APLA: Mexico opens up its energy sector

Mexico’s reform of its energy sector is now under way but there is a long way to go before the petrochemical sector gets access to more of its own indigenous feedstocks

For 75 years, Mexico has restricted energy production to the state energy producer Pemex. It took less than a year to end that monopoly.

Earlier this year, President Enrique Pena Nieto signed the secondary legislation to the energy reforms he proposed in August 2013. With his signature, the reforms went into effect and companies other than Pemex can now produce oil, natural gas and natural gas liquids (NGLs) in the country.

Despite their adoption, it is still too soon to measure how successful the reforms will be. The country has not even issued the first tender. Moreover, the country’s bidding process may not capture the full value of energy production, says George Baker, the editor of Mexico Energy Intelligence at the website energia.com.

Oil is not the only valuable item that comes out of the ground. The data produced by exploratory wells also holds tremendous value, Baker says. In the past, Mexico has awarded contracts to the lowest price bidder, and Baker warns that this practice could prevent the country from getting the full value out of a well. For Mexico’s petrochemical industry, the recent energy reforms are crucial because the country has had a long and persistent petrochemical deficit. From January through July 2014, the nation’s petrochemical deficit totalled $5.24bn, up from $5.04bn in 2013 and $4.81bn in 2012, according to Inegi, the Mexican statistical agency. This deficit will be alleviated somewhat by Ethylene XXI, the 1.05m tonne/year polyethylene (PE) complex being built by the Braskem Idesa joint venture in Mexico (see page 18). However, even with this complex’s start-up in 2015, Mexico will still have a deficit in PE.

MORE ETHANE NEEDED
Moreover, the cracker at Ethylene XXI will be the last new one that Mexico can supply with domestic ethane. After Ethylene XXI, Mexico will only have enough ethane to add up to 300,000 tonnes/year of new ethylene capacity at its existing crackers.

With the energy reforms, companies other than Pemex can now build natural gas processing plants and fractionators. These new units could produce enough ethane for a new cracker in Mexico.

“For a number of reasons, these reforms were long overdue,” argues Jose Valera, a partner at the law firm Mayer Brown. He made his comments earlier this year after Pena Nieto signed the secondary laws. “The amount of investment that should be coming into Mexico as a result of this is going to be very large.”

Early this year, Jose Simancas, general director of Alpek, said Mexico’s energy reform could lay the foundation for a shale-gas renaissance similar to that in the US.

These new projects, though, may not happen immediately. The necessary NGLs will likely come from natural gas production. Because Mexico is so close to the US, it will be easier for the country to import gas from its northern neighbour than to drill new domestic wells.

“There is such an excess of US gas,” says John Price, managing director of Americas Market Intelligence, a market-research firm that studies demand and the competitive environment of Latin American business. “It is so cheap, it’s probably just easier to pipe it in.”

RESERVES WILL ATTRACT ATTENTION
Longer term, companies may develop Mexico’s fields once US prices rise. In addition to higher prices, the size of Mexico’s reserves could also attract companies.

Mexico is estimated to have 545 trillion cubic feet of technically recoverable shale gas, the sixth largest in the world, according to the US Energy Information Administration (EIA).

Mexico’s own forecasts predict that natural gas production could reach 8 billion cubic feet/day (8bcf/day) in 2018, up from 6.37bcf/day in 2013. By 2025, it could reach 10bcf/day.

While US gas imports could delay production in Mexico, they should provide a quick benefit to the country’s power industry, which was also a target of the recent reforms. The current transmission and generation system is 
inadequate and many plants burn expensive oil-derived fuels, Valera says. As it is, Mexico’s industry is subject to power rationing.

The system also comes at a cost. Mexican industry pays up to 80% more for electricity than its peers in the US, says Price. This is a burden on the country’s large manufacturing base and its petrochemical industry.

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The reforms should have an immediate and powerful effect on the country by encouraging the construction of gas-fired plants in the northern part of Mexico, Price adds. These will be tied in to US gas, giving Mexican manufacturers access to some of the world’s cheapest natural gas. By the end of 2016, the Mexican premium on electricity should fall to 40%, Price believes.

The reforms will also make important changes to Mexico’s refining industry − although these new rules will play out over several years. Mexican refineries are unable to produce enough gasoline to meet domestic demand, and imports satisfy about 50% of the nation’s consumption.

In 2016, Mexico will allow retailers other than Pemex to sell gasoline and diesel, says Jorge Castilla, energy leader at Deloitte Consulting Mexico. He made his comments during an interview earlier this year. Currently, only Pemex, the state-owned producer, is allowed to sell fuel. In 2018, fuel retailers can purchase fuel from suppliers other than Pemex, Castilla says. This will open up Mexico’s fuel market and put an end to the government setting prices on fuel.

PETROCHEMICAL FEEDSTOCKS
By 2019, fuel prices in Mexico should be set by the market, he says. Market pricing should raise confidence and encourage investments in Mexico’s refining industry. These investments could increase supplies of petrochemical feedstocks, since catalytic reformers produce benzene, toluene and xylenes (BTX) and fluid catalytic crackers (FCCs) produce propylene.

Looking ahead, Castilla says Pemex may divest some of its refining assets. It may also establish joint ventures.

The most significant parts of the reforms target Mexico’s oil production, which has been sagging for years. It has fallen by about 25% since reaching a 2004 peak of 3.48m bbl/day.

Mexico has already completed the so-called round zero of the reforms, which assigned reserves to Pemex. Pemex may choose to develop these reserves by itself, through joint ventures or sell them to other producers.

The first round will start in the first quarter of 2015, and it could well indicate whether the reforms will be successful.

There are growing expectations that five or six Mexican industrial groups will successfully negotiate for a prime position to obtain the best fields that will be coming up for bid, Price says. He notes that there is still a lot of political pressure to make sure Mexico’s deep-water fields remain in Mexican hands.

FOREIGN PARTNERSHIPS
Price envisions that Mexican companies may establish partnerships with foreign companies possessing the know-how to develop these technical fields. Under this arrangement, the Mexican companies will contribute their knowledge of the country’s regulations and its political landscape.

While the reforms have received much praise from industry watchers, they could still fall short of their potential. Other factors could prevent Mexico from reaping the full benefits of its reforms, Baker warns.

Like all parts of the world, Mexico does not want government officials to award contracts based on kickbacks or other unsavoury practices, Baker says. As a result, it has adopted rules intended to discourage questionable contract awards.

However, the rules have also fostered a culture of self-defence among government officials, he said. To eliminate any suspicions of impropriety, they now tend to award contracts to the lowest-price bid. “The lowest price is always the best,” according to Baker.

That model will not work to maximise the benefits for both the bidder and the country, Baker says. “There are lots of other things you can consider. Not all of them can be easily quantified.” For example, wells produce an incredible wealth of information, Baker says.

With enough information, companies could determine the boundaries of an ancient coastline − and realise that subsequent wells will hit oil, he says. “That is an example of how data points can change the oil narrative of a region.”

Of course, those data points may not point to oil, but to other minerals or perhaps a large 
aquifer. In fact, the oil industry likes to say that there is no such thing as a failed well.

However, unless those extra benefits are recognised, they may become neglected during the bidding process. “There are all kinds of reasons the country wants to get data from drillers, independent of whether they get oil,” Baker says. The goal of the bidding process should not be to get the lowest price but the highest value, he adds.

Pitfalls aside, the reforms are still expected to increase oil production in the upcoming years. Long-term, production could increase by 75%, reaching 2.9m bbl/day through 2020, according to the US EIA. It could then rise to 3.7m bbl/day by 2040.