SEC Company Response from METHANEX CORP (MEOH) (CIK 0000886977) (MEOH) — Mar 13, 2020
METHANEX CORP (MEOH) (CIK 0000886977)
Date: March 13, 2020 · CIK: 0000886977 · Accession: 0001628280-20-003562
AI Filing Summary & Sentiment
File numbers found in text: 000-20115
Referenced dates: December 12, 2019
Letter
United States Securities and Exchange Commission Attention: Terence O’Brien, Accounting Branch Chief Form 40-F for the Year Ended December 31, 2018 Filed March 12, 2019 File No. 000-20115 Response Dated February 21, 2020
Dear Ms. Howser and Mr. O’Brien:
We have reviewed your comments outlined in your letter of February 21, 2020 relating to the captioned items and offer the following responses.
Form 40-F for the Year Ended December 31, 2018
o) Financial instruments, page 56
SEC Comments:
2. We note your response to comment 3 in our letter dated December 12, 2019. For each jurisdiction where your natural gas supply contracts include a revenue sharing mechanism (i.e., Trinidad, New Zealand, Chile, Egypt), please provide a detailed description of the following:
i.)
A breakdown of the consumers for natural gas and the approximate percentage of natural gas used by each. For example, you indicated that in Southern Chile approximately 50% of the natural gas supply is used for domestic residential and commercial/industrial electricity needs and you use the remaining 50% of the natural gas supply. Please help us understand the types of gas consumers and their proportionate consumption in the other regions.
ii.)
The pricing structure of gas supply contracts with gas consumers other than you in each of these regions to the extent you are aware. Please tell us the cost drivers of natural gas in
these regions and how this compares to the portion of the natural gas market that you occupy.
iii.)
The number and type of natural gas suppliers from whom you purchase natural gas. Please describe any differences in how you negotiate with the different types of suppliers (government owned versus private owners) and tell us whether there are any material differences in key contract terms between the types of suppliers.
3. For regions in which there are other methanol producers (e.g., Trinidad), please tell us if those entities’ gas supply contracts are also linked to the price of methanol. If not, please provide information on how those natural gas supply contracts are priced.
4. Please describe how you evaluated whether the economic characteristics and risks of the variable price component are closely related to the economic characteristics and risks of the natural gas supply contract. Please refer to IFRS 9 4.3.3(a) for guidance. To the extent the economics and risks are different among the jurisdictions in which you operate, please provide this analysis for each location.
Our Response:
Background
As noted in previous responses, our primary view is that the natural gas supply contracts held in Trinidad, New Zealand, Chile and Egypt are in effect, royalty arrangements, where the contract formula dictates the natural gas price based on a sharing of our revenue. The contract formulas reflect the anticipated gas conversion ratio specific to the plant or plants supplied and the destination market for the methanol sold.
Additionally, the natural gas in these locations is either government controlled or characterized by natural gas reserves that would not otherwise be consumed. In this sense, the price of natural gas is not determined by an active market. In many instances, pricing for natural gas in these locations is determined by the end use, with government often involved in the initial resource development for economic growth and/or to provide subsidized pricing of the natural gas to local users. The result is an economic relationship between the methanol we produce and the price of natural gas.
Under IFRS 9, there is no explicit test to determine whether the economic characteristics and risks of a variable price component are closely related to the economic characteristics and risks of a host contract. IFRS 9 B4.3.5 provides examples of embedded derivatives that are not closely related to the host contract and IFRS 9 B4.3.8 provides examples of potential embedded derivatives that are closely related to the host contract, none of which are analogous to our contracts.
In the absence of an explicit test, or analogous examples provided by IFRS 9, we have looked to published guidance on the topic. PwC’s Manual of accounting, IFRS 2019, outlines an approach for analyzing whether a pricing mechanism in a commodity contract is closely related to its host in situations where there is not an active market in the following:
“If an active market does not exist for a particular commodity in a similar location to the one specified in the contract, management should consider how other contracts for that particular commodity are normally priced, in the absence of a readily available market price. That pricing mechanism would not be considered an embedded derivative if it can be demonstrated that it is an identifiable industry ‘norm’ and that contracts are regularly
priced according to that norm. This is because such a pricing mechanism does not modify the cash flows under the contract (IFRS 9 4.3.1).” 1
EY, International GAAP 2019, has similar guidance noting that “…other proxy pricing mechanisms may arise in long-term supply agreements for commodities where there is no active market in the commodity.” 2 EY cites natural gas contracts that were indexed to other commodities such as crude oil before an active market developed that were considered closely related to the host contract because similar pricing mechanisms were commonly used by other participants in the market.
There is very limited guidance under IFRS to determine what constitutes an active market. IFRS 13-Appendix A, defines an active market as one in “…which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis.”
It is still generally recognized that a global natural gas market does not exist3. Unlike oil (which is widely considered a global commodity), natural gas markets exist at a regional or in some cases, at a sub-regional level, therefore our analysis considers natural gas regionally rather than globally.
Our methanol production facilities outside North America are in government controlled, developing or isolated natural gas markets where there are not sufficient transactions and market players to provide transparent pricing information on an ongoing basis to constitute an active market. One characteristic of each of these regions is that there is no market to purchase a stand-alone financial derivative in which one could hedge the price of natural gas. In addition, gas extraction in each region is heavily regulated and/or controlled by government.
In the absence of an active market, we consider the pricing within the market that the company transacts. IFRS 13 suggests that for purposes of measuring fair value, a company would look to the market to which they have access, acknowledging that different companies may have access to different markets (for example, dealer, retail, wholesale markets) (IFRS 13.19, IE24-26).
Where gas is government controlled, our contractual supply of natural gas cannot be monetized other than in our production and sale of methanol. For other locations, lack of transportation infrastructure and lack of alternative demand isolate these natural gas markets such that Methanex has been a market maker for the price of natural gas. In identifying the market for these regions we often only have access to natural gas that would not otherwise be used for domestic electricity production or consumption. This is either because the location of our plant is isolated; the natural gas supply we use is incremental to domestic needs; or the government restricts access to the market. As such, the market we transact in is best described as the wholesale gas market excluding domestic consumption (e.g. heating/cooking consumption and electricity production) in the regions in which our plants are located.
__________________________________
1 Manual of accounting, IFRS 2019, PwC. FAQ 41.62.4
2 International GAAP 2019, EY, Chapter 5.2.2
3 "Is Gas Global” publication dated March 23, 2018 by Center for Strategic and International Studies. https://www.csis.org/analysis/gas-global-yet
Consideration also needs to be given to whether there is an industry norm or proxy pricing mechanism used to price natural gas is used in these identified markets.
Natural gas industry publications describe contract pricing linked to the output economics where the gas suppliers participate in the risks and rewards of the end use commodity, such as methanol, as netback pricing (or product indexed pricing). These industry publications describe netback pricing as one of the common pricing mechanisms in determining regional natural gas prices and describe it specifically as a pricing mechanism used when natural gas is used as a feedstock in the petrochemical industry. The International Gas Union, Wholesale Gas Price Survey 2019 Edition4 provides the following definition for Netback from final product pricing for natural gas:
With that background as context, we have responded to the comments posed on a region-by-region basis to address all comments within the context of the specific region.
Trinidad
2.
i.)
A breakdown of the consumers for natural gas and the approximate percentage of natural gas used by each. For example, you indicated that in Southern Chile approximately 50% of the natural gas supply is used for domestic residential and commercial/industrial electricity needs and you use the remaining 50% of the natural gas supply. Please help us understand the types of gas consumers and their proportionate consumption in the other regions.
A summarized breakdown of natural gas consumers by use for the 2019 year as published5 by the Ministry of Energy and Energy Industries of the Government of the Republic of Trinidad and Tobago:
•
Liquified Natural Gas (“LNG”) 57%
•
Ammonia 16%
•
Methanol 16%
•
Domestic power and industry 11%
ii.)
The pricing structure of gas supply contracts with gas consumers other than you in each of these regions to the extent you are aware. Please tell us the cost drivers of natural gas in these regions and how this compares to the portion of the natural gas market that you occupy.
__________________________________
4 International Gas Union, Wholesale Gas Price Survey 2019 Edition - A global review of price formation mechanisms. 2019, Page 11
5 http://www.energy.gov.tt/meei-consolidated-monthly-bulletin-january-december-2019/
In Trinidad, the pricing for natural gas is determined by the end use6. Natural gas pricing for export petrochemical commodities (ammonia and methanol) and LNG reflect a netback on the produced output pricing for the Trinidad government to benefit from the upside movement in these output commodities. This is the case with our natural gas supply contracts in Trinidad which, as previously described, include a fixed base price and a variable sharing formula based on the price of methanol. The variable component has been a substantial portion of the historic cash flows on these supply contracts.
These export commodities are a substantial contributor to the Trinidad economy and represent approximately 90% of the total consumption of natural gas. The allocation of natural gas to these export industries is determined by the government in order to diversify the risks of the economy’s dependence on the gas sector. This netback pricing mechanism, where the natural gas supplier shares in the risks and benefits of the use, clearly links the economic returns on natural gas to the commodities produced including our production of methanol.
Domestic natural gas consumption is priced on a different paradigm to export commodities. Power for residential and commercial users is highly subsidized by the government, while local heavy and light industrial uses are priced on a cost-plus basis. As noted above, domestic use is approximately 10% of the total natural gas consumed in the country.
Methanol price is the primary cost driver for natural gas production into methanol in Trinidad.
iii.)
The number and type of natural gas suppliers from whom you purchase natural gas. Please describe any differences in how you negotiate with the different types of suppliers (government owned versus private owners) and tell us whether there are any material differences in key contract terms between the types of suppliers.
The Natural Gas Company of Trinidad & Tobago (“NGC”) is a State-Owned-Enterprise and the only supplier of natural gas in Trinidad. We have entered into long-term contracts with the NGC to underpin the initial investments in the two methanol plants in Trinidad. As described above, the use of netback (or product indexed) pricing is government policy in Trinidad & Tobago, so negotiations focus around the economic sharing.
3.
For regions in which there are other methanol producers (e.g., Trinidad), please tell us if those entities’ gas supply contracts are also linked to the price of methanol. If not, please provide information on how those natural gas supply contracts are priced.
Trinidad is the only Methanex location outside North America, where there are methanol production facilities that compete for local natural gas.
Methanol Trinidad Holdings Limited (“MHTL”), is a subsidiary of Consolidated Energy which is held by two shareholders Proman AG (Swiss private company) and Helm AG (German private company). MHTL has five methanol plants in Trinidad with total production capacity of
__________________________________
6 Trinidad & Tobago Gas Master Plan: Final Report. Prepared for: Ministry of Energy and Energy Affairs. September 2015. Section 1.9 Gas Pricing in T&T. Page 38.
approximately 4 million MT. There is another 1 million MT methanol plant currently under construction, Caribbean Gas Chemical Limited (“CGCL”), owned by a Mitsubishi consortium, NGC and local Trinidad conglomerate Massy Holdings Ltd.
The Trinidad & Tobago Gas Master Plan (“T&T Gas Plan”) outlines the Government of the Republic of Trinidad & Tobago’s (“GORTT”) use of netback pricing for LNG and product indexed pricing for natural gas supply contracts for use in the production of ammonia and methanol. The report does not provide definitions for each, but as described previously, netback pricing is characterized by a price for natural gas that fluctuates with the price of the product produced. The following excerpt from the T&T Gas Plan describes the pricing concepts in general and describes the pricing for LNG and petrochemicals (ammonia and methanol) as netback pricing in the paragraph below Table 1-9, indicating the terms can be used interchangeably.7
__________________________________
7 Trinidad & Tobago Gas Master Plan, Prepared for: Ministry of Energy and Energy Affairs, September 2015, 1-38
Though we do not have visibility over the specific pricing terms between the NGC and other methanol producers, we note that the NGC’s annual report provides explanations relating to both methanol and ammonia prices in the analysis of financial results and risk management disclosures which explain higher earnings as being the result of higher methanol and ammonia pricing in the year ended 2018. The government intention and NGC’s financial results are indicative that the same methanol link is applicable for other methanol producers.
4.
Please describe how you evaluated whether the economic characteristics and risks of the variable price component are closely related to the economic characteristics and risks of the natural gas supply contract. Please refer to IFRS 9 4.3.3(a) for guidance. To the extent the economics and risks are different
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CORRESP 1 filename1.htm Document Methanex Corporation 1800 - 200 Burrard St. Vancouver, BC Canada V6C 3M1 Investor Relations: 604-661-2600 Toll-Free: 1-800-661-8851 http://www.methanex.com March 13, 2020 United States Securities and Exchange Commission 100 F Street N.E. Washington, D.C. 20549 Attention: Terence O’Brien, Accounting Branch Chief RE: Methanex Corporation Form 40-F for the Year Ended December 31, 2018 Filed March 12, 2019 File No. 000-20115 Response Dated February 21, 2020 Dear Ms. Howser and Mr. O’Brien: We have reviewed your comments outlined in your letter of February 21, 2020 relating to the captioned items and offer the following responses. Form 40-F for the Year Ended December 31, 2018 o) Financial instruments, page 56 SEC Comments: 2. We note your response to comment 3 in our letter dated December 12, 2019. For each jurisdiction where your natural gas supply contracts include a revenue sharing mechanism (i.e., Trinidad, New Zealand, Chile, Egypt), please provide a detailed description of the following: i.) A breakdown of the consumers for natural gas and the approximate percentage of natural gas used by each. For example, you indicated that in Southern Chile approximately 50% of the natural gas supply is used for domestic residential and commercial/industrial electricity needs and you use the remaining 50% of the natural gas supply. Please help us understand the types of gas consumers and their proportionate consumption in the other regions. ii.) The pricing structure of gas supply contracts with gas consumers other than you in each of these regions to the extent you are aware. Please tell us the cost drivers of natural gas in these regions and how this compares to the portion of the natural gas market that you occupy. iii.) The number and type of natural gas suppliers from whom you purchase natural gas. Please describe any differences in how you negotiate with the different types of suppliers (government owned versus private owners) and tell us whether there are any material differences in key contract terms between the types of suppliers. 3. For regions in which there are other methanol producers (e.g., Trinidad), please tell us if those entities’ gas supply contracts are also linked to the price of methanol. If not, please provide information on how those natural gas supply contracts are priced. 4. Please describe how you evaluated whether the economic characteristics and risks of the variable price component are closely related to the economic characteristics and risks of the natural gas supply contract. Please refer to IFRS 9 4.3.3(a) for guidance. To the extent the economics and risks are different among the jurisdictions in which you operate, please provide this analysis for each location. Our Response: Background As noted in previous responses, our primary view is that the natural gas supply contracts held in Trinidad, New Zealand, Chile and Egypt are in effect, royalty arrangements, where the contract formula dictates the natural gas price based on a sharing of our revenue. The contract formulas reflect the anticipated gas conversion ratio specific to the plant or plants supplied and the destination market for the methanol sold. Additionally, the natural gas in these locations is either government controlled or characterized by natural gas reserves that would not otherwise be consumed. In this sense, the price of natural gas is not determined by an active market. In many instances, pricing for natural gas in these locations is determined by the end use, with government often involved in the initial resource development for economic growth and/or to provide subsidized pricing of the natural gas to local users. The result is an economic relationship between the methanol we produce and the price of natural gas. Under IFRS 9, there is no explicit test to determine whether the economic characteristics and risks of a variable price component are closely related to the economic characteristics and risks of a host contract. IFRS 9 B4.3.5 provides examples of embedded derivatives that are not closely related to the host contract and IFRS 9 B4.3.8 provides examples of potential embedded derivatives that are closely related to the host contract, none of which are analogous to our contracts. In the absence of an explicit test, or analogous examples provided by IFRS 9, we have looked to published guidance on the topic. PwC’s Manual of accounting, IFRS 2019, outlines an approach for analyzing whether a pricing mechanism in a commodity contract is closely related to its host in situations where there is not an active market in the following: “If an active market does not exist for a particular commodity in a similar location to the one specified in the contract, management should consider how other contracts for that particular commodity are normally priced, in the absence of a readily available market price. That pricing mechanism would not be considered an embedded derivative if it can be demonstrated that it is an identifiable industry ‘norm’ and that contracts are regularly priced according to that norm. This is because such a pricing mechanism does not modify the cash flows under the contract (IFRS 9 4.3.1).” 1 EY, International GAAP 2019, has similar guidance noting that “…other proxy pricing mechanisms may arise in long-term supply agreements for commodities where there is no active market in the commodity.” 2 EY cites natural gas contracts that were indexed to other commodities such as crude oil before an active market developed that were considered closely related to the host contract because similar pricing mechanisms were commonly used by other participants in the market. There is very limited guidance under IFRS to determine what constitutes an active market. IFRS 13-Appendix A, defines an active market as one in “…which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis.” It is still generally recognized that a global natural gas market does not exist3. Unlike oil (which is widely considered a global commodity), natural gas markets exist at a regional or in some cases, at a sub-regional level, therefore our analysis considers natural gas regionally rather than globally. Our methanol production facilities outside North America are in government controlled, developing or isolated natural gas markets where there are not sufficient transactions and market players to provide transparent pricing information on an ongoing basis to constitute an active market. One characteristic of each of these regions is that there is no market to purchase a stand-alone financial derivative in which one could hedge the price of natural gas. In addition, gas extraction in each region is heavily regulated and/or controlled by government. In the absence of an active market, we consider the pricing within the market that the company transacts. IFRS 13 suggests that for purposes of measuring fair value, a company would look to the market to which they have access, acknowledging that different companies may have access to different markets (for example, dealer, retail, wholesale markets) (IFRS 13.19, IE24-26). Where gas is government controlled, our contractual supply of natural gas cannot be monetized other than in our production and sale of methanol. For other locations, lack of transportation infrastructure and lack of alternative demand isolate these natural gas markets such that Methanex has been a market maker for the price of natural gas. In identifying the market for these regions we often only have access to natural gas that would not otherwise be used for domestic electricity production or consumption. This is either because the location of our plant is isolated; the natural gas supply we use is incremental to domestic needs; or the government restricts access to the market. As such, the market we transact in is best described as the wholesale gas market excluding domestic consumption (e.g. heating/cooking consumption and electricity production) in the regions in which our plants are located. __________________________________ 1 Manual of accounting, IFRS 2019, PwC. FAQ 41.62.4 2 International GAAP 2019, EY, Chapter 5.2.2 3 "Is Gas Global” publication dated March 23, 2018 by Center for Strategic and International Studies. https://www.csis.org/analysis/gas-global-yet Consideration also needs to be given to whether there is an industry norm or proxy pricing mechanism used to price natural gas is used in these identified markets. Natural gas industry publications describe contract pricing linked to the output economics where the gas suppliers participate in the risks and rewards of the end use commodity, such as methanol, as netback pricing (or product indexed pricing). These industry publications describe netback pricing as one of the common pricing mechanisms in determining regional natural gas prices and describe it specifically as a pricing mechanism used when natural gas is used as a feedstock in the petrochemical industry. The International Gas Union, Wholesale Gas Price Survey 2019 Edition4 provides the following definition for Netback from final product pricing for natural gas: With that background as context, we have responded to the comments posed on a region-by-region basis to address all comments within the context of the specific region. Trinidad 2. i.) A breakdown of the consumers for natural gas and the approximate percentage of natural gas used by each. For example, you indicated that in Southern Chile approximately 50% of the natural gas supply is used for domestic residential and commercial/industrial electricity needs and you use the remaining 50% of the natural gas supply. Please help us understand the types of gas consumers and their proportionate consumption in the other regions. A summarized breakdown of natural gas consumers by use for the 2019 year as published5 by the Ministry of Energy and Energy Industries of the Government of the Republic of Trinidad and Tobago: • Liquified Natural Gas (“LNG”) 57% • Ammonia 16% • Methanol 16% • Domestic power and industry 11% ii.) The pricing structure of gas supply contracts with gas consumers other than you in each of these regions to the extent you are aware. Please tell us the cost drivers of natural gas in these regions and how this compares to the portion of the natural gas market that you occupy. __________________________________ 4 International Gas Union, Wholesale Gas Price Survey 2019 Edition - A global review of price formation mechanisms. 2019, Page 11 5 http://www.energy.gov.tt/meei-consolidated-monthly-bulletin-january-december-2019/ In Trinidad, the pricing for natural gas is determined by the end use6. Natural gas pricing for export petrochemical commodities (ammonia and methanol) and LNG reflect a netback on the produced output pricing for the Trinidad government to benefit from the upside movement in these output commodities. This is the case with our natural gas supply contracts in Trinidad which, as previously described, include a fixed base price and a variable sharing formula based on the price of methanol. The variable component has been a substantial portion of the historic cash flows on these supply contracts. These export commodities are a substantial contributor to the Trinidad economy and represent approximately 90% of the total consumption of natural gas. The allocation of natural gas to these export industries is determined by the government in order to diversify the risks of the economy’s dependence on the gas sector. This netback pricing mechanism, where the natural gas supplier shares in the risks and benefits of the use, clearly links the economic returns on natural gas to the commodities produced including our production of methanol. Domestic natural gas consumption is priced on a different paradigm to export commodities. Power for residential and commercial users is highly subsidized by the government, while local heavy and light industrial uses are priced on a cost-plus basis. As noted above, domestic use is approximately 10% of the total natural gas consumed in the country. Methanol price is the primary cost driver for natural gas production into methanol in Trinidad. iii.) The number and type of natural gas suppliers from whom you purchase natural gas. Please describe any differences in how you negotiate with the different types of suppliers (government owned versus private owners) and tell us whether there are any material differences in key contract terms between the types of suppliers. The Natural Gas Company of Trinidad & Tobago (“NGC”) is a State-Owned-Enterprise and the only supplier of natural gas in Trinidad. We have entered into long-term contracts with the NGC to underpin the initial investments in the two methanol plants in Trinidad. As described above, the use of netback (or product indexed) pricing is government policy in Trinidad & Tobago, so negotiations focus around the economic sharing. 3. For regions in which there are other methanol producers (e.g., Trinidad), please tell us if those entities’ gas supply contracts are also linked to the price of methanol. If not, please provide information on how those natural gas supply contracts are priced. Trinidad is the only Methanex location outside North America, where there are methanol production facilities that compete for local natural gas. Methanol Trinidad Holdings Limited (“MHTL”), is a subsidiary of Consolidated Energy which is held by two shareholders Proman AG (Swiss private company) and Helm AG (German private company). MHTL has five methanol plants in Trinidad with total production capacity of __________________________________ 6 Trinidad & Tobago Gas Master Plan: Final Report. Prepared for: Ministry of Energy and Energy Affairs. September 2015. Section 1.9 Gas Pricing in T&T. Page 38. approximately 4 million MT. There is another 1 million MT methanol plant currently under construction, Caribbean Gas Chemical Limited (“CGCL”), owned by a Mitsubishi consortium, NGC and local Trinidad conglomerate Massy Holdings Ltd. The Trinidad & Tobago Gas Master Plan (“T&T Gas Plan”) outlines the Government of the Republic of Trinidad & Tobago’s (“GORTT”) use of netback pricing for LNG and product indexed pricing for natural gas supply contracts for use in the production of ammonia and methanol. The report does not provide definitions for each, but as described previously, netback pricing is characterized by a price for natural gas that fluctuates with the price of the product produced. The following excerpt from the T&T Gas Plan describes the pricing concepts in general and describes the pricing for LNG and petrochemicals (ammonia and methanol) as netback pricing in the paragraph below Table 1-9, indicating the terms can be used interchangeably.7 __________________________________ 7 Trinidad & Tobago Gas Master Plan, Prepared for: Ministry of Energy and Energy Affairs, September 2015, 1-38 Though we do not have visibility over the specific pricing terms between the NGC and other methanol producers, we note that the NGC’s annual report provides explanations relating to both methanol and ammonia prices in the analysis of financial results and risk management disclosures which explain higher earnings as being the result of higher methanol and ammonia pricing in the year ended 2018. The government intention and NGC’s financial results are indicative that the same methanol link is applicable for other methanol producers. 4. Please describe how you evaluated whether the economic characteristics and risks of the variable price component are closely related to the economic characteristics and risks of the natural gas supply contract. Please refer to IFRS 9 4.3.3(a) for guidance. To the extent the economics and risks are different