Pricing natural gas in Mexico: an application of the Little-Mirrlees rule--the case of quasi-rents.

• Author: Brito, Dagobert L.

1. Introduction

   The Comision Reguladora de Energia (CRE) has implemented the netback rule that uses the price of gas in Texas to set the price of gas in Mexico adjusting for transportation costs since 1996 (see Comision Reguladora de Energia 1996). At that time, the price of gas in Texas was viewed to be the result of a competitive market. The netback rule meant that the Mexican gas market would also have the characteristics of a competitive market as long as there were no constraints to the flow of gas, and gas was able to move to equilibrate supply and demand.

   Since then, conditions have changed. The increase in the demand for gas has resulted in various bottlenecks in the supply of natural gas. The price of gas in the United States now reflects the quasi-rents to these bottlenecks (Hartley and Medlock 2006). The current pricing policy in Mexico is now imputing these economic rents to the gas produced at Ciudad Pemex. This note is a re-examination of the optimality of the netback rule when the base price of gas reflects quasi-rents to such bottlenecks.

   The existence of quasi-rents in the Texas market has created political pressure in Mexico for a "Mexico Price." Many of the proposals are ad hoc, but a credible candidate is the intertemporal opportunity cost of gas. Mexico produces nonassociated gas, so at the margin, Mexico faces a tradeoff between consumption of gas in the present and consumption of gas in the future. The opportunity cost of finding nonassociated gas reserves reflects that margin. The cost of acquiring nonassociated gas reserves should reflect the value of gas when it is consumed in the future. The question is should the optimal price for gas in Mexico use the price implied by the intertemporal price, or should the current price of gas in Mexico reflect the quasi-rents associated with the various bottlenecks that exist in the gas market?

   To see the problem, suppose that Mexico was an isolated economy that was neither importing nor exporting gas. Assume that as a result of some intertemporal maximization, there is a well-defined price, nj, that is the correct measure of the opportunity cost of discovering and producing gas. In a dynamic programming problem, this would be the costate variable associated with nonassociated gas reserves. This is the value to Mexico of adding or subtracting one unit of gas at that time. It is easy to show that if Mexico is an isolated economy, the correct price for gas is that intertemporal price. At the margin, Mexico should be indifferent to consuming a unit of gas or adding it to its nonassociated gas reserves. Now suppose that Mexico is now linked to an external market where there is a different price of gas. Further assume that this different price reflects quasi-rents caused by some temporary bottlenecks. Using the netback rule to set the price of gas in Mexico would mean that Mexico would stop using the price of gas that correctly measures the tradeoff between the consumption of gas now and the consumption of gas in the future. The result is that the netback rule, rather than the intertemporal price, is optimal.

   The pricing rule based on the Houston Ship Channel price was an implementation of the Little-Mirrlees proposal for pricing traded goods (Brito and Rosellon 2002, 2005). (1) Since then, conditions have changed. The increase in the demand for gas has resulted in various bottlenecks in the supply of natural gas. The price of gas in the United States now reflects the quasi-rents to these bottlenecks (Hartley and Medlock 2006). The current pricing policy in Mexico is now imputing these economic rents to the gas produced at Ciudad Pemex. This article is a reexamination of the optimality of the netback rule when the base price of gas reflects quasi-rents to such bottlenecks. In this...