Navigating Mexico s Energy Reform: The LPG market

Navigating Mexico s Energy Reform: The LPG market

Demand Trends Mexico is among of the world s three largest consumers of liquid petroleum gas (LPG). According to Energy Secretariat (Sener) estimates, cooking accounts for about 60% of the country s domestic demand. Services represent roughly 14%, followed by transportation with 12% and industry with 10%. The remaining 4% is consumed by agriculture and the oil industry. Demand has been relatively stable since 2009, declining marginally to 280 kb/d on average in 2015. This is well below the peaks seen in the early 2000s (around 320 kb/d), which were probably related to the limited availability and dearness of natural gas during that period. By the same token, the gentle demand fall over the last four years suggests greater adoption of natural gas, which has become gradually more abundant and cheaper. In the long run, the government expects that many regions notably on the western side of the country, in remote locations and even in some large urban areas, such as Mexico City will have full access to natural gas as a number of pipelines are completed. This should accelerate further the decline of LPG, together with efficiency improvements. Strikingly, whereas half of the country s households use LPG, and about a fifth natural gas, some 40% still use biomass, which is much less efficient and more polluting but also much cheaper. Mexico: LPG Demand mb/d 0.34 0.33 0.32 0.31 0.30 0.29 0.28 0.27 0.26 0.25 1995 2000 2005 2010 2015 Sources: Pemex, SENER, EY Supply Trends Mexico: LPG Output* Domestic production, however, has lagged demand. This is largely due to Pemex s deteriorating infrastructure. LPG from both crude distillation (7% of total output) and gas plants (93%) has declined over the past two decades. Altogether, total domestic production has almost halved since 1995, and currently averages 170 kb/d, equivalent to roughly 38% of total demand. Naturally, the balance has to be imported, mostly from the US. Whereas Mexico posted a small LPG trade surplus twenty years ago, by 2015 net imports had reached 105 kb/d in 2015 but have remained within a 70-100 kb/d range since 2000. The cost of LPG imports exceeded US$2 billion in 2011, but have since halved following the oil price plunge. mb/d 0.29 0.27 0.25 0.23 0.21 0.19 0.17 1995 2000 2005 2010 2015 Sources: Pemex, SENER, EY *From refineries and gas processing plants 2 Navigating Mexico s Energy Reform

kb/d Mexico: LPG Trade US$bn Mexico: LPG Trade 150 3 100 2 50 1 - - (50) (1) (100) (2) (150) 1995 2000 2005 2010 2015 Imports Exports Balance Sources: Pemex, SENER, EY (3) 1995 2000 2005 2010 2015 Imports Exports Balance Sources: Pemex, SENER, EY About two-thirds of LPG imports are carried out via vessels. Similarly, two-thirds of total imports land in the Pajaritos terminal in Veracruz State. The following map summarizes the different import routes as of end-2014 (the latest data available). Tijuana 2.5 Mexicali 3.9 Rosarito 5.8 Nogales 0.8 Cd. Juárez 14.8 Piedras Negras 3.6 Topolobampo 1.6 Piedras Negras 3.8 Tuxpan 8.2 Importación marítima Importación terrestre Manzanillo 3.2 Pajaritos 36.7 Importación por ducto Exportación (destino) Cactus (Belice) 1.3 Source: SENER The LPG market 3

4 Navigating Mexico s Energy Reform

Transportation & Distribution LPG is the only oil by-product for which transportation and distribution has never been closed to the domestic private sector in Mexico (foreign players, though, were banned). Prior to the energy reform, Pemex had only a supply monopoly; private marketing companies would then sell LPG to millions of customers, usually in cylinders. The Energy Regulatory Commission (CRE) has handed hundreds of transportation and distribution permits over the years, as shown in the table. There are currently almost 2,700 LPG filling stations in operation, as well as close to a thousand distribution plants. In addition, there are eight main pipeline permits scattered around the country, as detailed in the table and map below. Similarly, 23 storage permits cover twelve States (Baja California, Chihuahua, Coahuila, Colima, Hidalgo, Jalisco, Mexico, Puebla, Sinaloa, Sonora, Tamaulipas and Veracruz). Total storage capacity stood at 2.6 mb by end-2014. LPG Wholesale Distribution Permits* Region LPG Station LPG Distribution Plant Center 550 171 Center-West 752 251 Northeast 640 272 Northweast 314 90 South- southeast 394 178 Total 2,650 962 * As of end 2014 Source: SENER Company Coverage Transportation TDF Ductos del Altiplano Penn Octane de México PGPB SNGLP From the Burgos gas processing plant to Monterrey, both in Nuevo León State From Tuxpan, Veracruz State, to Atotonilco de Tula, Hidalgo State From the Sabina border crossing to Matamoros, both in Tamaulipas State From the Cactus gas processing plant in Chiapas State to Guadalajara, Jalisco State Distribution Compañía de Gas de Tijuana Asociación de Colonos de la Herradura Gas del Caribe Hermogas Baja California State Mexico State Quintana Roo State Sonora State Source: SENER The LPG market 5

Compañía de Gas de Tijuana, S.A de C.V. Hermogas, S.A. de C.V. TDF.S. de R.L. de C.V. Penn Octane de México, S. de R.L. de C.V. Ductos del Altiplano, S.A. de C.V. Gas del Caribe, S.A. de C.V. Asociación de Colonos de la Herradura, A.C. Transporte Distribución Pemex - Gas y Petroquímica Básica (SN GLP) Source: SENER Energy Reform: Implications for LPG The energy reform introduced three mayor changes for the LPG industry. First, private players are now allowed (since the start of 2016) to fulfil their supply needs independently, either by producing their own LPG or importing it, rather than relying on Pemex. Second, end-user prices, which are still set by the government, will be freed in 2017, potentially leading to a significant fall if the oil price hovers around current levels. 2 Third, private foreign companies can now participate in the entire supply chain. In terms of regulations, CRE is responsible for issuing permits for transportation and distribution by pipeline, while Sener is in charge of all other permits for storage, transportation, and distribution. Permits are valid for 30 years, with the possibility of a 15-year extension. In terms of tariffs, these will be regulated asymmetrically only in those regional markets that are deemed uncompetitive; elsewhere, prices will be depend on supply and demand dynamics. These changes are intent on promoting a competitive and safer market. Indeed, despite the high number of private players, Mexico s LPG market is both highly segregated in rural areas and concentrated in urban ones. Volume-wise, though, the market is effectively dominated by a handful of companies. Some estimates reckon that most regional markets are served by no more than three companies; overall, about half of total country sales are carried out by less than ten companies. Such concentration is unlikely to diminish much, at least initially, since the largest companies are also the ones with the financial might to build their import supply chains and hence further entrench their dominance. On the safety side, there has been widespread anarchy regarding cylinders, which effectively belong to no one, as they rotate among users and companies. As such, many are battered, and are the source of frequent accidents. The same occurs with regards to car tanks and other equipment, which are often poorly maintained and are thus dangerous. Greater oversight and tighter safety standards will thus be required in order to attract more players. 6 Navigating Mexico s Energy Reform

Looking ahead, however, the LPG market is unlikely to expand much, despite the country s population growth. As noted earlier, Mexico is likely to follow other countries demand trends, with LPG use declining as it is substituted by natural gas and other energy sources. Nonetheless, the transition will probably be very gradual and the more so if urban natural gas grids take time to be build, if LPG remains competitive in terms of price vs. natural gas and if LPG takes off in the transportation sector (where it currently accounts for 2% of all energy sources). Still, unless Pemex s refining and gas processing operations improve dramatically, net imports will arguably continue rise, even if demand declines or remains stable at current levels. Finally, another long-term consequence will be the erosion of Pemex s dominant position. The company will have to supply LPG at very competitive prices in order to fend off the threat of cheaper independent imports. Alternatively, Pemex could try to find foreign customers. However, the export field is already crowded, with the US as a formidable competitor, which has become the world s largest exporter. Meanwhile, LPG could be displaced by a growing global LNG glut, notably in Asia. 2 Such price liberalization, though, will be carried out on a case-by-case basis, as long as CRE deems a particular regional market as sufficiently competitive. Otherwise, the current government determined first-hand sales prices will remain in place. These are subsidized maximum prices, which take into account a reasonable commercial margin for private companies, with Pemex effectively absorbing the subsidy. Contacts Alfredo Álvarez Energy Sector Leader + 52 55 1101 8422 alfredo.alvarez@mx.ey.com Gilberto Lozano Advisory Partner +52 55 5283 1459 gilberto.lozano@mx.ey.com Oscar López-Velarde Tax Partner +17 13 750 8393 oscar.lopezvelardeperez@ey.com Rafael Aguirre TAS Partner +52 55 5283 8650 rafael.aguirre@mx.ey.com Gerardo Flores Assurance Partner +52 55 1101 8405 gerardo.flores@mx.ey.com Francisco Forastieri Legal Partner +52 55 1101 7293 francisco.forastieri@mx.ey.com Rodrigo Ochoa Tax Partner +52 55 5283 1493 rodrigo.ochoa@mx.ey.com The LPG market 7

EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. 2016 EYGM Limited. All Rights Reserved. EYG no. ED None Clave NMER 001 This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. Is the answer to cybercrime more technology, or more people? ey.com/betterworkingworld #BetterQuestions 7 8