Interview with Francisco Salazar

Transcription

1 Interview with Francisco Salazar President, Energy Regulatory Commission (CRE) MEI Interview No. 7 December 1, 2013 FRANCISCO SALAZAR is a commissioner and president of Mexico s Energy Regulatory Commission (CRE), a position that he has held since December The CRE is a federal agency that plays key roles in the operation and expansion of Mexico s energy sector. The present interview was prompted by his testimony before the Mexican Senate on October 23, Before turning to the interview itself, it will be helpful to present a one-page introduction to the CRE s history, mandate and leadership. In 1995, this federal agency began with a narrow mandate to regulate natural gas transportation, distribution and storage. In relation to distribution, the CRE was charged with defining and awarding a franchise to the winner of a public tender. Since then, its mandate has expanded to include petroleum products, as well as an evolving role in the electric sector. The CRE s website contains institutional and regulatory news and history ( A section in English gives an overview of the functions and organization of the agency. 2 The CRE has benefitted from stable leadership. Second only to CFE, the federal power utility, among agencies in the energy sector the CRE has had the least turnover of chief executives. Unlike the Energy Ministry (SENER), which, in the Fox administration ( ), had four energy ministers, and unlike Pemex, which, since 1995, has had seven directors general, since its beginning the CRE has had only three presidents who, also, serve as commissioners. Each of these CRE presidents has faced special challenges and has brought to the job very different personalities and management styles. The first president, Héctor Olea ( ), was strident and assertive in his dealings with prospective investors in gas transportation pipelines and LDC franchises. 1 2 His Senate testimony and that of CRE Commissioner Francisco Barnés were critiqued in MEI Report 769, CRE Overflight of Energy Reform, issued Nov. 17, The testimonies are also available on the CRE website. news@energia.com Mexico Energy Intelligence Page 1 of 8

2 The second president, Dionisio Pérez-Jácome ( ), brought a soft-spoken, managerial style. Francisco Salazar, twice-elected to the Lower House of Congress (1997 and 2003), was tapped in 2005 to lead the CRE (and was reconfirmed in 2010 for a second five-year term). He brings the poise and temperament of a legislator who is accustomed to asserting his views in public debate while remaining attentive to the dissenting views of others. Each of these officials confronted distinct issues and challenges. It fell to Dr. Olea to roll out a netback pricing mechanism for natural gas, which he did with the consulting support of his former mentors at Rice University. He also had to devise a framework for public tenders for natural gas distribution franchises. Under his watch, the first public tenders were held for Mexicali, Monterrey and Mexico City, more than a dozen in all. In addition, the CRE was mandated to issue a permit to PGPB to operate Pemex s National Gas Pipeline System. The CRE had to certify that issues of maintenance, capacity, reliability and the like were fully documented; it turned out to be a big task to assemble and order the needed information. Dionisio Pérez-Jácome urged industrial consumers of natural gas not to over-react to the so-called ENRON crisis, during which over a period of six months natural gas prices rose to US$10/Mcf, more than double the ten-year average price of $4. On his watch the ugly head of LPG opposition to natural gas distribution appeared, a situation that stopped further expansion of the local gas franchises and which still exists today, as in Guadalajara. He also had to deal with thorny legal and political issues having to do with the siting of LNG facilities, notably in Baja California. Francisco Salazar is a chemical engineer by training with a graduate degree in economics from London School of Economics. It falls to him and his fellow commissioners and senior staff to reposition the CRE within the framework of a new energy reform.. Mexico Energy Intelligence (MEI): It s hard to know where to begin a conversation with you about energy reform in Mexico. You can come into the conversation through the front door or the back door. In your testimony to the Senate on October 23, you came into the front door of how you see the best outcomes for energy reform. You urged that the Congress proceed with a constitutional reform in order that it could free the State from the self-imposed constraints. Francisco Salazar (FS): Well, to continue on the same order of ideas (as we say in Mexico), in your opinion piece in REFORMA on the very next day you came into the discussion through the back door, that is, you tried to explain how we got into this very difficult situation of having these artificial constraints in our laws and constitution. As you have been a long-time analyst of the Mexican energy scene, I find it interesting I will not say amusing that you should want to instruct Mexicans that they have misunderstood their own legal and constitutional history. But I will agree that mixing law and emotionality predictably leads to bad public policy and unreliable historical memory. MEI: As we see it, the emotionality of the oil expropriation of 1938 led to confusion about the meaning of Constitutional Article 27, which, following Spanish legal tradition, was only about the ownership of minerals in their original state in Nature, that is, in situ. news@energia.com Mexico Energy Intelligence Page 2 of 8

3 FS: What was the confusion, as you see it? MEI: In the popular mind (el imaginario público), Article 27 came to refer not only to oil and gas in situ but also to all petroleum products in commerce. In the Petroleum Act of 1958 this confusion was made manifest in the doctrine of First-Hand Sale (Venta de Primera Mano, or VPM). Two orders of confusion We say that this doctrine has no constitutional foundation whatsoever. Once it was accepted without debate, and five days before the presidential term was to end it became the origin of second-order confusion in 1960 when legislators amended the language of Article 27 in order make it agree with the Petroleum Act. FS: The law is supposed to agree with the constitution, not the other way around. One of my key points in the presentation to the Senate is that the government must have the flexibility to adapt with diverse policy instruments; the choice of instruments should not be limited by a constitutional constraint. But clearing up the confusion (as you call it) is only the beginning: a great deal of attention needs to be paid to develop the legislation and institutions to devise complementary regimes for the oil and power sectors. MEI: It seems to us that implied in your call to modify, if not end, the regime of state-administered prices for energy products you are implicitly rejecting the legitimacy of the VPM doctrine. FS: In relation to prices, as well as in relation to what I called the architecture of the market, I m calling for a change to a market-driven, competitive regime. Up to now, the term that has been in circulation for the past dozen years is competitive prices ; but that term has been normally used without accepting its ultimate consequences. MEI: How so? FS: For the past half-century 55 years to be exact the State has set the prices of all oil products sold in Mexico. The CRE in its early years in the mid-90s was faced with the challenge of devising a pricing scheme for natural gas that was simultaneously supposed to be competitive and state-administered. MEI: An oxymoron, you could say. The real challenge comes after you ve amended the Constitution Competitive is a loaded word in Mexico FS: Up to now, almost no one in Mexico would want competitive to mean that the price that the customer would pay if he were given a choice among products or vendors. MEI: We should not overlook the double discourse of Mexico s industrialists. On the one hand, they say that they want competitive prices ; on the other hand they want those same prices to come from Pemex or CFE but not from a free market, where subsidies do not come from. We saw this behavior in spades in the reaction of Monterrey industry to the proposal offered during by MidCon Pipeline to build a new gas transportation line from south Texas to Monterrey, one that would compete directly with Pemex. news@energia.com Mexico Energy Intelligence Page 3 of 8

4 What happened? Instead of embracing this project, Monterrey industrialists merely flirted with the MidCon people. In 2000, the project, then in the hands of KinderMorgan, was on the verge of being cancelled in At our urging, Pemex s new director general, Raúl Muñoz Leos, took an interest in the project. Eventually, the pipeline was built as a Pemex project; it was not supported by Mexican private industry. FS: That is part of the reasons why in the nearly 20 years after the Natural Gas Act of 1995 we have no truly merchant pipelines in Mexico and, even more importantly, competition in gas supply. MEI: Our own view is that there has been a short-sighted perspective we do not say complicity on the part of the Finance Ministry (SHCP) regarding the financing of natural gas infrastructure. Pemex and CFE have been allowed to serve as the only credit-worthy, anchor customers for almost every major infrastructure project on either the oil or power sides. But wait. Pemex and CFE are agencies of the federal government; so it s not too much of a stretch to see that commercial bankers, government export-import banks and private equity managers are looking for a sovereign guarantee for their investment. As we see it, SHCP is doing the Mexican energy economy no favors by acquiescing to such demands. FS: I m convinced that CFE had to play a very important role as an anchor of many projects. The problem is that the rest of the consumers didn t have to face the need to contract capacity, what would have been the driver for private pipelines. If the government is coherent in implementing the market drivers of competition in oil and power, then this policy that vexes you so should go away. MEI: We are interested in your idea of sustainability. You mention three areas: environmental, financial and social. We may suppose that most people understand the concept of environmental sustainability; but the other two concepts are likely to need unpacking, as we say. FS: But there s an aspect of environmental sustainability that I want to emphasize. I said in my Senate presentation that a third of Mexican households use firewood as their primary domestic fuel. That high percentage is unsustainable. MEI: Indeed. We recall that in the early 1970s in order to reach to the peak of the Ajusco volcano, located on the edge of Mexico City, you had to pass through an extensive forest, maybe one or two kilometers; today, that forest is gone. Only tree stumps remain. FS: So here we come to the socially hard part of energy policy. To motivate people not to cut trees to heat water and soup you need to offer a substitute fuel source that is both readably available and affordable. The families for whom firewood is a viable option cannot afford competitive prices, as any price beyond the cost of cutting down a tree is non-competitive. How to supply energy to households that can t afford it? MEI: And the only real alternative to firewood is LPG, which, in effect, has to be given away ou presque. FS: There are no easy answers to the conundrum of delivering commercial energy to people who can t afford it. Their problem is not the lack of choice among suppliers but the lack of money to buy from any news@energia.com Mexico Energy Intelligence Page 4 of 8

5 supplier. That is why I believe part of the solution is to move away from generalized subsidies stemming from price controls and using direct subsidies targeted only to people who really need them. MEI: Perhaps that point leads us to your ideas about social sustainability. FS: I have primarily in mind the disruptions in people s lives that are caused by the way our state energy companies invest and operate. Sociologists, economists and other social scientists who have studied the effects of the Oil Boom in Mexico in the late 1970s and early 1980s have identified negative collateral effects of that expansion: inflation and evidence of social dissolution like alcoholism, crime and prostitution in the small cities and rural communities. And since the early 1990s there have been backlashes by persons and communities who feel that their lives, property and communities have been damaged by the operations of the state energy companies. One recalls the situation that occurred in which in order to build a hydro-electric plant, it was necessary to move an entire village that would be submerged once the dam were put into operation. MEI: Somewhere in our archives have the original edition of Proceso from that early period in which there is the iconic photograph of Andrés Manuel López Obrador as a young man with blood on his white shirt. He was leading a peasant blockage of Pemex oilfields in Tabasco. FS: Yes, I recall that photograph. You could say that it was just that photo and the anti-establishment narrative that went with it that almost led him to the presidency of Mexico. MEI: Do you regard as we do Mexico s national petroleum narrative as something that merits reexamination from the perspective of social sustainability? There s something not FS: Mexico s petroleum narrative gives the government and the congress a right about a national proxy language with which disagreements over the role of government narrative that mobilizes opposition to reform may be discussed. In that sense, a discussion of Pemex is simultaneously a discussion of how society sees the role of government in a general sense. At the same time, I ll agree that there s something wrong with a national narrative can serve to mobilize in the streets 50,000 teachers or oil workers to protest government policies and laws enacted by congress. And I ll agree that much of the power of that narrative comes from the confusion over the scope of Article 27. In my senate presentation, I emphasized that to define and commercially exploit Mexico s petroleum resources, it is unrealistic to imagine that just one company can manage to locate, define, develop and market everything from shale gas to deepwater oil. For this reason, more companies are needed. For this reason, more companies are needed. MEI: Many people on the Left, Cuauhtémoc Cárdenas, for example, would completely agree with you; but he would say that these companies should come as contractors to Pemex, and be paid for their services under existing laws. What in your mind is the compelling argument in favor of adopting a different oil regime? news@energia.com Mexico Energy Intelligence Page 5 of 8

6 You talk about the virtues of competition as offering the best signals for abundance and scarcity; but this idea about the benefits of competition applies to economies in the abstract. And Mexico is so idiosyncratic in its institutions, laws and history as to make it not immediately self-evident that competition will benefit more than a minority of the population that can afford XXI-century energy infrastructure and services. FS: You are right to remind us that there s a lot that we don t know that we don t know in relation to the effect of competition on the economy in the energy sector. But we are not completely helpless. Consider shale gas. There are estimates of recoverable resources in a range of Tcf of shale gas. So far, in 2013, Pemex has drilled some half-dozen exploratory wells, while in the U.S. upwards of 9,000 wells have been drilled. So we know as a fact that at the rate of six wells a year, Mexico s shale gas resource will never be produced. It s a little harder to say what is going to happen in deepwater. In twenty years Pemex has drilled some twenty-five deepwater wells (over 500 m.), whereas in the U.S. there have been nearly 2,800 wells drilled in this water depth or greater in the same period. [See insert. 3 ] Pemex proposes to develop a deepwater reservoir known as Lakach, but it is a gas field, and what Mexico needs is more oil production. There is plenty of cheap gas that can be imported. So far, in twenty years, Pemex has not produced is first barrel of liquids or Mcf of gas. We also know as a fact that Mexican consumers pay the highest prices for electric power in all of the OECD countries even when the price of gas in the U.S. is at historic lows. And that in February 2013 Pemex Gas paid upwards of US$21/MM BTU for natural gas in LNG cargos, when, in the U.S. the same gas was at $4. We know as a fact that the high price of electricity is a break on the economy and a deterrent to Mexican and international investment. Mexicans pay the highest electricity rates in OECD countries Put all these facts together and you come to the conclusion that the Mexican State must experiment with an alternative model, one in which there are many more than two monopolies that distort the behavior of suppliers and investors. That s my answer to your question: the present oil and power regimes are not delivering the outcomes that a growing, modern economy needs. The benefits of competition MEI: But others would say that the alternative model is to make are clear in the abstract Pemex more efficient by giving it a viable tax regime and operational autonomy. The CFE, also, would ask for more money to keep its self-proclaimed status as a world-class company. FS: We have had two decades of discussions of making Pemex more efficient ; but, frankly, I don t want to go through another discussion like that. Pemex s efficiency should come as a by-product of another 3 news@energia.com Mexico Energy Intelligence Page 6 of 8

7 conversation, not as the object itself of that conversation. As for the CFE, I would like it to compete with other players. I would like to see an Independent System Operator (ISO) be responsible for electric power dispatching and another ISO to operate the natural gas transmission grid. Two ISOs are needed: one for gas, the other for power MEI: We were struck by your observation in a conversation we had together some months back that the CRE regulates pennies. Please tell us what is behind that remark. FS: The CRE struggles to achieve price parity between the U.S. and Mexican markets. You could say that the whole institution is about the fairness of its decisions about US$/Mcf. If it had worked out that there were competitive price hubs inside Mexico, then, in that case, the CRE could have gotten out of this business; but, until then, we re stuck. MEI: We ve had the idea that if the reforms were to allow direct commerce between private oil and gas companies and private power generators then a boom in both gas production, pipeline construction and power generation infrastructure would follow. FS: You ll have to work out that if with my colleagues in the Finance Ministry and the federal deputies who are responsible for the federal budget. MEI: How do you see the major challenge of your administration as CRE president? FS: It would be a major step forward if, by 2015, when my term as president expires, we could have a secondary-capacity market for gas transportation pipelines. The information generated by independent transactions of owners of capacity would tell us in advance where the bottlenecks are forming. You could say it was the lack of such information that has produced the rush to build the so-called Los Ramones pipeline. MEI: In 1995, after the approval of the Natural Gas Act, which allowed for private gas pipelines, many of us believed that Pemex would never build another pipeline. FS: Things didn t work out that way, did they? Goal for the Salazar presidency: a secondary market in pipeline capacity MEI: Let s speak for a moment about the role of the government in the upstream, that is, in matters relating to the national petroleum patrimony. We see a lot of confusion and incomplete sentences, so to say. The CNH is established as a government oversight agency, but only of Pemex; the government, meanwhile, is proposing to invite other companies to be operators of blocks outside of contracts with Pemex. The Energy Ministry (SENER) has some overall authority, at least in theory. What agency is to administer the non-pemex contracts for exploration and production? The government has not given us a precise answer. And, going back to your issues of environmental sustainability, what agency is to have the authority and resources to serve as a real regulatory of HSE compliance, especially offshore? And we haven t even touched on the character of the oil regime that the government will devise in order to news@energia.com Mexico Energy Intelligence Page 7 of 8

8 offer investment opportunities to lots of world-class oil companies large ones in deepwater, small ones in shale plays. FS: Well, we should leave some subjects on the table to take up in our next conversation. MEI: Thank you for your time, and for sharing your deep experience and insights. Mexico Energy Intelligence Page 8 of 8