It is all in the file: Approval of Maximum Tariffs
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:
- 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.
- Financing plan: Percentage of debt/equity.
- Operation, management, and administration costs. This will be reviewed against a benchmark.
- Technical information: Demand, system’s capacity, size and number of users, energy, and volumes.
SOME COMMON MISTAKES
- Presenting a weighted average cost of capital (WACC) with a different methodology than CRE’s3.
- Failing to submit invoices that support the reported expenditures.
- 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.
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.
*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.
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.