George Baker
Baker & Associates
Oakland, Calif.
Baker is principal of management consultants Baker & Associates and director of Mexico Energy Intelligence, a research and advisory service.
Mexico's energy sector faces challenges that have been made more severe by last December's devaluation of the peso.
Fortunately, the country's new set of leaders at Pemex federal power utility CFE, and the energy ministry are veterans of complex Mexican public institutions.
With a market oriented vision, the long standing bottlenecks in energy policy in Mexico have a good chance of being eliminated. Those bottlenecks include electric power generation, regulations for natural gas transmission and distribution, and natural gas supply sources.
In the wake of the peso's devaluation, many observers have asked, "Will Pemex and CFE be privatized?" The near term answer is, "No."
As for Pemex the activities of its energy units will not be opened to private investment as a result of the devaluation.
Regarding CFE, while the privatization of electric power generation is a theoretical investment option, many obstacles stand in the way of funding any privately owned, independent power plants (IPPs). In the near term, issues more pressing than privatization need to be dealt with.
PRIVATE ELECTRIC POWER
One of the accomplishments of the energy ministry under former Sec. Emilio Lozoya, now replaced by former PRI Pres. Ignacio Pichardo, was development of a 10 year plan to supply Mexico's growing power needs.
The idea was to invite private capital, Mexican and foreign, to invest in electric power facilities. To increase installed capacity the next 10 years to about 50 million kw from a current level of about 28 million kw, the Lozoya team said major IPP investments would be needed.
One white paper said perhaps as much as 80% of future electric power capacity in Mexico could come from privately built and financed power stations. Toward this end, the federal law governing electricity was changed in late December 1992, and a new set of regulations for electricity was issued May 31, 1993.
At that point, to judge from results, the vision died.
In July 1993, the International Finance Corp. (IFC) of the World Bank withdrew its support of a proposed power plant sponsored by U.S. interests and known as Carbon II in the border state of Coahuila. In making this decision IFC was responding to a controversy over the perceived environmental threat posed by the plant, which would burn high ash content coal.
Because neither the project sponsors nor the Mexican government was willing to fund $300 million for the plant's scrubbers, the project also was dropped by normal commercial lenders who otherwise would have provided stand alone project financing. This unexpected turn in the outlook for financing sent the project sponsors to try the bond market, but the idea did not prosper, and by October the U.S. sponsors announced their withdrawal from the project.
A second project that appears headed toward the same crossroads is a proposed natural gas fired plant near Merida on the Yucatan Peninsula.
Initially, 30 companies each paid $10,000 for the bid package. Some of these companies have submitted bids, which were scheduled to be opened and evaluated this month.
Delays and a new cycle of negotiations, however, will extend this process into an indefinite future. As one prospective developer puts it, "Mexico is speaking the language of private electric power, but there's little evidence from either the CFE or Pemex of a genuine commitment."
Unless there is a major shakeup in policy, such bids, even if awarded, will likely not receive outside funding for construction. Here's why:
GAS TRANSMISSIONS
The proposed Merida power plant is about 600 km from the nearest source of natural gas.
Since early 1993 there have been discussions, debate, and acrimony between Pemex and CFE over who would pay for and lay the gas pipeline to supply the plant, known as Merida Ill.
Once the pipeline was built by whatever financing device, prospective lenders and developers have two other questions. The first concerns the mechanisms to be used to adjust future prices and tariffs of natural gas, gas pipeline transmission, and electricity. In the U.S. and Canada, questions of price are answered by the marketplace via multiple gas suppliers and transmission options. Questions of tariff are answered by state public utility commissions and federal agencies.
In Mexico, the government maintains a monopoly on natural gas supply and transmission, and there are no federal or state public utility commissions to serve as forums in which rates and tariffs are negotiated. Since 1992, the government has accepted a controversial policy, one proposed by Pemex market strategists, of indexing domestic hydrocarbon fuel prices to a basket of U.S. petroleum prices plus transportation.
In a break with policy, however, Pemex announced a 20% increase in petroleum prices for Monterrey industrialists, which account for most of the industrial natural gas demand in the country. Such arbitrary pricing should open opportunities for U.S. and Canadian gas exporters, whose prices respond to market forces, not to decrees by government agencies.
While end user gas contracts are in theory allowed by the North American Free Trade Agreement, such contracts have yet to be tested commercially or in court.
That raises the second question, involving the Mexican court system, where ambiguity and unpredictability undermine expectations of equity by Mexican and foreign companies. Mexican courts have never decided upon issues of Pemex liability regarding either the CFE or IPPs for costs associated with problems of fuel supply. Further, even if such cases had been decided, Mexican judges, operating under a civil code legal system, have no obligation to decide on the merits of similar cases in the same manner.
GAS SUPPLY SOURCES
The third question of uncertainty involves natural gas supply sources.
Analysts foresee a supply deficit of natural gas that cannot be met by increased oil production in the Bay of Campeche. To meet this challenge, Mexico has only two real options: import gas from the U.S. or Canada or develop major new supplies of dry gas.
Imports represent the easiest solution to visualize and fund, but the long term cost may be much higher than increasing domestic production. For this, the most promising areas for increased dry gas production are the Sabinas and Burgos basins near the northeastern border with Texas. The petroleum geology of these fields, however, is complex and requires costly 3D seismic evaluations.
Pemex which produces mainly oil in Southeast Mexico, is under pressure to keep oil production up to keep foreign exchange from export revenues steady. Pemex has little interest, therefore, in undertaking gas pipeline projects in Yucatan, Sonora, Baja California, or anywhere else not connected with oil production, refining, and distribution of refined products.
Spending capital on risky natural gas plays in the Northeast does not tap into Pemex's core interests or abilities.
Prospective investments in private power generation, therefore, are in doubt not only because of a lack of a regulatory framework that can support the requirements of project financing but because of the lack of peace of mind about Pemex's commitment to supply, transmission, and fair pricing of natural gas.
Such doubts, in turn, partly reflect a situation long observed by prospective lenders and investors: Namely, that managers in Pemex and CFE, as well as officials in the energy, commerce, and finance ministries, generally lack information about the economics, financing requirements, and operational and environmental efficiencies of market oriented energy policies.
ENERGY LEADERSHIP
Those and other career issues will require the attention of two recently appointed, capable, career public officials to lead the two major energy agencies in Mexico: Rogelio Gasca Neri at CFE and Adrian Lajous at Pemex.
Gasca, who has M.S., Ph.D., and M.B.A. degrees from Stanford, was trained in the field of nuclear energy. Leaving private industry in 1988, he joined the planning ministry, then headed by future President Ernesto Zedillo, and came to CFE from the finance ministry.
During Salinas' tenure, CFE sought to hold its monopoly on electric power distribution and often gave the impression of being impatient toward the what-if questions of prospective lenders and developers. Under Gasca, CFE can be expected to negotiate in a more straightforward manner.
Lajous, who received a master's degree in economics from Cambridge, has worked in diverse assignments related to energy policy in Mexico since 1977.
As director of Pemex's investment policy during 1992-94, Lajous was opposed to private upstream investments in any form. He argued that Pemex's oil finding costs were low and that Pemex had ample access to international capital markets. Further, he would say, Pemex had easy access to leading edge technology offered by oil field service contractors.
For all those reasons, there was no need to share production revenues with international oil companies who, if invited, would invest in E&P.
Now, as director general of Pemex Lajous is the object of contradictory speculation. Some see him as a reformer who will privatize not only the non-energy units of Pemex but some energy related activities as well. Most see him as a Pemex traditionalist who will seek to preserve Pemex's institutional authority and responsibilities.
Although traditionally the energy ministry has exercised little policy guidance over Pemex and CFE, which have operated largely as self-regulated bodies, this framework may change during the Zedillo presidency. Pichardo, with degrees from the London School of Economics and Dartmouth, is an experienced political figure, a former governor of the state of Mexico whose experience in matters of national economic policy stretches to 1964.
The challenge facing Pichardo, Gasca, and Lajous of crafting an integrated approach to power generation and natural gas supply will be made more difficult by the long established pattern of Mexican agency managers, ministry officials, and regulators acting independently of one another in relation to issues of energy policy.
REQUIEM FOR SALINAS
The Salinas administration, which just ended, kept private investment out of the energy sector.
Prospective investors and lenders were struck by how its economic modernization programs systematically overlooked opportunities for gains in production, efficiency, environmental protection, and tax revenue that the option of private investment in oil, gas, and electric power offered.
For all the talk of reform and modernization, 6 years passed without a single major private investment in any area of the petroleum or power industries. Private investment in petroleum took place only on a limited scale in the nonenergy areas of petrochemicals and lubricants.
While Pemex was given a new organizational law in July 1992, which divided it into three energy units and one petrochemical unit, 2 1/2 years passed without passage of operating regulations that would define the formal relationships between the units (OGJ, Jan. 17, 1994, p. 33).
Absence of a set of formal regulations, coupled with the lack of agreement among the Pemex units themselves, combined to derail the hope of Lozoya to issue natural gas regulations before the end of the Salinas term.
Another controversial legacy of the Salinas approach to oil policy was the decision in 1992 to price petroleum products for the domestic market using U.S. benchmarks.
That approach worked in times of a steady exchange rate, but to adjust Pemex prices for domestic production solely on the basis of the devaluation of the peso is risky. Fuel prices, especially gasoline's, are taken as the principal indicators of overall inflation.
The compromise solution disclosed by Pemex Jan. 3 was to divide the country into two parts: Mexico proper and the border strip with the U.S. Motor fuel in Mexico would gradually increase by not more than 10% by December, but motor fuel at the border would jump to the equivalent of U.S. prices. Wages throughout Mexico, meanwhile would in theory increase by only 10% this year.
CURRENT CHALLENGE
What Mexico's economy needs most is a confidence demonstration effect.
The energy sector offers several possibilities, such as the negotiation and financing of just one IPP. Conclusion of one such deal would be a signal that Pemex CFE, and the commerce, finance, and energy ministries have worked out their differences in philosophy and policy, and Mexico is again open for business.
Coupled with the recent devaluations of the peso, business as usual in energy policy in Mexico can be expected only to spur lenders and investors to look elsewhere.
The costs to Mexico and the U.S Mexico border region of not crafting a workable energy policy will be high and be measured in foregone increases in economic development, employment, and environmental protection.
Copyright 1995 Oil & Gas Journal. All Rights Reserved.