BMI View: We have largely maintained our forecasts for Mexico's power sector this quarter, and continue to hold the view that numerous industry-specific and macroeconomic fundamentals will converge to drive long-term growth - particularly the country's efforts to access greater volumes of cheap US gas. That said, we have grown more cautious with regards to the country's near-term economic trajectory, and also reiterate that the main risks to our forecasts stem from delays to bringing critical midstream infrastructure online, as well as uncertainty with regards to government efforts to push through energy sector reform.
Despite the fact our Country Risk team has downwardly revised its real GDP growth forecast for Mexico to 2.3% and 3.5% for 2013 and 2014 respectively (from 3.0% and 3.9%) we have largely maintained our positive forecasts for Mexico's power sector this quarter. While the slowdown has been attributed to weaker-than-anticipated growth in the country's manufacturing sector, and there have been delays to public spending (brought about by the arrival of President Pena Nieto's administration in December 2012, which disrupted the execution of budget matters in H113), we reiterate that Mexico's still-relatively strong manufacturing sector, increasingly strong private consumption and favourable demographics will continue to drive power sector growth - as will efforts to access cheap US gas.
As such, while we remain cognisant of the risks such a slowdown poses to our near-term outlook for electricity generation and consumption, we still expect power generation to grow at an annual average of 4.5% between 2014 and 2022 to reach 416TWh - based on the country's ambitious capacity expansion plans, strong demand growth and the fact that the sector will have to open up to yet greater private investment to support economic expansion.
|Having A Gas|
|Mexico - Growth In Natural Gas-Fired Electricity Generation, 1990-2017|
Gas-Powered Growth Comes With Risks
That said, we do highlight that - in addition to the aforementioned economic dynamics - there are numerous upside and downside risks to our outlook for Mexico's power sector.
To this end, while exposure to the US shale gas boom underpins our optimistic outlook for Mexico's power sector, we emphasise that the country must ensure it can meet demand for gas from industry (including its refining sector) and the private sector more broadly if it is to realise the benefits fully. In 2012, for example, extremely-low US-linked gas prices pushed state-owned oil company Petroleos Mexicanos (Pemex) to reduce its gas production and import more liquefied natural gas (LNG) to help meet demand - which still outstripped supply. This was in part due to the fact that state-owned pipelines were already running at 95% capacity and state price controls gave Pemex little incentive to produce more gas - especially when gas prices were so low (these same dynamics could hinder shale gas extraction). The affect of these shortages not only caused the shutdown of some industrial processes but also threw into question Mexico's wider economic competitiveness. Clearly, if the country hopes to establish a position as a manufacturing hub, developing cross-border pipeline infrastructure in cooperation with the US, as well as constructing national gas pipeline infrastructure, will be critical.
Threats To Los Ramones II Could Leave A Gas-Free Void
In this context, we highlight that a failure to establish the necessary mid-stream infrastructure would be hugely problematic. To this end, we highlight that concerns about the timely realisation of the second section of the crucial Los Ramones pipeline have emerged this quarter - creating downside risks to our forecasts. The 1,200km Los Ramones pipeline is one of Pemex's 'backbone' projects and will stretch from the US border to Mexico's industry heavy central regions. While the first phase is due to come online by end-2014, the second phase suffered what could be a potentially serious setback in early October 2013, after Pemex voided the results of a public auction, stating that the sole bid for the 740km pipeline did not comply with its required technical and economic specifications ( see 'Voided Auction Poses Risks To Bullish Natural Gas Consumption Forecast', October 18).
We believe the lack of interest creates significant risks to the realisation of Los Ramones Phase II and is a reflection of the considerable technical and financial challenges of the US$1.8bn project, as well as security risks. One of the most significant deterrents has been the cost of the mega pipeline, which is unprecedented in terms of scale and therefore hugely risky. Furthermore, the contract terms were relatively unattractive - with the winning company expected to provide 100% of the investment, but receive a 90% stake in the project, while Pemex would take the other 10%.
As a result of insufficient foreign interest, while Pemex has indicated it will complete the project on its own and will maintain its 2015 schedule, we see scope for delays - especially if the state company struggles to finance the pipeline. Clearly, the threat of delays poses downside risk, not only to our natural gas consumption forecast, but also to our outlook for the power sector and the country's broader economic trajectory - with the key manufacturing sector likely to feel the effects of insufficient pipeline capacity through higher electricity costs (Mexico has purchased spot LNG in the past). It also poses downside risk to our US Henry Hub gas price forecast, which currently factors in rising gas exports to Mexico as a support for an uptrend in prices.
Electricity Market Liberalisation Holds Promise
In addition to securing gas supplies, we also highlight that in order to mitigate the risk of electricity supply shortfalls and reverse macroeconomic imbalances, energy sector reform will be critical (granting private investors access to the oil and gas sector will be key to tapping Mexico's indigenous oil and gas reserves).
As such, we see scope for some positive developments in the electricity market. We highlight that we are more confident with regards to plans to liberalise the electricity market than we are for the broader energy sector. To this end, we believe that the most likely modification following energy sector reform in Mexico will be the introduction of competition into the electricity generation segment. Both (PRI) and opposition PAN proposals outline plans to establish a secondary market for electricity - requiring the amendment of the existing law surrounding private participation in the electricity sector, which is currently acting as a barrier to further expansion ( see 'Electricity Reform: Fewer Hurdles, More Promise', October 7).
|Liberalisation And Gas Needed To Sustain Competitiveness|
|Mexico - Average Price Of Electricity (Peso Cents/KWh)|
To this end, although independent power producers (IPPs) are allowed to operate in Mexico, electricity generated must be for 'own-use' or sold to Mexican state-owned power company, Comisión Federal de Electricidad (CFE). Although this has allowed CFE to retain its monopoly, it has prevented greater competition from pushing down (heavily subsidised) prices, and constrained CFE's ability to finance much-needed electricity capacity investment.
Given that both the Partido Revolucionario Institucional (PRI) and Partido Acción Nacional (PAN) are aligned with regards to encouraging greater private sector participation, and the generation of electricity is not as controversial as, say, the production of oil, this tenet of energy reform is more likely go through as part of any broader energy reform package - perhaps leading to a greater influx of IPPs. That said, we do note that the success of a secondary market would depend on subsidy reform and changes to the prices that private companies can charge, and whether they can make a profit at that level.