Open the taps: Reforms that lead to cheaper gas will be a boon to petrochemicals

The petrochemical industry stands to be one of the biggest beneficiaries of Mexico’s energy reform, as the measures are expected to liberalise the market for natural gas, on which Mexican petrochemical plants depend. Today, the industry is hamstrung by an inadequate supply of natural gas, which has sapped its competitiveness and fuelled Mexico’s trade deficit in plastics.

Scorecard

As petrochemicals go, Mexico scores well for raw advantages. Thanks to its location and free trade agreements, it has access to many markets throughout the Americas that would be prime targets for exports of petrochemical products. The technology that the industry needs can easily be imported, and qualified human capital is available, helped by its history as an oil-producing country.

The problem, most observers agree, is that Pemex, the state oil company, has a complete monopoly on oil and natural gas. From exploration and production to transportation and export, this one-seller model has led to a number of inefficiencies, from unresponsive pricing to pipelines that do not match the industry’s needs. “Traditionally, Pemex would build whatever natural gas pipelines CFE (the state-owned utility company) needed,” Montserrat Ramiro X, director of energy projects at the Instituto Mexicano para la Competitividad, a Mexican think tank, told OBG. “It made no sense. It was a monopoly with one customer.” To top all, Pemex lacks the resources to fully exploit natural gas reserves. The result is that natural gas and other petrochemical inputs are sometimes overpriced or in short supply.

“Natural gas is sometimes overpriced and other petrochemical inputs are often in short supply,” Fernando Hernández, country head of the Swiss chemical company Clariant, told OBG. “Uninterrupted supply will have to be provided so that the petrochemical industry in Mexico can rebound.”

Pivotal Reforms

The energy reform, if implemented through secondary laws as the industry expects it will be, may change all of this – not least because it will break Pemex’s monopoly. For the first time in decades, foreign companies will be able to seek out and extract natural gas and other hydrocarbons, which will boost domestic production. Crucially, the reform will permit private investment in transportation infrastructure.

This provision could spur two important changes. Private companies will be able, first, to invest in infrastructure that will better link Mexico’s upstream and downstream operations, and second, to build pipelines that draw natural gas from the US, where it is cheaper and more plentiful. Once Mexican petrochemical plants have access to low-cost natural gas from the US (or from Mexico but priced to market), they will be ripe for vertical integration, and may be far more competitive.

Industry Reaction

A second round of laws are still needed to implement the reforms passed in 2013, and were still pending as of May 2014. Yet industry and investors have already responded to the benefits petrochemical companies are expected to accrue from them. In summer 2013, in anticipation, the stock prices of Alpek and Mexichem, two of Mexico’s biggest petrochemical firms, rose 25% and 20%, respectively (though they have since fallen from unrelated market forces, such as a glut of polyester manufacturing in Asia).

Meanwhile, numerous petrochemical projects in Mexico have been announced. Styrolution, a petrochemical company headquartered in Germany, plans to begin producing alpha methyl styrene acrylonitrile on a new production line at its plant in Altamira, north-east of Mexico City, in the second quarter of 2014. Styrolution currently imports the stuff from its plant in Germany to Mexico, where it is used in acrylonitrile styrene acrylate and acrylonitrile butadiene styrene products.

Ultrapar, a Brazilian conglomerate, invested $62m in 2013 in Oxiteno, its petrochemicals division, to expand the latter’s plants in Pasadena, California and Coatzacoalcos, in the south-eastern Mexican state of Veracruz. The group said it would invest another $72m in these projects in 2014, and plans eventually to expand the production capacity at its Veracruz plant, which produces anionic surfactants, by 30,000 tonnes a year.

After a long and halting negotiation, Pemex and Mexichem agreed in 2013 on terms for a joint venture in vinyl chloride monomer (VCM) to be based at Pemex’s Pajaritos plant near Coatzacoalcos. The two parties will invest $556m to modernise the facility, increasing production by 24,000 tonnes in 2014, 146,000 tonnes in 2015, and 217,000 tonnes in 2016. As a result, Mexichem will depend less on foreign VCM, which it uses to produce polyvinyl chloride at several of its plants, and will move towards vertical integration within Mexico.

Complex Change

Dwarfing all of these is the Etileno XXI complex. A joint venture between Braskem, a Brazilian petrochemical company (70%), and Idesa, a Mexican conglomerate (30%), the project is backed by $3.2bn in financing from seven banks, including the International Finance Corporation. The new complex, slated to switch on in 2015 just south of Coatzacoalcos, will include an ethane cracker that can put out 1.05m tonnes a year of ethylene, two high-density polyethylene lines with a combined capacity of 750,000 tonnes a year, and one line of low-density polyethylene with a capacity of 300,000 tonnes a year. This new output would boost Mexico’s ethylene production by 66% from 2013 levels and its polyethylene production by 120%. Once it comes on-line, the complex will help shrink the country’s sizable trade deficit in plastics.

The ethane cracker will get its feedstock from Pemex Gas y Petroquímica Básica. This arrangement and Pemex’s new venture with Mexichem delight industry leaders, who are keen to see Pemex help lead the industry away from reliance on imported raw materials. “The petrochemicals industry in Mexico exports more than the rest of Latin America combined, but still runs a trade deficit that reached $7bn in 2012,” Luis Rebollar González, president of Dupont Mexico, told OBG. “To cut this deficit, there need to be investments to link downstream and upstream segments of the supply chain. It falls to Pemex to begin this investment, before other domestic and foreign companies will follow.” That Pemex is beginning to do so is a promising sign.

Home Markets

A growth spurt is likely, as there is no shortage of domestic demand for goods the industry produces. The construction and automotive sectors, which are big consumers of plastics, are humming along, and in the nascent but fast-growing (if protected) agriculture sector, new opportunities are emerging. Furthermore, Mexico today imports more than half the plastic it consumes. Once reforms are implemented, Mexico’s petrochemical industry should be better poised to compete for this slice of the local market.

True, the industry will face competition from the US: petrochemical inputs there are cheap, giving US plants a natural edge. But, assuming the secondary laws are written in such a way as to allow unrestricted investment in natural gas transportation, Mexican industry could soon see access to the same low-cost raw material. If this occurs, Mexican and US firms will compete only on operations, which Mexico’s ample experience as a global player should be able to handle. If Congress passes secondary laws consistent with the spirit of earlier reforms, the industry could see substantial growth.