The new Phoenix: Mammoth petrochemical project promises rapid returns on semi-private investment.

Mexico's hard-hit petrochemical industry is hoping that a new plan will rein-vigorate the sector. The plan, known as Project Phoenix, aims to revive a neglected sector whose soaring imports bill is hitting the nation's economy increasingly hard. At least eight Mexican and international companies are seriously interested in taking part in Project Phoenix, a future chemicals complex, in what promises to be the largest industrial investment of the present administration at US$1.6 billion to US$2 billion. "This will be the biggest investment in petrochemicals since the La Cangrejera and Morelos complexes were built in the 1980s," said Eduardo de la Tijera, CEO of Grupo Texne, a plastics and chemicals industries consulting firm.

The key difference between Phoenix and those projects of two decades ago is that Morelos and La Cangrejera, in the southern Gulf state of Veracruz, are wholly owned by the state oil monopoly, Petroleos Mexicanos (Pemex). But Pemex will only have a minority interest in Project Phoenix. Unlike other areas of the energy sector, where state control is pervasive, only "basic petrochemicals," or gas processing, remains a Pemex monopoly. Everything else is open to private enterprise.

The project is important in the North American context too, said de la Tijera. No one else has announced anything similar and, "as the Mexican saying goes, he who hits first hits twice." Pemex has not named the eight companies that are interested, but Mexico's two largest private-sector producers of petrochemicals--Grupo Alpek, a division of the Monterrey-based conglomerate Grupo Industrial Alfa, and Grupo Idesa--are definitely among them. Industry sources say the others could include Nova Petrochemicals of Canada, Dow Chemical of the United States, Spain's Repsol YPF and the Anglo-Dutch major Shell.

AN EVOLVING IDEA

Since its conception more than two years ago, Phoenix has changed considerably, and it continues to evolve in talks between Pemex and potential investors. Two key elements are the feedstock, or raw input materials, to be used and the location of the project. Pemex will supply the feedstock for the "cracker" that breaks it up into 1 to 1.2 million tons a year of ethylene, the building block from which a range of products is derived to meet the needs of the chemicals and plastics industries. The feedstock could be ethane, a constituent of natural gas, or it could be naphta--also known as natural gasoline--which is currently exported by Pemex.

But the price of ethane is linked to that of natural gas. "Because of the price advantage, the current thinking is that Phoenix will use naphta," said Jose Luis Zepeda, chief executive of Polioles, a unit of Alpek.

Another advantage of naphta is that it provides olefins such as polypropylene, another of the industry's building blocks.

One major factor is more difficult to divine: the project's location. The options are Coatzacoalcos in Veracruz, the traditional center of Pemex's petrochemicals industry, and Altamira, Tamaulipas, much further north in the Gulf.

Governors Tomas Yarrington of Tamaulipas and Miguel Aleman of Veracruz are lobbying hard for their states. But, despite their political muscle, Zepeda believes the decision will come down to economics.

"In Coatzacoalcos, you're nearer where the raw material is produced; in Altamira you're closer to the customers. It ought to be a straightforward case of calculating the respective netbacks [returns net of transport costs] then working out which has the advantage," Zepeda said.

Pemex has said that whatever feed-stock is chosen, it will be provided under long-term contract, an important concession by a company accustomed to offering its clients only short-term commitments. Less clear is what the policy will be on the price that Pemex charges for the feedstock, but de la Tijera maintained that, whatever happens, it will be cheaper than anything else in North America.

That has not always been the case. Indeed Grupo Idesa's Jose Luis Uriegas--who is also the president of the National Association of the Chemical Industry (ANIQ)--insists that the pricing policy applied in recent years has spelt near-disaster for the industry. "Ethane shouldn't be priced as natural gas but as an input for the petrochemicals industry," he said.

A NONSENSICAL MARKET FORMULA

Mexico has no market in gas. Pemex is the sole supplier for almost the entire country. But just over a decade ago, government technocrats decided that the market price should be set by a formula: Houston levels plus transport, currently around US$5 per million British Thermal Units (BTUs)--about twice what gas costs in Europe and more than three times what Pemex spends to produce it. The policy crippled Mexico's nascent petrochemicals industry, Zepeda said.

Polioles--part of a large and diversified group--was able to survive, "but many smaller companies simply went to the wall," he said. Mexico now imports some US$10 billion of chemicals and petrochemicals a year, up from US$1 billion a decade ago. The industry accounts for more than 70% of the nation's trade deficit, a sorry irony in a country proud of its petroleum tradition.

"The problem with applying market prices in Mexico is that there is no market," said an industry source who asked not to be named because of ongoing negotiations with Pemex. "In Houston, you can shop around for discounts or seek alternative fuels. None of that's possible here."

And the farther down the production chain you go, the more complicated it becomes. For products such as ethylene oxide, Pemex sets a market price that ensures a profit. "But that price is based on Pemex's levels of efficiency, which are a lot lower than those of foreign companies with integrated operations," the source said. "The result is that it's nearly impossible to compete internationally."

The market pricing policy was doubtlessly introduced with the intent of putting Pemex's once-profligate spending on a sound basis. The problem is that it has become a Prozac for the public finances. With true fiscal reform still pie in the political sky, the Mexican state depends on Pemex for a third of its income. And when push comes to shove, it could amount to much more than that. George Baker, president of the Houston-based consulting firm Baker and Associates, estimates that Pemex accounts for some 80% of the government's dollar earnings.

Meanwhile, argues Zepeda of Polioles, Mexico is shooting itself in the foot over gas prices. Growth in demand for natural gas is galloping along at 8% a year fuelled by the construction of combined-cycle power plants, but production by Pemex is falling behind. Imports, already running at 750 million cubic feet per day (Mmcfd) are likely to rise to 1 billion by the end of this year.

LOTS OF GAS, NO WAY TO GET IT

Mexico has substantial reserves of gas--15 trillion cubic feet--and much more in the "probable" category, yet it lacks the financial resources to develop them, and the law forbids Pemex from granting concessions.

Luis Ramirez Corzo, who heads the exploration and production subsidiary of Pemex, claimed recently that Pemex could triple its production of gas, leaving a healthy surplus for export. But that could happen, he emphasized, only if the laws are changed to allow production-sharing and other forms of association that are normal elsewhere in the industry.

"It simply doesn't make sense," Zepeda said. "We have the gas but we're leaving it in the ground. There's talk of a coming gas crisis in North America. We could be part of the solution but instead we're part of the problem."

But Project Phoenix, if the pricing issue can be resolved, promises rapid returns, Zepeda said. "Other Mexican industries, like autos and maquiladoras, have reached a point of maturity where growth can only be incremental. Petrochemicals is radically different. The imports bill shows a huge and rapidly growing demand for these products from the plastics industry and others."

He added, "There's no problem about finding a market. Everything that Phoenix can make will be snapped up from day one. Assuming it's planned right, and I feel confident that it will be, the ripple effect will be felt right through the whole economy."

Analysis By Ronald Buchanan

Ronald Buchanan is a freelance journalist and the correspondent in Mexico for Platts, McGraw-Hill's energy news service.