Given the high price environment for natural gas and the insistence of President Andrés Manuel López Obrador not to raise electricity prices, Mexico is likely to pay more than 73 billion pesos ($3.6 billion) in electricity subsidies this year, Oscar Ocampo, Coordinator for Energy at the Instituto Mexicano para la Competitividad (IMCO) told NGI’s Mexico GPI.
“If the fundamental source that is used to generate 60% of the country’s electricity generation becomes more expensive, obviously electricity generation is going to become more expensive as well,” Ocampo said.
Ocampo has been with IMCO since 2020, where he works on energy and foreign trade issues, especially those related to the implementation of the Mexico-United States-Canada Treaty.
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Prior to IMCO, Ocampo worked as an advisor to the independent directors of the Board of Directors of the Comisión Federal de Electricidad (CFE). Ocampo was also a public affairs consultant at De la Calle, Madrazo, Mancera, S.C., where he participated in the design and evaluation of public policies, regulation, legislative reforms, sectoral studies, international trade issues and the North American Free Trade Agreement, as well as in the review of international best practices for various industrial and service sectors.
Ocampo studied Political Science at Universität Hamburg and holds a Master’s degree in Public Policy from the London School of Economics and Political Science.
Editor’s Note: NGI’s Mexico Gas Price Index, a leader tracking Mexico natural gas market reform, offers the following question-and-answer (Q&A) column as part of a regular interview series with experts in the Mexican natural gas market. Ocampo is the 86th expert to participate in the series.
NGI: In some of your recent comments, you’ve discussed the impact of the electricity subsidies in Mexico and the impact high natural gas prices have on government finances. Can you explain how that dynamic works?
Ocampo: The presidential promise that López Obrador has repeated time and time again is that his government won’t increase electricity costs more than inflation. The national electricity rates that are regulated, which apply to about 97% of residential domestic consumption in Mexico, are subsidized. The domestic rate of high consumption isn’t more than 3% and in terms of homes, it’s not more than 1%. So, the large majority of electricity consumption in Mexico is subsidized.
So how does that subsidy work? At the end of the day, it’s a transfer that the Finance Ministry makes to the CFE. One of the changes of the energy reform of 2013-2014 was that they took away the ability of the CFE to make public policy. And the subsidy is a public policy that assures that the CFE doesn’t have to assume the cost of the subsidy. For that reason, year after year, the Finance Ministry makes a payment for CFE subsidies that is in the ballpark of around 70 billion pesos ($3.5 billion).
But, what happens when the natural gas prices see a substantial increase, as we’ve seen this year? Somebody has to assume that cost, right? CFE doesn’t have to cover it because it’s for natural gas, which is the primary fuel used for electricity generation in Mexico. That percentage changes some month by month, but natural gas is responsible for about 60% of the electricity generation in the country.
So, if the fundamental source that is used to generate 60% of the country’s electricity generation becomes more expensive, obviously electricity generation is going to become more expensive as well. And, given that the CFE can’t reflect that in the prices it charges consumers, somebody has to pay it and, in this case, that somebody is the Finance Ministry.
NGI: Approximately how much does the Finance Ministry pay to cover national electricity subsidies?
Ocampo: If we look at how much the CFE has budgeted for this year to cover subsidies, it’s 73 billion pesos ($3.6 billion). Last year it was 70 billion pesos and in 2020 as well. In 2018, it reached a bit more than 80 billion pesos. And, given the natural gas market conditions this year, it’s likely to exceed the budgeted amount, particularly with the president’s repeated promise to not increase consumer electricity prices more than inflation and, at the same time, not affect the financial health of the CFE. At the end of the day, the CFE is a company with finances that are relatively healthy and stable.
NGI: With natural gas prices so high and forecasts indicating they will remain that way throughout the year, do you think the electricity subsidies the Finance Ministry will have to pay exceed the 73 billion pesos budgeted?
Ocampo: Potentially, yes. The other option that you have is to compensate for the subsidies by increasing electricity prices that aren’t regulated, such as industrial electricity rates or commercial rates. But there’s of course a limit as to how much you can increase those. Or you could also increase prices in the wholesale electricity market, but that wouldn’t necessarily compensate for what is being subsidized for domestic consumer use for Mexican homes. So, it’s very probable that in the short term, there will be a deficit or a gap between what was budgeted for this year and the total cost of the subsidies for this year. And those will have to be covered by the finance ministry. They make these payments throughout the year.
NGI: In your opinion, are the increasing subsidy costs the finance ministry has to pay for electricity subsidies a consequence of Mexico’s dependence on the U.S. for natural gas?
Ocampo: To answer that, I wanted to share a figure that I think illustrates the impact of natural gas prices thus far in 2022. At the end of the first half of the year, through June, the CFE and Pemex had already paid 43 billion pesos to cover national domestic electricity subsidies, meaning for the second half of the year, they only have 30 billion pesos budgeted for that expense. The Russian invasion of Ukraine began in February and has continued, meaning that next year the budget for subsidies will likely need to be more, given that prices are considerably elevated in the current environment.
In regards to the relationship with Mexico’s imports of U.S. natural gas, I actually don’t see it as too much of a problem or causation for the elevated subsidies. We are located right next to the most competitive natural gas market in the world, and for Mexico, it’s a blessing to be located right next to Texas in terms of natural gas. And, in 2011, when the CFE began its ambitious plan to expand the network of natural gas pipelines, I think it was the correct decision, as it connected the local market to the U.S. market.
However, the problem isn’t the dependency on natural gas imports from the U.S. The problem is that Mexico has just one sole provider. This is fine in normal conditions and Mexico doesn’t run the risk of Texas just deciding to shut off the flow of natural gas. But what happens when conditions are abnormal, such as the storm in Texas last year? Gas prices proliferated and Mexico wasn’t and isn’t prepared for those abrupt changes in supply and demand, which, at the end of the day, is the definition of energy security — to be able to respond to unexpected circumstances and cover national energy demand regardless of the supply conditions.
And that’s where Mexico’s problem lies. And that problem is storage. Mexico doesn’t have sufficient storage terminals. It has three. In total, Mexico has 2.3 days of natural gas inventory in storage, while most countries in the OECD have no less than 30 or 40. So that’s really where I see Mexico’s primary issue in relation to natural gas. I see that as Mexico’s biggest risk in terms of energy security. You can depend on Texas all you want, but when there is an extraordinary event, Mexico needs storage to provide its own natural gas to meet national demand.
NGI: Changing gears a bit, what are your thoughts on the ongoing consultations between Mexico, the US and Canada regarding the United States-Mexico-Canada-Agreement, or USMCA, and what do you expect in the upcoming weeks, now that there is speculation López Obrador will comment on the situation Sept. 16?
Ocampo: The truth is I have an almost morbid curiosity about what is going to happen on Sept. 16. It’s interesting because the president is making these consultations part of the public discourse in Mexico, but in the U.S. it’s more a question of government policy. But now that the president of Mexico is making it part of his public discourse and will comment on the consultations with the backdrop of the national flag and in front of the army in the Zocalo in Mexico City, I think that runs the risk of making the consultations a public issue in the U.S., and that wouldn’t be a positive development for Mexico.
The truth is, these consultations informally began months ago. While the process formally began recently, these consultations about the energy industry have been going on for much longer than that, for example the four visits from U.S. Special Presidential Envoy for Climate John Kerry to Mexico in the past year, or the regular visits by U.S. Ambassador Ken Salazar to the National Palace, or the visit of the U.S. Energy Secretary Jennifer Granholm. It’s been a whole parade of visits, and it isn’t typical of the bilateral relationship between the two countries to see so many high ranking officials of the U.S. administration come to Mexico to discuss the energy industry. And, given that neither side arrived at any sort of agreement, the relationship became more complicated and thus the formal consultations began.
And now the consultations are a historic issue. Neither the injunctions issued regarding the USMCA nor the original treaty were resolved with these types of consultations, and never were there positions that were so opposing on each side of the debate, which is the case with the current Mexican energy policy. So, I think the probability that these consultations are brought before a panel are high, and I think the interesting question is to see how far the Mexican government is willing to go and exacerbate the situation to resolve this conflict.
NGI: Do you think there are available and viable channels available to solve the dispute?
Ocampo: I think there are clear ways to arrive at a middle ground. The U.S. and Canada are accusing Mexico of four main things.
The first is the reform to the Industrial Electricity Law (LIE), which I think might be the most complicated. What could happen is that the LIE, for practical purposes, is suspended and is left in a legal limbo, which is where it is currently. That seems likely to hold as there are lots of injunctions still under revision that are upholding the current suspension of the reform to the LIE. What the president could do is send a message to the judicial branch of the government to reaffirm its independence so that the courts respect it and don’t implement the law. It’s not the ideal scenario, but if the current limbo is maintained and companies can still operate, that might be acceptable in the consultations process.
The second topic of debate is that Mexico is being accused of not awarding permits, such as the import of fuels, storage, distribution, electricity generation, etc. That one is the easiest to resolve and could be done with just one phone call. If permits are allowed to be renewed and new ones are awarded, problem solved.
The third issue has to do with the extension that was given to Petróleos Mexicanos (Pemex) to comply with the norms included in Mexican law to lower the limits of sulfur content in diesel. The extension was awarded for five more years. This one is also easy to resolve. If Mexico is willing to cut the terms to two or three years or find a middle ground, the problem is solved.
And the last issue, which is also very easy to resolve, is the recent declaration by the Energy Ministry that attempts to mandate all private energy companies to buy natural gas directly from a state owned entity, CFE or Pemex. This has already been suspended in national courts for illegality, and if you just let it die, it incurs zero political cost.
So, I think there are very easy and accessible ways to reach the middle ground in these consultations and Mexico can save face instead of facing a panel that could easily rule against Mexico and weaken the stance of the government. There are still plenty of mechanisms available for Mexico to avoid the worst case scenario, which would be new and increased tariffs which could truly impact and damage the national economy. I think Mexico is going to do all that is possible to avoid that scenario.
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