Chemical reactions: Pemex Petroquimica moves to modernize without legal reforms.

In 1992, then President of Mexico Carlos Salinas oversaw the split of state-run oil monopoly Petroleos Mexicanos (Pemex) from one behemoth energy company into four divisions: crude exploration, natural gas production, refining and petrochemicals.

The shake-up sought to streamline operations and to imbue the monopoly with a new entrepreneurial--instead of bureaucratic--culture. But while Pemex executives began to grow conscious of the bottom line, they also captained separate divisions and were charged with maximizing their own profits, and not those of the entire group.

Under the new system, oil exploration and natural gas production reaped fat revenues, but the monopoly's refining and petrochemicals units, which were dependent on those upstream providers for raw materials, saw few advances.

"Once you separate the companies and fracture them, you fracture the business. The focus remains on crude exploration and production," one critic said.

Even before the Salinas revamp, Pemex Petroquimica had been suffering from a paucity of public spending that began in the previous administration and continued through the administrations of Salinas and Ernesto Zedillo.

Why? The Finance Secretariat, zeroing in on short-term revenue needs, focused Pemex budget money on quicker-returning crude projects instead of petrochemical projects, which don't turn profits until several years down the road. Moreover, Salinas and Zedillo focused efforts not on injecting investment into Petroquimica but on studying how to increase private-sector participation in petrochemicals, choosing not to prioritize budgets for the unit.

Critics today complain the legacy of the Salinas restructure and years of inadequate government funds have seriously crippled both Pemex Petroquimica and the private chemicals industry, which relies on it for raw materials. Compounding the problem has been a regime that limits private investment in Petroquimica to 49% of the value of individual plants, ensuring government control of the division and discouraging business involvement.

This impediment has kept Pemex from accessing resources to update its petrochemicals infrastructure. It has also culminated in chemical raw materials, or feedstocks, that are overpriced and inconsistent in quality and supply. Pemex has been forced to idle plants, and private businesses have been shuttered.

The lack of feedstocks, meanwhile, has exploded the trade deficit as private Mexican manufacturers seek foreign suppliers for the materials they need to produce specialty chemicals, plastics and synthetic fibers. Under Mexican law, only Pemex can produce the "basic petrochemicals" that are the inputs for these goods, and importing feedstocks is expensive because of transport costs.

In fact, the trade gap in chemicals widened to a whopping US$6 billion in 2001, accounting for about two-thirds of Mexico's total US$9 billion trade gap last year, said the National Association of the Chemicals Industry (ANIQ), the nation's main chemicals lobby. In comparison, the chemicals trade deficit was only US$3 billion in 1998, according to ANIQ data.

THERE IS HOPE

Still, hope for one of Mexico's most beleaguered industries may be on the horizon.

Pemex and the private industry have made recent moves to bridge historical rifts and work together to get domestic chemicals back on their feet.

Talking about "strategic alliances," private and government players are intently studying joint projects they hope will "reactivate" the industry by boosting installed capacity at Pemex's eight petrochemical plants. The partnerships are aimed at creating jobs, boosting production of high-quality chemicals and, ultimately, mitigating the overall trade deficit.

"We are seeking alliances with the private sector to jointly develop projects that will guarantee feedstocks supply and, thus, provide investors with certainty in the medium- and long-term," Pemex General Director Raul Munoz told reporters at an industry conference in March.

Discussions include a potential joint venture between BASF de Mexico and Pemex on a US$120 million styrene plant with a projected annual capacity of 500,000 metric tons, as well as possible paraxylene, high-density polyethylene and lineal low-density polyethylene projects, according to industry sources. Pemex also wants private-sector help to upgrade its petrochemicals facility in Cangrejera, in the southern Gulf, to boost beazene and toluene output. At least a dozen other projects are also being formulated; in all, the division plans US$1 billion in new plant projects and expansions, said Petroquimica head Rafael Beverido.

So far, no strategic alliances have been struck, but business representatives are seriously considering the Pemex proposals. Under most of the scenarios, the private sector would initially finance the upgrade of existing plants or help build new ones, while Pemex would pay back the loans with feedstock product. The dynamic would guarantee companies a cheap and ready availability of feedstocks and allow Pemex to renovate its intact--albeit less-than-modem--petrochemicals infrastructure.

The newfound interest from the business community, meanwhile, has dovetailed with the introduction at Pemex of a new pro-business management team. Centered around Munoz, who himself is the former president of chemicals company DuPont de Mexico, Pemex leadership is making a sincere effort to reactivate the petrochemicals industry, and the appeal is gaining the attention of the private sector, said Alejandro Villalobos, president of the Mexican Institute of Chemical Engineers (IMIQ).

Businessmen in their own right, Munoz and Beverido have been able to win over the business community to a greater extent than their predecessors. Earlier Pemex heads were less proactive about converting Pemex into a real company and one of them, Rogelio Montemayor, is being sought for questioning regarding a multimillion-dollar embezzlement inquiry. Also unlike his forerunners, Munoz isn't afraid of courting the private sector, even if it means earning the opprobrium of the Mexican left wing, which generally sees partnerships as a slippery slope to privatization.

Under the slogan "Pemex se transforma," (Pemex transforms itself), Munoz wants to convert the monopoly from principally a crude supplier to U.S. refineries into a vertically integrated company on the order of British Petroleum or Shell that stresses value-added goods and not just commodities.

To do so, Munoz knows he will need private backing. Pemex's fiscal burden is still too onerous to allow for the kind of reinvestment that he would like. The company ships off more than three-quarters of its profit to the Finance Secretariat in the form of taxes and royalties. Meanwhile, the government, which failed to pass any kind of meaningful tax reform last year, will continue to draw heavily on Pemex for short-term revenue needs.

PARTNERSHIPS NOT NEW

The notion of partnerships with the private sector is nothing new to Pemex, said Cesar Conde, head of the chemicals department of manufacturers lobby Canacintra.

DuPont de Mexico, Mexican chemicals firm Idesa and Celanese Mexicana all entered into agreements with the monopoly starting in the 1980s, but the partnerships had predetermined ends and weren't true joint ventures. Under the agreements, the private companies financed renovations to existing Pemex facilities in exchange for guaranteed feedstock supply.

Now, officials are talking about moving to a different level, and are aiming for longer-term associations with the private sector in order to commercialize products with a greater value-added component--something that could ensure higher tax revenues for Hacienda and help narrow the trade gap, an Energy Secretariat source said.

These new alliances are untested, but one area the industry is analyzing and perhaps using as a test case is the newly invigorated fertilizers sector, where production is moving toward full capacity after a two-year lull.

Here, Pemex Petroquimica recently inked a deal to supply competitively priced feedstocks of ammonia and carbon dioxide to private firm Soluciones Quimicas. The private company, meanwhile, has restarted production of the fertilizer urea at plants in Chihuahua and Veracruz states. Other companies are also eyeing renewed urea output.

Of course, market conditions have improved since two years ago when spiking natural gas prices and a world fertilizer glut forced Mexican companies to shut operations. Reactivating the fertilizer industry also has a political dimension: President Vicente Fox wants to ensure affordable domestic supply to farmers.

But officials point to the sector as an example of how industry and the government can work together. A second step would be for Pemex to team up with a private partner and market not just feedstocks but fertilizers themselves, the Energy Secretariat source said.

"The real business isn't selling ammonia. It's selling urea because urea has a greater value-added component. These steps will allow Pemex to become a world-class company and not just the provider of raw materials to industry," the source said.

Depending on whether joint ventures can be produced in the fertilizer field, Pemex will likely look for partnerships in other chemical related fields.

UNCERTAIN OUTLOOK

Surely the move toward joint ventures is a big plus for both Pemex and the chemicals industry. It allows the parties to circumvent the rigid investment regime that keeps the private sector from controlling existing Pemex petrochemical assets, while helping to modernize Pemex.

But the government has also initiated more conventional measures to boost petrochemical output. In the 2002 spending draft, for example, the administration sought and received a 33% funding increase for Petroquimica, raising its budget to $8.59 billion pesos from $6.44 billion pesos in 2001. Fox has also supported the Pidiregas project financing program begun by Zedillo. Pidiregas allows Congress to authorize debt so Pemex can finance infrastructure projects, such as the building of an ethylene cracker, through private loans backed by future sales.

Fox is also gingerly supporting broad private investment in the politically volatile natural gas sector. As it is, Mexico lacks the resources to exploit as much dry natural gas in the northern part of the country as it would like, but the Constitution hamstrings business involvement in the field. Greater production of the fuel likely would bring about wider petrochemical feedstock availability and help lower feedstock prices.

Munoz also recently unveiled socalled Multiple Service Contracts aimed at streamlining the farming out of natural gas projects by giving contractors the chance to lump several different kinds of non-risk contracts--drilling, geological study and others--in one document.

In all, the future looks mixed for Petroquimica and the nation's chemicals industry as a whole, and short-term worries continue to dog the market. Mexico's consistently strong "super peso" and the protracted global slowdown have heightened concerns for the export-dependent industry. Chemical leaders also fret that prices for natural gas, a key input and fuel for their industry, are too expensive compared with similar costs for regional rivals in Trinidad and Tobago, Venezuela and Argentina.

Still, the industry does have a lot to look forward to. Public approval may be rising for broad private investment in the energy sector, and new synergies between the business community and Pemex are developing.

Mexico's geographic proximity to wide-open Nafta markets and the country's profile as a burgeoning market also help benefit domestic companies and act as inducements to foreign firms looking to do business here. Moreover, while U.S. and Canadian industry is, to a large extent, mature, Mexican chemicals still have ample room to grow, Munoz said.

Though the outlook may be uncertain, the industry--both public and private--does share at least one mutual conclusion. The scenario of paltry government and business investment cannot continue and neither can the yawning trade deficit in chemicals. What is needed is a true reinvention of the industry that draws on private-public synergies, IMIQ's Villalobos said.

"I think our only limit is our imagination. We have to reinvent petrochemicals in this country," he said.

Robert Donnelly is a freelance writer and correspondent in Mexico of the online trade publication Chemical News & Intelligence.