June 10, 2014
Interviewed by: David Snow
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Partners Group’s Shale Play in Mexico

An overview of an energy powerhouse on the rise: two executives from Partners Group and the CEO of Fermaca, the Mexican gas pipeline they backed with a $750M investment, discuss the growing opportunity for Mexico’s oil and gas market, and the cross-border dynamics they hope will drive success.

An overview of an energy powerhouse on the rise: two executives from Partners Group and the CEO of Fermaca, the Mexican gas pipeline they backed with a $750M investment, discuss the growing opportunity for Mexico’s oil and gas market, and the cross-border dynamics they hope will drive success.

Partners Group’s Shale Play in Mexico

Energy Game Change

David Snow, Privcap:

Today, we’re joined by Todd Bright and Jean Perarnaud of Partners Group, and Fernando Calvillo of Fermaca. Gentlemen, welcome to Privcap today. Thank you for being here.

All of you are partners in the growth of a Mexican pipeline company called Fermaca. Your company received a $750-million investment from Partners Group, so I’m here to talk about how that works and what this means for the future of your company as well as for the future of Mexican energy. It’s a fascinating topic. Let’s start with a question for Fernando. You are the CEO of Fermaca. Talk briefly about what your company does, how you got in touch with Partners Group, and why the opportunity to partner with them seemed attractive. 

Fernando Calvillo Alvarez, Fermaca:

Thank you very much for the invitation. Fermaca was founded 52 years ago. My father was a founder. We started as an EPC company—engineering, procurement and construction. For many years in Mexico, the government handled the monopoly of almost everything and we learned how to develop infrastructure. By the mid-90s, President Zedillo modified the constitution and allowed the investment of private groups, foreign and national, on the natural-gas industry, storage, transportation, and distribution. It really started because I was in the correct place at the correct moment when a project came to the table because of the need for natural gas. What we knew about natural gas was just building the pipelines; we knew nothing about operation and maintenance.

Going back to how I met Partners Group, we were very lucky to meet one of the people of Partners Group here in New York and they understood very well what we were talking about. Suddenly, some weeks later, Jean came into the deal and he understood exactly what we were talking about, as well the committees where he was discussing the transaction. 

So, it’s not just by remote control that you need to handle a business. I like always to have our partners, our investors, involved because sometimes you have to make fast decisions and it’s not easy to convince someone to invest $500 or $600 million and just bury it there for the next 30 years. So, it was part of having the ability of taking risk and second, to understand and third, to obviously develop chemistry among the partners.

Snow: Talk about the investment thesis you had for energy in Mexico as a starting point. Then, when you came across the opportunity to invest in Fermaca, how did that fit into your investment thesis?

Jean Perarnaud, Partners Group:

I want to start with what we were trying to do for many years—we were trying to get into the midstream space in the U.S., ride the shale and gas story that probably we’ll talk about later. The fact is that in the U.S. you have a lot of competition, a lot of MLPs and foreign investors like us. Looking at investing at 6% to 8% in this sector is not attractive.

So, we started looking south when Fermaca came to us because we said, “It’s the same resource; it’s actually the same shale gas we would be transporting through our pipelines and the difference is only a line on the floor that separates Mexico from south Texas.” The attraction was to find a management team that could not only help us to operate the existing asset, but also grow the business. That’s the whole attractiveness in this. 

In terms of the more macro reason that we like the story, it’s actually very simple. You have the cheapest shale gas in the world in Texas, at about $4 per BTU, and one of the most expensive markets in Mexico with LNG being imported at $23 per BTU. The cheapest way to bring gas from one place to the other is pipeline. So, it seems like a no-brainer for both the government and industry to keep developing pipeline to bring this cheap shale gas into a growing economy.

Snow: Todd, you have spent a lot of time in the infrastructure investment business. Talk about how an asset like Fermaca would fit into an institution portfolio. What are its attributes and what buckets would you put in it?

Todd Bright, Partners Group:

A natural-gas pipeline is a classic infrastructure asset. Infrastructure assets are long lived, they provide essential services, there are high barriers to competition for these businesses, and they generate stable cash flows usually with some form of built-in inflation protection or FX (foreign exchange) protection. The cash flows tend to be non-correlated to business cycles and non-correlated to other asset classes within an investor’s portfolio.

So, you can think of an infrastructure asset as being a hybrid asset where it’s got the capital-appreciation benefits of an equity investment but the low-volatility yield of a debt investment. Institutional investors look very favorably on those sorts of benefits for their portfolio and, these days, most of them are looking to increase their allocations towards infrastructure assets because of that. 

Snow: How important are the reforms in Mexico’s regulatory structure to the success of your company? Will your company be able to grow regardless of the regulatory environment or could things break a certain way that would be either very good or negative for you?

Calvillo: We have a very clear and strong regulated environment in Mexico. The government officials 15 years ago took very much the model of the American model—the FERC model. So, yes. One thing is yes—the energy reform might help us, of course, because when we just had a market of natural gas today we’re talking about several mainstream assets that we can develop, crude oil pipelines, refined products pipelines, terminals. There are new opportunities to invest in these types of assets but I don’t think this is changing natural gas because this industry has been operating for many years. The crucial thing also on the market to natural gas is that we will have a power market. We will have power producers. When you have the cheapest gas in the world in front of you and you have the talent to bring that gas to Mexico, it’s a whole range of opportunities, not just thinking this type monopoly like [Pamex] or CFA trying to do things. The market will change dramatically, but there are tons of opportunities today.

Snow: Jean, to the point about power plants, can you talk about where Fermaca can go from here? You’ve got the long-lived contracts for the transportation of gas, but how can it be more of a growth play if executed correctly?

Perarnaud: One attraction of the investment was obviously to look into what else can we do with the asset we own and operate. In Mexico, you have the ability to transport the gas. If you have a pipeline that can carry more gas than originally contracted, you can actually do that and sell it to third parties. As Fernando said, one upside we have from the energy reform is the creation of a new energy power market for the electricity. That means more gas will be needed to fire private consumption. In that sense, we are currently looking for new customers that can take more gas out of the pipeline than we currently own.

Snow: Todd, a question for you about Partners Group and its infrastructure strategy. How did a deal like this fit into the broader ambitions of Partners Group to become more active as a direct investor in infrastructure around the world?

Bright: At Partners Group, we tend to look at the global infrastructure-opportunity set on what we call a relative-value basis. That means we’re constantly assessing the opportunity set globally across a number of different dimensions—core infrastructure versus value add, brownfield versus greenfield, direct investing versus primary and secondary-fund investing, emerging markets versus developed markets, then sector versus sector, power versus energy versus transportation, etcetera. Fermaca has a number of the characteristics we currently like when we looked at the global opportunity set from a relative-value standpoint 

The other thing I’d say is that Fermaca sits right at the nexus between two very important global and international dynamics within the infrastructure space now. Jean talked about the shale-gas boom in the U.S. There are a number of unique factors that have led to that in the U.S.—private ownership of the mineral rights, a well-developed energy delivery network, decades of experience with horizontal drilling and multi-stage fracking methodology, good access to capital, and low political risk. That’s taken us from 30 years of gas supply a few years ago to more than 100 years now and turning the U.S. into a major gas exporter. On the other hand, Mexico is moving up the energy per capita consumption curve driven by a growing middle class and growing urbanization. Fermaca is capitalizing on both of those dynamics in two different geographies at one time. That’s a powerful thing for our investors.

Snow: A quick follow-up, Fernando. Do you expect to see Mexican professionals returning to Mexico from elsewhere like the U.S. to participate in the growth?

Calvillo: Right now, Mexico is in the hands of a generation between 35 and 45 years old. A lot of these people running the country on the government side, private sector, and economy, are people who had the opportunity either having studied in the U.S. or in Europe that want to have their country a developed country. 

There is a lot of talent in the country. I don’t think we need a lot of talent coming into the country today. We need more technology; we need companies. As Todd was saying, we have the same basin in Mexico. Jean is a dotted line as well. But we share the basin. What we do not have because of the monopoly, we have had for many years and it never makes sense to produce natural gas at $5 when you can buy at $4, or produce it at $7 when you can buy it at $4. You need companies with expertise that come and make these activities. The technology and the skills of the people are already match-on.

Snow: Talk about the difference in development of the oil-and-gas pipeline in neighboring Texas versus Mexico. How much of a difference is there? How much catch-up can there be?

Perarnaud: There’s a huge opportunity for Fermaca to grow. The state of Texas has about 500,000 miles of pipeline laid in the ground. If you compare that to Mexico, there’s only 13,000 kilometers of pipeline operating, of which 3,000 are completely obsolete and need to be replaced. So, you’re talking about massive potential growth for Mexico. In fact, this morning, we were at a presentation of the CFE—the Mexican power utility who is tendering in the next couple weeks out of the five pipelines to bring the gas into the country. We think that will be the case for the coming year. In probably 24 months, we’re going to see a huge amount of new tenders that Fermaca obviously will participate in to bring even more gas into the country and develop this backbone of pipeline. 

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