Outlook Clouded for Open Mexican

George Baker

exico’s gas industry is poised for a dra- M matic expansion in the next ten years even if only half of the government’s latest projec- tions materialize. Still, there are profound distor- tions in the operating environment that tend to grant Pemex (the Mexican national oil com- pany) a de facto monopoly in gas transportation to Mexico’s prime industrial accounts. The result is that the outlook for open-access in gas trading is still clouded.

- - . tend to grant Pemex a de facto monopoly in gas

transportation to Mexico’s prime industrial accounts.

New Gas Demand Outlook In its new ten-year forecast (1998 to 2007)

for the natural gas market in Mexico, the Energy Ministry visualizes a dramatic market expan- sion. Where dry gas demand was 4.0 billion cubic feet a day (Bcfd) in 1998, the Ministry sees that demand at 8.6 billion cubic feet a day by the year 2007, implying a 9 percent average annual increase. The figure for average annual growth hides a number of surprising spikes in antici- pated demand at both the sectoral and regional levels (Exhibit 1).

The new Ministry forecast does not specifi- cally mention President Zedillo’s initiative of February 3 to restructure the power industry. However, the electric sector figures promi- nently in the Ministry’s forecast for future gas demand, rising annually by nearly 20 percent for ten years, reaching nearly 400 percent over 1998 levels by 2007, to almost 3 billion cubic feet a day. A similar pattern of growth is shown for the

George Baker is director of Mexico Energy lnteiii- gencerM, a newsletter and data service, based in Houston.

residential and commercial sector, but the de- mand level in 2007 is expected to reach only 437 million cubic feet a day.

At the regional level, gas demand for the electric sector is expected to grow annually by some 20 percent for five of seven regions listed. In the greater Monterrey area gas demand for power usage is seen to climb to over 1 billion cubic feet a day in 2007, up by nearly 600 percent over 1998’s level of 152 million cubic feet a day.

LPG Outlook Supply

Total supply will grow 11 percent over this period, from 304,000 barrels a day in 1998 to 336,000 barrels a day in 2001. The main source of domestic supply is PGPB (Pemex’s LPG subsidiary). Its production will increase 33 per- cent over the period, from 204,000 barrels a day in 1998 to 272,000 barrels a day in 2001. By 2001 PGPB will contribute 81 percent of total supply. Pemex Refinery (PR) production will increase slightly, from 30,000 barrels a day in 1998 to 34,000 barrels a day in 2001, a 13 percent growth rate for the period. However, its share in total supply will remain constant at the 10 percent level. Imports will fall to 30,000 barrels a day in 2001, a 57 percent decrease over 1998’s volume of 70,000 barrels a day. Their share in total supply will diminish from 23 percent in 1998 to 9 percent in 2001.

Demand A feature of the PGPB forecast is that total

supply equals total demand at all times (an assumption that does not fit with the reported figures by Pemex), therefore, total demand replicates the behavior of total supply. Domes- tic demand will grow from 300,000 barrels a day in 1998 to 312,000 barrels a day in 2001, a 4

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percent increase. According to Pemex’s forecast, the pattern of export growth will be dramatic: LPG exports will rise to 24,000 barrels a day in 2001, a 500 percent increase over 1998’s level of 4000 barrels a day.

Pemex’s Natural Gas Strategy The central strategic idea behind

the marketing strategy is to create two impressions in the minds of Mexican industrial consumers:

The terms and conditions offered by Pemex Gas are competitive with those available through other gas marketers. Additionally, they are better than others are if only because they are built on a long- standing supplier-customer rela- tionship. Open-access is the weaker option for Mexican end-users. To date, open-ac- cess gas trading has yet to begin, despite its being an option under gas regulations since January 1, 1997, in northern Mexico.

The premises behind this strategy are that Mexico needs to connect to US. and Canadian gas supplies only as a spot trader. Regional gas integration, then, is synonymous with spot trading. Mexico in this scenario is a natural gas island connected with the NAFTA mainland only when there is a shortage in Pemex supply or extra volumes require it.

In the view of U.S., Canadian, and European pipeline companies, this approach to market development has a high opportunity cost. For them, regional market integration carries a num- ber of benefits that are not being passed on to consumers. Regional integration offers these advantages:

Lower transaction costs Increased supply options and flexibility Increased hedging options Promotion of competitive pricing Increased export competitiveness of manu- factured goods by lowering energy bills Environmental benefits of switching to gas

Once the new open-access world begins in Mexico, new regional gas hubs will spontane- ously appear (Exhibit 2). Open-access trading

will be the trigger for the emergence of elec- tronic trading of natural gas, third-party gas marketers, and a secondary capacity market on gas transportation pipelines.

Impediments to the Implementation of Open-Access

The impediments to open-access gas trad- ing are commercial, cultural, and institutional. In terms of what is discussed publicly, the only two barriers are Mexico’s import duty on natural gas (currently at 4 percent on an annual reduc- tion schedule of 1 percent) and the absence, for over three years, of a published gas transporta- tion tariff by Pemex Gas.

The impediments to open- access gas trading are commercial, cultural,

and institutional.

Other factors also act as barriers to open access. One of these is what we have called “Pemex brand loyalty,” a strong force affecting customer choices. These factors may be thought of as the iceberg beneath the surface of the water.

There are also institutional barriers to open access. The organizational structure of Pemex favors the continuation of Pemex’s market domi- nance, if not de facto monopoly. One issue is the favored position of Pemex Gas in relation to gas supplies provided by Pemex’s exploration and

APRIL 1999 NATURAL GAS 0 1999 John Wiley & Sons, Inc.

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production (E&P) arm. Some international ob- problem is that there is no separation, Chi- servers argue that all gas marketers, including nese Wall or otherwise, between Pemex Pemex Gas, should be required to buy their gas Gas Pipelines (Ductos) and Pemex Gas Mar- supplies from Pemex E&P at delivery points on keting (Comercializaci6n). The result is that Pemex’s gathering systems or trunk lines. Pemex Gas Marketing only has to take the

A second issue is within the organiza- elevator in Edificio B in the Pemex head- tion of Pemex Gas itself (Exhib i t 3). The quarters to find out the prices offered

by competitors. To correct this problem, Pemex

Gas Marketing needs to be put on an equal footing with other gas marketers and end-users. In this way, all market players are indiffer- ent to the origin of gas or the pipeline system by which it is deliv- ered. Other market features of open- access system, such as e-commerce in gas trading, spontaneously appear (Exhibit 4) .

Investment Plan of Pemex Gas In a recent presentation Pemex

Gas director Marco Ramirez gave a broad overview of his unit’s invest- ment program for the period 1999 to 2001. A broad range of topics were covered:

20 NATURAL GAS APRIL 1999 0 1999 John Wiley & Sons, Inc.

Gas Processing A pie chart shows that income

was distributed across products with less than half (47 percent) corre- sponding to natural gas sales. LPG accounted for 32 percent and other NGLs for 18 percent. Pemex Gas anticipates that formation gas pro- duction will rise to 5 billion cubic feet a day in the year 2001, at an annual rate of growth of 5.3 per- cent starting in 1998. Gas supply from the Burgos Basin is expected to increase 16 percent.

. (. . income was distributed across products with less

than half (47 percent) corresponding to natural gas sales.

Gas Transportation For the period 1998 to 2001, Pemex Gas

anticipates the installation of additional com- pression totaling 5.15 billion cubic feet a day and 139,300 horsepower of capacity. Pipeline infrastructure will be needed to handle gas imports in excess of 1 billion cubic feet a day after the year 2001. A SCADA system is being put into place to automate pipeline operations.

A new management philosophy is being put in place through an ambitious U.S. $12.8 billion investment program for the period 1999 to 2001. The gas-processing and pipeline business units will receive 86 percent of the total.

Gas Marketing Pemex gas sees exports of LPG starting in

the year 2000, but also the need to invest in LPG storage facilities to be constructed and operated by a contractor.

Pending Issues for Market Development In relation to Mexico’s progress in creating

a natural gas market (where “market” refers to gas supplies delivered under competitive con- ditions), a great deal has taken place since 1995 to give the appearance of market-like behav- ior. At the same time, it may be true that, as of January 1,1999, not even one thousand cubic feet of natural gas has ever been competitively sold in Mexico. It is widely known that Mexico’s open-access policy has been unused since its

beginning in 1997. Moreover, it is not clear when that first thousand cubic feet will be sold competitively in Mexico. Presumably, how- ever, this first transaction will not take place before the year 2002, when Mexico’s import duty on natural gas expires.

Another central question about Mexico’s gas future is found upstream: Will Pemex be able to double its delivery of domestic dry gas supplies in the next ten years? If not, will some form of upstream opening take place? Will gas imports by Mexico go though the roof (affect- ing Texas gas prices and infrastructure)? Fi- nally, will the massive conversion to natural gas as the boutique hydrocarbon fuel of choice simply not take place as advertised by the Mexican Natural Gas Association and others?

Two broad conclusions follow:

Open-access gas trading will not occur before Mexico’s import duty on natural gas is eliminated in 2003 or sooner; even then, non-Pemex gas trading may be slow to start. Pemex’s “Microsoft” market position in Mexico will continue unless: 1. Pemex’s organizational structure is

changed to place Pemex Gas Marketing on equal footing with other gas market- ers, or

2. Regional gas hubs replace Houston Ship Channel.

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