Pricing natural gas in Mexico

Abstract

Natural gas in Mexico is produced by a state monopoly (Pemex). The price of gas at the Houston Ship Channel and the arbitration point between imported gas and gas produced in Mexico is used in a formula based on the netback to determine the price of gas in Mexico. This paper will show that the price implied by this methodology is equal to the shadow price of the domestic gas production constraint in a welfare maximization problem and therefore, this formula for regulating the price of gas in Mexico is consistent with the objectives of a regulator seeking to maximize social welfare. The netback formula, however, leads to incentives to divert or reduce production in the south in order to move the arbitration point south and increase the price of domestically produced gas. Since gas produced in the north is a substitute for gas from the Texas market, an increase in production in the north will not change the location of the arbitration point as the marginal gas is exported. The elimination of import tariffs in Ciudad Juarez does not affect the prices at Los Ramones and Ciudad Pemex unless limited pipeline capacity at Burgos restricts exports. If there is an export bottleneck at Burgos, the price of gas at Burgos will reflect the shadow price of that restriction. If the arbitration point is north of the junction at Los Ramones, elimination of tariffs at Juárez implies a reduction of the price at Ciudad Pcmex. Gas imported from the Permian Basin will displace gas imported from Texas at Burgos and move the arbitration point north. Only modifications in demand and supply that change the relevant arbitration point will affect the price in Ciudad Pemex. Changes in demand and supply between the relevant arbitration point and the border will not change the arbitration point.