with greater volumes of cash. But foreign investors in particular need to build up more trust in this market before that happens.
New World, Old World
Speaking of foreign investment, another dynamic that's shaping Mexican solar is the interplay of European clean energy giants and smaller, locally grown companies.
Enel made waves by grabbing about 1 gigawatt of capacity in the early auctions, which it then turned around and sold to pension funds in Canada and Mexico.
The global renewables heavyweight leveraged its scale to de-risk the investment -- the large solar play was just one part of a much broader renewables portfolio. And the corporate giant has access to a much lower cost of capital than its upstart competitors.
Even so, Enel decided it made more sense to cash out on the projects rather than hold onto them and try to eke out a profit on the tight margins.
Newly formed Mexican developers don't have the same room to maneuver as companies like Enel, Engie and Canadian Solar. They have to deal with expensive capital and a small portfolio, where any one project could make or break them.
The domestic developers do have local familiarity on their side, which could come into play when figuring out optimal sites and navigating the local politics. There has already been some friction with solar development and local communities concerning archeological sites and other land-use questions.
Where a corporate giant can go for scale and small margins, smaller developers can look for high value, chasing sites in isolated regions that really need the power.
Mexican storage: Not here yet
I led a panel on the role of energy storage in the Mexican solar market, which was hard to do because there isn't any storage there yet.
There is a 10-megawatt project going in with a solar plant in Baja California, which is essentially a grid island because it's so far removed from the mainland. And there's a lot of interest in storage as the solar market picks up steam. But significant hurdles stand in the way.
Those auction prices, again, make life difficult. If a developer has to compete against the lowest solar prices in the world, how do they get away with the premium required to throw in batteries?
There are no clear policy drivers to govern the deployment of storage just yet, and no government incentives to get initial deployments going. Something along those lines will be important for Mexico's energy agencies to figure out.
Industry may be getting more organized to advocate for this. During the panel, leaders from GE's energy storage team and Fluence, though competitors in large-scale storage development, expressed interest in teaming up to make the case for storage on the Mexican grid. The bigger the pie, the bigger each of their slices. We'll be watching to see if that conversation grows into Mexican energy storage industry group, which could serve as a counterpart to solar group Asolmex.
In addition, two officials from government energy agencies SENER and CFE stressed that storage is a top priority in the next phases of market reform.
Storage projects will make sense first in remote locations, like Baja Sur and the Yucatan Peninsula, where it's more expensive to transmit energy. But it will become more broadly valuable once solar generation spikes and Mexico gets its own version of the duck curve. Based on the auction commitments, that could come as soon as 2021.
With great newness comes great unpredictability. Here are key unknowns to decipher in the months to come:
- Wholesale markets. Getting more data will be crucial for calculating returns on merchant solar sales, which could be key to the auction projects succeeding.
- Presidential election. Mexico will pick a new president this July, and one of the leading candidates doesn't like the energy reform. Left-leaning candidate Andrés Manuel López Obrador told Bloomberg he'd like to hold a popular referendum on the policy, and if the people reject the electricity system overhaul, he'll set about undoing it. Panelists at Solar Summit reiterated that the market reform rests on a strong legal framework and they believe it will proceed, but there's a non-zero risk of political interruption.
- Distributed solar success. There's great potential for rooftop and commercial solar if the industry can sufficiently verify customer credit to secure financing from domestic and international sources. Corporate offtakers may also become vital to Mexico's utility-scale market.