R E G U L A T I O N OF GAS M A R K E T I N G ACTIVITIES IN MEXICO* Dagobert L. Brito Rice

University

Juan Rosellón C e n t r o de Investigación

y Docencia

Económicas

Resumen:

Estudiamos las implicaciones de vincular el precio del gas natural en México al del sur de Texas sobre la comercialización eficiente del gas en el primero. Argumentamos que a Pemex se le debería permitir firmar contratos spot o de futuros en la venta de gas. Sin embargo, el precio del gas debería ser siempre igual al precio n e t b a c k basado en el H o u s t o n S h i p C h a n n e l al momento de entrega. A Pemex no debería permitírsele descontar el precio del gas del precio n e t b a c k de Houston, incluso si lo hace de una manera no discriminatoria. Esta metodología es transparente, fácil de llevar a la práctica y no elimina ninguna opción legítima de mercado para ninguna de las partes involucradas. Pemex o los consumidores de gas pueden usar el mercado de Houston para cubrirse de transacciones especulativas.

Abstract:

We study the implications of linking the Mexican natural gas price to the Houston price on the efficient marketing of gas in Mexico. We argue that Pemex should be permitted to enter into spot contracts or future contracts to sell gas. However, the price of gas should always be the net back price based on the Houston Ship Channel at the time of delivery. Pemex should not be permitted to discount the price of gas from the Houston netback price even in a nondiscriminatory fashion. This arrangement is transparent, it is easy to enforce and does not eliminate any legitimate market options for any of the parties involved. Pemex or consumers of gas can use the Houston market for hedging speculative transactions.

J E L Classification: L51 F e c h a de recepción: 23 IX 2 0 0 1

F e c h a de aceptación: 25 VI 2 0 0 2

* The research reported in this paper was supported by the Comisión Reguladora de Energía in a grant to the Centro de Investigación y Docencia Económicas, A.C. We wish to thank the observations of an anonymous referee, [email protected], [email protected] 15

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1. Introduction T h e q u e s t i o n we are addressing is w h a t restrictions s h o u l d be p l a c e d o n P e m e x ' s m a r k e t i n g activities i n the n a t u r a l gas market. T o address this question, i t is useful to review w h a t are p r o b a b l y w e l l - a c c e p t e d public-interest goals for r e g u l a t i o n . These i n c l u d e the efficient a l l o c a t i o n of resources, a c h i e v i n g some r e d i s t r i b u t i v e goals, s i m p l i c i t y , and transparency. W i t h these goals i n m i n d , it is clear t h a t the decision to l i n k the price of n a t u r a l gas i n M e x i c o to the price at the H o u s t o n ship c h a n n e l by a netback rule solves some very difficult t e c h n i c a l a n d i n s t i t u t i o n a l problems i n a very s i m p l e f a s h i o n . T h e netback rule links the price of gas at any p o i n t i n M e x i c o to the p r i c e of gas i n H o u s t o n adjusted by the cost of t r a n s p o r t a t i o n . T h e n a t u r a l gas m a r k e t i n M e x i c o then has all the properties of the gas m a r k e t at H o u s t o n . In p a r t i c u l a r , a l l agents are price takers w i t h respect to the market a n d the H o u s t o n market c a n be used by agents i n M e x i c o for h e d g i n g a n d other forward contracts. T h e key to the i m p l e m e n t a t i o n of this p o l i c y is t h a t there be sufficient p i p e l i n e capacity so t h a t the gas markets c a n clear a n d rents do not accrue to the pipelines. If there is not sufficient p i p e l i n e capacity so that the n a t u r a l gas markets i n M e x i c o can clear at the H o u s t o n netback prices, it is i m p o s s i b l e to i m p l e m e n t the netback rule. A t the net back price, d e m a n d w i l l be greater t h a n supply. 1

2

A p r o p o s a l that is b e i n g discussed is to change the system so t h a t P e m e x sells gas only at the point of i n j e c t i o n . T h e prices i n the l o c a l markets w o u l d be set by l o c a l s u p p l y and d e m a n d c o n d i t i o n s . These changes w o u l d create u n c e r t a i n t y i n the gas m a r k e t a n d also create the p o s s i b i l i t y of strategic m a n i p u l a t i o n of the price of gas t h a t w o u l d be v e r y difficult to regulate. F u r t h e r , the current regulations p e r m i t the net back price to be an upper b o u n d a n d P e m e x c a n sell gas below t h a t price if it does so i n a n o n d i s c r i m i n a t o r y fashion. 3

T h e reason t h a t has been given for a l l o w i n g P e m e x to sell at a price below the H o u s t o n netback price, as long as the sales were n o n - d i s c r i m i n a t o r y , is that there is no reason to restrict v o l u n t a r y t r a n s a c t i o n between parties. However, there is a s u b s t a n t i a l agency 1

Political economy goals of regulation are more general since interest group pressure could influence the design of regulatory institutions, regulatory frameworks, and industry structures (see Laffont (2000)). 2

See Brito and Rosellón (2002). Future challenges of the Mexican natural gas reform are discussed in Comisión Reguladora de Energía (2001). 3

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M A R K E T I N G ACTIVITIES IN MEXICO

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p r o b l e m i n these transactions. It is h a r d to u n d e r s t a n d w h y P e m e x ( a c t i n g as a agent for the M e x i c a n people) w o u l d want to sell gas i n M e x i c o for less t h a n i t c o u l d net by selling the gas i n H o u s t o n . T h e r e m a y be p o l i c y reasons to subsidize gas i n c e r t a i n c i r c u m s t a n c e s ; however, this does not seem like a d e c i s i o n that s h o u l d be delegated to P e m e x gas m a r k e t i n g . P e m e x s h o u l d be p e r m i t t e d to enter into spot contracts or future contracts to sell gas. However, the price of gas s h o u l d always be the net back price based on the H o u s t o n S h i p C h a n n e l a t t h e t i m e of d e l i v e r y . P e m e x s h o u l d not be p e r m i t t e d to discount the p r i c e of gas from the H o u s t o n netback price even i n a n o n d i s c r i m i n a t o r y fashion. T h i s arrangement is transparent, it is easy to enforce a n d does not e l i m i n a t e any l e g i t i m a t e market options for any of the p a r t i e s involved. P e m e x o r consumers of gas c a n use the H o u s t o n m a r k e t for h e d g i n g of speculative transactions. T h e H o u s t o n market c a n also serve as a buffer for fluctuations i n P e m e x ' s p r o d u c t i o n or i n d e m a n d . P e m e x can v a r y its sales i n the H o u s t o n m a r k e t to s m o o t h fluctuations i n M e x i c o . T h i s buffer allows P e m e x to o n l y sell " p l a i n v a n i l l a " gas w i t h o u t h a v i n g to engage i n c o m p l e x market operations i n M e x i c o . T h u s , it is v e r y difficult to see w h a t useful role can be p l a y e d by P e m e x a c t i n g as a gas m a r k e t e r i n M e x i c o . If P e m e x wants to engage i n speculative market behavior, it can do so i n the H o u s t o n market. H o u s t o n has the advantage of b e i n g a well-developed m a r k e t . P e m e x ' s transactions i n that m a r k e t w o u l d not create any regulatory issues for the C o m i s i ó n R e g u l a d o r a de E n e r g í a , C E E , as long as P e m e x sells gas i n M e x i c o at the H o u s t o n spot netback price. A s l o n g as there is sufficient p i p e l i n e c a p a c i t y so t h a t there are no bottlenecks i n t r a n s p o r t i n g gas, this s i m p l e rule w i l l result i n a n efficient and transparent n a t u r a l gas market i n M e x i c o . 4

A l l o w i n g P e m e x d i s c r e t i o n i n p r i c i n g gas becomes a n even m o r e c o m p l i c a t e d p r o b l e m i f P e m e x is allowed to sell gas for future d e l i v e r y at a price other t h a n the H o u s t o n netback price at the t i m e of delivery. For example, P e m e x c a n sell gas for delivery 30 days i n the future at a given price a n d the next day sell gas for delivery 29 days i n the future a different price. Technically, these transactions w o u l d not be d i s c r i m i n a t o r y . T r a n s a c t i o n s that involve selling forward gas at a p r e d e t e r m i n e d price w o u l d be very difficult to m o n i t o r a n d give P e m e x gas marketers a very large amount of power a n d d i s c r e t i o n . T h e r e are i m p o r t a n t and legitimate reasons w h y private o i l c o m panies use forward markets to reduce risk; let us grant that such 4

This assumes that Pemex is exporting gas.

18

ESTUDIOS ECONÓMICOS

reasons may also a p p l y a n a t i o n a l o i l c o m p a n y s u c h as P e m e x . R e s t r i c t i n g P e m e x to sell gas i n M e x i c o at the H o u s t o n spot m a r k e t n e t b a c k price does not e l i m i n a t e any options for P e m e x . L i n k i n g t h e price o f gas i n M e x i c o to the H o u s t o n market p e r m i t s P e m e x to o p e r ate i n these s o p h i s t i c a t e d markets w i t h out i n v o l v i n g t h e i r c u s t o m e r s for gas delivered i n M e x i c o . F u r t h e r , buyers of n a t u r a l gas i n M e x ico c a n enter into transactions i n H o u s t o n w i t h o u t i n v o l v i n g P e m e x . T h u s , there is no economic reason w h y P e m e x has to operate as a gas marketer i n Mexico. It may seem m o r e efficient to p e r m i t P e m e x to enter i n t o s u c h transactions d i r e c t l y i n M e x i c o w i t h o u t going t h r o u g h the H o u s t o n m a r k e t . However, d u e to the v e r t i c a l i n t e g r a t i o n of P e m e x i n the gas i n d u s t r y , r e s t r i c t i n g P e m e x to make s u c h transactions o n l y i n the w e l l developed H o u s t o n m a r k e t reduces the p o s s i b i l i t y t h a t P e m e x c o u l d to set entry barriers to other p a r t i c i p a n t s i n the gas c o m m e r c i a l i z a t i o n business, reduces the regulatory b u r d e n i n M e x i c o , a n d p e r m i t s t h e development of proper market i n s t i t u t i o n s i n M e x i c o for futures a n d f o r w a r d contracts.

2. Problems with Flexibility in the Netback Rule T h e present regulations p e r m i t P e m e x to sell gas at below the H o u s ton netback price as l o n g as i t does so i n a n o n d i s c r i m i n a t o r y fashion. T h i s p o l i c y is s u p p o r t e d by the received w i s d o m i n regulatory theory t h a t holds t h a t p r o h i b i t i n g a v o l u n t a r y t r a n s a c t i o n on the p a r t of t w o competent parties does not i m p r o v e w e l f a r e . However, t h i s result does not a p p l y i n this case. T h e linkage to H o u s t o n means t h a t all parties i n the M e x i c a n m a r k e t are price takers. Since M e x i c a n gas can always be sold i n H o u s t o n , the value of the m a r g i n a l c u b i c foot of gas at the well i n M e x i c o is the H o u s t o n price less cost of t r a n s p o r t . W e w i l l d e m o n s t r a t e that a p o l i c y to sell at the H o u s t o n netback p r i c e is K a l d o r - H i c k s s u p e r i o r to a p o l i c y that discounts the price of gas i n a nondiscriminatory fashion. 5

6

5

Suppose the regulator forces the firm to charge prices P°. Total welfare would be V(P°) + Q 7 r ( P ° ) , where Vis consumer surplus, 7T is profits and Q in [0,1). If the firm is allowed to offer P such that V ( P ) > V(P°), this alternative policy would not make consumers worse off and the firm would make a greater profit. (See Armstrong, Cowan, and Vickers (1994), p.67). Under the Kaldor-Hicks test, state A is preferred to state B if those who gain from the move to A can hypothetical^ compensate those who lose and yet 6

GAS

M A R K E T I N G ACTIVITIES IN MEXICO

19

Figure 1

It is K a l d o r - H i c k s s u p e r i o r to have the price of gas i n M e x i c o equal to t h e H o u s t o n price adjusted for t r a n s p o r t a t i o n costs. A s s u m e t h a t gas is p r o d u c e d at B u r g o s and s h i p p e d to H o u s t o n and M o n terrey. Let p be the spot price at H o u s t o n a n d p be the spot price at M o n t e r r e y . L e t c be the cost of m o v i n g gas from B u r g o s to H o u s t o n , c be the cost of m o v i n g gas from B u r g o s to M o n t e r r e y . T h e n e t b a c k rule w o u l d lead to the c o n d i t i o n that the price of gas less t r a n s p o r t cost is the same at H o u s t o n and M o n t e r r e y , 7

H

M

h

m

Pm-Cm

= P h - C h

(1)

S u p p o s e a c u s t o m e r i n M o n t e r r e y h a d a d e m a n d curve Q* = D i ( ) for the gas. P e m e x can sell the gas to the customer i n M o n t e r r e y P

be better off. The Kaldor-Hicks criterion suggests that A is preferable even if compensation does not actually occurs. 7

e

S

d

the Tlxa sto rS ^ r have been d i s c o v L T ^ represent 57 1 perceTto"total natural[Zreservesin Mexico but contribute only s

t ' 01 f tt oti ali n i170 i . o percent uadtiuurradli cas gab npri no du nurcH un on ii. n p r n > 1 1

n

n

q

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ESTUDIOS ECONÓMICOS

or sell the gas i n H o u s t o n . Suppose P e m e x sold the c o n s u m e r Q i a m o u n t of gas at p < p . It is feasible for P e m e x to sell the gas i n H o u s t o n a n d transfer a n a m o u n t A p Q , + to the M o n t e r r e y m

8

consumer. (See figure l ) . T h i s w o u l d lead to greater revenue, to P e m e x a n d m a k e the M o n t e r r e y consumer no worse off. T h u s i t is K a l d o r - H i c k s superior to have the p r i c e of gas i n M e x i c o e q u a l to t h e H o u s t o n netback price a n d sell the balance of the gas o n the H o u s t o n m a r k e t rather t h a n to sell gas i n M e x i c o at a price below the H o u s t o n netback price.

3. Regulation of Pipeline Rates P i p e l i n e s have a h i g h fixed cost, a n d for a s u b s t a n t i a l p o r t i o n of t h e i r o p e r a t i n g region low m a r g i n a l costs. T h e capacity of the p i p e l i n e is u l t i m a t e l y l i m i t e d by the pressure l i m i t s of pipe. F i g u r e 2 i l l u s t r a t e s the cost curves for a 48-inch p i p e l i n e 100 miles l o n g . T h e d a s h e d lines represent w h a t the cost curves w o u l d be if the pressure l i m i t s were not b i n d i n g . A t a pressure l i m i t of 1,500 pounds per square i n c h , the p i p e l i n e reaches its l i m i t at a p p r o x i m a t e l y 3,800 m i l l i o n c u b i c feet per day. A t t h i s p o i n t it becomes i m p o s s i b l e to increase t h r o u g h p u t by i n c r e a s i n g power a n d it becomes necessary to add compressor sta¬ tions w h i c h increases t h r o u g h p u t w i t h o u t exceeding the line l i m i t b y i n c r e a s i n g the pressure gradient. 9

W e have s h o w n t h a t the n e t b a c k - p r i c i n g rule i a the s o l u t i o n of a s t a t i c welfare o p t i m i z a t i o n p r o b l e m if the fee for t r a n s p o r t i n g gas is the m a r g i n a l cost of t r a n s p o r t i n g g a s . However, m a r g i n a l - c o s t p r i c i n g results i n a loss of rents. (See figure 2). O n e s o l u t i o n to t h i s p r o b l e m is to set a fee t h a t yields a regulated rate of r e t u r n over the life of the project sufficient to cover a l l costs. A n alternative, m o r e s o p h i s t i c a t e d alternative is a two-part tariff w i t h a price cap. C R E c u r r e n t l y regulates P e m e x t r a n s p o r t a t i o n (and d i s t r i b u t i o n ) tariffs t h r o u g h a (average-revenue) price cap over two-part t a r i f f s . The 10

11

Recall that under the netback rule, the revenue after transportation costs of selling gas in Houston or Monterrey would be the same. The parameters used in constructing this example are based on numbers reported in the Oil & Gas Journal, November 27, 1995. . See Brito and Rosellon (2002), and Brito, Littlejohn and Rosellon (2000). Pemex estimates its fixed, variable and financial transportation costs (including an 11.5 percent rate of return) and sets its two-part tariff according to its revenue requirements. 9

1 0

1 1

GAS M A R K E T I N G ACTIVITIES IN MEXICO

21

cap prevails d u r i n g each five-year p e r i o d . T h e i n i t i a l value of the cap is set i n each p e r i o d t h r o u g h cost of service and adjusted by inflat i o n , efficiency, pass t h r o u g h a n d correction factors. A v e r a g e revenue is c a l c u l a t e d as the r a t i o of t o t a l revenue to o u t p u t i n the current p e r i o d . R a m i r e z a n d R o s e l l o n (2002) show that this regime creates a stochastic effect t h a t i m p l i e s higher levels of consumer s u r p l u s for higher levels of risk aversion a n d u n c e r t a i n t y . 12

Figure 2

M o r e generally, the economics literature on gas (and electricity) t r a n s p o r t a t i o n shows how usage congestion charges c a n be used to l i

We must point out that when only one product is supplied, as in the transportation service, average-revenue regulation coincides with tariff-basket regulation. For the case of gas distribution, Ramirez and Rosellon (2002) also show that the C R E ' s average-revenue regime creates incentives for setting two-part tariffs strategically. The usage charge is typically dropped to its lowest feasible level while the fixed charge can be raised to compensate for the loss of operating profit.

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ESTUDIOS ECONÓMICOS 13

give p r o p e r incentives for c a p a c i t y i n v e s t m e n t s . However, there a r e two caveats to the use of a flexible p r i c i n g m e c h a n i s m to regulate P e m e x t r a n s p o r t a t i o n tariffs t h a t seem to make preferable a f i x e d - p r i c e r e g u l a t i o n that does not allow P e m e x to c a r r y out price d i s c o u n t s . T h e first p r o b l e m is P e m e x ' s v e r t i c a l i n t e g r a t i o n i n gas p r o d u c t i o n , t r a n s p o r t a t i o n , a n d m a r k e t i n g , w h i c h allows P e m e x to c a r r y out cross subsidies a m o n g these three economic activities. A second p r o b l e m is the l i m i t e d i n s t i t u t i o n a l capacity of a s m a l l regulator to o b t a i n t r u e cost i n f o r m a t i o n o n a l l segments of the more t h a n 9,000-kilometerl o n g P e m e x t r a n s p o r t a t i o n network. U n d e r these c o n d i t i o n s , P e m e x c o u l d strategically m a n i p u l a t e p i p e l i n e rates to m a x i m i z e its revenues b u t reduce consumer surplus. 1 4

A s an e x a m p l e of the l a t t e r assertion, suppose P e m e x is p r o d u c i n g gas i n B u r g o s and C i u d a d P e m e x , a n d selling gas i n H o u s t o n a n d M e x i c o C i t y (see figure 3. T h e arrows i n d i c a t e w h i c h way gas is m o v i n g ) . L o s R a m o n e s is the arbitrage point. A s s u m e t h a t t is the "real" (cost-reflective) price per m i l e for t r a n s p o r t i n g gas t h r o u g h the p i p e l i n e segment B u r g o s - L o s R a m o n e s and t h r o u g h the C i u d a d P e m e x - M e x i c o C i t y segment. L e t i be the c o r r e s p o n d i n g price for the H o u s t o n - B u r g o s segment a n d the L o s R a m o n e s - C i u d a d P e m e x segment (ti < i ) . T h e dashed line i n figure 4 illustrates the regul a t e d price p a t t e r n that w o u l d result under perfect i n f o r m a t i o n . x

2

1 5

2

S u p p o s e however t h a t the regulator does not have i n f o r m a t i o n on the real cost i n each p i p e l i n e segment, a n d that P e m e x c a n set a price for t r a n s p o r t i n g gas t h r o u g h the p i p e l i n e network i n the range between t a n d t per mile. P e m e x can t h e n exploit its flexibility to set the p i p e l i n e tariffs to increase revenues. P e m e x c a n charge the x

2

1 3

Vogelsang (2001) proves how a two-part tariff can be used to solve short-run congestion problems as well as the long-run capacity expansion problems of an electricity transmission network. Under capacity congestion, the variable charge becomes a pure congestion charge and, whenever congestion charges are greater than the marginal costs of increasing capacity, the transmission company will have incentives to expand capacity. 1 4

This is not equivalent to the use of cost-of-service regulation. Rather, we propose to keep calculating the initial value of the (average revenue) cap in each regulatory period through cost of service and adjust it along the period by inflation and efficiency factors, but without allowing price discounts. 1 5

Then, according to the netback pricing rule, the price of gas at Mexico City will be equal to the benchmark price in Houston less the transport costs from Houston to Burgos, plus the transport costs from Burgos to Los Ramones, less the transport costs from Los Ramones to Ciudad Pemex, plus the transport costs from Ciudad Pemex to Mexico City

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Figure 3

Houston Burgos

U s Ramones

Mexico City Ciudad

Pana

low t r a n s p o r t charge t between H o u s t o n - B u r g o s , the h i g h t r a n s p o r t charge t between B u r g o s - L o s R a m o n e s , the low t r a n s p o r t charge h between L o s R a m o n e s - C i u d a d P e m e x a n d the high t r a n s p o r t charge t between C i u d a d P e m e x - M e x i c o C i t y . T h i s is i l l u s t r a t e d b y the solid l i n e i n figure 4. T h i s p r i c i n g p o l i c y m a x i m i z e s the revenues for P e m e x by cross-subsidizing its p i p e l i n e segments. T h e result is a higher price of gas i n M e x i c o as c o m p a r e d to the one that w o u l d prevail i f P e m e x charged the real t r a n s p o r t charges per segment. x

2

2

T h e C R E t h e n needs P e m e x to p r o v i d e accurate i n f o r m a t i o n o n its t r a n s p o r t costs by segment. U n d e r the v e r t i c a l l y integrated structure of P e m e x , w h i c h allows cross-subsidization a m o n g gas p r o d u c t i o n , t r a n s p o r t a t i o n and m a r k e t i n g , the regulator s h o u l d i m p l e m e n t a fix-price r e g u l a t i o n by t r a n s p o r t a t i o n region so t h a t P e m e x c a n n o t make discounts i n t r a n s p o r t a t i o n charges. O f course, the (first) best s o l u t i o n w o u l d be to v e r t i c a l l y separate P e m e x - a l l o w i n g u n b u n d l i n g and c o m p e t i t i o n i n m a r k e t i n g - a n d to regulate t r a n s p o r t a t i o n charges w i t h the incentive scheme already i n place.

4. Pemex Selling Gas Only at the Point of Injection One advantage of u s i n g the netback rule w i t h a fixed fee for transp o r t i n g gas is t h a t a l l parties act as price takers at a l l points a l o n g

24

ESTUDIOS ECONÓMICOS

Figure 4

Price

4

Houston

Burgos

Los

Ramones

Ciudad Pemex

City

the p i p e l i n e . R e s t r i c t i n g P e m e x to sell gas only at the point of i n j e c t i o n and a l l o w i n g l o c a l market c o n d i t i o n s to set the price creates the p o s s i b i l i t y t h a t marketers c o u l d acquire some degree of m a r k e t power. P a r t i e s c o u l d b u y the gas at the point of injection a n d s h i p either to the H o u s t o n market (where they face an essentially flat dem a n d curve) or to the M e x i c a n markets where they face an i n e l a s t i c d e m a n d curve. C o l l u s i v e b e h a v i o r o n the p a r t of marketers w o u l d allow t h e m to equate m a r g i n a l revenue i n b o t h markets and e x p l o i t the fact t h a t d e m a n d curves i n the l o c a l markets are very i n e l a s t i c and earn m o n o p o l y rents. It then becomes necessary to regulate t h e activities of the marketers. T h e r e g u l a t o r y p r o b l e m is m u c h s i m p l e r if P e m e x sells at a l l points o n the p i p e l i n e system Using the n e t b a c k rule to determine the price. T h i s w o u l d not e l i m i n a t e other m a r k e t e r s ' activities.

5. Forward Markets and Pipeline Capacity If P e m e x is required to sell gas o n the spot market at the H o u s t o n S h i p C h a n n e l price adjusted by the netback rule, can P e m e x use

GAS M A R K E T I N G ACTIVITIES IN MEXICO

25

its m o n o p o l y power over the pipeline to get m o n o p o l y rents i n this forward market? T o address this question let us consider a s i m p l e m o d e l . A s s u m e a two p e r i o d model. G a s is p r o d u c e d at B u r g o s a n d s h i p p e d to H o u s t o n a n d M o n t e r r e y . L e t p be the spot p r i c e at H o u s t o n at time 0, p the spot price at M o n t e r r e y at t i m e 0, p the spot p r i c e at H o u s t o n at t i m e 1, p the spot price at M o n t e r r e y at time 1, p the forward price at H o u s t o n at t i m e 0, a n d p the forward price at M o n t e r r e y at t i m e 0. L e t c be the cost of m o v i n g gas from B u r g o s to H o u s t o n , c be the cost of m o v i n g gas from B u r g o s to M o n t e r r e y , and A c = c - c . L e t Q be the c a p a c i t y constraint o n the p i p e l i n e from B u r g o s to M o n t e r r e y . If the c a p a c i t y constraint does not b i n d , the netback price at M o n t e r r e y is = p + A c , (see figure 6 left). If the capacity constraint binds, the price at M o n t e r r e y is = + Ac + R, where R are the rents associated w i t h the c a p a c i t y constraint, (see figure 6 right). o

0

h

m

x

l

h

m

h

m

h

m

m

h

m

P

P

r

m

P

r

r

m

r

h

h

Figure 5

i

M

4

.

B

>

•

H Figure 6

If the pipeline capacity does not b i n d , anyone who desires to engage i n forward transactions can do so i n the H o u s t o n market and P e m e x

26

ESTUDIOS ECONÓMICOS

does not have an effective m o n o p o l y of the forward market a n d w i l l c a p t u r e no rents. However, i f the pipeline capacity does b i n d , P e m e x c a n c a p t u r e the rents associated w i t h the pipeline constraint b y s e l l i n g o u t p u t forward. P e m e x can become a m o n o p o l y i n the f o r w a r d firmservice market. N o t e t h a t if the p i p e l i n e capacity does b i n d , rents w i l l exist and the o n l y question is who w i l l appropriate t h e m . G i v e n t h a t the capacity constraint on the pipeline is b i n d i n g , there are no real effects. T h e key regulatory issue i n this context appears to be i n s u r i n g t h a t P e m e x invests sufficiently i n p i p e l i n e capacity so that c a p a c i t y constraints are not a serious issue.

6. Optimal Pipeline Capacity A necessary element i n i m p l e m e n t i n g a p o l i c y where the H o u s t o n gas m a r k e t is the reference p o i n t for p r i c i n g gas i n M e x i c o is that there b e sufficient c a p a c i t y so that the market for gas can always clear at t h e netback price. T h e obvious question is whether the cost of m a i n t a i n i n g such c a p a c i t y is w a r r a n t e d . T h i s is a very difficult q u e s t i o n i n t h a t there are economic, p o l i t i c a l and i n s t i t u t i o n a l constraints i n v o l v e d i n the basic q u e s t i o n of p r i c i n g gas along the M e x i c a n pipelines. A b e n c h m a r k for discussion is the p a t t e r n of investment t h a t w o u l d be followed by a planner who is a t t e m p t i n g to m a x i m i z e a measure of welfare. S u c h a p o l i c y may involve periods where t h e c a p a c i t y constraint binds. T h e length of this p e r i o d is a measure o f the cost of the d e v i a t i o n from " o p t i m a l " that results from the p o l i c y of u s i n g the H o u s t o n gas market as a b e n c h m a r k for p r i c i n g gas. W e w i l l show t h a t a p o l i c y that insures sufficient p i p e l i n e c a p a c i t y so t h a t the gas market can clear at the H o u s t o n netback price deviates from a n " o p t i m a l " p o l i c y by o n l y a m a t t e r of weeks. Let us consider a case where pipeline capacity is given by Q. D e m a n d is g r o w i n g at a rate A. L e t p be the price i n M o n t e r r e y based o n H o u s t o n netback. A s s u m e that d e m a n d reaches p i p e l i n e c a p a c i t y at t = 0 so t h a t p = PM for Q < Q a n d p = 6(Q). If the p i p e l i n e capacity binds, p = 0{Qe and the excess b u r d e n associated w i t h this bottleneck is given by: M

M

M

X i

M

_

A p A Q

_

Q ( e

X

t

- l ) [ 9 ( Q e

x

t

- p

M

]

m

T h i s is the triangle a-b-c i n figure 7. T h e bottleneck results i n rents b e i n g generated and these rents result i n the loss given by

GAS MARKETING ACTIVITIES IN MEXICO

X (t) 2

=

7 :

QAp =

7 l

Q[0(Qe

A t

) - Vm\

27

(3)

where is a p a r a m e t e r t h a t c a n range from 0 to 1, a n d is the w e i g h t of the rents generated by the bottleneck i n the welfare f u n c t i o n . T h e loss i n e q u a t i o n (3) represents the fraction of rents t h a t are c o n s u m e d i n transfer a n d reflects such factors as rent seeking a n d X-inefficiency. T h i s is the rectangle p - p - a - b i n figure 7. Define the t o t a l loss i n welfare as: 7

l

M

X(t)

M

= X ( t ) + X ( t ) . 1

2

(4)

Figure 7

P

O p e n i n g a second p i p e l i n e reduces the m a r g i n a l costs of t r a n s p o r t i n g gas m o v i n g the o p e r a t i n g range of b o t h pipelines to f . W i t h c a p a c i t y constraints b i n d i n g , the m a r g i n a l cost of t r a n s p o r t a t i o n depends o n the c o n s t r u c t i o n of the new pipeline. T h e m a r g i n a l cost of m o v i n g gas w i l l t h e n be r e d u c e d by A M C . T h i s w i l l reduce the cost of m o v i n g

28

ESTUDIOS ECONÓMICOS

gas b y