Natural Gas Companies Eye Up Vertical IntegrationWed, 02/19/2014 - 12:08
The Energy Reform has been lauded for the chances it is extending to the private sector, but Fernando Calvillo Álvarez, President and CEO of Fermaca, believes the evolution of the market has been a subtler process. “This process was made up of a chain of activities that gradually evolved out of aspects of PEMEX’s monopoly being opened up to private investment, from joint ventures and investment agreements to bidding processes,” he explains. Mexico’s natural gas situation made this development process evident, given that the average price of natural gas in the US through 2013 hovered at around US$3.5 per million BTU, as compared to US$12 for fuel oil, US$16 for diesel and US$19 for LPG. Ever since the US began shale gas production forward with intensity, it has become the cheapest source of natural gas in the world. This means the lack of current infrastructure and interconnection points at the US-Mexico border makes for an extremely attractive opportunity for firms like Fermaca, who can now eye up bringing cheap gas to Mexico.
As this process moves forward, private companies will be competing against each other in a crucible that will test which of them have the capacity to guarantee the supply of natural gas. Fermaca feels confident it will come out on top, given the long-term vision it applies to its projects and due to the process of vertical integration that many natural gas companies end up going through, taking the step from being purely transporters of natural gas to becoming power generators. Fermaca dipped its toe into these waters a few years ago, setting up a partnership to develop power plants, but the closed generation market and dependence on supply from PEMEX derailed this move. Critical alerts, commonplace in certain parts of Mexico lead to a reduction in the volumes of natural gas being distributed to customers, and have also held back this integration process. For Calvillo Álvarez, it is unthinkable to invest in power plants while such a situation endures. “If you are going to invest between US$100 million to US$1 billion in a power plant, you have to ensure the reliability of the gas supply. It would be impossible to finance a project that is vulnerable to critical alerts and risks running out of fuel.” Such a problem led to innovations from Fermaca. The 385km Chihuahua Corridor pipeline was designed for the needs of CFE, but also to allow for greater capacity to be used by third parties. When building such infrastructure, Fermaca laments the short-sighted planning of certain players, as it vouches to plan for the next 15 to 20 years. With additional capacity in its pipeline and with natural gas prices at US$3.5 per million BTU, energy-intensive industries now see the potential of reducing their costs by more than 50 percent, says Calvillo Álvarez. “We have been pushing for the creation of energy hubs along the pipeline. This would be of most benefit to power producers as they consume the largest amount of gas.”
After decades with an energy monopoly, “the cost of producing, transporting and distributing fuels did not matter in Mexico. As for power, little attention was paid to daily, weekly or seasonal swings in generation. There was no certainty about whether enough gas or pipeline pressure was available at the time it was needed,” he explains. Given the obvious costs such inattention incurred in terms of penalties and mismanagement, the benefits of peak shaving became evident. Through a strategic alliance with a technological partner from the Netherlands, Fermaca developed peak shaving facilities that connect to pipelines at times of high availability but low demand. This gas is then stored as LNG, and can be re-gasified and re-injected into the grid, should gas supplies falter in peak hours. Calvillo Álvarez lists the advantages of peak shaving as optimizing the dispatching of power plants, safeguarding against temporary critical alerts, allowing for better management of the supply and use of gas over time; it also allows withdrawals during periods of scarcity or to cover a price spike. “We know that the peak shaving project will come to fruition because it is needed. We see ourselves as owning and operating such a facility and providing peak shaving services to power generators, initially with a capability to cycle up to 20 Mcf/d, which is not large but very important as a first step,” says Calvillo Álvarez.
Fermaca is committed to making an expansion into power generation, though it knows its experience does not lie in that field. By teaming up with a power producer to yield the best result, Calvillo Álvarez estimates that in the first stage of development, 700MW of private power generation could be set up, with Fermaca considering several options to best claim a slice of the power generation market. The company is looking at projects in different regions of Mexico, while also considering an expansion of its cogeneration projects, and combining gas and renewable energy. With the ink still drying on the Energy Reform, Calvillo Álvarez expects this process to be drawn out. “It is slow and difficult but we believe our first plant will be operating within two to three years. The Energy Reform will completely open up power generation. Fermaca can be extremely competitive and will become an important player in the region.” In the last two years, Fermaca invested almost US$600 million and estimates that with its current pipeline infrastructure, it could already move 20% of the natural gas consumed in Mexico.
Despite this early stage of its vertical integration, Calvillo Álvarez believes Fermaca has demonstrated its superior value offering through its previous projects. It secured the win for the Chihuahua Corridor pipeline by having a substantial difference in its offering to those of its competitors. In a joint venture with Spain’s Enagás, Fermaca tabled a bid of US$88 million to build and operate the compressed natural gas of Soto La Marina in Tamaulipas. Calvillo Álvarez said the difference in net present value was around US$100 million dollars, showing that Fermaca is confident that it can provide the best services around at the lowest price. Both companies naturally complemented each other since Enagás had certain problems developing and materializing projects in Mexico but had a lot of capital to invest. On the other hand, Fermaca had masterminded successful project executions but had struggled to find competitive financing alternatives. “Enagás brings a large technical base of experienced people, grown and seasoned in a fairly protected market,” says Calvillo Álvarez. “Fermaca brings local strength, adaptability, project and financing expertise and execution capabilities.”
Given these competitive strengths, why has Fermaca not had a greater range of projects to date? “Unfortunately, the administration of Former President Felipe Calderón made bids more attractive for international companies than for Mexican companies. So new criteria were added to the bidding rules that Mexican companies could not compete with,” says Calvillo Álvarez. He sees this failure to use Mexican potential to its full value as a shame, beyond the fate of Fermaca, since these projects missed out on the knowhow of Mexican players in areas such as how to obtain permits and how to control development and construction costs, among other advantages.
Fermaca itself has adapted to the different realities of different projects in the Mexican market. For example, its Chihuahua Corridor pipeline presented fewer problems than its Palmillas-Toluca pipeline. This was largely due to major differences in the conditions of the two construction projects, especially in terms of dealing with land owners and struggling with geographic challenges. The Chihuahua to Tarahumara pipeline involved dealing with 400 land owners over 385km, as compared to negotiating with 1,600 in just 122km for its Toluca equivalent. The Toluca pipeline also had to run across uneven terrain such as hills and expensive agricultural land, while the Chihuahua one had a clear run across flat desert and big ranches. Ultimately, both projects were completed in around 14 months, with Fermaca achieving a good learning curve from both, but mostly from Chihuahua. “In the case of Chihuahua, many complex factors were managed smartly. We excelled in the right of way process, we anticipated most of the engineering challenges which saved a lot of time and money, and we implemented a smart management plan for the construction. But whether it takes more or less days does not matter, it is about hitting the deadlines you set and finishing the project on time,” explains Calvillo Álvarez. “The Chihuahua pipeline is the first such project to be built and delivered on time to CFE. Foreign companies have not accomplished that in Mexico.” For him, this shows the importance of having Mexican companies be competitive in Mexico. If Canadian, French or Spanish companies are more competitive at home for having the support of their governments, there is no reason the same should not happen in Mexico.
Despite Mexico now facing a challenge in developing its own shale gas industry, Calvillo Álvarez is not overly concerned about what ultimate success in this line of work would mean for his business. “I do not think it will have an effect for some time to come. Fracking is not an easy process. Mexico must open up shale gas exploration and production to private investors, because that is the only way the country will see this activity happening.”
But with the Energy Reform having passed, a new market is being born, one in which Fermaca will have to navigate very different relations with the public and private sectors to ensure fruitful results. The company sees working with the private sector as a complicated process, varying according to which companies are willing to take risks and which have the right credit credentials. To ensure success in power generation with the private sector as customers, “you have to take the big players in the Mexican economy and negotiate stable power consumption for your project for 15 years. Unfortunately, in Mexico, nobody ever says no so you end up in negotiations that were never going anywhere,” says Calvillo Álvarez. But working with CFE is different, he adds. The bidding process is hard, involving a tough battle with competitors in which potential returns are reduced. But in case of a win, a 25 year contract is ensured. It will be interesting to watch the formation of the power market in the coming years. “With the Energy Reform, the participation of the private sector is imminent and a power market will be created. Today, 40 to 45% of power generation is already being done by private players but only through exclusive contracting with CFE. There is no power market yet.”