A period of adjustment

EY’s Mexico branch has 150 employees who dedicate 80% of their focus to the energy industry. The company has doubled the size of its local practice since the start of 2016. EY has been building a team with expertise on Mexico’s changing regulatory and economic landscape to better help its clients operate in the local environment. The firm has done this by emphasising the creation of multidisciplinary teams concentrating on different sectors of the energy value chain, from upstream to downstream, and by acquiring policy knowledge in key areas such as environmental regulation.

• On changes in the gas market: “Companies are used to simply receiving and paying for natural gas. They’ve never made a long-term commitment to anything or understood the difference in pricing of guaranteed supply versus a supply dependent on whether or not there is enough natural gas. You have to understand that if you want to be sure you will have natural gas for your processes, that will be costlier than the alternative. You’ll have to evaluate the economics of your own factory and how valuable it is for you to always be sure that you have natural gas.”

• On the reformed power sector: “On the supply side, a lot of traders and suppliers will start fighting for the electricity services market. Not everything is about who will provide the cheapest electricity, but also who has the best plan for a sustainable supply of electricity with the required quality and characteristics. Now, they have to think of risks, rewards, long- and short-term objectives and clean energy certificates. The environment is getting more complicated and companies will have to learn.”

Alvarez also discussed developments in the retail sector and the way Mexico’s NOC Pemex is addressing the challenges it faces in the downstream sector. Most TOGY interviews are published exclusively on our business intelligence platform TOGYiN, but you can find the full interview with Alfredo Alvarez below.

What were the main events in Mexico’s upstream sector over the past 12 months?
The past year was a year of definition. Upstream continued to show a positive outlook, with a fantastic result for the Trion oilfield, which is going to be developed as a joint venture between Pemex and BHP Billiton. This was followed by a spectacular round of bids in which 80% of the deepwater areas were awarded in December 2016 with significant commitments to exploration.
It was also a tough year filled with discussions with authorities about the terms and conditions of how these bidding procedures were going to take place. Still, there was major support from the industry. For Trion, both bidders – BP and BHP – offered to absorb as carry nearly the first USD 2 billion invested in the field. After that, each party will start [making] their additional investment, divided 60/40.

What developments are taking shape in other sectors of the oil and gas industry?
The petrol and diesel market in Mexico opened, generating a lot of discussion and questions about how to break the monopoly and start applying equal conditions for others to compete without putting unnecessary pressure on Pemex. With the devaluation of the US dollar and the increase in petrol and electricity prices, 2016 was tough.
There are also complex processes to define how other players will be invited to utilise the transportation and storage infrastructure that Pemex has developed over the years. It hasn’t been an easy path. The biggest example of the difficulty regulators face is determining who will pay for the fuel that may be stolen from the national pipeline system. The authorities haven’t decided yet.

What factors impact efficient transportation of petrol in Mexico?
Geographical differences are part of the reason behind delays in Pemex’s northwestern systems. They are close to the border and you can transport petrol using trucks rather than pipelines.
The southern system is more complex. The use of infrastructure is linked to the opening of the market, because nobody can sell if they cannot bring in petrol to be sold. It was after 2016 that one started to face the complexities of the problem that aren’t so easy to solve, such as stolen product, securing rights of way, access to water and so on.

Is the use of Pemex’s existing infrastructure by private players sustainable?
It all depends on your strategy, what you want and what you need the money for. Of course, there will be some players that will come in and build their own infrastructure. We have examples of companies asking the CRE [Energy Regulatory Commission] for permits for distribution using their own assets. Others will want to take a piece of a pipeline or storage facility from Pemex or others. Important players are interested in using Pemex’s existing infrastructure. This is a new, complex world, but I see a lot of interested players.

Will the market for natural gas vehicles expand in Mexico?
You have to be careful, but it could be a good business. Though gas is cheaper than petrol, the costs associated with converting vehicles for natural gas use makes it so that it is only viable for frequently used vehicles, such as taxis or public city buses, which are used daily.
Users will need to make considerable investments to install gas systems in their vehicles. Costs for vehicle conversion vary depending on the different markets, and that’s why gas and petrol markets are different. They have a completely different dynamic that could make your investment a good or bad one. At this moment, the environment is set for making money in natural gas vehicles, though I don’t believe it’s a big game changer.

What is Pemex doing to ensure it is being more efficient in the downstream sector?
In 2016, the CEO of Pemex announced that the company would like to have full control of some refineries, and at the same time, allow other companies to manage other facilities. For example, the operation of the hydrogen plant at the Tula processing complex is being outsourced to an international company. That’s one approach – outsourcing water, hydrogen and other ancillary services around the core business to make it more efficient.
The other way is to invite someone to co-invest with Pemex in the core business of the refinery. Some of the Pemex refineries need significant investments to operate, and load and digest the heavy oil that Mexico produces. Pemex also needs to stop producing heavy fuel, which is fortunately no longer consumed by the CFE [Federal Electricity Commission] because it is expensive and not environmentally friendly. The refineries used to produce a lot of combustibles for the CFE, so Pemex now has a very low refinery utilisation rate.

What challenges does the natural gas market face?
The real problem in the southeast of Mexico is that natural gas is produced with more nitrogen, which Pemex has been using to increase pressure in mature fields. However, Pemex has not invested in the infrastructure to clean the natural gas, so in the end, industrial consumers reject the product, leading to the problem of not having enough natural gas.
When we say natural gas, we’re talking about methane, but propane, butane and ethane are also injected together with nitrogen. There’s a scarcity of butane and other products, which is clearly a problem.
Companies are used to simply receiving and paying for natural gas. They’ve never made a long-term commitment to anything or understood the difference in pricing of guaranteed supply versus a supply dependent on whether or not there is enough natural gas. You have to understand that if you want to be sure you will have natural gas for your processes, that will be costlier than the alternative. You’ll have to evaluate the economics of your own factory and how valuable it is for you to always be sure that you have natural gas.
Industrial consumers, owners and traders will have to be willing to make an investment and take a long-term position. It’ll take time for Pemex to reduce its influence and for these consumers to understand that they’ll have to pay for it.

How can private companies help compensate for these chronic shortages?
They can invest in new plants. They have to reach a deal with Pemex, or eventually reach agreements with the upstream players that won in Round 1.4. The timing is important, as it’ll take a while for everyone to produce hydrocarbons. If someone is able to find them in the southeast, they’ll have a very good business there.

How will the power generation market develop in Mexico?
The CFE will have to define which areas it wants to play and invest in. In the past, it had the mandate to do everything. Now the company will have to be selective in where it wants to be.
On the supply side, a lot of traders and suppliers will start fighting for the electricity services market. Not everything is about who will provide the cheapest electricity, but also who has the best plan for a sustainable supply of electricity with the required quality and characteristics.
Now, they have to think of risks, rewards, long- and short-term objectives and clean energy certificates. The environment is getting more complicated and companies will have to learn. It’ll be a process of several years.

Is the regulatory framework clear enough to attract foreign companies to invest in Mexico?
The overall regulatory framework is good. The problem is now we’re getting into the small details of a lot of things at the same time. The petrol, diesel and electricity markets are not only being opened. The natural gas and LPG markets are also being opened at the same time by the regulatory entities.
They have to go into detail about how to assign a specific part of the natural gas system, and manage what would happen if someone wanted to bring natural gas from A to B and vice versa. It’s that level of complexity and detail that is needed now, and that is a process that has taken other countries many years to fully organise.

How will the relationship between the USA and Mexico develop and how will that affect the energy industry?
I still believe that we will have a North American energy market, whether the countries like it or not. North America is completely integrated, and in energy, there is interdependence.
For the US, it’s a win-win situation. If you stop selling natural gas from the US to Mexico, Mexican companies will suffer from scarcity, but the US gas producers will go bankrupt due to the price of natural gas, which went up as soon as the US started exporting natural gas to Mexico. There is an interdependence.
Perhaps what will give companies pause is the Mexican presidential election in 2018. The political environment will not affect energy itself, but it will affect the general mood related to the Mexican presidential elections, which is causing a lot of companies to have second thoughts about entering Mexico.

How is EY adjusting to the transition of the domestic oil and gas industry?
EY has been investing in more talent, far beyond our typical areas of accounting, taxes and so on. We’ve been investing in new advisors for the market. So far, we’ve incorporated several partners into our practice with a strong background in oil and gas, power and utilities, the supply chain, petroleum and other related areas of expertise. We’re hoping to continue that trend.
We believe this is really the beginning and companies will need a lot of advice to make their lives easier in this new environment. We have brought in people who used to work for EY in other countries, as well as people who are outside the EY environment. We’re open to anyone who can add value, and who knows something about the consultancy business and how to be an advisor.
We’re building teams for different sectors. We’re building a team for power and utilities, water, upstream and midstream.
We’re trying to take on more complex tasks that certainly require a higher level of specialisation. We now have more than 150 professionals who spend more than 80% of their time on energy projects. The more specialised we are, the better. We try to be one step ahead of the rest.

What are EY’s objectives for 2017?
Our objective is to keep growing at a good pace. We’ve been able to double the size of our energy practice in Mexico since the start of 2016. Now we’re taking the next step and trying to triple that income by 2021. It’s quite ambitious, but we’re investing in talent, so that we can participate in all these new and developing markets.

For more information on EY in Mexico or the country’s energy reform, see our business intelligence platform, TOGYiN.
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