1. Mexico Energy Reform: Opportunities and Challenges
Miranda Ferrell Wainberg, Senior Advisor

2. Mexico’s Transformative Energy Reform 2013-2014
Three articles (25, 27 and 28) of the Mexican Constitution were amended
16 new laws created
12 existing laws modified
8 enabling laws published
Guidelines, procedures and standards are being prepared
Private investment allowed in oil and gas exploration and production for the first time in 75 years
Gas imports by pipeline from US accelerated
Pemex to transfer gas pipeline assets to system operator CENAGAS
Generators can sell into wholesale power market and/or directly to customers
T & D system to be operated by ISO CENACE
35% of power generation from clean sources by 2024
Clean Energy Certificates to ensure investment beginning 2018

3. Energy Sector Framework
Source: Analitica Energetica S.C. December 2014

4. Upstream Sector
(Oil and Gas Exploration and Production)

5. Private Investment Allowed in the Upstream Sector WHY?
3P & Prospective Reserves (Billion BOE)
Substantial Resource Potential
Falling Oil and Gas Production
Sources: JP Morgan 2/9/15; U.S. EIA

6. Private Investment Allowed in the Upstream Sector WHY?
Pemex Duty and Taxes
Pemex Net Income
Underinvestment by Pemex due to high fiscal burden – 53% of total revenue in 2013
Source: JP Morgan 2/9/15

7. Private Investment Allowed in the Upstream Sector WHY?
Pemex Proved Reserves Replacement Rate
Pemex inability to replace production
Source: JP Morgan 2/9/15

8. Private Investment Allowed in the Upstream Sector HOW?
Round Zero – August 2013
CNH granted Pemex 83% of Mexico’s proved & probable reserves and 21% of prospective resources
Majority of the resources are in southeastern shallow waters
42% of deep water prospective resources were granted to Pemex
The CNH will conduct bidding rounds for investments in the remaining 17% of 2P resources and 79% of prospective resources
Round Zero balances the resources Pemex will operate and those resources which the State will manage and grant by subsequent bidding rounds.
Source: CNH

9. Private Investment Allowed in the Upstream Sector HOW?
109 fields or 14.6 billion BOE in prospective resources including 22% in deep water; 61% in Chicontepec; 5% in onshore, shallow water, and heavy oil fields; 1% in unconventional gas
60 fields or 3.8 billion BOE in 2P reserves including 71% in Chicontepec and other nearby unconventional fields
Bids open to Pemex as well as domestic and foreign private companies and other NOCs
SENER expects Round 1 to attract $50.5 billion in investment by 2018 or about $12.6 billion per year
Source: CNH

10. Private Investment Allowed in the Upstream Sector
Round 1 Bidding Processes
Source: CNH

11. Private Investment Allowed in the Upstream Sector HOW?
Initial Tender: 23 fields (19 contracts) of 169 Round 1 fields
14 shallow water exploration contracts (PSCs) with prospective resources of about 11 billion BOE
Province accounts for 80% of Mexico cumulative production
Bids due and winners announced July 15, 2013
5 shallow water development contracts (PSCs)
Low production costs
Bids due and winners announced September 30, 2015
Source: CNH

12. Private Investment Allowed in the Upstream Sector HOW?
In addition to Round 1, Pemex initially plans to farm out six shallow water fields with estimated potential of 1,097 million boe and requires $12.5 billion of investment. Additional farm outs are expected in 2015.
Source: CNH

13. Potential Investment Capital from Private Investors
Private investment in the upstream sector from 2015 to 2020 could be $56 billion or 45% of total oil and gas sector private investment
Source: Marcos y Associados 2/15

14. Mexican Upstream Sector Reform
Opportunities
Challenges
Substantial investment opportunities for companies in all phases of hydrocarbon exploration and production
Tax revenues from non-Pemex investors should reduce the Pemex fiscal burden while contributing to a public budget that relies on oil and gas production for 33% of its revenues
Increased production from Mexico will enhance North American oil and gas security
Post-reform Mexico’s GDP expected to grow at % annually compared to 3.3% pre-reform
Low oil prices
Very aggressive timing
Security
The fledgling CNH has new and expanded responsibilities with tight deadlines – is it up to the task?
Safety and environmental regulation and enforcement is the responsibility of a brand new and inexperienced agency
Industry has many concerns about the PSCs in Tender 1
Minimum national content of 25% required in 2015 increasing to 35% by 2025 in a country without a developed oil services industry

15. Natural Gas Midstream Sector (Pipelines, Processing & Storage)

16. Gas Imports By Pipeline From US Accelerated WHY?
Gas Production Vs. Gas Consumption
Impact of Gas Shortages on Quarterly GDP
Source: BCG 4/2014
Source: JP Morgan 2/9/15
Natural gas consumption, especially in the power sector, continues to grow while production declines
Shortfalls have been met by gas pipeline imports from the US and LNG

17. Gas Imports By Pipeline From US Accelerated WHY?
Natural Gas Share in Electric Generation
Electric Generation by Fuel, 2027
Natural gas demand from electric generators will continue to grow as more expensive fuel oil is displaced
Initial domestic production focus post-reform is oil and US natural gas is currently abundant and inexpensive
Natural gas is considered a “clean fuel” by Mexico and is important in meeting the country’s emissions targets
Source: JP Morgan 2/9/15

18. Gas Imports By Pipeline From US Accelerated HOW?
Total gas midstream investment for cross-border and domestic infrastructure could reach $34 billion by 2020
Source: RBN Energy

19. Gas Imports By Pipeline From US Accelerated (Import Now, Domestic Production Later)
Agua Dulce-Frontera and Los Ramones Phase 1 began operation in Dec with 2.3 Bcf/d capacity expandable to 3 Bcf/d
A $935 million contract was awarded by Pemex to Brazil’s Odebrecht and others for construction of Los Ramones Phase 2 to be complete in 2Q 2016 with capacity of 1.4 Bcf/d
Construction contracts for three connecting pipeline projects moving up to 1.4 Bcf/d of Permian Basin gas from West Texas to CFE power plants were awarded in early 2015
The Sonora Pipeline which will carry MMcf/d to several CFE power plants is under development by Ienova (Sempra)
These projects alone will add 3.9 Bcf/d of gas export capacity (gas exports in 2013 were 1.8 Bcf/d)
Source: RBN Energy

20. Domestic Natural Gas Infrastructure Requires Expansion
Current domestic infrastructure has limited capacity and coverage. The center, west and Baja California lack capacity. Much capacity is old – 20 years plus – many bottlenecks.
From natural gas demand more than doubled but the gas pipeline system grew by only 19%.
Since Nov Pemex has issued 35 critical alerts which pause imports and limit national gas supply.
Estimated losses due to pipeline limitations were $1.4 billion in 2012.
Substantial investment in domestic gas infrastructure is required.

21. Expansion of Domestic Gas System
The gas midstream sector has been open to private investment since 1995
Significant new non-Pemex open-access transportation has not been significant due to Pemex domination of the gas pipeline system and its limited capacity
Under the reform Pemex and CFE must transfer their gas pipeline assets to a new independent regulator, CENAGAS. CRE ordered the Pemex asset transfer in February 2015.
CENAGAS will operate the existing gas pipeline system and will ensure safety and equal access for transportation as well as permit new infrastructure and establish transport rates. New projects will be tendered through open seasons.
These measures should help stimulate new private investment approaching $21 billion in natural gas infrastructure

22. Natural Gas Midstream Sector
Opportunities
Challenges
Substantial investment opportunities for private companies in cross-border and within Mexico midstream infrastructure
The removal of Pemex from the gas transmission and distribution will allow new marketing companies to emerge bundling pipeline capacity and the gas commodity
CENAGAS to ensure open access to pipelines creating a more level playing field for investors
Pemex initial capacity reservation contracts could result in continued Pemex dominance of the mid-stream, at least in the short term
CENAGAS is a new and inexperienced regulator
Uncertain timing of the build out of the domestic Mexican infrastructure which is critical for a robust market

23. Electric Power Sector

24. Why Reform the Electric Sector?
Electric Rates Mexico vs. US (cents per Kwh)
CFE Historical Net Income (pesos billion)
Sources: SENER, JP Morgan 2/9/15
Electric rates are high and uncompetitive, especially for industrial customers
Negative impact on Mexican manufacturing sector and country GDP
Underinvestment by CFE due to budgetary constraints and the company’s financial losses. Heavy subsidies for residential and agricultural customers and huge distribution losses (20.8% - almost triple the OECD average) contribute to the losses.
Capacity growth has significantly lagged demand growth. Transmission and distribution networks are old (30% are past their useful life spans) and inefficient creating major bottlenecks in the system.

25. The Post-Reform Mexican Electric Sector
CFE has two years to separate its generation function from its transmission and distribution function
Generation is open to private investors who can sell to a new wholesale power market or directly to qualified end users whose consumption is greater than 3MW*
CFE T & D grid will be operated by CENACE, a new ISO, which will dispatch generation based on lowest cost, guarantee open access to the T & D grid and run the wholesale market
Private investors will be able to contract with CFE to build, finance and operate T & D networks
Should stimulate significant private investment in both generation and transmission and distribution
With the participation of more efficient private investors electricity rates should fall
*Since 1992 private participation has been allowed but all surplus power had to be sold to CFE, limiting the attractiveness of the IPP model.

26. Mexican Electric Power Sector
Opportunities
Challenges
Substantial investment opportunities for private companies: $50 billion from per SENER
Growth of the wholesale electricity market should generate opportunities for marketing and trading firms
Competition in all sectors of the power value chain should lead to lower electric rates
Mexico will become more attractive to industries with adequate electricity supply and lower rates
CENACE is a new, inexperienced agency
Initial CFE capacity reservations could dominate T & D system
SENER must craft a “never done before in Mexico” legal regime which will ensure open access to the T & D networks
Residential and agricultural subsidies – do they continue?
Timing of electricity rate reductions- infrastructure construction is multi-year
Security/theft

27. Renewable Energy Sector

28. Pre-Reform Renewables Sector
Robust legal framework in place to promote renewables: 2008 Law for the Application of Renewable Energy and Financing the Energy Transition; 2012 General Climate Change Law and 2013 National Climate Change Strategy
In 2013 renewables accounted for 24% of installed generation capacity and 14% of gross generation
Mexico has aggressive targets in terms of reducing power generation from fossil fuels and lowering greenhouse gas emissions:
In 2013 fossil fuels accounted for 82% of gross generation. The target is 65% by 2024 with 35% of generation coming from “clean sources.”
Emissions reductions targets: 30% by 2020 and 50% by 2050

29. Post-Reform Renewables Sector The “Clean Energy” vs
Post-Reform Renewables Sector The “Clean Energy” vs. Renewables Controversy
Reform Objective: Promote the use and development of “clean energy”
Under the 2014 Law of the Electricity Industry “clean energy” includes renewables (hydroelectric, wind, solar, geothermal, biomass) as well as efficient cogeneration, nuclear power and other low carbon emission technologies which could include highly efficient fossil fuel-based generation
The renewables industry is concerned that renewables will not be able to compete with less expensive natural gas, especially current “cheap gas” from the US
Others argue that natural gas is complementary to wind and solar by providing a back-up to these intermittent resources
H Costs for Mexico Selected Technologies Unsubsidized ($/MWH)
Source: Bloomberg New Energy Finance 2/2015

30. Post-Reform Renewables Sector Clean Energy Certificates (CECs)
The objective of the CEC program is to incentivize the private sector to invest in clean energy by providing an additional revenue stream for investors, thereby improving the investment’s attractiveness and competitiveness
Beginning in 2018, Clean Generators will receive CECs for each MWH generated without fossil fuels; when fossil fuels are used, the CEC is multiplied by the non-fossil generation percentage of the facility’s total generation
The following entities will be required to purchase CECs: suppliers and distributors that sell electricity to end users; qualified users that consume at least 3 MW in year one of the program, 2 MW in year two and 1 MW in year one and end users who generate or import electricity for their own use without using the national T & D grid
The initial requirement for power users to purchase CECs is 5% of electricity consumed which corresponds to Mexico’s target for clean generation by The requirement will be reset annually by SENER based on its estimates of the costs of achieving Mexico’s policy objectives regarding clean energy
SENER’s estimating procedures put a priority on low costs over low emissions given the goal of reducing electricity prices

31. Forecast Growth of the Renewables Sector
SENER forecasted that about $41 billion of investment in renewable generation is required between 2013 and 2027
This investment results in renewables (hydroelectric, geothermal, wind, solar and unidentified new clean technologies) accounting for about 30% of installed capacity and 20% of gross generation in 2027
Wind and hydroelectric power represent 79% of the renewables installed capacity
For Mexico to meet its 2024 goal of 35% of generation from clean sources, additional investment in renewables is required and/or nuclear and gas-fired generation will make up the difference
Source: SENER

32. Renewable Energy Sector
Opportunities
Challenges
Mexico’s emissions reduction targets and clean energy generation targets create a significant space for renewable energy investments
Mexico’s geothermal potential is large (2310 GWe) and CFE has not had the capital to develop. Sector could grow by 40% by 2020.
CECs will enhance the economic attractiveness of renewables investments
Inexpensive natural gas imports from the U.S. could be a serious competitor for renewables, at least initially
CECs do not come into effect until 2018
The preference for low costs over low emissions could hurt renewables in the short term

33. Mexico Energy Reform
Bold and Transformative Vision of the Mexican Energy Sector
The Execution Risks Should Not Be Underestimated
Multi-year Process to Achieve Reform Objectives-Manage Expectations