GLOBAL OIL INDUSTRY PUZZLED BY PEMEX EXEC SANCTIONS 1. Auditors lacked knowledge of commodity market trades

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1 PUBLIC POLICY PERSPECTIVE No Public Policy Perspectives are issued periodically, in English or in Spanish, as a public service with the aim of inviting fresh discussion of matters of law, policy, regulation and corporate governance. This document was prepared to help fill the vacuum in Mexico of public discussion in relation to the sanctions recently applied to two prominent Pemex executives and five members of their respective teams. Three hypotheses are offered for discussion: <1> In the case of the sanctions in PMI, the SFP auditors acted without a thorough grounding in oil market norms and practices. <2> The export sale of coker naphtha was at its true market price; and there was no discount, as alleged by SFP auditors. <3> The Public Servant Accountability Act of 2002 needs revision to provide additional protection to traders in any agency of the federal government. The topic of the sanctions given to personnel in Pemex E&P will be reported separately. GLOBAL OIL INDUSTRY PUZZLED BY PEMEX EXEC SANCTIONS 1 Auditors lacked knowledge of commodity market trades George Baker O n October 11, 2011, it became public knowledge that federal auditors had found fault with the performance of duty of the two Pemex executives who are the best known in the international oil industry: Rocío Cárdenas and Sergio Guaso. The first served as the CEO of PMI Comercio Internacional, Pemex s international arm; the second as the leader of the department in Pemex s upstream business unit that was responsible for designing public tenders that would put in practice the procurement philosophy of the Energy Reform of This turn of events was met with incredulity by industry and academic observers, customers and contractors. In conversation, industry and academic observers in Mexico and Houston express their concern that such measures will only hurt Pemex and the government, in addition to damaging the careers and professional networks of two outstanding executives. In none of these cases has there been an allegation of illegalities; but Mexico would not be Mexico if the media did not seize upon ambiguities in the language of the government s press briefing (where the word orchestrated was used once) in order to construct a narrative about a vast web of PMI corruption. Aside from a paid ad placed in REFORMA on October 18th by friends of Rocío Cárdenas, the Mexican media has not yet asked if the auditors reached the wrong conclusions. The aim here is to provide an alternative view, and to offer suggestions as to how to improve the law and the market knowledge of auditors. The issues in dispute are of such a different character that they 1 This document is a condensation of sections of Market Note 106 Making Sense of the PMI Sanctions, issued October 24, Page 1 of 5

2 deserve separate treatment, and the present discussion will focus on matters concerning the PMI executives. What observers found incredulous was not only that the allegations of administrative impropriety imputed to the PMI executives were of dubious merit, but also the severity of the sanctions meted out to four Pemex careerists who were internationally recognized for their competence and professionalism. It s easier to understand concerns about the magnitude of the sanctions than to explain the technical issues of the allegations: Not only was the employment of the four PMI executives terminated, but each was barred from returning to public service in the federal government for ten years. On top of these sanctions, which were severe enough in themselves, there were huge fines: US$21 million in the case of Rocío Cárdenas. We may turn now to the technical issues, which have to do with refinery operations, the commodity market for petroleum products and the nature of the trading profession. The federal auditors determined that in , when Ms. Cárdenas was in charge of the Refined Products Department, she and her subordinates authorized the sale of coker gasoline to two international trading companies at below market prices. The sale price was said to be $1.75 million dollars below cost and at a discount of $24.3 million dollars below the value that the product should have fetched if its price, adjusted for differences in quality, had been indexed to reformulated gasoline that is sold in Mexico City. By Article 15 of the Public Servant Responsibility Act of 2002 auditors are entitled to impose fines up to three times the amount of either the benefit received or the damages that were caused. There are several angles from which the findings of the Ministry of Government Accountability (SFP) may be seen in a different light: The SFP findings may be challenged on multiple counts. In carrying out an inspection of the transactions of a commodity trading company be the product corn oil, olive oil or gasoline auditors must be careful to make a sharp distinction between managerial discretion and behavior that may be characterized as illegal, grossly negligent or incompetent. Some observers believe that the auditors failed to make this distinction. The government s characterization of the product itself was incorrect: the product that was sold was coker naphtha, a highly toxic intermediate product that may not be compared for pricing purposes to finished gasoline; and for this reason the government s calculation of economic damage may be questioned. There is a thin market for the residual liquid waste of a refinery coker. To turn this twice processed material into an intermediate product that can be sold to a refinery as feedstock requires additional treatment such as caustic washing, which itself creates environmental liabilities. (The BBC reported on the environmental risks and legal liabilities associated with a previous sale of this product, citing an incident from 2006 with the Dutch trading company Trafigura.) Page 2 of 5

3 The sale by PMI of these cargos was motivated by the accumulation of this coker residual that threatened to exceed the storage capacity of Pemex s northern Cadereyta refinery. The choices for Pemex Refining were to a) add more storage capacity, b) cut back refinery runs so as to slow down the rate of the production of coker naphtha or c) export the product at whatever price it could obtain. For Pemex Refining, building more storage containers would only postpone the eventual day of reckoning. To cut back on refinery runs would have a huge opportunity cost, as it would mean that the output of the entire slate of refined products would be reduced, creating a gap in programmed domestic supply that would have to be covered by imports. On this point, one of the allegations of the government may be true: the PMI managers did not carry out an explicit cost benefit study where the opportunity cost of cutting back refinery runs was compared to the cost of exporting the product at or below cost (Exhibit A). But in the world of trading there may not have been time for such a study. In buying or selling, traders have to make quick mental calculations that include multiple variables: quality, demand, supply, storage and price. Timing is also important: A trade made Friday afternoon obeys calculations different from those made Monday morning. An oil company or any company that trades in commodities must respect the decisions of its traders. A corporate or government auditor who is displeased by trading losses must ask himself, if, at the end of the month or reporting period, the trader, on balance, made money. In some trades there will always be losses. If the auditor is still dissatisfied with the performance Termination is not an option. of a trader or commercial manager, his options are to admonish, retrain or reassign. Other than for illegal behavior or gross negligence, termination is not an option. Termination would send a demoralizing message, the effect of which would be to bias future trading decisions that would bring about greater economic losses. Seen in this light, the sanctions against the PMI executives are likely not to be sustained in court. In this case, by Article 22 of the cited law, the salaries and benefits of the affected persons will have to be restored. Lamentably, the appeal process is known to take years well beyond the tenure of the appointees of the current administration and involve significant legal costs. Such mistakes of factual interpretation by government officials are inevitable when they try to impose rules in place of market principles. Thirty years ago, June of 1981, Mexico s Lost Decade of the 1980s began with rescinding a discount on crude oil. Pemex, correctly sensing the weakening of the oil market, offered a $4 discount on its crudes; but government officials rescinded this discount. By mid July Pemex had lost half of its 1.5 million b/d export market and, with it, billions of badly needed dollars. Mexico s Lost Decade of the 1980s began with that mistake. Page 3 of 5

4 The Oil Boom of brought with it egregious acts of corruption, and it was for that reason that the original Public Servant Accountability Act of 1982 was passed within the first month of the installation of a new government. Twenty years later, a new version of the law was enacted that made public servants liable, not only for acts of corruption but for economic losses to the State caused by their actions or acts of omission. Ideally, this law could be used as a powerful tool to curb pervasive product theft from Pemex, or to limit multi million dollar transfers to the Oil Union. Where this law in its present form is not useful is as a tool for auditors to second guess Pemex managers who are trying to do their jobs and carry out their broad responsibilities. Stepping back, it would seem that the intent behind having Pemex s international trading function carried out by private law such as P.M.I. Trading, Ltd., was precisely to protect the traders from situations such as the one under discussion. As seen, this corporate structure does not offer PMI all the protections that were anticipated. The first conclusion to which these considerations point is that there is more work ahead for Congress: In the Public Servant Responsibility Act there should be a carve out for commodity traders in any federal service that would protect them from such sanctions for commercial transactions where illegal behavior is not alleged. The second conclusion is that auditors should be educated in market principles and transactions, possibly by means of internships with PMI as traders. What is not in question is the PMI concept, which dates from the late 1980s and developed under the leadership of Pedro Haas; and which recognizes that Pemex as a state owned company requires an agile international group in order for it to capture value by playing by market rules. But the careers of the Pemex professionals who have been sanctioned are in doubt. Should the executives prevail against the sanctions it may be hoped that Mexican auditors, policymakers and lawmakers will take notice. XX Public servants in the federal government are personally liable for actions that cause economic losses to the State. Revisions to law and policy are needed. George Baker is the publisher of, a subscription based business and policy advisory service based in Houston. Write to: perspective@energia.com Page 4 of 5

5 COMUNICADO DE PRENSA No. 98/ de octubre de 2011 CASTIGA SFP A CUATRO DIRECTIVOS DE PMI: PROVOCAN DAÑO POR 1.75 MILLONES DE DÓLARES A PEMEX AL VENDER GASOLINA BARATA La Secretaría de la Función Pública (SFP) destituyó e inhabilitó a la directora general de PMI Comercio Internacional S. A. de C. V. (PMI), por un periodo de diez años para trabajar en el gobierno federal, y le impuso una multa por 238 millones, 942 mil pesos. Cabe aclarar que estas sanciones a la directora general de PMI corresponden a hechos en los que está implicada en el periodo en que ocupaba el cargo de Directora Comercial de Refinados en la misma entidad. Además, la SFP sancionó a otros tres directivos: 1) Al Gerente Comercial de Gasolinas y Componentes de PMI con destitución, inhabilitación por diez años para trabajar en el gobierno federal y multa por 12 millones, 35 mil pesos. 2) Al encargado de despacho de la Dirección Comercial de Refinados de PMI con destitución, inhabilitación por diez años para trabajar en el gobierno federal y multa por 85 millones, 65 mil pesos. 3) Al Subdirector Comercial de Gasolinas y Componentes de PMI con destitución, inhabilitación por diez años para trabajar en el gobierno federal y multa por 170 millones, 683 mil pesos. En una investigación a la Subdirección de Gasolinas y Componentes de PMI, la SFP detectó que los directivos hoy sancionados autorizaron un descuento, excesivo e injustificado, en la venta de gasolina cóquer, a favor de las dos empresas de compra venta de hidrocarburos más grandes del mundo. Esta conducta generó un daño estimado en 1.75 millones de dólares, calculado a partir de la diferencia entre los ingresos por la venta, y los costos del combustible y de la venta. Además, si PMI hubiera vendido la gasolina cóquer a precio de mercado habría percibido 24.3 millones de dólares, por lo que el perjuicio es equivalente a esta cantidad. La investigación de SFP no encontró evidencia de que el descuento que otorgaron los directivos sancionados se sustente en la diferencia de calidad entre la gasolina cóquer y la gasolina RBOB (gasolina reformulada, similar a la que se distribuye en el Valle de México), como debería haber ocurrido. Los directivos de PMI que están implicados en este caso tampoco justificaron dicho descuento a partir de un análisis de costo beneficio. Para efectos de la investigación, el precio de mercado de la gasolina The PMI managers did not justify the cóquer se determinó a partir del precio de la gasolina discount on the basis of a costbenefit analysis. RBOB, menos un descuento que refleja la diferencia de calidades entre ambos combustibles. La revisión por parte de la SFP descubrió que la entonces Directora Comercial de Refinados omitió informar con detalle el estado de pérdidas y ganancias reales y los resultados de las operaciones comerciales al Comité Interno de PMI. La investigación de SFP detectó otras irregularidades en las operaciones de compra venta de gasolina cóquer: la falta de oferta del producto a diferentes clientes, así como la ausencia de estrategias y de actividades adecuadas de comercialización. Este comunicado se fundamenta en lo estipulado por el artículo 49, fracción VI del Reglamento Interior de la SFP. CORREO ELECTRONICO: subdeinformacion@funcionpublica.gob.mx October 11, 2011 Page 1 of 2 Page 5 of 5