After an ominous lull in activity in Mexico's liquefied natural gas sector, the market may be about to be re-ignited by competition to build the country's first import terminal.

Like most Latin American countries, Mexico has suffered from the global energy hangover, which started with the spectacular collapse in the fortunes of energy giants, Enron and El Paso, intensified with the war and ensuing reconstruction of Iraq and has been worsened by the deepening power crisis in the US.

However, the Mexican government is doing all it can to avert a surefire shortfall in gas supplies as it seeks to kick-start the construction of at least two LNG import terminals to secure future supplies.

The race to build the first is heating up, but without progress here the LNG sector is likely to remain stagnant.

Shell edged ahead of its rivals after it was the only company prepared to participate in the Comision Federal de Electricidad's (CFE's) tender to build a 500 million cu ft per day re-gasification facility in Altamira in August. The oil giant's $370 million proposal was approved technically on 25 August leading the CFE to open the company's economic bid. An announcement from the state-owned electricity supplier on whether Shell's bid has succeeded is due at the beginning of September.

If the bid is accepted, according to Cornelis van der Bom, general manager, Shell Gas & Power Mexico, the company will be looking to start construction next year with imports due to come on stream in 2006.

Financing will be firmed up at the end of this year or the beginning of 2004 if the plan is approved, he says.

ChevronTexaco, BP and Techint, which had all been eyeing sites on the Atlantic coast, were also expected to bid but were dissuaded by a number of factors, including the terms of the bid, which will see Shell manage and operate the facility for 15 years. The reluctance of other bidders, much to the disappointment of the Mexican government, highlights the concerns still felt about the potential of the Mexican market and the government's ability to structure bids to attract investors.

While some see the approaching conclusion of the CFE's only RFP this year as a step forward in the race to fill the forecast LNG supply shortfall, others feel it is an alarming sign of the lack of appetite for the Mexican LNG market.

California dreaming

That appetite will be tested further by a second RFP being proposed for an LNG terminal on the west coast that is being talked about as early as the end of the year.

The proposal to promote another bid in Lazaro Cardenas or Baja California is likely to come about "at the end of this year of the first quarter of next year" according to Fernando Alonso, head of investment promotion office at Mexico's department of energy.

"This means that in the next year there will be over a billion dollars for two plants," he says. His optimism is not shared by everyone, however.

"I'm sure the CFE would have liked to have seen more bids but apparently its not such an easy thing to get companies involved," says Thomas Mueller, partner at Ritch, Heather y Mueller

"The US, as a strong importer of LNG, is more attractive to many suppliers and that is why there was only one bidder," he says.

Furthermore, the absence of other bidders, according to Antonio Souza, managing director of Protego Financial Advisors, is likely to lead to the bid being rejected or hitting delays. The Altamira scheme, he says, "has all sorts of legal and regulatory problems because there is only one bidder".

His interpretation of Mexican law rests on the fact that to fulfil the obligations of a service contract there must be more than one bidder if the bid is not declared void. Only if the bid process is repeated three times and there are still no rivals to Shell the bid can be awarded to the sole bidder, says Souza.

Alonso argues otherwise. "They (CFE) can evaluate technical and economic proposals. If it is in the range that we have then it will be approved. If it's out of this range then it will be rejected," he says.

The final decision rests with the CFE and the government's desire to kick-start development in time could prove the decisive factor.

A 9% contraction in the level of Mexican gas extraction since 1998, has resulted in a fourfold increase in the level of imports into the country, mainly driven by US exports via pipeline projects in the north of the country.

In fudge-prone Mexico, most are certain the bid will be approved, opening the way for a further spate of IPPs that will have their supply underpinned by the terminal.

In its first phase the development is likely to underpin the construction of Altamira III + IV and another Tuxpan plant while in the second phase is likely to see one more plant added.

French player EdF, as well as Union Fenosa, is already operating the two existing plants in the region being supplied domestically.

US contagion

One of the underlying problems experienced by the Mexican government in trying to promote its plans has been the fallout from the energy meltdown being felt in the US. With the latest blackout focusing US regulators and investors on the prospects of restructuring in the US, competition for capital is getting stiffer while the appetite of investors has been badly dented by the ongoing restructuring by formerly very aggressive players such as El Paso. ?I think that many months ago the US was worried about gas,? says Alonso.

"The state will require large investment and that affects us because investment sentiment will change. Now you have a lot of opportunities in western countries and China. Many companies have financial restrictions and they have to be very careful over which rate they do deals at. Investors are looking for very transparent rules, a good return on their capital and very sound fiscal and monetary policy and a healthy macro-economic climate."

The full impact of the latest power-cuts in the US is, according to Alonso, "something we have to see about".

"We may see some regulatory changes to try and put some LNG plants in the US. With them trying to get more flexibility its something we have to wait and see in the next couple of months," he says.

While there are concerns about attracting investment ahead of rival projects in the US, in financial terms the prospects of future plants being pursued by institutions and developers alike has been greatly enhanced by an end to the ?mismatch' between supply and dispatch agreements.

A CFE commitment to take responsibility for supply away from Pemex and other independent suppliers is likely to start filtering through in the next phase of IPP projects. The developers of the IPPs hope that the CFE will seek to remove the existing problems for existing IPPs by offering to take an assignment of existing contracts with domestic supplier Pemex, according to Cory Goode, co-chair of Squire Sanders's energy practice.

Four plants were funded under the former regime, including Altamira II and Tuxpan III & IV. She says that financial transactions in the LNG sector have stagnated as a result of delays with the bidding process: "It hasn't developed but there have been a lot of activity in the obtaining permits and real estate for the LNG projects."

CFE's promise to provide secure supplies has removed the legal headache plaguing investors and developers caught between two government bodies, Pemex and the CFE.

While the lack of bids has meant this new arrangement has not been tested yet, the promise to remove this headache (supply contract mismatch) has at least animated the banks. Nord/LB's Nicolai Dillow says: "It makes things much more financeable. You are not running that risk if the project isn't dispatched. The supply contract is essentially taken out of the equation."

CFE doesn't?

However, developers such as Shell remain uncertain of the true impact of the CFE's decision to guarantee supply for future bids. Of particular concern is whether it will have a potentially negative impact on new entrants to the market.

"It's very difficult to make and an assessment whether this is a step forward or backward," says Van der Bom.

"It may be a step forward in that the CFE becomes a true player in the market, it may make it more difficult for new entrants because people will prefer to buy from the CFE," he says.

While Van der Bom is uncertain, Goode believes that it is unlikely to preclude new entrants in the gas marketing industry but means that gas marketing companies will end up selling directly to the CFE.

Concerns about the CFE over-stretching itself through increased financial commitments are also growing. With $12 billion of LNG projects on the table, the attitude of the credit agencies towards the CFE's credit rating is set to take centre stage in the next generation of projects.

"That's the whole issue of privatization - these LNG projects will mean $12 billion of obligations. If you really look at it that way it will solve a lot of problems of the IPPs but it does not solve the financial problems of the CFE," says Souza.

For Eduardo Andrade, head of the Mexican Electric Energy Association and Techint's Mexican head of business development, however, the added exposure is unlikely to cause problems.

"This is not a liability but an asset. It's a $12 billion commercial operation. That could be hard to understand but we are so short, both in gas and electricity, that they are ensuring that there will be enough LNG to supply 2,500-3,000MW, which will just cover the reserve markets.

"These projects will repay themselves very easily," he says. However, he admits, "in two or three years, the deals may become more marginalised".

For Mueller, there is no choice. They may have an "additional obligation on their shoulders but at the end of the day they need to do it and if there was a risk to the supply then that would be a worst case."

While the government is prepared to add to its liabilities through direct backing of its state-owned players it has failed to overcome the uneasiness with which developers are looking at the regulatory framework, according to Dillow.

?Talking to developers, they felt that the government's lack of experience in LNG has made it more difficult for them to negotiate viable and financeable structures? he says, explaining the CFE's decision to extend the bidding deadline for the Altamira terminal.

They will be hoping that the same is not repeated in Lazaro Caderas or Baja California, which will be required in addition to Altamira to avoid power shortages.

Of these two the strongest competition appears to be emerging in Baja, while Tractebel has emerged as the clear runner in the Lazaro Cardenas project, which is designed to feed demand from Manzanillo and Guadalajara.

Sempra Energy and Shell both joined Marathon Oil in the race to establish their operations in Baja when they were awarded their federal permits to go-ahead with their proposed $500 million development in this region in August.

Supply sidings

Marathon, which is partnered with Golar LNG and Grupo GGS, has already secured its supply contract through an agreement with Pertamina to supply gas from Asia. The deal places the plant to be located in Tijuana marginally ahead of its rivals, according to Andrade. Associated with the import terminal capable of handling 750 million cu ft per day, will be a 400MW gas-fired power plant with the remainder exported to California.

Techint's involvement in the $1.8 billion Camisea gas project in Peru ensures that he is keeping a close watch on the development of import terminals on the West Coast. Sempra Energy's $600 million proposal in Baja California could be another point of sale for Peruvian gas if its preferred partner, Bolivia continues to stall due to political opposition to exports via Chile. The third proposal from Shell, which has 'numerous options' available to supply its proposed facility in Baja, Costa Azul, has also recently received its environmental permit from the Federal government. All three now have to overcome local opposition.

Both West Coast projects will require substantial investment in pipeline infrastructure, according to Goode and Andrade.

In Central Mexico, insufficient pipeline infrastructure would also mean the need for additional pipeline construction in the order of 400 km which could add approximately $300-$500 million to the proposal, according to Goode.

Further down the coast, Tractebel's proposed Lazaro Cardenas proposal pipeline investment could reach $200-$300 million, according to Andrade. The Belgian company is working up its plans to build a $500 million terminal capable of in the region of 500 million cu ft per day, although the impact of this in terms of future IPP bids is likely to be limited.

Gas from this terminal has been linked to the conversion of existing heavy oil power stations operated by the CFE. Coal-fired plants were also up for conversion, but have been found to be unsuitable.The decision to forge ahead with these plans has already been taken by the CFE, according to Andrade.

Which of the three will be built first will depend on the market, according to Alonso. One of the positive things to emerge from Mexico in the last 12 months is that its credit risk has not been hit by the contagion sweeping through the rest of Latin America. The fiscal prudence of president Fox, means that at least when the developers pass their environmental hurdles Mexican credit risk is likely to fall in the investment grade bracket.

The fallout from Venezuela and Argentina, has been avoided, according to Souza. "We have proven our credentials that we are part of the North American block and that has a kind of stability. The credit risk spread it's totally different. We are moving more towards the Chilean spread."