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The recent appointment of two officials from Mexico's federal Finance Ministry to lead the country's two state-owned energy monopolies is an unmistakable sign that the Government is worried about the financial health of the energy sector.
A quick survey Mexico's energy landscape shows several areas for concern: one is the lack of private investment in electric power generation, a second area is the lack of regulations for natural gas transmission and distribution, a third area is the issue of natural gas supply itself.
One of the accomplishments of the Energy Ministry under outgoing Lic. Emilio Lozoya was the development of a visionary ten-year plan for supplying Mexico's growing electric power needs. The idea was to invite private capital, Mexican and foreign, to invest in electric power facilities. Toward the end of increasing installed capacity in the next ten years to something in the area of 50 GW, from a current level of roughly 28 GW, the Lozoya team visualized major investments by independent power producers (IPPs). One white paper anticipated that perhaps as much as 80% of future electric power capacity could come from privately built and financed electric power stations. Toward this end the federal law governing electricity was modified in late December 1992 to allow for private investment, and a new set of regulations for electricity were issued on May 31, 1993.
At this point, to judge from results to date, the vision died: In July of that year the International Finance Corporation (IFC) of the World Bank withdrew its backing of a proposed electric plant known as -Carbon II in the border state of Coahuila. In reaching this decision, the IFC was responding to a controversy over the perceived environmental threat posed by the plant, which would burn high-ash coal. As neither the project sponsors nor the Mexican Government were willing to fund the $300 million for emission scrubbers, the project also was dropped by the normal commercial lenders who, otherwise, would have provided stand-alone project financing. This unexpected turn in the outlook for financing sent the project sponsors scurrying to the bond market, but the idea did not prosper, and by October the American sponsors announced their total withdrawal from the project.
A second project that appears headed toward a similar fate is a proposed natural gas-fired electric plant near Merida, on the Yucatan peninsula. Initially, thirty companies were interested enough to pay $10,000 for the construction bid package. Some of these companies have submitted bids, which are to be opened and evaluated in January.
Yet, unless there is a major shake-up in policy, such bids, even if awarded, will likely not receive funding for construction. Why?
The proposed electric plant is some 600 kilometers from the nearest source of natural gas. Since early 1993 there have been discussions followed by debate and then acrimony between Pemex and the Federal Power Utility (CFE) over who would finance and build the gas pipeline to supply the plant, known as Merida III.
Even if the pipeline were to be built, prospective lenders and developers have two other awkward questions about managing risk. One question concerns the mechanisms to be used to adjust future prices and tariffs of natural gas, gas pipeline transmission and electricity. In the United States and Canada questions of price are answered by the marketplace of multiple gas suppliers and transmission options. Tariffs are set 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. market prices, to which are added transportation costs. In a recent break with policy, however, Pemex has announced a 20% increase in petroleum prices for Monterrey industrial plants, which account for most of the industrial natural gas demand in the entire 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 NAFTA, such contracts have yet to be tested commercially or in court.
Which raises the second question: Can investors trust the Mexican court system, where ambiguity and unpredictability undermine expectations of equity by Mexican and international companies? Here there are two matters: the Mexican courts have never decided issues Pemex liability to either the CFE or IPPs for costs associated with problems of fuel supply; but, 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.
The third area of concern in energy policy is natural gas supply itself. 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 Texas, New Mexico 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 that of 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 expensive 3-D seismic evaluations.
Pemex, which is essentially a southeastern oil producer, is under pressure to maintain oil production to keep foreign exchange from export revenues steady. Pemex has little interest, therefore, in undertaking gas pipeline projects in the Yucatan, Sonora, Baja California or anywhere else that are unconnected with oil production, refining or the distribution of refined petroleum products. Spending capital budgets on risky natural gas plays in the northeast does not tap into Pemex's core interests or abilities.
Prospective investments in private electric 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 also because they lack of peace of mind about Pemex's commitment to the production, supply, transmission and fair pricing of natural gas. Such doubts, in turn, reflect a situation long-observed by prospective lenders and investors, namely, that managers in Pemex and the 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.
All of this points back to the recent appointment of two capable career public officials to head the major two energy agencies in Mexico, Carlos Ruis Sacristan in Pemex and Rogelio Gasca Neri in the CFE. Their challenge of crafting an integrated approach to electric 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 each other in relation to issues of energy policy.
Financing will be a central dilemma: Pemex wants to apply marginal investment dollars to oil production first, refining second. Natural gas supply and distribution have never had a high priority in Pemex. The CFE wants to keep its monopoly on electric power distribution, and often gives the impression of being impatient toward the folded arms and what-if questions of prospective lenders and developers.
For six years, the Salinas Administration, which just ended, staked out the energy sector with signs that read "No Trespassing." Prospective investors and lenders were struck by how Salinas's economic modernization programs systematically overlooked the opportunities for energy-sector gains in production, efficiency, environmental protection and tax revenue that the option of private investment in the oil, gas and electric power offered. For all the talk of reform and modernization, six years passed without a single major private investment in any area of the petroleum or electric power industries.
Business as usual in energy policy in Mexico can only be expected to spur lenders and investors to look elsewhere around the world. Massive investment opportunities in Asia and elsewhere in Latin America beckon. The costs to Mexico and the U.S.-Mexico border region of not crafting a workable energy policy will be high, and will be measured in missed opportunities for economic development, employment and environmental protection. So the new Government is right to be worried, and it will take courage and an informed vision to make the immediate future turn out better than the recent past.
George Baker directs Mexico Energy Intelligence, a subscription service based in Oakland, California.
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