Unbundling, the creation of a wholesale electricity market and an increased push for clean energy carry important tax implications and open new opportunities.
After 75 years of nationalization, Mexico's oil and gas and electricity sectors are opening fully to the private sector. Unbundling, the creation of a wholesale electricity market and an increased push for clean energy carry important tax implications and open new opportunities.
According to Bank of America, Mexico's sweeping energy reforms could generate an additional US$20b of foreign direct investment as early as 2015, strengthen the peso and boost economic growth. (See our RECAI publication, in the Mexico section.)
"We have all the regulations but
still do not know what the rules of the market will be."
Alfredo Alvarez Laparte, EY
Mexicans hope that electricity prices will fall: current prices can run as high as 75% more (though the Government subsidizes low-income residential customers) than its neighbor, the US. This has created a significant disadvantage for Mexico's energy-intensive industries, such as manufacturing.
- Unbundling will fully open up generation and retail for investment by the private sector. Co-investment will also be possible with the Government in transmission and distribution (T&D).
- Creation of a wholesale electricity market covering the country's entire generation capacity – this could be up and running by the end of 2015, with further functionality added in 2016.
- The Government has set a target of 35% from clean energy by 2024, including effective cogeneration with natural gas and hydro power generation.
Tax implications and challenges:
- CFE now taxed: Government-owned Comisión Federal de Electricidad (CFE) was incorporated into the regular tax system as of 1 January 2015 – a significant change for the institution, as it used to be fully tax-exempt.
- Deeper pockets needed after loss of waiver on thin capitalization: Companies investing in generation and retail no longer qualify for a waiver on thin capitalization. Given that the applicable debt to capital ratio is 3:1, it will be hard to justify subordinated debt on top of regular project finance. Although large companies may be happy to loan those funds, new generators must evaluate the opportunities carefully.
- Support for renewables: Investment in solar and wind projects has ramped up in recent years due to incentives granted before the energy reform and the reforms support clean energy.
- Rules of the market to be decided: Tax legislation was drafted for a different market, when CFE was tax exempt and electricity companies could not act independently. Currently, therules of the marketare yet to be defined, and ad hoc regulations for tax-specific circumstances will be needed.
- Clarification needed on industry issues such asT&D line losses: Mexico loses 15% of generated electricity through its T&D line. The average for countries in the Organisation of Economic Co-operation and Development (OECD) is 6%. The tax authority may expect generators to absorb the cost of lost electricity — in which case, electricity companies will need to claim a deduction though this is unclear under current regulations.
Mexico's wind energy capacity
Working together to provide clarity
Opening up oil, gas and electricity markets after 75 years of monopoly is no small task for the tax authorities. The sector, its advisors, regulators and tax authorities will need to work together to resolve issues.
As the regulations evolve, we will seek to provide as much clarity as possible to our clients and to work closely with the authorities. EY has the largest tax practice in the country, and a specialized P&U tax team in place that understands this reform regulation and how it works.
The starting point is an expensive electricity industry, so imagine what that change could mean for Mexico. Imagine what it could mean for our manufacturing industry. I believe that we are on the right path to transform Mexico's energy and economic landscape.
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