3 Introduction This document is aimed at presenting an overview of the current policy issues in the Mexican electricity and natural gas industries prior to meeting with Mexicos new Secretary of Energy, Ernesto Martens. Secretary Martens has been extremely supportive of our Vitro project. He has gone out of his way to help us. President Fox has publicly expressed that electricity reform is one of his top three items in the agenda together with fiscal reform and legislation to benefit Mexicos indigenous population. In the past few weeks President Fox has proposed a coordinated energy policy for North America which would include the interconnection of the electricity transmission grid and of the natural gas transportation infrastructure. Despite his intentions President Fox faces strong political barriers to carry out reform since both houses of Congress are divided practically in three. He needs the PRI (the party he beat) to pass this reforms. To be able to carry out the reorganization of the electric industry and to allow for private participation in the production of dry natural gas, a Constitutional amendment is required. Sixty six percent of the vote is required in both houses to pass the amendment as well as the vote of the majority of the Congresses at State level. On Monday, February 5 th, President Fox announced an initiative to create a completely new Constitution for Mexico. On Tuesday, policy makers in the energy sector were still uncertain if the awaited reforms would be postponed until there is a new Constitution.
Mexico summary Economy GDP 2000 $ 570.1Bn U.S. Growth 99-00 7.1 % Expected Growth 00-01 4.5 % Enron 245 Mw plant -Construction begins: 01-01 -Commercial operation: 10-02 Enron Americas Offices Demographics Population 97.4 million Open unemployment 2.3% Highlights Fastest growing economy in the world 2Q/99-2Q/00 @ 8%+ Second largest trade partner with U.S.(229 billion in trade in 2000) Eighth largest exporting economy (only 10% oil down from 80% 15 yrs. ago). Exports growing @15.7% per yr. EBS Offices Azurix presence Territory Square miles 758,463 756,484 1,979 Continental IslandsTotal Mexico is the fourteenth largest country in the world Enron in Mexico 4
5 Electricity In February of 1999 President Zedillo sent an initiative to Congress by which he proposed the privatization of the Mexican Electric Industry. The initiative did not pass due mainly to two reasons: 1. It proposed the sale of existing assets and, 2. He did not get the support from the PAN (now the party in power) due to a political struggle related to the Mexican banking system crisis At that time Enron approached the PAN to help them understand the industry and the need for change. We also helped them come up with specific alternative solutions to problems in Zedillos initiative which they viewed as politically unviable. When Vicente Fox was elected President, Enron was invited to participate in the electricity transition team. That team designed the new electricity policy and the reform initiative. The team also wrote several legislation drafts. Today, Enron is cooperating closely with policy makers and regulators and has gained support from other industry participants in this effort. Enron will be serving as a link between leading opposition legislators and policy makers in the reform process. Commercial success Financial closing for the Vitro project in Garcia, Nuevo Leon, was achieved in December 2000. Our three off- takers are Vitro (glass), Apasco (cement) and Imsa (steel). The Enron commercial team in Mexico successfully continues to develop new businesses in the current regulatory environment.
6 Current status 6.1% 28,751 MW 12.85% Annual growth Peak load Losses Supply Nuclear 4% Hydroelectric 27% Installed generation capacity National Electric Grid Transmission lines: Sub-transmission lines: Distribution lines: Geothermal 2% Hydrocarbons 60% 145 TWh 1900 kwh/inhab. Coverage 95%+ 23 millon 0.55 ¢/kWh 1.30 ¢/kWh 0.52 ¢/kWh Electricity consumption: Per capita consumption: Customer base: Total users: Average rates –Residential : –Commercial: –Industrial: Demand Coal 7% 21,790 mi. 26,267 mi. 341,914 mi. Wind 0.0058% Source: Prospectiva del Sector Eléctrico 98-2007, CFE 100%= 37,488 MW (Dec. 2000) Retired CFE LFC Total Labor force (000) Active 17 14 31 72 38 110 Electricity supply in Mexico is a public service rendered by the State through CFE and LFC. Since 1992 IPPs sell electricity to the CFE through long term contracts and self-supply arrangements are allowed.
7 Currently, the operations reserve is below its critical limit. During 2000 many large industrial users were required to stop operations on several occasions in order to avoid generalized blackouts. Percentage The system requires a constant minimum reserve of 6% of generation capacity in every moment to prevent short term contingencies 25 20 15 10 6% 5 0 Jan Source: CENACE, CFE FebMarAprMayJunJul Operations reserve margin OPERATIONS RESERVE MARGIN Reserve crisis
8 Current capacity Under construc- tion IPPs under bid process Program- med capacity not bid Capacity to be removed Total program- med capacity Total capacity needed by 2010 Additional capacity over programmed capacity 37,448 9,700 950 14,229 (2,019) 60,308 64,590 75,865 15,557 4,282 11,275 7% GDP growth 5% GDP growth GENERATION CAPACITY SCENARIOS 2001 - 2010 (MW) Source:Prospective of the National Electric Sector 1998-2007; President elects transition team, Secretaria de Energia 11,275 ESTIMATE To be able to meet the increase in demand for electricity new capacity will have to be built. If the new administration meets its economic goals capacity should almost duplicate in the next ten years Capacity growth
9 REQUIRED INVESTMENTS 2001-2010 19.0 39.05 12.75 4.4 5.8 3.7 5.4 0.75 0.25 1.3 7.8 1.6 1.8 New generation capacity Mainte- nance TransmissionDistributionOther investments TotalIPP amortization 11,275 MW 27,142 MW 26.8 5.0 7.0 6.0 1.0 51.8 US $2.7 billion per year for new generation US $5 billion per year for the industry 7% GDP growth 5% GDP growth $US Billions ESTIMATE Source:Prospective of the National Electric Sector 1998-2007; President elects transition team, Secretaria de Energia In order to achieve the required growth of the electric system yearly investments of between $US 4 and 5 billion will have to be made in the next ten years. Investment NOTE: According to experts investments required for transmission are underestimated.
10 GOALS AND PRINCIPLES FOR THE REORGANIZATION To ensure sufficient electricity supply for economic development and social well- being. To reduce public investments in order to free resources and borrowing capacity for other government activities To establish a competitive structure to promote private investment without government guarantees. To achieve reduced operational costs and system expansion for additional consumer benefits. Goals Current assets will not be privatized Phasing out of the IPP model Establishment of a competitive energy market with effective and transparent regulation Establish a tariff structure that supports the financial needs of the sector in the medium and long terms. Guarantee the stability of the operation of the system during the reorganization process Principles There is consensus on the need for the reorganization of the industry but due to political reasons reform has not been passed Reorganization of the electric industry
CFE Nuclear & Geothermal CFE Hydro Payments according to contracts Generation CFE Thermo CFEs division for IPP Self - suppliers and Co- generators Generators TransmissionGrIdTransmissionGrId Payments Energy Payments Energy Payments Energy Payments Energy Users Payments Energy OperatorOperator IPP Energy Large users PROPOSED REORGANIZATION MODEL SystemandMarketSystemandMarket Bilateral Contracts Autonomous entities Government Activity Private activity Concession DistributionDistribution Regulator Marketing Authorities Contracts RegulatedRegulated Payments Energy Payments 11
12 Distribu- tion and marketing Transmi- ssion Generation Short termMedium termLong term Current capacity stays under Government property IPP expansion Opening to the market of surpluses (self-generators and co-generators) Current capacity in hands of the Goverment Participation of some IPPs in the market New private capacity enters the market System operation (dispatch) and market as an autonomous public organization (independent of the CFE) National regulated monopoly with guaranteed open access The Government retains the planning, operation, maintenance and expansion Regulated regional monopolies The Government maintains planning, operation, maintenance and expansion Marketing open at wholesale level Tariff restructuring Marketing open at retail level Today2001- 20052005- System and market operation PROPOSED EVOLUTION OF THE REORGANIZATION Concession of operation, maintenance and expansion Separation of system and market operation (PX and ISO)
13 Gas Despite the fact that competition is allowed in gas transportation and marketing, Pemexs market power and a price formula that does not reflect true market conditions make it impossible to participate in these businesses. Currently most of the Mexican gas market uses a South Texas gas market price index. This would make import of natural gas viable. Nevertheless, a variable introduced in the price formula makes competing against Pemex impossible by not taking into account the real price of gas at the border. Added to this situation, Pemex is the sole producer of natural gas through its subsidiary PEP. This subsidiary in turn sells the gas to Pemexs own marketing and transportation company (PGPB)which is the only company authorized to enter first hand sale of gas agreements. This company sells the gas to other Pemex subsidiaries, the the CFE, to the LDCs and to its potential competitors. Pemex needs to change the way it does business through its subsidiaries and allow for other would be marketers and transporters to buy the gas directly from PEP under identical conditions than PGPB. Price crisis Despite opposition from Secretary Martens, the CRE (FERC equivalent), the CEO of Pemex and the Secretary of the Treasury, President Fox ordered that a fixed price of $US 4 dollars per Mmbtu be offered to the end users for a 3 year period starting in January of 2001. …continued on next page
14 Gas… continued Enron has been called on several occasions to discuss gas policy with Secretary Martens, with the President of the CRE (FERC equivalent), with the CEO of Pemex and with the Chief advisor to the Secretary of the Treasury. Although there was consensus on not offering an artificial price, the pressure from the big industrials and a Presidential instruction forced them to come up with what in their perspective is the least damaging solution. The 4 dollar fixed price is supposedly based on a Pemex hedging instrument. This measure has taken longer than planned to implement. Our risk management team is trying hard to do business in this very uncertain environment after a very successful 2000 during which they traded approximately $US 250 million dollars in risk management products.
15 Increase of natural gas in the fuel mix: –Electricity, from 705 Bcf/d in 1999 to 3,618 Bcf/d in 2009 (+20.5% from 99 to 2000) – Industrial, from 1,194 Bcf/d in 1999 to 2,150 Bcf/d in 2000 1.1 2.7 2.5 1.8 0.4 0.1 20012006 4.8 8.1 Electricity Oil & Petchem Industrial Residential & commercial 75% NATURAL GAS DEMAND– 2001-2006 Bcf/d The Mexican gas market needs to stay linked to the U.S. gas market to guarantee supply in the future Supply and demand
16 NATURAL GAS IMPORTS FROM THE U.S. 1993-2000 199519961997199819992000 Million cubic feet per day 172.92 83.68 114.96 153.16 148.95 238.12 59% In 2000 imports from the U.S. increased by 59%. This trend will continue as new power plants start operations
17 Millions of cubic meters per day STRATEGIC NATURAL GAS PROGRAM SUPPLY PROJECTIONS 0 2000 4000 6000 8000 10000 12000 20012002200320042005200620072008 National demand Demand covered by Pemex by implementing the Strategic Program The Strategic Natural Gas Program planned by Pemex requires $US12 billion in investment. Even after implementing the Program, Mexico will need to import gas from the United States. Imports
18 Although some regulatory reform has taken place, Pemexs market power makes it virtually impossible to enter the wholesale gas marketing and transportation businesses in Mexico CURRENT SITUATION End users StorageWholesaleTransportDistribution Imports Production Concessions have been given to local distribution companies There is no storage infrastructure There is no real competition due to PGPBs market power PGPB sells the gas to its competitors Users are subject to rigid and non- competitive commercial conditions There is no real competition due to PGPBs market power PGPB sells the transport to its competitors There are some companies that have their own transportation infrastructure Pemex is the sole producer through PEP* and sells the gas to another subsidiary (PGPB**) for transportation and marketing Pemex carries out most of the imports and markets it through it subsidiary (PGPB) Today, users are at a disadvantage with respect to their competitors in other countries *Pemex Exploration and Production **Pemex Gas and Basic Petrochemicals No competition – The problem
19 PEMEX BUSINESS SYSTEM PGPB Dry gas Ethane Liquefied gas Gasoline Basic petrochemicals Sulfur Gas and liquids processing PEP Crude oil production Natural gas production Pemex Subsidiaries Clients * Exports Today, PEP produces the gas and sells it to PGPB which in turn transports and markets it to other Pemex subsidiaries, to other marketers, to LDCs and to large users. * Other marketers, local distribution companies and large users
20 DISADVANTAGES OF THE CURRENT SITUATION There are no incentives to invest in transportation infrastructure The first hand sales of gas contract (from PGPB) cannot be financed There is no commercial certainty to establish a natural gas market (price, supply, non-discriminatory open access, capacity information, etc.) PGPB does not offer competitive commercial conditions The market for transportation capacity cannot be established Despite some progress, end users have not been benefited by deregulation. It is absolutely necessary to promote the modernization of this sector through competition Without a solution in the short term Mexico will suffer a natural gas shortage
21 CHANGE PROPOSITION End users Storage WholesaleTransportDistribution Imports Production Production: Private investment or Joint Ventures for production of non-associated gas in the Burgos basin Imports: Promotion of imports through the establishment of a competitive wholesale market The establishment of a competitive wholesale market would result in investment in storage infrastructure A truly competitive natural gas wholesale market will be the foundation for the transformation of this industry Absolute guarantee to non- discriminatory open access to gas transportation infrastructure Continuation of the LDC concession program Benefit from competition Competition – The solution The establishment of a competitive gas market will create the certainty needed for increased production and imports, for investment in storage and transportation infrastructure and for the existence of efficient commercial conditions Establishment of an electronic bulletin board for prices and volumes of gas and transport
22 ALTERNATIVE PEMEX BUSINESS SYSTEM TO ALLOW COMPETITION PGPB Dry gas Ethane Liquefied gas Gasoline Basic petrochemicals Sulfur Gas and liquids processing PEP Crude oil production Natural gas production Transport Clients Marketing companies and large users are able to buy gas directly from PEP PGPB should exit the gas marketing business and focus on selling transport capacity * PGPB could monetize its gas sales contracts by bidding them out to other industry participants Unbundling the Pemex business system does not require major regulatory changes. Modifying Pemexs management strategy will allow competition and with it, the creation of an efficient wholesale market that will ensure investment in the industry and supply for the consumers. Pemex Subsidiaries Clients * Exports
24 Secretaría de Energía - Department of Energy Throughout his working career, Ernesto Martens has faced great challenges and obtained successful results. For eighteen years, he worked for Union Carbide, becoming its General Manager; for seventeen years he worked for Grupo Vitro (glass,our client in the Monterrey plant), which he also directed. Subsequently he became the Chairman of the Board of Aerovías de Mexico and the General Attorney in Fact of Mexicana de Aviación. He was appointed Chairman of the Board of Directors and General Manager of Cintra (holding company for Mexicana and Aeromexico airlines), holding that position until 1999. During the time he worked for the latter company, he was successful in having both airlines and their subsidiaries become leader companies in Latin America. He turned losses into profit and improved efficiency. Throughout his professional career, he has been a member of the Board of Directors of renowned companies, both national and international: Board of Regioempresas, Aeromar, Hulnort, Vitro and subsidiaries; Regional Board of Banamex-Accival, Transportación Marítima Mexicana, Afore, Ahorro Santander, Gatx de Mexico, Hylsamex, Anchor Glass Container Corporation, Grupo Financiero Serfin and the Business Advisory Council of the International Finance Corporation, among others. He received a degree in Chemical Engineering from the Technological Institute and Superior Studies of Monterrey (Monterrey Campus) and took post-graduate courses at the Technological Institute of Karlsruhe in Germany, and of Business Administration at the Harvard Business School. He was born in Tlilapan, Veracruz on January 28, 1933 Ernesto Martens Secretary of Energy
25 Petróleos Mexicanos – PEMEX Raúl Muñoz began his professional career at Du Pont, S.A. de C.V. in 1964. There, he held different positions in the areas of production, sales, marketing, planning, personnel and administration. He also held the position of Executive Vice President and, for the past 12 years, President and CEO of Du Pont México. Up until now, he has been the National Vice President of COPARMEX. He is a member of the editorial board on industry of the newspaper El Economista, president of Grupo Diálogo Inversión, and member of Diálogo México. Among his activities, he has been a member of the Board of Directors of Química Flúor, S.A. de C.V., Nylon de México, Sears Roebuck, S.A. de C.V., the Mexican Foundation for Rural Development, an independent consultant for Grupo AFORE Garante, and member of the Board of the Mexican Foundation for Health. In addition, he has been on the governing board of the International Chamber of Commerce, the National Association of the Chemical Industry, the Mexican Institute of Chemical Engineers, of which he was national president. He is a member of the American Chamber of Commerce of Mexico. He is a chemical engineer from the National Autonomous University of Mexico. He is a member of the Board of the School of Chemistry of the UNAM, the Museum of Mexico City, and the Old College of San Ildefonso. He was born in Mexico City on October 14, 1939. Raúl Muñoz CEO
26 Selected economic indicators for Mexico Economic recovery after crisis of 1994 was faster than originally expected. The GDP grew at an Average of 5.5 % between 1996 and 2000. ESTIMATE -8 -6 -4 -2 0 2 4 6 8 19941995 1996 1997 1998 19992000* 4.5 -6.2 5.1 6.8 4.83.7 7.1 GDP GROWTH (%) *Economic Policy Guidelines for 2000. The GDP per capita was of $4,938 dollars in 1999 $570.1 USbn
27 0 50 100 150 200 250 19931994199519961997199819992000 Source:Secretaria de Economia, Banco de Mexico and US Deparment of Commerce $US Billions U.S. imports from Mexico Mexican imports from U.S. NAFTA 40 45 50 55 62 54 73 68 86 82 95 93 110 105 126 103 85 105 116 188 168 141 215 229 GROWTH 93/99 169% NAFTA BENEFITS Trade
28 0 100 200 300 400 Canada Mexico Japan China UK Germany Taiwan France Korea Singapore 0 5 10 15 20 Mexico China Germany Canada Korea UK France Singapore Taiwan Japan $US Billion % Trade Volume 2000Average Growth 1993-1999 Source:US Census Bureau Mexico is the second largest trading partner of the United States U.S. – MEXICO TRADE BENCHMARKS
29 8.9 Inflation Inflation has shown a clear downward trend towards one digit level in 2000. The Mexican Central Banks inflation goal for 2001 is 6.5%