Volume 4, Number 35, Page 1

Mexico's Gas Import Duty: NAFTA MAY ALLOW FOR accelerated reductions, BUT TIME IS RUNNING OUT

by George Baker

Since the approval of NAFTA three years ago, natural gas imports by Mexican end-users in markets supplied by Pemex have been basically zero — despite an Open Access program that went into effect in northern Mexico at the beginning of this year. The problem is Mexico’s import duty on natural gas, which has left Pemex as the only supplier to principal Mexican gas markets. This market distortion could correct itself in the coming months, however, depending on the outcome of a review process currently being orchestrated by the Mexican Commerce Department (SECOFI).

The NAFTA parties agreed to the import duty in 1993. The duty, initially 10%, is scheduled to decline by 1% per year. Today, at 6%, the duty is sufficient to eliminate the incentive for Mexican industry to source alternative (U.S.) gas supplies.

The effect of the import duty has been to delay any progress from the Open Access program announced by the Mexican Energy Ministry two years ago. The import duty has been treated by the Mexican government as a matter of trade policy, not energy policy. For this reason, chief gas regulator HŽctor Olea and others have encouraged U.S. companies to lobby the Office of the U.S. Trade Representative (USTR) to horsetrade import duties — gas in exchange for tomatoes, for example.

The USTR categorically rejects this approach, however, on the grounds that the USTR does not negotiate across industries (petroleum and agriculture in the example just given). The USTR’s advice to gas exporters: This is a Mexican duty, one that's entirely in the hands of the Mexican side to modify or eliminate. International companies should lobby the Mexican Commerce Department to have the import duty reduced or eliminated.

An element that makes this policy gridlock even harder to untangle is Pemex’s opposition to eliminating the tariff. Since May 1997, Pemex has carried out unprecedented lobbying efforts to assure Mexican industrialists that a sole-sourced gas market would be fair and competitive, and that there is no present need for them to seek gas supplies elsewhere.

Pemex head Adrián Lajous has argued that the tariff was negotiated in good faith, and that there is no good reason to change it. Furthermore, significant displacements of Mexican gas caused by imports could conceivably shut in Pemex oil production, which, in turn, would have significant negative impact on federal tax revenues. Critics of Lajous's point of view argue that Pemex is stalling on the tariff issue until its own dry gas production program in the Burgos Basin (see Oil & Gas Journal, 10 Nov. 1997, p. 89) has increased output sufficiently to displace potential American or Canadian gas supplies to Mexican end-users.

Pemex's reluctance to have alternative supplies of natural gas imported into Mexico is understandable given the serious environmental and commercial problems it faces with its high-sulfur (4%) fuel oil produced at its mostly land-locked refineries. Current production is 400,000 b/d. Pemex needs Mexican industry as an outlet for its fuel oil, which, otherwise, has little or no commercial value in world markets.

The principal Mexican gas market that could benefit from competition is Monterrey, where Pemex is currently the only supplier. Demand is about 400 MMcfd, a level that is expected to double in the next 10 years. Demand principally comes from industries such as steel, glass, chemicals, breweries and tile. Several new power generation stations are being proposed for the Monterrey region. Benefits to Monterrey would be both economic and environmental. Progress on the environmental front, however, is also at risk because of the years of delay in the construction of a 50,000 b/d coker in Pemex's Monterrey refinery. With the refinery upgrade still in the bid-evaluation stage, it is unlikely that operations will begin before the year 2001.

Absent alternative gas supplies, Monterrey industry foregoes the economic benefits from competition in gas sourcing. Absent a coker, the region foregoes the environmental benefits from fuel switching to natural gas, making it almost certain that compliance with the 1994 emissions codes (NOM 085/086) will not be met in 1998 as required. (With U.S. gas availability and the enforcement of the emissions standards by PROFEPA, the environmental standards enforcement agency, the region could nevertheless make substantial environmental gains well in advance of the operation of the coker.) The elimination of the gas import duty therefore would have direct economic benefits and indirect environmental benefits for the region.

There are, then, at least four reasons why the odds are likely to be low that vigorously argued comments from the Mexican side will be forthcoming: the silence of the energy ministries of the three NAFTA countries; the neutrality shown by the USTR; the hostility of Pemex to change; and the reluctance of Mexican heavy industry to risk a public disagreement with their principal energy supplier.

On the positive side, the Mexican Gas Association (AMGN), comprised of equipment suppliers and natural gas distributors, has publicly expressed support for the accelerated reduction or elimination of the gas tariff. It remains to be seen if the key Monterrey trade association, CAINTRA, will support the elimination of the import duty in policy arguments to SECOFI.

Few things in Mexico are decided by the principle of public consultation. In the present case the status quo will certainly prevail unless Mexican and international companies step up to the plate and urge that the gas import duty be eliminated entirely or put on a schedule for accelerated reduction.

This author’s concern is that absent a strong industry voice, Pemex's view, which is that no accelerated reduction of the tariff is needed, will probably carry the day. If the recent past is any guide, Mexican heavy industry will be reluctant (even through its trade associations) to speak up and request that the import duty on natural gas be eliminated.

International companies who have subsidiaries in Mexico should submit comments to the USTR by Dec. 12 and to SECOFI by Dec. 19 (see sidebar, cover page). Mexican industrial companies and trade associations should also be encouraged to submit their comments. Those in favor of an integrated North American gas market should make their data and arguments known to the commerce departments of all three NAFTA governments.

George Baker is managing principal of Baker & Associates, Energy Consultants based in Houston, Tex., which publishes Mexico Energy Intelligence, a newsletter and data service. Mr. Baker can be contacted via e-mail, energia@neosoft.com.