A C O U N T R Y F R A M E W O R K R E P O R T Private Solutions for Infrastructure In Mexico Private Solutions for Infrastructure In Mexico Country Framework Report for Private Participation in Infrastructure World Bank and Public-Private Infrastructure Advisory Facility (PPIAF) Copyright © 2003 The findings, interpretations, and conclusions expressed in this paper are The International Bank for Reconstruction entirely those of the authors and should not be attributed in any manner and Development to the Public-Private Infrastructure Advisory Facility (PPIAF) or to the THE WORLD BANK World Bank, to its affiliated organizations, or to members of its Board of 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. Executive Directors or the countries they represent. 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Permission to photocopy portions of this publication should be addressed to: Copyright Clearance Center, Inc., 222 Rosewood Drive, Dan- vers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, or through the Internet at www.copyright.com. For questions about this report or information about ordering more copies, please refer to the PPIAF website or contact PPIAF by email at the following address: PPIAF c/oTheWorld Bank 1818 H Street, N.W. Washington, D.C. 20433 Tel: 202-458-5588 Fax: 202-522-7466 www.ppiaf.org Email: info@ppiaf.org ISBN: 0-8213-5414-0 Library of Congress Cataloging-in-Publication data has been applied for. Contents Abbreviations vii Acknowledgments viii Executive Summary 1 PART 1. INFRASTRUCTURE INVESTMENT CHALLENGES IN MEXICO 8 1. Main Issues and Challenges 8 Overview and Cross-Sectoral Concerns 8 Recent Economic Performance 9 Business Environment and Institutional Issues 10 Government Liabilities and Debt Management 11 Financing Infrastructure Investment 12 Regulatory Issues 13 Government Role in Lowering Risk 14 Part 2. Sector Reviews 17 2. Telecommunications 17 Government Strategy and Policy 17 Private Sector Participation Experience 18 Institutional and Regulatory Framework 20 Sector Performance 21 Performance Comparisons with other Latin American Countries 26 Regulatory Assessment 28 Recommendations for Reform 32 3. Natural Gas 35 Government Policy and Institutional Framework 35 International Comparisons 37 Regulatory Framework 37 Private Sector Participation Experience 40 Prospective Demand and Future Private Participation 41 Principal Policy and Regulatory Challenges 42 4. UrbanWater Supply and Sanitation 46 Institutional Framework 46 Government Policy and Regulatory Framework 47 Sector Performance 48 Private Sector Participation Experience 52 Prospective Demand and Future Private Participation 53 iii Contents Principal Policy and Regulatory Challenges and Recommendations 56 Conclusions 59 5. Toll Roads 61 Sector Performance 61 Government Policy and Strategy for the Sector 63 Institutional and Regulatory Structure 64 Private Sector Participation Experience 65 Recommendations 68 6. Railroads 70 Government Strategy 70 Regulatory Framework and Institutional Structure 71 Private Sector Participation Experience 73 Future Demand and Investment Needs 75 Recommendations and Remaining Issues 75 7. Ports 77 Sector Structure and Performance 77 Government Strategy 78 Regulatory Framework and Institutional Structure 78 Private Sector Participation Experience 79 Future Demand and Investment Needs 82 Remaining Issues 82 8. Civil Aviation 84 Sector Performance 84 Regulatory Framework and Institutional Structure 85 Government Strategy 85 Remaining Issues 86 9. Airports 87 Sector Performance and Characteristics 87 Government Strategy 87 Regulatory Framework and Institutional Structure 88 Private Sector Participation Experience 88 Impact of Privatization 89 Remaining Issues 89 10. Multimodality and CommercialTransport 91 Impact of Reform 91 Remaining Issues 92 Freight Road Transport 93 Passenger Road Transport 94 Conclusions 95 PART 3. POLICY RECOMMENDATIONS 96 11. Proposed Action Program 96 Cross-Sectoral Issues 98 Sectoral Issues 99 Telecommunications 99 Natural Gas 100 Urban Water Supply and Sanitation 102 Toll Roads 103 Railroads 104 Ports 105 Passenger Road Transport 106 Airports 107 Freight Road Transport 107 iv Contents TABLES Table 2.1 Indicators of Network Expansion and Modernization in Telecommunications 20 Table 2.2 Teledensity 21 Table 2.3 Indicators of Telecommunications Traffic, Sector Revenues, and Labor Productivity 21 Table 2.4 General Indicators of Telephony 23 Table 2.4a Telephone Tariffs: Comparison with other LAC and OECD Countries (US$) 24 Table 2.4b Tariffs: Fixed Telephones, Latin American Countries 24 Table 2.5 Telecommunications Tariffs in Mexico, 1988-1998 27 Table 2.6 Network Investment and Usage Indicators in Selected Latin American Countries, 1998 28 Table 2.7 Tariffs, Revenues, and Productivity of the Telecommunications Sector in Selected Latin American Countries, 1998 31 Table 2.8 Financial Performance of Selected Telecommunications Companies 31 Table 2.9 Latin America: Comparative Penetration of Mobile Telephony, Users per 100 Inhabitants 32 Table 3.1 Current Structure of the Gas Sector: International Comparisons 36 Table 3.2 Natural Gas Distribution in Mexico, U.S., and Argentina, 1998 36 Table 3.3 Institutional Framework for Gas Sector Regulation: International Comparisons 39 Table 3.4 Permits Issued, 1996 to August 2000 39 Table 4.1 Urban Access to Water and Sanitation by Income Group, 1996 49 Table 4.2 Quality of Piped Water Supply in Mexico, 2000 49 Table 4.3 Investment:Water Supply and Sanitation Sector 50 Table 4.4 Revenue Generation per Water Connection 50 Table 4.5 Distribution of Financing in the Water Supply and Sanitation Subsector, 1991-1999 51 Table 4.6 Treatment of Municipal Effluent, 1994-1999 52 Table 4.7 Status of Private Sector Contracts, 1992-1999 52 Table 4.8 Goals and Investment Requirements in the Urban Water Sector, 2000-2010 53 Table 4.9 Investment Needs, Efficiency Indicators, and Tariffs 54 Table 5.1 Mexico's National Road System, 1999 62 Table 5.2 Characteristics of Main Road Corridors, 1998 62 Table 5.3 Comparative Performance of Toll Roads by Operator and Type of Traffic 67 Table 6.1 Comparison of Specific Performance Indicators Before Privatization 70 Table 6.2 Rail Privatization Process, September 2000 71 Table 6.3 Main Results from Concessions Completed, December 1999 72 Table 6.4 Railway Concession Market Area Characteristics 72 Table 6.5 Performance Indicators After Privatization 74 Table 6.6 Macroeconomic Impact of Railroad Restructuring 74 Table 7.1 Type of Goods Handled: Evolution of Shares, 1992-1999 78 Table 7.2 Details of Concession Contracts 80 Table 7.3 Change in Port Cargo Handling Tariffs 81 Table 7.4 Port Labor Reform 81 Table 7.5 Installed Capacity and Capacity Utilization 82 Table 7.6 Port Investments, 1995-1998 82 Table 7.7 Financial Position of APIs 82 v Contents Table 8.1 Aeromexico and Mexicana: Result Indicators, 1995-1999 86 Table 9.1 ASA Airport Activity, 1990-1997 87 Table 9.2 Main Characteristics of the Airport Groupings for Concession 89 Table 10.1 Modal Distribution of Transport Services for Mexico's International Trade, 1999 91 Table 11.1 Summary of Proposed Action Program 96 FIGURES Figure 1.1 Mexico's Infrastructure Investments as % of GDP 9 Figure 2.1 Mexico: Increase of Public Telephony Network by Type, 1990-1999 22 Figure 2.2 Teledensity and Per Capita GDP In Selected Latin American Countries, 1999 27 Figure 2.3 International Comparison of Telephone Density: Telephone Lines per 100 Inhabitants 28 Figure 2.4 International Comparison of Penetration in Mobile Phones: Users per 100 Inhabitants, 2000 29 Figure 2.5 International Comparison of Penetration in Internet: Internet Users per 100 Inhabitants, 2000 30 Figure 3.1 Industry Structure Before 1995 37 Figure 3.2 Industry Structure After 1995 38 Figure 3.3 Natural Gas Demand and Domestic Production, 1999-2009 41 Figure 4.1 Mexico's Urban Water 55 BOXES Box 4.1 Is $252 Million Enough? 50 Box 4.2 Sector Experience in the Distrito Federal 54 vi Abbreviations ADR American Depository Receipt FARAC Fideicomiso de Apoyo al Rescate AFORE Administración de Fondos de Autopistas Concesionadas para el Retiro FNM Ferrocarriles Nacionales de México API Administración Portuarias Integrales FINFRA Fondo de Inversión en ASA Aeropuertos y Servicios Auxiliares Infraestructura BANOBRAS Banco Nacional de Obras INFONAVIT Instituto del Fondo Nacional de y Servicios laVivienda para losTrabajadores BLT Build LeaseTransfer IPAB Institute for the Protection of Bank BOT Build OperateTransfer Savings CANACAR Cámara Nacional de NOX Nitrogen Oxides Autotransporte de Carga PCS Personal Communication Services CANAPAT Cámara Nacional de Autotransporte PEMEX Petróleos Mexicanos de Pasaje yTurismo PIDEREGAS Proyectos de Infraestructura CAPUFE Caminos y Puentes Federales Productiva de Impacto Diferido CFC Comisión Federal de Competencia en el Registro del Gasto CFE Compania Federal de Electricidad PUMEX Puertos Mexicanos COFETEL Comisión Federal de SCT Secretaría de Comunicaciones y Telecomunicaciones Transporte CNA Comisión Nacional de Agua SE Secretaría de Energía CRE Comisión Reguladora de Energía SHCP Secretaría de Hacienda y Crédito CINTRA Controladora Internacional del Público Transporte Aéreo SEMARNAT Secretaría del Medio Ambiente y DGAC Dirección General Aeronáutica Civil Recursos Naturales DGTTFM Dirección General deTarifas, SENEAM Servicios a la Navegación en el Transporte Ferroviario y Multi- Espacio Aéreo Mexicano modal SIEFORE Sociedad de Inversión Especializada DGCF Directorate General of Federal de Fondos para el Retiro Roads SOX Sulphur Oxides DGCC Directorate General of Road UFW Unaccounted-forWater Maintenance vii Acknowledgments This Country Framework Report for Mexico is one of as a team of consultants: Javier Campos-Mendez,Vale- a series of country reviews aimed at improving the en- ria Carou, Jim Haas, Roger Noll, Gustavo Nombela, vironment for private sector involvement in infrastruc- Juan Rosellon, John Strong, and Lourdes Trujillo. ture. Prepared at the request of the government Helpful comments were received from Oscar Alvarado, concerned, Country Framework Reports have three Stephen Everhart, Ioannis Kessides, Anjali Kumar, main objectives: Danny Leipziger,Mike Lubrano,Abel Mejia,Fernando · To describe and assess the current status and per- Montes-Negret, Mirtha Pokorny, and P.S. Srinivas. Lo- formance of key infrastructure sectors gistical and production support was provided by Joy · To describe and assess the policy,regulatory,and in- Troncoso, Lily Franchini, Karina Kashiwamoto, and stitutional environment for involving the private Gabriela Vidals.The report also draws on inputs from sector in those sectors, and various staff from theWorld Bank,as well as discussions with representatives of the private sector.The Mexican · To assist policymakers in framing future reform Ministry of Finance served as the primary counterpart and development strategies and to assist potential to this work. private sector investors in assessing investment opportunities. The report preparation process of all Country Framework Reports is intended to facilitate dialogue This report is being published jointly by the Public- among key stakeholders on priorities for government Private Infrastructure Advisory Facility (PPIAF) and reform and the concerns of investors, policymakers, theWorld Bank. PPIAF is a multidonor technical assis- and consumers of infrastructure services. tance facility aimed at helping developing countries improve the quality of their infrastructure through The Country Framework Report process was private sector involvement. For more information on supported by an advisory group comprising represen- the facility, see the website: www.ppiaf.org. tatives from the private sector,financial institutions,and bilateral donor agencies. The advisory group also The report was prepared by a core team led by Jose included representatives from the Inter-American De- Luis Guasch, the regional advisor for the Regulation velopment Bank (Jacques Rogozinski) and and Competition Division of the Finance, Infrastruc- the Japan Bank for International Cooperation ture, and Private Sector Unit (LCSFP) in the Latin (Shuhey Kurosawa). America Region of the World Bank, assisted by Sheoli Pargal, Senior Economist, LCSFP. The team included Antonio Estache, Jonathan Halpern, Ada Karina Izaguirre, and Kalim Shah (World Bank/IFC), as well viii Executive Summary During the last two decades,Mexico has proven itself a investments required to maintain current service levels pioneer in Latin America in spurring private sector are enormous. Policies and programs to ensure access, participation in the economy. Starting in the late protect consumers, and increase coverage for the poor 1980s, the government opened up large parts of the are all required. Action on these fronts is urgently economy to the private sector with the sale of state- needed, since lagging performance in a core upstream owned enterprises, the privatization of banks, and sector such as infrastructure has cascading negative ef- major initiatives in infrastructure, including an ambi- fects throughout the economy. It increases the cost of tious program of private sector participation in toll doing business, decreases international competitive- roads. In 1989, with the sale of the state-owned mo- ness, and hinders the country's growth and poverty al- nopoly supplier of telephone services,Telmex, Mexico leviation prospects. Mexico can ill afford such lags and became the second country in Latin America to priva- delays: the World Competitiveness Index 2000, devel- tize its telecommunications sector. Since then, it has oped by the International Institute of Management invited private investment in railroads, ports, airports, Development, ranks Mexico 36th out of 47 large and the natural gas sectors, and to a lesser degree in economies worldwide. water and electricity. Starting with NAFTA in 1993 Among the government's overarching infrastruc- and continuing with more recent free trade agree- ture-related challenges are competitiveness and decen- ments, such as the one with the European Union, tralization. If Mexican enterprises are to compete Mexico has further committed itself to an open trade effectively and profit from open trade, particularly policy, and to commercial and financial integration within NAFTA, they will increasingly require higher- with the global economy. quality infrastructure services, particularly in energy, During the past decade, Mexico has made major telecommunications, ports, highways, and roads. This gains in infrastructure service provision. This is espe- means ensuring that genuine competition exists where cially true for the telecommunications, railroad, ports, it is feasible--especially in the telecommunications and and airport sectors, which have experienced successful natural gas sectors. In addition, this necessitates new privatization. Much more needs to be done, however, approaches to pricing and subsidization, such as uni- particularly in the water and energy sectors. Govern- versal service, financing, the promotion of private par- ment reform in the water sector was designed to ticipation, and capacity building for regulatory improve service quality and promote private participa- institutions at both the national and subnational levels. tion, but major reform is still pending and the experi- Since an increasing number of key infrastructure deci- ence to date has been mixed. At the same time, the sions will be taken at the subnational level,the success- 1 Executive Summary ful implementation of the decentralization process will ensure competitive service provision and consumer be a critical determinant of the feasibility and effi- access to infrastructure services remains a major ciency of infrastructure investment programs, particu- challenge. In sectors such as transport, water, and en- larly in the roads and water sectors. ergy, a single line ministry or agency has been respon- There has been a significant improvement in the sible for policy formulation, promotion, actual investment climate in Mexico during the last five years operation, and investment, as well as monitoring and with an increase in macroeconomic stability and con- regulation. The resulting environment of confused sequent decline in country risk. However, fiscal adjust- roles and poor incentives has led to the perception of ment in the recent past has relied significantly on cuts high risk for private entrants,ineffective regulation,and in public investment, particularly capital formation.As poor sector performance.Decisions are pending on the a consequence, public sector investment in infrastruc- actual enforcement capacity of the regulator in many ture has declined from 12 percent of GDP in 1981 to sectors, and regarding the development of a coherent less than 2 percent in 1998. If such low levels of public universal service strategy,as well as a plan for extending investment endure, the country will increasingly rely access to rural areas.The tariff structure in many sectors on the private sector for infrastructure investment. But needs to be revisited with a view to removing distor- in the face of shallow domestic capital markets, private tions and to providw the appropriate behavioral incen- investors have been forced to raise capital of the re- tives. Finally, across all sectors, a clearer distribution of quired maturity and volume in overseas markets.The responsibilities between the competition agency and continued development of local capital markets, there- the sectoral regulator is needed. fore, will be critical to ensuring the availability of local The government needs to define its priorities and long-term capital and thus the development of local policy for universal service access while taking into ac- infrastructure finance during the next decade. count the particular characteristics of each sector. It In the short term,however,it is unlikely that private also needs to explicitly consider possible mechanisms debt and equity alone will be able to finance most new for financing service coverage requirements. The ex- infrastructure requirements in Mexico. Some form of tent, scope, and cost of desired levels of coverage, po- public support will be required to make private invest- tential sources of funding, target groups or regions and ment feasible. Especially in the water and sanitation mechanisms for service delivery need to be clearly sector, government contributions will be needed to thought through.As a start,subsidies for access to water complement private efforts. Other examples of public supply need to be targeted to the poor.Currently,most commitments include up-front cash equity participa- of the subsidies go to the non-poor. tion, assumption of subordinated bond issuing, and shadow-toll payments for highways or some other type Is Private Participation in Infrastructure of"ramp-up"risk-sharing contribution.Structures that Reaching Its Potential? permit debt service to be "back-loaded" in order to recognize ramp-up revenue limitations may also need This report analyzes regulatory and efficiency issues in to be encouraged as part of the capital market the telecommunications, natural gas, urban water and development process. sanitation, and transport sectors.After reviewing recent Mexico's experience to date with autonomous and performance in these sectors, the report identifies areas credible regulation that protects users and investors has where changes in the policy and regulatory environ- been limited.To attract private investment, the institu- ment could yield better outcomes for future transac- tional and regulatory framework needs to explicitly tions, or broaden and deepen private involvement.The lower investor regulatory risk and foster the develop- findings reveal considerable potential for private sector ment of a range of regulatory instruments, as well as participation in infrastructure service provision in expand the use and effectiveness of existing instru- Mexico.They also show how the country's experience ments. Institutionalizing regulatory reform that would has been less successful than that of many other coun- 2 Executive Summary tries because of gaps in the regulatory framework,poor American standards--with the ratio of main lines to concession design and implementation, and the lack of telecommunications staff significantly lower than in Ar- a coherent strategy that clearly defines the roles of the gentina, Brazil, Chile, and Peru, for instance. However, public and private sectors. The principal messages of this profitability has not led to high rates of service ex- the report are summarized below. pansion in comparison with its neighbors. Telmex seems to be less constrained in exercising its Telecommunications market power than are the dominant carriers elsewhere Mexican telecommunications policy and performance in Latin America. New market entrants, such as AT&T made great strides during the 1990s.The state-owned and MCI, have had limited success.As of 2001,Telmex monopoly carrier,Telmex,was successfully privatized as remains the dominant operator with 96 percent market a vertically integrated firm. Before privatization, share on local telephony, 78 percent in mobile teleph- its performance was substantially improved by increas- ony, 73 percent in domestic long distance, and 55 per- ing its rate of investment and bringing prices more in cent in the Internet market. Competition is hampered line with costs. After an initial period of monopoly, by slow and ineffective regulation, attributable to limi- competition was introduced in 1996, first in long dis- tations on the authority of the primary regulator, the tance, then in mobile telephony, and finally in local Comisión Federal de Telecomunicaciones (Cofetel). It service, especially fixed wireless service. Under private is also hindered by an opaque, secretive, and cumber- operation,sector efficiency increased and costs were re- some regulatory process, and by an inadequate system duced as penetration and usage of phone service more of oversight in the courts and the political branches of than doubled. the government. Abuse of the Mexican instrument of Despite these gains,the performance of the Mexican judicial review, or amparo, has frequently caused paraly- telecommunications sector continues to lag behind that sis in the implementation of many of Cofetel's decisions of other Latin American countries, despite the fact that and findings. it was the second to privatize and open the sector to Telecommunications penetration in Mexico will competition (Chile was the first).There are several rea- continue to increase with economic growth and sons for this.The incumbent former monopoly,Telmex, Telmex's profit incentive, and over time rapid technical is extremely powerful and does not have an impressive progress will probably cause some price reductions. record in investment and coverage. Indeed, in 1999, However, Mexico's performance in telecommunica- Colombia,Costa Rica,and Uruguay had not yet priva- tions will continue to lag behind that of other countries tized their wire-line telephone company, yet all had in Latin America, despite its natural advantages arising better performance indicators than Mexico. Of the from its proximity to the United States. For Mexico to large Latin American countries, only Peru has lower achieve its full potential in the sector,further regulatory telephone penetration, and Peru's GDP per capita lags reform is necessary. Regulation must become simpler behind Mexico by more than $1,000.1Within two years and more focused on promoting competition while si- after privatization,Brazil was able to leapfrog Mexico in multaneously balancing the remaining pockets of mar- terms of coverage indicators. Whereas the installation ket power.The key issue in the MexicoTelecom sector charge in Mexico is below average, the fixed monthly is expansion.This will only take place if prices fall (or if tariff and the usage price are high compared to those in there are substantial increases in GDP per capita). But other countries. For instance, international long-dis- prices will fall only through effective competition and tance tariffs in Mexico are estimated to be the highest regulation. And both have been deficient in Mexico. among large Latin American countries, except for Until these issues are resolved, Mexico will continue to Uruguay andVenezuela.Both high prices and high rev- lag behind other Latin American countries, and expan- enues, as well as its ability to limit competition, has al- sion will be hindered, resulting in foregone economic lowed Telmex to become a very profitable company opportunities. despite relatively low physical productivity by Latin 3 Executive Summary Natural Gas iates, new participants will remain highly reluctant to Liberalization of this sector is complex because the invest in these activities.The scope for Pemex market natural gas industry combines naturally monopolistic manipulation would simply remain too large.This calls activities such as pipeline transportation and distribu- for restricting future Pemex investment in gas transport tion with potentially competitive activities such as to rehabilitation and maintenance of existing facilities. production and marketing. Moreover, key features of Given the enormous volume of resources required to Mexico's natural gas policies have shaped the develop Mexico's domestic gas resources, the budget- design of the regulatory framework in the sector: ary and borrowing restrictions under which Pemex Petróleos Mexicanos (Pemex) retains its statutory currently operates as well as its overriding mandate to monopoly in domestic production and it remains the generate tax receipts through the export of crude and dominant incumbent in transport, although it has the supply of petroleum fuels domestically, investing exited distribution. billions of dollars in gas transport activities--which are Reforms to date have been directed at fostering already open to the private sector--is of questionable private participation in transport, storage, and distribu- priority. tion activities as well as in trade and marketing.Mexico Two immediate regulatory challenges stand out in has been quite successful in attracting private invest- this regard: enforcing the recent directive on gas mar- ment for developing distribution and,to a lesser extent, keting and conducting the five-year review of gas for transport infrastructure and services. However, transport and distribution tariffs. entry in gas storage and marketing services has been Gas Marketing. This directive issued by the Comisión limited, because of the presence of the dominant, ver- Reguladora de Energía (CRE) regulates Pemex gas con- tically integrated incumbent, Pemex. tracting in an effort to establish more transparent, bal- Electricity generation is the largest source of pro- anced, and reciprocal conditions between Pemex and jected growth in gas demand (18 percent a year). For natural gas buyers.This is important since the contin- the power sector to meet Mexico's rapidly growing de- ued vertical integration of Pemex poses serious obsta- mand for electricity without encumbering public cles to introducing competition in gas marketing.The finances, it is important that competitive conditions in directive calls for accounting separation by functions-- power generation be established. Critical to creating a for production, transport, and marketing--to discour- level playing field among generators (public and pri- age cross-subsidies between marketing and first-hand vate) is ensuring an adequate supply of fuel (principally sales.While consumers are now permitted to contract natural gas) on competitive terms.This reinforces the with gas marketers other than Pemex, the market importance of instituting additional measures to foster power Pemex wields is likely to continue to deter new entry in gas exploration and production, trans- entry of new competitors. In the absence of further port,storage,and marketing.The continued vertical in- structural reforms, such as the full legal separation of tegration of Pemex gas affiliates, as well as its Pemex's gas production from its transport and market- continuing status as a state monopoly in gas production ing subsidiaries, the company's marketing activities and processing, both pose a formidable obstacle to the may have to be further constrained. competitive conditions needed to ensure efficient and Five-Year Tariff Review. This review provides an oppor- reliable gas supplies during the next decade. Moreover, tunity to critically assess whether current policies and further regulatory reforms will be required to ensure regulations are working as anticipated and to modify that the necessary investments in gas infrastructure and them as deemed necessary.Several key issues to be con- production materialize. sidered during the review are: (1) the sustainability of In addition, current commitments for new pipeline initial distribution tariffs and minimum coverage tar- capacity are insufficient to meet projected demand gets bid by developers in lower-density zones; (2) the over the next decade. Barring restrictions on Pemex's impact on projected throughput and connection rates ability to develop new transport pipeline capacity or (and hence tariffs) of unanticipated obstacles to system continue coordinating its marketing and transport affil- build-out, such as delays in permits and technology 4 Executive Summary limitations; (3) the efficacy of the acquisition pricing companies as autonomous utilities with full responsi- methodology in protecting captive consumers; and (4) bility for all aspects of service provision holds the the suitability of the revenue yield methodology for promise of relatively rapid and sustained improvement price caps. in performance, particularly when combined with private participation. Urban Water Supply and Sanitation Reorienting Private Participation. Successful private par- Since the early 1990s, federal sector policy has explic- ticipation requires more harmony between the modal- itly promoted private participation as a tool for im- ity of participation and fundamental service problems, proving the efficiency and quality of urban water enhanced specification of contracts,and more transpar- supply and sanitation service. In practice this has pri- ent contract award processes. In water systems charac- marily involved wastewater build-operate-transfers terized by high losses, poor commercial practices, and (BOTs) and a few service contracts.However,few mu- low tariffs, BOTs for wastewater treatment or water nicipalities have had any success thus far in attracting abstraction and conveyance are singularly inappropri- long-term private funds or in generating efficiency in ate and tend to magnify the economic and financial service provision through private management. The losses already being incurred. A solution is to initially sector faces concurrent challenges of declining invest- use integrated management contracts or leases of rela- ment, low revenue mobilization, and limited cost re- tively short duration to raise operating efficiency and covery. The reasons for this are related to pricing, cash flow. In conjunction with gradual increases in tar- commercial and technical inefficiency, and continuing iffs, this would provide the preconditions for subse- dependence on federal transfers. quent private arrangements where operators would The modality of private participation and the kinds take more risks and provide greater benefits, particu- of benefits it can bring depend on the prospects for larly with respect to the mobilization of debt and generating sufficient revenues to recover costs. Water equity financing for investment. and sanitation tariffs charged by the majority of Refocusing Federal Financial Support. Local authorities Mexico's urban water companies are quite low continue to rely heavily on federal transfers and direct ($.3/m3) compared with tariffs in other countries in investment from the Comisión Nacional deAgua (CNA), Latin America and the OECD ($.90-$2.5/m3), and not only for financing new investments, but increas- barely cover operational costs. Subsidy policies and the ingly for rehabilitation and even periodic maintenance. tariff structure need to be reexamined in order to in- Revamping lending policies and instruments remains a crease the degree and efficacy of private participation critical need. For water companies that already arrangements. In addition, the government will need generate substantial net revenues, a first step would be to pursue a progressive reform agenda encompassing to redirect much of the resources of the Banco Nacional inter-related changes in the three areas described de Obras y Servicios (Banobras) to support subnational below as well as conclude the associated legal and reg- governments in issuing debt in private financial mar- ulatory reforms.Transitional federal, state, or municipal kets.This would be effective since the cost of issuing financial support will be required to assist local utilities debt is high for local governments that are creditwor- as they orient themselves toward cost recovery. thy, but whose funding requirements are modest. Enabling Environment. A credible regulatory environ- Banobras, as well as private financial institutions, can ment is necessary to reduce investor uncertainty. Few play a constructive role in pooling smaller issues to re- states in Mexico have put in place regulations govern- duce transaction costs and in providing credit enhance- ing private sector participation and none have estab- ment to boost credit ratings. lished distinct regulatory entities to oversee service provision. Greater clarity and coherence is required on Transport policy goals, on institutional responsibilities for regu- Mexico has been successful in attracting private sector lating service providers, and on pricing policies com- interest and investment in the port and railroad sectors, mensurate with those goals. Constituting water as well as in roads,though with mixed results.It has also 5 Executive Summary made an impressive start in private participation tariffs. Rail and road access to port facilities and distri- through concessioning and privatizing airports. In bution centers, however, still needs improvement.The terms of highway investment, country risk is perceived level of containerization of Mexican freight,also a crit- to be quite high, primarily on account of the govern- ical requirement for integration of the transport net- ment's political constraints and consequent inability to work, still remains low at 36 percent. deliver on guarantees and contractually obligated ad- Logistical problems persist.The most important is justments during the toll roads debacle of the early the need for greater coordination between multimodal 1990s.This experience continues to cast a shadow over agents and the authorities, especially regarding toll roads. Devising mechanisms to finance the opera- repeated customs inspections and administrative tions and maintenance expenditures required in this paperwork at the ports. Although the performance of sector remains an urgent priority. ports has improved significantly in terms of turnover The foremost issue in the highways sector thus re- time and most other indicators (including the transfer lates to devising an appropriate restructuring that ad- to trucks), the gains achieved through the port reform dresses the problems of growing demand, which is are often undone by long waiting times for truckers straining an under-financed, under-maintained, and and trains in cargo reception areas in the interior. debt-ridden network. Excluding the federal toll road Improvements in the logistic management of surface system, at least half of the network is non-core and transport modes will require higher intramodal should be devolved to the states (along with the neces- competition (within the trucking industry) and inter- sary share of revenues).The rationalization of the exist- modal competition (between trucks and rail).A major ing toll road system should focus on maximizing the obstacle to achieving intermodal competition is the transportation value (and use) of existing infrastruc- lack of intermodal facilities,particularly with respect to ture, possibly through transparent cross-subsidies and international traffic. less rigid toll revisions, along with enhanced planning It is important that the government follow a policy and financial analysis before any further concessions of encouraging multimodality by ensuring non-dis- are considered. The network as a whole needs to criminatory access to all service providers by removing be managed in a consistent and coherent fashion, barriers to the smooth interchange of freight and pas- reducing the diffusion of responsibility among sengers across modes. It is equally important that the agencies, which has led to disparities in maintenance transport regulators develop a vision for the need for and pricing standards across the system. In the long- greater integration across modes so that regulatory term, corporatization of the toll road system under an problems do not impede the flow of goods and people autonomous entity--run on commercial principles of across the country. Partly in recognition of this, the accountability and transparency--would allow the Secretaría de Comunicaciones y Transporte (SCT) is in the system to access capital markets. process of creating an Administration Facilitation Integration. Another important challenge is the need for Commission to harmonize the requirements of the further transport deregulation at the state level, and for various authorities involved in the sector,thus reducing policies that encourage greater coordination between administrative delays. Other critical areas for govern- modes to create a more integrated system.This will en- ment action include developing overarching insurance sure better use of transport infrastructure and the de- legislation across modes and facilitating the develop- velopment of more efficient supply chains. ment of essential bottleneck facilities, such as dry ports Road transport is the predominant mode of trans- and distribution centers, through public-private part- port within Mexico and for cross-border trade with nerships if necessary. the United States.The success of the railways privatiza- Regulation. Substantial uncertainty remains concerning tion program has generated significant new interest in regulatory structure and conduct. SCT has not yet multimodality and improved intermodal coordination, shifted in outlook and role from operator to monitor, since the new operators are competing for market and has applied regulations and laws inconsistently, ap- share through better facilities, better service, and lower pearing at times to be prone to regulatory capture.To 6 Executive Summary reduce investor uncertainty, it is necessary to complete Notes the structural transformation of SCT to a policymak- 1 All dollars are United States dollars, unless otherwise ing body and create an independent regulator for the indicated by $P (Mexican peso). integrated transport sector with transparent rules and well-defined responsibilities. The main role of SCT should then consist of establishing mechanisms that favor competition, such as a clear definition and pric- ing of access rights. A regulatory body of acknowl- edged professionals that would benchmark performance and set tariffs as well as ensure rationaliza- tion of the existing system would be an important in- dication of the government's commitment to improving the environment for private participation in the transport sector. Antitrust issues, particularly related to equal access and market power, have been a major concern in the sector. In this respect, greater clarity is needed on the respective jurisdictions of SCT and the competition agency,Comisión Federal de Competencia (CFC).Follow- through on the recent order by the CFC to break up the domestic airline holding company is also needed. This will induce competition in the domestic market and lower the price of air transport in Mexico, and send a strong signal regarding government commit- ment to a robust pro-consumer competition policy and to a powerful and independent competition agency relative to sectoral ministries and private inter- ests. Structure of the Report The report reviews Mexico's recent macroeconomic performance and the business environment. It consid- ers various sources of financing for infrastructure in- vestment, and reviews recent legal and regulatory reforms that are critical to attracting private sector fi- nancing. The remainder of the report then explores current issues,as well as prospects and concerns regard- ing private entry and investment in each infrastructure sector--telecommunications, natural gas, urban water and sanitation, toll roads, railroads, ports, civil aviation and airports, and multimodality. 7 PART 1. INFRASTRUCTURE INVESTMENT CHALLENGES IN MEXICO 1 Main Issues and Challenges Overview and Cross-Sectoral Concerns electricity, ports, highways, and roads.This means en- suring that genuine competition exists, especially in During the past two decades, Mexico has proven itself the telecommunications and natural gas sectors. In ad- a pioneer in Latin America in spurring private sector dition, this necessitates new approaches to pricing and participation in the economy. Starting in the late subsidization, financing, the promotion of private par- 1980s,the government opened large parts of the econ- ticipation, and capacity building for regulatory institu- omy to the private sector, with the sale of state-owned tions at both the national and subnational levels. Since enterprises,the privatization of banks,and major initia- an increasing number of key infrastructure decisions tives in infrastructure, including an ambitious program will be taken at the subnational level, the successful of private sector participation in toll roads. In 1989, implementation of the decentralization process will be with the sale of the state-owned monopoly supplier of a critical determinant of the feasibility and efficiency of telephone services--Telmex--Mexico became the infrastructure investment programs in the roads and second country in Latin America to privatize its water sectors. telecommunications sector. Since then, it has invited During the past decade, Mexico has made major private investment in railroads, ports, and airports. progress in infrastructure service provision.This is es- Starting with NAFTA in 1993 and continuing with pecially the case for the telecommunications, railroads, more recent free trade agreements, such as the one ports,and airport sectors,which have experienced suc- with the European Union, Mexico has further com- cessful privatization. Much more needs to be done, mitted itself to an open trade policy and commercial however, particularly in the water and energy sectors.2 and financial integration with the global economy.The Government reform in the water sector was designed government's decision to focus public spending on the to improve service quality and promote private partic- social sectors, in combination with its fiscal constraint, ipation,but major reform is still pending and the expe- has meant that the role of the private sector in infra- rience to date has been mixed. At the same time, the structure service provision has become increasingly investments required to simply maintain current levels important, as shown in Figure 1.1. of service are enormous. Among the government's overarching infrastruc- To keep pace with the growth of the economy, the ture-related challenges are competitiveness and decen- energy and water sectors will require expenditures of tralization. If Mexican enterprises are to compete close to $100 billion and $6 billion, respectively, over effectively and profit from free trade, particularly the next decade.In highway transport,SCT has identi- within NAFTA, they will increasingly require higher- fied 2,360 kilometers of priority projects and an addi- quality infrastructure services in telecommunications, tional 407 kilometers of bypasses for construction 8 Main Issues and Challenges Figure 1.1 Mexico's Infrastructure Investments as % of GDP 30% 25 20 15 10 5 centreP 0 Year 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Total Private Public between 2001 and 2010. At the same time, federal Recent Economic Performance highway finances are severely constrained.The govern- At the onset of 2001, Mexico's economic performance ment is in the process of restructuring the debt it took had been robust, with economic growth of more than on during construction of the federal highway system. 6.7 percent, inflation at year-end 2000 of 8.2 percent, Deferred maintenance requirements for the highway and a current account deficit of 3.7 percent of GDP. system (the "rescued" roads under Fideicomiso de Apoyo Such positive macroeconomic indicators reflect sound al Rescate de Autopistas Concesionades or FARAC) are management during the final years of the Zedillo ad- high, and have been estimated at $59.5 million.3 In ad- ministration--namely a tight and independent mone- dition, the debt has been increasing steadily since the tary policy, flexible exchange rates, and a conservative rescue because the system does not generate adequate fiscal stance (the year-end fiscal deficit was 0.8 percent cash flows to service the debt. of GDP).Tight monetary policy and the appreciation This chapter provides a brief overview of recent of the peso led to high interest (deposit) rates (between economic performance and the general investment cli- 7 and 9 percent) during the year. In addition, the gen- mate in Mexico. It outlines the implications for infra- erally low tax effort and the large refinancing needs of structure investment in light of government liabilities, the relatively low but poorly structured government as well as outstanding legal and regulatory reform debt also put upward pressure on interest rates.Overall, issues in the financial sector. It also considers infra- however, the smooth democratic transition to the next structure investment with regard to capital market de- administration within a context of a strong economy velopment, and the need to redefine the role of the was an important legacy of the former administration, national development bank, Banobras, in an environ- and formed a solid foundation for continued ment of increasing private participation in infrastruc- economic confidence, particularly on the part of the ture supply. This chapter also focuses on critical private sector. cross-sector issues and key regulatory concerns for In this respect, increased macroeconomic stability the future. It concludes by outlining a possible role for has led to a decline in country risk and a significant the government in mitigating risk and catalyzing improvement in the investment climate in Mexico private investment. during the past five years. However, general 9 Main Issues and Challenges procyclicality of Mexican fiscal policy is a concern to date has meant that infrastructure has not attracted a since it exaggerates the business cycle and has a nega- large share of FDI flows during the past five years. Be- tive impact on investor confidence.The reliance on oil tween 1994 and the first half of 2000, 61 percent of earnings for almost one-third of fiscal revenues also total FDI went to manufacturing (one-third of that to make the fiscal balance acutely vulnerable to oil price the maquiladoras--those assembly and processing plants changes, with the result that fiscal adjustment has traditionally positioned close to the U.S.border),while mainly relied on cuts in public investment, particularly transport and communications received 5.1 percent, capital formation. As a consequence, public sector and construction, mining, water, electricity, and agri- investment in infrastructure in Mexico has declined culture received less than 1 percent among them. from 12 percent of GDP in 1981 to less than 2 percent Legal Framework for Investment.Mexico's laws governing in 1998,underlining the need for a more active role for corporations, partnerships and other forms of business the private sector in investment. enterprise must keep pace with the growing role of the private sector and the increasing importance of FDI Business Environment and Institutional Issues (particularly from Canada and the U.S.). Effective pro- The investment climate has improved substantially tection for minority shareholders and transparent ac- since 1995. Mexican manufacturing efficiency has in- counting are both needed to reduce the likelihood of creased with labor productivity growth of 6 percent a controlling parties conducting enterprise affairs to year from 1994 to1998, buoying the country's external their own advantage. Such practices increase the per- competitiveness.Such an increase in labor productivity ceived risk of portfolio investment and decrease in- is due to four major forces: (1) the relative flexibility of vestor interest. In this regard, the cross-ownership of Mexican labor markets; (2) significant liberalization of banks and securities houses has also created a major the external trade regime, which resulted in increased structural disincentive toward the development of in- exposure to foreign competition and improved access stitutional investors in Mexico since the banks' owner- to imports; (3) a sharp increase in foreign direct invest- ship of brokerage houses discourages brokerage firms ment (FDI) since 1994; and (4) a comprehensive from marketing savings products that directly compete deregulation program, which streamlined regulations with traditional bank deposits. and procedures. To reduce perceived risks in lending and investing, Capital Inflows. Foreign confidence in the economy is important steps have been taken toward reform of the witnessed in the impressive resumption of foreign cap- legal and institutional framework for investment, ital inflows following their collapse during the 1994- including the Bankruptcy Law, the system of asset 95 crisis and the enthusiastic reception accorded to collateralization and securitization,and rules for disclo- recent government global bond issues.4 Total net capi- sure and reporting. More fundamental changes are tal inflows to Mexico (public and private) averaged $18 still pending. billion a year between 1997 and 1998, and the current The complicated and expensive procedural re- account deficit is mostly financed by FDI,with net pri- quirements of the former Bankruptcy Law enabled vate FDI in 1999 amounting to $11.8 billion.5 FDI is debtors to stave off collection and made it disadvanta- expected to continue its dominance in Mexico's capi- geous for lenders to force a debtor into bankruptcy,ef- tal inflows in view of further trade liberalization envis- fectively transferring the rights of creditors to equity aged under NAFTA and Mexico's free trade holders. Under the new Commercial Insolvency Law agreement with the EU. that became effective in May 2000, bankruptcy pro- The regulatory framework governing FDI was first ceedings have been streamlined and time limits im- liberalized in 1993 with the enactment of the new For- posed on each step of the proceedings.The new law eign Investment Law,and was subsequently further lib- includes better recognition of creditors and is expected eralized in 1996 and 1999. However, the limited to improve the overall investment environment as it is opening of the telecommunications and energy sectors increasingly implemented. 10 Main Issues and Challenges Secured Credit. Mexico's system for pledging movable Government Liabilities and Debt Management assets as collateral for loans and enforcing such pledges As discussed above,macroeconomic stability is key to a should accommodate a broader set of permitted and sound investment climate. In Mexico today, possible secured transactions at lower transaction costs. Cur- risks to stability arise from the maturity structure and rently,many businesses remain shut out from important servicing cost of the consolidated public sector debt, sources of secured credit, including lending secured by various contingent fiscal liabilities, and the relationship equipment, inventories, and receivables, since the vast between domestic and external savings. Although the majority of lending by financial institutions is secured fiscal deficit is currently on the order of 1 percent of by personal guarantees, mortgages on real property, or GDP, the low tax effort and new pressures foreseen on both.The recent amendments to the law,while accept- public resources attributable to the Institute for the ing the security interest in pledges on movable prop- Protection of Bank Savings (IPAB) debt and the state erty, have introduced aspects that are likely to deter the retirement regimes are sources of concern. development of lending secured by these pledges.6 A Government Liabilities. While the pension system for mechanism for expeditious recovery of collateral also private sector workers has been reformed, the multi- needs to be introduced, since in most cases secured tude of pay-as-you-go, unfunded pension systems for lenders must bring suit and await the outcome of a full public sector workers pose a risk to the government's court proceeding before a judge authorizes recovery. 7 fiscal position, with negative implications for the in- Finally, the system of public registries could be made vestment environment.The low-income housing fund, more efficient, permitting lenders to record pledges Instituto del Fondo Nacional de la Vivienda para los and providing them with quick and reliable access to Trabajadores, or INFONAVIT (funded through manda- information about existing liens.This would enable the tory pension contributions), is another major threat to development of asset-backed securities and encourage the financial sustainability of the pension system be- the development of specialized non-bank financial in- cause of the poor returns it generates.9 The pension stitutions such as leasing, factoring, and housing fi- system for federal government employees is already nance. The decision to allow public registries of experiencing a cash-flow deficit and is actuarially commerce to work on an electronic basis is a needed insolvent.10 In addition, the large volume of govern- step in this direction. ment and quasi-government bonds11 outstanding and Trusts. Most relevant for infrastructure transactions is the need to refinance them pose the risk of further the fact that the majority of special purpose entities for pushing up interest rates and crowding out domestic the issuance of asset-backed securities (the main fi- private issues.12 nancing mechanism used for infrastructure) are organ- The government's debt management strategy cur- ized as limited-purpose trusts (fideicomisos) or rently relies on taking advantage of market opportuni- corporations, a legal concept that has deep roots in ties to reduce the financing costs of public debt on Mexico.However,legal restrictions on trusteeship have issue and to achieve a more even maturity profile.13 limited competition and resulted in high fees.There are Thus foreign holdings of domestically issued securities also no clear guidelines for the issuance by a trust of have declined sharply in both proportional and ab- true debt instruments,including the securities typically solute terms since the early 1990s, reducing a major issued for asset-backed transactions.This has resulted in source of volatility in the investment environment.14 an excessive reliance on the issuance of trust certificates Investor concerns need to be addressed, however, re- rather than debt obligations for most deals, including garding four important issues: (1) government debt infrastructure transactions. Although a trust participa- management and its impact on the availability and cost tion certificate can work like a debt security, the me- of capital; (2) legal issues affecting the security of pri- chanics are complicated and different from that to vate investment; (3) the government's potential role in which investors are accustomed so that marketability private-public partnerships for the financing of non has been adversely affected, limiting investor interest.8 creditworthy welfare improving projects; and (4) the availability of long-term financing. 11 Main Issues and Challenges Experience has demonstrated the huge long-term long-term institutional investors, such as pension and costs and exchange rate risk attached to dollar-denom- mutual funds, efficient financial intermediation, and inated debt financing of domestic infrastructure. This the development of domestic markets for the long- reflects key characteristics of infrastructure investment: term debt instruments that could potentially finance large up-front capital requirements, long gestation infrastructure projects. The government can assist by times resulting in an extended initial period of low or providing credit and other information, as well as by negative cash flow, long-lived assets, and revenues that catalyzing investment at the subnational level through are almost exclusively generated in local currency.The Banobras, the national development bank for public low levels of public investment in Mexico foreseen for works. Overall, however, a stable macroeconomic track the future imply an increased reliance on the private record is the most important prerequisite for the devel- sector. In the face of shallow domestic capital markets, opment of a market in the longer-term instruments however, private investors have been forced to raise that would finance infrastructure. capital of the required maturity and volume in overseas Banking System. Banking regulation and supervision markets. This necessity underscores the continuing have improved since the crisis and the banking system importance of foreign financing for short-term has been opened to foreign investment. As a result, investment (both FDI and debt).The development of Mexico currently has a better-capitalized and regulated local capital markets, therefore, will be critical to financial system that is more integrated into interna- ensuring the availability of local long-term capital and tional capital markets than in the past.While the finan- thus the development of local infrastructure finance in cial fundamentals of the banking system have the next decade. improved, the banks need further capitalization to Contingent Liabilities. Official estimates of domestic meet international standards and are following conser- debt do not include the growing volume of bonds is- vative lending policies to restore adequate capital lev- sued by quasi-governmental entities such as IPAB and els, preferring to invest in low risk public sector FARAC--which are net contingent liabilities of the issues.17 Partly as a result,real banking system credit has government.15 Including IPAB liabilities in public debt remained stagnant, with credit limited to the largest figures would increase the overall ratio of public debt companies and long-term financing unavailable except to GDP for 1999 from 28.3 percent to 44 percent.Nor to those with access to international capital markets. do government debt statistics include direct public in- High real interest rates have also lowered demand for vestment projects financed and executed by the private bank credit.Although external financing has been crit- sector.The budgetary impact is not registered until the ical to the economic recovery since 1995,access to do- project is completed and delivered to the mestic credit will be crucial for investment,particularly government Proyectos de Infraestructura Productiva de in infrastructure, and sustained broad-based growth in Impacto Diferido en el Registro del Gasto, or (PIDERE- the future. GAS).16 Integrating these needs into overall govern- State Development Bank. The dominant financial insti- ment funding requirements would improve the tution in state and municipal infrastructure borrowing transparency of government borrowing, provide an ac- (project finance through loans and equity participa- curate idea of the magnitude of the government's tion) is Banco Nacional de Obras y Servicios, or Banobras. involvement in these sectors (primarily energy), and Thus any program of infrastructure finance will need thus increase investor confidence. to address the future role, efficiency, functions and organization of Banobras even as the majority of Financing Infrastructure Investment infrastructure funding will need to come from the The health of Mexico's domestic banking sector and private sector. capital markets and their ability to provide long-term Banobras has assets of $12 billion, of which $11.5 local currency financing are vitally important for gen- billion are loans. On the liability side, Banobras funds erating funds for infrastructure investment by the pri- itself with a combination of loans from the IDB and vate sector. Critical elements are the growth of theWorld Bank ($5 billion) and its own debt and note 12 Main Issues and Challenges issues ($4.9 billion), which are guaranteed by the fed- different asset classes and currencies.20 The availability eral government. Banobras operates a currency swap of infrastructure finance and the securitization of infra- facility that allows it to borrow in foreign currency and structure investment would increase immensely if lend to states and municipalities in pesos. Loan origi- AFOREs could gradually diversify a part of their port- nation and supervision practices are being reformed folio into domestic and international equities and now that Banobras no longer relies on federal guaran- privately issued corporate securities. tees for lending and debt service.18 However, the Of the other institutional investors, mutual funds process remains slow (the processing time for a munic- are the largest investors in Mexico's stock market, but ipal loan is three to four years). hold only about 5 percent of Mexico's total financial With the move to increased private sector financ- savings. Fund investments are largely in fixed-income ing, the model of the national development bank as a instruments, which are extremely short-term, making first-tier lender is changing.Banobras can most usefully mutual funds a poor source of long-term investment operate as a second-tier lender and help link borrowers finance.21 Mexican insurance firms are not currently a to sources of private funding by facilitating investment source of long-term infrastructure funding either.They transactions, such as state and local debt issues into the are small by international standards and are not market. Important functions for Banobras include (1) equipped to offer products such as annuities,since they the provision of credit information and analysis; (2) too, hold most of their assets in fixed-income instru- funding the lowest income states and cities,which gen- ments (government bonds and corporate debt) and real erally cannot obtain private credit; (3) providing tech- estate, mortgage, and other collateralized loans. nical advice (on budgeting, accounting, finance, Stock Market. The Mexican stock and bond markets planning,and management) for states and cities making have been limited with declining sources of investment the transition to creditworthiness; and (4) managing a funding in recent years, and they are unlikely to be- currency swap facility for state and local issuers.19 come a major source of infrastructure finance. In fact, Capital Markets. The volatility of past Mexican macro- the greater liquidity, transparency, and relatively lower economic performance has shaped the development of fee structure of the New York stock exchange has re- its capital markets, which has resulted in the over- sulted in three times the volume of shares traded in the whelming dominance of short-term debt instruments local market being traded abroad in the form of Amer- in domestic trading.The development of a full-fledged ican Depository Receipts (ADRs). government yield curve extending beyond one year is It is thus unlikely that private debt and equity alone a priority, with a liquid secondary market able to pro- will be able to finance most new infrastructure re- vide a minimum risk benchmark for the pricing of quirements in Mexico. Some form of public support privately issued liabilities.The successful placement of probably will be required to make private investment 3- and 5-year government paper in 2000 was a suc- feasible. Examples of public commitments include up- cessful first step in this process. front cash equity participation, assumption of a subor- The most rapidly developing segment of the insti- dinated bond issuing, and shadow-toll payments for tutional investor market is the new pension system for highways or some other type of ramp-up risk sharing private sector workers. Assets under management of contribution. Structures that permit debt service to be the pension fund management companies (Sociedad de back-loaded in order to recognize ramp-up revenue Inversión Especializada de Fondos para el Retiro, or limitations may also need to be encouraged as part of SIEFOREs) rose to about $19.7 billion as of May the capital market development process. 2001.The SIEFOREs operate under a highly restric- tive regulatory regime that allows investment only in highly rated domestic peso-denominated fixed-in- Regulatory Issues come instruments, preventing the private pension In light of the government's policy of attracting private funds (Administración de Fondos para el Retiro, or resources and expertise for new investment as well as AFOREs) from benefiting from diversification across for the maintenance of existing infrastructure,there is a 13 Main Issues and Challenges need to cultivate an investment climate characterized Universal Service. The government needs to define its by low political risk and adequate returns.There is also priorities and policy for universal access to service tak- a need to institute mechanisms for the protection of ing account of the particular characteristics of each the competitive process and of consumers from abuse sector. It also needs to explicitly consider potential by dominant operators. mechanisms for financing service coverage require- Regulatory Structure and Processes. To attract private in- ments. For instance, a requirement of intra-sector vestment, the institutional and regulatory framework cross-subsidies (which is the traditional mechanism needs to explicitly lower investor risk. Mexico's expe- that has been used) cannot always be imposed on rience to date with autonomous and credible regula- private operators because of the inability of open and tion has been limited. In the transport, water, and competitive sectors to sustain such practices and energy sectors, a single line ministry or agency has the distortions that can be induced by the same. been responsible for policy formulation, promotion, The extent and scope of desired levels of coverage, its actual operation, and investment, as well as monitoring cost, sources of funding, target groups or regions and and regulation.The resulting environment of confused mechanisms for service delivery, need to be clearly roles and poor incentives has led to the perception of thought through. high risk for private entrants, ineffective regulation, in- Institutional Capacity. At a more micro-level, institu- adequate consumer protection from abuse of power by tional capacity building is critical. Although the gov- dominant operators,and poor sector performance.This ernment began a decentralization program in the late is most clearly seen in the telecommunications sector, 1980s by delegating more responsibility to states and where the regulator, Cofetel, has been unable to con- municipalities, there still is a lack of capacity to plan, trol anti-competitive practices by the incumbent for- design, and execute complex transactions at the subna- mer monopoly,Telmex. tional level, such as infrastructure concessions. The As is well known,agencies need political and finan- problem is exacerbated by the lack of fiscal authority cial autonomy,accountability,as well as transparent and and the consequent paucity of autonomous sources of open processes to minimize conflict of interest, cor- funding at the state and municipal level. Federal tech- ruption, and other pressures. Decisions need to be nical assistance to develop a consistent core of expert- taken regarding the range of regulatory instruments ise at the state level in project finance, as well as in available and the actual enforcement capacity of the procurement, evaluation, and contracting procedures, regulator in many sectors. Regulatory instruments will be necessary to overcome this. need to be expanded and the use of existing instru- ments optimized.This would involve the development Government Role in Lowering Risk of a sound system of regulatory accounting including In order to improve the investment climate, the gov- appropriate financial and cost models,a policy decision ernment may need to redefine its role to support the on the regulatory treatment of investment and depreci- transition to a new regime of cost recovery and market ation, the design of information systems to enable ac- signals, maintaining subsidies where necessary and de- curate and timely data collection by regulators, and sirable, but in a manner that is as targeted and transpar- developing methods of benchmarking performance. ent as possible.The difficult financial environment of It is also important that well-defined conflict reso- the last decade has caused project managers to seek lution rules be developed, as well as rules for direct in- ways of mitigating or buying down risks so as to reduce teraction with users to address complaints and the cost of capital and thus enhance project viability. disseminate information, streamlining processes and One notable mechanism to lower project risk and fi- administrative procedures that optimize the consulta- nancing requirements when private funds are not tion measures already available under Mexican law.22 forthcoming or when projects are not fully financially Across all sectors, a clearer delineation of the roles and viable, involves the government participating finan- responsibilities between the competition agency, CFC, cially in some way.23,24 and the sectoral regulator is direly needed. 14 Main Issues and Challenges Possible Strategies. Since public finances are insufficient price adjustments for political reasons. It may to fund all such projects,Mexico needs to develop new thus serve to reduce regulatory risk.The trade instruments to facilitate private investment.There is a off is the associated liabilities. range of possible options: · Government participation may make it easier 1. Permitting international investors to own majority to refinance initial project debt, and may make stakes. This could be achieved by relaxing the 49 slightly longer initial maturities feasible. percent ownership limits on foreigners and expand- · A lower project cost of capital would be ing efforts to list infrastructure projects on interna- achieved if the government requires a lower tional markets when possible.This strategy places a rate of return for its equity investment relative premium on continued macroeconomic stability, to private equity investors. Government invest- since most infrastructure services are non-tradable ment also serves to "buy down" project size to and generate peso-denominated revenues. make it more attractive to private capital. 2. Accelerating the development of a privatized pen- Guarantees. An alternative or complementary approach sion system. Infrastructure investment fits well into is for the government to provide guarantees, which pension fund portfolios. This would also help de- could take two forms: (1) guarantees of project vol- velop a longer-maturity domestic capital market, umes or revenues,with appropriate adjustments for in- thereby helping infrastructure projects reduce the flation and exchange rate factors; and (2) guarantees of risk of rollover of bridge financing and recurrent the debt service (both principal and interest, as well as balloon refinancing. possibly a guarantee of debt refinancing at maturity). 3. Developing an infrastructure fund, perhaps in part- Guaranteeing a minimum level of revenue serves to nership with an international investment bank.The reduce risks to both equity and debt investors, while equity positions acquired by the Mexican Govern- debt guarantees serve primarily to reduce borrowing ment through restructuring or through direct in- costs.25 Debt guarantees can increase the relative vestment could be transferred to an infrastructure amount of debt that the private sector would provide, fund for subsequent offering to investors.The gov- so that the amount of equity investment needed would ernment could also dedicate a portion of its infra- be lower. Given the poor experience with guarantees structure-related revenues to such a fund, which in Mexico, however, guarantees are likely to be rela- would allow the fund to raise debt capital like a de- tively expensive. An option would be to establish a velopment bank. Subsequent loans could then be consortium of high-quality, reliable insurance firms used to establish an earmarked revolving fund. and multilateral institutions to develop insurance prod- 4. Developing a mix of public investment instruments, ucts that would be jointly offered. Premium payments ranging from direct investment to debt financing could then be made by project sponsors or as part of to guarantees.This is in recognition of the fact that fees paid to the government. the nature of many infrastructure projects makes However, there is a need for a caveat regarding di- them unattractive for 100 percent private rect government participation.The disadvantage is that investment. Direct investment by the government the influence or control that this participation gives the may stimulate private investment that otherwise government can be manipulated for political objec- would not be forthcoming, and has the following tives, particularly during the electoral cycle.Therefore, attractive features: care might need to be exercised when advocating or · It allows the government to participate in the implementing these alternatives. upside if the project turns out to perform well in In summary, Mexico needs to develop a diversified the long run. set of financial instruments to deepen funding sources, · The guarantee option might create incentives to extend maturities, and to blend direct public invest- for the government to manage regulatory affairs ment with guarantees depending on the nature of in a timely manner, and makes the government specific project risks. less likely to adopt price constraints or limit 15 Main Issues and Challenges Notes 2 As an indicator,theWorld Competitiveness Index 2000,devel- 15 Although the government did not guarantee a minimum oped by the International Institute of Management Development, traffic volume in connection with the private provision of toll ranks Mexico 36th out of 47 large economies analyzed worldwide. roads, the government rescued the toll roads in 1997. As of No- Being a core upstream sector,poor performance in infrastructure has vember 1998, the FARAC road concession rescue trust had a neg- cascading effects throughout the economy, critically affecting the ative net worth of $P 14 billion in present value terms. cost of doing business, international competitiveness, and thus the 16 Including PIDEREGAS alone would imply an increase in country's growth and poverty alleviation prospects. the public sector deficit of 1.3 percent of GDP in 1999 and 1.6 per- 3 "Mexico Toll Road Rationalization: Status and Alternatives," cent of GDP in 2000. by Jeff Parker. 17 At the same time the lack of liquidity of the 4 Moody's awarded creditworthiness to Mexican long-term IPAB/FOBAPROA notes the banks hold has reduced the pool of debt (Foreign Currency Baa3) in March 2000, and S&P was ex- loanable funds. pected to do so by mid-2001. 18 This had led to criticism of its credit standards and project 5 Portfolio investment in 1999 amounted to $3.9 billion and analysis, and for its being politically oriented in its lending. long-term private loans were $13.87 billion. 19 Because the local markets may be swamped with demand 6 For instance, it is almost impossible for a borrower to pledge for funds from FARAC and IPAB, it may also be necessary for only a portion of its current assets such as receivables and inventories Banobras to assist sub-national borrowers to access external debt. since only movable property that has been sufficiently identified can 20AFORES are almost entirely invested in government bonds. be pledged.Furthermore,there is a requirement that for each pledge 21 While on the supply side there is a shortage of long-dated without a transfer of possession, if the proceedings from the sale of paper, on the demand side, mutual fund investors are wary of long- collateral are insufficient to cover the secured obligation, the uncov- maturity securities given the volatility of inflation in Mexico. Eq- ered portion is deemed to be extinguished or discharged--so the uity mutual funds are further hampered by the fact that there is lit- debtor cannot be sued for the shortfall. tle liquidity in the markets when the funds most need it and 7 At end-1998, it took a credit institution in Mexico an average therefore there is a genuine concern about redemptions.The pro- of six years to repossess a pledged non-movable asset while in the posed removal of universal deposit insurance by 2005 should con- state ofTexas it takes an average of three months. tribute to promoting broader demand for mutual funds as an alter- 8 Amendments to the law,which became effective in May 2000, native to bank deposits. have removed some of the flexibility of this device and added addi- 22 Agencies are often impeded by the law that restricts the use tional regulations, which are likely to increase trustee fees. of information collected through the national Statistical Office as 9The minimum pension guarantee allows workers to switch or well as most of the cost accounting data generated through the pri- opt for a pension under the old system.Hence,poor performance by vatization process. INFONAVIT has substantial fiscal implications. 23 Government participation in project investment may be on 10The total implicit debt of the ISSSTE is estimated at 120 per- an equity basis. An important additional justification for ensuring cent of 1997 GDP. arms-length regulation is avoiding the problems inherent in a situ- 11 According to the SHCP, federal debt in mid-1999 amounted ation where the government must manage its interests as both in- to 51.3 percent of GDP (direct liabilities or gross public debt being vestor/guarantor and regulator. 29.2 percent, the cost of the financial rescue being 16.2 percent and 24 For transport infrastructure, for instance, direct investment other contingent liabilities (FARAC, Development Banks, CFE, by the government can serve as a supplement to construction com- etc.) being 5.9 percent). pany equity. Governmental contributions would need to be suffi- 12These include IPAB bonds, issued as part of the banking sys- cient to achieve the 50 percent debt to 50 percent equity standards tem rescue, which are government-guaranteed securities, as well as that are now the norm for roads and aviation. For ports and rail- PICs, which are special promissory notes issued with a government roads, the standard is 60 percent debt to 40 percent equity. guarantee by the FARAC trust fund as the indemnity paid for the 25 If project revenues are insufficient to cover debt service, reversion to the public sector of toll roads and highways built by the then the equity holders would receive no returns during that time private sector. period. 13 A priority is to retire outstanding Brady bonds and replace them with newer and cheaper sovereign issues. 14 As of September 2000, net external public debt (gross debt minus the guarantees of the Brady bonds and other assets) at $79.6 billion was only 13.9 percent of GDP. 16 PART 2. SECTOR REVIEWS 2 Telecommunications The Mexican telecommunications sector is undergo- Government Strategy and Policy ing a dramatic transformation. In 1990, Telmex, the state-owned monopoly supplier of telephone services, The political rationale for telecommunications restruc- was privatized. In 1995 the Ley Federal deTelecomunica- turing in Mexico lies in the poor performance of a ciones was passed, placing in a statute the policy to cre- host of state-owned enterprises during the early 1980s ate a fully private competitive industry and establishing and the government's subsequent desire to establish a regulatory framework.Then in 1996 a decree created stricter fiscal controls and a more open economy.This the Comisión Federal de Telecomunicaciones, or Cofetel, led Mexico to consider privatizing a long list of indus- the front-line regulatory agency, as a quasi-indepen- tries.Telecommunications was an attractive target be- dent offshoot of the Secretaría de Comunicaciones yTrans- cause of its strategic significance in a trade-oriented portes (SCT). Soon thereafter competition began to growth policy, its potential for significant improve- emerge in the industry first in mobile telephony, then ments in service, the opportunity to derive substantial in long distance, and finally in fixed access service. revenues from the sale of the company, and the After the industry was restructured, its performance prospect of using the political cover offered by privati- improved significantly. During the first decade after zation to raise prices to cost.Thus in 1990 the state- privatization, the number of wire-line telephones in owned operator, Telmex, was privatized by selling a service doubled,wireless telephony grew from nothing 20.4 percent controlling stake for $1.757 billion to a to nearly 40 percent of all telephones, and waiting lists consortium that included the Mexican company Grupo for service virtually disappeared. By 2000, competitors Carso, Southwestern Bell, and France Telecom. Be- were reasonably successful in mobile wireless,domestic tween 1990 and 1994, the remaining government long distance, and international services, and had shares in the company (34.7 percent equity stake) were begun to enter fixed-access service in the largest cities. sold through public offerings and private sales, which Nevertheless, major regulatory issues concerning raised more than $6 billion. interconnection rules and prices remain unresolved.As The decision to privatize Telmex as a temporary a result, the Mexican telecommunications sector has monopoly and to worry about setting up regulatory not reached its full potential. Telephone density (a institutions and introducing competition after privati- combined 19 fixed and mobile phone lines per 100 in- zation was completed, was based on the argument that habitants) is low for a country with a per capita income the sale of an integrated company with exclusive rights of $3,800. Moreover, prices are still high, and the would increase the value of the company. The belief prospects for achieving high penetration and competi- was that the regulatory work could be done in parallel, tive pricing in many telecommunications services are and that the complete regulation for interconnection not good. would be done prior to the full opening of the sector. 17 Telecommunications In addition, this would enable Telmex to continue to tance concessions and nine of them were operating by pursue a universal service objective that included 1999. Among those, Alestra (partly owned by AT&T) wiring households that could not afford service that and Avantel (partly owned by MCI) have succeeded in was priced to recover its full cost, and to commit to a obtaining significant market shares in the largest cities. major investment program to improve service. During Facilities-based domestic long-distance carriers are also the same period, most developing countries took a allowed to sell international service,using their own fa- similar path­Mexico was not unusual in this regard. cilities out of the largest cities or reselling Telmex cir- Telmex received a six-year exclusivity period to oper- cuits from other areas.27 All domestic facilities-based ate basic services (local and long-distance calls from long-distance carriers provide termination of incom- fixed phones).The government andTelmex also agreed ing international service. However, this service is not to progressively eliminate cross-subsides from long-dis- competitive because the traffic is allocated by formula tance to local services. at a fixed, regulated price. The temporary Telmex monopoly with the Incoming calls are allocated among the carriers in opportunity to earn substantial excess profits for many proportion to their market shares in outgoing calls (the years probably resulted in Mexico receiving a higher so-called proportional return policy). Price competi- price forTelmex when it was privatized. But high mo- tion is also precluded because termination of incoming nopoly prices, in the absence of a substantial state sub- calls is priced according to the settlement rate.28 This sidy for customers with a low ability to pay actually allocation mechanism is very likely to change, in part reduce the demand for service so that the monopoly because the U.S. is strongly advocating the elimination leads to less, not more, private investment. Thus cus- of the proportional returns policy in favor of competi- tomers and, more generally, the Mexican economy tion and is both forcing settlement rates lower and ad- paid a high cost in the form of an underdeveloped vocating that they be price ceilings, not floors.29 telecommunications infrastructure.26 To protect the cartelized allocation and prices of in- coming calls, pure resellers have not been permitted in Private Sector Participation Experience international service in Mexico. The policy of a de facto ban on international resale has prevented large Since the introduction of private participation,compe- private-line customers from legally offering use of tition in international long distance in Mexico has their private lines to others for international service, achieved significant footholds.Facilities-based compet- and has spawned substantial enforcement efforts by itive entry in domestic long distance has also been both Cofetel and Telmex to detect and prosecute such allowed in stages. In 1996, 1997, and 1998, the govern- "bypass" for international calling.As a result, regulators ment held successful auctions for electromagnetic and the courts find themselves in the strange role of fa- frequency assignments for paging, cellular telephones, cilitating the effective operation of a cartel in main- local microwave distribution, and wireless personal taining extremely high monopoly prices.The ban on communications services (PCS). Several companies international resale is likely to change in the near fu- have been reasonably successful in entering wireless ture since, as a signatory to the World Trade Organiza- telephony, especially mobile service.The introduction tion (WTO) Agreement on Telecommunications, of calling party pays and prepaid calling for radiotele- Mexico must permit foreign carriers to offer interna- phony substantially increased both penetration tional service to and from Mexico whether through and usage because these policies allowed customers to their own facilities or by resale. gain firmer control of the money they spent on tele- Conflicts over resale services have arisen between phone service. Telmex and the long-distance entrants. Competitors claim that Telmex engages in discriminatory pricing International Long Distance and denies adequate access to its long-distance net- Since competition started in long distance services in work,and that the purpose and effect of these practices August 1996, 18 carriers have been granted long-dis- is for Telmex to leverage its monopoly in domestic 18 Telecommunications long distance to a monopoly in long-distance and in- bile service, except thatTelmex was barred from offer- ternational services that are competitive. For instance, ing fixed wireless access until 2001. the wholesale prices that long-distance carriers pay to The cellular tenders created one national operator be able to terminate both domestic and international (Telmex), one multiregional operator (Isabel, that op- long-distance calls in areas where Telmex has a long- erates in four regions),and five regional operators (Baja distance monopoly are very high. Celular, Movitel del Noroeste,Telefonía Celular del Norte, Telmex's competitors charge that Telmex refuses to Celular de Telefonía, and Portatel del Sureste). The PCS provide all of the private circuits for resale purposes auctions resulted in three carriers,Telmex, Pegaso, and that they would like to buy,even though legallyTelmex Unefon, obtaining mobile telephone licenses in all re- is required to do so.30 They also claim that the retail gions and accounting for nearly all customers.A fourth price that Telmex charges its customers for long-dis- set of PCS licenses, which were auctioned in seven re- tance calls is about three cents below Telmex's charges gions, went to Iusacell (2), Midicell (4), and Grupo to competing carriers and their customers, for com- Hermes (1).While Midicell defaulted on its payments pleting a call that must use the Telmex long-distance and so lost its licenses, Iusacell increased its coverage to network to reach the termination point.31 six regions and 80 percent of the population with its two PCS regional licenses. Overall, the mobile phone Domestic Long Distance market is dominated by Telmex (which accounts for Facilities-based competitive entry in domestic long more than two-thirds of the total subscriber base), and distance has been allowed in stages. Currently, service Iusacell (which controls one sixth of the mobile phone in 200 cities is open to competition.Nearly 30 percent market). of pre-subscribed customers in the twelve largest cities Wireless fixed access is only just beginning to be of- are now served by competitors. However, in the re- fered. Hence its potential for creating strong access maining cities in which competition was introduced, competition remains uncertain. Licenses for fixed Telmex retains about 97 percent of the lines so that wireless have been granted to Axtel, Midicell,Telmex, only roughly 30 percent of domestic long-distance and Unefon, with Midicell defaulting. traffic is carried by competitors. All new long-distance carriers are part facilities- Internet based and part resellers since no entrant has a complete While competition has gained a foothold in Mexican national facilities-based network. In order to offer full Internet services, the ISP business is atypically concen- national coverage, an entrant needs to buy dedicated trated. Telmex's affiliated ISP controls about half the long-distance circuits to each of Telmex's local ex- market; Terra (an affiliate of Telefónica de España) has change areas from the nearest point on its own net- about one-fourth;and the rest is divided among several work.The low call density in less populous areas of the smaller companies.Competitors claim thatTelmex dis- country makes resale the most attractive way for en- criminates in favor of its ISP affiliate in two ways: (1) trants to reach these areas, assuming reasonable inter- bundling computer leasing and Internet service by re- connection rules and wholesale prices. quiring customers who use its computer equipment service to use Prodigy as their ISP; and (2) denying Wireless Services switched trunks and other capabilities for Internet Wireless services are reasonably competitive in Mex- usage to competing ISPs. ico.The spectrum for cellular, PCS, and fixed wireless Telmex believes that unbundling is not necessary was divided into nine regions, each containing two or because anyone could enter the business of providing three major cities. For cellular service, two licenses in computers and a modem through a lease or installment each region were sold separately in 1990. For PCS and payment. Competitors and other critics contend that fixed wireless, licenses to operate in each of the nine Telmex is subsidizing Internet access in order to gain a regions were sold separately in simultaneous auctions. dominant position in Internet services.32 Also, for sev- The PCS licenses can be used for either fixed or mo- eral years, competing ISPs have charged (and Telmex 19 Telecommunications has denied) that they can not acquire trunk connec- Tariff Regulation tions in sufficient volume and speed because Telmex The revised concession agreement specified that a gen- does not offer access lines having these capabilities to eral tariff regulation would apply to a basic basket of customers of competing ISPs, nor does Telmex allow core services:installation fees,monthly service charges, ISPs to acquire and resell such lines. usage charges for local calling, and prices for domestic and international long-distance calls, with the first two Institutional and Regulatory Framework tariffs differentiated between residential and commer- cial customers. The concession agreement stipulated The present regulatory system for telecommunications that the method of tariff regulation would be a price was only put in place in 1996. Until 1995, formal reg- cap for the bundle of these services, with the stipula- ulation was limited to the enforcement by SCT of the tion that no service would be cross-subsidized. revision of the Telmex concession that permitted pri- As a practical matter,Telmex has set prices so that vatization. The concession granted the newly priva- the price cap ceiling has not been reached. In its cur- tized Telmex a temporary monopoly in domestic and rent form,the cap increases each year by the rate of in- international long-distance telephone service, but in flation minus 4.5 percent. Telmex has experienced return required Telmex to expand and improve its productivity gains, however, in excess of the 4.5 per- wire-line network. In theory, competitors could have cent target, because of rapid technological progress, in- entered local service, but in practice no concessions creased usage that captures scale economies in parts of were granted. Two companies, Iusacell and Pulsar, the network, and improved operating efficiency. This sought but were denied concessions for fixed wireless has allowed it to earn increasing profits while not rais- local service. ing prices as fast as is allowed under the price-cap for- The 1995 Telecommunications Law and the 1996 mula. Regulation of prices as well as oversight of Presidential Decree that implemented it established an compliance with the price-cap rule is the responsibil- institutional and regulatory framework for the indus- ity of Cofetel. However, the new regime has several try. The act lodged authority for regulating telecom- features that prevent effective regulation. munications in the SCT. The presidential decree created Cofetel and delegated most day-to-day regula- Interconnection tory functions to this agency. The law included the Interconnection arrangements, including pricing, can provision that facilities-based telecommunications be regulated by Cofetel if operators request interven- firms had to file tariffs and that Telmex could be sub- tion after failing to negotiate an agreement. The jected to regulation of specific prices upon a finding by premise is that interconnection issues should be re- the antitrust authority, the Comisión Federal de Compe- solved by the carriers.This approach to interconnec- tencia (CFC), that Telmex was a dominant carrier in tion creates two problems. First, because some that market. interconnection issues inherently bring carriers into Table 2.1 Indicators of Network Expansion and Modernization inTelecommunications Indicator 1988 1990 1992 1994 1996 1998 1999 Main fixed lines (in thousands) 4,387 5,355 6,754 8,493 8,826 9,927 10,757 Main fixed lines per 100 inhabitants 5.50 6.40 7.80 9.5 9.50 10.30 11.00 Residential fixed lines per 100 households 20.3 23.7 28.2 33.2 33.9 34.5 N/A % digital network 18 29 52 83 90 98 N/A Pay phones (in thousands) 53 83 125 217 240 315 N/A Pay phones per 1,000 inhabitants 0.7 1 1.4 2.4 2.6 3.3 N/A Waiting list (thousands of fixed lines) 863 1,044 663 197 na 6 N/A Mobile phones lines per 100 inhabitants N/A 0.08 0.35 0.62 1.07 3.5 7.11 Internet hosts* N/A N/A 1,239 6,656 29,840 N/A N/A * The number of computers that are directly connected to the worldwide Internet network. Source: ITU,Yearbook of Statistics Telecommunications Services Chronological Time Series 1998-1997. Cofetel web site for 1998-99 information. 20 Telecommunications conflict, bilateral negotiation cannot be expected to ited opportunities for competition. But careful reviews work very well, and the presumption in favor of nego- of entrants serve no valid public purpose when a mar- tiation simply causes delays.Second,in other cases,car- ket is competitive and where customers decide riers may be in a position to use interconnection whether to patronize a new entrant.Thus a concession agreements to fix prices. For example, interconnection process is unnecessary for these cases, and forces the prices between competing local access carriers (includ- agency to use its resources in unproductive ways. ing mobile telephone operators), place a floor on local calling prices, thereby limiting the degree to which Sector Performance competition can drive prices to cost. Starting in the late 1980s and especially during the Concessions 1990s, the performance of the Mexican telecommuni- The Federal Telecommunications Law also retains a cations sector in terms of penetration and prices im- system of concessions as a means of licensing entry for proved dramatically. all facilities-based carriers.This entails a far more elab- orate specification of the facilities and services that the Penetration carrier will offer than would be the case if entrants re- Penetration, measured by the per capita number of quired licenses or permits. It also does not differentiate lines in service, indicates the extent to which the citi- between competitive and monopolized services since zens of a country have access to the telephone system. all carriers must have a concession.To grant one,Cofe- Changes in penetration are used to track progress to- tel is required to review an entrant's detailed business ward the goal of universal service, which is achieved plan and its technical and financial competence to pro- when everyone is connected to the public switched vide the service described in the plan. If a firm decides network.However,in a developing country,the annual to alter the configuration or capacity of any compo- cost of providing service can be so large a fraction of nent of the network while building it, the firm must household income that it is neither affordable nor an seek an amendment to its concession. attractive best use of subsidies for assisting the poorest The premise behind concession review is that pub- members of society. In this context, universal service lic oversight is needed to ensure that a carrier offers ad- targets that ensure other measures of access, to pay equate service at reasonable prices. Such reviews can phones for instance, are probably more relevant. have substantial value in a monopolized market or Wire-line Penetration. During the 1990s, wire-line tele- when a licensee uses a public resource that offers lim- phone penetration in Mexico essentially doubled and Table 2.2 Teledensity 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000P/ Jun-2000 Fixed Telephony 6.4 7.0 7.8 8.6 9.4 9.6 9.5 9.8 10.3 11.2 12.5 13.1 Mobile Telephony 0.1 0.2 0.4 0.4 0.6 0.8 1.1 1.8 3.5 8.0 14.3 17.4 P/ Preliminary numbers as of the date that is indicated. Source: COFETEL, with information given by the concessionaries. Table 2.3 Indicators ofTelecommunicationsTraffic, Sector Revenues, and Labor Productivity Indicator 1988 1990 1992 1994 1996 1998 Domestic long distance (million of minutes) N/A 951 1,221 1,630 2,002 2,881 International long distance (million of minutes) 126 212 351 451 593 737 Sector revenues ($ million) 1,499 3,801 6,175 8,655 6,937 8,873 Revenue/population 19 46 72 97 75 90 Revenue/line 342 710 914 1019 786 894 Lines per staff 88 109 144 185 201 155 Source: ITU,Yearbook of Statistics Telecommunications Services Chronological Time Series 1998-1997. 21 Telecommunications digitalization of the fixed network grew from 29 to 98 telecommunications services,including text and video. percent (seeTables 2.1,2.2,2.3,and 2.4 ).33 During the In Mexico, paging (a text service) and cellular tele- second half of the 1990s, the number of business lines phony were introduced first, then PCS and fixed wire- roughly doubled, while the number of residential lines less service.As of mid-2000, almost all-wireless service grew by about 10 percent. In 1999,Telmex launched was mobile telephony, which has enjoyed spectacular two initiatives that conceivably could turn around the growth since 1995.The ratio of fixed to mobile lines stagnation in residential wire-line access. One is fell from more than 10 to 1 in 1995 to about 3 to 2 in "shared service," or multiparty lines, at a lower price 1999, and the number of wireless customers will soon than single lines. By mid-2000,Telmex had 1.2 million exceed the number of wire-line connections.34 telephones using shared service. The other initiative As in many countries,mobile wireless telephony has was prepaid wire-line service, enabling customers to been the main vehicle for introducing limited access commit to a firm budget for telephone service competition for both business and residential service in (seeTable 2.4a). Mexico. The possibility of competition encourages The number of pay telephones has tripled during wire-line carriers to make service more attractive in the 1990s, making Mexico one of the Latin American order to retain customers. A recent study reports that countries with the highest pay-phone penetration at entry by competing wireless carriers causes the incum- 3.28 per 1,000 inhabitants. However, the number of bent to expand wire-line service significantly more pay phones is still small, and the annual growth in pay rapidly than if the incumbent wire-line company is lines is a small proportion of total line growth. Pay- given a wireless monopoly.35 Telmex's introduction of phone penetration is also well below the OECD aver- prepaid wire-line service in 1999 reflects the competi- age of 4.9 per 1,000 inhabitants. tive influence of wireless on wire-line service, which Wireless Access. Wire-line penetration is not a com- also arises because wireless service offerings can be pletely accurate measure of telephone penetration, for comparable in cost to wire-line service. In some re- wireless telecommunications also offers local tele- mote areas, wireless service is less costly than wire-line phone service. Mexico relies primarily on two tech- service, which has led Telmex to encourage the entry nologies: cellular telephones and personal of wireless resellers in rural areas. communications service (PCS),which is similar to cel- The growth in wire-line service between 1990 and lular but can accommodate a broader range of 1995 (see Figure 2.1), followed by the growth of wire- Figure 2.1 Mexico: Increase of PublicTelephony Network byType, 1990-1999 12,000 10,000 8,000 vice ser 6,000 in lines 4,000 of 2,000 thousands In Year 1990 1991 1992 1993 1994 1995 1996 1997 1998* 1999* * Preliminary Fixed lines Mobile lines Source: Cofetel. 22 Telecommunications Table 2.4 General Indicators ofTelephony Concept 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000P/ Sept-2001P/ Fixed telephone lines (thousands) 5,352.8 6,024.7 6,753.7 7,620.9 8,492.5 8,801.0 8,826.1 9,253.7 9,926.9 10,927.4 12.331.7 13,368.4 Annual growth rates 12.6 12.1 12.8 11.4 3.6 0.3 4.8 7.3 10.1 12.9 11.59 Telmex-Telnor 5,352.8 6,024.7 6,753.7 7,620.9 8,492.5 8,801.0 8,826.1 9,253.7 9,926.9 10,878.2 12,069.0 13,012.0 Annual growth rates 12.6 12.1 12.8 11.4 3.6 0.3 4.8 7.3 9.6 10.9 10.5 New concessionaires of fixed local telephony 49 263 356 Annual growth rates 433.6 71.2 Wired public telephones (miles) 93.7 107.0 131.7 183.2 217.2 246.5 238.6 259.6 316.6 N/A Annual growth rates 14.2 23.1 39.0 18.6 13.5 -3.2 8.8 22.0 Telmex-Telnor 93.7 107.0 131.7 183.2 217.2 246.5 238.6 257.6 311.1 N/A Annual growth rates 14.2 23.1 39.0 18.6 13.5 -3.2 8.0 20.7 New license holder 1.9 5.5 8.8 21.6 Annual growth rates 186.1 59.8 144.5 Percentage of digitalization in the telephone plant 29.00 39.00 52.00 65.00 82.70 87.60 89.80 90.10 97.70 99.61 99.98 Optic fiber net (kilometers) 360 N/A 5,520 15,787 37,494 42,765 56,150 65,130 75,304 85,705 98,112 Annual growth rates 186.0 137.5 14.1 31.3 16.0 15.6 13.8 14.5 Telmex-Telnor 360 N/A 5,520 15,787 37,494 42,765 46,832 51,573 54,572 62,093 68,165 Annual growth rates 186.0 137.5 14.1 9.5 10.1 5.8 13.8 9.8 New concessionaires of local and long distance telephony 9,318 13,557 20,732 23,612 29,947 Annual growth rates 45.5 52.9 13.9 26.8 Microwave federal net, developed length (thou- sands of kms.-circuit) 60.0 69.7 83.1 83.7 83.8 87.4 96.0 113.0 133.0 155.0 Annual growth rates 16.2 19.2 0.7 0.1 4.4 9.8 17.7 17.7 16.5 Population with telephone service 7,270 10,500 13,985 16,815 21,589 22,104 23,145 31,695 38,368 43,648 51,077 Annual growth rates 44.4 33.2 20.2 28.4 2.4 4.7 36.9 21.1 13.8 17.0 Personnel working, in telephony (people)*/ 49,912 49,488 48,937 48,771 48,810 49,016 48,817 54,608 55,622 58,112 60,237 Annual growth rates -0.8 -1.1 -0.3 0.1 0.4 -0.4 11.9 1.9 4.5 3.7 Quality and continuity indicators of theTelmex service Faults for each hundred lines (faults per hundred lines) 13.5 9.4 9.1 7.5 6.0 4.6 3.7 3.3 2.8 2.2 1.9 1.7 Percentage of repairs the same day 50.1 52.9 66.8 74.1 78.7 78.8 83.9 84.4 77.8 72.9 74.3 75.5 Establishment of local calls, percentage of successful events 93.1 93.5 95.7 97.2 99.2 99.7 99.2 97.4 97.5 97.9 98.6 97.7 Waiting average time for the installation of a line (months) 23.9 N/A .N/A N/A. 2.4 2.4 1.2 1.0 1.0 1.2 1.1 Note:The information referring to populations with telephone service was provided by the Secretary of Communications and Transports. */ Includes the personnel occupied in the services of fixed local telephony, public telephony and long distance telephony. P/ Preliminary numbers as of the date that is indicated. Source: COFETEL, with information provided by the concessionaires. 23 Telecommunications Table 2.4a TelephoneTariffs: Comparison with other LAC and OECD Countries (US$) 2000 (US$) Brazil Chile Argentina Mexico New Zealand Australia UK Ireland Finland Connection charges - Residential 27.3 43.4 150 119.5 28.1 100.6 150.0 141.4 157.4 - Business 27.3 43.4 150 370.0 28.1 100.6 176.3 116.9 157.4 Subscription fees (monthly) - Residential 7.7 10.8 13.22 15.5 16.5 8.1 15.1 17.7 9.6 - Business 12.0 10.8 33.89 20.9 29.9 14.5 23.4 17.7 9.6 Residential Subscription as % of GDP per capita 0.10 0.11 0.11 0.17 0.08 0.03 0.06 0.08 0.04 Fixed phone call ($ per 3 min) - Peak 0.04 0.12 0.09 0.15 0.13 0.18 0.17 0.12 - Off-peak 0.02 0.05 0.08 0.12 Cellular connection rate 16.4 25.6 47.3 7.4 Cellular monthly subscription 10.9 23.6 31 25.4 6.8 6.4 25.8 33.8 6.5 Cellular phone call ($ per 3 min) - Peak 0.25 0.88 1.23 0.82 2.45 2.30 0.45 1.68 0.51 - Off-peak 0.17 0.59 1.23 0.82 0.27 1.15 0.23 0.66 0.38 Data Source: International Telecommunication Union - 2000 (ITU) and World Bank Report for GCP per capita. Table 2.4b Tariffs: FixedTelephones, Latin American Countries 1991 1993 1995 1998 2000 Argentina Connection charges - Residential 947 750 500 200 Monthly subscription - Residential 6 8 8 13 Cost of call ($ per 3 min.) 0.08 0.08 0.08 0.10 Lines per 100 inhabitants 9.50 11.76 16.17 20.27 21.32 Brazil Connection charges - Residential 1215 69 27 Monthly subscription - Residential 3 9 8 Cost of call ($ per 3 min.) 0.04 0.09 0.04 Lines per 100 inhabitants 6.85 7.46 8.51 12.05 18.18 Chile Connection charges - Residential 258 183 161 43 Monthly subscription - Residential 15 20 13 11 Cost of call ($ per 3 min.) 0.09 0.14 0.11 0.12 Lines per 100 inhabitants 11.04 12.74 20.42 22.13 Columbia Connection charges - Residential 317 357 214 Monthly subscription - Residential 3 3 Cost of call ($ per 3 min.) 0.01 0.01 0.01 0.03 Lines per 100 inhabitants 7.38 8.46 10.05 15.59 16.92 Mexico Connection charges - Residential 385 529 279 107 119 Monthly subscription - Residential 8 11 7 14 16 Cost of call ($ per 3 min.) 0.11 0.14 0.07 0.13 0.15 Lines per 100 inhabitants 6.86 8.36 9.39 10.36 12.47 Peru Connection charges - Residential 332 585 504 151 131 Monthly subscription - Residential 2 3 9 15 14 Cost of call ($ per 3 min.) 0.10 0.10 0.08 0.07 Lines per 100 inhabitants 2.45 2.97 4.71 6.27 6.69 Uruguay Connection charges - Residential 359 292 384 214 85 Monthly subscription - Residential 6 8 9 9 8 Cost of call ($ per 3 min.) 0.04 0.05 0.06 0.18 0.17 Lines per 100 inhabitants 14.50 16.84 19.50 25.04 27.84 Venezuela Connection charges - Residential 45 42 27 99 102 Monthly subscription - Residential 1 3 3 8 11 Cost of call ($ per 3 min.) 0.03 0.03 0.06 0.07 0.10 Lines per 100 inhabitants 8.08 9.96 11.38 11.15 10.78 Source: ITU, 2002. 24 Telecommunications less service has meant that the waiting list for fixed ac- their quantity of calls exceeds 100 per month. (Telmex cess service,the best measure of excess demand,has es- reports that approximately half of residential customers sentially disappeared.The problem remains that many make fewer than 100 calls per month.) These charges households do not want service at current prices, in are much higher than during the period of state own- some cases because their incomes are insufficient to ership. make telephone service affordable. In the eleven Mex- Internet Access. The price for access to an ISP is simply ican states where per capita GDP fell below $3,500 in the $.14 local calling charge (paid in addition to the 1999, penetration averaged 5.3 lines per 100 house- monthly fee that the ISP charges for its services).Alter- holds. In the four states where per capita GDP ex- natively, a customer can buy Telmex's bundled service ceeded $7,000, telephone penetration was roughly of a computer, a modem, and its affiliated ISP for a twice as high at 10.5 lines per 100 households. hook-up fee of about $100,a monthly charge of about Internet. Use of the Internet in Mexico has been low, $40,and the same usage charge of $.14 per connection. with only 2.6 percent of the population connected in MobileTelephony. Calling charges from a wire-line tele- 1999.That year,Telmex introduced a new program to phone are $.14 plus about $.26 per minute, expand Internet usage. In this program, customers re- but from mobile to wire-line are about $.23 per ceive a low-end personal computer and access to the minute.The difference in these charges arises from dif- Internet as a bundled service.Telmex reports that dur- ferences in access and interconnection charges, as ex- ing the first half of 2000, about 1,200 new customers a plained below. day acquired this service.Another element of the pro- Domestic long-distance and international calling gram is to increase Internet usage at schools by using rates have fallen dramatically but still are relatively high funds from an affiliated foundation to pay part of the at $.14 plus an additional $.20 per minute for domes- initial cost and monthly fee for a computer and Inter- tic long-distance. Outgoing international calling net access for schools and teachers (at home) if the charges are $.14 plus an average of $.50 per minute.In- government agrees to pay the rest. coming international calls typically are priced at the official settlement rate. The OECD estimates that Prices among its member countries, Mexico has the second- Telephone prices are much higher in purchasing highest international calling prices for businesses power parity than at the official exchange rate.36 Thus and the third highest for residential customers, even the ability of Mexican households to afford service, as though Mexico is one of the organization's lowest-in- measured by per capita income, appears to be far come members. greater than it really is since purchasing power parity Access and Interconnection Charges. Calling prices are rates imply a much higher poverty rate and much strongly influenced by access charges that must be paid lower per capita income among Mexican citizens. As a to Telmex for the local component of a call. These result,as of 2000,Mexico has only 13 fixed phone lines charges are supposed to differentiate between recover- per 100 people, much less than poorer countries such ing the cost of physically interconnecting separate net- as Brazil, Colombia, Costa Rica, and Panama. works (interconnection) and the contribution of The Basic Installation Fee.The fee for residential users has various competitive services to recovering the cost of fallen dramatically to around $100 from nearly $300 the local network (access). The tariff (at $.03 per during the period of state-owned enterprise. Business minute in 2000) is still substantially above estimates of installation charges are far higher, in the range of $350 the actual cost of interconnection,including the cost of per line, but these, too, are declining (seeTable 2.5).37 terminating or originating a call, which are at most Recurring Service Prices. At the beginning of the year $.01 per minute. 2000, the basic monthly tariff was about $15 for resi- The interconnection charge applies to each end of dences and $20 for businesses, and the local calling domestic long-distance calls and to one end of inter- charge was about 14 cents for each call.38 Businesses national calls. It also applies to calls between two com- pay this rate for all calls, but residences pay only when peting local carriers, except for fixed access carriers if 25 Telecommunications they offer service in at least 40 percent of the local Mexico also has relatively low domestic utilization of market, and the traffic between the two carriers is not the telephone system as measured by long-distance "unbalanced."39 Since the competing local carrier calling. Per capita long-distance calls per year in Mex- must pay more to Telmex for interconnection if a call ico are sixth among the eight of these countries for exceeds five minutes--in addition toTelmex's $.14 per which data are available, exceeding only Peru and call charge for local calling--competitors have a strong Venezuela. In addition, Mexico ranks third in incom- incentive not to compete for customers who are likely ing international calls per capita, and fourth in per to have long connect times with Telmex customers, capita total international calling. The large expatriate such as those who use the Internet. Mexican community in the United States and the sev- For calls from wire-line to mobile telephones,$.063 eral large border cities that are shared by the two coun- per minute must be paid to Telmex for billing and in- tries create a huge potential demand for long-distance terconnection, producing a price of $.4040 for the first calling, so it is somewhat surprising to see that Mexico minute and $.26 per minute thereafter.41 Because this does not clearly dominate Latin America in interna- interconnection charge is so high, it strongly discour- tional usage.It is likely that international calling is sub- ages the use of mobile telephones. stantially suppressed by high prices. Tariffs Performance Comparisons with other The installation charge in Mexico is below average,but Latin American Countries the fixed monthly tariff and the usage price are high in comparison to those in other countries. For instance, Mexico was among the earliest Latin American coun- international long-distance tariffs in Mexico are esti- tries to undertake substantial reform in telecommuni- mated to be the highest among large Latin American cations, but during the 1990s, most other countries countries, except for Uruguay and Venezuela.42 These initiated similar reform programs. Table 2.4 and 2.4a high prices cause Mexico to have the fourth-highest provide data for 10 Latin American countries in 1998 revenues per line (seeTable 2.7). and 2000, the most recent year when such information Mexican interconnection prices are also relatively was available for all of them.In general,these data show high.Apart from Peru,which has an on-peak intercon- that the Mexican telephone system has not performed nection charge of $.029, but an off-peak charge of well in comparison with other Latin American coun- $.015, other large Latin American countries clearly tries. Indeed, in 1998, Colombia, Costa Rica, and have lower prices than Mexico. The estimated local Uruguay had not yet privatized their wire-line tele- loop usage cost in Mexico is about $.01 per minute. phone company, yet all had better performance indica- Because call set-up is more costly than maintaining an tors than Mexico,and prices in 2000,in Mexico,remain open circuit and because part of the usage cost is re- among the highest for the Region (seeTable 2.4b). lated to metering and billing based on call duration, this amount, if accurate, overstates true usage costs past Physical Performance the first minute. The positive indicators for Mexico are that it is at or Such high usage-based prices greatly favor firms near the top in the brevity of waiting time for service that are vertically integrated at both ends of a long-dis- and avoidance of faults (service outage) per 100 lines. tance call since a long-distance carrier that is not verti- However, of the other countries in Figure 2.2, only cally integrated must pay its vertically integrated Peru has lower telephone penetration, and Peru's GDP competitor $.06 per minute ($.03 at each end) if it per capita lags behind Mexico by more than $1,000. does not provide its customer with local access.As a re- Moreover, in the richest states in Mexico where per sult,the pricing structure puts a high floor,substantially capita income is comparable to the Latin American above costs, on the price of long-distance calls, which countries with the highest per capita GDP, telephone discourages usage.Also, the pairing of a per-minute in- penetration is far lower than in these countries (see also terconnection charge and a fixed local calling charge Table 2.9 and Figures 2.3, 2.4, and 2.5). distorts local access competition.43 26 Telecommunications Financial Performance cent standard for well-managed telephone companies. As a result of Mexico's high prices, revenues per line The proportion of operating income accounted for by have increased substantially since the period when capital investment at 40 percent is also lower for Telmex was a state-owned enterprise. High prices and Telmex than for the other carriers.44 Considering that revenues have made Telmex a highly profitable com- the U.S. and British companies operate in industrial- pany, despite relatively low physical productivity by ized countries where telephone penetration is very Latin American standards, with the ratio of main lines high,Telmex's investment rate appears quite low.These per telecommunications staff (179 in 1998) signifi- data indicate that,if anything,the gap in telecommuni- cantly lower than in Argentina (336), Brazil (236), cations services between Mexico and these countries Chile (292), and Peru (241), for instance. is widening. Table 2.8 shows the financial statements of Telmex Cumulatively, the data on prices, revenues, and costs and several other large carriers.Telmex is far ahead of indicate that Telmex is a relatively efficiently managed these companies in terms of operating income as a company. High revenues per line, combined with effi- share of revenues. Its operating costs are around 60-65 cient management, have made Telmex extremely prof- percent of revenues, much lower than the 75-80 per- itable, but this has not led to high rates of expansion in Table 2.5 TelecommunicationsTariffs in Mexico, 1988-1998 Tariff ($) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Connection charge Business line 509 471 731 661 840 917 921 480 409 442 383 Residential line 283 261 494 385 485 529 531 277 236 123 107 Monthly subscription fee Business line 4 7 12 19 21 24 24 14 13 19 19.3 Residential line 3 2 5 8 9 11 12 7 9 14 14 Local call 0.10 0.09 0.11 0.11 0.13 0.14 0.14 0.07 0.10 0.14 0.13 Source: ITU,Yearbook of Statistics Telecommunications Services Chronological Time Series 1988-1997, and ITU Americas Telecommunications Indicators 2000. Figure 2.2 Teledensity and Per Capita GDP in Selected Latin American Countries, 1999 40 Uruguay Chile 35 Brazil 30 Argentina inhabitants Panama Venezuela 100 25 Columbia Costa Rica per 20 lines Mexico 15 El Salvador mobile Dominican Republic and Peru ed Fix 5 0 Year 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 Per capita GDP (1998 $) Source:Telecom regulatory agencies and ITU (2000). 27 Telecommunications service in comparison with its neighbors.ThusTelmex Regulatory Assessment seems to be less constrained in exercising its market power than are the dominant carriers elsewhere in Successful privatization of a formerly state-owned Latin America. monopoly infrastructure provider almost always re- quires the creation of a new regulatory institution and regulation to encourage efficient investment. Effi- Table 2.6 Network Investment and Usage Indicators in Selected Latin American Countries, 1998 Indicator Argentina Brazil Chile Colombia Costa Rica Mexico Panama Peru Uruguay Venezuela Main fixed lines per 100 inhabitants* 20 15 19 16 20 11 16 7 27 11 Waiting List (as % installed main lines) 0 12 2 25 6 0 2 3 0 14 Residential lines per 100 households 60 29 73 64 63 35 34 28 66 46 Mobile lines per 100 inhabitants 8 5 7 4 3 4 1 3 6 9 % digital network 100 73 100 99 67 98 73 90 100 66 Pay phones per 1000 inhabitants 3 3 1 1 2 3 1 2 3 3 Internet hosts per 1,000 inhabitants* 3.9 2.7 2.7 1.1 2.1 4.2 0.5 0.4 7.7 0.6 Internet users as % of population* 3 2 4 2 4 3 2 2 8 2 Domestic long distance (million minutes)** N/A 25,400 2,413 5,543 N/A 8,232 2832 638 1223 3163 Outgoing international long distance (million minutes) 480 533 259 204 77 1,308 50 96 80 167 Total International long distance traffic (million minutes)** 732 1254 476 527 147 3768 134 343.1 162 436 * 1999. ** 1997. Source: ITU, Americas Telecommunications Indicators 2000. Figure 2.3 International Comparison ofTelephone Density:Telephone Lines per 100 Inhabitants 80.0 70.0 67.7 69.2 65.3 60.1 60.0 58.0 56.7 53.954.7 55.0 54.6 52.4 49.5 50.0 47.4 46.0 44.2 44.1 42.1 40.2 38.8 40.0 32.3 30.0 27.7 22.0 20.5 21.3 20.0 17.0 13.4 12.5 10.8 9.5 10.0 6.7 7.6 6.4 7.2 6.5 6.5 2.7 0.0 y y y eruP Ital pan Brazil Chile Spain Ja Mexico Finland United France Canada United States enezuelaV Urugua Colombia Argentina Australia Kingdom German 1990 2000 Note:The figure for the United Kingdom is from 1989. Source: International Telecommunications Union, for Mexico; for Argentina, Brazil, Chile, Colombia, the United States, Peru, and Uruguay the data was provided by regulatory bodies in each country. 28 Telecommunications ciency requires that firms be able to cover their costs, system continues to subsidize access to service from that prices be capped somewhat near the level that usage charges, and has not adopted clear rules regard- would emerge under competition, and that carriers ing unacceptable conduct with regard to Telmex's op- make sufficient investments to provide all services that erational practices and obligations in competitive are demanded at these prices.The 1990 Telmex con- markets. Hence, the long-standing controversies in cession achieved this objective by including growth long distance, and the new ones in interconnection targets in the number of lines in service, but after these among competing local access carriers and Internet targets expired, growth slowed. Post-1996 regulation services, remain unsettled. has not proven to be effective in causing wire-line pen- Moreover, to induce adequate investment, regula- etration to continue to grow. tory policy should be stable, predictable, and timely so Regulation must be proactive in supporting the de- that regulators avoid becoming an important source of velopment of competition where it is feasible, since a business uncertainty. In practice, telecommunications competitive environment forces firms to operate effi- regulatory policy in Mexico is neither stable, pre- ciently. Mexico has policies that provide protection dictable, nor timely. Finally, the effectiveness of regula- against anti-competitive activity byTelmex in compet- tory institutions in improving the efficiency of itive markets.45 The basic Telecommunications Law telecommunications,or any other infrastructure indus- adopts competition as the preferred market structure try, depends on the structure and process of regulation. and establishes policies against pricing services below Key aspects are discussed below. cost, implying that Telmex has a responsibility not to subsidize its competitive affiliates and not to disadvan- Independence tage competitors by providing technically inferior in- Cofetel is not independent.In most cases,Cofetel's de- terconnection. Nevertheless, the Mexican regulatory cisions must be approved by SCT before they are Figure 2.4 International Comparison of Penetration in Mobile Phones:Telephone Lines per 100 Inhabitants, 2000 80.0 73.7 72.6 70.0 67.0 60.9 60.0 58.6 52.6 49.4 50.0 44.6 40.0 36.5 30.0 28.5 21.8 22.4 20.0 15.3 16.3 13.6 14.3 10.0 4.2 5.3 0.0 y y y eruP pan Ital Brazil Chile States Ja Spain Mexico Urugua Canada United France United Finland Colombia Argentina enezuelaV Australia German Kingdom Note:The figure for the United Kingdom is from 1989. Source: International Telecommunications Union, for Mexico; for Argentina, Brazil, Chile, Colombia, the United States, Peru, and Uruguay the data was provided by regulatory bodies in each country. 29 Telecommunications adopted, which makes these decisions more political vice. For example, the prohibition against cross-subsi- than is necessary or desirable. In addition, Cofetel's dies, which implicitly requires that no price should be commissioners, though appointed to fixed terms, can below long-run incremental cost, is interpreted as ap- be removed by the SCT.The continued involvement of plying to the entire bundle of basic services,rather than SCT in day-to-day decisions vitiates the more natural to each one separately. As a result, interconnection function of SCT,which is policy oversight:to assess in- prices contain a contribution to cover local access dustry developments, to review the adequacy of policy costs,thereby subsidizing access through usage charges. in light of these developments, and to make proposals for changes in the legislation and decrees that underpin Competence the current system. Cofetel is in many ways a well-designed agency.At the top are four commissioners, with requirements to in- Clear Mandate clude relevant technical expertise among them. In In many ways, the 1995 Federal Telecommunications 1999, the agency's budget was $22 million and it had Law provides reasonable policy guidance for the regu- about 530 employees,which appears adequate.Because lator. Price regulation properly focuses on monopoly Mexico has a large number of well-educated civil ser- markets, and adopts the policy that regulated prices are vants,the technical competence of the agency does not to be cost-based and free of cross-subsidy. However, appear to be a problem. because the Act is silent about Cofetel, it fails to define the powers of the agency to gather information and it Transparency and Openness places the agency in a weak position to enforce its reg- Cofetel's procedures are neither transparent nor open. ulations. In addition, the Act is not clear about policy In nearly all cases, and especially with respect to pric- objectives with regard to telephone penetration, price ing,the agency develops regulations by engaging in se- rules, interconnection arrangements, or universal ser- cret bilateral negotiations on a case-by-case basis, as Figure 2.5 International Comparison of Penetration in Internet: Internet Users per 100 Inhabitants, 2000 70.0 59.7 60.0 50.0 49.1 44.7 41.3 40.0 37.1 37.2 35.0 29.2 29.9 30.0 25.8 21.7 20.0 13.3 14.5 10.5 11.1 11.6 10.0 6.8 3.9 1.6 2.1 2.8 2.9 0.0 y y w y e y eruP Ital pan Brazil Chile Spain Ne por Ja Mexico France United States Urugua Zealand Finland Canada United Iceland Colombia enezuelaV Argentina Kingdom German Singa Australia Norwa Source: International Telecommunications Union for Mexico; COFETEL. 30 Telecommunications opposed to open rule-making proceedings in which all competition advocacy agency. However, Cofetel has firms in the industry,users,and disinterested experts are not been able to react in a timely and predictable way allowed to participate. No other parties have the right to carry out the tasks it has been assigned.This has lim- to participate in these bilateral negotiations, including ited the impact of having a competition advocate. the CFC,despite its interest in the competitive effect of Cofetel's proceedings do not have an explicit time interconnection rules that affect relations among com- limit, and negotiations frequently are protracted. For petitors. Cofetel believes that this procedure is man- example, in March 1998, the CFC ruled that Telmex dated by existing law.46 was dominant in five markets: local service, intercon- The information from these negotiations and the nection, retail domestic long distance, wholesale do- basis for Cofetel's decisions typically are not made pub- mestic long distance, and international long distance. lic, because Cofetel believes that the information it re- Yet,Cofetel was unable even to launch a proceeding to ceives from the carriers should be treated as develop regulations in response to these findings until confidential. Moreover, Cofetel lacks the authority to March 27, 2000. compel information from regulated firms. Since pub- By far the most important of the CFC's findings was lished regulations are neither explained, nor supported with respect to interconnection and access to local net- by evidence, the agency's underlying policies and pro- works.Telmex owns virtually all fixed access connec- cedures remain unclear. tions, about two-thirds of mobile access connections, and all long-distance facilities outside of the largest Competition Advocacy cities. Hence, for competition to develop fully in local Granting to the CFC the role of deciding whether a access, domestic long distance, and international call- carrier is dominant gives an important function to the ing, reasonable interconnection arrangements between Table 2.7 Tariffs, Revenues, and Productivity of theTelecommunications Sector in Selected Latin American Countries, 1998 Indicator ($) Argentina Brazil Chile Colombia Costa Rica Mexico Panama Peru Uruguay Venezuela Residential connection charge 150 43 159 214 64 107 10 151 214 99 Business connection charge 150 43 159 305 64 383 20 151 331 321 Residential monthly subscription fee 13 7 16 3 4 14 10 15 9 8 Business monthly subscription fee 36 12 16 5 6 19 20 16 20 22 Local call 0.1 0.09 0.12 0.02 0.03 0.14 - 0.08 0.18 0.07 Telecom revenue per capita 183 122 160 100 71 94 93 58 211 97 Telecom revenue per line 927 1009 860 692 411 907 7 64 930 844 829 Lines per employee (#) 336 236 292 180 147 179 109 241 142 206 Source: ITU, Americas Telecommunication Indicators 2000. Table 2.8 Financial Performance of SelectedTelecommunications Companies Total Revenue Operating Income Capital Expenditure $ million $ millions % of revenue $ million as % of revenue Bell Atlantic 31,566 6,627 21 8,675 27 GTE 25,473 5,336 21 4,940 18 British Telecom 25,138 5,151 20 4,775 18 Ameritech 17,154 4,193 24 2,954 17 Telmex 8,187 3,111 38 1,235 15 Telefónica de Argentina 3,436 918 27 686 20 Telecom Argentina 3,174 817 23 770 27 Brasil Telecom Participacoes* 1,446 335 23 679 47 Compania de Telecomunicaciones de Chile 1,393 405 29 570 41 Telefónica del Peru 1,129 374 33 299 27 * Formerly known as Tele Centro Sul Participacoes S.A. Source: ITU 2000. 31 Telecommunications Table 2.9 Latin America: Comparative Penetration of MobileTelephony, Users per 100 Inhabitants Country 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Argentina 0.01 0.01 0.08 0.16 0.41 0.70 1.17 1.89 5.63 7.39 10.56 16.34 Brazil 0.00 0.00 0.02 0.12 0.37 0.83 1.58 2.68 4.45 8.95 13.64 Colombia 0.18 0.64 1.30 3.15 4.42 4.73 5.33 Chile 0.04 0.11 0.27 0.47 0.61 0.82 1.38 2.20 2.78 6.46 14.96 22.36 Peru 0.01 0.03 0.10 0.16 0.22 0.31 0.70 1.77 2.97 3.92 4.19 Uruguay 0.05 0.13 0.22 1.27 2.53 3.13 4.80 9.52 15.26 Venezuela 0.01 0.02 0.04 0.08 0.38 0.86 1.27 1.78 2.24 4.68 8.63 15.82 21.75 Mexico 0.01 0.08 0.19 0.37 0.45 0.62 0.75 1.10 1.84 3.48 7.96 14.28 Note:The numbers in bold show the year in which the "calling party pays" method of payment was introduced. Source: COFETEL, with information from the Unión Internacional de Telecomunicaciones, and the regulating organizations of each country. Telmex and its competitors are essential.The method cations were pending resolution, including one for resolving interconnection disputes that is given obtained by Telmex against the CFC's finding that preference in the statute--bilateral negotiation be- Telmex was a dominant carrier. The result of all of tween carriers--failed years ago.Yet, Cofetel has not these successful amparos is confusion and disruption been able to implement any regulations regarding in- with respect to exactly what is required of each carrier terconnection and access. in terms of its legal obligations regarding prices and service.47 Formal Oversight Oversight in the form of periodic review of regulatory Recommendations for Reform statutes does not currently exist in Mexico.In addition, timely and reasonable judicial review is absent. The preceding review of the regulatory system sug- Part of Cofetel's problem in implementing effective gests several changes that would likely improve the regulation arises from its inability to convince the performance of the telecommunications sector: courts that its regulations are reasonable and necessary. · Grant Cofetel true independence. The Telecommuni- An important aspect of judicial review in Mexico is the cations Act should be amended to make Cofetel a amparo, a form of temporary injunction that can be statutory agency with authority to regulate. granted by the courts if a private party believes that a Whereas SCT can be granted the right to partici- decision by the government will cause it financial pate in Cofetel's decisions, its role should be no harm.The amparo stays implementation of a decision-- different than that of other participants. It should in this case, a regulation promulgated by Cofetel-- not have the right to communicate secretly with pending an evidentiary hearing by the court. Since the Cofetel or to overturn Cofetel's decisions. Cofe- court system often proceeds slowly, an amparo can re- tel's decisions should be reversible only by the main in place for two or three years,by which time the courts through judicial review or through new regulation is obsolete because of subsequent develop- legislation. True independence also requires that ments in the industry. Cofetel be able to compel information from the Because the results of Cofetel's regulatory negotia- carriers it regulates, and that its Commissioners be tions are secret,proposed regulations are not supported appointed to a secure fixed term of several years. by evidence and arguments, which makes the agency SCT should be assigned the responsibility for peri- vulnerable to amparos as long as the court requires odic assessments of the performance of the sector, some justification for the agency's decisions. Since but should not have direct responsibility for mak- 1997, almost all the regulations promulgated by Cofe- ing decisions about prices, interconnection tel have been challenged successfully by either Telmex arrangements, or entry. or its competitors in that the implementation of the · Require open decisionmaking processes for regulatory pro- regulation has been stayed by an amparo. In mid-2000, ceedings. The Act should authorize Cofetel to con- approximately 300 amparos concerning telecommuni- duct open rule-making proceedings as well as 32 Telecommunications case-by-case decisions. Proceedings should be open · Eliminate the existing system for regulating international to participation by anyone affected by them, and all service. The system of proportional return should participants should have access to the evidence that be abolished, allowing all carriers to negotiate is submitted. Cofetel should also be required to ex- agreements with foreign carriers about call termi- plain the legal and informational basis for its deci- nation and charges.The settlement rate should be a sions. ceiling for international prices, with both the · Focus judicial review on whether decisions have a reason- domestic and foreign components of the call having able basis. Clear standards for judicial review are use- a ceiling price equal to half the settlement rate. ful in shaping how the agency explains and justifies International resale over private lines should be its decisions.The appropriate standard is that Cofe- permitted,either with no formal reporting require- tel's decision should have a reasonable basis in law ment to Cofetel or at most, a notification leading and fact. automatically to a permit if the reseller agrees to re- · Grant standing to CFC on matters related to the compet- porting requirements. itive effects of decisions. The CFC should have the re- sponsibility of assisting Cofetel in understanding the competitive implications of its regulations. Be- cause the Act envisions a competitive industry, among the issues to be resolved in judicial review is whether Cofetel reasonably took into account the effects of its regulations on competition and dealt adequately with the views of the CFC. · Make concession requirements simpler for competitive en- trants. In a competitive environment, agencies need not be responsible for dictating the specific invest- ments and business plans of a carrier. · Clarify the national policy on universal service. Provide explicit directions to Cofetel about how to implement this policy. Legislation should define universal service in terms of both the services it entails and the bench- marks that should be used to measure whether progress toward these objectives is adequate.48 Once a universal service objective is adopted, it should not interfere with policies to set prices for each service equal to something approximating long-run average incremental cost and to eliminate regulatory impediments to investment and compe- tition. If the government seeks to increase penetra- tion by more than would occur in an environment where prices reflect costs, then the best approach is to directly subsidize low-income households.These subsidies could be financed either by general taxes or a competitively neutral tax that falls equally on all telecommunications services and providers. 33 Telecommunications around ten to one in 1998,but the purchasing power parity rate was Notes approximately 17 to 1. 26 See Scott Wallsten, "Telecommunications Privatization in 37 Telmex has announced plans to cut installation charges to Developing Countries: The Real Effects of Exclusivity Periods," $30 for households and $100 for businesses by 2005. Stanford Institute for Economic Policy Research, May 2000. 38 All calls originating in the public network in Mexico are 27 A "facilities-based" carrier is one that owns transmission subject to the basic $.14 calling fee. links and switches, and a "reseller" is a carrier that leases facilities 39 If both conditions are met, there is no interconnection from a facilities-based carrier at wholesale,bulk-rate prices and then charge-- "bill and keep" then applies to each carrier for all the calls markets the use of these leased facilities to its customers. that originate in its network. If the local competitor does not satisfy 28The"official accounting rate"for an international call is a bi- these conditions,the competitor must payTelmex the long-distance laterally negotiated tariff between two nations. In most cases they interconnection fee of $.03 per minute for calls that it originates, are many times the true costs and prices that would emerge from a but is paid only $.01 per minute for calls that originate in Telmex competitive market.The"settlement rate"is the amount paid by the and terminate in the competitor. carrier that originates and bills for the call to the carrier in the other 40The $.14 call charge plus $.20 per minute to the mobile car- country that terminates the call,and in almost all cases is half the ac- rier, plus the $.063 per minute. counting rate. Each country then determines how the originating 41The difference between the interconnection charge for mo- prices will be determined. In Mexico, originating rates are deter- bile compared with other services is not cost-based, and the part mined competitively,but termination is billed at the settlement rate. that is intended to recover billing costs constitutes double charging, In the U.S., both rates are competitively determined; as a result the since billing costs are already part of the costs of local service that price of calls from Mexico to the U.S.is substantially lower than the underpin the prices for installation, monthly access, and the $0.14 price of a call from the U.S. to Mexico. usage charge per call. 29 In January 2001,Telmex agreed to allow its main competi- 42 Edelman, Margalit and Peter Mountford, A Telecom tors,Avantel and Alestra,to participate in negotiations with interna- Scorecard 1999-2000: Consumer Costs for Basic Services in the tional companies on the settlement rate. Americas, Alexis de Tocqueville Institute, http://www.adti.net 30 Recently the U.S. Federal Communications Commission /html_files/telecom/telecom2000scorecard.html Appendix A. (FCC) investigated these claims. In this proceeding,Telmex admit- 43 Obviously,no competitor would want to originate local calls ted that as of July 26, 1999, it stopped providing additional private that are long in duration and that terminate in another carrier, for lines to Alestra and Avantel because of a dispute in Mexico over in- after five minutes the usage charge paid to the terminating access terconnection prices, including the refusal of these firms to pay all company would exceed the calling charge.Likewise,entrants can be of the fees that Telmex believed it deserved.The FCC concluded expected to be especially aggressive in going after customers that that the facts"appear to establish a continuing pattern of willful and terminate a large number of calls of long duration, such as Internet repeated violations pertaining to the provisioning of private lines service providers, but especially wary of customers who originate and circuits" by Telmex, and fined Telmex $100,000. See Federal calls of long duration, such as Internet users. Communications Commission, Notice of Apparent Liability for 44 The investment figures for Telmex do not include its acqui- Forfeiture, January 13, 2000, paragraphs 1, 10. sitions of telephone companies in other countries. 31 In January 2001, Telmex, Avantel and Alestra signed an 45 Where technology does not create a natural monopoly, in- agreement in which Telmex was to reduce interconnection fees cumbent monopolists in one component of the industry (e.g., in from 3.36 U.S. cents per minute to 1.25 U.S. cents per minute and, local access) frequently can extend their monopoly into other parts among other aspects, the two competitors were to pay Telmex a that clearly can be competitive. one-time sum to cover interconnection and existing debts. 46 Cofetel's press release announcing a procedure to develop 32To schools by grants from its nonprofit affiliate and to all In- regulations in response to the finding of the Competition Commis- ternet customers through interconnection fees on all types of usage sion thatTelmex is a dominant carrier states that federal law requires that subsidize access. that the proceedings be closed. See Federal Telecommunications 33 The ratio of residential lines to number of households grew Commission, "The Procedure to Establish Specific Obligations to rapidly until 1994-95 but then stagnated,partly due to the recession Telmex Due to Its Substantial Market Power Begins," press release, that was created by the peso crisis. A slowdown in the growth of March 27, 2000 (English translation). penetration plausibly could have come about anyway because the 47 For example, Cofetel's 1998 ruling regarding interconnec- Telmex privatization agreement contained an ambitious investment tion charges between local service and long distance carriers were commitment for the first five years after privatization,but not there- stayed by an amparo.The implication of this amparo was interpreted after. (Telmex committed to a 10 percent increase per annum in in- very differently by Telmex and its long-distance competitors. The stalled lines during its first five years as a privatized entity.) former interpreted the amparo as re-establishing the prior charges, 34 10.5 million wire-lines compared to about 7 million wireless which were much higher, while the latter interpreted the decision customers. as causing the charge to be zero until a regulation could be put in 35 See ScottWallsten,"Competition,Privatization,and Regula- place and accepted by the court. tion in Telecommunications Markets in Developing Countries:An 48 For example, does universal service mean that every resi- Econometric Analysis of Reforms in Africa and Latin America," dence has a separate, dedicated telephone connection to the public Stanford Institute for Economic Policy Research, May 1999. network, or does it mean that shared lines and pay telephones are 36 The exchange rate between the peso and the dollar was available in reasonable proximity? 34 3 Natural Gas Mexico is fortunate to possess abundant gas resources, ply not capable of responding adequately to the pro- since natural gas has many technical, economic, and jected rapid growth in demand.The principal sources environmental advantages over other fuels. However, of demand growth were accelerating electricity de- until the mid-1990s,the exploitation of natural gas was mand, and entry in force of environmental regulations. largely limited to supplying the petroleum sector with An industry structure with inefficient production and fuel and feedstock, and pressurizing oil fields to en- lack of competition would not be able to meet these hance yield. Pemex, the state-owned oil company, had growing demands without imposing a huge fiscal bur- a complete monopoly on gas trade, production, and den on the government. transport,and distribution networks were severely lim- Table 3.1 describes the key structural features of the ited. Residential consumption of natural gas was also natural gas sector in Mexico,comparing it to the struc- quite limited.49 ture that exists in other countries. Since then, the situation has started to change.The final stages of new air pollution emission standards, Government Policy and Institutional which will come into force in 2002, have been driving Framework industrial consumers and electricity generators to sub- stitute natural gas for fuel oil to meet reductions in per- The gas law (Regulatory Law of Constitutional,Arti- missible levels of nitrogen oxides (NOX), sulphur cle 27) was amended in April 1995 to allow private in- oxides (SOX),and particulate emissions.The main sub- vestment in new transportation facilities, and in the stitute for natural gas for industrial consumption is do- distribution, storage, and marketing of natural gas. mestic fuel oil, which has a high sulfur content and, Pemex was to focus on maintaining its existing large therefore is polluting and inefficient. Since Pemex has transportation network, and gas exploration and pro- had limited refining capacity to process cleaner fuels, duction.The reform also included institutional changes and because there is little international demand for the with a view to separating and more clearly defining re- high-sulfur residual produced, this product was allo- sponsibilities for policy and planning, regulation, and cated to the domestic market.Thus heavy fuel oil was service provision. the predominant fuel for steam-cycle power plants and The institutional setting before 1995 was plagued large industrial consumers.Since 1997,the final price of by overlaps and ambiguities regarding the state's roles natural gas has remained below that of liquefied petro- in the sector as owner of natural resources, policy- leum gas and diesel, but generally above that of fuel oil. maker, regulator, and producer of goods and services. By the mid-1990s, it became clear that the existing in- In most cases Pemex played the roles of producer, en- dustrial organization of the natural gas sector was sim- ergy prospects analyst, and self-regulator. In addition, 35 Natural Gas Table 3.1 Current Structure of the Gas Sector: International Comparisons Structure Argentina Colombia United Kingdom U.S. Mexico Multiple suppliers, Single supply, multi- Multiple suppliers, Multiple vertical Single state two transport ple transportation transportation integrated supplier, one main and multiple and distribution and distribution regional state transporter, distribution companies companies companies multiple private distribution companies Number of specialized companies Transportation companies 2 1 (ISA) 1 15 1 (Transco State company (previously British Gas) Distribution companies 8 10 41 40 plus 18 Load growth 8% 6% 2% 3% 9% Demand Industrial 25% 24% 50% 40% 31% Residential & commercial 40% 31% 35%** 37.6% 6% Electricity generation 35% 45% - 13.5% 22% Oil production - - - 8.9% 42% Ownership Private Public/Private Private Private Public/Private **Only residential. Source: Lehman Brothers. Table 3.2 Natural Gas Distribution in Mexico, U.S., and Argentina, 1998 Mexico U.S. Argentina Number of users * Residential 676,355 62,366,243 5,290,164 Industrial 2,710 231,438 255,743 Total 679,065 62,597,681 5,545,907 Tariffs ($/million BTU) Residential 5.49 7.35 5.35 Electricity 2.6 2.60 - Industrial 2.36 2.97 3.55 Reserves (trillions of ft3) 30.1 164 - Production (billions of ft3/year) 34.800 543.800 29.300 Imports (billions of ft3/year) 38.741 2,994.000 64.626 Exports (billions of ft3/year) 13.243 157.010 23.661 Per capita volumes (Thousands of m3 /year/user) Residential 2.29 3.42 1.11 Electric - 16.85 - Industrial 3,865 398.62 39 * In the case of Mexico, according to acquired commitments of winners of distribution bids. Sources: CRE, Energy Information Administration, ENARGAS, Ministerio de Economía de Argentina. regulatory authority was scattered across several · The Comisión Reguladora de Energía (CRE) was as- institutions. For example, an inter-ministerial commit- signed regulatory authority, including permit granting, tee--typically Pemex, the Energy and Finance Min- price and tariff regulation, regulation of access to serv- istries--fixed gas prices. The new institutional ices,oversight of distribution franchise award and com- arrangements included the following: pliance, and dispute resolution. · The Secretaría de Energía's role was strengthened as · Pemex's role was restricted to operations and it was the rector of the nation's energy resources,charged with to disclose previously classified information to the au- planning and supervision of state firms in the sector. thorities (though not to the public). 36 Natural Gas Figure 3.1 Industry Structure Before 1995 Supply Transportation Distribution Demand Private LDC'S Small Users · Industrial State Owned · Commercial Oil and Gas LDC'S · Residential Competition Wells from other Pemex fuels Transportation GAS activities Large Users Pemex · CFE Processing Plants · PEMEX Petroquímica · Industry Exports Legend Imports Supply Activities reserved Transportation to Pemex Distribution Source: Comisión Reguladora de Energîa. Figures 3.1 and 3.2 describe the industry structure Regulatory Framework before and after the 1995 reform. Liberalization of this sector is complex because the International Comparisons natural gas industry combines naturally monopolistic activities such as pipeline transportation and distribu- It is relatively early to comment on the impact of re- tion with potentially competitive activities such as pro- duction and marketing. Moreover, there were several form in the natural gas sector in Mexico.However,key key features of Mexico's natural gas policies that shaped indicators of the coverage or penetration of natural gas, the design of the regulatory framework: Pemex would average consumption, tariffs, and reserves in Mexico, retain its statutory monopoly in domestic production, Argentina,and the U.S.as of 1998 are provided inTable it would remain the dominant incumbent in transport, 3.2.The Mexican natural gas market is small relative to and there were few distribution systems operating in theArgentinean and the U.S.markets,with the number the country.These factors influenced the range of reg- of consumers in Mexico almost 10 times smaller than ulatory options and the selection of specific instru- those inArgentina,and one hundred times smaller than ments to achieve three principal goals: to develop in the U.S. Likewise, total consumption in Mexico is infrastructure (policy measures regarding exclusivity three-quarters of the consumption inArgentina and far and vertical integration), to regulate market power smaller than the consumption in the U.S.While indus- (price and tariff regulation and liberalization of inter- try consumes more natural gas in Mexico than in national trade), and to promote competition (liberal- Argentina, residential use and consumption for the ization of marketing activities and open access generation of electricity is higher in Argentina. to services). Excluding Pemex's consumption of natural gas, more gas is consumed in total in Argentina than in Permit Regime Mexico--although the intensity of both residential Issuing permits was selected as a fundamental regula- and industrial use is greater in Mexico. tory instrument because it provides certainty to in- 37 Natural Gas Figure 3.2 Industry Structure After 1995 Supply Transportation Distribution Demand Transport LDC'S Small Users · Industrial · Commercial Competition Pemex · Residential from other GAS fuels Storage GAS Large Users · CFE · PEMEX Petroquimica · Industry Trading Exports Legend Imports Supply Storage Transportation Trading Activities reserved Distribution Source: Comisión Reguladora de Energîa. to Pemex vestors, unlike the traditional alternative of allowing stricted to transport in order to encourage entry of economic agents to operate under provisional ap- new participants in distribution.Vertical integration provals by city or state authorities. Regulators grant between transportation and distribution is authorized permits to ensure technical and economic uniformity when a transportation permit is necessary for a distri- in projects across the country. bution project or a distribution permit is necessary for Pemex and private transporters, distributors, and a transportation project. If a company wants to estab- operators of storage facilities obtain permits from the lish a distribution network in an isolated area where regulatory authority to carry out their activities. Users there are no transportation pipelines and no other that wish to construct pipelines for their own use must party interested in constructing them, the distributor also obtain permits. Permits are issued for 30 years and may construct and own the transportation system. are renewable.Transportation and storage permits are Producers, transporters, distributors, and operators issued under market risk with no exclusivity, for of storage facilities can buy and sell gas. But they have specific capacities, and in the case of transportation, for to unbundle their services and must have separate defined routes. For transportation projects promoted accounting systems for their commercial and service by the government, permits are issued through public activities in order to prevent cross-subsidies. bidding.50 Distribution permits are granted for geo- graphic zones defined by the regulatory authority International Trade through a public tender.The first distribution permit Since Pemex remains the sole domestic producer, the grants 12-year exclusivity in gas distribution but not in price of domestic gas is regulated,and imports of natu- gas marketing. ral gas from the United States are permitted without an import license and without import duties.51 Since Vertical Integration competition prevails in the North American market, Because Pemex dominates the industry, the new gas this policy sought to establish a credible threat for law permitted other market participants some degree Pemex in prices and possibilities of contracts.This was of vertical integration.At the same time,Pemex was re- especially relevant for consumers in the north of the 38 Natural Gas Table 3.3 Institutional Framework for Gas Sector Regulation: International Comparisons Argentina Colombia United Kingdom U.S. Mexico Status of regulatory Authority Independent Govt. dept. Independent Govt. agency Independent Framework established 1992 1995* evolving evolving 1995 Price regulation RPI-X Rate of return RPI-X rate of return RPI-X *: Ongoing. Source: Lehman Brothers. Table 3.4 Permits Issued, 1996 to August 2000 Permits (#) Capacity (mmcfd) Length(km) Investment Service planned ($M) Transport 63 9,900 11,475 1,168 Open access 14 7,450 10,893 1,015 Self-use 49 2,450 636 152 Distribution 21 1,493 28,042 989 Total 84 - 39,517 2,156 Source: CRE: Info CRE-December 2000. country--such as local distribution companies and domestic production and processing is through regula- power generators--that wished to import gas either tion of"first-hand sales prices."Mexico uses a net-back directly from the United States (as in Mexicali or Ciu- based on an international benchmark to compare the dad Juárez) or by bypassing the Pemex transportation performance of Pemex to that of similar North pipeline (as in Monterrey). American firms in comparable settings.Finding a yard- stick with desirable conditions for the Mexican gas Marketing Activities market was feasible because Mexico is physically linked To encourage vigorous competition in gas marketing to the U.S. natural gas market.The regulatory formula activities, no permit is required to carry out the fol- uses the dynamic behavior of the Houston Ship lowing transactions: (1) buying gas, transporting it Channel, a gas trading hub close to the physical con- through the transportation network, and selling it to nection between Pemex and the U.S. pipeline sys- distributors or to consumers; (2) selling gas to con- tem.52 It is a highly liquid market and has an associated sumers within a distribution franchise area (commer- hedging market. cial bypass); and (3) buying and selling transport The economics of transportation is key to under- pipeline capacity. standing the way the net-back formula works. The Mexican pipeline system looks like a "Y," with Ciudad Open Access Pemex--where 80 percent of total domestic natural Open access for consumers to transportation and gas is produced (associated gas)--at the bottom. distribution capacity is intended to limit market power Reynosa-Burgos is the northeast arm and produces and create competitive conditions for providing non-associated gas (18 percent of production). Ciudad goods and services in the natural gas industry. For ex- Juárez, an import point, is in the northwest arm. Los ample, a consumer in a distribution area may wish to Ramones marks the junction of the three branches. bypass the local distribution company, buying gas in The net-back formula is based on the benchmark the gas field or storage facility and transporting it price in southeast Texas, the arbitrage point, and net through the pipelines, and pay the transport and distri- transport costs.The arbitrage point is where northern bution charges. and southern flows meet, and where prices from both sources are equal (Los Ramones). This point moves Regulation of the First-hand Sales Price of Domestic Gas north as northern flows decrease and south as northern Another feature to deal with the Pemex monopoly in flows increase.The price cap for Mexican natural gas is 39 Natural Gas the price at Ciudad Pemex, which in turn is equal to Final Prices to Captive Consumers the price in Southeast Texas plus transport costs from When there are not enough marketers or competing Texas to the arbitrage point minus transport costs from fuels,competition may be weak.The distribution com- the arbitrage point to Ciudad Pemex. pany might be the only supplier for a group of cus- tomers.The regulatory mechanism to protect captive Gas Distribution Concessions consumers is the acquisition price,which sets the max- In Mexico natural gas distribution has "greenfield imum price that can be passed through to the final user project"characteristics because liquefied petroleum gas by the distributor to cover costs of gas purchase, trans- has traditionally been used for household purposes,and portation, distribution, and storage. It permits the dis- fuel oil for industrial and electricity generation tributor to transfer the cost of acquiring gas as long as purposes. Greenfield investments carry demand, it is less than or equal to a predetermined benchmark. financing, and operating risks that are typically not This benchmark is the regulated price of domestic gas present in divestitures and acquisitions of existing plus the regulated tariffs for transporting and storing it. assets. These considerations influenced the design of When the distributor is not connected to a national distribution regulation. production field, and therefore imports most of its gas, Mexico's natural gas distribution networks are to be the regulatory authority may authorize a reference developed through temporary regional monopolies price different from the regulated price of domestically in defined geographic zones. The initial permits, produced gas (first-hand sales price). tendered through an open bidding process,provide 12- year exclusivity. Commercial bypass is permitted from Regulatory Authority day one in local distribution zones, but physical bypass Table 3.3 summarizes features of the institutional and is allowed only gradually. During the first two years regulatory framework that was designed for Mexico only consumers inside local distribution zones using and compares it to other countries.Argentina, Colom- more than 60,000 m3/day may construct their own bia, the U.S., and U.K. have strong regulatory institu- connection to the transportation system. In years tions, empowered with the necessary regulatory three and four, this right would be extended to con- instruments and with financial independence.They are sumers of more than 30,000 m3/day, and to all others typically concerned with the regulation of prices, tar- after year five. iffs, permits, and contracts, as well as the oversight of service quality, safety, and environmental matters.The existence of these institutions ensures credibility and Distribution Tariffs The greenfield nature of natural gas distribution in transparency of the regulatory framework, which is Mexico also influenced the design of distribution tariff critical for mobilizing private investment on the scale regulation. The choice was between cost-of-service required. In this vein, the reform of the policy frame- regulation and price caps to regulate price level, and work in Mexico focused on institutional changes to between tariff basket and average revenue yield to reg- separate and clearly define responsibility for policy- ulate price structure.53 Mexico opted to use average making and planning,regulation,and service provision. revenue regulation in the first five-year regulatory pe- riod because most natural gas distribution projects are Private Sector Participation Experience greenfield and thus characterized by greater cost shocks--or unexpected changes in market condi- Since the early 1980s, several Mexican companies have tions--at the beginning rather than in later phases of provided gas distribution services to a small proportion build-out and operation of the distribution network. of the population in several urban areas (Ciudad Juárez, The average revenue yield method allows the firm to Reynosa,and certain districts in Mexico City,Monter- choose its relative prices at the beginning of each year rey,and Guadalajara).The enactment of legislation (Ley based on forecasts of the volume that will be de- Reglamentaria del Art. 27 de la Constitución) and imple- manded at the end of the year. menting regulations (Reglamento de Gas Natural) in 40 Natural Gas Figure 3.3 Natural Gas Demand and Domestic Production, 1999-2009 Million cubic feet per day 12000 10000 8000 6000 4000 2000 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Prospectiva Gas Natural, Secretaría de Oil Sector Electric Industrial Residential and Commercial Vehicular Transport Total Supply Energía 2000. 1995 provided the clarity, certainty, and predictability to connect large industrial users (steel,mining,cement, required for significantly increasing private participa- and chemicals), and new power generation facilities to tion in downstream natural gas activities. Between gas fields or to the trunk network.These have all been 1996 and 2000, Comisión Reguladora de Energía (CRE) private sector undertakings. awarded 21 gas distribution permits under which con- The 11,000 kilometers of transport pipelines will cessionaires are obligated to serve 2.3 million cus- have a capacity to deliver about 7.5 billion cfd of dry tomers by 2004.This represents a 15-fold increase in gas. Much of that capacity will be used to supply gas the customer base relative to 1995.The permit-holders for power generation, industrial processes, and to a have pledged to invest $990 million to develop the dis- lesser extent, distribution services in most major urban tribution networks and paid roughly $500 million to areas. As discussed below, current commitments for acquire existing distribution facilities previously oper- new pipeline capacity will be insufficient to meet pro- ated by Pemex and Comisión Federal de Electricidad. jected demand during the next decade and further reg- Sixty-three transport permits have also been ulatory reforms will be required for the necessary granted over the same period, 14 for open access and investments in gas infrastructure and production to 49 for self-use (see Table 3.4). Of the $1 billion in in- materialize. vestments committed under open access permits, roughly half is for private sector projects,the other half Prospective Demand and Future Private being Pemex commitments for maintaining and ex- Participation panding the main trunk network. Self-use transport permits carrying investment commitments of about Demand for natural gas is expected to continue to $150 million have been secured primarily for spur lines grow rapidly over the next decade. Key drivers are de- 41 Natural Gas mand for electricity generation, environmental stan- Annual growth rates of demand for natural gas for dards that require fuel oil­run industrial facilities in power generation (18 percent), industry (8 percent), critical zones to convert to natural gas, and the build- and the oil sector (7 percent) in the 2000-2009 period out and operation of distribution systems throughout imply significant future demand for additional trans- the country.The Gulf of Mexico will continue to sup- port pipeline capacity. Moreover, interconnection with ply a large, but decreasing, share of gas demand based the U.S. gas transport system will be expanded to ac- on projected increases in crude extraction and refining commodate increased import requirements. Possible and petrochemical processing activities in Pemex in- transportation projects include pipelines in Rosarito, stallations that require large quantities of natural gas. Hermosillo-Guaymas, El Paso-Chihuahua, Guadala- These figures for demand growth imply a significant jara-Manzanillo,Monterrey-Venta de Carpio,Monter- increase in gas penetration in the energy matrix. Be- rey-Bajío, Altamira-Ciudad Pemex, and Ciudad tween 1998 and 2007, the share of natural gas in en- Pemex-Central America. ergy consumption is expected to increase from about Regarding storage, the Secretaría de Energía (SE) has 18 percent to 58 percent for thermal power genera- identified potential sites in Monterrey (salt caves), tion, 50 percent to 70 percent for industrial use, and Reynosa (depleted fields),and Coatzacoalcos (depleted most remarkably, from 7 percent to 25 percent for dis- fields). Additionally, the SE is developing modeling tribution systems serving residential, commercial, and tools that consider different supply and demand municipal users. scenarios, as well as interconnection restrictions with Domestic production, while projected to increase the North American pipeline system, in order to significantly, will not keep pace with demand: imports evaluate costs and benefits from developing different are projected to grow from 800 million cfd in 2001 to storage systems. 2.5 billion cfd in 2009.The deficit in production al- ready incorporates planned Pemex investment in ex- Principal Policy and Regulatory Challenges ploration, field development, and production facilities amounting to more than $50 billion over the next Reforms to date in the natural gas sector have been di- decade. Slightly less than a quarter of this sum is to be rected at fostering private participation in transport, devoted to finding and exploiting non-associated gas storage, and distribution activities as well as in trade reserves.The difference will come from imports from and marketing. As indicated above, Mexico has been the U.S. and Canada.The former is currently facing its quite successful in attracting private investment for own supply constraints. This points to the urgency economically developing distribution and to a lesser for Mexico to introduce structural and regulatory extent transport infrastructure and services. However, changes to mobilize significant financial and entrepre- the entry of new participants in gas storage and neurial resources to exploit its abundant gas resources marketing services has been limited because of the (see Figure 3.3). presence of a dominant, vertically integrated incum- bent, Pemex. Opportunities for Private Participation The first challenge will be that of applying and en- Sustained growth in demand for natural gas will con- forcing existing regulations in a consistent and trans- tinue to present opportunities for private participation parent manner, and coordinating among government in distribution, transport, and perhaps gas storage facil- agencies to perform these tasks. Two issues are para- ities.For gas distribution concessions,CRE is expected mount: enforcing the new directive on gas marketing, to call for bids for Pachuca (expected investment com- and conducting the five-year review of gas transport mitments of $11.3 million, Cuernavaca ($15 million), and distribution tariffs. and Guadalajara ($111 million). Likewise, other distri- · Gas Marketing. Five years after liberalization com- bution zones are expected to be defined for Veracruz, menced, CRE issued the directive regulating Mérida, Cancun, Nogales, and Orizaba. Pemex gas contracting in an effort to establish more 42 Natural Gas transparent, balanced, and reciprocal conditions be- price caps--particularly the effectiveness of the ad- tween Pemex and natural gas buyers.54 This lag re- justment factor in offsetting the stochastic effect of flects the initial belief that competition in gas demand uncertainty. marketing was ensured by its contestable character- A second challenge is the fact that current govern- istics.However,Pemex's continued vertical integra- ment policy permits the continued vertical integration tion posed serious obstacles to introducing of Pemex gas affiliates and its retention as a state mo- competition in gas marketing.The directive calls for nopoly in gas production and processing.This will pose accounting and functional separation of produc- an obstacle to fostering the competitive conditions tion, transport, and marketing to discourage cross- needed to ensure efficient and reliable gas supplies dur- subsidies between marketing and first-hand sales. ing the next decade and beyond.The principal target The huge information asymmetry on costs, prices, for new transport infrastructure will be in supplying and quantities between the state monopoly and the new and retrofitted power plants as well as cross- regulator will make this task difficult. While con- border pipelines and storage facilities to permit more sumers are now permitted to contract with other competitive conditions for accessing gas sourced from marketers, the market power Pemex wields is likely the U.S. and Canada. In the absence of restrictions on to continue to deter entry of new competitors. In Pemex's ability to develop new transport pipeline ca- the absence of further structural reforms, such as pacity or continue coordinating its marketing and full legal separation of Pemex's gas production from transport affiliates,new participants will be reluctant to its transport and marketing subsidiaries, the com- invest in these activities, since the scope for Pemex pany's marketing activities may have to be further market manipulation will remain prohibitive. limited. · Five-YearTariff Review.This review marks an impor- Restricting Expansion of Pemex Transport tant milestone for the sector and for the CRE. This argues for restricting future Pemex investment in Until recently,much of CRE's efforts were devoted gas transport to rehabilitation and maintenance of ex- to promoting private sector entry in downstream isting facilities. Given the enormous volume of re- natural gas activities.As more and more permittees sources required to develop Mexico's domestic gas conclude construction, the CRE is focusing in- resources, the budgetary and borrowing restrictions creasingly on regulatory oversight and compliance. under which Pemex currently operates as well as its The five-year review provides an opportunity to overriding mandate to generate tax receipts through critically assess whether current policies and regula- the export of crude and the supply of petroleum fuels tions are working as anticipated and to modify domestically, the investment of billions of dollars in gas them as deemed necessary. Several key issues that transport activities--which are already open to the pri- should be considered during the review are: (1) the vate sector--is of questionable priority. sustainability of low initial distribution tariffs and minimum coverage targets bid by developers in the lower-density zones; (2) the impact of unantici- Fostering Private Investment in Gas Storage pated obstacles to system build-out such as delays in Structural measures such as the separation of Pemex permitting (environmental, construction, rights of Gas and Transport into independent entities, and con- way) and technology limitations (in the lack of fea- duct measures governing Pemex's contract terms and sibility of directional drilling attributable to the ab- transport-access conditions--in combination with re- sence of sewer/power/telecom cable mapping) on strictions on Pemex's investment in new transport fa- projected throughput and connection rates, and cilities--will go a long way toward creating a more hence tariffs; (3) the efficacy of acquisition pricing level playing field for private investment in transport methodology in protecting captive consumers and storage activities.That in turn would permit better where competition in marketing is weak; and (4) transport logistics and inventory management, thereby the suitability of revenue yield methodology for reducing costs and improving reliability. 43 Natural Gas Moderating Growth in Imports tractual arrangements and financing vehicles are a less- Demand for natural gas is projected to grow at 10 per- than-optimal instrument for securing efficient private cent and domestic supply at 7 percent a year over the participation. For Mexico to quickly exploit its natural next decade. Roughly 25 percent of gas consumption gas resources and avoid soaring increases in gas im- will come from imports, which in financial terms is ports, new arrangements for risk sharing with experi- more than the entirety of Pemex's sales revenues in enced private companies should be considered in the 2000.The implied growth in domestic supply assumes short term, with associated changes in licensing, taxa- that Pemex--and by extension the federal govern- tion, and audit policies and practices. ment--will be able to mobilize roughly $55 billion in Pemex has recently launched a new private sector investment financing during the next decade for ex- participation scheme called "contracts for multiple ploration (according to the Programa Estratégico de Gas services," which aims to increase investment in the ex- Natural, $10 billion), production ($40 billion: Burgos, traction of non-associated gas in the Burgos region. In Gravilja, Cantarell) and upgrading and expanding pro- principle, forms of such contracts are already in place. cessing infrastructure and transport infrastructure ($5 What is unique about the initiative is the intention is billion). The underlying premise of these programs, to expand the types of services that private operators which is increasing domestic extraction capacity by 60 are allowed to provide,including construction of roads, percent, merits critical assessment. Pemex's budget is drilling, transportation, etc. One of the main reasons to determined annually by the Mexican Congress and is have contracts for multiple services is that procurement frequently cut to accommodate other national priori- laws in Mexico are relatively complex,and increase ad- ties Often, more investment has been made for the ex- ministrative costs because of the need for separate con- traction and export of crude as well as the production tracts for each service.The first objective pursued by of cleaner vehicle fuels required by current and the promoters of these contracts is the exploitation of prospective emission standards. Moreover, since Pemex about 2,000 new production sites with an average cost operates under the same government procedures as any of $2.5 million each. That may allow an increase in government agency, its record in managing costs of production of 1 billion cubic feet of gas. (As of now, finding,developing,and exploiting hydrocarbons is not Pemex exploits approximately 400 production sites per impressive. It is therefore far from certain that these year.) Financial analysis shows that such investments programs will be fully funded or that the resources are profitable once the price of natural gas reaches be- invested will yield the expected magnitude of in- tween $2.50 and 3.00 per million BTU.The main crit- creased production. icism of this scheme, however, is that risk may be unequally borne by PEMEX.The company providing Private/Public Cooperation Upstream the service will be guaranteed to receive the cost of the To date Pemex has been permitted to outsource cer- investment at its present value,from the revenue gener- tain gas exploration, field development, and logistics ated by gas exploitation.The future of these contracts is activities through narrowly defined service contracts. yet to be discussed by Congress. Such contracts are a relatively costly way for Mexico to develop commercially exploitable gas resources since Gas Development and Future Power Markets Pemex, and indirectly the federal government, bears The largest source of projected growth in gas demand, most of the risks. Moreover, the majority of future in absolute and percentage terms is for electricity gen- service contracts are to be financed off the balance eration (18 percent a year) as the majority of new ther- sheet, through PIDEREGAS (a form of leveraged mal power plants are likely to use combined cycle gas lease), which while not reflected as a financial liability turbines irrespective of gas prices.For the power sector from the start, represents a very sizable contingent lia- to meet Mexico's rapidly growing demand for electric- bility for the federal government. Given the inherently ity in an efficient and reliable manner, without unnec- risky and demanding nature of gas-exploration activi- essarily encumbering public finances, new forms of ties--future revenues are highly uncertain--such con- industrial organization are required in this sector. 44 Natural Gas While various formulations are currently under discus- Notes sion, all aim to introduce competitive conditions in 49 Liquefied petroleum gas is used instead and is fairly well dis- power generation.A critical element for creating a level tributed in large cities. Until quite recently, its price was subsidized. playing field among generators (public and private) is 50 For instance, the CFE recently bid independent power proj- ensuring an adequate supply of fuel--principally natu- ects together with the pipeline that connects the generation plant to the natural gas field. ral gas--on competitive terms. In the absence of suffi- 51 Mexico eliminated the import tariff on natural gas in August cient gas supplies, infrastructure to optimize delivery, 1999. and flexible and competitive marketing arrangements, 52 Texas Eastern Transmission (Tetco) and Valero Transmission the scope for realizing the welfare benefits of competi- (Valero) are the south Texas pipelines that have a physical connec- tion in power generation will be limited. This rein- tion to the Pemex network.The historical price differential between Tetco andValero and Houston Ship Channel is $.07. forces the importance of instituting additional 53 Price-level regulation refers to the long-run distribution of structural and conduct measures to foster new entry rents and risks between consumers and the regulated firm. Price- in gas exploration and production, transport, storage, structure regulation refers to short-run allocation of costs and ben- and marketing. efits among the different types of consumers. 54 Firsthand Sales Directive, CRE 2000. 45 4 Urban Water Supply and Sanitation The adequate provision of water and sanitation Mexico, serving 65 million inhabitants. One hundred services in Mexico is critical for improving the quality and forty-five companies provide service to cities of of life of ordinary Mexicans. Population growth and more than 50,000 persons.These cities constitute more economic transformation have put increasing demands than 50 percent of the population and 75 percent of on water resources.55 In combination with continuing those with access to piped-water supply. urbanization, this has led to growing physical scarcity Following several reorganizations, the main federal and environmental damage to groundwater,and coastal agency with oversight of the sector is currently the ecosystems.This, in turn, continues to raise the costs of Comisión Nacional del Agua (CNA). The CNA is re- providing clean drinking water.At the same time, fed- sponsible for formulating and implementing national eral funding for the sector has declined markedly in water policies, which form part of the national policy line with broad national priorities to devote a larger for environmental management, health, and economic share of fiscal resources to the social sectors and within development.One element of that mandate is to define the water sector, to impoverished rural communities. policies and strategies aimed at strengthening the tech- That fact notwithstanding, sectoral policy has empha- nical, managerial, and financial capacities of state and sized improving access to water and sanitation services municipal water companies. Other responsibilities in- as well as the quality of such services.Private participa- clude regulating water use, planning and construction tion in the operation and financing of water and sani- of major hydraulic infrastructure, monitoring water tation services represents an explicit strategy of the quality, and the promotion of private participation in government in pursuing sectoral policy goals. urban areas. Institutional Framework Other federal agencies overseeing the sector include the Secretaría del Medio Ambiente y Recursos Since the early 1980s, responsibility for the provision Naturales (SEMARNAT), to which CNA reports, of urban water and sanitation services has been pro- which sets environmental standards and water abstrac- gressively transferred from the federal government to tion and wastewater discharge levies. The Secretary sub-national authorities.This policy was strengthened of Health defines potable water quality standards. in 1983 with the amendment to Article 115 of the Secretería de Hacienda y Crédito Público (SHCP) is the Constitution, by which municipalities were assigned collection authority for water charges, and distributes direct responsibility for most basic infrastructure serv- federal transfers to sub-national jurisdictions.Banobras, ices, including water.56 Today there are more than the state development bank, provides credit for 2,000 municipal water companies operating in financing infrastructure. 46 Urban Water Supply and Sanitation State government plays an important role in the therefore not included in the company's financial state- sector, despite the fact that municipalities have the ments.The proceeds derived from payment for water constitutional mandate to provide service. States ad- services often have the legal character of a tax, or minister water within their jurisdictions,distribute cer- derecho fiscal, rather than an income, or ingreso. In other tain federal transfers to municipalities,control access to words, these revenues are not considered resources of credit, and frequently provide fiduciary and financial the water company, and their disposition is governed guarantees for municipal water company undertakings. by municipal or state government administrative pro- However states, with some notable exceptions, do not cedures. In addition, tariff rates for the mobilization of typically have clear sectoral investment policies, tariff these resources are set by the same procedures as those setting rules, and financing strategies. Where regula- for authorizing taxes and expenditures at the local and tions exist, their enforcement is uneven. In recent state level, rather than being transparently tied to for- years, a few states have established water and sanitation mulae that relate to the costs and quality of service. agencies (comisiones estatales del agua). Their primary function has been to develop and approve state water Government Policy and Regulatory Framework master plans (a requirement for obtaining federal fund- ing) rather than to regulate service provision.57 To the Within the overall policy framework for water re- degree that states exercise economic regulations, such source management and environmental protection,the as approving municipal water and sewerage tariffs,such new administration has the following basic policy goals authorization is rarely based on clearly defined criteria. for urban water supply and sanitation services:enhanc- State health agencies rely on the water companies ing the efficiency and quality of service; expanding ac- themselves and, to a lesser degree, on CNA to monitor cess to piped water, sewerage, and wastewater drinking water quality while most state environmental treatment; and ensuring the financial self sufficiency of agencies have not yet developed the capacity to moni- water companies.To finance the achievement of these tor and enforce discharge standards. goals, the government's strategy is to rely on a combi- In principle, municipalities control the water-use nation of the following: enhanced internal cash gener- rights (derechos de aprovechimiento) granted through ation in the water companies,use of federal investment CNA. Municipalities have the legal authority to dele- funds (including internal and external sources),and in- gate or concession water service responsibility to third creased private sector participation. parties, for example by constituting public water com- The principal guide for sectoral policy is the federal panies (organismos operadores) or by awarding service water law (Ley deAguas Nacionales) enacted in 1992 and contracts or concessions to private parties. It is also amended in 1994. In addition to providing a modern within their powers to devise governance structures framework for water resource management, it includes and regulations to guarantee the commercial auton- the following stipulations with regard to urban water omy of those service entities. Most state-level water supply and sanitation: (1) CNA is to grant local gov- laws in fact stipulate that urban water companies are to ernments rights to use national waters; (2) Municipali- operate as autonomous entities. In practice, the degree ties and their companies are to operate in a manner of managerial autonomy afforded to water companies that will ensure their financial self-sufficiency; (3) It is varies considerably. Frequently, important operational in the public interest for local governments to grant decisions are taken by the political authorities, includ- concessions to private parties for the provision of water ing the municipal mayor and the water company board and sanitation service; and (4) CNA will continue to that the mayor appoints and chairs. undertake water supply and sanitation projects under The relationship between the municipality and the certain conditions. These dispositions were meant to water company is generally one of delegated service clarify the responsibilities and powers of different whereby the public water company is authorized to levels of government.As discussed below, their impact undertake operations and maintenance,billing and col- on decentralization depended significantly on the lection on behalf of the municipality.The water com- clarity of sub-national sectoral and administrative pany does not own or manage existing assets,which are legal frameworks. 47 Urban Water Supply and Sanitation In parallel with policies to improve sectoral cover- CNA continues to undertake construction of hy- age and efficiency, over the past five years the govern- draulic works at the request of local authorities. ment has put in place a fairly comprehensive In parallel with support for public sector operators, framework for addressing water pollution and its a number of municipalities had sought to contract part impact on human health and aquatic ecosystems.A key of their service obligations to private parties via service policy objective has been to reduce municipal and contracts, BOTs, and concessions, in the belief that industrial discharges of untreated wastewater effluent. such arrangements would permit greater efficiency and Since 1995, environmental legislation has been access to long-term funds.The limited success in initi- modified to clarify policies, procedures, and responsi- ating many of the private projects that the municipali- bilities in this area.58 The principal strategies employed ties put forward prompted the federal authorities to to control water pollution in the most polluted water develop and promote several instruments to address bodies include: (1) promulgating and successively sim- gaps in the legal framework at the local level and in fi- plifying discharge standards; (2) writing off past nancing for greenfield private projects. While most discharge fees owed by polluters (including water states and municipalities had laws that created public companies) in exchange for their presenting invest- water companies and permitted private participation, ment plans for meeting the revised standards; and (3) none had fully elaborated subsidiary legislation employing economic instruments to motivate polluters (reglamentación). Since 1996, the federal authorities, to internalize the environmental costs of discharging under the leadership of CNA, have elaborated a model untreated wastewater. The latter is embodied in the state water sector law that incorporates elements con- manner in which fees are levied for wastewater sidered critical for providing clarity and juridical cer- discharges and for setting penalties for tainty to the local authorities, private operators, and discharges that exceed the relevant effluent standard.59 financiers.These include the transfer of sector planning The new regulatory framework for controlling from CNA to state water commissions, tariff princi- wastewater effluent aims to regulate all agents that dis- ples, the creation of a regulatory entity, water company charge into water bodies and sewer systems by dealing attributes, and concession terms and arbitration proce- with discharges in a comprehensive manner and dures. To date, many states have adopted certain ele- providing incentives to create economies of scale in ments of the model law, for example those permitting treatment. These measures are intended to induce cut-off of service for non-payment, creation of state polluters to adopt new practices, processes, and tech- water commissions,and granting of concessions to pri- nologies to reduce effluent pollution loads. As dis- vate parties.In contrast,very few have put in place reg- cussed below, however, the weak financial capacity of ulations governing concessions and none have most municipalities and associated water companies established distinct regulatory entities to oversee serv- has resulted in very limited investment in wastewater ice provision. treatment to date. 60, 61 Sector Performance Program Priorities Since the principal agents responsible for the provision The recent performance of the sector has been variable of water and sanitation services are the municipalities in terms of achieving the overarching goals of increas- and their water companies, federal programs have fo- ing coverage, enhancing efficiency, and ensuring the cused on measures to directly improve service as well as financial self-sufficiency of service providers.63 to strengthen the legal and institutional framework in which service providers operate. The former include Network Access financial and technical support to municipalities and Water supply and sewerage coverage grew significantly water companies to improve investment planning, and during the 1980s and early 1990s. More than 14 mil- commercial and operating efficiency, principally lion Mexicans gained access to piped-water supply and through the Programa de Agua Potable y Alcantarillado en 16 million to sewerage,a number that is comparable to Zonas Urbanas (APAZU) program.62 At the same time, the entire population of Chile.This exceeds the rate of 48 Urban Water Supply and Sanitation Table 4.1 Urban Access to Water and Sanitation by Income Group, 1996 Income Group Water Sanitation (percentage of group with access) (percentage with access) Extremely poor 72 55.8 Moderately poor 88.7 79.4 Middle class 95.8 93.7 Others 99.8 99.1 Source: Raygoza and De la Torre 1999, based on data from INEGI (1996). Quoted in "Reconstruir Las Ciudades Para Superar La Pobreza" by Rodolfo De la Torre and Cesar Velazquez, 2001. the first to reap the benefits of reform. Poor neighbor- Table 4.2 Quality of Piped Water Supply in Mexico, 2000 hoods are often the ones that most need the service, Households in the country and simultaneously the ones that are most unlikely to receiving piped water Percent be able to afford the real cost of the service. Despite Receiving service daily 79.3 explicit targeting to the poor in concession contracts, All day 56.39 Part of the day 21.37 actual investments are often delayed.Tariff design usu- Not specified 22.24 ally includes cross-subsidies to make service delivery to Every third day 11.15 the poor feasible, but this can also make connecting Twice a week 3.82 Once a week 2.16 poor customers less desirable for investors.The appro- From time to time 2.79 priate design and structuring of private sector partici- Not specified 0.78 pation in concession contracts is thus critical to Source: Census, 2000. ensuring that the poor benefit from reform. urban population growth. Moreover, urban service Often, where high per capita investment costs exist coverage in Mexico (95/87 percent of water access and in conjunction with a large proportion of low-income sanitation access, respectively) is quite high in relation beneficiaries, it is not possible for a concessionaire to to its peers, for example Brazil (90/60), Chile (99/89), cover the cost, given constraints on the tariffs that can and the OECD average (95/77). However, water cov- potentially be charged. This is especially common in erage does not necessarily mean clean water nor serv- small- and medium-size cities, where economies of ice standards comparable to the best international scale are low and the backlog in service is high. One indicators.Approximately 95 percent of water provided strategy is to use public subsidies to complement the is disinfected, but less than 30 percent undergoes financial gap in order to make a concession 100 potabilization through a water treatment plant, a per- percent viable. Such subsidies could be targeted to centage that is lower than that of some OECD and investments in poor areas. The use of the minimum Latin American countries. Second, aggregate coverage subsidy required as an award criterion ensures that sub- figures mask wide regional disparities in Mexico, with sidies are kept low. access most limited in the southern states.As is the case elsewhere, larger cities enjoy the highest coverage. Investment Trends As shown in Table 4.1 above, even within areas classi- The rapid increase in access to piped-water service at- fied as urban, the coverage of basic water supply and tained in the 1980s and early 1990s can be explained sanitation service varies quite dramatically across by significant investments in the sector--mostly with income classes. government funds provided as subsidies--and network In terms of the quality of supply, again, the defini- expansion by urban developers. However, real invest- tion of access or coverage masks huge disparities.This ment in the sector has steadily declined since the mid- is most tellingly illustrated in Table 4.2 on the quality 1990s (see Table 4.3).This alarming trend reflects two of the water supply service provided to those who related factors. First, decentralizing responsibility for receive piped water. water supply and sanitation to municipalities was pred- Experience with private sector participation in icated on the expectation that municipalities and their other countries has shown that the poor are not usually water companies would become financially self-sus- 49 Urban Water Supply and Sanitation Table 4.3 Investment:Water Supply and Sanitation Sector Year Investment $ million GDP $ billion % of GDP 1991 862 319.3 0.27 1992 716 327.4 0.22 1993 837 333.3 0.25 1994 570 348.2 0.16 1995 398 326.3 0.12 1996 237 340.8 0.07 1997 278 367.8 0.08 1998 265 384.3 0.07 1999 252 402.9 0.06 Source: CNA "Situación del subsector agua potable, alcantarillado y saneamiento a diciembre 1998, 1999." Box 4.1 Is $252 Million Enough? Table 4.4 Revenue Generation per Water Connection Country Year Revenue per · Coverage. Using conservative assumptions of $150 per capita Water Connection ($) for new investments in water supply,$100 for sewerage,and a 2 Mexico (urban average) 1998 60 percent yearly increase in the population,at least $500 million a Argentina (Santa Fe) 1998 245 year is needed to maintain existing coverage. (This does not Argentina (average in major cities) 1997 127 include wastewater treatment). Colombia · Depreciation. For maintaining existing assets (given the current (average in major cities) 1998 170 95 percent and 85 percent coverage for water supply and sew- Brazil (Sao Paolo) 1998 344 Brazil erage) and assuming a $100 value per capita for existing water (average in major cities) 1998 240 supply and sewerage infrastructure and 2 percent yearly depre- OECD average 1998 210 ciation (50 years), depreciation costs amount to $260 million a Source: Banobras,World Bank estimates. year. · Wastewater Treatment. To construct the minimum capacity urban systems in roughly comparable countries.While needed to treat wastewater in the major urban centers,$30 per the quality of assets and costs vary among countries, a capita is needed for new investments in treatment (without comparison of per-unit revenues is revealing. Rev- investments to replace aged existing facilities) resulting in a re- enue-per-connection-per-year for Mexico is roughly quirement of at least $270 million a year for the next five years. one-quarter that of Brazil and one-third of the OECD average (see Table 4.4). Revenue per connection ex- ceeded $200 a year (about $17/month) in just four Mexican municipalities.To illustrate further, Mexican taining, hence the marked decline in federal funding. water systems could in principle generate $32 billion, Second, water companies in aggregate have not been or 300 percent more than the current amount, if rates able to recover their costs,and therefore have been un- and performance were equated to the Brazilian aver- able to finance the necessary investments to maintain age, given that Brazil is a country of roughly compara- current service levels. ble socioeconomic indicators. As shown in Box 4.1, recent investment levels are The low level of revenue obtained at the sector level not even sufficient to maintain coverage, much less in turn has sharply restricted the capacity to generate cover depreciation of existing assets and construction the earnings needed to contribute to investment and to of wastewater treatment facilities. access debt markets to adequately finance operations on a long-term basis.While the official figures reported Revenue Generation by the water companies indicate that many cover oper- The urban water and sanitation sector generated rev- ational and management costs, this can be misleading enues of approximately $8 billion in 1999.This sum, since operating expenditures are dimensioned to cover while it represents a modest nominal increase over revenues rather than reflecting true costs, and little or prior years, is remarkably low in comparison to other no allowance is made for the depreciation of assets. 50 Urban Water Supply and Sanitation Table 4.5 Distribution of Financing in the Water Supply and Sanitation Subsector, 1991-1999 Investments Federal States and Internal cash Investment Year government municipalities Loans generation $ million 1991 39% 28% 33% * 862 1992 52% 25% 23% * 716 1993 50% 29% 18% 3% 837 1994 61% 18% 15% 6% 570 1995 24% 30% 27% 19% 398 1996 67% 20% 3% 10% 237 1997 53% 21% 5% 21% 278 1998 65/% 17% 8% 9% 265 1999 60% 27% 6% 7% 252 Source: CNA. Situación del Subsector Agua Potable, Alcantarillado y Saneamiento, 1998,1999. Pricing and Operational Efficiency Sources of Investment Finance Several factors explain the parallel trends of declining The low levels of revenue generation and cost recovery investments, low revenue mobilization, and limited have limited the ability of many water companies to cost recovery at the sector level.These relate to pricing, access credit and to finance investments that are re- commercial and technical efficiency, and continuing quired to sustain service into the future. Internal cash dependence on federal transfers. For the majority of generation is so low in absolute terms that it has all but Mexico's urban water companies, the prices charged precluded access to debt finance. As a consequence, a for water and sanitation services are quite low decade after the decentralization of responsibility to ($0.30/m3) compared with prices in comparable coun- municipalities and their water companies, the sector tries in Latin America and the OECD countries ($0.9- remains more dependent than ever on federal support. $2.5/m3).While there is considerable variation among As the same time, in line with federal policies to shift support to the social sectors and to poverty alleviation localities in Mexico, less than 10 out of the 120 water programs, the absolute level of federal financing, and companies in municipalities with more than 50,000 therefore of aggregate sectoral investment has declined persons charged more than $1.00/m3 in 1999. by more than 70 percent since 1991 (seeTable 4.5). As with tariffs, the proportion of revenue collected is also low by international standards. Mexican water Wastewater Treatment companies collected 75 centavos on average for each Beginning in 1994, the federal government put in peso billed. In 1998, only 8 out of 120 water compa- place a policy to reduce the discharge of untreated nies in towns with populations greater than 50,000 wastewater effluent in the most polluted water bodies persons collected more than 90 percent of billings. by establishing wastewater discharge levies (derechos) Production of raw water,its treatment,and distribution and penalties for exceeding the standards. The levies are major cost components of service. Efficiently re- and penalties were set at levels believed to be sufficient covering those costs requires, among other things, that to motivate those responsible for discharge to under- physical losses be kept to a minimum and that those re- take the investments in treatment necessary to comply ceiving the service be charged for it. Failure to do so with the new standards.64 Since that time, some leads to lost revenues for the water company, inde- progress has been made in treating municipal waste- pendent of the level of tariffs or efficiency of bill col- water effluent, with coverage (installed capacity) in- lection. Rates of unaccounted-for water (UFW) are creasing by 22 percent (see Table 4.6). However, the generally quite high among most large Mexican water volume of untreated effluent has nonetheless increased companies (48 percent) in comparison with companies in absolute terms, which has contributed to the in- in comparable countries in Latin America, such as creasing deterioration of water bodies. Poor operation Brazil (36 percent) and Chile (25 percent), or OECD and management of existing installations has reduced members (9 percent). the productivity of past investments,with 15 to 25 per- 51 Urban Water Supply and Sanitation cent of installed capacity out of service. Moreover, a However,while there are a number of different pri- significant proportion of treatment facilities that are in vate arrangements that have been put in place, their operation do not provide adequate treatment. scope has been rather limited. Service contracts, or Against these trends, given the generally precarious BOTs, for example, do not fully address many water financial position of most water companies, only a mi- companies' performance problems. Moreover, only 34 nority of urban municipalities will be able to comply percent of contracts awarded are currently operating. with federal discharge standards within the revised The remainder have been suspended, canceled, or are time frame of 2000 to 2005. under prolonged negotiation. Lastly, the extent of re- source mobilization for investment financing has been Private Sector Participation Experience below that which was anticipated (seeTable 4.7). There are several reasons that only a limited num- Since the early 1990s, federal sector policy has pro- ber of private projects have reached the operational moted private participation as a tool for improving the phase. These include inadequate project design, the efficiency and quality of urban water supply and sani- lack of specification of contractual obligations and tation service. It was also believed that the backlog of remedies, legal ambiguities, and the lack of creditwor- investment could be overcome by relying on private thiness of the poder concedente (concession awarding au- arrangements to mobilize financing for capacity ex- thority).The 1994 peso crisis and the ensuing banking pansion to meet the requirements of a rapidly expand- crisis greatly aggravated the situation by raising costs ing urban population and for wastewater treatment and reducing the availability of private (and public) fi- facilities required to comply with new effluent stan- nancing.To address the financing gap and to improve dards.Some positive results have been obtained.By the contractual terms, the government introduced several beginning of 2000,approximately 14 million Mexicans financing schemes to aid private undertakings. Most were served by water systems with varying degrees of notable among these was the Fondo de Inversión en In- private participation (including the Mexico Distrito fraestructura (FINFRA), which provides equity to make Federal service contracts). Private investments totaling investment programs financially viable by reducing the $400 million have been committed, and approximately financing contribution required from private investors. 16 percent of the 43m/s of wastewater effluent that is Hence, it also reduces the tariffs needed to recover treated is being handled by private operators. costs as well as Banobras' contingent line of credit, Table 4.6 Treatment of Municipal Effluent, 1994-1999 1994 1995 1996 1997 1998 1999* Effluent discharge (m3/s) 261 272 277 284 291 320 Installed treatment cap.(m3/s) 42 48 51 57 63 67 Operating treatment cap-nominal (m3/s) 32 41 33 39 41 42 Operating treatment cap-adequate (m3/s) 14 17 20 25 29 N/A Effluent treated (%) 12 15 12 13 14 13 Treatment operating adequately (%) 33 35 39 44 46 N/A Source: CNA estimates, various reports; 1999 is estimate. Table 4.7 Status of Private Sector Contracts, 1992-1999 Contract Mode Awarded Negotiated In Operation Operating/Awarded (#) (#) (#) (%) Concession 4 2 2 50 Management contract 3 2 1 33 Service contract 11 11 8 73 WTP/BOT 50 41 11 22 Source: CNA, Participación Privada en la Prestación de los Servicios de Agua Potable, Alcantarillado y Saneamiento, 2000, and World Bank estimates. 52 Urban Water Supply and Sanitation Table 4.8 Goals and Investment Requirements in the Urban Water Sector, 2000-2010 Current Proposed Iinvestment requirements Activity urban coverage urban coverage $ billion Potable water 95% 97% $5.3 Sewerage 87% 97% $1.4 Sanitation 37% 93% $2.7* Total $9.4 Source: CNA internal long-term forecasts "Requerimientos de inversión." which provided short-term cover for a municipality's there must be clear prospects for recovering costs. payment obligations to the private sector operator. Moreover, it is not sufficient for water companies to These programs, directed primarily at the wastewater break even under current governmental accounting treatment BOT projects, helped keep a modest num- practices. Given the magnitude of prospective invest- ber of contracts moving forward albeit with a signifi- ment requirements,their long-term nature,and the de- cant public sector stake in financing. clining availability of federal grants, significant debt financing will be required.To leverage debt, the water Prospective Demand and Future Private systems must generate sustained increases in cash flow Participation and net revenues. A minority of water companies in Mexico already do so. Private participation can be in- The population living in urban areas in Mexico is ex- strumental in supporting other water companies to be- pected to increase substantially over the next decade. come creditworthy and hence gain access to Rapid urbanization combined with the rising incomes investment financing through a combination of effi- and aspirations of a growing populace will require a ciency improvements and cost-reflective tariffs. Based significant expansion of the existing water supply and on an analysis of 34 medium-size Mexican water com- sewerage networks as well as improvements in the panies, the average water company/municipality needs quality of services (see Table 4.8). The key challenge to borrow about $20 million to reach its investment facing the sector will be mobilizing and efficiently goals but has an incremental debt capacity of only managing the enormous volume of investment re- $350,000.65 quired to maintain existing water supply and sewerage As shown inTable 4.9, efficiency gains alone have a systems in their current condition, significantly in- relatively modest impact on creditworthiness and debt creasing access to sewerage, and providing adequate capacity, permitting financing that covers only a quar- treatment to a much higher proportion of municipal ter of investment needs.This does represent a major in- effluent. CNA has calculated that the investment re- crease in borrowing capacity compared to the current quired solely for the urban areas is about $1 billion a situation. Private management arrangements that do year over the next decade.In addition,replacement and not require investment financing on the part of the op- efficiency programs add another $650 million a year. erator could be an effective vehicle for delivering such This huge figure does not include incremental operat- efficiency gains. Nonetheless, the model demonstrates ing costs, mainly attributable to wastewater treatment, that to fully meet investment needs, tariffs would have which are estimated to add another $500 million a to rise on average from $0.15/m3 to $0.25/m3, a 75 year.This contrasts sharply with recent capital expendi- percent increase.That would generate net revenues suf- tures in the sector of roughly $200 million annually. ficient to leverage earnings by a factor of three to one. Many water companies, while generating paper At the higher tariff,the water system generates net rev- "profits" of an average of 20 percent, achieve this by enues sufficient to attract private debt and equity, for under-spending on operational and management costs example in the form of leases, integrated concessions and not accounting for depreciation. For private oper- or build-own-operate and build-own-transfer ators to mobilize financing for urban water systems, (BOO/BOT) wastewater treatment facilities.With the 53 Urban Water Supply and Sanitation Table 4.9 Investment Needs, Efficiency Indicators, andTariffs Step 1: Increase Step 2: Efficiency Variables Current average efficiency +2 x tariffs % User registered 80% 90% 90% Collection rate 80% 90% 75% Administrative ratio 87% 75% 55% Tariff ($/m3) .15 .15 25 Analysis Population 275,410 275,411 275,411 Users 68,853 76,503 76,503 Water Q (000m3) 49,686 49,686 49,686 Registered users / total 80% 90% 90% Water billed (000m3) 39,748 47,717 47,717 Average use/month (m3) 48 49 49 Key results Affordability Average bill / month (US) 7.24 7.33 12.32 Bill as a % of SMM 6% 6% 10% Tariff ($/m3) .15 .15 25 Credit worthiness ($ million) Existing debt 2.76 2.76 2.76 Additional debt capacity .360 4.8 20.1 Investment needed 20.2 20.2 20.2 % of Investment need 1.5% 24% 100% Source: Capital Advisors "Towards Greater Private Participation in Mexico's Water Sector," based on CNA data Box 4.2 Sector Experience in the Distrito Federal Mexico City (the Distrito Federal, or Federal District (DF), which Although the initial plans were fairly modest, with a limited comprises about 9 million inhabitants) provides an role for private operators, the results after eight years fall short interesting example of service contracts involving multiple of initial expectations. On the positive side, information dissem- private operators and a progressive process of involving the ination has greatly improved, meter coverage increased to 65 private sector in stages. percent, and billing tripled, increasing by 22 percent. Customer service also improved. However, other goals were not achieved, In 1992,during a major crisis in the water and sanitation sec- including improvements in actual collection (an increase of only tor,the DF was divided into four areas,roughly equal in terms of 7 percent in real terms). Service quality and reliability as well as population. A 10-year phased contract was envisaged for each operational efficiency remain roughly unchanged. area in which private participation would gradually increase from simple activities like mapping and meter installation in phase Delays in implementation, weakness in the regulatory frame- one, to billing and shared responsibilities in collection and cus- work--particularly in the tariff-setting process--and the above- tomer service in phase two. Finally, during phase three, activities mentioned renegotiation affected the process. Nonetheless, it is would include network rehabilitation, operation and mainte- clear that the Mexican authorities are better off with the private nance of the secondary network, and control of leaks. It was ex- operators than before.The achievements of the reform, though pected that private participation would give the authorities bet- modest, would not have been possible without these contracts. ter information, increase efficiency in billing and collection, and Key (and very serious) problems remain, including very low thus increase revenues.It was also expected that there would be tariffs (less than a third of the calculated economic cost), opera- better incentives for operators to improve the quality of service tional inefficiencies, and high costs. Moreover, the city continues delivered while reducing water losses and operational costs. to face major problems related to pollution abatement and the need for costly new water resources in the face of severe In 1998, the contracts for the DF were renegotiated, making water scarcity. the operator's role in the third phase supplemental and limiting it to on-call activities for maintenance and leak detection. 54 Urban Water Supply and Sanitation higher tariffs, household water expenditures increase · Those in region I do not even register paper prof- from 6 to 10 percent of monthly minimum salary. its, suffer large technical and commercial losses, This may be too high for the poorest customers,which have depreciating infrastructure, and have no debt may call for a narrowly targeted subsidy for capacity. Under these conditions, modest forms of such households. private participation such as service or management The scope for future private participation in Mex- contracts could be viable and, together with transi- ico is considerable,given that the country has 160 cities tional federal grants, could significantly improve with populations greater than 50,000. However, the operational and financial performance in a rela- nature or modality of private participation and the tively short period of time (3-5 years),provided tar- kinds of benefits it can bring will depend on the iffs are gradually adjusted upwards. prospects for generating sufficient revenues to recover · Those in the middle range have attained positive costs.As indicated above, tariff levels are key.The rela- net revenues but are still characterized by substan- tionship between tariffs, investment, and viable private tial inefficiencies. They can leverage some debt, participation arrangements is shown in Figure 4.1.66 which will permit financing periodic maintenance, As shown, the higher the tariff, the larger the invest- and minor rehabilitation and network extension. ment program that can be supported.The diamonds on Roughly 50 percent of the cities in the sample fall the x-axis represent Mexican cities according to their in this range. About a quarter currently generate average residential tariff.The cities are segmented into revenues sufficient to be considered attractive can- three regions,representing distinct levels of operational didates for operating leases or performance-based and financial performance: management contracts with private operators.The goal should be to put in place management prac- Figure 4.1 Mexico's Urban Water Investment Program and Private Sector Participation Increase Exponentially with Tariff Increases 113 Cities with Population > 1000,000 (Average 350,000) Region I: Region II: Region III: 30 BasicTechnical Assistance Increase Operations & Capital Markets Access Management Efficiency Build-Operate-Transfer Contracts - marginal water quality - no quality improvements - quality improvements 25 - 50% water losses - 40% water losses - 10% water losses - 75% service coverage - 80% service coverage - 95% service coverage - no leverage - 1:1 leverage - 5:1 leverage Build Plant #2 - system depreciation - system maintenance - system upgrades 20 Build Plant #1 15 "Profitability"Threshold CreditworthinessThreshold 10 Fix Minor Leaks Millions) 5 (US$ Fix Major Leaks Temixco Torreon Juarez Leon Cancun estmentv In 0 0 1 2 3 4 5 6 7 8 Tariff/m3 (N$) Distribution 113 Urban Water Systems 55 Urban Water Supply and Sanitation tices, tariff adjustment mechanisms, and financial · Orienting private sector participation as a tool to disclosure procedures that permit them to make the improve the efficiency and sustainability of service transition to region III. provision; and · Cities in region III charge tariffs of about $0.60/m3 · Refocusing federal financial assistance to support and are well-managed in terms of water losses,cov- the reform efforts of sub-national governments. erage, and billing and collection.Their profitability provides them with the potential to access signifi- Enabling Environment at the State and Local Level cant volumes of private debt and equity. Of the Formulating state sectoral policies is required. For sector seven cities in this range, most already have some performance to improve markedly, greater clarity and form of private participation, primarily wastewater coherence is required on policy goals and instruments, treatment BOTs. However, more comprehensive on institutional responsibilities for establishing and reg- forms of private participation, such as full conces- ulating service providers, and on pricing policies com- sions for potabilization, distribution, and sewerage mensurate with those goals.Municipalities are assigned may be attractive to some of these municipalities if primary jurisdiction for provision of water and sanita- that brings with it better access to international tion services.While municipalities have certain advan- debt markets. tages such as proximity to constituents and relatively The foregoing indicates that there is a lot of scope good information on local conditions, their technical for private participation in Mexico's urban water sys- capacity, particularly with regard to policymaking and tems. It also demonstrates that the significant increases regulation is limited. Consideration should therefore in resource mobilization needed to finance the sector's be given to delegating these responsibilities to state growing investment requirements are attainable. government.This may be desirable for several reasons: Greater resource mobilization can be achieved by in- consistency in policy and investment planning across creasing management and operating efficiency through geographic areas that are hydrologically and politically private participation, raising tariffs to more sustainable interdependent; greater administrative and financial levels, and by providing better-targeted direct subsidies capacity; and the ability to coordinate federal (and from central government. state) assistance. Key sectoral policies requiring greater consistency, Principal Policy and Regulatory Challenges which might be better established at the state level in- and Recommendations clude: · Planning, including coverage and quality targets; For private participation to deliver genuine benefits for · Sources of investment finance; Mexican consumers, policies must provide incentives · Social policy (service to the poor and targeted for cost recovery.There is currently a backlog of cor- subsidies); rective maintenance and rehabilitation, and sub-opti- · Tariff principles; mal pricing and management practices that characterize many (though not all) urban water sys- · Governance of water companies; and tems, as well as an immense backlog that exists in · Concession/lease award and regulation. wastewater treatment.Therefore transitional federal or These policies need to be determined jointly, state financial support will be required to assist locali- which the current fragmentation of jurisdictions works ties as they implement these policies.This implies that against. What the desired levels of access and service the government must pursue a progressive reform quality are to be, how they are to be achieved, what agenda,encompassing a number of related changes that level of investment is required,how the investment will increase the degree and efficacy of private participation ultimately be financed, and how non-compliance will arrangements, and finish implementing the associated be sanctioned are major policy decisions that must be legal and regulatory reforms.The main policies are: made explicit. State-level planning institutions such as · Creating an enabling environment at the state and the Comisiones Estatales del Agua are better placed to local level for efficient provision; provide technical support to state and municipal poli- 56 Urban Water Supply and Sanitation cymakers to do this than are the federal authorities Creating Commercially Oriented Autonomous Water (who are more remote) or the municipalities, (which Companies.The limited functions and poor governance have limited capacity and cannot readily coordinate arrangements that prevail for most water companies policies that have implications beyond their narrow ju- need to be addressed as a matter of high priority. Con- risdictions). stituting water companies as autonomous utilities with Credible Regulatory Environment to Reduce Uncertainty. full responsibility for all major aspects of service provi- Translating policies into enforceable rules requires a sion holds the promise of relatively rapid and sustained well-elaborated regulatory framework and detailed improvement in performance, particularly when com- definitions of obligations, penalties, rights, and over- bined with private participation. Important measures sight responsibilities. This is an area that has been include: creating autonomous boards that appoint largely neglected in Mexico. Reglamentación of state managers for terms that do not coincide with the po- water laws, public procurement laws, and other legisla- litical cycle, broadening water company obligations to tion bearing on private participation is limited and include asset management and new investment,and re- often contradictory. In other cases, it presents obstacles tention of revenues within the company with com- to private provision of infrastructure as, for instance, mensurate authority to incur prudent levels of debt when service cuts for non-payment are disallowed or financing. One possible model is to create a formal when the state legislature must approve tariff levels. In contractual relationship between the municipalities part, this is due to the lack of clarity on policy dis- and the water companies, with well-defined obliga- cussed above and to the absence of an identified regu- tions and outputs, thus creating an arms-length rela- latory authority. Regulatory institutions matter for tionship.The water companies could be issued formal several reasons.They can reduce actual and perceived concessions by the conceding authority, be it a munic- investor risks, improve governance, reduce the percep- ipality or state government, and the concessions could tion of corruption, and increase public confidence in be subject to impartial oversight by a regulator at the the system. state level as is envisaged in the model state water law. Also, a rating system for water utilities, based on well Sector reform in other federated countries similar established and credible benchmarking would greatly to Mexico, notably Brazil and Argentina, included the benefit policymakers and customers by providing a creation of regulatory authorities at the state level basis for improved targeting of federal and state subsi- rather than at the municipal level.This has a number of dies and programs. In addition, comparison with other benefits including the following: utilities can bring public pressure for improving effi- · Ensuring some distance from the political ciency. Lastly, regular public disclosure of financial and authorities, which assists in ensuring the agency's operational performance in accordance with commer- autonomy both from government and from cial budgetary and accounting practices should be re- the operators. quired for the benefit of customers, potential investors, · Encouraging greater capability of accessing techni- and policymakers. cal expertise, which is more feasible than providing experts for every municipality. Reorienting Private Participation · Regulating more than one service provider, which Private participation should be viewed as an instru- allows for the possible use of yardstick competition ment for improving the efficiency and sustainability of (benchmarking) and diminishes the risk of service provision, not as an easy source of off-budget regulatory capture. funding for a financially strapped sub-national govern- The establishment of state-level regulatory com- ment. In Mexico, the latter has been exposed as an ap- missions is contemplated in the model state water law proach fraught with difficulties and frustration. In CNA has prepared. It will be key to ensuring that the addition to greater clarity in sector policies and regula- bodies remain independent,technically competent and tory arrangements, successful private participation re- credible, and that they focus primarily on the core task quires appropriately matching the modality of of economic regulation. participation with the fundamental service problems to 57 Urban Water Supply and Sanitation be addressed, better specifying contracts, establishing a were characterized by bilateral negotiation without the more transparent contract award process, and dissemi- benefit of transparent competitive bidding processes. nating more consistent, accurate information on Non-discriminatory pre-qualification, clear award cri- demand and water system characteristics. teria, and pre-bid standardization, or homologación, are Different forms of private participation, such as in- important elements that need careful formulation, in tegrated service contracts, leases, or concessions, carry conjunction with precise specification of contractual varying degrees of risk for the operator, which in turn, obligations and rights. CNA has prepared a series of require that different preconditions be in place for model contracts and bidding documents that incorpo- public benefits to be realized. For example, cost cover- rate many of these points.What is still lacking is their ing tariffs are essential for concessions and well-elabo- broad dissemination and the elaboration of secondary rated regulations are key for both concessions and legislation at the local level to provide legal certainty to leases.Reliable information is important for all modal- the contractual terms. ities. Selecting the modality requires an evaluation of Taken together,these measures will significantly re- the difficulty and costs of achieving the necessary pre- duce uncertainties and hence the probability of failure. conditions for its successful execution relative to the All of them require significant up-front costs to the benefits to be obtained. For example, management conceding authority,be it the municipality,water com- contracts provide technical and managerial expertise pany, or state planning agency--costs that they are while doing little to improve investment efficiency and often unable to bear.This is an area where concerted nothing to mobilize financing for systems rehabilita- federal technical support would be well placed. tion and expansion. In water systems characterized by high levels of UFW, poor commercial practices, and Refocusing Federal Financial Support low tariffs, BOTs for wastewater treatment or water As discussed above, local authorities remain highly de- abstraction/conveyance are singularly inappropriate pendent on federal transfers and CNA direct invest- and will tend to magnify the economic and financial ment, not only for financing new investments but losses already being incurred. Integrated management increasingly for rehabilitation and even periodic main- contracts and leases of relatively short duration could tenance. Federal transfer programs and state develop- be used initially to raise operating efficiency and cash ment bank lending need to be reoriented to providing flow, which together with gradual increases in tariffs, clear incentives for sub-national governments to un- would provide the preconditions for subsequent pri- dertake essential sectoral reforms;creating autonomous vate arrangements where the operator would take water companies;establishing adequate local legislation more risk and provide greater benefits. and regulations; raising collections and tariffs; and, put- Better contract specification and award processes ting in place private management arrangements. are also important for attracting significant private par- Transfers Keyed to Reform. Localities that aggressively ticipation. Many of the earlier contracts were designed pursue reform should be provided with sufficient re- within a traditional public works framework where the sources needed to execute the necessary changes dur- focus is on construction of installations and rapid pay- ing the transition as unit costs are brought down and back rather than sustaining service over a lengthy pe- revenue generation increased. Localities seeking to im- riod of time. The principal features that require prove efficiency, but without undertaking significant attention include: (1) formulae for updating tariff lev- reforms should be given some access to resources, but els over time; (2) targets for service quality and cover- on restricted terms.Those that continue as-is should be age, together with penalties for non-compliance; (3) denied access altogether. In parallel with a graduated procedures for appeal of regulatory decisions; and (4) scale of financial support keyed to reform actions, the established terms for compensation in the event of responsibility for planning and oversight of works fi- early termination. nanced by federal funds should be shifted from CNA The manner in which contracts are awarded has a to the state and local authorities.This would strongly bearing on the likelihood of a successful outcome. reinforce transparency, accountability, and the Some of the early attempts at private participation decentralization process. 58 Urban Water Supply and Sanitation Revamped Lending Policies and Instruments. Federal sec- Conclusions toral lending policies and practices also need to be ad- justed in order to give local authorities the incentive to There is a lot of scope for private sector participation implement needed reforms. Long-term lending by in the water and sanitation sector in Mexico.The pri- commercial banks is virtually non-existent and state vate sector can play a major role in improving effi- development bank lending (for example,Banobras) has ciency and sustainability and in contributing fresh declined significantly with the coming into force of capital that the government cannot afford, especially the new financial rating mechanism with which many for sewerage and wastewater treatment. Past attempts institutions cannot yet comply. This is attributable to to introduce private participation have largely failed, the removal of interest subsidies as well as to lengthy mainly on account of a poor regulatory framework and loan origination procedures. Moreover, project lend- flawed processes and contract design.The current ad- ing, by its very nature, is a singularly ineffective vehicle ministration has emphasized private sector participa- for supporting policy reform. tion as an important strategic element for sector For those water companies that are generating sub- development and is currently preparing a plan to in- stantial net revenues, a first step would be to redirect crease private sector participation in the sector. How- much of Banobras' resources from retail lending or ever, major hurdles need to be overcome and loan underwriting to supporting debt issuance by sub- coordinated steps are needed to address the existing national governments in private financial markets.This obstacles of a legal, administrative, and institutional na- implies a shift from special purpose or project loans to ture before significant private entry is likely to take revenue or general obligations bonds as the latter ad- place.Among the most urgent needs are the following: dress the basic credit quality of the core source of a more coherent regulatory framework; greater auton- funds, the local government itself. Recent changes in omy for local water utilities; and financial, tariff, and banking regulations on the capital requirements for subsidy policies that are consistent with government lending to sub-national governments (based on their objectives for private sector participation. credit ratings) will facilitate this process. Secondly,for those local governments that are cred- itworthy, but whose funding requirements are modest, the costs of issuing debt are high. Banobras, as well as private financial institutions, can play a constructive role in aggregating or pooling smaller issues to reduce transaction costs and in providing credit enhancement to boost their credit ratings.A number of possible facil- ities merit consideration in this regard.These might in- clude (1) peso/dollar swap facilities to cover currency risk; (2) state-level revenue bond facilities to broaden options for creditworthy utilities to access long-term debt markets; (3) bond insurance funds to facilitate the issue of general obligation and revenue bonds by sub- national authorities; and (4) an infrastructure financing fund providing several financial products to sub-na- tional entities such as water companies.These types of facilities should be managed by experienced private companies. Some of them could eventually securitize their portfolios with possible placement in interna- tional financial markets. 59 Urban Water Supply and Sanitation Notes 55 Many water supply systems in the northern states of the country are subject to intermittent service due to a combination of wastage, inefficient consumption patterns, and extreme variability in hydrological cycles. 56 In eight states, some or all of the urban municipalities have delegated service provision responsibility up to the state government. 57 In addition, some commissions provide services ranging from laboratories to check water quality, to technical assistance to municipal companies, and the construction of sewerage facilities. 58 Ley Federal de Derechos en Materia de Aguas, Ley General de Equilibrio Ecológico y Protección al Ambiente. 59 NOM-001-2-ECOL 1996, NOM-003-ECOL 1997. 60 Since compliance usually requires significant investment in wastewater treatment, most water companies and municipalities have not complied with the discharge standards or paid the pollu- tion fees/penalties imposed. This has resulted in growing arrears, which are currently about $6.5 billion. CNA is now studying measures to revamp the system of charges, which will probably mean forgiving large portions of existing debt and developing a new set of rules. 61 Enforcement of pollution regulations has been much easier with regard to private operators and industry.This sends a confus- ing message to the private sector since it is treated differently than public water companies.On the one hand,the costs of meeting en- vironmental standards can make concessions financially less viable, and on the other hand,a disparity in enforcement constitutes unfair competition from the public sector.This situation needs to be clar- ified. 62 Programa de Agua Potable y Alcantarillado en Zonas Urbanas. 63 Lack of consistent, reliable time-series information on sec- toral and water company level parameters preclude systematic analysis with a unified data base. Instead, results of several surveys and case studies have been combined with existing CNA data sources. 64 NOM-001-2-ECOL 1996, NOM-003-ECOL 1997. 65Thirty-five cities with populations ranging from 100,000 to 500,000 for which relatively complete data sets were available. 66 Source: Capital Advisors "Towards Greater Private Partici- pation in Mexico'sWater Sector."From CNA database of 113 cities with populations greater than 100,000. Average population is 350,000, and median tariff is $.26/m3. 60 5 Toll Roads The national road system constitutes the most inten- importance of high-quality forecasts and analysis, with sively used transport infrastructure for the movement independent verification of assumptions, the need for of people and carriage of goods in Mexico, in addition flexibility in project and concession designs specified to serving as a social and economic integrator of the by the SCT,and the need for fast government action at country as a whole.Mexico's road transport network is project inception. less dense than that of most advanced countries, with Country risk after the debacle is perceived to be about 127 kilometers of roads per-square-km. This quite high, primarily because of the government's in- represents a road density which is about one-fifth that ability to deliver on guarantees and contractually obli- of the United States and just over half the road density gated adjustments, attributable to various political of Brazil. Roughly one-third of the network is paved. constraints. In addition, substantial uncertainty remains Most of the Mexican road system is currently about regulatory structure and conduct. SCT has not owned and operated by the federal and state govern- yet shifted its role from operator to monitor, and has ments. A few toll roads are privately operated by applied regulations and laws inconsistently.The inter- concessionaires, but these represent only a small per- nal evolution and reorganization of SCT have lagged centage of the overall road network.While the govern- behind developments in the private sector with the re- ment attempted an elaborate program of road sult that the existing regulatory system appears prone privatization in the early 1990s, private roads were a to regulatory capture. failure because of lower-than-expected traffic volumes and the impact of the financial crisis of 1994.The gov- Sector Performance ernment finally had to buy back most of these conces- sions at considerable cost. In June 1999 the Mexican highways network com- This experience with the toll road program has prised 92,932 kilometers of paved roads, about half of been the major factor in shaping private perspectives which were operated by the federal government and on Mexican transport infrastructure investments. The the other half by states (seeTable 5.1).The length of the scope and speed of the program,along with its empha- road network amounts to 321,368 kilometers, includ- sis on domestic construction companies and domestic ing non-paved and small roads.There were also 5,768 banks, resulted in extreme financial problems and the kilometers of toll roads, most of which were built dur- restructuring of all but three of the concessions. Be- ing 1990-1992 under the Salinas administration. cause the initiative was so vast, a majority of banks and the most important construction companies in the country were involved.The experience underlined the 61 Toll Roads Table 5.1 Mexico's National Road System, 1999 Classification Paved (kms) Non-paved (kms) Total (kms) Federal network 47,588 - 47,588 Free roads (managed by SCT) 41,820 - 41,820 Toll roads (autopistas de cuota) 5,768 - 5,768 CAPUFE roads 1,529 - 1,529 Private concessions 3,176 - 3,176 State concessions 1,063 - 1,063 State network 41,817 21,224 63,041 Free roads 41,223 21,224 53,424 Toll roads 594 - 594 Rural roads 3,527 154,193 157,720 Other roads - 53,019 53,019 TOTAL 92,932 228,436 321,368 Source: SCT. Dirección General de Planeación (DGP), 1999. Table 5.2 Characteristics of Main Road Corridors, 1998 Length % Upgraded % 4 Vehicle- Vehicles/ Operating IRI Estimated (kms) as of or more kms per day costs rating investment 1997 lanes (millions) ($/km) (1-6 required Corridor scale) (P$ million) (1) Mexico-Nogales 3,545 63% 60% 16.8 6,223 1.09 4.23 3,040 (2) Mexico-Nuevo Laredo 1,654 76% 68% 16.4 10,136 1.22 4.32 1657 (3) Queretaro-Cd. Juárez 1,639 83% 79% 11.4 6,680 1.06 3.86 582 (4) Acapulco-Matamoros 784 74% 70% 11.4 8,324 2.19 3.00 256 (5) Mexico-Chetumal 2,976 64% 36% 11.2 5,173 1.04 4.13 4,522 (6) Mazatlán-Matamoros 1,007 67% 52% 7.1 6,002 1.29 3.24 37 (7) Manzanillo-Tampico 1,006 47% 47% 4.6 5,437 1.25 3.42 180.0 (8) Acapulco-Veracruz 242 31% 55% 10.2 9,152 3.52 2.54 0.0 (9) Veracruz-Monterrey 1,292 57% 18% 6 5,768 1.21 5.59 1,296 (10) Tijuana-C.San Lucas 1,686 10% 10% 3.8 2,228 1.30 4.35 89 Source: SCT, Modernización del Sistema Carretero Troncal, 1998. As shown in Table 5.2, the federal network is than 85 percent of surface freight cargo.The network divided into ten main national axes (15,831 kilome- carries slightly less than 13 million vehicles per day, ters) that connect the most important production and about two-thirds of them cars. Following trucking consumption areas in the country, the most important deregulation in 1989 and the advent of NAFTA,truck- tourist sites, and all the major urban areas.The average ing activity has grown by 32.5 percent,and the author- daily traffic flow on the national axes varies between ized weight of vehicles was raised (from 34 tons in 2,000 and 10,000 vehicles, with about 21 percent of 1960) to 66.5 tons in 1997.The growth in both vol- the non-tolled federal network carrying more than ume and weight places new and growing demands on 5,000 vehicles a day on two-lane roads. Currently, 29 the road network, especially the federal system. Safety percent of the network has capacity problems.The state has improved markedly, although the accident rate of network comprises 63,041 kilometers of roads, of 0.8 accidents per million car-kms remains high. which 66 percent are paved. Most of these roads are Over 45 percent of the road network remains in free roads, with only 594 kilometers of state toll poor condition.By comparison,only 20 percent of the roads.67The untolled system involves many of the same Brazilian network is in poor condition. The mainte- corridors as the toll roads assumed by the government, nance and improvement of main federal corridors lag which reflects the constitutional requirement of a par- behind demand and many federal roads go directly allel free alternative. through central cities, thereby increasing congestion In 1999 road transport by bus and truck accounted and delays. Bypasses need to be built to improve traffic for 98.5 percent of domestic passenger traffic and more flows, especially for long-haul and trade-related traffic. 62 Toll Roads Road access to ports and border crossings is inadequate rescue of 1997. This is a huge and growing fiscal and there is a need to expand bridge capacity into the burden since toll revenues from the FARAC network United States. The interregional network is incom- have not been sufficient to cover interest payments on plete, while the secondary and rural road network has the debt. many gaps and is often of poor quality.In fact,since the Different strategies are being explored to finance 1980s the only significant additions to the federal and implement new road projects, including inviting network have been through the now defunct toll private funding for toll roads, which need to be better road program. integrated into the overall road system. Data collection The government currently plans to upgrade the and analysis for any future program of private partici- major national corridors, upgrade and extend the rural pation must not focus solely on each individual con- network, and construct bypasses around principal cession but rather on regional portfolios, or packages. cities.The road infrastructure program aims to raise the As the economy and traffic grow, there will be an op- percentage of the network in good condition to 80 portunity to securitize packages of the government's percent by 2001 and 100 percent by 2009, improve equity in toll concessions rather than the single prop- connectivity within Mexico, and increase integration erty securitizations that have been problematic in re- with the rest of the continent.The government is also cent years. In this regard, serious consideration is being considering different financing and administrative given to contracts for the maintenance and upgrading mechanisms that would allow it to devolve manage- of ten key commercial routes, including highways be- ment of the non-core part of the federal road network tween Mexico City and Guadalajara, Mexico City and to the states (approximately 20,000 kilometers). This Puebla, and Monterrey and Laredo. has been hindered so far by the lack of resources and Substantial scope exists for greater efficiencies in technical capacity at the state level. Under current operation, maintenance, and administration at revenue-sharing arrangements most states lack the CAPUFE. This is burdening road users with higher financial ability to adequately maintain the current tolls than necessary and siphoning potential revenues state road system. from new investment. The government's mechanisms for capturing CAPUFE surpluses,either through direct Government Policy and Strategy for the Sector transfers of cash balances or payment of fiscal obliga- tions (or derechos), remove the motivation for cost dis- Until the early 1980s Mexico continued to extend and cipline and foster a perception of tolls as an alternative deepen its road network through public investment, form of federal taxation, rather than as a means to fi- but the program was overtaken by macroeconomic dif- nance and optimize the use of strategic infrastructure. ficulties. The toll road program of privatization and The rate policies also have tended to follow an across- concessions of the late 1980s added some 6,500 kilo- the-board approach to keeping pace with inflation and meters to the network. This program, however, was are generally insensitive to elasticity variations among flawed and,ultimately,unsustainable,resulting in a gov- different facilities or user categories. Maximizing rev- ernment bailout of operators and takeover of the phys- enue should not necessarily be the main objective of ical infrastructure. tariff policy.Highways were built to be used and charg- After the rescue of the toll roads the federal govern- ing higher tariffs in order to generate a substantial sur- ment ended up owning about 50 percent of the roads plus (which is the case with CAPUFE) could imply a in the original program.68There are now three types of major misallocation of resources. roads under the federal system, with the re-national- In addition, the government has started to review ized or rescued toll roads under the FARAC trust fund alternative models for private participation in road in- separated administratively from the toll roads operated frastructure, signaling its awareness that private debt by the state through Caminos y Puentes Federales (CA- and equity alone are unlikely to be able to finance most PUFE).The government is in the process of restructur- new facilities. Some form of public support probably ing the debt overhang associated with the toll road will be required to make private investment feasible. 63 Toll Roads Examples of public commitments include: bidding for The institutional structure for the administration of minimum government investment; cash equity partici- tolled facilities is currently spread across many enti- pation; assumption of a subordinated debt tranche; ties--CAPUFE, SCT, and FARAC. FARAC is a trust shadow-toll payments directly from the government to fund, or fideicomiso, set up to manage the debt of the a concessionaire; or some type of ramp-up risk-shar- rescued toll system. SCT has oversight over FARAC ing. Banobras is already conducting operations with regarding technical decisions, while on financial mat- the states that involve minimum toll subsidies or capi- ters,Secretaría de Hacienda y Crédito Público has oversight tal contributions. Another option to be explored is a of FARAC. FARAC contracts out to CAPUFE the role for Banobras in providing or guaranteeing longer- operations and maintenance of the system and pays term financial instruments. CAPUFE 30 percent of its toll revenues. In itself FARAC does not have either the structure or the Institutional and Regulatory Structure power to make policy decisions. It is the only trust fund for the rescued toll roads, although other trusts As summarized in Table 5.1, the federal network exist for toll roads in the states.The establishment of (47,588 kilometers or 43.7 percent of the total net- various trusts for publicly owned facilities, each with work) is mainly composed of free paved roads, directly their own reporting and financial monitoring systems, managed by the Secretaría de Comunicaciones y serves to inflate costs, tolls, and overhead, and diverts Transportes (SCT). There are also 5,768 kilometers of needed resources from investment and debt service. toll roads under its control, whereas a separate body, Economies of scale are frequently foregone and the ex- CAPUFE, manages 1,529 kilometers of roads and pertise needed to operate and maintain the network to bridges. Concessions to private sector operators (3,176 high standards is diffused. kilometers) or to states (1,063 kilometers) make up the In addition, the diffusion of responsibility for high- remainder of the network. way infrastructure development makes planning and SCT is an integrated organization that does not sep- priority setting less coherent, potentially reducing the arate system funding and planning from maintenance benefits derived from scarce funding available for capi- and management.Recently,efforts have been launched tal investment. The result is a lack of consistency in to expand and improve the productivity of construc- maintenance standards and prices and poor connectiv- tion and maintenance activities, both through private ity across the different components of the road net- contracting and through more performance-driven in- work. In recognition of this, careful consideration is centives internal to SCT. being given to the idea of merging CAPUFE and Within SCT, the responsibility for the federal net- FARAC into a new holding company that would work is divided between two agencies.The Directorate allow the use of surpluses generated by the CAPUFE General of Federal Roads (DGCF) is responsible for network to meet FARAC needs and also increase co- upgrading roads as well as building new infrastructure, herence in the system.69 However, central to meaning- while the Directorate General of Road Maintenance ful institutional reform will be the ability to retain the (DGCC) is in charge of maintaining the road network. additional revenue streams derived from improved The DGCC is in the process of transforming itself efficiency and better toll administration in the from an operating agency to more of a policymaking highway sector. and monitoring agency. Operationally, DGCC has Finally,Mexico does not yet have an adequate regu- commenced a program which, if carried out fully, latory system to address issues pertaining to private would result in major changes in maintenance con- concessions. Regulatory risk adds to the cost of capital tracting,in decentralization of functions,and in decen- and can compromise the viability of private projects. tralization of highways and roads. In 1996, the DGCC Regulatory capacities,possibly in the shape of an inde- launched a national bid to contract out routine main- pendent transport regulator outside SCT,will therefore tenance services. Multi-year maintenance contracts need to be developed before privatization can begin were subsequently signed, covering 20,000 kilometers anew. SCT needs to be oriented toward a policy and (88 percent of the primary road network). role of setting standards and overseeing harmonization 64 Toll Roads and integration across transport modes, rather than its · Low financial feasibility of many concessions attrib- current operational focus. utable to the ambitious scope of the program.The concessions with the highest profit potential were Private Sector Participation Experience awarded first.The program was too extensive, how- ever, for each of the concessions to be financially Toll roads have been constructed and operated by self-sufficient.By 1990,as the program expanded to CAPUFE since the 1950s. However, Mexico's first roads with less traffic or with more costly construc- experiment with private concessions began in the late tion, the government began to offer concessions in 1980s. After the success of three demonstration which it contributed 25 percent of the cost. By projects, President Salinas announced in February 1992, only 4 of the 12 concessions awarded to date 1989, two months after taking office, a program to had reasonable returns, while 6 of the 12 faced build 4,000 kilometers of toll highways through negative returns. private concessions.These highways were an important · Short concession periods and resultant high toll part of the President's program to stimulate the then- levels.The minimum period award criteria encour- flagging economy. aged very short concessions--the average duration was 12 years and two were for only five years.Thus Program Design the maximum allowable toll was charged in Under the toll road program,SCT selected the roads to virtually all cases, resulting in some of the newly be offered for concession and specified the maximum built toll roads being almost empty on account of toll that could be charged,with future toll increases in- high tolls while the parallel untolled roads dexed to inflation.It provided preliminary designs,cost remained heavily congested. Truck traffic, in estimates,and traffic forecasts.Unlike the pilot projects, particular, fell below forecast levels, attributable not these projects were financed from private sources. only to high toll levels, but also to a lack of Construction contractors were to contribute 25 to 30 enforcement of weight and operational regulations percent of the cost--largely in the form of sweat eq- on untolled roads. uity,that is,by discounting their construction bills.Re- · Poor quality of feasibility studies.At that time, SCT maining costs were to be financed by debt from banks did not have the experience or the resources to or other sources. undertake appropriate design, cost, and demand The government partially guaranteed the cost and forecasts for such an extensive toll road program. It traffic projections. In the event that traffic flow was less also failed to anticipate that demand elasticities on than forecast, the government would compensate the the toll roads would be so much higher than owner by increasing the length of the concession.Sim- prevailing levels. ilarly, cost increases over 15 percent of forecast or · Underbidding and overvaluation of contractor caused by delays or design changes ordered by the gov- contributions. Contractors tended to overvalue ernment were also grounds for requesting a concession their contributions, especially when financial prob- extension. By early 1992, concessions for 3,600 kilo- lems began, since cost overruns led to concession meters had been awarded and 1,500 kilometers were extensions.The nationalized banks,some pressed by already in service. Each concession was bid out com- the government to lend to the concessions, also did petitively with the project awarded to the consortium not effectively monitor construction bills. that offered the lowest concession period, which, by Despite these problems, the government expanded law, could not exceed 15 years. the toll road program by an additional 2,000 kilome- ters. In total, the government awarded 52 concessions, The Failure of Privatization totaling 5,500 kilometers, between 1987 and 1994. Four basic problems undermined the success of the Most were given to private consortia, but some were Salinas government's attempts at road privatization awarded to state governments. The states themselves through concession: awarded approximately 20 additional concessions, al- 65 Toll Roads though some were never begun or were not completed Lessons for lack of financing. CAPUFE also participated in a The main lessons from the toll road experience are limited way:by 1996 it was operating 1,115 kilometers as follows: of its own toll roads, 29 toll bridges, 579 kilometers of Toll Road Programs Are Driven by Traffic and Demand toll roads, and six toll bridges under contract with Needs Rather Than Macroeconomic or Political other concessionaires. Considerations. Many of the concessions in Mexico faced low traffic volumes and high costs from the out- Public Bailout of Private Concessionaires set.To the extent that a proposed toll road is for new The problems with toll roads forced several rounds of construction where there is substantial cost and de- restructuring during the 1990s. Initially, SCT provided mand uncertainty, it is probably best not to award con- relief in the form of extensions to the concession pe- cessions on the basis of shortest term demanded by the riod, up to 30 years. But some roads had such severe bidder to deliver the program. A shortest-term crite- traffic shortfalls or cost overruns that extensions were rion is better suited to existing roads in need of up- insufficient.The government then began direct finan- grading or expansion to relieve congestion. In cial contributions toward operating toll concessions. addition, in the private sector, there is no substitute for The peso devaluation of December 1994 and the independent project evaluation. Many problems in ensuing recession further reduced traffic levels. Lower Mexico came about because designs and cost and de- revenues combined with higher interest rates had a se- mand estimates were accepted by concessionaires and vere adverse impact on private concessionaires, espe- lenders, sometimes unwittingly and sometimes based cially those that had borrowed internationally. In turn, on the existence of a government guarantee. the banks that had supplied much of the debt were Project Finance. The magnitude and speed of any toll themselves hard hit, so that they were unable to pro- road program should take into account the design, vide relief in debt restructuring. evaluation and implementation capacity of the govern- During negotiations with the concessionaires, the ment, lenders, and equity holders.The financial struc- government decided that the toll road crisis could not ture of the concession and of the participating be solved through financial restructuring alone, but re- organizations is also critical. Mexico's problems were quired reductions in the tolls being charged.An initial exacerbated by concessions that had too much lever- reduction in the average toll rate by 28 percent in 1995 age, and worsened by floating rate debt denominated did not prove to be enough. In late 1997, the govern- in international currencies. Project financial structures ment assumed all bank liabilities and temporary own- should have equity that is risk-bearing--discounted ership of 23 toll roads.Tolls were further reduced and sweat equity cannot absorb project risks such as cost the government ended up owning about 50 percent of overruns. Such structures may simply worsen a situa- the roads in the toll road program.70 tion by creating incentives to overstate contributions. The restructuring plan has been criticized on the The private sector must realize that most toll roads grounds that concessions with the highest leverage in are driven by domestic economic conditions. This the form of bank debt received the most support in the places a premium on using domestic finance where bailout, while more conservatively financed conces- possible. Moreover, if financial distress occurs, there sions or those with international borrowings did not may be incentives for the government to treat domes- receive the same level of benefit from the restructur- tic participants differently from international ones. If ing.The government estimates that the total cost of the major cost overruns or traffic shortfalls occur because bailout could reach as much as $7-8 billion.The con- of macroeconomic events,the government's ability and cessions that were not assumed by the government willingness to act on any guarantee may be limited. vary in their financial condition, with about half earn- Toll Roads Should Be Considered Part of theTransport Sys- ing a reasonable level of return. Of the remaining con- tem, and as Complements to Untolled Roads.The require- cessions, 15 appear to be in a weak financial position. ment that there be a parallel free road for every tolled road in Mexico had important implications for conces- 66 Toll Roads sion viability since it significantly raises the price elas- Toll Road Proposals May Often Be Feasible on a Mixed ticity of demand. Since Mexico's major roads initiative Basis, Using Both Public and Private Financing. Project for 2000-2005 is the improvement of 10 major corri- evaluation should try to determine how much financ- dors, almost all untolled, it is critical that the govern- ing the toll road might support, and then consider ment determine how the existing toll network would alternative concession designs to incorporate a public fit in with the corridor investment plan. Incorporating contribution. Consideration is currently being given relatively underutilized toll facilities into the highway for concessions based on the minimum present program would reduce investment needs and the fiscal value of payments from the government, as well as burden considerably. projects that would be bid based on minimum While Competition is Desirable, it Has To Be Fair. This government contribution at inception. As any single means that the government has to make sure that reg- government is inherently limited in its ability to ulations are consistently enforced,which has not always diversify its guarantee risks and since existing private been the case in the past. Indeed, truck traffic on the insurance products are limited in their applicability to Mexican toll roads has been well below forecast,in part developing countries, opportunities for joint products because of toll levels, but also because size and weight with multilateral development banks and other entities enforcement has been less effective on free roads. should be explored. Guarantees. Governments commonly seek consistency After the 1997-1999 crises in emerging markets,the of toll charges across concessions. This is most com- cost of capital for toll roads rose sharply--to the point monly done by specifying maximum tolls. If the gov- where many projects are no longer viable.While un- ernment also supplies design, cost, and demand certainty about demand and overall economic condi- estimates, the government also will have to provide tions has spurred the rise in the cost of capital, project guarantees of some sort.If guarantees are called regulatory risk also matters. From the outset of the upon, extensions to concession tenure or contract ex- program,the concession process should include the es- tensions are unlikely to provide much financial relief, tablishment of organizations and procedures to moni- especially in present value terms.This is especially true tor contract performance, to identify problems early, for new toll roads,which typically require long periods and to create dispute resolution mechanisms. for financial returns.The government should evaluate alternative approaches, such as debt service guarantees, Performance Post-restructuring revenue guarantees, or even buyout provisions. Performance comparisons can be constructed with Table 5.3 Comparative Performance ofToll Roads by Operator andType ofTraffic Number of roads % Change in traffic % Change in revenues Cars Jan 96 - Jan 99 Jan 96 ­ Jan 99 CAPUFE 13 45.0% 27.0% Rescued concessions 17 61.2% 32.0% Private concessions 16 28.6% 19.6% Buses CAPUFE 13 6.2% 3.1% Rescued concessions 17 57.4% 17.5% Private concessions 16 7.3% 2.8% Trucks CAPUFE 13 50.9% 32.5% Rescued concessions 17 170.4% 91.1% Private concessions 16 54.2% 74.8% Total ­ All vehicle Types CAPUFE 13 41.0% 25.2% Rescued concessions 17 74.7% 40.7% Private concessions 16 29.1% 30.0% 67 Toll Roads data on traffic and total revenues for the different network.This could provide the resources for needed groups of toll roads (CAPUFE, the government- spending on maintenance, upkeep, and for moderniza- operated rescued toll roads, and the toll concessions tion of the system, as well as stabilize the financial situ- that remained in the private sector). These data are ation of the sector and provide the basis for re-entering shown in Table 5.3 for the three-year period January the capital market for toll road financing.A rationaliza- 1996 through January 1999. Both traffic and revenue tion of activities would thus minimize the risk of hav- increases were significantly higher for the rescued ing to return to the government for servicing the debt concessions compared to those operated by CAPUFE of FARAC. or those concessions that were not bailed out by As the government further explores commercializa- the government. tion of the network, complementary reforms will be Automobile demand was found to have a price elas- required in management and accountability,in stabiliz- ticity of -0.75, with a corresponding income (GDP) ing funding for operations and maintenance, and in elasticity of 1.61. The price elasticity is somewhat clarifying oversight and regulatory responsibility. The higher than would be expected because of the require- experience with toll roads has made the Mexican ment that a parallel free road be available. The esti- public and the private sector skeptical of the whole mated trucking toll price sensitivity is -1.46, with a idea of private sector participation in this subsector. corresponding GDP elasticity of 5.16, showing how New initiatives in this respect must therefore start sensitive transport is to overall economic conditions, slowly and be less ambitious in size and scope to especially those related to trade.These estimates high- minimize risk, thereby ensuring the best chances of light the major difficulties the Mexican Government success, and avoiding the huge public bailouts of the has experienced in inducing the trucking companies to past. Other specific recommendations for future toll use the toll roads that were restructured. roads are as follows: An internal study by SCT evaluated eight traffic · Toll roads need to focus on specific niche invest- corridors by vehicle type for comparative operating ments that are either expansions of existing, con- costs of using the toll road versus the alternative free gested facilities (adding lanes to major arterial road.71 Using the toll roads resulted in lower direct op- roads), or that serve to reduce bottlenecks, such as erating costs plus time savings of 7-22 percent for cars, targeted bridge investments that are oriented to- 15-50 percent for buses, and 14-59 percent for trucks, ward densely traveled trade corridors.These proj- depending on the type of vehicle and the specific cor- ects have well established traffic patterns and tolling ridor. In monetary terms, the estimated cost savings histories, so that demand risk is reduced substan- (driven by time savings) were greatest for heavy trucks, tially. In addition, they are likely to have substantial ranging from $0.13-0.36 per kilometer. political support. · The government needs to rethink pending toll road Recommendations concession design.This may involve breaking con- cessions into smaller components (maintenance Currently, the major issue in the sector relates to the contracts for example) and to consider delaying poor state of the highway system, which is increasingly some project proposals.Restructuring and reducing in need of maintenance and improvement, but faces a the size of individual components of the program huge shortfall in resources to finance these invest- would help reduce the financial burden and gener- ments. Also, the toll road system, burdened with the ate business for more companies. These benefits growing debt obligations of FARAC, is in an ex- should be weighed against the gains from conces- tremely precarious situation.However,there appears to sioning regional packages that recognize the net- be substantial scope for generating savings from greater work character of the road system. operating efficiency in the CAPUFE system as well as · Alternative bidding and award mechanisms need to through synergies and economies of scale from run- be developed.This would include identifying those ning the FARAC and CAPUFE systems as a unified segments of the road network where a mix of pub- 68 Toll Roads lic and private participation would be possible. Notes Such projects might be bid on the basis of a mini- 67 Rural and other smaller roads, many of which are only open mum government equity contribution. As more during the dry season, add another 211,000 kms, constituting 65 experience is gained with negative concessions, a percent of the total network. The economic importance of these project utilizing shadow tolls could be attempted. roads is limited. This would allow the government contribution to 68 The government had planned to re-auction the concessions it took over within two years, but so far an unfavorable investment be made over time and could help restore the cred- environment and the low credibility of the private sector have pre- ibility of public commitments. vented this. Overall the government needs to develop a long- 69 FARAC must exist in order to preserve the framework of the ongoing debt-restructuring program.This requirement may be met term strategy for the sector, in which toll roads would through a "shell" which minimizes the overhead and administrative be viewed in the context of the road network as a difficulties of operational separation. whole.As a start, this implies the implementation of a 70The average real reduction in tolls was 8 percent for cars,16.7 more scientific and independent approach to rate set- percent for light trucks, and 25-29 percent for heavier trucks. ting. Given the low usage of existing toll roads that has 71 Instituto Mexicano delTransporte, SCT,"Un Análisis de Cos- tos de Operación entre algunas autopistas de cuota y vias libres alternas," resulted from the high and inflexible tolls that were mimeo, 1997. contractually mandated, it also may be time to explore cross-subsidy mechanisms that would allow these facil- ities to be used. In addition,the sector needs an autonomous regula- tor with transparent rules and responsibilities in order to minimize the uncertainties related to investing in road transport. A regulatory body of acknowledged professionals that would benchmark performance, and set tolls as well as ensure rationalization of the existing system would be an important indication of the gov- ernment's commitment to improving the environment for private participation in the sector. 69 6 Railroads The Mexican railway system has been largely priva- Government Strategy tized since 1997. Operational control and ownership of most railway assets have been transferred to The inefficient performance of FNM placed a heavy the private sector.The three most significant railroads financial burden on the Mexican government and the are now operated and owned by private consortia, and economy as a whole. Under FNM, the railway system a number of short lines have also been bought by required an average annual subsidy of $400 million be- private companies. tween 1990 and 1996. To promote greater efficiency Until railroad privatization starting in 1996,Ferrocar- and conserve public resources, the government de- riles Nacionales de Mexico (FNM), the state-owned cided to turn over ownership and operation of railway railroad company controlled by SCT, provided freight assets to the private sector. services in both the national and international markets. In May 1995 the Ley Reglamentaria de Servicios Fer- It also provided some inter-city passenger services. roviarios, a new law regulating railway services, defined By the early 1990's many of its operational indicators the conditions under which private participation in the (see Table 6.1) clearly depicted inefficiency, low levels railways would be allowed for the first time in 40 years. of safety, overstaffing72 and low productivity73 related Privatization involved the geographic separation of to the age and state of maintenance of track and FNM's assets and operations to set up a number of rolling stock. route-based companies according to pre-existing re- gional divisions, each of which was awarded a 50-year extendible concession title allowing it to operate, ex- ploit, and if required, build new lines.The second stage Table 6.1 Comparison of Specific Performance Indicators Before Privatization Compared to Compared to Performance indicator FNM levels similar countries developed countries Average haul 2,830 tons Fair Poor Train length 41 cars Fair Poor Average train speed 25 km/h Poor Poor Average daily distance 250 km Poor Poor Staffing level 7 employees/locomotive Fair Poor Investment $700/locomotive Fair Poor Overall productivity Below 1 million TU/employee Fair Poor 70 Railroads Table 6.2 Rail Privatization Process, September 2000 Railroad Bid solicitation Bids opened Result Ferrocarril Chihuahua al Pacifico Jun 1996 Oct 1996 No bids accepted. Later included in Ferrocarril Pacifico-Norte Ferrocarril Del Noreste Aug 1996 Dec 1996 Won and operated by Transportación Ferroviaria Mexicana (TFM) Ferrocarril Pacifico-Norte Mar 1997 Jun 1997 Won and operated by Grupo Ferroviaria Mexicana Ferrocarril Del Sureste Feb 1998 Mar 1998 Won and operated by TRIBASA Vía Corta Ojinaga- Mar 1997 Jun 1997 Won and operated by Topolobampo (SL) Grupo Ferroviaria Mexicana Unidad Ferroviaria Jul 1997 Oct 1997 Won and operated by Grupo Acerero Coahuila- Durango (SL) del Norte and Industrias Peñoles Unidad Ferroviaria Mar 1999 Jul 1999 Won and operated by Grupo Mexico Nacozari (SL) S.A. de C.V. Vía Corta Tijuana-Tecate (SL) Jul 1997 Dec 1999 Concessioned to the Government of Baja California Unidad Económica Mar 1999 July 1999 Won and operated by Compania Chiapas- Mayab (SL) de Ferrocarriles Chiapas-Mayab Unidad Ferroviaria Oaxaca (SL) Mar 1999 July 1999 To be sold Notes: SL= Short line. Source: SCT and Diario Oficial de la República Mexicana. of the privatization process was the sale of the shares The competition agency, CFC, can veto a partici- owned by the government in the concessionaire com- pant in the concession process on the grounds of panies through a public bidding process. Table 6.2 market concentration and potential monopoly abuse. shows the status of the process in September 2000.The In addition, foreign investors wanting more than government decided to first auction 80 percent of the 49 percent of the voting capital stock of a concession- capital stock of each of the companies and obliged it- aire require permission from the Foreign Investments self to sell the remaining 20 percent stake in each com- Commission (Comisión Nacional de Inversiones Extranjeras). pany through public offerings within 81 months. Most Concessionaires are free to set their own tariffs in of this process has been completed. As of September recognition of the extensive competition from trucks 2000 (ask transport cluster if any new information),the and the potential for competition between conces- concessionaire company, Unidad Ferroviaria Oaxaca, sions. Maximum prices are registered with the DGT- remained to be sold as well as the government's 20 TFM,which may intervene if no effective competition percent stake in Ferrocarril del Noreste. exists or if users complain. No subsidies (except for small public service obligations) or guarantees are Regulatory Framework and granted to overcome potential losses. Institutional Structure Concession Characteristics The 1995 railroad law retained regulation of the priva- Concessionaires have the exclusive right to operate tized Mexican rail industry within SCT, under the services and infrastructure for 30 years on their lines control of the Dirección General deTarifas,Transporte Fer- (18 for short lines), including the right to build new roviario y Multimodal (DGTTFM),a 250-person regula- lines within their rights of way.To counteract potential tory body that is also in charge of tariffs and monopoly power over exclusive domains and to pro- multimodal issues. The regulatory functions of this mote effective competition among operators, conces- body are now limited to supervision of the activities of sions were designed to share several common tracks concessionaires, formulation of a general policy for the around major urban and industrial areas (particularly, industry, and arbitration in the event of conflict among Monterrey and Mexico City) and ports (Tampico and concessionaires. Quality and technical regulation are Veracruz). also the responsibility of the DGTTFM. 71 Railroads Table 6.3 Main Results from Concessions Completed, December 1999 Railroad Bidders Winning consortium Transfer Date Ferrocarril ICA/UP/SBC (P$4.1 billion) TFM (TMM and Kansas City Southern) Jan 1997 Del Noreste Grupo Ferroviario Mexicano (P$4.2 billion) TMM/KCSI (P$11.0 billion) Ferrocarril Ferroviario Mexicano (P$3.9 billion) Grupo México, ICA and UP Aug 1997 Pacifico-Norte Grupo Ferrocarril GAN/Peñoles/Illinois (P$ 1.2 billion) FerroSur (TRIBASA) Aug 1998 Del Sureste TRIBASA (P$ 2.8 billion) Ferrocarril One bidder No bid above minimum Chihuahua al Pacifico (later included with FPN) Vía Corta Ojinaga- Grupo Ferroviaria Mexicana (P$255.7 million) GFM Aug 1997 Topolobampo (SL) U.F. Coahuila- Grupo Acerero Norte (GAN)+ Ind. Peñoles GAN/Peñoles Nov 1997 Durango (SL) (P$180 million) Grupo Mexico (P$101 million) U.F. Nacozari (SL) Grupo Mexico (P$ 20.5million) Grupo Mexico Feb 1999 Vía Corta Government of Baja California Dec 1999 Tijuana-Tecate (SL) Unidad Económica Cia de Ferrocarriles Chiapas Mayab Cia de Ferrocarriles Chiapas Mayab Mar 1999 Chiapas- Mayab (SL) (Grupo Genesse & Wyoming) (P$ 141 million) Grupo Mexico (P$ 62.5 million) Source: SCT and Diario Oficial de la República Mexicana. Table 6.4 Railway Concession Market Area Characteristics Indicator Pacific-North Northeast Southeast Short Lines Track (as a % of total) 30.3 19.3 10.7 38.7 Freight traffic (as a % of total) 46.2 37.6 8.6 7.8 Revenues (as a % of total) 44.7 37.1 9.8 8.4 Main cargoes Iron, Coal, Oil Corn,Wheat, Iron Corn,Wheat,Oil Vary across regions Major industrial cities Mexico City Mexico City Mexico City Several Monterrey Monterrey Guadalajara Guadalajara Major ports (*) Tampico (G) Tampico (G) Veracruz (G) None Manzanillo (P) Veracruz (G) Coatzacoalcos Laz. Cardenas Salina Cruz U.S. border crossings Piedras Negras Nuevo Laredo - Tijuana Ciudad Juárez Nogales Nogales Ciudad Juárez Mexicali U.S. connecting railroads (**) BSF, SP TM, UP - - Notes: (*) P= Pacific; G= Gulf. (**).The U.S. railroads are Burlington-Santa Fe (BSF), Southern Pacific (SP),Texas-Mexico Railway (TM), and Union Pacific (UP) Source: SCT (1996): Investment Opportunities in the Mexican Railroad System. In these cases, concession titles include detailed anism for the assignment of trackage and haulage rights mandatory access and connecting rights between con- will be needed.Such a mechanism should not discour- cessionaires. Prices of these rights are to be bilaterally age investment and should facilitate the determination negotiated between private operators, although SCT of trackage and haulage rights in the absence of effec- can intervene if no agreement is reached within 90 tive competition. days, or if any of the concessionaires request it.74 The If quality and technical performance standards are DGTTFM is currently working on a detailed method- repeatedly violated, concessions may be revoked.The ology to determine appropriate access prices. Since concession title includes safety performance indicators problems may re-emerge in the future,a flexible mech- (for example, accidents per train-km) and operational 72 Railroads performance indicators (locomotive availability, main- main companies. These lines represented approxi- tenance costs, energy consumption) which need to be mately 7,950 kilometers of track and about 12 percent reported every year to the DGTTFM. No explicit in- of the total traffic in the system. It was decided that at vestment obligations are required, apart from the tar- least six of them would be sold separately. gets set by the concessionaires in the business plans Mexico City's terminal, Terminal Ferroviaria Valle de submitted with their technical bids. These targets are México,has been privately managed since April 1998.It jointly revised every five years and the government is was incorporated into a separate company with its entitled to enforce the investment target unless excep- concession held by the three main railroads that had tional circumstances prevent a concessionaire from access to the metropolitan area. Each company owns meeting its target. 25 percent of the shares whereas the Mexican Govern- ment retains the remaining 25 percent, which will be Private Sector Participation Experience transferred to a metropolitan railroad at some point in the future. The results of the rail concessioning process, including With respect to passenger transport, apart from the value of the bids, are summarized inTable 6.3.The those lines already included in the concessions, routes concessioning of railway projects has proceeded in the that lack an alternative transportation mode are in- following stages: tended to be privatized through a least-subsidy based · Registration and authorization of interested parties. All auction. In other cases, passenger services were fore- interested parties need to obtain clearance from the seen to disappear since road transport was perceived to competition agency (Comisión Federal de Competen- be an adequate means of transport for the country. cia, or CFC) regarding their participation in the The restructuring process of FNM's core business auction in question.As mentioned earlier, the CFC initiated in 1995 has now been largely completed.The may veto a participant on the grounds of market remaining steps will be the privatization of any re- concentration and potential monopoly abuse. maining short lines and a commuter railroad for the · Technical-financial appraisal of the authorized partici- Mexico City area. pants. The appraisals are conducted by internation- ally recognized appraisers accredited in Mexico by The Impact of Privatization the Commission for Appraisal of National Assets Most private investors and government officials agree (Comisión de Avalúos de Bienes Nacionales). that railroad restructuring in Mexico has been a · Bidding. The Ministry invites bids for the shares of success.The reform process may be evaluated in terms capital stock of the Railway Companies.These in- of the overall performance of the institutional proce- vitations are published in the Gazeta Oficial de la dures created by the Railroad Law of 1995, the micro- Federación,or Official Gazette of the Federation,and economic impact of private operations on the in at least two newspapers with national circulation. efficiency and quality levels delivered to users, and the · Award and transfer. Once the technical proposals are macroeconomic impact on the fiscal deficit and unem- approved in accordance with the criteria estab- ployment level. lished in the invitation for bids, the awards are In general, the procedures described in the above- granted to the bidder that offers the best economic mentioned 1995 Ley Reglamentaria de Servicios Ferroviar- proposal for the state.The government reserves the ios have worked well.Most conflicts have been resolved right to cancel the sale if the highest bid is less than without much tension.When the desired objectives of the reserve price, which is kept secret until the bids the government were not achieved, contingency are opened. mechanisms provided smooth solutions that did not The main characteristics of the concessioned com- disrupt the remainder of the process. panies are summarized in Table 6.4. Several short lines Despite the termination of all labor contracts, no that served local markets were not included within the major social opposition emerged against the rail reform 73 Railroads Table 6.5 Performance Indicators After Privatization Performance indicator After privatization % Change since privatization/ 1997 Total volume of freight handled 75 million tons in 1998 Increased by 21.5% Ton-Km 49,554 ton-km in 1998 All time record Transit time (TFM) - Reduced by 36% Transit time (FerroMex) - Reduced by 20% Punctuality (TFM) 80% - Theft (TFM) - Reduced by 80% Theft (Ferromex) - Reduced by 50% Table 6.6 Macroeconomic Impact of Railroad Restructuring Item One shot Annual value Dynamic flow $ million $ million (NPV)78 $ million Proceeds from the sales 2,000 - - Savings in subsidies to FNM - 360 2,000 Concession canon payments - 2 - Leases and tax payments - 30 - Compensation payments - 250 - Labor adjustment payments 600 - - process.In most cases union leaders collaborated in the ance of the system during 1998 and 1999 has im- reform process and the changes in collective labor proved. More tellingly, no major complaints concern- agreements that followed.The process was successfully ing prices have been received either by SCT or the CFC. projected as a long-run strategy to save the sector. In addition,direct employment has been growing because Macroeconomic Impact of heavy investments made by concessionaires. Indirect The immediate revenues from the sale of the main employment generated by railroad industry suppliers lines and short lines during 1997-1999 amounted to at has grown as well. least $2.3 billion (including the estimated proceeds from the sale of the remaining short lines and assets to Performance Post-Restructuring be carried out during 1999). It is still too early to carry out a detailed assessment of The annual saving in subsidies during these years the impact of restructuring on the sector's overall per- has averaged about $360 million.77 There is an addi- formance. Initial figures provided by SCT are positive: tional canon payment to the state of 0.5 percent of the new operators invested more than P$3 billion on gross sales during the first 15 years of the concession maintenance of infrastructure and the renewal of (1.25 percent after year 16). Based on 1998 sales, this rolling stock during 1997-1998 and another P$3.3 bil- amount would be $4 million every year on average.In- lion is expected to have been spent during 1999.75 In come tax from concessionaires was $40 million in that 1998 the total volume of freight handled by the rail same year. Adding these three figures and discounting system in Mexico increased by 21.5 percent with re- them over the 50-year concession period at a discount spect to 1997. As a result of this traffic increase, most rate of 20 percent, the present value of these flows productivity and safety indicators have also improved.76 amounts to at least another $2 billion, assuming there Operating performance also seems impressive, al- are no large increases in traffic. though the poor quality of reference data has made On the negative side, as shown in Table 6.6, initial comparisons difficult.These results are summarized in investments and transaction costs associated with the Table 6.5. process have been estimated at $250 million. Another In general, partly attributable to a positive macro- major cost relates to labor adjustment payments.A total economic environment in the U.S., overall perform- of 45,000 workers were working at FNM at the begin- 74 Railroads ning of the restructuring process, and it is estimated Recommendations and Remaining Issues that the labor toll of privatization (workers neither re- hired by concessionaires nor retired) was about 20 per- Railroad reform in Mexico has not been plagued with cent of the initial workforce. Retirement and conflict as in other countries or sectors. However, four compensation benefits were paid out of the proceeds major sources of risk remain, relating to: (1) the con- of the sales. A retraining program was established for clusion of the privatization process; (2) the implemen- those workers not rehired by concessionaires.The total tation of true intramodal competition; (3) the liability is estimated at a maximum of $1.5 billion, in- integration of the sector within the country's overall cluding the disputed labor liability in FNM's balance transport system; and (4) the institutional changes re- sheet.The overall macroeconomic impact of the priva- quired to manage the transition.The main issues relat- tization of Mexican railroads has been tremendously ing to this set of risks are as follows: encouraging, even after including the costs of restruc- · Although the relative importance of passenger turing. According to government estimates, the net services is low, the government is still developing a present value to the country of the freight concession- final policy for the subsector. ing is about $6 billion.What is most important is that · Vertical monopolies may pose problems.The new the efficiency and competitiveness of the rail sector in rail concessionaires in Mexico are consortia formed the long run has increased. by diverse firms, with different capacities and ob- jectives, some of them spanning more than one Competitive Effects transport mode.The potential threat posed by ver- The railroad privatization model has incorporated sev- tically integrated monopolies or strategically domi- eral factors that promote competition among private nant conglomerates needs to be closely monitored. railroads. The potential for intramodal rivalry, which For instance, the ownership of Terminal Ferroviaria was one of the goals of the reform, is large. Intramodal Valle de México by the three trunk railroad competition has not yet affected tariff levels. Prices concessionaires, may face conflicts resulting from have increased with respect to past years, but since the owners' asymmetry in terms of traffic volume, services and quality have also risen, it is difficult to dis- number of connections with Mexico City's net- cern a general negative response.There appears to be work, and even in the price paid for their little difference between authorized (maximum) tariffs concessions. Other conflicts may arise related to and effective tariffs over the competitive tracks. the fact that they all have the same voting power and a majority of 75 percent is required for all Future Demand and Investment Needs decisions. If, for example, cargo volume discounts are introduced in the future, this could create fears For the medium term, the only major rail project in of discrimination. Mexico will be theTrans-Isthmus railroad inTehuante- · There is a need to encourage intramodal competi- pec,which will remain public for possible future devel- tion. The concessioning process was designed so opment. Following a political mandate from the that, where possible, no concessionaire would have Mexican Congress, SCT will create a corporation to exclusive access to major cities, industrial areas, or run the infrastructure and then offer open access to ports. This required the mandatory imposition of private operators in exchange for a price.It is estimated trackage and haulage rights on key routes and the that the investment required to run this operation, en- limitation of exclusivity rights in concession titles hance the existing infrastructure, and to make it acces- (by not hindering other companies from operating sible to the ports of Coatzacoalcos and Salina Cruz, the same routes, whenever they were willing to in- will be about $42 million in two years, plus P$15 mil- vest in parallel tracks). Transported cargo volume lion every year to subsidize operating expenses. may in the future permit the coexistence of more than one carrier.There is therefore an urgent need to develop a detailed scheme for defining access 75 Railroads payments, especially as additional trackage and Notes haulage rights are negotiated. A more flexible 72The ratio of employees to locomotives was 7:1, compared to mechanism for the assignment of trackage and the global standard of 1:1. haulage rights is also needed--one that would not 73 The overall productivity ratio, in terms of traffic-units (YU) discourage investment--in order to encourage the per employee, was below the benchmark of one million (with the development of competition among concessionaires, exception of the Pacific-North railroad). 74Variations in the bids offered by each concessionaire and the which has been slowed by conflicts over access.79 lack of a detailed methodology on how to include these in the ac- · Just as intermodal competition can have positive ef- cess rights has been a controversial issue that has prevented agree- fects,multimodal coordination must be encouraged ments between private operators. The Ley Reglamentaria de Servicios Ferroviarios does not address this issue in detail and considers only too. Until recently, intermodal traffic was basically maintenance and operating costs, the incremental costs associated non-existent in Mexico because of the lack of in- with the other firm's operation,depreciation,and a reasonable profit frastructure and inadequate services. To enhance for the access provider. competition with road transport and stimulate the 75 According to the concessionaires business plans, the present overall efficiency of the network, the new rail sys- value of investments during the next five years of private activity should be about P$13.0 billion. tem favored the regional separation of FNM to re- 76 For example, TFM transit times have been reduced by 36 move the possibility of cross-subsidies between percent, accuracy is now about 80 percent and cargo theft has been railroad routes. The major obstacles to achieving reduced 80 percent. FerroMex average speed has increased by 20 competition between the rail and trucking industry percent on several routes and theft has been reduced by 50 percent. Volumes at Terminal Ferroviaria Valle de México had increased by 15 include the lack of intermodal facilities,particularly percent during the January-May period in 1999 as compared to the with respect to international traffic, and the rela- same period in 1998, when it started operations. tively high power apparently enjoyed by trucking 77 Prior to privatization, $400 million was paid on average to associations. Better coordination is also needed FNM. Currently only $40 million is paid to compensate FNM for operating non-privatized short lines and unviable public service ob- among different bodies in the federal administra- ligations. tion (for example, regarding the enforcement of 78 NPV for savings are calculated over 50 years.For investment, trucking transport norms). it only refers to the first five years of operation. · Regulatory conflicts may appear in the future,once 79 For instance, in March 2001, Grupo México asked the CFC to intervene against TFM on the grounds that the prices being the initial impact of the short-term improvement of charged to it for access to tracks,interconnections,and terminals op- services dissipates.Yardstick competition would be erated byTFM in Queretaro and Monterrey impede competition. the natural instrument for such regulatory control. This would require an extensive and updated infor- mation database. To reduce uncertainty in the sector,it is necessary to complete the structural transformation of SCT. If regulation is kept within SCT there is a potential risk of regulatory capture that could be avoided, or at least minimized, with the development of an inde- pendent regulatory agency. The main role of SCT should then consist of establishing mechanisms that favor competition, such as a clear definition and pric- ing of access and trackage rights. Creating an inde- pendent agency with the regulatory capacity to supervise the privatized railroad system,especially from an informational point of view and designing adequate regulatory systems is urgent. 76 7 Ports Mexico's ports handled 85 percent of the country's including both bulk and containerized goods,made up total international trade, besides serving more than 7 8.5 percent of total tonnage.The movement of cargo million passengers in 1998.This traffic passed through by Mexican ports increased by 40.5 percent from 169 an extensive system comprising 108 ports and termi- million tons in 1990 to 237.4 million in 1998. Most of nals, distributed along the 11,500-kilometer coastline this increase (28 percent) took place after 1995,follow- of the country.Half of these facilities are located on the ing the reform of the port system. Passenger traffic Pacific coast, with the other half on the Mexican Gulf doubled during the period 1990-1998,while container and the Caribbean coast.80 traffic rose threefold, although its share compared to Most operational functions in Mexican ports have total general cargo remains low. been privatized since 1993, although ownership of Table 7.1 shows the relative evolution of different port assets is still vested in the government.The port types of cargo since 1992 as percentages of total cargo structure has been decentralized so that state-owned handled. General cargoes have a growing share, as do independent administrators manage each port. These dry bulk cargoes. Liquid bulk products have slightly administrators are required to concession various port lost share, although they are still the main category of assets and services to the private sector.With freedom cargo (62 percent). Liquid and mineral ore cargoes to- to set tariffs, ports now have to compete with each gether constitute 80 percent of the total goods passing other. Within each port, private operators compete through Mexican ports. with each other for concessions. The relative share of containerized cargo has been increasing. In 1998, more than 7 million tons of con- Sector Structure and Performance tainerized goods passed through Mexican ports, which implies a containerization index of 36 percent.81 The In 1998, about 72 percent of total cargo was handled increase can be largely credited to reforms introduced by eight main ports. Four of the main ports are on the since 1993.This level is, however, still well below the Atlantic coast and the other four on the Pacific.If oil is international containerization standard of 60 percent excluded, approximately half of total cargo movement which suggests high potential growth for container is accounted for by the following five ports:Veracruz, traffic in Mexican ports. Tampico, and Altamira on the Gulf of Mexico, and The ports of Manzanillo andVeracruz accounted for Manzanillo and Lázaro Cárdenas on the Pacific side. about 70 percent of the totalTEUs handled by the port The main cargo is oil and oil derivatives, with a system. These ports have the most modern container share of 62 percent, followed by mineral ores, which terminals of the country, and therefore enjoy higher account for 23 percent of total tonnage.General cargo, productivity and efficiency levels than other ports. 77 Ports Table 7.1 Type of Goods Handled: Evolution of Shares, 1992-1999 Type of cargo 1992 1993 1994 1995 1996 1997 1998 1999 General cargo* 6.33 6.67 6.70 7.18 7.32 8.39 8.41 9.68 Agricultural 3.56 2.71 2.81 2.82 4.50 3.67 4.41 4.40 Mineral ores 19.28 19.55 19.55 24.10 25.42 23.46 22.79 22.01 Oil and derivatives 68.90 69.32 68.64 63.96 60.68 62.57 62.09 60.86 Other liquids 1.93 1.75 2.29 1.93 2.09 1.91 2.31 3.05 Total 100 100 100 100 100 100 100 100 *Includes bulk and containerized cargoes Source: SCT. The improvement of the road network and the have an autonomous, self-financing Port Adminis- higher efficiency of railways have reduced the rele- tration, so that the government would only have a vance of cabotage (domestic maritime transport) in supervisory role over the system.This was achieved Mexico. Cabotage is now largely restricted to oil and by the creation of independent, publicly owned mineral ore traffic and accounts for only 30 percent of Port Administrations (Administraciones Portuarias the total tonnage handled by Mexican ports.Given the Integrales, or APIs) at each port or group of extensive coastline of the country, there is potential for small ports. more intensive use of this mode of transport. · Privatization required that the port industry be opened to the participation of private investors, Government Strategy both national and foreign, in the operation of ter- minals and other facilities, and eventually even in Under public ownership and administration, the the port administration. Mexican port system was inefficient and suffered large · Competition, between ports and between operators losses.Between 1990 and 1994,the port system needed within ports, necessitated liberalization of tariffs an average of 665 million pesos a year to subsidize op- and the elimination of cross-subsidies and barriers erations. Despite strong potential demand, the system to entry.Another necessity was the liberalization of used only about half its installed capacity. Labor pro- the labor market, so that wages and work condi- ductivity and overall productivity were low and invest- tions would be determined by market forces and ments in the port system were stagnant on account of firm-level bargaining rather than collective bar- the government's fiscal constraints. gaining. Port tariffs were also generally liberalized. Since international trade is critical for the Mexican Regulation is limited to cases where there is not economy, the government sought to improve the effi- enough competition between operators, with the ciency of the port system and increase capacity by de- Federal Competition Commission determining centralizing the system and reducing the role of the when tariff regulation is or is not required. public sector. Modernization and reform of the Mexi- can port system started in 1993 with the passage of a Regulatory Framework and Institutional new Ports Law that set up a legal framework to allow Structure private firms to enter the port industry as operators. Thereafter Puertos Mexicanos (PUMEX), the public The 1993 Ports Law created a new framework of insti- monopoly that had managed the port system, was dis- tutions with responsibility over ports.The federal gov- mantled. The federal government, however, retained ernment, through SCT, retains the role of port ownership of port assets. authority and is the agency that grants all concessions, The reform process rested on three key instruments: licenses, and authorization.82 SCT also acts as regula- decentralization, privatization, and the introduction of tor--in cases where competition is absent or is not competition in the port system. strong enough--by determining maximum tariffs to · Decentralization implied that each port needed to charge users. Safety and security is the responsibility of 78 Ports the navigation authority (Capitanía de Puertos),which is The concessioning process consisted of three independent of SCT. phases. First, concessions were granted by the federal Each port creates a Consultation Commission government to the APIs (Títulos de concesión). Second, (comprising the port administrator and representatives concession contracts were signed between APIs and from the federal, state, and local governments, business private operators for the use of port assets and the pro- associations, users, and unions), which is mandated to vision of services (Contratos de cesión parcial), and third, promote the port and make recommendations on mat- APIs were to be privatized. ters relating to the master plan of the port, tariffs, and environmental questions. Concession Characteristics The Federal Competition Commission (CFC) also The salient features of the concession contracts between plays a significant role in the port system through its the government and theAPIs and between theAPIs and participation in the concessioning process. Potential the private sector are summarized inTable 7.2. participants in auctions for concessions of port assets Potential private service providers and operators must be evaluated by the CFC,which attempts to min- need to apply to the API for a license or a concession. imize the concentration of market power after privati- If the service involves the exclusive use of some facil- zation.The main restriction is that a single firm cannot ity, the API is required by law to hold a public auction acquire a dominant position in the relevant market. to select the best offer.Once the winner of this auction is selected,a contract is signed between theAPI and the The Role of Port Administrators private concessionaire for a period that varies between The Administración Portuarias Integrales (APIs) are com- 15 and 25 years, according to the investment require- panies in charge of managing ports.They act as land- ments imposed on the operator.83 More detail on these lords, since the Ports Law precludes their acting as port types of contracts is provided inTable 7.1. operators and requires them to contract services with third parties.The board of each API must include rep- Private Sector Participation Experience resentatives from the states and municipalities, and some from the private sector.The APIs of the 16 main The reform has been extraordinarily successful so far. ports are owned by the federal government, while The decentralization process has been completed and there are five specialized ports (tourism, fishing, and independentAPIs have been created at each main port. those serving small markets) whose APIs are owned by Concessions have been granted for the operation of state governments. Acapulco is the only API that has the main terminals of the system and have resulted in been sold to the private sector so far, although substantial gains in efficiency and productivity. Finally, Topolobambo and Guaymas are in the process of being tariff liberalization has led to significant tariff reduc- privatized. The state-controlled APIs and the one in tions:tariffs are now equal to or are lower than those of Acapulco are distinct from the others--the API is also U.S. competitors. the operator of port services because of the size or spe- cialization of these ports. Impact of Privatization After February 1994, the APIs assumed port plan- Although the reforms are too recent to have produced ning, infrastructure management, and promotion, apart their full impact, they appear to have resulted in sub- from regulating safety procedures. At that time, the stantial improvements in efficiency and productivity, as APIs were authorized to grant concessions over port well as in the quality of service. In 1993, the port of assets to private firms, without permanently transfer- Veracruz was handling 43 containers/hour per ship. ring their assets to the private sector, and pay compen- This figure has now risen to 84 containers. Manzanillo sation to the federal government for the use of these now moves 65 containers/hour per ship, and Altamira publicly owned assets. All labor contracts and obliga- has achieved the international standard of 50 moves per tions directly between the government and workers hour. In Veracruz, the total capacity for loading/un- were terminated. loading agricultural bulk cargo improved from 2,500 79 Ports to 9,000 tons/day between 1995 and 1998, with the The impact of reform is reflected in the following port of Progreso showing similar improvement.Private key indicators: tariffs and costs, employment and pro- participation has thus induced significant changes in ductivity, investments, and fiscal impact. the port industry, in terms of investments in infrastruc- · Tariffs and Costs. Before sector reform, tariffs were ture and improvements in quality of service. set by the federal government and applied uni- Table 7.2 Details of Concession Contracts Concession contracts between Concession Contracts between federal government and APIs APIs and Private Operators (Títulos de Concesión) (Contratos de Cesión Parcial) Prequalification APIs must be companies established 1.Technical and administrative capacity according to Mexican laws, with 2. Operation and business plan, and negotiable shares labor strategy Obligations APIs had to abide by the Port Investment on infrastructure and Development Master Plan; equipment, according to proposed plan Elaboration of Annual Operative Plan Targets on productivity indexes, as Dredging and signaling detailed in the Annual Operative Creation of fund for port modernization Plan elaborated by API Environmental and safety regulations Environmental and safety regulations Payments API compensates SCT for the use of Private operator compensates infrastructure owned by federal API for the use of infrastructure government for its business Contracts APIs must grant concession contracts to private operators for them to provide port services The system of granting contracts must be a public auction Winner Selection Direct Higher annual payment to API Term 50 years, extensible 15-20 years, extendible. Example: container terminal of Manzanillo granted for 20 years Limitations SCT can oblige APIs not to perform any Private operators cannot have concessions port service directly, but to contract the on similar facilities at neighbor ports provision with private operators Ownership Maximum foreign participation: 49 percent No limits to foreign participation Operators or their associates are not allowed to own shares of API Operators or their associates cannot own shares of firms providing services on similar facilities at other ports on the same coastline Information Requirements Elaborate statistics regularly Provide API with statistics Elaborate efficiency and productivity indexes, on traffic and operations and set targets regularly Tariff Regulation Port tariffs set freely by APIs. Only for special Tariffs for port operations set freely by market conditions, some maximum limits will private operators if enough competition be established. exists, otherwise maximum limits are imposed. Applications to Federal Commission of Competition to determine need of regulation. Example: at port of Manzanillo a maximum tariff was established for a 4-year period Contract Renegotiation If term is extended, or when public share of If term is extended capital falls below 51 percent Conflicts API must respond directly to SCT Arbitration mechanism established: institution, Mexican section of Inter-American Commission for Commercial Arbitration. Each party selects an arbiter, and both arbiters select a 3rd member Sanctions Determined by SCT Penalties detailed by type of fault 80 Ports formly to all ports,without any reference to the real form of maximum limits or price caps.To promote costs incurred by specific ports. In January 1995, a incentives for cost reduction and innovation, the new system was established in which prices are set price caps are to be revised every five years to re- freely by market forces when feasible so as to reflect flect efficiency gains. The new pricing system has the costs generated.The new system sets maximum achieved substantial tariff reductions, so that han- limits that APIs may not surpass--essentially price dling costs for containers now are equal to or are caps.APIs are allowed to make discounts over these even lower than at U.S. ports that compete with maximum tariffs. The limits are calculated on the Mexican ports, such as Los Angeles or Houston. basis of each port's long-run marginal cost (operat- · Employment and Labor Productivity. Employment fig- ing and investment costs) and the limits are there- ures indicate that port labor reform has been suc- fore different for each port, but close to the level cessful (see Table 7.4). Port labor reform had the that would result from competition. objective of promoting free negotiation between The tariff for the use of infrastructure includes companies and workers, determining wages ac- the cost of capital incurred by the government so as cording to worker qualifications and effort levels, to allow APIs to cover operating costs and to re- and promoting incentive mechanisms that allow cover infrastructure costs.The idea is that the sys- companies to enhance labor productivity. In the tem as a whole would not require any external first phase, an agreement was signed between the subsidy for efficient operation, and that cross-subsi- government and unions to terminate all existing dies between ports would be eliminated.Moreover, contracts between public firms and workers. All the system promotes competition between ports, port workers were effectively dismissed by the gov- since APIs can lower tariffs to attract traffic. ernment and redundancy payments were paid to The reforms have also established a system of those legally entitled to receive them. Before the liberalized prices with regard to tariffs charged by changes, labor costs amounted to between 45-90 operators for port services (seeTable 7.3). Firms are percent of cargo handling tariffs. free to set prices provided there is a sufficient de- When negotiating the reform, workers ac- gree of competition in the market.When competi- cepted the proposal to eliminate the single union tion is absent or weak, regulation is imposed in the and create new unions by firm.84 In the new sys- tem, each firm negotiates wages and working con- Table 7.3 Change in Port Cargo HandlingTariffs ditions with its own workers.Wages are now paid by tons moved rather than days worked,which pro- Weighted average reduction vides the incentive to enhance labor productivity. for 5 large ports Dec 1998 Jan 1995 In terms of total employment, even though the Agricultural number of public port workers was dramatically re- Bulk Goods -34.5% - duced and unionized workers dismissed, total em- Mineral Bulk goods -24.5% - Palletized goods -21.7% - ployment in the ports sector (including private Containers -5.6% - operators) has increased. This may reflect the Source: SCT. greater number of users of the port system attracted Table 7.4 Port Labor Reform Indicator Before Reform After Reform Number of workers in the payrolls of PUMEX's delegations and related port public firms 4,200 824 Payroll of PUMEX's central offices 1,006 100 Workers linked to port operators: CROM unions (excluding Manzanillo) 4,835 N/A Manzanillo 2,100 4,200 Workers linked to port operators,Veracruz 6,647 8,260 Approximate cost of labor reform P$133.8 million 81 Ports by the increase in the ports' efficiency as well as the Table 7.5 Installed Capacity and Capacity Utilization recovery of the economy. Indexes published by SCT are ambiguous Performance Indicator In 1993 In 1998 about the impact of reform on port labor produc- Installed capacity 59 million tons 94 million tons tivity. In certain cases, as in Veracruz, productivity Capacity utilization 24 million tons 55 million tons improvements were clear-cut for all types of cargo. Capacity utilization (%) 40.6% 58.5% In other ports, performance has improved for some types of cargo and deteriorated for others. Table 7.6 Port Investments, 1995-1998 ($P millions) · Performance and Investment. Investments in infra- structure and equipment have generated substantial Year Total API Private Sector capacity increases within the Mexican port system. 1995 879 160 719 1996 826 181 645 Improvements in efficiency have increased capacity 1997 1,617 458 1,159 utilization. These indicators are summarized in 1998 1,773 687 1,086 Federal ** Table 7.5. Period 95-98 760 New investments have reduced disparities across Total. Period 95-98 ports, and have prevented bottlenecks at the ports of API+ Private+Federal 5,854 ** excluding API Veracruz, Manzanillo, Tampico, and Progreso. Total investment in equipment and new terminals was around 6,000 million pesos between 1995-1998, 62 Table 7.7 Financial Position of APIs ($P thousands) percent of which was private investment (see Table 1995 1996 1997 1998 7.6).The balance consists of public investment, mostly Revenues 510,832 951,048 1,263,572 1,718,832 made byAPIs with their own resources,that is,without Expenses 436,107 781,009 1,022,690 1,340,723 Profits 74,725 170,039 240,882 378,109 recourse to public budgets. Private operators are Tax paid 24,833 64,399 96,993 137,560 expected to invest 942 million pesos between 1999 Source: SCT. and 2000. · Fiscal Impact. Before reform of the sector, Mexican shares to investors.At present, there is only one private ports were net recipients of subsidies from the fed- API (Acapulco), and two ports are in the process of eral government. In contrast, the port system today privatization (Topolobambo and Guaymas).The dates generates resources for the government instead of and conditions for privatizing the port administrations draining them. Between 1990 and 1994, the port of the main ports have not yet been finalized. Oppor- system received an average of 665 million pesos a tunities remain for concessionaires to invest in expand- year. Since 1995 the system has been able not only ing the installed capacity of the ports. to cover its operating costs, but also to compensate the government through payments received from Remaining Issues APIs for the concession of port assets and taxes paid by APIs and private concessionaires (see Table 7.7). Despite the success of this well-structured and timely For instance, in 1998 the total amount of taxes paid reform process, there are lingering issues of concern. by APIs to the federal government was P$137.5 · Reduction of delays. Because of increased port effi- million. The sound financial situation has allowed ciency, waiting times have declined, but they could both APIs and private concessionaires to invest easily be cut further. While handling and service heavily in port infrastructure and equipment. time has been reduced as a consequence of invest- ments in modern equipment and increasing labor Future Demand and Investment Needs productivity,paperwork and administrative time re- mains high because of repeated lengthy, uncoordi- The last phase in the process of port reform is the nated administrative controls on ships and cargo.An transfer of APIs to the private sector by sale of their example is the inspection of goods by anti-drugs 82 Ports police units, which manually check cargoes. This centive would be to maximize profits over the takes longer than automated controls and leads to a horizon of its life as port administrator.The poten- higher likelihood of loss and thefts.Moreover,these tial for opportunistic behavior by private firms checks are performed on the cargo at every port of would necessitate the creation of a regulator to call, even if previous stops were at other Mexican guard against such undesirable practices. Regula- ports. Recognizing this, the port regulator is con- tion would limit the benefits of the privatized API, sidering the privatization of cargo inspection, and and consequently would reduce investor interest in the introduction of a degree of automation to re- the business. duce ship waiting times and the risk of cargo losses. The private agents most interested in acquiring · Ensuring that regulated tariffs reflect the gains from com- control of APIs would be the private operators that petition. Using yardstick competition would enable work in the port. However, Mexican port legislation the port regulators to avoid micro-managing tariffs prohibits concessionaires from acquiring shares in in the sector and ensure that tariff revisions indeed the API. Therefore, given that the business of buying reflect potential efficiency gains ­ but this requires an API and managing a port does not look attractive greater capacity and data than currently exists. for the private sector, one has to assess the alternative · Coordination between port authorities. This is impor- of keeping port administration within the public tant to reduce the high waiting times, which put sector. In the case that publicly owned APIs perform Mexican ports at a disadvantage in comparison their role efficiently, there does not seem to be any real with U.S. competitors. SCT has created a commit- advantage to be obtained by transferring this firm to tee to simplify administrative paperwork and ensure the private sector. better coordination between authorities. An option would be to award management con- · Effects of publicly financed investments on infrastructure. tracts for port administration to the private sector. The goal is to have self-financed ports (both for op- These contracts are shorter by definition, and the con- erations and investment), but the federal govern- tracted firm faces exceedingly low risk, since it works ment has a large program of investments ongoing, for an almost fixed payment and its decisions on in- possibly reflecting the shortage of private capital vestments do not affect its profits.This type of contract and the political preference for shorter concessions. has been tried with good results by some ports around Given the international financial environment, this the world (for example, port of Bristol, U.K.). may be a sound short-term solution to catalyze in- vestment. However, public investment, especially if Notes it differentially affects port access and infrastructure, 80 There are 22 ports dedicated to commercial activities, 77 can distort competition between different ports in fishing ports,22 tourist ports,and 25 oil ports.Ten terminals special- the system. Since the government's objective is ize in oil and mineral ore traffic. 81 Defined as the ratio between containerized cargo and total competition between ports, it is advisable to allow general cargo. ports to take their own decisions on investment and 82 The federal government (through the SCT) can also grant allow markets to point out where these are required concessions over port assets (berths, terminals, etc.), which are without interference from the public sector. publicly owned but located outside the API management area.This is the case with specialized facilities destined for industrial uses, · Risks regarding the privatization of the APIs. The last fishing ports, etc. phase in the reform process was to transfer the 83 A license is the sole requirement to provide simple services ownership of theAPIs to the private sector.This has such as towing and pilotage. Ports that have multi-use berths rarely been attempted elsewhere in the world since can authorize stevedoring firms to provide loading/unloading services with their own equipment, thus promoting competition a private firm has limited incentives to perform the between them. tasks of a port administrator exclusively, that is, 84 Since the old system was controlled by only a few union without any interest as a port operator. A private leaders, the number of workers who benefited from the reform was API in charge of managing a port might not be probably greater than those who stood to lose. This may explain the low level of conflict observed in Mexico compared to other interested in investment for the future, since its in- countries that have reformed their port systems (such as Brazil). 83 8 Civil Aviation After an unsuccessful attempt at deregulation in the 1997. SCT estimates that approximately $3 billion will early 1990s, the civil aviation sector in Mexico is cur- be needed for fleet replacement over the next rently state-dominated. The federal government and five years. the Institute for the Protection of Bank Savings (IPAB) The advent of an expanded open skies agreement hold the majority stake in Controladora Internacional del with the United States beginning in 1999 has led to Transporte Aéreo (CINTRA), a financial holding com- the combination of smaller regional jets and additional pany that controls Aeromexico and Mexicana (the gateways making many thinner markets viable as main Mexican passenger carriers), Aeromexpress (the spokes to hub airports in Houston and Dallas-Fort largest cargo carrier),the main regional airlines,and as- Worth. Alliance relationships (Mexicana-United and sociated service providers.The commercial airline in- Aeromexico-Delta), if maintained, should create a dustry, consisting of trunks, regionals, charters, and highly competitive market for air services between the cargo-only airlines,declined from 31 to 22 carriers be- United States and Mexico. tween 1994 and 1997 as a result of financial problems, management issues, and a more aggressive government Sector Performance policy toward certification and operational oversight. In 1997,total commercial demand was about 33.5 mil- After a period of financial difficulty following the lion passengers, with a compound annual growth rate deregulation of the industry in 1991, the overall finan- of just under 6 percent between 1991 and 1997. Do- cial performance of Mexican airlines (dominated by mestic passenger growth is forecast at 5-7 percent Mexicana and Aeromexico's results) began to improve annually through 2005, with international growth of in 1994.The industry turned a profit in 1996 with a 9-12 percent annually. strong performance in 1997.The improved perform- Overall, Mexican airlines carry about 66 percent of ance continued through 1998 and 1999, despite the total passengers, with domestic passengers representing fact that rising fuel prices and enhanced international about 68 percent of total passengers carried. In inter- competition from U.S. carriers negatively affected re- national service there is strong competition from U.S. sults. In addition, the commercial fleet is quite old (av- airlines,which have held a market share between 55-60 erage age just under 20 years), and the improved percent in recent years. Cargo operations have grown financial performance will need to continue in order at a compound annual rate of 14 percent, which is to finance new equipment in the coming years. This forecast to continue in the medium term. However, heavy investment burden means that there will be con- Mexican airlines have steadily lost share in this impor- tinuing pressure for productivity gains and for lower tant market, from 59 percent in 1991 to 44 percent in infrastructure charges. 84 Civil Aviation The turnaround in performance in Mexicana and with the United States has opened up many new Aeromexico was not matched in the rest of the sector. routes as code-sharing gateways. In other international The regional airlines have suffered from a growing markets, Mexican aviation policy has been to liberalize debt load, and are now operating at or below break- within specific markets, but to maintain restrictive air even levels.The same is true for charter and cargo air- agreements with Latin American countries seeking lines. The marginal performance of these airlines is "beyond" rights to stop in Mexico and then continue important because they play significant roles at smaller on carrying passengers to the United States. airports and can also affect the financial health of major airports and the associated packages of concessions.For Government Strategy instance, the grounding ofViasa,AeroPeru, and others has not only affected service and fee revenues at smaller The growing economy and poor performance of the airports,but also required adjustments at major airports main Mexican carriers spurred deregulation of the until substitute service could be found. airline industry in 1991.The new policy allowed for- mation of new airlines, aided aircraft acquisition, and Regulatory Framework and Institutional virtually eliminated restrictions on route entry.This led Structure to major capacity increases on trunk routes,resulting in fare wars, predatory pricing, ill-qualified airlines, and Public regulation of civil aviation is the responsibility poorly trained personnel.At the same time more open of SCT, through the Dirección General de Aeronáutica bilateral agreements were signed. This led to the ex- Civil (DGAC), which is the body in charge of airline pansion of flights from other countries to major Mex- authorization. It is also responsible for technical regu- ican destinations, especially by U.S. carriers, and a lation and safety standards for airlines and airports.The major negative impact on Mexican carriers. However, DGAC monitors industry performance with an oper- these industry and policy changes were not accompa- ational reporting system that is more efficient than that nied by better oversight or the reform of public regu- of most other countries in Latin America.Air naviga- lation.A new law on civil aviation was not passed until tion is the responsibility of Servicios a la Navegación en el 1995 and, perhaps more important, a regulatory struc- Espacio Aéreo Mexicano (SENEAM), a separate body ture and guidelines were not put in place until 1998. controlled by SCT.The airport authority,ASA, assigns In 1995, faced with the imminent collapse of landing slots jointly with SENEAM and the airlines Aeromexico,the government coordinated a restructur- according to a system that emphasizes seniority, thus ing in which a holding company,CINTRA,was estab- favoring companies with existing allocations. lished to operate both Aeromexico and Mexicana. The implementation of a new air code in 1995 and The process resulted in government ownership of 66 supporting regulations in 1998 has given Mexico a percent of CINTRA.While the two airlines have been sound regulatory base for the oversight of the civil maintained as separate entities, cost-sharing measures aviation sector.Moreover,the safety record of Mexican and coordination have been implemented, and finan- airlines in recent years has been good.The authorities cial and operating performance greatly improved (see have been active in inspections and certification, with Table 8.1).The group is now the 15th largest company the leading example being the grounding of Taesa in in Mexico and contributes between $100-150 million 1999 after safety and operating violations. annually to the government through taxes, duties, and Currently Mexican law does not allow foreign profit participation. ownership of more than 25 percent of domestic air- Antitrust issues have been a major concern in the lines.Along with the system of allocating airport space, industry. In October 2000 the competition agency, general obstacles to granting concessions,route permits CFC, ordered the break-up of CINTRA in order to and frequency expansions, this has proved to be a bar- induce competition in the domestic market and lower rier to entry into the domestic market. In terms of in- the price of air transport in Mexico.85 CFC contends ternational travel, the expanded open skies agreement that as a result of its dominant position, CINTRA's 85 Civil Aviation Table 8.1 Aeromexico and Mexicana: Result Indicators, 1995-1999 (millions of 1999 pesos) 1995 1996 1997 1998 1999 Aeromexico Gross operating profit (loss) 207 725 1063 533 638 % w.r.t. operating income 2.0 6.7 9.3 4.7 5.3 Mexicana Gross operating profit (loss) 848 1099 1270 499 753 % w.r.t. operating income 8.4 10.8 11.5 405 6.7 Source: SAI, Summary of the financial evolution of Aeromexico and Mexicana 1996-99, May 2000. On the CFC website. subsidiaries have set fares at levels higher than those external financing. The limit on foreign ownership that would have prevailed under competition.The low may make it more difficult to raise the necessary funds market share of competitors to CINTRA, combined for this. with the low financial capacity of potential entrants The CINTRA issue is an important indicator of the and existing institutional and regulatory barriers to independence and power of the competition agency entry have limited competition in the domestic relative to the sectoral ministry and private interests.Its market.Furthermore,CFC contends that the improved resolution will send a strong signal regarding the im- financial performance of Mexicana and Aeromexico portance attached by the government to a strong pro- shows that each could stand alone and that greater consumer competition policy. improvements in productivity and lower fares In this regard, the dominant position of the two would result from enhanced competition within the major carriers in the domestic market means the CFC domestic market. will need to continue to be vigilant regarding collusive In addition to the belief that competition creates practices irrespective of whether the break-up goes incentives for achieving cost and quality efficiencies, through or not. In particular, non-discriminatory ac- CFC's philosophy is that the existence of two major cess rules need to be developed and ownership struc- competitors in domestic air transportation reduces sys- tures in the industry must be closely monitored to temic risk and the sector's vulnerability to adverse cir- ensure that barriers to entry are lowered. At the same cumstances (with the consequent need for a time, it is important that Mexico's domestic air trans- government bailout). Moreover, it is important for so- port industry remain healthy so that the fruits of com- cial and equity reasons to increase access to passenger petition continue to accrue. The CFC has noted the air transport services in Mexico (currently only 1 per- need to be vigilant in order to prevent a recurrence of cent in modal share). CINTRA's own estimates are the destructive price competition and predatory prac- that a 10 percent decline in air travel fares would in- tices of the past. crease demand by 12 to 14 percent. In light of the law limiting foreign ownership of Mexican airlines to 25 percent, CFC believes that Notes competition would most effectively be generated by 85 CINTRA's holdings combined control about 70 percent of the splitting CINTRA and divesting the government's domestic market, including 80 percent of domestic passenger traffic ownership share.As of January 2002, the break-up and as of December 1999. sale of CINTRA was being considered by the Execu- tive branch and Congress. Remaining Issues Given the huge financing needs for fleet replacement, Mexicana and Aeromexico (especially Mexicana) will require strong internal cash flows as well as substantial 86 9 Airports Sector Performance and Characteristics percent in 1990. As of 1998, the six major airports in the country (Mexico City, Cancún, Guadalajara, Ti- Of Mexico's 83 civil airports, 58 of these are operated juana,Monterrey,and PuertoVallarta) accounted for 71 by Aeropuertos y Servicios Auxiliares (ASA), a public cor- percent of passenger traffic and 45 percent of opera- poratized entity.About two-thirds of commercial oper- tions. This has important implications for the airport ations are domestic and one-third are international. concession program as regional packages are more at- Annual growth in operations between 1990 and 1997 tractive in a decentralized system. averaged 3.5 percent while passenger growth has risen at an annual rate of 5.7 percent.Table 9.1 demonstrates Government Strategy the evolution of traffic and operations at ASA airports over the past decade. Existing capacity and ongoing The government's fiscal constraints have meant that ASA investment were able to accommodate most public investment has lagged behind growth in airport growth in the 1990s with the principal exception of activity.As a consequence,in 1995 the government de- Mexico City airport, which has suffered from conges- cided to offer concessions to the private sector for the tion and delays at peak periods.Annual growth of 7.6 operation of the 35 major airports currently run by percent is forecast for the period 1997-2001, which ASA, all of which are deemed profitable. will soon necessitate extensive investment to serve The Airports Law (Ley de Aeropuertos) that author- both commercial and general aviation. ized private participation was enacted in December Airport activity, while still concentrated in the 1995, and in February 1998 general guidelines for pri- major cities, is beginning to decentralize with the ex- vate investment in the Mexican airport system were pansion of trade and tourism and the opening of more published in the Gazeta Oficial de la Federación. These international gateways through bilateral agreements. guidelines provided for the creation of majority gov- Notably,Mexico City's share of the country's passenger ernment-owned entities--each would be granted a traffic has declined to 34 percent from more than 50 50-year concession to operate a specific airport, with Table 9.1 ASA Airport Activity, 1990-1997 1990 1991 1992 1993 1994 1995 1996 1997 Passengers (millions) 34 37 42 46 53 45 46 50 Total flight operations (`000) 1,087 1,239 1,276 1,427 1,500 1,345 1,346 1,380 Air cargo (`000 tons) 164 181 207 249 282 277 326 335 Source: ASA Annual Report, 1997. 87 Airports partial privatization to occur in stages.The law allows All concession packages are subject to a form of for up to 49 percent foreign investment, although the price-cap tariff regulation, with adjustments for infla- National Commission on Foreign Investment may tion and for investment program additions and modifi- subsequently waive this requirement. cations. Specifically, a maximum tariff is to be Concessionaire entities are grouped under a con- developed and applied to a basket of services at each trolling entity, which owns the shares of the conces- particular airport. This tariff is to be re-established sionaire entities. The first stage in the privatization every five years, depending on actual traffic volumes in process involves the selection of a strategic partner comparison with forecasts. In the interim, tariff adjust- (which must include a foreign investor with experi- ments will occur to take account of efficiency and pro- ence in airport management) to hold 15 percent of the ductivity gains.86 controlling entities equity.The remaining shares are to A key question is whether the concession contract be offered to the public in the second stage.The strate- will be overseen by SCT or a (proposed) Transport gic partner is responsible for the operating, financial, Regulatory Commission.The institutional mechanism investment,commercial and marketing functions of the chosen--airport packages--is complex and involves airports, the development and transfer of technology, substantial transaction costs.The interaction among the and the training of employees. different public bodies,ASA, SENEAM, DGAC (tech- nical and safety regulation of both airlines and air- Regulatory Framework and Institutional ports), and private partners will require bilateral or Structure even trilateral contracts, with a consequent potential for conflict and coordination failure. Prior to 1998, ASA was responsible for infrastructure requirements and for providing or contracting for Private Sector Participation Experience aeronautical services. ASA has been independent of political patronage and has sustained an aviation infra- The airport privatization program was launched in structure that has operated reasonably efficiently. Air 1998 with the identification of 35 airports to be in- navigation services are in sound condition. Mexican cluded in four concession packages. These airports, radar coverage is complete and quite reliable, and there which handle 97 percent of total passenger movements has been a consistent investment program to introduce in the country,were to be transferred from public con- ILS approaches and to upgrade ground-based naviga- trol to private operation.The remaining airports would tion systems. Even after concessioning of the airports, be retained by ASA and financed through the revenues air traffic control will remain the responsibility of SE- received from the four packages that would be sold. NEAM (Servicios a la Navegación en el Espacio Aéreo The 35 airports to be privatized have been divided Mexicano, which is controlled by the SCT). Also, fuel into four groups for auction purposes according to ge- revenues, which represent between 40-50 percent of ographic location and internal homogeneity (for ex- operational charges, will remain under ASA control ample, tourist airports and domestic ones). The four (for fiscal and safety reasons). controlling entities set out in the program are the: Following privatization, the operation of airports · Mexico City Group, comprising Mexico City's will be governed by a master concession that will lay Benito Juárez airport (17.8 million passengers/year down the terms of provision of airport services,such as and revenues of $250 million in 1997) the maintenance of runways, communications towers, · Northern-Central Group, 13 airports, including and safety functions. It will also describe the terms of those of Monterrey and Acapulco (8.1 million pas- complementary services such as baggage handling, fuel sengers/year and revenues of $120 million in 1997) sales and ticketing, and commercial services, including · Pacific Group, 12 airports, including those of airport stores and restaurants.Minimum investment re- Guadalajara and PuertoVallarta (12.9 million passen- quirements are to be specified for the initial period. gers/year and revenues of $200 million in 1997),and 88 Airports Table 9.2 Main Characteristics of the Airport Groupings for Concession Mexico City North-Central Group Pacific Group Southeast Group Number of airports 1 13 12 9 Passengers 1997 (millions) 17.8 8.1 12.9 9.3 Annual passenger growth 1990-1997 5.9% 3.6% 5.2% 7.6% % International passengers 33% 22% 34% 53% Operations 1997 (`000) 249 341 378 192 Revenues 1996 (millions of constant pesos) 2,228 979 1,820 1,214 Revenue without fuel sales 1996 852 390 620 440 Operating profits 1996 432 151 258 218 Source: ASA Annual Report, 1997. · Southeastern Group, nine airports, including those take six years and is likely to include government as of Cancún and Mérida (9.3 million passengers/year well as private sector investment.However,major issues and $150 million in 1997 revenues). need to be resolved with respect to choosing the site Table 9.2 summarizes the operating and financial and monitoring environmental considerations before aspects of the four packages.The packages differ widely private capital can be raised for the program. in traffic volumes and growth rates, in the share of in- ternational traffic, and in their revenues and profitabil- Remaining Issues ity.They also differ markedly in their investment needs and the potential to improve commercial performance. The key issues to be resolved from the perspective of the private sector are completion of the airport con- Impact of Privatization cession process, regulation of the new concessions, and the ownership structure of airports in the longer term. It is still too early to evaluate the results of the privati- The bundling of airports with diverse characteristics zation process.The first package to be awarded was the (type of traffic, scale of operation, etc.) implicitly cre- Southeastern Group, which was seen as the most at- ates a structure of cross-subsidization. Although this tractive financially, since Cancun has a new airport can be positive from the point of view of risk diversifi- with little investment required and with strong and cation,private investors may have a different idea of the growing demand. In December 1998 control of the business potential of each airport and could possibly Southeastern Group was awarded to Azur, a consor- have preferred a differing ordering. If preferences are tium of Mexican, Danish, French, and Spanish in- widely divergent, the sale or the price obtained from vestors.87 The concession for the Pacific Group was the remaining groups--particularly the North-Central awarded to a consortium with Mexican and Spanish Group--could be affected.The government should be capital in August 1999,88 and the North-Central prepared to address this contingency. Group to a consortium with Mexican and French cap- The government needs to think of how it will en- ital in June 2000.89 force the cross-subsidies inherent in the packages. The remaining 85 percent stake of the Southeastern Will the concession contract be overseen by SCT or Group concession was sold in a public offering in Sep- by the (proposed) Transport Regulatory Commission? tember 2000. Minority investors now own the major- The institutional mechanism chosen (airport packages) ity of shares.The packages for the Pacific Group and is complex and involves substantial transaction costs.As the North-Central Group (financially the least attrac- in other sectors, regulatory mechanisms should have tive regional package) are expected to follow suit with been in place at the outset of the concession program. initial public offerings in the next few years. It is vital to ensure consistency and coordination be- The final concession involves the tender of Mexico tween the various actors and public institutions in- City airport, which may include an obligation to build volved: the ASA, SENEAM, and DGAC. a new airport.The construction of a new airport could 89 Airports A final issue that needs to be addressed is clarifica- Notes tion of the ownership structure of airports in the long 86 Thereby making this program similar to the U.K. RPI-x term.Would it be acceptable if eventual flotation allows price-cap system. a private entity to control a majority of the Mexican 87 The consortium was formed by GrupoTribasa, Copenhagen airport system? Would such a change in ownership Airports, Grupo GTM and Grupo Ferrovial. It was selected over six affect the management contract? other groups (all made up of both Mexican and foreign investors). The consortium won by offering P$1.165 billion ($117 million) for 15 percent of the shares.The private partner has the option to pur- chase an additional 5 percent of the shares and may sell up to 5 per- cent three years after the initial public offering.While the concession is for 50 years, the consortium has entered into a 15-year manage- ment contract.All risks and responsibilities are to be split among the project's private partners. 88 The winning consortium consists of Grupo Empresarial An- geles S.A. de C.V., Inversora del Noreste, AENA Servicios Aeron- aúticos, S.A., and Grupo Dragados. 89 The winning consortium consisting of Constructoras ICA S.A. de C.V.,Aeroports de Paris, and Societé Generale d'Entreprises SGE, paid $90.8 million for the 15 percent stake available. 90 10 Multimodality and CommercialTransport An important challenge remaining for the transport in the share of road transport for freight from 1994 sector in Mexico is the need to develop greater coor- levels and a compensating increase of 3 percent in the dination between modes in order to create an inte- share of rail over the same period. With the share of grated transport system and ensure a more efficient use freight moving by rail increasing, the pressure has of transport infrastructure with consequent gains.90 heightened for improved intermodal coordination. Table 10.1 presents the current distribution of trans- This will also result in greater competition between port modes in Mexico, which is similar to that in most multimodal businesses.While the performance of ports Latin American countries.91 Raw materials inventory has improved significantly in terms of turnover time levels in Mexico are 58 percent higher, while levels for and most other indicators (including the transfer to finished goods are 46 percent higher on average than in trucks) the level of containerization of Mexican freight the U.S.This indicates a potential for Mexico in terms remains low at 36 percent. This is an important of cost savings and gains in international competitive- requirement for integration of the transport network. ness deriving from improved inventory management, just-in-time delivery, and efficient supply chains.92 An Impact of Reform integrated transportation system,with smooth transfers of goods and passengers across modes, is key to the de- In 1995, after several unsuccessful attempts at multi- velopment of efficient supply chains. modal regulation, SCT gave up the idea of regulation Road transport is the predominant mode in Mexico for agents providing integrated intermodal services, and for cross-border trade with the United States since deciding that neither the multimodal operator nor freight transport relies primarily on trucks. The im- cargo agents required strict regulation.This was based provement in rail services has led to a 3 percent decline on the thinking that they are basically commissioned Table 10.1 Modal Distribution ofTransport Services for Mexico's InternationalTrade, 1999 Freight Passengers Millions of tons % Thousands % Roads 417 57.2 2,720 98.5 Rail 80.4 11.0 0.8 0.0 Maritime 231 31.7 7.5 0.3 Air 0.4 0.1 33 1.2 Total 728.8 100 2,761.3 100 Source: SCT website. 91 Multimodality and Commercial Transport traders and hence should be subject to commercial law. The Government of Mexico is well aware of exist- For terminals, SCT simply requires a special permit ing problems and is working closely with the private that allows the government to monitor the perform- sector to resolve outstanding issues and increase con- ance of multimodal infrastructure by obtaining infor- nectivity between the ports and rail and road networks. mation from potential terminal operators and ensuring For instance, the government and the railway compa- quality control at entry into the business. nies are both making investments to upgrade bridges As of 1999, Mexico had 17 multimodal port termi- and tunnels on the line going from Manzanillo to nals, 26 railway terminals and two dry ports (where Guadalajara and between Lázaro Cárdenas and merchandise is tax exempt while stored). In addition, Coróndiro-Las Truchas to allow the use of the latest seven permits for new intermodal installations and two container transport technology (double deckers). The dry ports have been allowed. In part, this reflects the government is building a road from Lázaro Cárdenas to success of the railways privatization program,which has Morelia,and recently a new road toVeracruz was inau- generated significant new interest in multimodality gurated. At the same time, access to Manzanillo, since the new operators are competing for market share Altamira, andTuxpan is being improved. through better facilities,better service,and lower tariffs. Currently, the main problem facing local providers Rail and road access to port facilities and distribution in the door-to-door business is not legal or regulatory, centers, however, still needs improvement. but the difficulty of finding adequate insurance cover- age because of a lack of security and protection Remaining Issues for cargo. International operators manage more easily, although they too cannot get coverage for lost or Logistics costs remain high, which requires attention. stolen cargo. The most important need is for greater coordination Government action is urgently needed to support between multimodal agents and the authorities, espe- the development of brokerage markets for freight.This cially in reference to repeated customs inspections and will greatly increase system efficiencies by ensuring administrative paperwork at the ports. maximum capacity utilization. Another critical re- Also, the gains achieved through the port reform in quirement is the development of overarching insurance terms of loading and unloading time are undone by legislation across modes. In addition, the government long waiting times for truckers and trains in cargo re- needs to encourage the entry of third-party providers ception areas in the interior. Improvements in the lo- of point-to-point service, which is a critical compo- gistics management of surface transport modes will nent of efficient and competitive multimodal supply require the development of a higher user orientation chains. Finally, the government needs to facilitate the among service providers. A prerequisite for this is use of and ensure open access to essential bottleneck higher intramodal competition (within the trucking facilities--including setting up dry ports and distribu- industry) and intermodal competition (between trucks tion centers through public-private partnerships if nec- and rail). essary--and be willing to grant the use of public spaces Apart from the need for greater competition in for this. trucking, the fleet is aging and there is a shortage of It is essential that the government follow a con- vehicles to deal with peak demand, resulting in uncer- scious policy of encouraging multimodality by ensur- tainty regarding the availability of trucks for peak ing non-discriminatory access to all service providers times.While the connectivity between rail and port is and removing barriers to the smooth interchange of improving fast, the timeliness of rail service inland is freight and passengers across modes. It is equally im- still a problem that increases logistics costs. In particu- portant that the transport regulators also have a vision lar, small- and medium-size users are the main victims of the need for greater integration across modes so that of delays caused by a lack of coordination at the ports regulatory problems do not impede the flow of goods and at distribution centers. and people across the country. Partly in recognition of this, SCT is in the process of creating an Administra- 92 Multimodality and Commercial Transport tion Facilitation Commission to harmonize the re- Impact of Reform quirements of the various authorities involved in the The first effect of reform was to create a more com- sector and thus reduce administrative delays. petitive environment in the road freight transport in- dustry. Between 1988 and 1993, the number of firms Freight RoadTransport providing freight road transport service nearly tripled--from 4,456 to 12,972.The number of trucks Freight road transport was deregulated in 1989 at increased from 58,133 to 142,973.The increase in the which time all restrictions were abolished by a new number of firms is mainly due to the entry of small Law for Federal RoadTransport.Regional concessions firms, while medium and large firms have significantly were dismantled and all federal routes and cargo types increased the size of their fleets. Deregulation also pro- were opened to competition.93 The role of the state is moted the entry of many self-employed drivers. limited to regulating road safety and issuing permits to Tariffs have decreased in real terms, although it is carriers. No legal barriers to entry remain, and the sys- not clear if this is the result of genuine competition tem of permits has been simplified. Privately owned among trucking firms, or is due to predatory practices. trucks are now allowed to transport third-party cargo, A major association of large- and medium-size firms in thus ending the inefficiency of empty truck returns,al- the sector, Cámara Nacional de Autotransporte de Carga though the development of brokerage markets for (CANACAR), was sanctioned by the Federal Com- freight is still lacking. A program of regularization for mission for Competition in 1995 on grounds of price- informal truckers has also been established,thereby au- fixing. The impact of deregulation is therefore thorizing illegal carriers to enter the market formally, ambiguous.While it is clear that the entry of new op- subject to safety requirements. All these policies are erators has increased service choice for shippers, the aimed at better balancing supply and demand and at concentration of market power in the hands of a few promoting competition between firms. large firms still remains high. NAFTA required the cross-border liberalization of the provision of freight and passenger services by 1997, Remaining Issues while reserving domestic service for nationals.The im- The reform of the freight road transport sector has had plementation of the agreement was delayed by the positive results for users and for the economy as a U.S., which has expressed concern about the safety of whole, but several problems still need to be resolved: Mexican trucks. Following a ruling that the U.S. was · Overlapping federal and state responsibilities. Although under violation of NAFTA, the new U.S. administra- the federal government liberalized freight transport tion indicated in early 2001 that it would soon begin regulation, not all state governments have modified allowing Mexican trucks to haul goods throughout the their regulations accordingly, and some restrictions United States.94 The limitation on crossing the border on competition still exist.Apart from the work on and the consequent transfer of cargo has had high costs harmonizing regulation across the country follow- since 75 percent of the approximately $250 billion in ing federal law, states are also obliged to make their U.S.-Mexico trade is carried by commercial trucks. regulations for freight transport conform to A major concern in Mexico is that U.S. trucking NAFTA requirements. firms, which are better equipped and more efficient · Cartelization. Larger firms may attempt to control than their Mexican counterparts, will out-compete the provision of services. If the entry of foreign op- Mexican truckers when barriers are lifted. American erators is delayed further, it is possible that the effi- firms enjoy a lower cost of acquiring trucks and lower ciencies and cost reductions of liberalization do not interest rates. Moreover, the price of diesel fuel is sig- get passed to shippers. nificantly lower in the U.S.The specter of competition · Safety. Serious problems relating to safety and theft has led to Mexican companies forming alliances with in the freight sector remain.This increases insurance U.S. and Canadian companies. premiums and drives up logistics costs significantly. In 1998, about 750 load units were reported lost 93 Multimodality and Commercial Transport and there was a 15 percent increase in the safety information. Exit requires only that a firm providing index that measures accidents. regular service provide 30 days advance notice of the · Aging Fleet. Mexico's trucks are on average over 13 elimination of a route. years old.Apart from pollution and the risk of acci- The impact of the reform has been seen in: dents, this implies a competitive edge for American · Increased entry of new firms or regularization and regis- trucking firms whose fleets are around 5-years old. tration of existing firms. Employment has risen with · High Tolls. Mexican trucks currently avoid toll 15,000 new jobs having been created but the sector highways in favor of the free federal roads, causing remains highly concentrated. The net impact on externalities in terms of congestion and rising costs tariffs is thus unclear. It is difficult to compare the of pavement maintenance and repair.95 pre- and post-reform situations since it would be necessary to adjust for quality improvements.How- Passenger RoadTransport ever, the high degree of market concentration would suggest that deregulation is unlikely to have Deregulation of passenger road transport services was lowered tariffs dramatically. introduced in 1990, following a pattern of perform- · Increased demand. Both the number of passengers ance similar to that of freight transport.The problems and the size of fleets increased significantly between of market concentration and monopolistic rents were 1990 and 1996. During this period, the number of even more severe in passenger traffic than for cargo, total passengers transported increased from 1.97 since public regulation of services imposed quite effec- million to 2.75 million and the number of vehicles tive barriers to entry in the sector. In fact, in 1990 rose from 36,593 to 53,133.This may be attributed although the market comprised 658 service providers, in part to the impact of reform and in part to gen- five groups of firms controlled about 75 percent of eral economic growth and the decline in train serv- the market. ices. Passenger road transport services were deregulated · Quality and reliability of services have also improved sig- in 1990.Services are now classified as either regular in- nificantly. Data from the main association in this sec- terurban services or tourism services.96 With tourism tor, Cámara Nacional Autotransporte de Pasaje y becoming a major industry, an efficient transport sys- Turismo (CANAPAT), indicates that firms are in- tem is necessary to support tourist traffic.97 It is also creasingly renovating their fleets. important because almost no inter-city railways oper- ate in Mexico at this time,so that inter-urban buses are Remaining Issues the main mode of transport for many people,especially The passenger transport sector faces some of the same in rural areas. problems as freight transport: the overlapping of insti- Mexican firms providing passenger service have tutional responsibilities between federal and state gov- been lobbying the government for the liberalization of ernments, high costs (attributable to road tolls, fuel international services scheduled for 1997 under prices,and high interest rates),road insecurity,and par- NAFTA, which the U.S. has delayed implementing. ticularly,cartelization,and ensuring access to terminals. The large Mexican operators are well financed with · Cartelization. Market concentration in the passen- renovated fleets.Therefore, they are well positioned to ger transport sector was not altered by the 1990 compete with American firms for passenger services, deregulation. Tourist bus service and regular bus especially in the premium tourism sector. service are both controlled by just a few firms. In the face of limited competition, there is a real risk Impact of Reform of collusive practices and entry deterrence. The 1990 reform authorized the free entry and exit of · Control of terminals. A related concern is the possi- firms both in tourism and regular services. A license bility of groups of firms deterring entry through can now be obtained quite swiftly, and entry is rela- their control over access to passenger terminals.The tively easy if the firm satisfies basic norms on safety and 94 Multimodality and Commercial Transport privatization of passenger terminals needs to have Notes safeguards built in to avoid market capture by in- 90 The standard gains expected from improved coordination cumbent firms. are: savings in operational costs (labor and energy); cuts in waiting time and reduced spoilage; reliability in transshipment and transit; Conclusions and the safety and protection of cargo.Improved multimodality thus results in greater aggregate demand, stronger competition, and en- hanced export competitiveness. While major opportunities exist for gains through 91 Logistics costs in LatinAmerica are typically between 30 per- greater private sector participation in both freight and cent and 40 percent of the final sales price of products.This is twice passenger transport, the following issues need resolu- the level observed in most OECD countries. (Guasch and Kogan, 1999, Inventory Levels in Latin America.World Bank.) tion: 92 Recent analysis of inventory levels in LatinAmerica indicates · Coordination with the competition agency.Deregulation that poor infrastructure, poor integration into global supply chains, in road freight and passenger transport has led to and missing markets are the main determinants of productivity and the entry of large numbers of new firms, and the economy-wide competitiveness.(Guasch and Kogan,1999,Inventory Levels in Latin America.World Bank.) regularization of many illegal truckers. However, 93 Apart from hazardous cargo. concentration still seems to be high with larger 94 Since the U.S.is entitled to set its own safety standards under firms in the sector attempting to control the provi- NAFTA and to ensure that all truckers meet them, this will proba- sion of service.This suggests the need for close col- bly lead to a harmonization of standards in the two countries in the medium term. laboration between the transport regulator and the 95This is myopic behavior on the part of the truckers,since the competition agency. time savings could more than compensate them for the tolls. · Intergovernmental coordination is needed for inter-city 96 Basic categories of services have been defined, in order to transportation. Many state governments have not ensure that levels of quality are maintained.For the tourism segment there are four basic categories: luxury, normal, special trips, and ve- fully modified their regulations to be consistent hicles with driver-guides. For regular services, there are luxury, first- with federal requirements.Therefore benefits from and second-class services,with various requirements on bus ages and competition are obtained mainly on federal routes other facilities. and some of the gains from federal reforms are not 97 Regular and tourist bus services transported more than 2.7 million passengers in 1996. passed on through to users. 95 PART 3. POLICY RECOMMENDATIONS 11 Proposed Action Program During the 1990s, Mexico was one of the pioneers of gains, there were difficulties exacerbated by both ad- privatization reform and private sector participation in verse internal and external environments.The country infrastructure in Latin America, particularly in grappled with the "Tequila Crisis" of 1994, which in- telecommunications and transport. Despite significant creased the cost of capital for infrastructure projects Table 11.1 Summary of Recommended Actions Short-term Actions Medium-term Actions Long-term Actions Cross-Sectoral Issues Build up institutional capacity of reg- Create an autonomous and inte- Assess impact of contingent ulatory framework and agencies, grated transport regulatory agency liabilities based on independence and auton- overseeing all modes of Develop appropriate new instru- omy, transparency, implementation transport ments for financing non-viable (par- of regulatory instruments, and Implement multimodality unit and ticularly) infrastructure projects appeals processes associated multimodal legislation Clarify jurisdiction and roles of Refocus federal financial support competition policy agency and and reconsider mechanism for state regulatory agencies participation in non-financially viable Ensure open access policy to essen- projects tial facilities Implement incentive-driven decen- tralization strategy based on observed performance Develop strategy for universal service in infrastructure and a sus- tainable mechanism for its financing Develop and implement a program for training of regulators and an effective benchmark model Consider increased private sector participation in all infrastructure sectors Sectoral Issues Telecommunications Grant Cofetel true Focus judicial review on whether independence decisions have a reasonable basis Require open decisionmaking Grant standing to CFC on matters processes for regulatory related to the competitive effects proceedings of decisions Make concession requirements Clarify the national policy on simpler for competitive entrants universal service Eliminate the existing system for regulating international service 96 Proposed Action Program Table 11.1 Summary of Recommended Actions - continued Short-term Actions Medium-term Actions Long-term Actions Natural Gas Enforce the new directive on gas Provide guidelines and conduct the Foster private/public cooperation marketing 5-year review of gas transport and upstream distribution tariffs Develop gas and future power mar- Restrict expansion of Pemex trans- kets port Foster private investment in gas storage Water Supply Formulate state sectoral Create enabling environment at Create commercially oriented and Sanitation policies state and local level for efficient autonomous water companies provision Orient private sector participation as a tool to improve efficiency and sustainability of service provision Refocus federal financial assistance to support reform efforts of subnational governments Build a credible regulatory environ- ment to reduce uncertainty Reorient private participation Refocus federal financial support through incentive to support reform efforts of subnational government Toll Roads Develop a long-term strategy for Rethink pending tollroad concession the sector design Address low-traffic volume Develop alternative bidding and award mechanisms Create autonomous regulator with transparent rules and responsibilities Railroads Conclude the privatization process Implement true intramodal competi- Integrate the sector within the tion country's overall transport Make institutional changes required system to manage the transition Ports Ensure procedures for coordination Reduce delays Ensure that publicly financed between port authorities Facilitate linkages with other trans- investments on infrastructure do not Address and oversee vertical inte- port modes distort competition between ports gration issues Ensure that regulated tariffs reflect Phase out ongoing public financing Ensure open and non-discriminatory the gains from competition for operations and investment access Control for risks regarding the priva- Develop a strategy for the non-con- tization of the APIs cessioned ports Passenger Road Transport Ensure against cartelization Develop safety standards Develop and enforce open access for terminals Airports Account for and control Ensure consistency and coordination cross-subsidies between the various actors and rel- Develop autonomous transport evant public institutions regulatory commission Clarify the ownership structure of airports in the long term Freight Road Resolve overlapping federal and Control cartelization Address issue of aging fleet Transport state responsibilities Implement and enforce safety stan- Facilitate development of logis- Enforce NAFTA requirements and dards tic and distribution terminals give incentive for state deregulation Review toll fees structure 97 Proposed Action Program and weakened the financial sector. Nonetheless, it was widespread practice of judicial injuctions, or able to quickly restore macroeconomic stability and re- "amparo," mechanism. sume growth. Currently, Mexico remains attractive for · Secure universal access. Another major weakness of foreign investors,with plenty of opportunities across all the Mexican infrastructure program is the lack of a sectors.Yet to secure the full benefits provided by a systematic strategy and schedule to secure universal modern and efficient infrastructure sector and to at- access.As a result,there is a need to develop and im- tract needed new investment in infrastructure, the plement such a policy and strategy, which is consis- country needs to undertake a number of institutional tent with sector structure and a competitive and structural reforms.The telecommunications sector framework in order to secure universal access and requires more effective competition, and the transport service.The tariff structure should also be revised as sector is in need of a more integrative approach an instrument to ensure these objectives. with a focus on multimodality. Moreover, the gas · Develop a strategy and appropriate financing for priority sector would benefit from further deregulation. Two infrastructure projects that are not fully financially viable. sectors where reform has barely begun--and where it There are a number of projects, particularly in the is sorely needed--are water and sanitation, and elec- transport, and water and sanitation sectors, that tricity.The political economy of reform in these two while highly desirable from an economic and social sectors is complicated in Mexico, but the foregone perspective, are not fully financially viable. For opportunities and socioeconomic impact are large. those projects, the government ought to rethink its There is a broad need for institutional reform in role and the most appropriate financing vehicle to governance, regulation, and conflict resolution.While complement any private sector investment. these issues have been detailed in this report, this · Provide incentive for decentralization strategy. On a chapter summarizes the main issues in the infrastruc- number of infrastructure activities the government ture sector and puts forth specific recommendations to does not have full jurisdiction, which belongs address them (seeTable 11.1). either to the state or municipality. To facilitate the implementation of those decentralized projects Cross-Sectoral Issues deemed socially desirable, the government should design and implement an incentive-driven A number of issues cut across sectors.Addressing these decentralization strategy based on successful issues is critical for the Government of Mexico to se- observed performance. cure urgently needed investments, and achieve vital · Revise the jurisdiction of the Competition Agency relative objectives, including increasing access to services and to regulatory agencies. As more segments of the infra- turning efficiency gains into lower prices for con- structure sectors become contestable, competition sumers. tends to replace regulation. The jurisdiction and · Improve regulatory framework. A major weakness of oversight for infrastructure competition issues the Mexican infrastructure program is the regula- needs to be revised, to avoid overlapping responsi- tory framework and structure of regulatory bilities and ensure high enforcement. agencies. The fact that agencies have strong links · Increase private sector participation in all infrastructure with line ministries leaves them open to political sectors. Given the significant competition for influence, which does not convey the right signals government finance, as well as the consensus for to potential investors. There is a strong need to improved operational efficiency of public services revise the regulatory framework in each sector, and by private operators, there is a need to reconsider build up the institutional capacity of the regulatory facilitating increased private sector participation in agencies based on independence, autonomy, and all sectors. transparency.There is a similarly important need to develop the appropriate regulatory instruments and an effective appeals process to deal with the 98 Proposed Action Program Sectoral Issues decisions about prices, interconnection arrange- ments, and entry. Telecommunications · Require open decisionmaking processes for regulatory pro- Mexico privatized its telecommunications sector in ceedings. The act should authorize Cofetel to con- 1989, and fully opened it in 1996. It achieved signifi- duct open rule-making proceedings as well as cant advances after privatization, including improve- case-by-case decisions. Proceedings should be open ments in service quality, a minimization of waiting to participation by anyone affected by them, and all time for requested new lines, and significant growth in participants should have access to the evidence that both the quantity of new main lines and mobile is submitted. Cofetel should also be required phones. Despite this progress, Mexico still lags behind to explain the legal and factual foundation for in a number of sector indicators relative to other Latin its decisions. American countries that privatized much later. More- · Focus judicial review on whether decisions have a over,Telmex remains the dominant operator in practi- reasonable basis. Clear standards for judicial review cally all segments of the sector. As of 2001, Telmex are useful in shaping how the agency explains and remains the dominant operator with 96 percent market justifies its decisions. The appropriate standard is share of local telephony, 78 percent in mobile teleph- that Cofetel has a reasonable basis in law and fact ony, 73 percent in domestic long distance and 55 per- for its decisions. cent in the Internet market.The primary obstacles to · Grant standing to CFC on matters related to the greater sector efficiency and increased coverage are competitive effects of decisions.The CFC ought to have weak governance and a weak regulatory framework re- the responsibility to assist Cofetel in understanding sulting in weak sector competition, high prices, and the competitive implications of its regulations. Be- less-than-optimal expansion. The use of information cause the act envisions a competitive industry, and communications technology is proven to be a key among the issues to be resolved in judicial review is instrument to ensure greater information dissemina- whether Cofetel reasonably took into account the tion, technological improvements, and reduction of effects of its regulations on competition and dealt transaction costs with a large impact on growth and adequately with the views of the CFC. poverty.To secure those desired gains, a number of is- · Make concession requirements simpler for competitive en- sues need to be addressed, with appropriate measures trants. In a competitive environment, agencies need taken.The main ones are listed below. not be responsible for dictating the specific invest- · Grant Cofetel true independence.TheTelecommunica- ments and business plans of a carrier. tions Act should be amended to make Cofetel a · Clarify the national policy on universal service, and pro- statutory agency with authority to regulate. vide explicit directions to Cofetel about how to implement Whereas SCT can be granted the right to partici- this policy. Legislation should define universal serv- pate in Cofetel's decisions,its role should be no dif- ice in terms of both the services it entails and the ferent than that of other participants. It should not benchmarks that should be used to measure have the right to communicate secretly with Cofe- whether progress toward these objectives is ade- tel or to overturn Cofetel's decisions. Cofetel's de- quate.98 Once a universal service objective is cisions should be reversible only by the courts adopted, it should not interfere with policies to set through judicial review or through new legislation. prices for each service equal to something approxi- True independence also requires that Cofetel be mating long-run average incremental cost and to able to demand and receive information from the eliminate regulatory impediments to investment carriers it regulates, and that its commissioners be and competition. If the government seeks to in- appointed to a secure fixed term of several years. crease penetration by more than would occur in an SCT should be assigned the responsibility for peri- environment where prices reflect costs, then the odic assessments of the performance of the sector best approach is to directly subsidize low-income but should not have direct responsibility for making households. These subsidies could be financed ei- 99 Proposed Action Program ther by general taxes or a competitively neutral tax and first-hand sales. The huge information asym- that falls equally on all telecommunications services metry on costs, prices, and quantities between the and providers. state monopoly and regulator will make this task · Eliminate the existing system for regulating international difficult. While consumers are now permitted to service.The system of proportional return should be contract with gas marketers other than Pemex, the abolished, allowing all carriers to negotiate agree- market power Pemex wields is likely to continue to ments with foreign carriers about call termination deter entry of competitors. In the absence of fur- and charges.The settlement rate should be a ceiling ther structural reforms, such as the full legal separa- for international prices,with both the domestic and tion of Pemex's gas production from its transport foreign components of the call having a ceiling and marketing subsidiaries, the company's market- price equal to half the settlement rate.International ing activities may have to be further constrained. resale over private lines should be permitted, · Conduct the five-year tariff review. This review marks either with no formal reporting requirement to an important milestone for the sector and for the Cofetel or at most, a notification leading automati- CRE. Until recently, much of CRE's efforts were cally to a permit if the reseller agrees to devoted to promoting private sector entry in reporting requirements. downstream natural gas activities. As more and more permittees conclude construction, the CRE Natural Gas is focusing increasingly on regulatory oversight and Reforms to date in the natural gas sector have been di- compliance. The five-year review provides an op- rected at fostering private participation in transport, portunity to critically assess whether current poli- storage, and distribution activities as well as in trade cies and regulations are working as anticipated and and marketing. As indicated above, Mexico has been to modify them as deemed necessary.Several key is- quite successful in attracting private investment for sues to be considered during the review are: (1) the economically developing distribution and to a lesser sustainability of low initial distribution tariffs and extent transport infrastructure and services. However, minimum coverage targets bid by developers in the the entry of new participants in gas storage and mar- lower density zones;(2) the impact of unanticipated keting services has been limited because of the pres- obstacles to system build-out such as delays in per- ence of a dominant, vertically integrated incumbent, mits (environmental, construction, rights of way) Pemex. and technology (the lack of feasibility of directional The first challenge will be that of consistently and drilling because of the absence of sewer/ transparently applying and enforcing existing regula- power/telecom cable mapping) on projected tions and coordinating among government agencies to throughput and connection rates, and hence tariffs; perform these tasks.Two areas stand out in this regard: (3) the efficacy of acquisition pricing methodology enforcing the new directive on gas marketing and con- in protecting captive consumers where competition ducting the five-year review of gas transport and distri- in marketing is weak; and (4) the suitability of rev- bution tariffs. enue yield methodology for price caps-particularly · Enforce the directive on gas marketing.This directive is- the effectiveness of the adjustment factor in offset- sued by the CRE regulates Pemex gas contracting ting the stochastic effect of demand uncertainty. in an effort to establish more transparent, balanced, Second, current government policy to permit con- and reciprocal conditions between Pemex and nat- tinued vertical integration of Pemex gas affiliates and ural gas buyers.This is important since the contin- its retention as a state monopoly in gas production and ued vertical integration of Pemex poses serious processing pose an obstacle to fostering the competi- obstacles to introducing competition in gas market- tive conditions needed to ensure efficient and reliable ing.The directive calls for accounting separation by gas supplies over the next decade and beyond. The functions for production, transport, and marketing principal target for new transport infrastructure will be to discourage cross-subsidies between marketing in supplying the new and retrofitted power plants as 100 Proposed Action Program well as cross-border pipelines and storage facilities to lion for exploration,$40 billion for production,and permit more competitive conditions for accessing gas $5 billion for upgrading and expanding processing sourced from the U.S. and Canada. In the absence of and transport infrastructure.The underlying prem- restrictions on Pemex developing new transport ise of these programs--increasing domestic extrac- pipeline capacity and with continuing coordination tion capacity by 60 percent--merits critical between its marketing and transport affiliates,new par- assessment. Pemex's budget is determined annually ticipants will be reluctant to invest in these activities by the Mexican Congress and is frequently cut to since the scope for market manipulation on the part of accommodate other national priorities. Often, the incumbent remains significant. more investment is made for the extraction and ex- Enforcing the gas marketing directive and conduct- port of crude as well as the production of cleaner ing the tariff review will benefit the sector. Likewise, vehicle fuels required by current and prospective there are five ways Pemex might be reformed: emission standards. Moreover, as Pemex operates · Restrict expansion of Pemex transport. This argues for under the same government procedures as any gov- restricting future Pemex investment in gas transport ernment agency, its record in managing costs for to rehabilitation and maintenance of existing facili- finding, developing, and exploiting hydrocarbons is ties. Given the enormous volume of resources re- not impressive. It is therefore far from certain that quired to develop Mexico's domestic gas resources, these programs will be fully funded or that the re- the budgetary and borrowing restrictions under sources invested will yield the expected levels of in- which Pemex currently operates as well as its over- creased production. riding mandate to generate tax receipts through the · Foster private/public cooperation upstream. To date, export of crude and the supply of petroleum fuels Pemex has been permitted to outsource certain gas domestically, investing billions of dollars in gas exploration, field development, and logistics activi- transport activities--which are already open to the ties, through narrowly defined service contracts. private sector--is of questionable priority. Such contracts are a relatively costly way for · Foster private investment in gas storage. Structural Mexico to develop commercially exploitable gas measures such as the separation of Pemex Gas and resources as Pemex--and indirectly the federal Transport into independent entities, and conduct government--bears most of the risks. Moreover, measures governing Pemex's contract terms and the majority of future service contracts are to be transport access conditions--in combination with financed off of the balance sheet, through restrictions on Pemex's investment in new transport PIDEREGAS (a form of leveraged lease), which facilities--will go a long way toward creating while not reflected as a financial liability from the a more level playing field for private investment start, represents a significant contingent liability for in transport and storage activities. That in turn the federal government. Given the inherently risky would permit better transport logistics and inven- and demanding nature of gas exploration activi- tory management, thereby reducing costs and ties--future revenues are highly uncertain--such improving reliability. contractual arrangements and financing vehicles are · Moderate growth in imports. Demand for natural gas is a-less-than-optimal instrument for securing projected to grow at 10 percent and domestic sup- efficient private participation. For Mexico to ply at 7 percent a year over the next decade. quickly and economically exploit its natural gas Roughly 25 percent of gas consumption will come resources and avoid soaring sustained increases in from imports,which in financial terms is more than gas imports,new arrangements for risk sharing with the entirety of Pemex sales revenues in 2000.The experienced private companies should be consid- implied growth in domestic supply assumes that ered in the short term, with associated changes in Pemex, and by extension the federal government, licensing, taxation, and audit policies and practices. will be able to mobilize roughly $55 billion in in- · Spur gas development and future power markets. The vestment financing over the next decade ($10 bil- largest source of projected growth in gas demand, 101 Proposed Action Program in absolute and percentage terms is for electricity · Planning,including coverage and quality targets.There is generation (18 percent per year) as the majority of a need for a sector vision and strategy. It should in- new thermal power plants are likely to use com- clude both urban--particularly medium and small bined cycle gas turbines, irrespective of gas prices. towns--and rural areas, where the needs are press- For the power sector to meet Mexico's rapidly ing and poverty rampant. growing demand for electricity in an efficient and · Investment financing sources. Given that appropriate reliable manner, without unnecessarily encumber- service in a number of communities may not ing public finances, new forms of industrial organi- be financially viable, and the required invest- zation are required in this sector. While various ments considerable, there is a need to develop formulations are currently under discussion, all aim a coherent financing strategy, which clearly delin- to introduce competitive conditions in power gen- eates the role of the government and the most eration.A critical element for creating a level play- appropriate instruments. ing field among generators (public and private) is · Universal service policy. Given the government's de- ensuring an adequate supply of fuel--principally sire to reach universal coverage and the reality that natural gas--on competitive terms. In the absence the ability of some socioeconomic groups to pay of sufficient gas supplies, infrastructure to optimize might be limited, there is a need to develop a social delivery, and flexible, competitive marketing policy that addresses this issue. arrangements, the scope for realizing the welfare · Tariff principles. The current tariff structure is benefits of competition in power generation will be cumbersome and devoid of alignments to costs and limited.This reinforces the importance of institut- incentives to drive efficient consumption. More- ing additional structural and conduct measures to over, the existing implicit and explicit subsidies foster new entry in gas exploration and production, have considerable leakages that are assisting certain transport, storage, and marketing. social groups that should not benefit. Therefore, there is a need to revise the tariff structure to Urban Water Supply and Sanitation address these issues. Reforms in urban water supply and sanitation in Mex- · Governance of water companies. By and large, social ico have lagged behind those of all other infrastructure sectors (with the exception of electricity), and far be- and political objectives appear to drive the manage- hind those reforms implemented by most other Latin ment of water companies, which compromises American countries. The fiscal cost of the current their sustainability. There is a need to rethink the structure and subsidy levels is not sustainable, and effi- governance objectives and to run the water compa- ciency and coverage needs to be improved urgently. nies more like corporations. Some efforts to introduce private participation, mostly · Concession design and regulation. The few experi- in greenfield and BOT projects, have shown mixed ments in the sector with private sector participa- results.Clearly,sector reform has proven more complex tion--mostly BOT--have led to at best mixed than that in other sectors, because of an elaborate results, largely induced by faulty concession design system of jurisdiction for states and municipalities. and ineffective regulation.There is a need to incor- Nevertheless, the federal government greatly needs to porate the substantial learning secured through this create an enabling environment at the state and local decade on concession design and regulation in this level for efficient provision.It needs to facilitate private complicated sector. sector participation as a tool to improve efficiency Reform of the urban water supply and sanitation and sustainability of service provision and refocus sector in Mexico would benefit from: (1) a more cred- federal assistance to support efforts at the subnational ible regulatory environment to reduce uncertainty; (2) government level. commercially oriented autonomous water companies; Key issues to be considered as a starting point for (3) a reorientation of private participation; and (4) a reform are: renewed focus for federal financial support. 102 Proposed Action Program Credible Regulatory Environment to Reduce Uncertainty. Lastly, regular public disclosure of financial and opera- There are three primary ways that a more credible reg- tional performance in accordance with commercial ulatory environment would reduce uncertainty: budgetary and accounting practices should be required · Maintain arm's-length relationships with all stakeholders. for the benefit of customers, potential investors, Ensuring a safe distance from political authorities and policymakers. may assist in maintaining the agency's autonomy Reorientation of Private Participation. The principal fea- both from government and from the operators. tures that require attention include: (1) formulae for · Create a better context for general technical expertise. updating tariff levels over time; (2) targets for service Providing greater access for technical expertise quality and coverage, together with penalties for non- is more feasible than providing experts for compliance;(3) procedures for appeal of regulatory de- every municipality. cisions; and (4) established terms for compensation in · Competition breeds accountability. Regulating more the event of early termination. than one service provider allows for the possible use Renewed Focus for Federal Financial Support. Transfers of yardstick competition (benchmarking) and di- keyed to reform, as well as revamped lending policies minishes the risk of regulatory capture. and instruments will help spur reform in the sector.For Commercially Oriented Autonomous Water Companies. those local governments that are creditworthy, but The limited functions and poor governance arrange- whose funding requirements are modest, the costs of ments that prevail for most water companies need to be issuing debt are high.Banobras,as well as private finan- addressed as a matter of high priority. Constituting cial institutions, can play a constructive role in aggre- water companies as autonomous utilities with full re- gating or pooling smaller issues to reduce transaction sponsibility for all major aspects of service provision costs and in providing credit enhancement to boost holds the promise of relatively rapid and sustained their credit ratings. A number of possible facilities improvement in performance, particularly when com- merit consideration in this regard. These might bined with private participation. Important measures include: (1) peso/dollar swap facilities to cover cur- include: creating autonomous boards that appoint rency risk; (2) state-level revenue bond facilities to managers for terms that do no coincide with the polit- broaden options for creditworthy utilities to access ical cycle, broadening water company obligations to long-term debt markets; (3) bond insurance funds to include asset management and new investment, and facilitate the issue of general obligation and revenue retention of revenues within the company with bonds by subnational authorities; and (4) an infrastruc- commensurate authority to incur prudent levels of ture financing fund providing several financial products debt financing. to subnational entities such as water companies.These One possible model is to create a formal contractual types of facilities should be managed by experienced relationship between the municipalities and the water private companies. Some of them could eventually se- companies, with well-defined obligations and outputs, curitize their portfolios with possible placement in in- thus creating an arms-length relationship. The water ternational financial markets. companies could be issued formal concessions by the conceding authority, be it a municipality or state Toll Roads government, and the concessions could be subject to Currently,the major issue in the toll roads sector relates impartial oversight by a regulator at the state level as is to the poor state of the highway system, which is in- envisaged in the model state water law. Also, a rating creasingly in need of maintenance and improvement, system for water utilities, based on well established but faces a huge shortfall in resources to finance these and credible benchmarking would greatly benefit investments. Also, the toll road system, burdened with policymakers and customers by providing a basis for the growing debt obligations of FARAC, is in an ex- improved targeting of federal and state subsidies and tremely precarious situation.However,there appears to programs. In addition, comparison with other utilities be substantial scope for generating savings from greater can bring public pressure for improving efficiency. operating efficiency in the CAPUFE system as well as 103 Proposed Action Program through synergies and economies of scale from run- network character of the road system. ning the FARAC and CAPUFE systems as a unified · Alternative bidding and award mechanisms need to be de- network.This could provide the resources for needed veloped. This would include identifying those seg- spending on maintenance, upkeep, and for moderniza- ments of the road network where a mix of public tion of the system, as well as to stabilize the financial and private participation would be possible. Such situation of the sector and provide the basis for re-en- projects might be bid on the basis of a minimum tering the capital market for toll road financing.A ra- government equity contribution. As more experi- tionalization of activities would thus minimize the risk ence is gained with negative concessions, a project of having to return to the government for servicing the featuring shadow tolls could be attempted. This debt of FARAC. would allow the government contribution to be · Introduce complementary reforms. As the government made over time and could help restore the credibil- further explores the commercialization of the net- ity of public commitments. work, complementary reforms will be required in Overall, the government needs to develop a long- management and accountability; in stabilizing term strategy for the sector, in which toll roads would funding for operations and maintenance; and, in be viewed in the context of the road network as a clarifying oversight and regulatory responsibility. whole.As a start, this implies the implementation of a · Overcome skepticism gradually. The experience with more scientific and independent approach to rate set- toll roads as described above has made the ting. Given the low usage of existing toll roads that has Mexican public and the private sector skeptical of resulted from the high and inflexible tolls that were the whole idea of private sector participation in this contractually mandated, it also may be time to explore subsector. New initiatives in this respect must cross-subsidy mechanisms that would allow these facil- therefore start slowly and be less ambitious in size ities to be used. and scope to minimize risk, thereby ensuring the In addition,the sector needs an autonomous regula- best chances of success and avoiding the huge tor with transparent rules and responsibilities in order public bailouts of the past. to minimize the uncertainties related to investing in Specific recommendations. More recommendations for road transport. A regulatory body of acknowledged future toll roads are as follows. professionals that would benchmark performance, and · Minimize risk. Toll roads need to focus on specific set tolls as well as ensure rationalization of the existing niche investments that are either expansions of ex- system would be an important indication of the gov- isting,congested facilities (adding lanes to major ar- ernment's commitment to improving the environment terial roads), or that serve to reduce bottlenecks, for private participation in the sector. such as targeted bridge investments that are ori- ented toward densely traveled trade corridors. These projects have well established traffic patterns Railroads and tolling histories, so that demand risk is reduced Railroad reform in Mexico has not been plagued with substantially.In addition,they are likely to have sub- conflict as in other countries or sectors. However, four stantial political support. major sources of issues and associated risks remain, re- lating to: (1) the conclusion of the privatization · Restructure.The government needs to rethink pend- process; (2) the implementation of true intramodal ing toll road concession design. This may involve breaking concessions into smaller components (for competition; (3) the integration of the sector within example, maintenance contracts) and considering the country's overall transport system;and (4) the insti- delaying some project proposals. Restructuring and tutional changes required to manage the transition. reducing the size of individual components of the Specifically: program would help reduce the financial burden · Foster policy development. Although the relative and generate business for more companies. These importance of passenger services is low, the benefits should be weighed against the gains from government is still developing a final policy for concessioning regional packages that recognize the the subsector. 104 Proposed Action Program · Be aware that vertical monopolies may pose problems. road transport and stimulate the overall efficiency The new rail concessionaires in Mexico are consor- of the network, the new rail system favored the re- tia formed by diverse firms,with different capacities gional separation of FNM to remove the possibility and objectives, some of them spanning more than of cross-subsidies between railroad routes. The one transport mode.The potential threat posed by major obstacles to achieving competition between vertically integrated monopolies or strategically the rail and trucking industry include the lack of dominant conglomerates needs to be closely intermodal facilities,particularly with respect to in- monitored. For instance, the ownership of Terminal ternational traffic,and the relatively high power ap- Ferroviaria Valle de México by the three trunk parently enjoyed by trucking associations. Better railroad concessionaires,may face conflicts resulting coordination is also needed among different bodies from the owners' asymmetry in terms of traffic in the federal administration (for example, regard- volume, number of connections with Mexico ing the enforcement of trucking transport norms). City's network and even in the price paid for · Manage regulatory conflict. Regulatory conflicts may their concessions. Other conflicts may arise related occur in the future, once the initial impact of to the fact that they all have the same voting power the short-term improvement of services is and a majority of 75 percent is required for all dissipated. Yardstick competition would be the decisions. If, for example, cargo volume discounts natural instrument for such regulatory control. are introduced in the future, this could create fears This would require an extensive and updated of discrimination. information database. · Encourage intramodal competition. The concessioning To reduce uncertainty, it is necessary to complete process was designed so that, where possible, no the structural transformation of SCT. If regulation is concessionaire would have exclusive access to kept within SCT there is a potential risk of regulatory major cities, industrial areas, or ports.This required capture that could be avoided or, at least, minimized, the mandatory imposition of trackage and haulage with the development of an independent regulatory rights on key routes and the limitation of exclusiv- agency.The main role of SCT should then consist of ity rights in concession titles (by not hindering establishing mechanisms that favor competition, such other companies from operating the same routes, as a clear definition and pricing of access and trackage whenever they were willing to invest in parallel rights.The need to create an independent agency with tracks).Transported cargo volume may in the future the regulatory capacity to supervise the privatized rail- permit the coexistence of more than one carrier. road system is urgent, especially from an informational There is therefore an urgent need to develop a de- point of view, as well as the design of adequate regula- tailed scheme for defining access payments, espe- tory systems. cially as additional trackage and haulage rights are negotiated. A more flexible mechanism for the as- Ports signment of trackage and haulage rights is also Mexico undertook a very effective program of reform needed--one that would not discourage invest- in the port sector, which focused on the major ports ment--in order to encourage the development of through a concessioning program and a mix of compe- competition among concessionaires, which has tition and regulation.The results have been encourag- been slowed by conflicts over access. ing. Yet at this stage there is a need to address · Enhance competition with multimodal transport. Com- second-generation issues, aside from the privatization petition between railways and trucking companies of the port associations.Despite the success of the well- can have positive effects.Similary,multimodal coor- structured and timely reform process, there are linger- dination must be encouraged as well.Until recently, ing issues of concern: intermodal traffic was basically non-existent in · Reduce delays. Because of increased port efficiency, Mexico because of the lack of infrastructure and in- waiting times have declined at Mexican ports, but adequate services. To enhance competition with they could easily be cut further.While handling and 105 Proposed Action Program service time has been reduced as a consequence of theAPIs.The last phase in the reform process was to investments in modern equipment and increasing transfer the ownership of the APIs to the private labor productivity, paperwork and administrative sector.This has rarely been attempted elsewhere in time remains high because of repeated lengthy, un- the world since a private firm has limited incentives coordinated administrative controls on ships and to perform the tasks of a port administrator exclu- cargo. An example is the inspection of goods by sively,that is,without any interest as a port operator. anti-drugs police units, which manually check car- A private API in charge of managing a port might goes.This takes longer than automated controls and not be interested in investment for the future, since leads to a higher likelihood of loss and thefts.More- its incentive would be to maximize profits over the over, these checks are performed on the cargo at horizon of its life as port administrator.The poten- every port of call, even if previous stops were at tial for opportunistic behavior by private firms other Mexican ports. Recognizing this, the port would necessitate the creation of a regulator to regulator is considering the privatization of cargo guard against such undesirable practices. Regula- inspection, and the introduction of a degree of au- tion would limit the benefits of the privatized API, tomation to reduce ship waiting times and the risk and consequently would reduce investor interest in of cargo losses. the business. · Measure competition to ensure that regulated tariffs reflect The private agents most interested in acquiring the gains from competition. Using yardstick competi- control of APIs would be the private operators that tion would enable the port regulators to avoid work in the port. However, Mexican port legislation micro-managing tariffs in the sector and ensure that prohibits concessionaires from acquiring shares in the tariff revisions indeed reflect potential efficiency API. Therefore, given that the business of buying an gains--but this requires greater capacity and data API and managing a port does not currently look at- than currently exists. tractive for the private sector,it seems as if port admin- · Foster coordination between port authorities. This is im- istration will remain within the public sector. In the portant to reduce the high waiting times,which put case that publicly owned APIs perform their role effi- Mexican ports at a disadvantage in comparison ciently,there does not seem to be any real advantage to with U.S. competitors. SCT has created a commit- transferring them to the private sector. tee to simplify administrative paperwork and ensure An option would be to award management con- better coordination between authorities. tracts for port administration to the private sector. · Decentralize port investment decisionmaking. The goal These contracts are shorter by definition, and the con- is to have self-financed ports (both for operations tracted firm faces very low risk, since it works for an and investment) but the federal government has a almost fixed payment and its decisions on investments large program of investments ongoing, possibly re- do not affect its profits.This type of contract has been flecting the shortage of private capital and the po- tried with good results by some ports around the world litical acceptability of shorter concessions. Given (for example, port of Bristol, U.K.). the international financial environment,this may be a sound short-term solution to catalyze investment. Passenger Road Transport However, public investment, especially if it differ- Although this sector represents a minor share of total entially affects port access and infrastructure, can infrastructure investment, addressing its weaknesses has distort competition between different ports in the important social implications because a disproportion- system. Since the government's objective is compe- ate quantity of the poor are affected.The 1990 deregu- tition between ports,it is advisable to allow ports to lation of the sector was a welcome initiative. However, make their own decisions on investment and allow competition issues and service quality issues need to be markets to point out where these are required addressed.The main ones are: without interference from the public sector. · Cartelization. Market concentration in the passen- · Be cognizant of risks associated with the privatization of ger transport sector was not altered by the 1990 106 Proposed Action Program deregulation. Tourist bus service and regular bus public institutions involved--the ASA, SENEAM, service are both controlled by just a few firms. In and DGAC. the face of limited competition, there is a real risk · Clarify ownership issue. A final issue that needs to be of collusive practices and entry deterrence. addressed is the clarification of the ownership · Control of terminals. A related concern is the possi- structure of airports in the long term.Would it be bility of groups of firms deterring entry through acceptable if eventual flotation permits a private their control over access to passenger terminals.The entity to control a majority of the Mexican airport privatization of passenger terminals needs to have system? Would such a change in ownership affect safeguards built in to avoid market capture by the management contract? incumbent firms. Freight Road Transport Airports Freight road transportation is a critical sector, which The Government of Mexico took a very practical and significantly affects Mexico's competitiveness, because creative approach to introducing private participation Mexico counts on trade as a main engine of growth, in the airport sector by geographically segmenting the particularly with the United States. Logistics costs, of country, and bundling the corresponding airports and which transport costs are the largest component, must concessioning them as a geographical package.The re- be reduced.Yet in Mexico those costs remain signifi- sults to date have been encouraging, yet a number of cantly higher than those of the other OECD coun- issues remain that need to be addressed: tries. Federal deregulation did help to improve sector · Control cross-subsidization. The bundling of airports performance, yet the failure of states to deregulate with diverse characteristics (type of traffic, scale of within their jurisdictional boundaries did not allow the operation, etc.) implicitly creates a structure of country to capture the full benefits.The main issues are cross-subsidization. Although this can be positive as follows: from the point of view of risk diversification, · Overlapping federal and state responsibilities. Although private investors may have a different idea of the the federal government liberalized freight transport business potential of each airport and could regulation, not all state governments have modified possibly have preferred a different ordering. If their regulations accordingly, and some restrictions preferences are widely divergent, the sale or the on competition still exist.Apart from the work on price obtained from the remaining groups--partic- harmonizing regulation across the country follow- ularly the North-Central Group--could be ing federal law, states are also obliged to make their affected and the government should be prepared to regulations for freight transport conform to address this contingency. NAFTA requirements. · Plan enforcement. The government needs to think of · Cartelization. Larger firms may attempt to control how it will enforce the cross-subsidies inherent in the provision of services. If the entry of foreign op- the packages. erators is delayed further, it is possible that the effi- · Strengthen regulatory mechanisms. Will the concession ciencies and cost reductions of liberalization do not contract be overseen by SCT or by the (proposed) get passed to shippers. Transport Regulatory Commission? The institu- · Safety. Serious problems relating to safety and theft tional mechanism chosen (airport packages) in the freight sector remain.This increases insurance is complex and involves substantial transaction premiums and drives up logistics costs significantly. costs. As in other sectors, regulatory mechanisms In 1998, about 750 load units were reported lost should have been in place at the outset of the and there was a 15 percent increase in the safety concession program. index that measures accidents. · Foster collaboration. It is vital to ensure consistency · Aging fleet. Mexico's trucks are on average over 13 and coordination between the various actors and years old. Apart from pollution and the risk of 107 Proposed Action Program accidents, this implies a competitive edge for Notes American trucking firms whose fleets are around 98 For example, does universal service mean that every resi- five-years old. dence has a separate, dedicated telephone connection to the public · High tolls. Mexican trucks currently avoid toll high- network, or does it mean that shared lines and pay telephones are ways in favor of the free federal roads, causing ex- available in reasonable proximity? 99 This is myopic behavior on the part of truckers since the ternalities in terms of congestion and rising costs of time savings could more than compensate them for the tolls. pavement maintenance and repair.99 108 1818 H Street, N.W. PPIAF Program Washington, D.C. 20433 USA Management Unit Telephone: 202.473.1000 c/o The World Bank Facsimile: 202.477.6391 1818 H Street, N.W., MSN I9-907 Internet: www.worldbank.org Washington, D.C. 20433 USA E-mail: feedback@worldbank.org Telephone: 202.458.5588 Facsimile: 202.522.7466 Internet: www.ppiaf.org E-mail: info@ppiaf.org TMxHSKIMBy354148zv,:&:/:":% ISBN 0-8213-5414-0