Strategic Behavior and International Benchmarking for Monopoly Price Regulation: The Case of Mexico

Abstract

This paper looks into various models that address strategic behavior in the supply of gas by the Mexican monopoly Pemex. The paper has three very strong technical results. First, the netback pricing rule for the price of domestic natural gas (based on a Houston benchmark price) leads to discontinuities in Pemex’s revenue function. Second, having Pemex pay for the gas it uses and the gas it flares increases the value of the Lagrange multiplier associated with the gas processing constraint. Third, if the gas processing constraint is binding, having Pemex pay for the gas it uses and flares does not change the short run optimal solution for the optimization problem, so it will have no impact on short-run behavior. These results imply three clear policy recommendations. The first is that the arbitrage point be fixed by the amount of gas Pemex has the potential to supply in the absence of processing and gathering constraints. The second is that Pemex be charged for the gas it uses in production and the gas it flares. The third is that investment in gas processing and pipeline should be in a separate account from other Pemex investment.

Zusammenfassung

Dieser Artikel betrachtet verschiedene Modelle, die sich mit strategischem Verhalten in der Gasversorgung durch den Mexikanischen Monopolisten Pemex befassen. Der Artikel hat drei sehr starke technische Ergebnisse. Erstens führt die „Netback“-Preisbildungsregel für den Preis von heimischem Erdgas (auf der Basis eines Houston-Richtpreises) zu Diskontinuitäten in der Ertragsfunktion von Pemex. Zweitens erhöht, wenn man Pemex das von ihm verbrauchte Gas und das von ihm abgefackelte Gas bezahlen lässt, dieses den Wert des Lagrange-Multiplikators in Verbindung mit der Gasverarbeitungsbeschränkung. Drittens ändert, wenn die Gasverarbeitungsbeschränkung bindend ist, der Umstand, dass man Pemex das verbrauchte und abgefackelte Gas bezahlen lässt, nicht die kurzfristige optimale Lösung für das Optimierungsproblem, sodass sie keinen Einfluss auf das kurzfristige Verhalten hat. Diese Ergebnisse implizieren drei klare politische Empfehlungen. Die Erste besteht in der Festlegung des Arbitrage-Punktes anhand der Gasmenge, die Pemex ohne Verarbeitungs- und Gewinnungsbeschränkungen liefern kann. Die Zweite besteht darin, dass Pemex für das in der Produktion verbrauchte Gas und für das abgefackelte Gas bezahlt. Die Dritte besteht darin, dass Investitionen in Gasverarbeitung und Pipelines von anderen Pemex-Investitionen getrennt bilanziert werden.

Appendix: Background of the Mexican Natural-Gas Industry

In 1992 the Mexican government initiated modest changes to permit entry of private participants in power generation, and a more ambitious reform in natural gas was begun in 1995. Before this, state companies had controlled energy activities: Pemex in the oil and gas sector, and Comisión Federal de Electricidad (CFE) and Luz y Fuerza del Centro (LFC) in the electricity industry. So far, no decisions have been made on private participation and structural reform in gas production, oil extraction and processing, and production of petrochemicals. Structural reform of the electricity sector has been postponed.

The natural gas sector in Mexico was reformed in 1995 through an amendment of the Regulatory law of Constitutional Article 27 (the Gas Law) to allow private investment in new transportation projects and distribution, storage, and commercialization of natural gas. The law established principles for developing the country’s natural gas industry. Putting these principles in practice required creating a regulatory framework that specified the organization, operation, and regulations of the industry. Such a framework was designed in 1995 and presented in the Reglamento de Gas Natural. It explicitly took into account noncompetitive conditions in production since Petróleos Mexicanos (Pemex) would keep its statutory monopoly in gas exploration and production, and focus on increasing natural gas production and maintaining its existing large transportation network of more than 9000 kilometers (see Fig. 11).¹⁴

Fig. 11

Natural gas transportation network of Mexico

A new regulatory institution, Comisión Reguladora de Energía (CRE), was created in 1993 to provide limited regulatory oversight of private investment in power generation.¹⁵ The CRE’s mandate was expanded and clarified in 1995 in tandem with the natural gas reforms. Since then, the CRE has ample regulatory powers in the natural gas industry, including attributions to regulate prices, and grant distribution and transportation concessions.