Case Study

PEMEX: The Ethanol Decision

Sunday, December 7, 2014

Abstract

In the early 2000s, the Federal government of Mexico enacted a series of laws promoting the use of alternative fuels in gasoline, beginning with ethanol from sugarcane. This meant that the national oil company PEMEX had to find ways to implement this policy. Nevertheless, in spite of efforts by various government agencies as well as PEMEX, by mid-2014 no ethanol had been incorporated into Mexico's gasoline supply.

As Mexican policy makers looked at the country's energy supply, they expected that substituting bioethanol for some portion of gasoline fuel would meet a number of the country’s needs. First, it could help extend the country’s supply of crude oil. The country's demand for gasoline was growing, but the production of crude oil from the country's shallow-water wells in the Gulf of Mexico was decreasing and its deep-water reserves had not yet been developed. Second, ethanol could help Mexico meet its ambitious goals addressing climate change. Third, biofuels could provide a new market for Mexico's struggling agricultural sector. Finally, PEMEX would soon face competition due to new energy reforms that promised to introduce private sector competition to PEMEX, including at the retail fuel station. The ability to add Mexican-produced ethanol could be a selling point in a new competitive world.

The introduction of ethanol seemed a logical choice. Mexico already had commercial production of sugar, and in recent years had seen a surplus. Many sugar mills in Mexico already had the ability to distill ethanol and could expand to produce ethanol for fuel as well as for rum. Ethanol had become a major gasoline component in other countries. In the United States, ethanol from corn made up as much as 8% of the vehicle fuel blend at the pump, the maximum amount that could be incorporated without requiring changes to vehicle internal combustion engines and station pumps. Brazil had gone even further, requiring vehicles to be "flex-fuel," engineered to run on either a gasoline-ethanol blend or pure ethanol. In 2008, ethanol from Brazil’s sugarcane crop had provided 55% of vehicle fuel, either in gasoline blends or as pure ethanol.

With all these positive indications, in 2009 and in 2012 PEMEX introduced two tender offers requesting supplier bids to provide ethanol to the company. As first steps, the amounts requested were relatively small, using ethanol to replace oxygenators in the fuel, up to 5.6% by volume. PEMEX had to adhere to two basic constraints in setting the price: by law, PEMEX could not subsidize the purchase price of ethanol, and there could be no increase in the price of gasoline at the pump. No bids came in under PEMEX's maximum.

Considering (1) the constraints in the economics of ethanol for fuel production, (2) the potential market opportunities for PEMEX, and (3) the climate change commitments for the Government of Mexico, you have been tasked to suggest the best way forward to make ethanol production a reality in Mexico. 

Developed in partnership with EGADE Business School, Tecnológico de Monterrey, Monterrey