Mexico's CRE approves natural gas price liberalisation from July

16 June 2017 00:18 Source:ICIS

Mexican natural gas prices will be fully liberalised from 1 July onwards following the decision by national energy regulator CRE to remove the maximum price cap for the VPM formula used to regulate the cost state oil company Pemex can charge customers per molecule.

A resolution approved by CRE’s governing body of seven commissioners on 15 June will coincide the removal of the maximum VPM price cap with the launch of Mexico’s new natural gas market.

VPM has been used to regulate the cost of natural gas during the first sale of gas within Mexico, such as at Pemex processing facilities or at the points of injection into Mexico from the US. The legislation, a draft version of which was published on the website of Mexico’s regulatory reform agency COFEMER on 13 June, allows Pemex to revert to market-based pricing for all its supply contracts.

For the sake of legacy contracts, VPM will continue to exist as the price of Pemex’s first sale in Mexico. The price will, however, no longer be regulated by CRE.

Market sources have suggested that Pemex’s initial offers to clients across most of Mexico will now default to the $0.25/MMBtu premium on the US Henry Hub benchmark offered by Pemex to clients selected in the first round of the company’s contract release programme.

Relaxation

Until now, two VPM prices have been published: Reynosa, which covers the north of the country and is based on imports as the expected source of the gas; and Ciudad Pemex, which covers gas injected into the system from domestic production sites in the south of the country.

The relaxation of VPM in the north of the country this year had been suggested by blueprints for the development of Mexico’s natural gas market published in 2016 by CRE and Mexico’s energy ministry SENER.

However, a perceived lack of competition to state oil and gas company Pemex as a supplier to the south of the county had led regulators to propose postponing the removal of VPM Ciudad Pemex until 2018 at the earliest.

This move has now been accelerated in the belief that market-based pricing will boost domestic gas production in the south of the country.

Output nationally has declined by over 1.3 billion cubic feet – 37 million cubic meters- per day between 2009-2016. Production over the first quarter of this year was 12% below that of the year-ago quarter, and sources warn that further declines are expected through coming years.

VPM has been cited by many sources as a reason for this decline, as the formula does not provide financial incentives for Pemex to invest in new output. Pemex has also complained that the use of VPM has made the import of the fuel from the US uneconomic.

With the opening up of Mexico’s natural gas market through the open season for capacity in the national Sistrangas transmission grid, which concluded in May, and an imminent second auction for capacity in US pipelines delivering gas into Mexico, CRE believes sufficient competition exists in the market for VPM to be removed.

Sources suggest that up to 16 new natural gas producers awarded assets through the first two rounds of Mexico’s upstream licensing programme are in a position to offer domestic supply to the market, and could thus provide competition to Pemex as a supply source.

At least nine of these companies are located in the south of the country. One of these suppliers has already offered the delivery of gas to the market from August onwards, a source said.

Reaction

In the aftermath of the announcement, market participants were divided on whether the removal would be beneficial.

While many agreed that the move could stimulate domestic production, one source said that the move might make it more difficult for new companies arriving in Mexico to take market share away from Pemex.

Most sources have suggested that ongoing supply shortages in the south of the country would see prices in that region become the premium for the market. One source suggested that these premiums could amount to several dollars when compared to the rest of the country.

Demand in the region comes mainly from power generators, which are forced to switch to expensive liquid fuels such as diesel in the absence of natural gas.

Diesel was consumed by generators in the south at an average cost of $7.90/MMBtu over 2016, according to CRE estimates. This compares to the 2016 average Henry Hub spot price of $2.53/MMBtu, according to the estimates of the US Energy Information Administration (EIA). james.fowler@icis.com

By James Fowler