Could Mexico Be Powered by the Sun?

Mexico's Baja isn’t only home to stunning beaches and a thriving tourism industry, but also one of the largest solar farms in Latin America. Just outside of La Paz sits a plant that generates more than half of the city's electrical needs—it may also represent a promising new future for the country.

Thanks to recent energy reforms and the decreasing cost of renewables, solar power in Mexico is beginning to take off. While the country (and planet) stands to benefit from this solar shift, the trend also bodes well for industrial energy users who can tap this now inexpensive, green power to improve their earnings.

This represents a sea change for the country's energy sector. “A surprising consequence of the Mexican energy reform will be the rapid acceleration of decarbonization and a transformation of the electricity market,” says Nikolaj Lippman, Morgan Stanley equity analyst and lead author of the recent report, “Good to Be Green and Getting Better: Decarbonization to Boost Mexico's Competitiveness and Profitability.” When it comes to renewable energy, Mexico seems poised to become a leader—and investors paying attention can also ride this solar wave.

About four years ago, Mexico embarked on an ambitious, national energy reform program that opened the sector to more private investment. Previously, state-run enterprises had dominated the energy industry, with private companies permitted in only a handful of regions. “The liberalization of the electricity market allowed private capital to build generation plants to sell electricity in the wholesale market, or sign power-purchase agreements directly with customers,” Lippman says.

A driving factor of the reform was to bring more private investment into oil exploration; however, the initiative also spurred the development of more natural gas and renewables, including wind and solar. According to the report, more than $15 billion of natural gas pipeline has already been constructed or is under construction. Mexico's electricity generation capacity is primed to increase by an impressive 50%, with 55% of that driven by renewables and the rest from natural gas.

Mexico may be a second mover in the renewable energy market, but the country could end up a major player going forward. The aforementioned reform paved the way for new solar projects—and the current conditions make solar plant development exceptionally attractive, says Stephen Byrd, who leads coverage of the North American power and utilities and clean energy industries for Morgan Stanley.

First, and perhaps most important, Mexico has plenty of sun, as well as land close to power grids that is suitable for building big solar projects. Even after holding two auctions to procure renewable energy projects, Mexico has still only allotted 2% of its land available for potential solar plants, according to the Morgan Stanley report.

Beyond ample sunshine, plenty more business factors may entice solar developments. For instance, land and labor remain relatively inexpensive. Also, Mexico has no trade restrictions with China, which means that companies building solar plants there can import solar panels from China for 20% to 30% less than the usual market rate, Byrd notes.

Another perk: Implementing solar projects in Mexico is easier than other types of renewable energy sources, says Lippman, offering power-generation companies more visibility into their business and more flexibility with their contract rates.

All of this will affect energy costs. Mexico has long struggled with high electricity prices for industrial users, at times more than 50% above prices in the U.S. Now, the added generation capacity and affordability of solar projects has already begun to reduce the cost of electricity in Mexico, a boon for businesses.

In a recent example, a private company that is developing a solar plant in Mexico signed a contract with an industrial customer there to provide power for about $30 per megawatt hour. This is in line with costs in the U.S. and “suggests that Mexican and South U.S. solar operations are best-in-class globally and highly competitive with other types of electricity,” Lippman says.

The solar potential and ensuing rates certainly give Mexico a competitive advantage when it comes to attracting new industrial businesses. In fact, it may be exactly what private industry wants. According to a Morgan Stanley/AlphaWise survey, industrial company leaders reported that they'd be more likely to invest in Mexico if electricity costs were lower (they also wanted to see better governance and lower taxes).

But Mexico's national and regional economies aren't the only possible winners. Others that may benefit from this sector shift include:

• Companies in the metals and mining sector: Morgan Stanley research estimates these companies could witness a 20% to 30% savings in electricity costs, which would translate into improved earnings.
• Infrastructure companies: These private players would stand to benefit from the build-out  of power generation capacity. Returns on such projects have hovered around 10%, according to the report.
• Robotics companies and manufacturers: The combination of cheaper electricity and the declining cost of robotics may give manufacturers in Mexico the opportunity to explore robotics sooner, rather than later.

For more Morgan Stanley Research on Mexico’s energy sector and the outlook for solar, ask your Morgan Stanley representative or Financial Advisor for the full report, “Good to Be Green and Getting Better: Decarbonization to Boost Mexico's Competitiveness and Profitability" (Jun 25, 2017). Plus, more Ideas.