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.

Cenagas

Recently, officials at CFEnergía, the trading arm of Comisión Federal de Electricidad (CFE), announced plans to create a secondary market for natural gas transportation capacity in Mexico. Although this initiative will also include the resale of the molecule with delivery in the United States, it is the opening up of capacity in CFE-anchored gas pipelines south of the border that is most relevant for the participants in the gas industry in Mexico.

In general terms, a secondary market is a pipeline transportation capacity allocation mechanism that, if competitive, facilitates intermediation transactions among more participants. This increased activity fosters liquidity that serves as the basis for price and quantity risk mitigation mechanisms. In theory, users achieve benefits derived from efficiency and better conditions for continuity. But the simple appearance of a secondary market does not ensure the benefits described above. There are examples in experience in which the resale of a scarce asset, such as transport capacity on a specific route, can help a dominant seller to obtain extraordinary rents. Hoarding, obtaining privileged information and the lack of counterbalancing mechanisms can undermine an open market.

In the Mexican legal framework, users who have capacity reservation contracts and do not make them effective, must market them in secondary markets or make them available to the independent manager of the Sistrangas (Cenagas) or the carrier in charge of the gas pipeline. The law instructs that the availability of such capacity must be made public in an electronic bulletin so that it can be contracted. If the release of capacity were permanent, then what would be appropriate would be its reallocation in a general process, that is, an open season.

In 2016 and 2018, Mexico’s Comision Reguladora de Energia (CRE) issued guidelines for secondary market and capacity transfers. In these general provisions there is a fundamental understood value: any assignment of capacity will be considered an agreement of the wills of the assignor and the assignee. In other words, in these transactions there is no inherent market power and, therefore, it is not necessary to protect the acquirer with terms and conditions. In this sense, there is nothing that restricts CFE in its intention to resell its capacity.

The absence of open seasons since 2017 makes CFE’s announcement major news. CFE is the dominant player in the Mexican gas industry with massive transportation capacity in almost all existing gas pipelines in the country. At first glance the measure seems very sensible. CFE has stated that it is the holder of contracts for excessive capacity. A secondary market for such capacity is a mechanism that will reveal the real appetite for such unused capacity. CFE would ease its financial burden, the capacity it owns would function as a full asset, and brokerage opportunities would be open to many U.S. investors.

The key issue for the success of this market is to design capacity transfers with an adequate size and duration to favor the agreements. The terms and quantities must be attractive to the obvious capacity takers: retailers and large end users. The agreements are a balance of interests. Consequently, the central focus of the new market must be sensitive to the needs of CFE’s counterparties. On the one hand, natural gas traders, from Mexican or global brands, will look cautiously at the evolution of exchanges. If the implementation of this allocation mechanism gains a reputation for reliability, expediency and transparency, many clouds around the investment climate existing since December 2018 will dissipate. Its success will be linked to the perception that it is a medium- and long-term channel for the movement of gas produced in Texas.

The secondary market, however, does not necessarily provoke the same sense of jubilation in all the players in the industry. For carriers, and eventually distributors, dealing with more users, both familiar and newcomers, is not an easy task. For carriers, having a single client lowers transaction costs and despite some political hurdles, CFE’s financial credentials have provided serenity about meeting projected cash flows. When a pipeline has all its capacity subscribed with an anchor customer, a new user does not necessarily provide additional revenue. But the service obligation, with economic viability and technical feasibility, is part of the regulation to which it is subject. And this issue must be a consideration if one is seeking to place the capacity among new agents.

So far, the secondary market is only an announced intention. Details of its design and implementation plan are not public. What is pertinent is that the scope of the sale of capacity is as comprehensive as possible. The secondary market must function consistently with the regulatory mechanisms applicable to carriers. Before a massive assignment of capacity takes place, the CRE must review and monitor the way in which the gas pipelines consolidate information. The free and open flow of information as a requirement to develop a capacity market is the central premise that a modern sectoral regulator should embrace and promote. It is enough to navigate a few minutes on the electronic pages of private carriers to notice that there are numerous cases of non-compliance.

In many cases, pipeline company electronic bulletin boards are updated carelessly, with no intention of facilitating information collection and analysis, with no way to trace the past and, in specific cases, without complying with the correct regulation. Some companies that own open access transportation systems simply do not know what “open access” means, and others do not even bother to use an electronic bulletin board. Transparency must be the primary antidote to avoid discrimination and abuse of market power. Ideally, private information on pipelines should cease to exist by regulatory definition.

Transactions must occur on a trading platform available to everyone, with predetermined and auditable algorithms. Agents interested in exchanging capacity should do so with the same information available to everyone. In this sense, it is desirable that the secondary market platform be sponsored by the operator of the gas pipelines in which CFE serves as primary market anchor. To foster a liquid market, electronic bulletins should be the effective means of dissemination of all information regarding transportation routes and amounts.

But transparency is not a natural aspiration of companies. CFE’s good intentions must be accompanied by regulatory actions and public policies aimed at establishing an even floor for all participants. The CRE must work on disseminating more and better information and must develop dissuasive mechanisms for market manipulation.

Again, the news is positive. A secondary market initiative from CFE implies an acceptance that the presence of private companies in the energy sector is part of a healthy industry. If successful, the relief in the payment of obligations will be positive for public finances. If CFE’s intentions are materialized with the transfer of logistics costs to intermediary agents, they will have all the incentives to optimize the use of the infrastructure, which will encourage an expansion of the user base. The appearance of a secondary market, with all its imperfections, will cause more actors to want to get involved in intermediation and will demand more and better information. Transparency in the energy sector will have more chances of being understood as an aspect of public interest and value for the welfare of Mexican society.

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.