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Interview

Manuel Rodriguez Arregui, GBM Infraestrutura, Mexico.

“The power sector in Mexico is poised to undergo significant transformations following the implementation of the reforms. The constitution basically establishes a wholesale market with an independent system operator and an independent market operator—a model that has successfully been tried and tested elsewhere,” comments Manuel Rodriguez Arregui, GBM Infraestrutura, Mexico.   

 

How can an independent investment bank maintain market leadership in Mexico?

GBM is the largest investment bank in Mexico and is quoted on the Mexican stock exchange. In fact, it is interesting to note that an independent investment bank can be the market leader in a country like Mexico given today’s financial markets.

We do not recommend our clients investments, which we ourselves also do not invest in; we put our money where our mouth is. Every action we take is based on thorough research and analysis. GBM has also, since its inception, adhered to strict corporate governance practices and, as a result, has maintained an immaculate track record clear of any negative news. We are committed to the undertakings we pursue and strongly value our word. As the Spanish saying goes, ‘don’t do good things that may appear bad.’

GBM launched GBM Infraestructura, Mexico’s largest infrastructure and energy fund. This was executed through a listed private equity fund because Mexico has defined contribution pension funds, as opposed to defined benefits. As such, these defined contribution funds, also known as Administradores de Fondos para el Retiro (AFOREs), can only invest in publicly traded securities and that is why we pursued a listed private equity model, eligible for investment by Mexico’s pension funds.

What do you make of the energy reforms?

We are certainly optimistic about Mexico’s wide-ranging and comprehensive energy reforms and are eagerly awaiting their implementation. The proposed changes are unprecedented.

Nevertheless, it must be said however, that a majority of the hype surrounding the reforms has been disproportionately placed at the upstream segment, and with undeservedly little attention being paid to the midstream, downstream and electric power sector. The respective implications to these latter sectors are also huge.

Between your infrastructure and energy focus, what is the relative weight or importance of the energy sector in terms of investments?

The energy segment of our business is undoubtedly set to experience significant growth. Nevertheless, as of now, although we have analyzed numerous energy projects, we have not yet invested in that area.

Why is that you have not yet invested in the energy sector just yet?

GBM Infraestructura has, for instance, participated in the Chicontepec round with a strong consortium, interested particularly in the Soledad field. However, we decided to withdraw our bid shortly before the closing date because the bidding process had been, in our view, distorted to be a play for service operators.

We have also analyzed a number of power generation projects. For instance, in Oaxaca, a region known for its wind power potential, we explored these more sustainable power generation options. Our analysis indicated that obtaining a desired return on equity would be challenging given the power purchase agreement (PPA) that was signed. Similarly, we have also explored options at the state of Tamaulipas, another region known for its wind potential, as well as Baja California. Although solar radiation is comparatively superior in Mexico compared to other locations, we made a strategic decision not to pursue solar power as a source of renewable energy for the time being.

The power sector in Mexico is poised to undergo significant transformations following the implementation of the reforms. The constitution basically establishes a wholesale market with an independent system operator and an independent market operator—a model that has successfully been tried and tested elsewhere.

Mexico charges tariffs that are approximately 25 percent higher than in our northern neighbors, the US. Couple this with cross-subsidies, you then have huge arbitrage opportunities that will drive very large investments in the near future. These large investments in combined cycle power plants will serve to provide the credit worthiness for the natural gas pipelines that will ultimately help to introduce natural gas distribution to places that have never had it before.

What other opportunities have you identified across the oil and gas value chain?

In terms of the downstream, Mexico will begin to see an end to the Pemex monopoly of gas stations with the introduction of other franchisors. The moment new brands are introduced into the picture, the entire paradigm of fuel distribution, storage and whole sale will be transformed. To illustrate, it is hard to imagine that in today’s day and age in Cancún, a city in southeastern Mexico, Pemex still uses trucks instead of pipelines to import its gasoline.

On the other hand, the refining sector is still experiencing tight margins, making private investments still unattractive and unlikely.

Another sector that will be turned on its head will be the petrochemicals sector. Since the 1990s, Mexico created a legal barrier in terms of the vertical integration of petrochemicals. For instance, the reason why private sector has never opted to build an ethylene plant until very recently is because the ethane procurement process was not assured. Pemex was not signing long-term contracts to provide ethane. This will fortunately no longer be the case once the reforms are enacted as the production of ethane is liberalized. Hence, with the price of natural gas that we have in North America and their implication on ethane price levels, I am confident we are set to see a boom in petrochemicals.

The upstream sector will also become an entirely new ball game. The constitution has truly established a critical role for the department of energy (SENER), which it previously lacked. The same applies to the national commission of hydrocarbons (CNH), as well as the energy regulatory commission (CRE).

With that backdrop, Pemex will be allowed a transition period with the so-called ‘’round zero’’ in which it can propose which fields are “assigned” to it. At the same time, however, Pemex will for the first time be obligated to perform in terms of its recovery factors. Countries do not account for assets in terms of their government accounting. Pemex, as a state owned enterprise, did not own its reserves. It is the state that effectively owns those assets but no one in the government itself played the role of owner of the resources. As a result, the restitution of reserves was neglected, as were the recovery factors. Now, with the implementing of the reforms, the department of energy and the CNH have a very clear role in this respect. In addition, both Pemex and the private sector will now be able to book reserves.

To what extent will the authorities’ leash on Pemex be loosened following the reforms?

A key article in the constitution establishes a new concept for Pemex. Instead of being a state-owned enterprise, Pemex will now be considered a ‘productive-state entity’. What the new constitution establishes is a new and better corporate governance model. Ultimately governance implies accountability and this applies to the public sector, as much as it does to the private sector.

On the other hand, the federal government will have the power to limit the company in terms of its bottom line and its human resource expenditures. In addition to this, Pemex will have to coordinate with the government when issuing financial instruments to the capital markets for the very simple reason that one does not issue Pemex bonds and UMS (United Mexican States) bonds the same day.

When and where can we expect to see the initial flows of investment taking place across Mexico’s energy sector?

The power sector is most probably among the first to undergo the biggest transformation and investment.

 

In the oil and gas sector, because of the transition period, or “round zero” in the upstream, the large investment activities we will see are likely to first take place in the silent mergers and acquisitions of a large number of gas stations. Simultaneously, we can also expect to see a significant flow of investments targeting the natural gas and petrochemicals sectors, as well as in sophisticated storage and transportation solutions. The scale of opportunities is so great that Mexico will see projects it has never seen before. For instance, as a monopoly exercising its monopoly power, the country has so far never stored natural gas allowing it to increase margins by restricting supply. This too will now change and I am confident that we will soon see natural gas storage projects taking off in the country.

How has GBM Infraestructura’s fund performed so far and what lies ahead?

Our objective is to achieve above average industry returns and so far we have been on track, achieving 16–19 percent returns. Having been active for the past year, we have so far invested approximately 30 percent of the fund. Some projects have been turned down due to risk profiles that were not aligned with returns, whereas some have been rejected due to a misalignment of corporate governance or conflicts of interest.

We expect to invest the full fund in the near future and will likely raise a second fund shortly thereafter. We demonstrated that we have the right process, analytical skills and proactive attitude to succeed; we are well positioned to achieve this and continue along our growth trajectory.

With 20/20 hindsight, we have no regrets in the decisions we have made so far. As a fund composed of pension investors, I have a fiduciary responsibility to some 19 million Mexicans. As such, we are focusing on the long term, carefully selecting the projects we chose to pursue while ensuring that those projects we do pursue are in line with or objectives and philosophy.

 

To read more interviews and articles on Mexico, and to download the latest free report on the country, click here.

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