Navigating Mexico's Energy Reform: The Natural …

1 Navigating Mexico's Energy reform : The Natural Gas Market Natural gas has emerged as a key Energy source given The five-year plan is based on two key imperatives: 1) to its low greenhouse gas emissions, greater efficiency and minimize the risk of supply disruptions and 2) to ensure competitive prices. In order to increase the supply of that infrastructure capacity builds can meet demand peaks Natural gas, the Mexican government intends to implement across the country. In this regard, the plan includes the a comprehensive regulatory and institutional framework construction of 5,159 kms of new pipelines, requiring in order to foster an efficient and competitive Natural gas investments of almost US$10 billion.

2 As of today, the market. The Energy Secretariat (SENER), together with majority has been tendered, and several have already been the National Natural Gas Control Center (CENAGAS), has built. drafted the regulations that will apply to the industry, following consultations with private players. SENER is working on a five-year plan (2015-2019) to expand the transportation and storage infrastructure. A. thorough assessment on the outlook of supply of Natural gas fundamentals will inform future transportation infrastructure projects in the country and guide investment decision making by the private sector.

3 Source: , accessed on July 18, 2016. 2 Navigating Mexico's Energy reform New Players in the Industry Manages and Federal regulates the oil Government industry Oil Industry State Private Operators Operators pemex /EPE the former Individuals or legal entities state-owned monopoly incorporated pursuant to the Mexican legislation Energy Policy - Supply policy - Instruct the development of strategic and social projects - Opinion on the distribution network expansion Independent System Operator State Productive Enterprises - System management - Guarantee demand - Network operation - Will bid strategic projects instructed

4 By Sener - Bidding of strategic and social projects until August 2016. Coordinated Regulatory Entity - Permits for pipeline transportation, distribution, storage, liquefaction, regasification, compression, decompression, retail and integrated systems management. - Service fees - Opinion on the biddingguidelines Private Companies - Wholesale market regulation - Infrastructure development - Service terms and conditions - Transportation and storage services Safety, Energy and Enviroment - Natural gas commercialization Agency - Industrial and operational safety - Decommissioning and abandonment - Emissions and waste control The Natural Gas Market 3.

5 Before and after the Energy reform The model of operation of pemex as a sole hydrocarbons producer pemex Before pemex After in mexico has been modified by a Old Model New Model new competitive model. Descentralized Public Entity State Productive Enterprise ( pemex ), with two main subsidiaries (PEP & TRI). and several affiliated companies Resource Manager Aimed at generating economic value. Becomes one among other market participants Responsible for Supply Under new regulations pemex will compete in all activities of the value chain Permit regime for some activities Energy reform in the Natural Gas Market Natural Gas Production Participation of various producers under permits Commercial Trade Open Market Restructuring of affiliates and their functions Subject to permit regime Transportation And Storage Creation of CENAGAS.

6 Limitation of pemex in participation in projects of social interest pemex becomes a user Compression, Liquefaction, Decompression, Regasification Participation of different agents subject to permits regime Fist Hand Sales (Vpm). Can be made by subsidiary companies on behalf of the State Subject to the principle of asymmetric regulation Retal Considered added sale pemex affiliates are allowed to sale subject to asymmetric regulation Participation of different agents subject to permits 4 Navigating Mexico's Energy reform Integrating the Value Chain The Energy reform intends to promote the participation of numerous market players in all segments of the value chain.

7 Processing Raw Material Imports Transport Storage Distribution Sales mexico : Key Oil Industry Indicators bf/d mexico : Natural Gas Supply by Source Natural Gas (1995 = 100) 12. 300 2,500. 10. 250 2,000. 200 8. 1,500. 150 6. 1,000. 100. 4. 50 500. 2. - - 1995 2000 2005 2010 2015 - Production Proven Reserves 1995 2000 2005 2010 2015. Demand Net Imports (RHS) Production Net Imports Sources: pemex , SENER, EY Sources: pemex , SENER, EY. bf/d mexico : Natural Gas Demand by Sector bf/d mexico : Natural Gas Imports by Type 12 10 8. 6. 4. 2. - - 1995 2000 2005 2010 2015 1995 2000 2005 2010 2015.

8 Oil Sector Industrial Power Pipeline LNG. Stock Chg. & Stat. Adj. Sources: pemex , SENER, EY Sources: pemex , SENER, EY. The Natural Gas Market 5. 6 Navigating Mexico's Energy reform What to Expect? The opening of the Natural gas market will provide a bridge between the oil and electricity sectors. According to the Mexican authorities, new guidelines should be issued by September 2016. Their purpose will be to promote the development of a competitive domestic Natural gas market. Indeed, as the gas pipeline network is expanded, the number of arbitrage points will increase, with imported gas (by pipeline or vessel) competing with gas produced by pemex .

9 These arbitrage points will help determine reference prices in their respective regions, based on the source of gas and transportation costs. Currently, the main arbitrage points, according to SENER, are located in northern Tamaulipas State, Encino (Chihuahua State), the Bajio region and Cactus (Chiapas State). Gas suppliers, including private companies, will be able to reserve transportation capacity in the Natural Gas Transportation and Storage System (Sistrangas). As a result, the market will eventually move to prices determined by supply and demand, rather than being based on First Hand Sales prices (VPM for its Spanish acronym), which are essentially the maximum prices at which pemex can sell Natural gas.

10 The transition, though, will be gradual. Liquidity will build up as private companies invest in the industry. One of the biggest challenges is carrying out open seasons, through which transportation capacity is reserved. Open seasons, which are expected to start in September 2016, will be administered by CENAGAS, which is in charge of managing the national pipeline grid. CENAGAS will carry out a Round Zero , in order for pemex and CFE to reserve capacity for their own needs, followed by two rounds for private distribution companies: Round One for those with so-called acquired or legacy rights and Round Two for other users.