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JANUARY 2015 EDITION: LEGAL UPDATES

January 7, 2015
JANUARY 2015 EDITION: LEGAL UPDATES

The New Regulatory Framework on Natural Gas Infrastructure in Mexico, byJosé María LujambioIn 1995, a few activities of the Mexican energy sector were opened for private participation, including transportation, storage and distribution of natural gas. Since then, Mexico has received significant investments from transnational companies that provide natural gas midstream services. This has been most evident in (i) gas distribution, where the Energy Regulatory Commission (Comisión Reguladora de Energía, “CRE”), the federal regulatory agency, has granted more than 20 permits covering several geographic areas throughout the country, and (ii) storage and regasification of liquefied natural gas, which takes place at the import terminals of Altamira on the Gulf coast, and Ensenada and Manzanillo, both located on the Pacific coast. Also, some Mexican distribution companies have operated in several cities in northern Mexico, and others have taken advantage of the niche market created by the self-supply scheme.Although substantial foreign and domestic investments have been made in the transportation of natural gas, Petróleos Mexicanos (“Pemex”), through its subsidiary organism, Pemex Gas y Petroquímica Básica (“PGPB”), has continued to be an extremely dominant player. Until last year, PGPB was still the owner of approximately 90% of all natural gas transportation infrastructure, including the National Pipeline System (Sistema Nacional de Gasoductos, “SNG”) and the Naco-Hermosillo system. This scenario was deplorable, given that PGPB was the sole supplier of natural gas of domestic origin, without the law requiring the creation of “Chinese walls” for unbundling transportation and commercialization activities, without real capacity reservation in place, and with a widespread “at the door” gas delivery scheme for large consumers. For years, the CRE attempted to implement the so-called “permanent regime” of first-hand sales of natural gas, which implied the capacity reservation in the transportation system, but it was never able to achieve its aim, due to a deficiency of effective regulatory tools, and a lack of political will by successive government administrations then in power.The absence of adequate incentives for the construction of infrastructure, especially in the northern and western parts of the country, and the supply shortages from the southeast, gave rise to the “critical alerts” of 2011 and 2012, operative imbalances that made clear that the “timid” opening model had reached its limit. Attention to this crisis forced the federal government to promote the importation of liquefied natural gas utilizing the available capacity of the Manzanillo terminal. The regulatory impact of such was reflected in the increase of the SNG rates and, ultimately, in higher costs for end users.Since the end of 2011, it became clear that there was an urgent need to construct a huge gas pipeline that would connect the enormous production of natural gas in south Texas with the increasing demand in northern Mexico and in the Bajío region of central Mexico. As a result, the Los Ramones pipeline project was conceived. In spite of its magnitude, however, one single project seemed insufficient if it would play with the existing rules. With a new federal administration by the end of 2012, the favorable political environment for a major energy reform was the opportunity to modify the regulatory foundations of the infrastructure that connects natural gas supply and demand.In December 2013, the Mexican Constitution was amended in order to change the paradigm of the Mexican energy sector towards a free market model with strong regulation where needed. In August 2014, the new Hydrocarbons Law was published, and on November 1, 2014, the presidential Rules for the Activities referred to by the Third Title of the Hydrocarbons Law (midstream and downstream activities) became effective.The principal innovation of these legal bodies is the creation of the National Center for Control of Natural Gas (Centro Nacional de Control del Gas Natural, “CENAGAS”), mandated by the transitory constitutional articles and materialized by a presidential decree issued last September. The CENAGAS has a double mandate: (a) it will inherit and administer all the infrastructure that PGPB owned for rendering gas transportation services, and the corresponding contracts, and (b) it will serve as the operator of the natural gas transportation and storage national integrated system, made up by its own infrastructure and other interconnected infrastructure that offers systemic benefits. Thus, the CENAGAS is not itself an independent system operator but a “transco”, following the Anglo-Saxon terminology. While this is not an ideal world, it is better than what we had in the past.The Hydrocarbons Law further provides that other integrated systems may be formed with the purpose of expanding coverage or offering benefits in terms of improvements in security, continuity, quality and efficiency in the rendering of services. Each of these systems shall have an independent operator, which will coordinate the different transporters and ensure open access, subject to a CRE permit.On this point, the new legal framework is very clear: open access that is not unduly discriminatory is the cornerstone of the regulation of natural gas networks. To ensure such, rules exist detailing the posting of available capacity, secondary capacity markets, “Chinese walls” and unbundling, users’ investments for interconnection purposes, rate regulation, and strict constraints (although the extent of such is still uncertain) on self-supply.In addition, first-hand sales by productive State companies (Pemex and the Federal Electricity Commission, “CFE”), or any corporate entity on behalf of the State, must be carried out at the origin of the product and are subject to asymmetric regulation, with which one should expect an orderly and transparent use of system capacity and, hopefully, the flourishing of commercialization by agents other than Pemex, under a permits regime.The CRE is now also responsible for granting permits for the compression, decompression, liquefaction and regasification activities that began to develop independently in the past decade; the first two, particularly regarding the supply of natural gas for vehicles, and the second two being fundamentally linked to ground transportation in regions without pipelines.All of these changes occur in an institutional context in which the CRE will be a stronger, more independent, transparent and accountable economic regulator, which will transfer the authority for technical regulation of this entire infrastructure to the National Agency for Industrial Safety and Environmental Protection in the Hydrocarbons Sector.In the meantime, the federal government has launched an ambitious expansion plan of the pipelines’ network, which includes the Los Ramones system with its 1,000 kilometers tract and 42-inch diameter, whose first segment was recently opened, as well as the Pacific corridor, anchored through bidding by the CFE in order to supply U.S. gas to combined cycle power plants in northwestern Mexico and to industrial and residential consumers in that region. Consequently, before there is a boom in shale gas production in Mexico utilizing fracking techniques, we will see more and more importations.There is no doubt that Mexico is betting heavily on natural gas to be the fuel of the present and the future.

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