NEW COLUMN: INTERNATIONAL/CROS8-6ORDER

THE MONTHLY JOURNAL FOR PRODUCERS, MARKETERS, PIPELINES, DISTRIBUTORS, AND END USERS

Outlook for LDC Acquisitions in Mexico George Baker

y the year 2000, the throughput of natural gas B in privately owned LDCs could exceed 3 billion cubic feet a day of load (Exhibit l), roughly the gas volume of metropolitan Los Angeles. The demand for natural gas service is expected to increase significantly in the coming years owing to several factors. First, Mexico’s Clean Air Act of 1994 requires a shift to natural gas in major metropolitan areas by heavy industries and electric utilities by the year 1998. Second is the scheduled privatization of Pemex’s petrochemical plants. Once in private hands, plant output and gas feedstock demand are ex- pected to increase sharply. Pemex’s chemical plants alone consumed 658 million cubic feet a day in 1994, a load that could rise to 1 billion cubic feet a day by the year 2000.

The meaning of such load projections for pipe- line companies, gas transporters, and distributors will be shaped by the evolution of the legal and regulatory environment, Pemex’s present and future divestiture plans, Mexico’s domestic gas production, and the availability of dollar financing for Mexico energy projects.

Present Market Conditions In the residential marketplace, at present Mexico

lacks a natural gas culture. The very term “gas” (spelled in Spanish as in English) means LPG for 19 out of 20 Mexicans. In most residential units in Mexico, heating needs are met by LPG, which arrives in tanks by

George Baker is the director of Mexico Energy Intelli- gence, an industry newsletter with offices in Oakland, Houston, and Mexico City.

delivery trucks and is typically stored on the roofs of homes, apartment complexes, and commercial buildings. As Jorge Rebolledo, the general manager of the natural gas LDC in Mexico City comments, “Most of my own custom- ers believe that they are paying for LGP. They imagine that we have some huge, off-site tanks from which we supply their apartment complexes.”

8

12

D. 77wnas Taylwand RussdO. Thonyaeon

Natural Gas Vehicles:

16 Marketa

Quit complaining and Go GIet the Market Benjamin S c h k l ~ 21

0 1995 John Wiley 8 Sons, Inc. Printed on recycled paper. @

INATURAL Q A S AnocbbPuMkh.r:RokrtE.wIIMt ISM.glngEdltor:k.klkCdrm

Ekhml Qaa (ISSN 0713-5666) is published monthly, 12 issues per year, byJohnWiley8 Sons, Inc., 605ThIrdAvenue, New York. NY 10158. copytight Q 1995 John Wiky 8 sons, Inc. All rights resenred.

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1 EDITORIAL ADVISORY BOARD

Cath.rlmaoodAbbott,\lioePnW&nt End User Finance Enmn Gas services

M k h d B.ly 111, PtW&Wand Chkf Emrwtrw, . OPRcer Ame&tnGasAssodation

Wlllkm T. h h a m , Vice President Regukkny A M r s AmoooProduclioncompany

Nafkma/ Gas Supply Associalion Nkhd.r J. Bmh, President

William F. D.mul#1 Jr., Esq.

Mlchnl 1. OmMn, Senior \lioe P&

Hdlendd Hart

Gas Wness Unfi, New Yorksaate EIeCMc8 Gas corp.

Sutherlend. Asbill & Bmnan Edward J. Gmnk Jr., Esq.

Mlchnl J. Hanko, Esq.

R. Sklp Horvath, Senior Vm Pres&nt ReteandPdicyAnelysis Intemte hletuml Gas Assodalion

vinson 8 Elkim

D0ugl.r F. John, Esq. John, Hengemrd Esposiro

Jamaa C. Longdon Jr., Esq. Akin, Gump, Stmuss, Hauer & FeM

Willlam R. Luth.m, Vice PI&W?Z ProducHOnandSu~ Baston Gas

mtkering and Government Ahirs o w Energy Co.

Becky McGee, Chief Counsel

Richard 0. Morgan, Esq. Lene&MiltW&ti

Frederick Morlng, Esq. CrobU?ll& M n g

K.nnahE.l3andolph Senhm-r

RMM, president

Natuml Gas cleenrnghoupe

lmqutn3GasTtansmMmSystem

Benjemin Schk.lngw, PrasMent !3chlesinger and Assodates, Inc.

R i c h r v d G . S ~ ~ ~ d , Senior President cdorado Interstate Gas Cmpany

William H. Smlth Jt., ChW & m u of Rate and EWWkm Iowa utilities Board

Edward J. soncky ~eni~rvicepresident BIooMyn Union Gas Cumpimy

thomcrr J. Nwrk, Senior \lice Pmsi&nt C h a w 6. Stalon T e n m Gas FormerCommissioner

FERC John E. O I ~ , First V ~ S president

Carl v. swmaon, President Swansm Enegy Group. Inc. Mern7l Lynch P k m Fenner 8 Smith Inc.

on R. ~ ~ r r l n g , President

Mary Anne Walkew, Esq.

B a n D. ON.ill, Esq.

Norman A. Podoram, Esq.

LeBoeirf, Lemb, Gmne 8 MacRae ARTA lnc.

Mudp Rose Guthrie Alexan&r& Femdon Jones, Day, Reavis 8 Pogue

2 NATURAL GAS DECEMBER 1995 Q 1995 John Wiley 8 Sons, Inc.

Outlook for LDC Acquisitions in Mexico (Continued from page I )

A second factor affecting the slow emer- gence of a natural gas culture is the perception of heating needs in Mexican households: The unexamined assumption in the United States and Canada that central space heating is stan- dard for residences and commercial buildings does not fit Mexico, where the general view is that the climate does not require central space heating. In this way, serapes, rebozos, and sweaters effectively compete against natural gas. The same story applies to household appliances that could be gas-burning. In most households clothes dryers are unnecessary be- cause of energy-efficient clotheslines on the roofs of residential buildings. Given the wide availability of low-wage domestic help, the middle class that could afford dryers pays their seruientus (live-in maids) to hang out the clothes.

- - - serapes, rebozos, and sweaters effectively corn Pete

against natural gas.

Of the ten or so LDCs in Mexico that serve residential markets, by far the largest is that owned by the government and operated by the Federal Power Utility (CFE) in Monterrey.

Regarding the electric utility market, de- mand for natural gas has been artificially sup- pressed by a bottleneck in Pemex’s refin- ery system. The problem is that Pemex’s refineries produce over 400 thousand barrels a day of heavy fuel oil, the competitive pricing of which in the do- mestic market displaces potential gas load from the electric market.

As for the industrial market, there are two channels of distribution. One is through several industrial-market LDCs whose principal load of about 650 mil- lion cubic feet a day is in the Monterrey area. A second channel is Pemex’s own portfolio of industrial accounts, includ- ing deliveries to its to-be-privatized chemical units.

The aggregate load of these industry, electric, and residential markets reached 2.0 billion cubic feet a day. As the

historical data from 1992 to 1994 suggest, mar- ket conditions have not been favorable to the expansion of natural gas markets, and this has been especially true in the residential sector. As the sole supplier of natural gas for the LDCs (those at Piedras Negras and Cananea are ex- ceptions and rely on imported gas), Pemex has had little interest in expanding gas markets. The explanation is to be found in the regulatory structure (discussed below) that makes gas distribution a low-priority activity. Pemex rea- sons that little money is to be made under market conditions in which the Commerce Ministry can set prices to make gas affordable to the tenants of low-income, government housing units such as Tlatelolco (the site, incidentally, of the 1968 violent confrontation between the Army and university students). With low burner- tip prices set by the government, and Pemex’s policy of pricing its fuels by U.S. benchmarks, the person caught in the squeeze is the middle- man distributor.

Future Acquisition Scenarios Where might the future lie for gas LDC

acquisitions or investments? Basically, there are five possibilities:

Acquisition of the government’s to-be-auc- tioned residential-market LDCs in Monterrey, Mexico City, and Querktaro Acquisition of an interest in existing

1 Exhibit 1. Outlook for Gas LDC Markets in Mexico to the

Industry Industrial acc<wtlw 86s 803 as1 l#277 Pemex chemical& rn 634 668 987 subtotal industry 1,574 1m 19- 2sm

ElecMcPoweP 400 385 437 656 ResklentiaP 100 82 80 120 Total LDC Matlab 2,074 l,W4 Zans 3,040

DECEMBER 1995 NATURAL GAS Q 1995 John Wiley & Sons, Inc.

3

nongovernment LDCs from their present owners Inside-the-fence and dedicated power-gen- eration (IPP) markets Greenfield LDC industrial- and residential- market projects in cities such as Tijuana, Mexicali, Hermosillo, San Luis Potosi, and Guadalajara where there is a strong middle class Acquisition of Pemex industry-market port- folios in metropolitan areas such as Villahermosa, Toluca, Mexico City, and Guadalajara

The first four of these acquisition scenarios are contemplated by the present legal and regulatory frameworks in Mexico. By our esti- mates (Exhibit 2) however, over a third of the industrial market is accounted for in Pemex’s direct accounts to non-Pemex customers as well as Pemex’s distribution arrangements with its to-be-privatized chemical units.

To date, neither Pemex nor the government

has publicly addressed the need for Pemex to spin off these accounts to private gas distribu- tors. Pemex’s present position is that it will compete with private gas distributors for those accounts. Industry observers note that Pemex has what amounts to a privileged position in the marketplace, as it is able to offer discount prices based on volume. From this position Pemex will always be able to underprice any potential competitor that it chooses. For this reason, the argument runs, Pemex must withdraw entirely from some segment of the gas value chain. Which segment is less important than the prin- ciple of allowing true private competition to exist in some portion of the gas industry. Given a choice between E&P, processing, transport or distribution, by far the easiest segment for Pemex, the goverment, and prospective inves- tors is distribution. The risk to Pemex and the government of not taking this step will take the form of delays in getting investor commitment in franchise areas in which Pemex is allowed to compete either directly with gas distribution or

indirectly with discounted fuel oil. (See Exhibit 3 for a list of Mexican LDCs.)

. . . by far the easiest segment for Pemex, the

government, and prospective investors

is distribution.

The picture is much clearer in areas in which greenfield LDC projects could be initiated. The most promising area is Baja California, where, in relation to natural gas service for the state, there is a long history of studies, meetings, negotiations-and more studies. The tiebreaker may lie in the fact that the hometown of President Ernest0 Zedillo is Mexicali, capital of the state. The new Greenfield Natural Gas Pipeline Act of 1995 may be the answer to getting natural gas to Baja California. By the terms of the new act, private investors, hopefuls such as SoCal Gas, SDG&E, and El Paso will be able to build and operate natural gas pipelines in the state; moreover, natural gas may be imported and exported freely. There are two pipe-

4 NATURAL GAS DECEMBER 1995 8 1995 John Wiley & Sons, Inc.

I Exhibit 3. Non-Pemex Distribution of Natural Gas and LPG in Mexico

Divemumor Main No. of ThrouOhput -

-Paw- Locaion (MIbs) Curtomm Typa Mktd &cwdukd?

Monterrey Area Comisidn Federal de

Electricidad (CFE) Cia. Mexicam de Gas Gas Industrial de Monterrey Subtotal Monterrey

DIGANAMEX DIGAQRO Cia. de Gas Nuevo Laredo Gas Natural de Juarez Juarez Natural Gas Co. Cia. Nal. de Gas Distribuidora de Gas de Saltill0 Cia. de Gas de Cananea Frac. Ind. del Norte Almac. de Dep. Univ. Cia. de Gas de Mexicali” Cia. de Gas de Tijuana**

Mexico city Queretaro

Nvo Laredo Cd Juarez Cd Juarez

Piedras Negras Coahuila sonora

Matamoros Matamoros

MexicaH Tijuana

3,350

1 49 16

307 27

168 621 124 109 111 43 3 1 2 2

277,529

250 21

126,624 9,095

18,500 4,OOo 12,500 9,OOO 8.1 00 5,480

6 5

945 945

50.0

350.0 e 300.0 e 700.0

7.3 2.5 5.1 e

12.3 e 3.4 e 2.5 e 2.2 e

0.8 e 7.1 NIA NJA

*Repsd bought- LDC diredyfrom Pemex in 1994. ‘“Aggmgaw estknateg of LPG service for Tijuana and Mexiceli.

line approaches to Baja, one from the north, the other from the east (Exhibit 2). Pemex has favored the eastern route for the advantages of avoiding the California regulatory costs and supply uncer- tainties. While the initial capital costs would be significantly less through the northern routes, it may turn out that California is bypassed.

Regulatory Structure of the Gas Sector The regulatory picture in the gas sector is as

complicated as most things are in Mexico (Ex- hibit 4). First, there are three energy-policy ministries, even though, formally, there is only one energy ministry. Second, it has long been informally true that Pemex makes energy policy in Mexico by the simple fact of its investment decisions. Third, there are two regulatory bod- ies, the CRE (Comisi6n Reguladora de Energia, a made-in-Mexico FERC-PUC hybrid), and the Anti-Trust Comisi6n.

Pemex’s biggest gas customer is by far Pemex, mainly to its chemical unit. The second largest

customer is the CFE, followed by two groups of customers, those in Pemex’s own industrial port- folio and those in the portfolio of existing DCs.

. . . there are three energy-policy ministries,

even though, formally, there is only one energy ministry.

Challenges Ahead There are two main obstacles still blocking

the emergence of natural gas markets in Mexico. One is the perceived shortfall in natural gas supply from Pemex production (Exhibit 5). Pro- spective investors will want to see a surplus of dry gas production in Mixico before investing in pipelines, distribution systems, or even IPPs. In their view, gas imports will not be an adequate substitute for domestic output. Additionally, that

DECEMBER 1995 NATURAL G A S 0 1995 John Wiley & Sons, Inc.

5

Pemex's own trunk lines have excess capacity can hardly be of any comfort to them.

The second challenge is the orchestration of regulatory, legal, and market elements that, taken together, would enable investors to ob- tain financing for gas and gas-powered electric projects in Mexico. There is no easy way to describe or itemize the complex checklist of interrelated tasks required for the investment climate in Mexico to achieve credibility as a site for the stand-alone, corporate financing that energy projects will need. It would be better to say that the several parties involved each has its

PRESIDENT

own checklist. For IPP developers, for example, it is important that the government fix electricity rates to some U.S. dollar-denominated basket of rates, in much the same way that Pemex prices its fuel products by reference to U.S. market benchmarks.

The items on the initial checklist that can be marked off as completed include the Air Quality Act of 1994, the Greenfield Electric Power Act of 1992, the Greenfield Pipeline Act of 1995, the Open Access Pipeline Act of 1995 (included in the text of the Pipeline Act), the definition of the internal statutes of the energy ministry and CRE,

4

1 Exhibit 4. Complex Organization of the Natural Gas Sector

consultations b V

(Gas Dept.) (Formal Authority)

Energy Policy Ministries

Formal r-l regulatory bodies

Anti-Trust

I

Gas imports from US.

Consultations 1 PEMEX

'0 producer 5 'v

Fuel oil 5 I Refining 1 bottleneck .n -

Gas processing

ConsUltatiOns t

I CFE (Largest non-Pernex gas customer)

Gas supply to LDCs 1

PEMEX INDUSTRIAL CUSTOMERS (Natural Gas)

LDC t local (retail) gas distribution companies, mainly residential. 'Established in 1994 to monitor electridty rates. Redefined as the FERWUC of Mexico in November 1995. "In theory. will determine tariffs in absence of competihre market conditions.

6 NATURAL GAS DECEMBER 1995 0 1995 John Wiley 8 Sons, Inc.

and, finally, the issuing of regulations for the private transport, storage, and distribution of natural gas. (The CIE statutes and the gas regulations were completed in November 1995.)

This is an impressive list of accomplish- ments by the Salinas and Zedillo administra-

Our own list is led by the need to develop dry gas reserves and includes the ongoing dispute as to who manages energy policy in Mexico. Until some of these issues are clarified, it will be dif- ficult to assert that real gas markets, ones driven principally by market forces, exist in Mexico.

Pent-up gas demand by

industry

tions. At the same time, there still remain many items still pending. Bank- ers, developers, operators, and regulators have not yet reached an agreement as to the number, weight, or ranking of “items pending” (Exhibit 6). As evidence of this lack of consensus, in October 1993, after at least $30 million had been spent, the proposed developer walked away from the coal- fired Carbon I1 electric power project in Coahuila. People close to the gas- fired Salamayuca plant in Chihuahua say that financ- ing is “almost closed,” but then it has been almost closed for so long.

Settle Major gas interagency

E&P effort in disputes over Northern Mexico energy policy

I Exhibit 6. Elements of a Competitive Gas Market in Mexico

COMPLETED

distribution Act of 1992 Act of 1995 Act of 1995 (norms for year 1998)

ITEMS PENDING

development of natural

gas reserves gas fields

of nonrecourse markets as financing of principal gas

consumers

Pemex will not by Pemex to dump fuel oil increase gas on domestic gas markets match new gas distributors

pipeline capacity

DECEMBER 1995 NATURAL GAS 0 1995 John Wiley & Sons, Inc.

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