Cheaper electricity will boost manufacturing in Mexico

By Nancy J. Gonzalez

Energy is vital for manufacturing and electricity has an important quantitative and qualitative impact on the output.
According to the World Economic Forum (WEF) Mexico ranks 80 out of 144 countries in the quality of electricity supply. But quality is not the only problem the Mexican electrical system has because electricity is also expensive.
Even though the electricity in Mexico is subsidized it is still more expensive than in the U.S. In Mexico, a kw/hour for the industry costs about US$0.15, while in the U.S. the price is US$0.068.
The high demand residential U.S. electricity tariff is US$0.11 per kw/hour while in Mexico it is US$0.29 per kw/hour, the commercial sector in the US pays US$0.10 per kw/hour compared to US$0.23 per kw/hour in Mexico.
The Federal Electric Commission in Mexico (CFE) explains this price difference comes from the fuel source to produce electricity. (Exhibit 1) In Mexico at least 21% of the electricity comes from oil, while in the U.S. the main fuel is natural gas.
“Oil is four times more expensive than natural gas and produces 68 percent more pollution. Therefore, we want to substitute oil for natural gas to produce electricity,” said Enrique Ochoa Reza, CFE executive director. “We want to change our infrastructure to natural gas to reduce the cost of electricity production.”
He said at least 80 percent of the cost of energy comes from the cost of the fuel used to produce it.
A 2012 study conducted by CFE shows Mexicans pay, on average, 125% more for electricity than in the U.S. This analysis show the industrial sector in Mexico pays 85% more in electric bills than a similar business in the U.S., while in the Mexican retail sector the cost is 135% higher than in the U.S. The residential sector shows the biggest gap, a 150% higher in Mexico than in the U.S.
Researcher Rodrigo Gallegos, director of Climate Change and Technology at the Mexican Institute for Competitiveness (IMCO), said the proposed changes on infrastructure on CFE will have a positive input to reduce the cost of electricity.
“CFE will be more competitive now because natural gas and renewable energies will be used to produce electrical power. Also, more competitors will come to the Mexican market and the ultimate goal of competition is to reduce prices,” he explained.
Gallegos said Mexico needs to be more competitive and electricity is a key subject because the electrical power is expensive, and the bureaucracy and corruption are also high.
According to the 2015 Doing Business Report -published by the World Bank- getting electricity for a company in Mexico costs about US$30,574. This process can take up to 85 days and the company needs to do 7 different procedures. The ranking for Mexico in this subject is 39 out of 189 countries (Exhibit 2).
On the other hand, getting electricity for a company in the U.S. costs US$7,880; it takes up to 60 days and requires 4 different procedures. The U.S. ranks 7th on this list.
For Gallegos, these numbers are really important because manufacturing facilities are returning to the U.S because the cost in other countries has been up for several years.
“Mexico should be paying attention because many ´dead´ sites in the U.S., such as Oklahoma, are attracting manufacturing companies established overseas,” he said.
Recently, the CFE tendered 24 electricity and natural gas infrastructure projects worth US$9.8 billion, including eight pipeline; one combined cycle and one geothermal power stations, two wind farms, and various transmission projects. These projects will improve CFE infrastructure and will reduce the production cost once they are up and running.
Although CFE claims the price of energy has dropped 27 to 36% in the industry compared with last year´s, for Gallegos this is a political propaganda rather than a fact.
The IMCO researcher claims the prices will drop in the next 5 years when CFE transform its facilities and infrastructure and when more competitors operate in Mexico.

Electricity and manufacturing

A recent analysis published by the International Monetary Fund states that the reduction in electricity prices in Mexico are directly associated with a 2.8% increase in manufacturing output.
Moreover, by changing the structure of electricity generation in favor of natural gas and away from fuel oil, the energy reform could lead electricity prices to decline by 13%, boost manufacturing output by up to 3.9%, and increase overall GDP by up to 0.6%.
“Larger effects are possible if increased efficiency in the sector leads electricity prices to converge to U.S. levels. When contrasted with the response of services, manufacturing is more sensitive to energy prices, but because services account for a larger fraction of GDP -about 60 percent-, the combined impact of the reform on GDP through higher manufacturing and services output could reach about four times the contribution of manufacturing alone,” the study says.
The sub industries most benefited by lower energy prices include metals, machinery and equipment, which includes the export-oriented auto industry, according to this analysis.
The constitutional reform approved in December of 2013 and the associated secondary legislation approved in August of 2014 comprises a substantial transformation of the state-controlled oil, gas, and electricity sectors in Mexico. In a nutshell, the reform attempts to open parts of these sectors to private investors while retaining control of transmission and distribution channels through more autonomous regulatory agents.
The main objective of this radical reorganization is increasing much needed investment to finance the exploitation of current reserves, the exploration of new ones, the expansion of transmission networks, and the general improvement of oil, gas, and electricity infrastructure. In the oil industry, the reform increases the autonomy of the state-owned oil company PEMEX, and allows joint ventures with private agents in order to take advantage of unexploited Mexican oil and gas reserves.
“The reform allows competition, a main driver for competitiveness because companies are forced to reduce costs and be more productive,” said Gallegos. “The energy reform also allows companies to co- generate electricity, another competitiveness advantage.”
Even though the energy reform opens the market for foreign and domestic companies and CFE losses its monopoly of power generation and sale of electricity, but keeps its distribution (power lines) monopoly. Therefore, the companies must pay CFE a fee to use these power lines to distribute electricity, which increases the operation costs.
The free-trade aspect of electric power does open the door to additional renewable energy projects that will now be able to not only produce power but will be able to sell it in the open market. But companies must pay to use CFE´s infrastructure to distribute the power energy they produce.
The generation and co- generation of electricity in Mexico is now allowed by the energy reform, but financing and tax incentives are needed for companies to succeed and the Mexico Government is not offering many. In the U.S. companies get tax incentives to produce clean energy.

Conclusion

The cost of electricity in Mexico is expected to drop in the next 5 years; in the meantime, CFE is creating more infrastructure and transforming its facilities. Furthermore, Mexico needs more companies to generate electricity increase competition and reduce the prices.
The energy reform also allows companies to co – generate electricity; therefore, these businesses can be more competitive in Mexico because they will be reducing cost.
The Mexican Federal Government forecast the energy reform will boost some industries and will turn Mexico into a more competitive country.