Pricing liquid petroleum gas in Mexico

Abstract

The economics of oil and gas in the 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 it impossible to allocate costs of production to a specific product. Finally, the goods produced are substitutes in consumption. Gas and oil are substitutes in the generation of power; natural gas liquids, gas and oil are substitutes as feedstocks. This creates very difficult problems in regulating prices. The Comision Reguladora de Energía (Energy Regulatory Commission) has been given the responsibility of regulating the price of liquid petroleum gas (LPG), natural gas and electricity. They are attempting to link the prices in Mexico to world markets. This paper considers the means by which LPG prices in Mexico can be tied to observable world market prices in economically defensible fashion. We begin by considering the essentials of the market for LPGs in North American and the Gulf of Mexico, demonstrate that it is appropriate to tie prices in Mexico to the readily observable LPG prices at Mont Belvieu, Texas, and calculate approximate values for LPG prices at the points of import (or export) of LPG into Mexico. We then consider a detailed linear programming model of LPG import, export and distribution in Mexico (a model proposed by PEMEX and approved by CRE, to serve as the basis for pricing in Mexico) and demonstrate that the dimensionality of the problem can be greatly reduced without loss of information about optimal pricing. Finally, we construct an appropriate simplified model which incorporates all information essential to the pricing question, and derive relationships which should hold between prices in Mexico and prices in world markets.