Editor’s Note: NGI’s Mexico Gas Price Index, a leader tracking Mexico natural gas market reform, is offering the following column by Eduardo Prud’homme as part of a regular series on understanding this process.

Sistrangas

For most Mexicans, the word “gas” is not associated with natural gas, but with liquefied petroleum gas (LPG), a fuel used in about 75% of Mexican homes for cooking and heating. In one of the curiosities of the Mexican energy sector, LPG market private agents have participated in the distribution segment for a long time. Petróleos Mexicanos (Pemex) traditionally has had a monopoly on LPG production and import transactions, but the distribution of LPG has always been an activity carried out exclusively by private companies. Due to its social importance, it is also a segment that has constantly been subject to government intervention.

We are now seeing another wave of LPG market interference, and in this column I’ll explore the potential implications of this for the natural gas market.

In general, the aim of regulators has been that both natural gas and LPG operate with similar rules and with the same sector regulator in charge. Among the long-term objectives of energy sector players is the aspiration for natural gas to become the preferred energy source for urban households and for LPG to serve niche rural areas from the gas pipeline network. The role of the Comisión Regulardora de Energía (CRE) is to promote investment in infrastructure with predictable rules that allows for competition between both fuels.

Earlier this century the governments of Vicente Fox and Felipe Calderón imposed a continuous policy of price controls on LPG. Natural gas had a much lower price expressed in energy terms than LPG, but the final price paid for LPG substantially distorted relative prices so that this relationship was reversed. This harmed the development of natural gas. The natural gas network was underutilized and fixed costs had to be transferred to lower flows, which implied increasing rates. The limitations in supply and the lack of open access made it harder for gas to compete. One of the goals of the 2013-14 energy reform was to promote a market with greater competition and one that reflected the true cost of energy.

In January 2016, LPG imports that were previously limited to Pemex were made available to private distributors and other marketers. Anyone could purchase propane and butane directly in international markets. This meant no more intermediation on the part of the international commercial arm of Pemex. A year later, price caps were abolished in order to liberalize the price to final consumers. Regarding the wholesale market which Pemex still dominated, this necessarily meant re-linking the price of LPG to an international reference benchmark.

The liberalization of the LPG market was a desirable condition for the development of the natural gas market, particularly at the residential level. In 2011, the total number of natural gas residential users was around 2 million. In 2020, residential users exceeded 2.4 million. Although natural gas demand volumes mainly come from industrial users and power generation, it is possible to estimate that the daily consumption of natural gas in Mexican households is just over 100 MMcf/d. The room for growth is tremendous. Cities like Monterrey, Ciudad Juárez and Mexico City are the few cases with more than 100,000 users. Their success could be replicated in a country that has 35 major urban areas with more than half a million inhabitants in each.

The gas network in 2021 is infinitely superior than the one of 10 years ago, with more reliable supply thanks to the multiplicity of injection points and the presence of different marketers. The potential for natural gas as a domestic fuel is attractive especially given that it is a cleaner option to LPG and firewood. Rural Mexicans who use firewood for energy can migrate to LPG, and urban LPG users can switch to natural gas.

However, as one more example of the lag between President López Obrador’s energy policy and the legal framework of the energy sector, announcements in recent weeks could undermine this potential. Given the increases in the price of propane in international markets, LPG prices are up too, and so the president announced the creation of a new public company called Gas del Bienestar, or Gas for Wellbeing. Pemex will be in charge of the company and will distribute cylindrical LPG containers at prices below those offered by private distributors. CRE will impose a new price control scheme based on directives from the government. For the month of August, this new pricing scheme reduced the LPG price for Mexico City by approximately 25%.

CRE claims they are able to impose the pricing rule based on the small number of agents involved in LPG distribution and monopolistic tendencies. The competition watchdog Cofece has confirmed in several studies the existence of significant concentration levels in the most relevant sales areas. But the studies are not conclusive as to whether this concentration signifies collusive behavior that causes price increases. There is less evidence that rising prices are due to anti-competitive practices by distributors. The fact is 70% of LPG consumption originates from imports and international prices are up.

So far, the consequences of the LPG price controls for natural gas distributors and marketers are uncertain. On the one hand, they will certainly once again alter relative prices to the detriment of the competitiveness of natural gas. Convincing new customers to switch to gas now involves competing with a state company willing to sell LPG without an incentive to make money.

It’s also likely that the LPG sector will see shortages and a decrease in the quality of the service. In this regard, pipeline distributors of natural gas should be able to exhibit the benefits of reliability and the security of having fixed installations. Perhaps this is a good time to show that gas utility services are superior to LPG. Unfortunately, what we’re seeing is the power of political and arbitrary decisions to hamper the development of competitive industries. Regulatory risks are on the rise and López Obrador’s energy policies are a sword of Damocles to investment, a threat that impedes the growth and efficient development of the natural gas industry even as the industry itself is not being directly targeted.

Prud’homme was central to the development of Cenagas, the nation’s natural gas pipeline operator, an entity formed in 2015 as part of the energy reform process. He began his career at national oil company Petróleos Mexicanos (Pemex), worked for 14 years at the Energy Regulatory Commission (CRE), rising to be chief economist, and from July 2015 through February served as the ISO chief officer for Cenagas, where he oversaw the technical, commercial and economic management of the nascent Natural Gas Integrated System (Sistrangas). Based in Mexico City, he is the head of Mexico energy consultancy Gadex.

The opinions and positions expressed by Prud’homme do not necessarily reflect the views of NGI’s Mexico Gas Price Index.