Mexico’s Gas Import Tariff: Roadblock to Investments and Recovery

George Baker

exico is seeking to attract private invest- M ment in electric power generation and natural gas distribution. This goal is comple- mented by its Clean Air Act, which becomes effective in 1798.

There is an important p o k y obstacle that must be overcome before either of these goals will be attainable. At present, Mexico imposes a 6- percent tariff on natural gas imports, an amount that translates into roughly a 100-percent tariff on transportation rates that would be charged to bring South Texas gas to Mexico. How does 6 percent on the commodity become 100 percent on the transportation? The transportation cost between the Houston Ship Channel and the south Texas border is roughly 7 cents a thousand cubic feet; from the border to Monterrey, the tariff is approximately 5 cents a thousand cubic feet-for a total of 12 cents a thousand cubic feet. At a wellhead cost of $2.00 a thousand cubic feet, a 6- percent tariff on the natural gas itself doubles the transportation tariff from the United States.

This matter should be decided in the NAFTA review process, during which an acceleration of the reduction of the tariff nationwide can be considered. However, the concern is that such a negotiation process will take an additional year to implement. Meanwhile, the viability of Mexico’s energy policy and the outlook for environmental gains from a greater mix of natural gas in industrial fuel supplies are in doubt.

Background In 1992, during NAFTA negotiations, tariff

negotiators agreed to reduce all tariffs between Canada, the United States, and Mexico on one of

George Baker is director of Mexico Energy Intelli- gence, Houston.

four schedules: (1) immediate elimination, (2) five-year reduction, (3) ten-year reduction and (4 ) 15-year reduction. In addition, there would be annual reviews during which time any item’s tariff reduction schedule could be either put on “standstill” or accelerated.

At that time, Mexico had a 10-percent tariff on natural gas imports. Negotiators agreed to put natural gas on a ten-year tariff reduction schedule. At that time, the activities of gas transportation and storage were reserved exclu- sively to the state. Private gas distribution, mainly to residential markets, existed in only a few northern cities. At present, the gas import tariff is 6 percent on the commodity.

During 1975-1796, the Mexican government took unilateral steps to open the areas of natural gas distribution and storage to private investment. The government’s purpose in doing so was mainly to stimulate private investment and financing in electric power generation, which had been held up by the requirement of lenders that private power plants needed at least an alternative to PEMEX in its gas s~ipply. (The government had passed its Private Electric Power Act at the end of 1792, but it was not until the spring of 1796 that financing for the first such project was con- cluded-and then only with the intervention of the US-Exim Bank.) In early December 1974, the Mexican government formally announced the terms of the Clean Air Act for major metropolitan centers. In effect, the law requires users of Pemex’s high-sulfur (3 percent) fuel oil to switch to natural gas by January 1, 1998.

Natural Gas and the Outlook for Mexican Economic Recovery

Natural gas has a special meaning in the outlook for Mexican economic recovery from the

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peso crisis that unexpectedly seized Mexico (and the United States Treasury) in late December 1994. The Mexican government visualizes an increase in the international competitiveness of Mexican manufactured goods by means of introducing the efficiencies of market competition in natural gas transportation and distribution. The principle is sound: As competition between suppliers of natu- ral gas emerges (at present, PEMEX is the sole supplier) and as competition between energy sources takes force (at present, LPG dominates the residential market, and fuel oil dominates the industrial and power markets), there will be important economic and environmental gains (Exhibit 1). With the emergence of real compe- tition, prices for the delivery of energy products will decline (Exhibit 2).

Monterrey, the industrial capital of Mexico, will be the first and most important city in Mexico to feel the effect of the tariff. Most observers believe Mexico's pro-natural gas energy policy must succeed in Monterrey if it is to succeed at all. The future competitiveness of Mexican manufac- tured goods in world markets will depend in large measure on the competitiveness of the output of Monterrey manufacturers. Monterrey manufactur- ers therefore will be disadvantaged to the extent that their sources of energy supplies are restricted in both price and environmental quality.

In this way, by putting investments in gas

transportation pipelines at risk (by making im- ported gas noncompetitive with PEMEX's do- mestic supplies), the Mexican government is jeopardizing private investments not only in natural gas infrastructure, but also in electric power generation.

PEMEX also pays the tariff on natural gas imports, but the charge is not passed on to the industrial or residential consumer, who buys at fixed regional prices. The tariff's effect on the customer for PEMEX-imported gas is therefore zero. In contrast, the tariff's effect on the same customer of gas imported by a private company would be an additional pass-through cost. The result is that the Mexican company is penalized by using a non-PEMEX supplier by the value of the tariff. As a result, PEMEX remains the sole natural gas supplier to Monterrey, and the entire set of efficiencies to have been gained by opening Monterrey and other industrial cities to competitive gas supplies is in suspense. In addition, the U.S.-Mexico border region will pay the environmental opportunity cost of forego- ing investments that would have an environ- mental efficiency gain.

The closest source of natural gas in indus- trial quantities is found in south Texas, approxi- mately 100 miles from Monterrey. In the past, PEMEX has had limited production of dry natu- ral gas in the Burgos Basin in the neighboring

MAY 1997 NATURAL GAS 0 1997 John Wiley & Sons, Inc.

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state of Tamduhpas, but existing production of about 300 million cubic feet a day is insufficient to meet the current Monterrey demands, much less the expected future demand.

By providing relief on the import duty, Mexican consumers in Monterrey will gain en- vironmental benefits, and it will still be possible for the Mexican environmental authority (PROFEPA) to insist on the original schedule for compliance with the 1994 Clean Air Act.

Recognizing the importance of the potential natural gas market in Monterrey, a number of international companies have offered to make investments in gas pipelines to this region to make possible alternative sources of energy for Monterrey industrialists. The financial feasibility of such investments, however, is put in doubt by the existence of the import tariff, the value of which is roughly equivalent to doubling the transporta- tion price of gas from the Houston ship channel to Monterrey. Expressed this way, from the stand- point of the key Monterrey market, there is an import tariff on natural gas transportation in the neighborhood of 100 percent.

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Agenda Item for NAFTA In early 1996, in preparation for the annual

review of the NAFTA tariff schedules, negotia- tors discussed Mexico’s natural gas import tariff as an item for possible accelerated reduction. The Mexican position was that, in exchange for a reduction on the gas tariff, the U.S. side needed to accelerate the tariff reduction sched- ule on certain products of interest to Mexican producers (tomatoes and brooms were two products, among others, that were mentioned). Because the U S . side was unwilling to accept the principle of reciprocal tariff reduction in the matter of natural gas, the item did not reach the formal agenda of the NAFTA negotiators when they met in the summer. At present, negotiators have not taken up the matter of the natural gas tariff for the annual NAFTA review that will take place in the summer of 1997.

Meanwhile, President Clinton has sched- uled a visit to Mexico City for May. He should be encouraged to ask that Mexico’s tariff on natural gas imports be included in the upcoming NAFTA review process. H

NATURAL G A S MAY 1997 0 1997 John Wiley & Sons, Inc.