Pricing Liquid Petroleum Gas in Mexico.

• Author: Brito, Dagobert L.

Dagobert L. Brito [*]

William Laney Littlejohn [+]

Juan Rosellon [++]

This paper considers the regulation of pricing of liquid petroleum gas in Mexico. We construct a model that incorporates all information essential to the pricing question and derive relationships that should hold between prices in Mexico and prices in world markets. Prices in Mexico can be tied to the readily observable prices in the United States by a netback rule. However, this rule can lead to incentives to increase the price of domestic liquid petroleum gas by diverting production from the regulated market.

1. Introduction

   The economics of oil and gas in Mexico are difficult, and many of the issues involved are very subtle. It is not surprising that there is substantial misunderstanding of many of the issues involved. The difficulties arise from three sources. First, the national oil company Petroleos Mexicanos (PEMEX) is a monopoly and many of the markets involved are regulated. Prices are not a good guide for economic decisions as to production. PEMEX must solve a very difficult programming problem to reach decisions as to quantities produced. Second, oil, gas, and natural gas liquids are often produced jointly, and in such cases, is impossible to allocate costs of production to a specific product (see Adelman 1963). Finally, the goods produced are almost perfect substitutes as inputs in production. Gas and oil are substitutes in the generation of power; natural gas liquids, gas, and oil are substitutes as feedstocks. There is little or no curvature in the marginal rates of technical substitution. There are very difficult pr oblems in regulating prices. The Comision Reguladora de Energia (CRE, Energy Regulatory Commission) has been given the responsibility of regulating the price of liquid petroleum gas (LPG), natural gas, and electricity.

   To overcome the difficulties created by the technology, national institutions, and market structure, the Comision Reguladora de Energia has linked the LPG market in Mexico to the price at Mont Belvieu near Houston, Texas. The link is real when Mexico is importing LPG and LPG is moving into the Gulf of Mexico or if Mexico is importing (or exporting) LPG from Mont Belvieu. When Mexico is not importing LPG or exporting LPG into Mont Belvieu, the price at Mont Belvieu serves as a reference point for the price of LPG in Mexico.

   This paper considers the means by which the price of LPG in Mexico can be tied to observable world market prices in an economically defensible fashion. We begin by considering the essentials of the market for LPGs in North America and the Gulf of Mexico and demonstrate that it is appropriate to tie prices in Mexico to the readily observable LPG prices at Mont Belvieu, Texas. We then demonstrate that the detailed linear programming models currently used for the planning of the import, export, and distribution of LPG in Mexico can be greatly reduced in dimensionality without loss of information about optimal pricing. This permits the construction of simple, transparent policy models that incorporate all information essential to the pricing question and derive relationships that should hold between prices in Mexico and prices in world markets.

2. The North American Liquid Petroleum Gas Market

   The U.S. is a net importer of LPGs, with net imports running about 100 thousand barrels per day. The majority of this material comes from Canada via pipeline, but significant volumes are imported as waterborne cargoes from Algeria and Venezuela. Depending on market conditions in various parts of the world, the U.S. also imports LPG from Europe (North Sea) and the Middle East (Saudi Arabia, UAE). In the future, as new gas processing facilities come onstream, Nigerian LPG can be expected to flow into the U.S. Of particular interest to Mexico, is the fact that an annual average of 35 million barrels a day (MBD) of LPGs are imported into the U.S. Gulf Coast (USGC) region from outside North America. About 70% of this material comes from Algeria and the remainder from Venezuela. These imports are landed at Houston, where they can move into storage facilities at Mont Belvieu.

   Mont Belvieu is located 20 miles northeast of Houston and has long been the center of the U.S. market for natural gas liquids (NGL). There are four large fractionators that produce 23 million gallons per day of finished product in Mont Belvieu. Mont Belvieu has the largest NGL storage facilities in the world. Located in underground salt domes, the total storage capacity exceeds 4000 million gallons. The market is large so the price at Mont Belvieu is used for trading in Texas, Louisiana, and throughout the Caribbean basin. LPG, butane, and propane, which include ethane, isobutane, and natural gasoline, are a subset of NGL.

   LPG from South America and North Africa is also traded at Mont Belvieu. One of the reasons that LPG trades in an international market is that NGL becomes liquid at a temperature of about 0[degrees]F. By contrast, natural gas becomes liquid at about --275[degrees]F. Thus, it is relatively cheap to liquefy and transport LPG. It costs about $5.00 to ship a ton of LPG 1000 miles by sea. This is approximately $0.10 per MMBTU (million BTU) or $0.02 a gallon.

   It should be noted that there is considerable seasonal variation in these imports. In winter, LPG prices in Europe typically rise sufficiently to attract all of the waterborne LPG available from Africa and South America. Under these conditions, it becomes uneconomic to ship this material to the USGC, and imports cease. In summer, however, European prices drop, imports into the U.S. become attractive, and some 50-60 MBD moves into the USGC.

   When the U.S. is importing LPG into the USGC, prices at Mont Belvieu should equate to the landed cost of imports (including terminal costs). [1] Noting further that the sailing distance from Algeria to Pajaritos, Mexico (c. 5500 nautical miles [nm]), differs only slightly from that from Algeria to Houston (c. 5400 nm), the landed cost of imports into Pajaritos should be approximately the same as the landed cost in Houston, differing only by the amount of the differences in terminal costs. Consequently, one would expect the price of LPG at Pajaritos to be the same as the price at Mont Belvieu.

   ...