PETROCHEMICAL PLANT SALES TO KICK OFF MEXICAN PETROLEUM PRIVATIZATION

Mexico's petroleum sector privatization is getting under way in earnest. Previous halting efforts have yielded to a fresh round of privatization. That begins this month with the first sale of interests in petrochemical complexes operated by state owned Petroleos Mexicanos (Pemex).

Also on the drawing board are efforts by the government to open the country's downstream natural gas sector to private investment. The regulatory framework for this program is expected to be unveiled this month as well.

At the same time, plans are proceeding for the sale of electrical power plants in Mexico. It's an effort deemed vital to success of the country's energy privatization efforts (OGJ, June 26, p. 30).

While Mexico's previous limited efforts at petroleum privatization fell by the wayside, these new efforts are given urgency by economic necessity in the financially beleaguered country.

The government is anxious to see the first auction of petrochemical interests fare well, viewing it not only as a litmus test for future petroleum privatization but also as a barometer of Mexico's overall foreign investment appeal.

It is unlikely the first sale of interests will come off without a hitch, given the extremely sensitive nature of privatizing anything in Mexico's petroleum sector. Some elements in Mexico fear this maiden effort will lead to a broader campaign to privatize Mexico's petroleum industry, even going as far as ownership of oil and gas reserves. That is a scenario Pemex and Mexican energy officials vehemently deny will happen (see Comment, p. 20).

Still, these first measures represent a remarkable change for a petroleum sector that has long been viewed as perhaps the most tightly closed to foreign participation in the Western Hemisphere.

In short, any opportunity for foreign investment in Mexico's petroleum/ energy sector offers tantalizing prospects for the petroleum industry worldwide.

PRIVATIZATION BACKGROUND

On the heels of one of the worst economic crises in the country's history, the Mexican government, led by President Ernesto Zedillo, has begun a second wave of privatization. The wave includes strategic sectors such as power generation, petrochemicals, natural gas, telecommunications, railroads, seaports, and airports.

The opening of those sectors to private investment will give a big lift to sagging federal coffers. More important, it will inject those key sectors with an infusion of capital they desperately need to lead the recovery of the whole Mexican economy.

The previous administration of President Carlos Salinas de Gortari started the first stage of this privatization process by selling a wide variety of government properties from banks to agrochemical giant Fertimex and telecommunications conglomerate Telmexant. However, it is widely believed that not until now has the Mexican government grown serious about shedding unnecessary responsibilities in order to concentrate on good governance.

Shortly after the "December mistake" that detonated the current economic crisis, Mexican Finance Sec. Guillermo Ortiz disclosed in New York plans by the government to sell $14.5 billion in government holdings.

Central to those plans are state owned petroleum/energy operations, a politically thorny but necessary focus because of the huge role Pemex plays in the Mexican economy.

To sell those assets, the government has had to make a number of changes in the country's laws: in 1992, a second reclassification of petrochemicals and a variety of changes to the Public Electric Energy Service Law; in 1995, an almost total transformation of the bylaws of Article 27 of the Mexican Constitution, which deals with oil and gas law; and several changes to the Foreign Investment Law.

In addition, Mexico's Department of Energy (DOE) is putting the final touches on constitutional bylaws governing the newly opened natural gas industry and the law that will transform the Energy Regulatory Commission (ERC) into a decentralized, independent body.

THE STARTING POINT

Pemex, which through its subsidiary Pemex Petroquimica Secundaria (secondary petrochemicals) controls the country's production of petro-chemicals, was expected to disclose by early November details of the first petrochemical bidding round.

Government sources say this will involve the massive complex at Cosoleacaque, the biggest producer of ammonia in Latin America and one of the largest of its kind in the world.

After Cosoleacaque will come the sale of interests in plants in the La Cangrejera, Morelos, and Pajaritos complexes. These complexes mainly produce ethylene and propylene derivatives.

By privatizing these and six smaller petrochemical complexes at San Martin, Tula, Escolin, Reynosa, Camargo, and Salamanca, the government expects to earn about $6 billion.

In all, Pemex operates 61 petrochemical plants at these 10 complexes.

According to data Pemex provided Mexico's congress, Pemex's secondary petrochemicals unit was valued at a total 16.6 billion pesos ($2.8 billion) as of June 30, 1995.

Total liabilities were estimated at 6.3 billion pesos ($1.05 billion), of which 1 billion pesos ($167 million) was short term debt and 5.3 billion pesos ($883 million) was long term debt.

Pemex's secondary petrochemicals unit posted first half 1995 net operating income before taxes of 1.3 billion pesos ($223 million) compared with a loss for the same period last year.

RESISTANCE TO PRIVATIZATION

In its efforts to privatize petrochemicals, the government has faced fierce resistance from unions, opposition parties, and some industrial firms represented under the umbrella group National Chamber for Industrial Transformation.

These groups' main arguments against privatization are:

It would endanger national sovereignty and a huge sector of Mexican industry as a result of elimination of subsidies.
There is no comprehensive legal framework to support the auction process.
There are fears the petrochemical plants might be bought by big foreign firms that would prefer to shut them down in order to import those products at higher prices.
There is danger of massive job losses. Currently, about 40,000 persons work in Pemex's petrochemical industry.
There could be little room for compromise with new owners with regard to environmental preservation.

The government insists all these fears are groundless and has promised these measures to facilitate the transition:

Pemex will continue to be a shareholder in new companies established to own the petrochemical interests, with participation of one third to one fifth of total capital. How long it will retain those interests remains a question. The interests are likely to be short term, possibly tendered to the public on the stock exchange after a predetermined period.
The other participant in a privatized venture must, upon winning its bid, prove it has enough resources to guarantee development and growth of the business it acquires. The winning bidder will serve as plant operator.
Pemex Petroquimica Secundaria's assets will be sold in international bidding. This guarantees participation by all interested parties as long as they meet the standards set by the government commission in charge of the auction. There will be no limits on foreign ownership, other than Pemex's initial shareholding.
Composition of the company or companies that are winning bidders can change as long as the control of the complex remains in qualified hands.
The new owners must respect all previous contracts signed between Pemex Petroquimica and its workers affiliated with the powerful Syndicate de Trabajadores Petroleros de la Republica Mexicana. These collective contracts were renegotiated this year to be extended for another 2 years.
The main contracts signed by Pemex Petroquimica and its clients--about 300 that represent more than 80% of all of its sales--will be transferred to the new entities in charge of the complex.
Pemex Petroquimica will conduct periodic environmental audits to ensure the petrochemical complexes meet current official environmental standards.

PROSPECTIVE BUYERS

The list of companies interested in buying Pemex plants includes big international players in the chemical industry and some smaller Mexican companies.

Among them are BASF, Hoechst, Mitsui, British Petroleum, Royal Dutch/Shell, Exxon, Repsol, Dow Chemical, and Praxair, along with the Mexican companies Alfa, Cydsa, Girsa, Idesa, Primex, Agronitrogenados, and Ferquimex.

The government has made clear it will encourage participation of Mexican firms. However, some grumbling has arisen among private Mexican petrochemical producers. They contend the structure of the tender process all but rules them out as individual bidders.

The government plans to sell the petrochemical plants in 10 lots, corresponding with the number of complexes, to preserve the benefits of scale and proximity.

However, this approach puts off many potential bidders that could afford individual plants but not groups of plants, much less entire complexes. Many of those companies don't have enough capital to participate alone in bidding for the petrochemical assets. That is certain to lead to formation of several joint ventures, likely dominated by multinational companies.

At the same time, while the government has outlined its policy on petrochemical privatization, prospective buyers still are not able to conduct studies needed to underpin their bids.

That's because Pemex has not completed reports in three crucial areas related to the petrochemical privatization: technology/operations, labor regulations, and environmental impact assessment. All three reports are expected to have a negative effect on appraising the value of Pemex's petrochemical assets.

Even so, some private companies are lining up joint venture deals to invest in Pemex secondary petrochemical units. BASF Latin America Pres. Eggar Voscherau said his company is interested in investing in the La Cangrejera and Morelos complexes in Veracruz and may sign a joint venture deal with Alfa to pursue this investment.

Dow Quimica Mexicana Legal Director Victor Bermudez said his company will bid solo for assets at La Cangrejera and Morelos.

La Cangrejera and Morelos are expected to attract most of the bidding because they mainly produce ethylene. Cydsa, Resistol, Idesa, Alfa, and Celanese are considering a joint venture to bid for assets at the two complexes.

Meantime, Grupo Primex has set its sights on the Pajaritos complex, which produces vinyl chloride monomer, to strengthen its production line for PVC resins and plastics.

WHY SELL?

The government and most national industry leaders believe the Mexican petrochemical market has great growth potential.

That in turn can lead to a surge in exports, which will bring much needed foreign exchange hard currency into the Mexican treasury.

However, growth means significantly stepped up investment-- something totally out of reach for Pemex, especially with its current urgent capital needs focused heavily on oil exploration and development.

Official estimates show the Mexican petrochemical industry will require a total investment of at least $5 billion during the next 5 years to meet international production standards under tighter environmental rules.

"The fiscal adjustments and the changes made (during the last decade) to the country's economic strategy led to modifications on price subsidies and government investment plans," said Pemex Chief Executive Officer Adrian Lajous. "Pemex was no longer able to cope with growing petrochemical imports, made at much higher prices than the ones it was permitted to offer in the domestic market. This inevitably led to the end of the Pemex monopoly on the petrochemical market."

However, he added, the lack of integration of the petrochemical chain, caused by artificial barriers between public and private producers, forced a series of reclassifications of basic and secondary products. The idea was to attract foreign investment in petrochemicals but within a limited scope. The strategy failed to revitalize the industry.

In light of this, in October 1992 Pemex decided to privatize all its petrochemical complexes. Only the production of eight basic petrochemicals--ethane, propane, butane, pentane, hexane, heptane, naphtha, and carbon black feedstock--is to remain in state hands.

PRIVATIZATION OBJECTIVES

The privatization of petrochemicals--that was scheduled to begin this month and may be complete by the end of second quarter 1996--aims to:

Facilitate development of a world class, competitive Mexican petrochemical industry.
Attract private investment to the national chemical industry in general.
Maximize government gains from the sale of Pemex assets.
Achieve a clean, short, simple privatization process to send the right message to future foreign investors.
Give buyers the opportunity to rearrange and rationalize these assets to better meet their economic and strategic goals.

However, most companies interested in acquiring the complexes are not very sure about the context under which privatization will take place. They worry about how to deal with the strong oil union, which has inherited the reputation of its predecessors as a breeding ground for poor operating efficiency.

On file other hand, there remain doubts about Pemex's capability of keeping control over the petrochemical interests that will remain in government hands.

Finally, the question remains as to who will assume responsibility for the many debts Pemex has acquired in the last 30 years as a result of labor disputes and environmental damage.

ON THE RIGHT TRACK

The government, represented by DOE, is promoting several legislative reforms to assure the success of this privatization.

Last March, Energy Minister Ignacio Pichardo disclosed reforms to Article 27 of the Mexican Constitution to liberalize all commercial activities related to natural gas, except exploration and production, which remain Pemex's responsibility.

Because of these changes, private companies will be able to market, transport, store, distribute, and import and export natural gas. The government says this will assure gas supply for petrochemical feedstock and industrial fuel.

These reforms allow for the unfettered import of natural gas. However, exporting Mexican gas will require a permit from the Trade Ministry to guarantee adequate domestic supply of natural gas.

Mexico's new gas regulatory regime, first disclosed in July 1995 and still undergoing revision, will outline the private sector's degree of participation in gas storage, distribution, and marketing. A final draft is expected to be released this month.

In the meantime, the natural gas regulatory framework is under review by analysts, businesses, financial institutions, end users, and legislators who will submit suggestions to the Energy Regulatory Commission.

Pichardo has made it clear that Pemex will retain control of the country's main gas transmission lines but will sell its two local distribution companies in Queretaro and Mexico D.F. states.

Licenses to be granted for transportation, storage, and distribution are expected to cover a 30 year term, with the possibility of exclusivity in routes and territories for 5 years.

The new regulatory framework proposes some variable controls designed to encourage competition. These include the freedom to import gas, the obligation to provide a predetermined service without forcing a customer to take additional services, free access by third parties to storage and transportation systems, unbundled services, regulatory oversight of prices and contracts in direct sales between producers and transporters, and tariff limits in transportation, storage, and distribution services.

The end user price will be deregulated and indexed to market conditions. As sole producer, Pemex will continue to set prices for gas and gas products.

POWER PRIVATIZATION

The opening of Mexico's natural gas industry had its roots in the same initiative that led to liberalization of the power generation sector, which began in 1992.

The government expects changes made to the Public Electric Energy Service Law--which allows private participation in electric power generation, including cogeneration and small power production--will promote private investments of about $13 billion.

CFE, the state electricity monopoly, in coming months will sell several power plants, among them Rosarito and Samalayuca. The government expects to earn about $6 billion from these transactions.

The government plans to issue a tender for sale of the 440,000 kw Merida III power plant on the Yucatan Peninsula.

OTHER PRIVATIZATION?

There have been reports that if the petrochemical sector privatization is successful, such an effort also could spread to refining, which Lajous has denied.

Even though officials insist this new wave of privatization in the energy sector responds only to very specific requirements of the nation's petroleum industry, some analysts believe it marks the beginning of the long awaited opening of the upstream oil and gas sector.

There is an upstream precedent on the service contractor side. Some turnkey drilling programs have been undertaken in the Bay of Campeche by foreign drilling contractors. In addition, local firm Cia. Perforadora Mexico recently won the first private contract for onshore drilling in Mexico, in southern Tabasco state.

Could oil and gas exploration and production by private companies be on the horizon?

Francisco Curl, head of the Chamber of Deputies' Energy Commission and member of the leftist PRD party, thinks this possibility is still remote because of the upstream sector's economic allure. "Oil exploration and production are still highly profitable activities for the state," he said. "Oil will continue to be a strong support of national economy."