On April 12, 2018, King & Spalding, alongside the Mexican law firm Gonzalez Calvillo, hosted its quarterly Energy Forum in Houston, Texas. Attended by approximately 100 guests, the Energy Forum featured three panels of experts ranging from banking experts and project developers to Mexican government officials.
Infrastructure Opportunities in Mexico
The Energy Forum kicked off with a presentation from consulting firm Wood Mackenzie. Michel Muylle, the Director of Downstream Consulting, succinctly described the need for additional Mexican midstream energy infrastructure. Following the presentation a panel discussion was moderated by Enrique González Calvillo, partner at Gonzalez Calvillo where many of the details of Mexican infrastructure, both the positives and negatives, were presented in great detail, including specific opportunities presented by Tania Rabasa, head of deal structuring at CFEnergía. However, one statistic resonated most clearly with the audience: at full capacity, Mexico has enough storage space to fill the country’s hydrocarbon needs for a mere three days. In comparison, the United States has more than thirty days’ of storage capacity to meet its needs for hydrocarbons. The scarcity of storage space, combined with the energy reforms of 2013, has attracted the interest of foreign investors seeking to develop much-needed storage and related infrastructure projects.
Despite the opening of the upstream energy market and the award of numerous blocks to foreign investors, it is expected that the production of hydrocarbons will not increase in the next 5 years since most blocks require exploration efforts that will not materialize immediately. The production of natural gas will also decrease but the demand for natural gas and petroleum products will increase, which means that imports of these products will also increase. There is an immediate need for an increase in storage capacity and further infrastructure investments in pipelines. Investors looking for opportunities may find that as infrastructure develops the demand for additional projects will increase, not decrease.
But, despite the clear and immediate need for increased infrastructure, there are political and social obstacles that must be on the forefront of any developer’s mind when considering a Mexican infrastructure project. Hydrocarbon transportation and storage projects often create political and social issues. Gasoline is expensive in Mexico and prices are no longer subsidized by Pemex so politicians use such issues to attack the energy opening. Additionally, storage areas and pipelines may be in environmental or socially protected areas. It is necessary to understand the social impact and obtain the appropriate assessment to ensure a smooth development of any midstream project.
Structuring Financing and Implementing Infrastructure Projects
After the first panel discussion related to the needs for midstream infrastructure and an overview of some of the high level public issues with developing Mexican infrastructure, the second panel brought to light some major considerations related to ‘getting the money’ to get the deal done. Moderated by Ken Culotta, partner in King & Spalding’s CFI group, the panel represented commercial lenders, construction attorneys, consultants and financial advisors.
The primary discussion addressed how to get projects financed for Mexican energy infrastructure. Similar to any domestic project financing arrangement, international project finance is unique and must be judged on the individual merits of each project. However, the panel tried to discuss some key themes that help make projects more financeable in Mexico.
First, lenders want to see higher levels of equity in the project than in comparable US domestic projects. As the cost of capital (especially on international projects) is higher than equivalent amounts of debt, the project lenders view additional equity as a sign of vetting by outside investors and, therefore, additional equity signifies a more attractive (financeable) opportunity. Second, lenders also require tight EPC contracts that minimize the risk of construction. Finally, the expectation is that the project is more advanced when the request for debt capital is made, than on a domestic project. It is expected that land rights and permits have been secured and that binding agreements on the terms of the offtake have been reached (storage or purchase and sale of fuel products) before a financing decision is made.
A central component of any development project is the quality of customers that help monetize the project. A central analysis of a lender will be the quality of the third parties off taking the product from a storage facility, for example, or storing product in the facility. However, there is an inherent contradiction that arises when analyzing the quality of the customers of many of these infrastructure projects. Lenders often look to see high quality long term contracts and the projected profitability of the project. But, those often work in opposition of each other, that is, the longer the term of the customer contract, often the less profitable for the project developer. This balance must be managed in the context of the project development.
While the panel also mused on the looming Mexican presidential elections, the overall consensus was that this should not be a deterrent to future projects. The energy reform cannot be amended by the President because it would require an amendment of the Constitution. It is likely that there will be a delay in decision making but the need for new energy infrastructure will not go away.
Mexican Regulatory Issues
The last panel of the Energy Forum, moderated by Vera De Brito de Gyarfas featured a discussion of the Mexican regulatory environment with a panel that included two high ranking officials from the Mexican regulatory bodies, Comisión Reguladora de Energía (CRE) and El Centro Nacional de Control de Energía (CENACE). The massive shift after the 2013 constitutional energy reforms in Mexico resulted in the creation of a regulatory structure that was previously non-existent. Regulations that in the US have developed over decades needed to be created immediately in Mexico. The general consensus is that Mexico’s regulatory environment has made tremendous strides since the opening of the energy industry.
Meney de la Plaza, head of Natural Gas at CRE, which is in charge of regulating all aspects of natural gas except exploration and production done by Comision Nacional de Hidrocarburos (CNH), emphasized that the unbundling of services and elimination of price regulations have ensured market liberalization and fairness to the participants. CRE’s primary focus has been on legal certainty, removal of barriers to entry (open access) and the publication of information.
Dr. Cesar Hernandez Ochoa explained how CENACE has had a key role in the liberalization of the market. CENACE’s opinions based on deep analysis of the energy market have resulted in fundamental amendments to existing regulations to avoid the consolidation of resources in the hands of a few participants.
Finally, Diana Pined and Paulina Poo, two Mexican attorneys from Gonzalez Calvillo, discussed regulatory issues such as the newly enacted Public Policy on Minimum Storage of Petroleum Products, which requires commercial minimum inventories of 5 days of sales in 2020, 9 days in 2022 and 13 days in 2025. Paulina focused on environmental aspects and concluded that the balancing of the needs of the community stakeholders, investors and political climate are all central to implementing new infrastructure projects in Mexico.
One of the main conclusions of the Energy Forum is that the Mexican energy infrastructure market is just beginning to develop and there are countless opportunities to successfully implement transport, storage and terminal projects; provided that regulatory, social, economic and financial aspects are carefully analyzed and addressed.