PRIVATE SECTOR OPPORTUNITIES IN MEXICAN ENERGY
INTRODUCTION AND OVERVIEW
Mexico faces significant public investment constraints in developing its energy sector over the next decade. As such, the government of Mexico is gradually opening up certain energy activities to the private sector. This opening provides exceptional opportunities for energy companies from Mexico, the U.S., and other countries. While constrained by Constitutional restrictions, a strong public emotional attachment to Mexican energy resources, and strong public sector unions, both Presidents Salinas and Zedillo have made significant progress in freeing certain energy areas away from the "core" of oil exploration and production.
ENERGY IN THE MEXICAN ECONOMY
In 1997, the Mexican energy sector accounted for 2.7 percent of Mexico’s GDP.
In the early 1980s, oil exports accounted for roughly 70 percent of Mexico’s export earnings. In the mid-1980s Mexico began a process of integrating its economy into the world economy, symbolized by joining the GATT in 1986. By 1997, oil exports accounted for only 10 percent of Mexico’s export earnings, a figure that is expected to fall to 7.5 percent in 1998 due both to the continued opening of the Mexican economy and the low oil prices in 1998.
The Mexican Government depends on revenues from oil for 38 percent of its fiscal income.
Mexico ranks 5th in world oil production, 8th in oil reserves and 14th in natural gas reserves. To put this in perspective, the United States ranks 2nd in world oil production, 11th in oil reserves and 6th in natural gas reserves. While crude oil production in the U.S. is more than twice Mexico’s production of 3 million barrels per day, the U.S. is a net oil importer of 8.9 million barrels per day while Mexico is a net exporter of 1.5 million barrels per day.
Growth in natural gas production in Mexico has averaged about 9 percent annually over the past four years. Currently, about 58 percent of natural gas production is used by the industrial sector and 20 percent is used to produce electricity. Because of the changes taking place in both natural gas and electricity in Mexico, these percentages are expected to reverse over the next 8 years.
CONSTITUTIONAL AND LEGAL STRUCTURE
Articles 27 and 28 of Mexico’s Constitution establish the nation’s exclusive right to exploit hydrocarbons, provide public electric power service, manage nuclear fuels, and some other activities. The 1938 nationalization of Mexico’s oil industry put oil production in the hands of the state monopoly Pemex (Petroleos Mexicanos). Today, Pemex is a decentralized agency with four subsidiaries: Pemex Exploration and Production, Pemex Gas and Basic Petrochemicals, Pemex Refining, and Pemex Petrochemicals. However, as with all state-run monopolies, Pemex is not as efficient as a multinational oil company.
Electric power generation, transformation, transmission, supply, distribution and marketing activities intended to serve the public are carried out and coordinated by the Federal Electricity Commission (CFE) and to a lesser degree by the electric company for Mexico City (LFC).
While the Energy Secretariat establishes energy policy for Mexico, one of its decentralized agencies, the Energy Regulatory Commission (CRE), regulates the activities of public and private operators in the electric power and gas sectors and issues permits as provided by legislation.
OPPORTUNITIES FOR THE PRIVATE SECTOR - PETROLEUM
While the energy chapter of NAFTA was used by Mexico to maintain its state control over petroleum, the government procurement chapter provides U.S. companies considerable opportunity to develop business relationships with Pemex and CFE and the investment chapter provides U.S. companies protection where investment is permitted. Under NAFTA, Pemex and CFE are subject to government procurement rules, with 50 percent of contracts open to U.S. companies initially in 1994 and with the percentage to grow to 100 percent by 2002. While these government procurement rules have been resisted by Pemex and CFE, an increasing share of purchases are made from foreign suppliers. These include service and performance contract arrangements and turnkey drilling contracts.
Pemex is the world’s sixth largest oil company, and Mexico has the second largest oil reserves in the Western Hemisphere (40 billion barrels) after Venezuela.
Oil production in Mexico has been growing rapidly, by 9 percent in 1996 and 5 percent in 1997. The goal for 1998 had been a crude oil increase of over 6 percent, which would require a planned investment by Pemex of over $9 billion. Even with Mexico’s commitment to OPEC to cut oil production, output should be up 3 percent to 3.11 million barrels per day.
Pemex revenues fall by $1.1 billion annually for every dollar per barrel decline in its average oil price. The 1998 net export earnings are expected to be $5.92 billion, some 30 percent lower than in 1997.
OPPORTUNITIES FOR THE PRIVATE SECTOR – NATURAL GAS
While the production of natural gas remains in the hands of Pemex, a 1995 law opened up natural gas transportation, storage, and distribution to private investment and allows private companies to import and export natural gas.
This 1995 law tasks the regulatory agency CRE to achieve a competitive, efficient, safe and sustainable natural gas industry.
CRE expects that natural gas demand will double over the next decade, and that half of this gas will be used to generate electricity.
CRE issues permits, regulates prices, sets and enforces regulations, inspects facilities, and provides overall supervision of the industry.
As of 1997, private companies in Mexico can use the Pemex gas pipeline infrastructure under a completed open access policy for transmission services.
Natural gas production grew of 9 percent per year over the past 4 years. This production is small, however, compared to its potential. Current proven reserves are about 64,000 billion cubic feet (Bcf) and potential reserves of 160,000 Bcf.. Natural gas entering Mexico’s domestic market in 1997 was about 2.4 Bcf per day and is expected to double over the next decade under Mexico’s Integrated Fuel Policy.
This policy aims to replace much of the use of fuel oil used in electricity generation to natural gas, both through the conversion of several existing electric power plants and by encouraging the construction of new combined-cycle electric power plants. About half of this increased demand for natural gas will be for generating electric power.
Environmental regulations will also drive an increased use of natural gas in Mexico both for industrial and household use.
A major constraint in developing Mexico’s natural gas reserves has been the lack of investment in pipeline infrastructure for transporting gas over long distances. Most of Mexico’s natural gas is produced in the far south of the country onshore and to a lesser extent offshore. This gas is produced in association with the production of crude oil. Mexico’s population is located inland and to the north.
Mexico does have one large non-associated gas production field in the north near much of the country's industrial base (Burgos). Pemex has begun an ambitious plan to increase production at Burgos from .5 Bcf per day in 1997 to 1.4 Bcf per day in 2001 through the use of 3D seismic technology combined with new drilling techniques and hydraulic fracturing. This $2 billion technology investment through the year 2000 provides an excellent export opportunity for U.S. firms (one of which won the first major $110 million contract).
Since 1996, Mexico’s energy regulatory agency (CRE) has been busy defining natural gas distribution zones to be opened to private investment and conducting the bidding process for distribution permits.
The first such bid was won in 1996 by a consortium formed by U.S. firms Enova and Pacific Enterprises and Mexico’s Proxima. This consortium was granted the distribution rights in Mexicali.
The same consortium won a 1997 bid to distribute gas in Chihuahua City and surrounding cities in the north.
Another consortium formed by KN Energy Inc and a Mexican group called Marhnos won the bid to supply natural gas in Hermosillo and nearby cities.
Nine permits have been granted to date for natural gas distribution, two distribution zones are currently being tendered, and tenders for at least three more distribution zones will be solicited in the remaining months of 1998.
For long distance transmission, in October 1997, CRE granted a 30-year permit for a consortium of private companies to transport natural gas 450 miles from the south of Mexico to the Yucatan Peninsula (north-east from the production in the south). This $276 million investment will supply gas to the first Independent Power Producer (IPP) electric power plant called Merida III.
CRE is exploring at least 6 major transmission projects that it believes have short-term development possibilities.
In February 1998 CRE approved permits for two separate gas pipelines to run from Palmillas to Toluca, a city to the west of Mexico City.
Mexico is currently a net importer of natural gas and natural gas producers and marketers in southern Texas would like to increase exports to support the fast growing northern industrial zones in Mexico. Mexico has made a tentative offer to speed up the phase-out of the current 5 percent tariff on imported natural gas from the U.S. in exchange for U.S. tariff reductions on imports of specific Mexican chemicals. The Mexican tariff on imported natural gas was 10 percent at the beginning of NAFTA in 1994 and is due to fall 1 percent per year through 2002. The Interstate Natural Gas Association of America urged the U.S. Trade Representative in April 1998 to negotiate this accelerated tariff reduction on natural gas.
OPPORTUNITIES FOR THE PRIVATE SECTOR – ELECTRIC POWER
In 1937, the government of Mexico created a state utility, the Federal Electricity Commission (CFE) to generate, transmit and distribute electric power in areas not served by private utilities. Beginning in 1960, CFE purchased the shares of those private utilities and became the sole supplier of electric power in Mexico.
CFE owns most of the 34.8 gigawatts (GW) of electric generating capacity. Electricity demand is expected to grow at a 6 percent annual rate over the next 7 years.
CFE will not have the resources to supply the 13 GW of additional capacity required over the next 7 years.
Consistent with the Energy Chapter of the NAFTA, in 1992 Mexico changed its basic law on electricity to permit private investment in electric power generation in:
Independent Power Production (IPP)
Export and import of electricity
Work on the first IPP, the 450MW Merida III gas-fired power plant in the state of Yucatan began mid-1998 and should be completed by late 1999. The consortium building this plant consists of AES Corporation of Virginia, Nichimen of Japan, and Grupo Hermes of Mexico.
Four projects are currently being built on a 15-year Build-Lease-Transfer (BLT) basis.
Chihuahua – 450MW, gas and diesel
Rosarito III – 450 MW, gas
Monterrey – 450 MW, gas
Cerro Prieto IV – 100MW, geothermal
Also built on the BLT framework was the recently completed Samalayuca power plant, which will burn natural gas imported via a pipeline from the United States.
The consortium consisted of General Electric Power Systems, General Electric Capital Services, El Paso Energy Corporation, and Grupo ICA of Mexico.
The $647 million project was partly financed by loans from the Inter-American Development Bank and the U.S. Export-Import Bank.
This BLT framework, however, has not been popular with bidding companies and the number of bids kept decreasing. Mexico has gone back to the IPP concept that is more popular with power developers. There are currently four projects with ongoing bid solicitations:
Hermosillo, 225 MW
Rio Bravo, 450 MW
Saltillo, 225 MW
El Sauz, 450MW
with the expectation that at least four additional solicitations will commence shortly.
Electricity Trade between the United States and Mexico
The United States and Mexico have traded electricity since 1905, when privately owned utilities located in remote towns on both sides of the border helped meet one another’s electricity demand with a few interconnected low voltage lines. Electricity trade has been limited except between California and the Baja region in Mexico which are both part of the Western Systems Coordinating Council (WSSC). This is one of the regional reliability councils set up after the 1965 Blackout of much of the northeastern U.S. and Ontario, Canada. The alternating current (AC) electricity generation in a reliability council must be synchronized, and electricity passing between these synchronized areas needs to be converted to direct current (DC) and then converted back to AC, synchronized to the electricity in the importing region. The Electric Reliability Council of Texas (ERCOT) makes up another synchronized area and all of Mexico except Baja comprises a third synchronized area. Thus, expansion in cross-border trade between Texas and Arizona and the adjacent Mexican states will require a DC conversion facility or that one side of the border or the other join their neighbors synchronized area.
While Mexico was changing its electricity law in 1992 to be consistent with NAFTA, the U.S. Congress passed the Energy Policy Act, which contained provisions to encourage competition.
The U.S. had been operating under the 1935 Federal Power Act, which had created the Federal Power Commission (FPC).
Today, its successor, the Federal Energy Regulatory Commission (FERC) still regulates interstate electricity sales, and the Department of Energy issues permits to export electric power and to construct and operate international transmission lines.
FERC’s April 1996 Orders 888 and 889 opened much of the U.S. electricity transmission system to all wholesale buyers and sellers of electricity, thereby increasing competition in wholesale markets. While a new electricity reform bill has yet to pass the U.S. Congress, new power projects are rapidly being developed in the U.S.
There has been a remarkable technological revolution in electricity production over the past decade.
Standard designs have replaced the practice of engineering anew each power plant.
Technology in combined cycle gas fired plants has reduced the cost of generating electricity to a fraction of what it was a decade ago. While this leads to political fights over how to handle past investments which are now technologically obsolete (eg., nuclear power), it provides an exceptional opportunity for the U.S. to develop this low cost electricity in the competitive U.S. environment and export the electricity to Mexico.
Exporting significant quantities of new electricity to Mexico would require a significant investment in new transmission lines. Under existing Mexican regulations, these must be owned and operated by CFE. Since CFE does not have the resources to invest in these lines, an alternative, which permits private investment in transmission services, would need to be adopted.
OPPORTUNITIES FOR THE PRIVATE SECTOR – PETROCHEMICALS AND REFINING
In the downstream oil sector, Pemex maintains monopoly control over refining of crude oil and the production of eight basic petrochemicals (butane, carbon black feedstocks, ethane, heptane, hexane, naphtha, pentane, propane).
As a result of legal changes in 1996, up to 100 percent investment (domestic or foreign) is allowed in new non-basic petrochemical plants. Currently there are 85,000 workers in this secondary petrochemical industry.
Pemex Petrochemicals has plans to partially privatize 59 petrochemical plants at nine complexes in the country. It has reorganized itself into 7 independent subsidiaries and the Mexican Congress mandated that the government could sell up to 49 percent ownership of these subsidiaries.
In September, 1998, the government initiated the sale of the stock on one of these subsidiaries: PetroquR mica Morelos.
As with petrochemicals, Mexico’s domestic refineries are also in need of upgrading. In November 1997 Pemex signed a contract for a massive upgrade of its Cadereyta refinery with a Korean, German, and Mexican consortium. In November 1997, Pemex announced $3.5 billion in planned spending over three years to upgrade three other major refineries to help Mexico meet its demand for jet fuel, diesel, and gasoline with the possibility of eliminating imports of these products.
Under a $1 billion per year joint venture between Pemex and Shell Oil Co. of the United States, Mexico exports 135,000 barrels per day of heavy Mayan crude to the refinery in Deer Park, Texas, and in turn imports 45,000 barrels per day of gasoline.
COOPERATION BETWEEN THE UNITED STATES AND MEXICO ON ENERGY
In May 1996 the governments of the United States and Mexico signed an Agreement for Energy Cooperation in the development, application, and sustainable and improved use of renewable energy and energy efficiency technologies and fossil energy technologies. This agreement established a Working Group on Energy of the two governments.
In June 1998 the Working Group held its third meeting within the framework of the Mexico-U.S. Binational Commission. The delegations were led by Secretary Luis Tellez of Mexico’s Secretariat of Energy and Secretary Federico Peña of the U.S. Department of Energy.
In addition to signing annexes to the agreement on renewable energy and energy efficiency, the secretaries agreed that electricity market integration is an important component of sustainable energy development and that greater emphasis needs to be given to promoting electricity trade across our mutual borders.
CONCLUSIONS AND RECOMMENDATIONS
Mexico is blessed with abundant energy resources. Developing these resources for the benefit of the Mexican population requires extensive investment. There is recognition within Mexico that private investment to develop at least some of these resources is essential if energy is going to continue to play an important role in economic development within Mexico.
The U.S.-Mexico Chamber of Commerce recommends that the Mexican government continue to be aggressive in defining areas within the energy sector where private investment can play a role. The Chamber also strongly encourages both governments to actively follow up on the agreements of the two secretaries in June 1998 to develop ways to facilitate cross-border electricity trade.
-- October, 1998
The preceding paper is part of the United State-Mexico Chamber of Commerce's NAFTA Forum series, which considers general trade issues and sector-specific concerns between the two nations. The information contained herein is for informational and educational purposes only.
Albert C. Zapanta, President
John Harrington, Senior Economist and author of NAFTA Forum series
Jeff Sparshott, Director of Communications
United States-Mexico Chamber of Commerce
1300 Pennsylvania Avenue NW, Suite 270
Washington, DC 20004-3021
Tel: 202-371-8680 Fax: 202-371-8686
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