Talanza Energy Consulting

April, 2020

It is all in the file: Approval of Maximum Tariffs

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The activities of storage, pipeline transportation, and distribution of fuels (natural gas, petroleum products,  and petrochemicals) are natural monopolies subject to economic regulation by the Mexican Energy Regulatory  Commission (CRE or the Commission). Among other aspects that we will discuss later, economic regulation means  that the regulator has the attribution to approve (or to refuse!) the maximum fare applicable for each type of service  within these activities. According to current regulation, Permit Holders (permisionarios) must apply for approval of  their maximum tariffs before CRE, who has a wild card: it ultimately sets the maximum fare for each project.

* Economic regulation applies only to activities that are linked to pipeline use which makes them natural monopolies.

Permit Holders often struggle with the approval of their tariffs, which can represent a delay in the commencement of  operations. Even though the Commission has ninety business days1 to approve the maximum set of tariffs for a  project, the procedure is known to take up to two years (or more!). To minimize the risk that the approved revenue is  below the tariffs agreed with the anchor shippers (tarifas convencionales), a proper filing is key.

CRE is frequently behind schedule for permit granting and file review. In consequence, the institution takes  advantage of any inconsistency in the file to delay approval. If the Commission can argue that the tariff application file  does not provide the necessary information for an evaluation of the tariffs, further information will be requested  until it meets its requirements, costing time and effort to Permit Holders, while the clock is ticking.

MEXICAN TARIFF REGULATION

The regulation allows CRE to authorize rates for services to its regulated natural monopolies. The referee uses a  “Price-cap model” (maximum fares, as opposed to the “Revenue-cap model”) determined by a review of efficiencies  in the expenses, plus a regulated rate of return. The price-cap is determined by several economic factors, such as the  Opex, Capex, ROE, taxes, depreciation, expected efficiency savings, inflation, and other components. The model will  review the efficient and acceptable rate of return: “the regulated rate of return”.

Therefore, each permisionario must put special attention when presenting its business plan to calculate the  proposed tariffs for each service provided to the shippers. The Commission approves the maximum rates by  reviewing the business plan with the rules and methodologies established in the Directives for the determination of  tariffs and price transfers of regulated activities in the field of natural gas and liquefied petroleum gas2. The business  plan must clearly indicate the annual income requirement and expected capital return, considering the following key  elements, which ought to be properly addressed:

  1. Investment: Asset base, the structure of fixed assets (currency proportion USD/MXN), and working  capital.The regulator will review the level of investment against a benchmark built with similar projects.
  2. Financing plan: Percentage of debt/equity.
  3. Operation, management, and administration costs. This will be reviewed against a benchmark.
  4. Technical information: Demand, system’s capacity, size and number of users, energy, and volumes.

SOME COMMON MISTAKES

  1. Presenting a weighted average cost of capital (WACC) with a different methodology than CRE’s3.
  2. Failing to submit invoices that support the reported expenditures.
  3. 3.Showing a different ratio for working capital than the generally approved by the Commission,  without proper justification.

1Reglamento de las actividades a que se refiere el título tercero de la Ley de Hidrocarburos.

2Directiva sobre la determinación de tarifas y el traslado de precios para las actividades reguladas en materia de gas natural DIR-GAS-001-2007.  Directiva de contabilidad para las actividades reguladas en materia de gas natural, DIR-GAS-002-1996.

3Resolución RES/233/2013.

TARIFF SCHEME 101

The regulation allows CRE to recognize in the  business plan capacity and usage charges that  will allow the recovery of fixed and variable costs.

The business plan for distribution services, with  commercialization and interruptible basis  services, can consider a structure with a single  variable term.

TRANSPORTATION AND STORAGE TARIFF

Permit Holders may agree to long-term agreed  tariffs and charges (leveled rates), which may be  higher than the maximum fare, if and so far, some  conditions are accomplished.

DISTRIBUTION

*Tariff groups: Residential, Commercial, and Industrial.

Permit holders can choose between two tariff  schemes: blocks or step structure.

WHICH OTHER ECONOMIC REGULATION  CONDITIONS DO YOU NEED TO ADDRESS?

LET’S TALK ABOUT TERMS & CONDITIONS

Even before the tariff application, Permit  Holders must present to the Commission, for  approval, the proposal of Terms and Conditions  (T&C). The T&C define the scope of the services,  rights, and obligations of both Permit Holder and  users. In consequence, the T&C are the rule book  for the Permit Holder in front of the market as a  whole and its users.

In that sense, the proposal must be: 1) aligned to  the current regulation; 2) valid through time; 3)  beneficial for the Permit Holder; 4) assuring not  unduly discriminatory open access.

From a regulatory and economic perspective, in  Talanza we advise Permit Holders and interested firms  in the proper definition of their tariff structures (for  new projects or five-year updates), and also, in the  design of Terms and Conditions that are aligned with  the regulation as well as with the interests of the firm.

Analysts

Daniela Flores

Daniela Flores oversees the tailoring of midstream and downstream regulatory compliance schemes. Her areas or expertise include analysis of natural gas and liquids markets as well as first-hand experience on the implementation of procedures to guarantee not only regulatory compliance but also assure supply, demand and infrastructure review for a comprehensive advice in each of our clients' energy projects.