Wednesday, March 20, 2019

American Market Architect Reflects on Mexico’s Reforms

By Tom Kleckner

MEXICO CITY — So what drove a nice kid from Chicago — a “regular American” with a minimal knowledge of the Spanish language — to move to Mexico and not only make his home there, but help design the country’s deregulated electricity markets?

Pavlovic, | © RTO Insider

“I really had no link to Mexico,” said Jeff Pavlovic, the nice-kid-turned-40. “After looking at the whole world, I figured electricity is a very important industry, and I could make a very big impact. If you can make electricity cheaper, you can change the economy.

“I saw Mexico as a great opportunity, as a place that hadn’t embraced market principles in the electric industry,” he said in a recent interview. “It was a long shot. You’re making a big bet on major change. If I could help change the electric markets in Mexico, I thought that could have as big an impact on the world as anything. I just thought about it and came to Mexico.”

Simple as that. Pavlovic obviously has an analytical mind. The son of a teacher, he also has the academic pedigree to match his entrepreneurial spirit. He picked up economics and math degrees from Duke, an MBA from Stanford and, after moving to Mexico in 2008, a master’s in economics from the Centro de Investigacion y Docencia Economicas (Center for Economic Research and Teaching).

Pavlovic, who spent a few months studying Spanish before moving to Mexico, is now fully bilingual. “I thought my Spanish was good enough, but it took three or four years before I could really communicate,” he said.

Fortunately, Pavlovic found himself in the right place at the right time. He was in Mexico, where the state-run electric monopoly doesn’t have “51 state governments deciding the rules.”

And though he admits it was a longshot, Pavlovic’s expertise in unbundling electric utilities as a financial consultant and in generation control and dispatch for Xcel Energy landed him several different positions with the Ministry of Energy (SENER) and the Federal Electricity Commission (CFE), Mexico’s national utility. In 2011, he took a position as general director of generation, conduction and energy transformation with SENER, just as the push for electric reform, driven by the need for more efficient generation and lower prices, began in 2012.

“Very good timing. I thought it would happen six years later than it did,” Pavlovic said, referring to Mexico’s single, six-year presidential terms. “When I was dreaming of this, I didn’t think I’d be in government writing the rules. I thought I’d be on the sidelines, maybe in some private company sending suggestions that would mostly be ignored. Being in the middle of the process was better than anything I dreamed of.”

Big Designs, Slow Progress

Anxious to make the sector “more efficient and reduce costs,” Pavlovic said he and the market-design team borrowed textbook principles and elements from RTOs in the U.S. “We wanted a Day 2 settlements market at least. We wanted nodal prices,” he said. “We followed MISO and PJM in letting the system operators make the commitment decisions.”

Mexico began its incremental rollout of market reforms in 2014, but progress has been slow and halting. The financial transmission rights market has been delayed until 2019, frustrating participants who have complained about a lack of liquidity. The first midterm capacity auction in February cleared only one transaction, Enel’s 50-MW purchase from Spain’s Global Power Generation, leading one observer to say, “Whenever a bilateral agreement is signed, [the market] has a party.”

Market participants have complained about the market’s lack of transparency, exemplified by the confusion around transmission retail rates that led to a new, transitory methodology. Rate increases will be phased in through 2018 while a permanent solution is developed.

Some market participants have given themselves six months to see how the market shakes out and “grows legs,” as one player said during the recent Gulf Coast Power Association market conference in Mexico City, before jumping headlong into the market.

Pavlovic left the government last year, forming his own generation asset firm, Bravos Energia, and taking his message on the speaking circuit. (See “Market Architect Calls for Increased Transparency,” Overheard at the GCPA Mexico Electric Power Market Conference.)

Asked about his reaction to how the market has developed, Pavlovic said he believes the market design “was mostly efficient.”

“A perfectionist can always find things that could have been done better, but in the big picture, I was happy,” he said. “The way the powers were separated among the government authorities was right. The implementation has had some very good early successes with the short-term market, the auctions, the capacity market. I was pretty satisfied, but always conscious of things not going as well as I had hoped.”

mexico Bravos Energia Jeff Pavlovic

Bravos Energia

Pavlovic pointed out that several market pieces — FTRs, virtual trading and a fully functional real-time market — still need to be implemented.

“Most of the [market’s] weaknesses are caused by the environment the market operates in,” he said. “How many participants are there? What kind of positions do those participants need to take?”

Pavlovic said many market participants can’t take large positions because of the lack of private generation assets in operation and uncertainty over regulated transmission rates.

“A lot of auction projects are under construction, but the market suffers from the lack of a dynamic retail market,” he said. “It’s a chain of cause and effect. With no retail market, the speed of investments is slowed down.”

A New Wave

When Pavlovic rejoined the private sector, his biggest worry was whether the market reform’s unbundling of CFE’s generation, distribution and retail businesses would hold. It hasn’t. During his GCPA keynote, he said the former monopoly continues to combine the financial accounting for its several subsidiaries.

“It’s not turning out to be as strong a separation as we had hoped for,” Pavlovic said. “They are the big player in the market, but I don’t think they have built the systems or generated the knowledge to be able to use the market as a tool to hedge their risks. If they were using those markets, then there would be a lot more liquidity, a lot more price discovery, and that would bring in a lot more participation from private companies.”

Complicating matters is the country’s July 1 presidential election. With presidents and their administrations limited to a single-six year term, governmental work naturally slows to a crawl in the months before the election. This year, populist Andres Manuel Lopez Obrador holds a 26-point lead over his two opponents from the traditional ruling parties.

Obrador’s energy platform includes increasing hydroelectric generation and preventing the retirement of 16 GW of thermal generation, without allowing their modernization, repowering or conversion to cheaper fuels. He is also calling for a million small renewable plants for residential users and the services sector.

“It’s dangerous, because those [hydro and thermal] investments could crowd out more productive and efficient investment from the private sector,” Pavlovic said. “The rest of his proposals are not going to have a big impact on the market. He’s not talking about undoing the power market, he’s not talking about the states taking over private assets. It doesn’t look like there’s a very big downside to be worried about.”

Pavlovic’s greater worry is about the industry’s regulation. The Energy Regulatory Commission (CRE) consists of seven commissioners serving staggered seven-year terms. Every New Year’s Day, a new commissioner joins.

“The big risk is whether they will nominate competent technical leaders to regulate the electrical sector,” Pavlovic said. “There’s still a lot of work to be done, in the regulation and implementation of the market. You need competent technocrats and technical leaders in the power sector.”

Still, Pavlovic draws hope from the growing number of participants in the market’s capacity auction.

“There is a new wave that will come in,” he said during the GCPA conference. “I think the market will continue to get deeper and help us exercise influence over the policy.”