This article was written in response to a seminar given by George Baker, Publisher of Mexico Energy Intelligence and Patrick Duddy, Director of the Center for Latin American & Caribbean Studies at Duke University in an EDGE Seminar on Oct. 7, 2015 at Duke University’s Fuqua School of Business. This article voices one student’s perspective and does not necessarily represent the views of either Duke University or the seminar speakers.
In a presentation to the EDGE Seminar on October 7, 2015, George Baker explored the sometimes blurred lines that delineate Mexico’s new program of energy reform. Mr. Baker, the Editor of Mexico Energy Intelligence, suggested that Mexico’s quest was about restarting a stalled industry and supporting the economy. To do this, Mexico must bring in new capital via private investment in its oil, gas, and power sector. While the process of reform is complex, messy, and far from complete, the question underlying the program is simple: will experienced private companies bring capital and expertise to invest in Mexico?
In this post I speculate on Mexico’s attractive qualities and what sort of suitors they might lure. Before reading on, it may be helpful to get some quick background on energy reform in Mexico via Mr. Baker’s own www.energia.com or a report such as Mexican Energy Reform, by Adrian Lajous of Columbia University’s Center on Global Energy Policy.
Investment in Mexican energy sector is appealing, but not without risk
What makes Mexico attractive? At the top of the list are the enormous oil and gas reserves Mexico has access to. As Mr. Baker points out in a recent article, “Pemex says that in the deepwater area of the Mexican portion of the Gulf of Mexico there are some 500,000 km2 with oil and gas prospectivity. If Pemex were to annually assess the oil and gas potential of 2,500 km2 (unlikely at the current rate of exploratory 2–4 wells/year), it would take two centuries to fully define the potential of the region.” Additionally, Mexico has an electric system that has suffered decades of underinvestment and market structures that operate without pricing signals. This combination has resulted in very high electricity prices, strong demand for services, and huge inefficiencies that can be eliminated by better business practices. In other mid-stream markets such as natural gas pipelines, the historic underinvestment has created a market opportunity where private companies benefit from 100% off-take agreements with BBB+/A3-rated off-taker PEMEX. $7.6 Billion in private partnership pipeline projects have already been announced.
With new access for private companies, the most significant obstacle to investing is non-diversifiable sovereign risk. That is, Mexico has previously nationalized its energy industry and the reform process leaves most of the control still in governmental hands. Any investor must be wary of internal political changes in Mexico that could lead to appropriation or breach of contracts without recourse. What helps overcome this risk? It may just be good timing. With global borrowing rates at record lows (in some cases, even hitting negative interest rates) there is a driving need for projects that can generate real returns. Mexico wants capital and there is in some sense, a global glut of capital looking for opportunities to be deployed. With institutional memories surprisingly short and Mexico’s last credit crisis now 20 years in the past, investors are likely to turn to Mexico as a safe (BBB+/A3) place.
But who will come?
The obvious participants are the global integrated oil companies such as Exxon, Shell, BP, and Chevron. With private capital to deploy and a pressing need to keep developing international reserves they have the right incentives to pair up with Mexico. Yet in the first oil auction, many of the major oil companies skipped bidding entirely while others made non-winning bids. Only two of fourteen blocks had qualifying bids. After many bad dates with Latin American governments and a Mexico playbook that seems designed to make sure a private company always picks up the bill, caution is understandable. Perhaps newer a brand of suitor will step in?
One leading contender is IEnova Infraestructura Energetica, a subsidiary of U.S.-based Sempra Energy. IEnova has been in Mexico since 1996 in a small way, but is rapidly expanding to take advantage of the new reformed marketplace. Their recent investor presentation at Morgan Stanley’s 18th Annual Latin America Conference highlights opportunities with 10 gas pipeline projects, 9 transmission projects, and a LNG export project. $2.3B of capital is already committed to wholly owned and joint venture (with PEMEX) projects that are underway.
Other diversifying power companies seeking regulated or government-backed projects may look to Mexico. Traditionally U.S.-based utilities such as Duke Energy or Dominion that have growing gas pipeline businesses may be an attractive fit. They benefit from a creditworthy counterparty offering long-term stable contracts–ideal for their investor’s risk profile.
In business, as in love, sometimes the partner you need is the one you least expected.
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