Co-authored by: Emilio Estrada V., Hydrocarbons Consultant
Originally published in PETRÓLEO Y ENERGÍA magazine (December/January edition)
Notwithstanding international and domestic adversities (ups and downs of prices for crude oil, peso-dollar parity, a not so-friendly neighbor president), the energy reform, perhaps the most daring of those undertaken by President Peña, offers yet a lot to reap from. So far, we have harvested a dubious reduction in the price of liquefied petroleum gas. The global eyes of the world's Energy sector look expectantly towards our country.
The other vein of the reform, the electric industry one, seems to have experienced better luck; at least up to now. That is not precisely because of the questionable reduction in domestic service rates—the preserve of the formerly State-run Federal Electricity Commission ("CFE"). Rather, such high morals are due to the success of the first two long-term electric auctions—held in last March and September—, in which power generators tried to outbid each other in selling the most affordable, renewable-sourced, energy to the Wholesale Power Market, thus accelerating the development of renewable technologies, and giving a mouthful of hopes to honor our bold national environment-oriented commitments (just around the corner: due on 2024), the generation of clean energy vis-á-vis the abatement of the polluting carbon footprint.
Be that as it may, perhaps the highest expectations are in the deregulation of the exploration and production of hydrocarbons ("E&P"). Such legislative paradigm shift has surely laid the foundations for a competitive and efficient industry, with the national oil company, Pemex, ridded to a large extent of a lumbering bureaucratic regime, which strangled it for decades. Indeed now, not only Pemex but also CFE boast the appropriate regulatory framework to become the State-owned subsidiaries that their new constitutional legal nature establishes: State-owned productive companies.
Within the hydrocarbons sector there is an important segment that seems to require punctual attention of the legislative, or perhaps that of the Coordination Council of the Energy Sector. The level of benefits that Mexicans expect from the energy sector as a whole could be leveled out resultingly, i.e. the refining, distribution and retailing of fuel (and the various commercial activities that enrich its supply)—namely, Downstream.
Summary of the current situation
The situation is rather complicated.
Current fuel shortage in a number of States makes it all the more pressing.
Pemex refineries operate at a production level well below its break-even point; its primary distribution logistic system is insufficient, saturated and suffers serious lack of maintenance. With regards to certain operational and safety issues, some criminal groups have managed to institutionalize its modus operandi of milking pipelines, causing unbearable losses for a so-called productive company which intends to increase the petroleum revenue.
The hydrocarbon shortage, therefore, is pandemic and its mitigation would go pyrrhic, by incurring in extremely high costs. No wonder the level of importation of products has reached record levels, which would have been unimaginable a few months ago. It should come as no surprise the import terminals are overdriven from having to handle such high volumes.
Behold the deadlock: current fuel prices do not cover Pemex's opex and discourages capex to build new strategic logistics projects, be it by the private sector or Pemex. One can only hope that oil prices keep on recovering to a competitive unhampered market price level.
In a nutshell, Downstream is not bearing the fruit harvested in other segments of the sector. So much it could even appear to be in a lower state than it was before the reform, if looked at shallowly. This is due to the Downstream being the touchstone, the efficiency index of the energy reform; whence the average citizen appreciates its progress and benefits. There is surely a lot progress to accomplish, along with the incumbent political cost to pay by the current administration; not only because of certain unfulfilled expectations, but also for the impression of a sectorial relapse.
Far from attempting an exhaustive diagnosis, there nevertheless are several circumstantial causes that can be pinpointed, other than the usual historical ones that provoked the current situation of Pemex, and which to a large extent motivated the constitutional reform itself.
The Downstream industry is complex. It involves more factors than in an ordinary business plexus; namely, different types of products are distributed: there is a great variety of assets: terminals, interdependent pipelines...; the refineries have asynchronous maintenance cycles vis-á-vis relevant demand curves; often unit failures affect system supply. Last but not least, there are only eleven thousand service stations, grosso modo, for two million square kilometers of territory and 130 million inhabitants; let alone they are supplied by means of a fleet of tanker trucks, which have their own difficulties.
One or two ad hoc bodies that manage the entire incumbent production chain regulate several energy subsectors. Such are the cases for electricity or natural gas. The same is true with Upstream, which is also managed in a comprehensive way. This is not the case for Downstream, whose regulation is dismembered between several entities: SENER, CRE, COFECE... That hinders the coordination between regulators and Pemex. And as it happens with the so-called tragedy of the Commons, while belonging to everyone, it belongs to nobody...
Cats may be felines, but not all felines are pets.
The fact that the gas companies and participants of the Wholesale Electricity Market belong to the energy sector does not mean that the same scheme of deregulation should also work for those of the Downstream segment. That would be a truism if it were not for the Open Season announcement with regards to Pemex' Logistics Assets.
It is very difficult for a system as complex and overdriven as that of the primary logistics of Pemex to operate overburdened with a large number of independent operators. These operators would be reserving capacities in the different parts of the system and introducing products through the importation terminals.
The system is in need of an exclusive technical operator which currently cannot be anyone else but Pemex itself; and of powerful computer systems to manage inputs, outputs, nomination rules, operation, conflict resolution, priorities, among others.
Bottom-line, the situation calls for an independent entity to handle all these processes on the basis of public transparent both transmission and storage rates.
Another important factor for an Open Season to be successful is that there be different operators in the market to serve clients not supplied by Pemex. Currently, Pemex is supplying nearly the entire market. It goes without saying, a company, before opting to reserve logistical capacity, needs clients or a market to supply.
Hopefully, that will happen in the near future.
One of the most noticeable causes is that Pemex has not defined its strategy for Downstream. Hopefully, from the dawn of the discussion of the Reform, Pemex had outlined a strategy: a comprehensive one including refining and primary distribution (Midstream), as well as retailing (Service stations and other points of sale); and that it had defined in which parts of the value chain and in which ways it would participate.
Nowadays, the operators in the market barely know what Pemex wants to do with its refineries; they also scarcely know the company's plans regarding their logistics assets, and are unaware of how and where they want to participate in the retailing market —service station business owned by franchisees or permit holders whose commercialization of the return on hydrocarbon goods and services represents a significant percentage of their income.
The CRE has taken the initiative by advancing deadlines, declaring Open Seasons and taking another series of measures to accelerate reform in the Downstream, let alone the announcement that the country is opening the retail market to private participation nine months beforehand. Unfortunately, these efforts could turn out to be ineffective should Pemex be not clear about its plans and objectives, and should the regulation be not coordinated with the tasks Pemex has to perform to make it possible. Without Pemex working in the same direction, regulation, no matter how well conceived, will hardly suffice.
The presidential term is coming to an end and more sustainable results are yet to be seen. For the most part, the people is still expecting more tangible fruits of the Reform, other than politically-costly increases in the price of gasoline ... It should then not come as surprise that some political actors are wagging a counter-reform as an electoral slogan. Worst, it would not be all that populist a measure should by virtue of a poor regulatory design, the system were to demise.
In the face of this challenging outlook, the next ones are a few feasible solutions.
When it comes to bureaucracy, there is no doubt that the Principle of Subsidiarity must be applied: "as little as possible, as much as necessary".
Under this premise, the recommendation is to create an autonomous regulatory body, such as CENAGAS for the gas industry and CENACE for Electricity.
The ideal situation would be a team (a coordinated body from the sector) made up of Pemex, the CRE, COFECE, and chaired by SENER's Undersecretary of Hydrocarbons. Such a team would synergize a peripheral vision —the big picture, as it were—, with the data to be reconciled, the course to follow, the goal to arrive at, and the authority to execute.
A clear mandate, binding on Pemex's directors and advisers, must emerge from this coordinated body; to guide Pemex's Downstream business strategy in the long term and to face crises like the present one, while keeping the constitutional imperatives of the Reform.
With its peripheral vision, and its ability to reconcile agendas, this new body could establish a schedule of Reforms that finally keep in step with the rhythms of Pemex and those imposed by the market.
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There are still 16 months left in this presidential term, which seems to be sufficient time to impose order in this segment of the sector and to abundantly perceive the results that all Mexicans had in mind when this bold energy reform was approved.
Hopefully these lines shall serve to urge the authorities not to pass up this opportunity presented to us on a silver platter.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official opinion, position or institutional view of Rodríguez Dávalos Abogados.