Documents on Mexican Politics.



por George Baker (

        Decisions will be taken within the next six months that will
determine the shape, direction and activity of Mexico's energy and
petrochemical industries for the rest of the decade.  Four decisions will
be made:

*Prospective investors in the chemicals business will decide if the current
balance of opportunity and risk justifies serious bidding on Pemex's
petrochemical plants and complexes which are scheduled to be auctioned off
in the coming year.

*Natural gas transportation and distribution companies will decide if the
regulations for natural gas--scheduled for release by November 11--will
provide enough protection against Pemex's overwhelming presence in Mexico's
industrial fuels market to justify an investment in pipelines or local

*Developers of private electric power plants (IPPs) will ask themselves
whether or not the same natural gas regulations, coupled with Pemex's new
interest in entering into long-term gas supply contracts, will
counterbalance the inherent investment risk of Mexico's uncertain electric
power market.

*Lenders, investors and developers will individually decide on acceptable
discount rates applicable to future earnings associated with prospective
investments or acquisitions.  These discount rates, in turn, will affect
both the bidding and the availability of off-balance-sheet financing.


        By early 1991 several important decisions had been reached in Pemex
regarding its mission and medium-term business strategy.   With McKinsey &
Company consultants as advisors, Pemex's decision was to concentrate
investments, staff and other corporate resources on its energy business
units (E&P, refining, gas and distribution). Pemex's non-energy business
units (e.g., lubricants and asphalt), termed "non-core" by the McKinsey
people, were to be down-graded in their ability to draw on corporate
financial and staffing recourses.

        The initial problem for Pemex was that neither its core nor its
non-core business units were set up as businesses; at the time they were
but large departments of an integrated, state-owned oil company.  But it
was only after the tragic explosions of a sewer line in downtown
Guadalajara in April of 1992 that Pemex's made its strategic thinking
public.  In July of that year the Mexican Congress reestablished Pemex as
an organization made up of a corporate staff and four operating units.  The
operating units were E&P, Refining, Gas and Gas Products,  and Chemicals.

        The new organizational chart for  of Pemex did not point to
management's strategy to concentrate future resources on its energy
business units.  During the period 1992-95 Pemex would aggressively seek
partners for some of its non-energy business units; for example, partners
from the private sector were found to take majority positions in the areas
of air transport unit, lubricants, and bunker fuel (Fig. 1).

        In addition, Pemex sought strategic partners in selected areas of
its energy businesses, principally the joint venture with Shell U.S.A. to
refurbish and upgrade its refinery in Deer Park.   With Shell as a partner,
Pemex was able to obtain off-balance-sheet financing for the first time in
its history--and possibly the first time for any Mexican company.  The
terms of the financing were favorable:  Shell gained a long-terms source of
crude supply from Mexico and Pemex gained badly needed coker capacity for
its heavy Maya-grade crude (provide citations to the OGJ articles that
discuss the Shell JV with Pemex).

        With Pemex established in operating units, and with the arrival of
the new Government of Dr. Ernesto Zedillo, it became possible to launch a
program to spin off Pemex's petrochemical units.  March 18, 1995, was the
kick-off date:  With President Zedillo and his principal cabinet ministers
present at the annual Expropriation Day ceremonies, Pemex CEO Adri=E1n Lajou=
set forth a frame of reference that justified the prompt sale of Pemex's
petrochemical plants.

        In April, with Pemex senior management intensely involved in
planning for the privatization of the petrochemical plants and in dealing
with prospective electric power investors who wanted long-term gas supply
contracts, the Government unexpectedly changed the rules in the areas of
natural gas transport and distribution.   At 6:00 p.m. on Friday, April
21--with Lajous in Houston--Energy Minister Ignacio Pichardo called a press
conference to announce that the Government had decided on a new policy that
would allow the private ownership and operation of greenfield natural gas
pipelines and storage and distribution systems.

        In July the Energy Regulatory Commission, an agency that reports to
the Energy Ministry and one which had been set up in 1993 to advise the
Ministry on electric power tariffs, held hearings with representatives from
companies from a half-dozen countries to learn their views on the
appropriate regulation of natural gas transport and distribution.  At these
hearings Pemex also presented its views.

        Meanwhile, in the area of private electric power generation,
despite nearly three years of having the principle of private investments
in electric power in force in Mexican legislation, there have been no
projects successfully negotiated.  The much-touted Carb=F3n II project in
Coahuila failed to get financing and the principal U.S. developer withdrew
in October 1993.  The long-delayed IPP at Salamayuca in Chihuahua
(nicknamed "Salamanunca"--literally, "Salama-never"--by persons close to
the project) is still awaiting closure and financing.

Petrochemical investments

        Lajous's plan called for the privatization of sixty-one Pemex
chemical plants located primarily in ten petrochemical complexes (see map
1).  The idea would be for Pemex to take a minority position in each plant
for several years, at least until labor conditions and contractual terms
had been stabilized to the satisfaction of the new investors, the
Government and the Union.

        The privatization initiative was immediately questioned, however,
by the head of the Oil Union, Carlos Deschamps, who, as the next speaker
after Lajous on March 18, stridently argued that the moment had come, not
to privatize Pemex's petrochemical plants but to rededicate the resources
of the State and the experience and commitment of Pemex's workforce toward
upgrading the technology, operating efficiencies and profits of the plants.
(In the succeeding months the Union's opposition to the privatization
measure would not subside but would grow to include full-page ads in the
Mexico City press as well as rallies in a number of the towns that make up
Mexico's Petrochemical Corridor in the States of Veracruz and Tabasco.)

        In the past, Pemex has had to negotiate with the Union in good
times and bad.  In January 1989 in a blitzkrieg against the Union's top
leaders the Mexican Government tried to break the Union's authoritarian
grip over workers and Pemex itself.  The government's measure only
partially succeeded, as Deschamps himself is someone who grew up in the
union ranks as one of the supporters of the Old Guard. Doubtless, in the
event that privatization of the plants takes place, the current Union
leadership would angle for a perpetuation of its exclusive negotiating role
with the new plant owners.

        Issues for prospective investors other than labor include feedstock
supply and pricing and environmental liabilities.

Natural Gas transportation and distribution

        The Republic of Mexico is made up of two natural gas production
areas:  the Southeast and the Northeast.  The former is predominantly
associated gas, the latter overwhelmingly dry, non-associated gas.  There
are two gas distribution systems, which are connected together by a 48"
line built in the time of the Oil Boom in the late 1970s; currently, this
line is only minimally in use.         There is no natural gas service at
all in the western and northwestern regions of Mexico.

        If all goes well, this situation will change in the next two years.
Since roughly 1980, the State of Baja California Norte has asked Mexico
City for natural gas service for its principal cities, Mexicali and
Tijuana.  City and state planners along with industrial park developers
have said that, until now, numerous international companies have chosen
Ciudad Ju=E1rez over Mexicali because the former has natural gas service.
"With natural gas service to the state, Baja California would gain in
investments, jobs, exports =0Cand environmental quality," they have argued.
With natural gas as a fuel supply, an expansion of electric power capacity
in Rosarito could take place free from the environmentally risky operation
of unloading fuel oil and diesel from barges coming from refineries in Long
Beach and South America.

        For ten years the answer in Mexico City to this request was
silence.  Since 1990 Pemex and the CFE have been carrying out feasibility
studies of Baja California as a market for natural gas.  With the coming
into office of President Zedillo, whose hometown is Mexicali, Baja
California is taking on new importance (despite it having voted for the PAN
in the recent gubernatorial elections).

        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 and SDG&E will be able
to build and operate natural gas pipelines in the State (see map 2);
moreover, natural gas may be imported and exported freely.
        The problem of financing the gas imports needed for Baja California
might be solved by a policy innovation that would bring in production
contractors with experience in South Texas to explore for and develop gas
would be exported to the United States and swapped for gas supplies to Baja
California.   In this way, indirectly, Baja California gas demand could be
satisfied with Mexican production.  In a swapping strategy the equivalent
number of jobs and backward and forward linkages stay in Mexico.
Otherwise, given a gas demand of something in the neighborhood of 250 MMcfd
(at $1.50/Mcf), the Mexican treasury is facing an import bill of some $400
million dollars a day for Baja California alone.

        The investment needed for this program could be carried out by
international companies in association with Mexican partners in the private
sector.  There are dozens of production companies (of all sizes) who might
be qualified from a technical and financial standpoint.  Compensation to
any combination of large and small contractors could be handled by the
concept of a sliding management fee for reservoir development (Baker,

        For all of these reasons and considerations, Baja California may be
a market for which private investments in natural gas infrastructure may be
easily workable.  For the rest of Mexico, however, the picture is much less

        In 1994, the Mexican Government conceived of a plan to have a major
upgrading of environmental standards for the year 1998.  The plan calls for
a sharp reduction in the production of heavy, high-sulfur fuel oil  (HSFO)
as well as a corresponding sharp increase in delivered natural gas supply
of 1.8 Billion cubic feet/day (Bcfd) by the year 2005.  A critical obstacle
presently blocking the outlook for a successful execution of this plan is
that Pemex produces some 400 Kb/d of heavy fuel oil that has no real
commercial market in Mexico or abroad.   While there are investment plans
in Mexico to reduce fuel oil production by adding processing upgrades to
its Cadereyta and Tula refineries, by the year 2000 Pemex will still be
producing over 300 Kb/d of heavy fuel oil.

        Each barrel of fuel oil has a heat content equivalent to some 6,000
cubic feet of gas; 400 Kb/d, therefore, is the natural gas equivalent of
some 2.4 Bcfd.  Said differently, Pemex's fuel oil production currently
displaces  2.4 Bcfd of natural gas from the energy markets of Mexico.  The
commonly heard observation that Mexico's natural gas production is "in
balance" is utterly fallacious, since whatever "balance" is obtained is
only the result of balancing fuel oil against natural gas, not natural gas
against raw energy demand.

        Thus, even if the World Bank were to grant Pemex funding to develop
another 1.8 Bcfd of natural gas supply from domestic production, there
would still be the unresolved problem of disposing the fuel oil produced by
refineries that were never designed to produce unleaded gasoline from heavy
Maya crude oil.

        This investment policy and market conundrum has important risk
implications for prospective investors in natural gas pipelines and
distribution systems in Mexico.  Pemex, because of its overwhelming
position in the industrial fuels market in Mexico (natural gas, fuel oil,
LPG and diesel) is in a position to under-price natural gas by giving
volume discounts to itself or others to consumers of alternative fuels.  As
long as Pemex is able to offer discount pricing anywhere along the gas
value chain, Pemex's competitors will find themselves disadvantaged in the

        There are several basic issues that have held up the consummation
of investments in private electric power generation, but probably the most
important one is the pricing of electricity.  Most developers will need to
have electricity rates in the area of 7-8=A2/Kwh to cover fuel and
operational costs, plus debt amortization and profit.  The State Electric
Power Utility (CFE), however, is more or less told by the Government to
sell electricity at subsidized rates.  Hurricane Roxanne provided a recent
example of the Government ordering the CFE to provide electricity at
discounted rates for those in the disaster area.

        The problem for the prospective developer is that, to obtain
funding, either Pemex must be willing to supply fuel on a retrospective,
netback basis, whereby Pemex takes the fuel risk indirectly associated with
the CFE's pricing of electricity for a given month, or the Government and
the CFE must be willing to benchmark electricity rates to a U.S. index (in
much the same way that Pemex is indexing Mexican gasoline prices to those
of U.S. markets).  Understandably, Pemex is not keen on the idea of
subsidizing the CFE, but neither does the Government want to guarantee any
form of a dollar-indexed price of electricity in Mexico.

Lender discount rates

        The problem for investors and lenders in relation to a given
project is to reach a consensus about how to understand Mexican risk.
Depending on the measure of risk, developers will want the period of
pay-back shortened, and lenders will want interest rates increased.
Mexican investors face an exchange-rate risk.  There seem to be two schools
of thought:  some see the combined Mexican risk as 100-200 basis points
above U.S. prime rates, while others evaluate the risk at 5-10 times that


        Regarding natural gas, the issue of exclusivity in the new gas
regulations will be easy to misunderstand.  it's not that a given gas
transporter or distributor should be given local exclusivity for five,
twelve or twenty years.  The issue is giving the private sector permanent
exclusivity over some segment of the gas value chain; for, only in this
way, can the market neutralize Pemex's ability to compete-by-volume

        For the foreseeable future it is not realistic for Pemex to
withdraw from interstate gas transportation.  In the first place, there is
no legislation authorizing Pemex to privatize its own pipelines.  Even if
there were such authority, however, the divestiture process would be
lengthy and the outcome uncertain.

        The only real option is for Pemex to withdraw from local gas
distribution, starting with its non-Pemex accounts.  Although there are
only a dozen gas LDCs in Mexico, Pemex operates virtual LDCs in some 50
cities; in these cities Pemex has a portfolio of industrial accounts.
These accounts should be spun off to gas LDC investors in a given
distribution franchise area.

        A second layer of protection needed by prospective gas LDC
investors concerns Pemex's ability to undercut gas markets with competitor
fuels, mainly fuel oil.  Pemex should be restricted from supplying fuel oil
within gas franchise areas except to customers who lack gas-burning
boilers, and then, prices should be equivalent (on a MMbtu basis) to
discourage switching to fuel oil.

        Regarding electric power market in Mexico, energy officials of the
government of former president Carlos Salinas estimated that by the year
2010 Mexico would need to double installed electric power, to some 54,000
MW, up from 27,000 MW.  Some 70% of this new capacity, they said, would
come from power plants financed and run by the private sector.  In this
way, energy infrastructure would keep up with expected population growth
and also stimulate economic development.  The total investment bill was
estimated at some $20 billion dollars.  That, subsequently, three years
have passed without completing any private investment in electric power is
cause of concern to everyone.

        Regarding the policy area of hydrocarbon exploration and
production, many U.S. and Canadian analysts believe that the linchpin of
energy policy in Mexico is to be found upstream.  While no one is proposing
that Pemex withdraw from E&P, many observers believe that Pemex is
unnecessarily restricting its ability to provide industrial fuels to
satisfy, not only end users, but investor middlemen (and their bankers) in
the areas of pipelines, distribution and power generation.

        There are energy policy implications for Mexico of the way natural
gas is produced in Texas: over 50% of gas production comes from independent
companies, most of whom are producing from fields that would be regarded as
noneconomic by Pemex or any other major oil company.  Given a transnational
resource base, the production pattern in South Texas can be expected to
repeat itself in Northeast Mexico.  The inference to be made is that Pemex
is probably leaving upwards of 1.0 Bcfd of gas in the ground that could be
produced by operators with lower overheads.  An additional 500 MMcfd or
more could be produced in abandoned or rapidly declining fields by major
companies who have developed specialized techniques for resuscitating
reservoir output.  Such new production from private contractors would
complement Pemex's production and provide a basement rock that would
support the emergence of competitive energy markets in Mexico.



Baker, George.

"Mexico's new energy leadership must push reforms to spur growth."  Oil &
Gas Journal (Tulsa), Jan. 16, 1995, pp. 20-22).

"Applying a virtual economy in Mexico's energy sector." Energy Studies
Review (McMaster University, Ontario, Canada), VI (3): 254-264. [1994a].

"Challenges in Petroleum Policy for the Next President of Mexico," Oil &
Gas Journal  Jan. 17, 1994, pp. 33 ff, [1994b]

"Mexico Must Emulate U.S., Canada gas rules to boost its gas industry," Oil
& Gas Journal (Tulsa) Oct. 24, 1994, pp. 30 ff. [1994c].

Canadian Energy Research Institute (CERI).
 1995   Toward a Continental Natural Gas Market:  The Integration of
Mexico.  Study No. 63.  Calgary.

Tel: 713-627-9390 Fax: 713-627-9391

George Baker