The Impact of Electricity Congestion in Mexico

June 6, 2019


June 4th, 2019

Congestion is one of the three components of Local Marginal Prices (LMPs). LMPs means the value of the energy at a specific location (node) and time when it is delivered. Congestion is defined as the restrictions which prevent meeting system demand at the lowest possible cost to provide electricity.

Simply said, congestion represents the additional cost businesses pay for their electricity, because of the heavy use of the transmission system in a specific area due to an increase in demand or, in some cases, supply. Congestion works a lot like Uber car service pricing; the more demand for an Uber at a specific location and time, the higher the rate will be due to the effort to deliver the service.

Understanding the impact of congestion on LMPs is very important for businesses, so how can large electricity consumers mitigate congestion risk?

Mitigating congestion risk is not easy and can be expensive. The most effective way is having the capability to buy or sell Derechos Financieros de Transmisión (DFTs or FTRs in English) is to create a financial hedge against the congestion cost. DFTs are normally bought and sold through auctions, which require participants to be very sophisticated in their understanding of transmission and distribution networks and electricity market fundamentals. Congestion

hedging through DFTs also requires complex analysis and having enough capital to post the amount of collateral required to participate in these auctions and having the ability to do Mark-to-market (MTM) on their DFT hedges. Unfortunately, DFTs auctions are not yet available in Mexico and it is still unclear when they will take place.

The lack of an effective congestion hedge in Mexico results in the generators and suppliers passing this risk entirely onto the end user, which could have a significant impact on the final price you pay for electricity at the end of each month. At Acclaim, we believe that the impact of congestion risk on electricity prices is somehow underestimated by suppliers for the following two reasons.

The first reason is that renewable generation is not currently fully considered. Congestion in areas with substantial renewable generation tend to have high congestion when significant quantities of this type of generation is being produced. The other reason is that renewable generation is normally built in areas with low demand, which cannot consume all the electricity being generated, so this electricity needs to be distributed to the grid which pushes up congestion and, therefore, the LMP at that node.

Renewable generation is rapidly becoming an important operational issue to manage the supply in markets with a significant presence of renewables. As such, some markets, like California (CAISO), have implemented renewable curtailment mechanisms to reduce the impact of the renewable generation on the grid, by automatically or manually decreasing this type of generation to balance the market.

It is also worth noting, that the increase in electricity demand in Mexico combined with insufficient investment in transmission and distribution will lead to more congestion around the country. The areas where transmission bottlenecks are currently present,
such as the Yucatan Peninsula and the Bajio region, are expected to be affected the most by the increase in congestion risk.

Underestimating congestion risk is leaving business customers exposed to a risk they cannot hedge. As such, it is Acclaim’s position for customers to be supplied from a generation source as close as possible to their load points. This will minimize customers’ exposure to implied congestion, which is the difference between the congestion at the source (generation node) and the sink (consumption node). However, it is increasingly difficult to get generation close to the load point(s) as available merchant generation is becoming scarce in Mexico.

Given the current market conditions, we suggest taking a very conservative approach in how to estimate congestion risk, regardless of the location of supply. In this context, businesses need to understand market dynamics and how the Mexico electricity market is evolving. If businesses want to keep ahead of this risk, they should look for an advisor like Acclaim, who can help them manage and understand this important and costly business risk.