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.
The opinions and positions expressed by Prud’homme do not necessarily reflect the views of NGI’s Mexico Gas Price Index.
In the midterm elections in June, Mexico President Andrés Manuel López Obrador lost ground in the lower house of Congress. It appeared that modifying the constitution was now out of reach. Not only did he lose support among voters, but up until that point his energy policy to protect the interests of the Comisión Federal de Electricidad (CFE) and his attempts to change the Electricity Industry Law had been shot down by the nation’s courts. But at the end of September, with the same obstinacy with which he sought the presidency of Mexico on three occasions, López Obrador went ahead and sent to Congress an initiative that seeks not only changes to the constitution to undo some of the structural changes of 2013 -2014, but also eliminates many of the private participation schemes established in 1992.
For the unlikely counter reform to pass, Lopez Obrador is already trying to persuade the opposition, in particular members of the Partido Revolucionario Institucional (PRI) party. He has said he will call out by name those who do not back the bill. The underlying threat is to open investigations into acts of corruption on the part of PRI congressmen when they headed state or municipal governments. The opposition is wavering. The fate of the energy sector lies with a weak opposition party that lacks ideological congruence.
Let’s be clear. The changes to the constitution that the government intends are radical. CFE would cease to be a company that operates in the electricity sector under the coordination of the power grid operator Centro Nacional de Control de Energía (CENACE). CFE would instead assume the total management of the electricity industry as a ministry would, so that its actions would be under the tutelage of the president. Each segment of the electricity supply chain would be deemed strategic, and therefore would be operated by the state. Vertical integration would be explicitly restored.
The midstream, downstream and electricity regulator Comisión Reguladora de Energía (CRE) would be abolished and with it all its powers to economically regulate the transmission, distribution, and basic supply of power. The principle of open access would have no purpose. CENACE would cease to be independent since its functions and powers would be integrated within CFE.
By law, CFE would have to generate at least 54% of the electrical energy that the country requires. The definition of these thresholds reveals one of the intentions of this counter reform: to limit private participation in the generation of electricity and to forcibly grant CFE market share.
In a drastic measure that specifically affects investors, the constitutional change proposes the cancellation of some electricity generation permits already granted. Private generation projects that were developed with the promotion of the state in the regime created in the 1990s would stop working, with substantial economic losses.
The companies that have plants in self-supply modes, many of them gas consumers, would no longer consume the electricity they produce or supply their partners who have legally contracted their services. Consequently, their own consumption would give way to supply through CFE under the contractual conditions and rates determined by it.
In the case of cogeneration projects, whose economic attractiveness lies in the joint optimization of the thermal and electrical resources necessary for their production processes, they would face legal restrictions to maintain their operating methods. The electrical energy they generate would no longer be a function of their production processes but of what CFE requires to satisfy the needs of market rules. A good fraction of this generation capacity has used natural gas for decades. Their dismantling will surely drastically change gas consumption patterns in the areas in which they operate.
Although the government’s discourse foresees that private electric power generation should be offered to CFE through a competition scheme for its dispatch based on lower total production costs, the proposed changes to the constitution say little about how this would work. In a hostile investment climate, with the consolidation of CFE as a monopsony leaving significant amounts of investments stranded, discouragement will prevail over appetite for risk. Financing for new generation capacity will not flow to the same degree that was plausible until today. The same will happen with new gas flows dedicated to the electricity sector.
Although CFE would be integrated as a single vertical and horizontal state agency, some of its subsidiaries, including CFEnergía and CFE Internacional, would prevail. In this sense, a strategic behavior is to be expected in the intermediation of natural gas as fuel for the remaining private generators. CFE would be the sole purchaser of energy; it would surely be the exclusive natural gas supplier to all the outside power plants that remain at its service. This could lead to better use of its gas purchase contracts and transportation capacity. CFE and the government would achieve enormous control over electricity costs, not to reduce them but to allocate them at will.
This would not be good news for gas marketers looking to serve new generation projects in a competitive environment. And even in a gas market with huge distortions derived from the commercial discretion that CFE would apply, competing to bring gas to non-electric users would be an almost impossible task. In a domino effect, the strengthening of CFE would bring comparative advantages to the state’s natural gas marketers: CFE Energía and Pemex.
Flows from Texas most likely would not be altered in the aggregate volume, but in the composition of the agents involved in the transactions. CFE Internacional would gradually consolidate its market power in gas imports. The tenuous visibility of the market that has been achieved in recent years would be lost so that the North American market sees in Mexico a great and monolithic client, without nuances and without great opportunities on Mexican soil.
In the medium and long term, the growth in consumption would be explained not by greater dynamism in demand but by a sharp drop in domestic natural gas production. Strangely, the reform that the government proposes also seeks to eliminate the Comisión Nacional de Hidrocarburos (CNH) even as its motivations lie in the electricity sector where CNH does not have any direct role.
With the disappearance of this upstream oil and gas regulator, the incentives to invest in oil and gas exploration and production will simply disappear. Few companies will have the mettle to undertake an upstream gas project when the fate of their project will depend on the Ministry of Energy (Sener) and, therefore, on the particular sympathy of the president.
In this scenario, there will be no more resources for natural gas extraction than those that can be dedicated within the weak public budget. Texas would become more important as the source that makes up for the drop in production that will surely persist. Gas producers will continue to have a market in the North American subcontinent and the marketer that will be in charge of taking their production to Mexican homes in multiple ways, to turn on their stoves or to produce electricity, will be the very powerful CFE.
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.
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