Mexico UpdateGovernment and Regulatory Affairs

February 2001

CONFIDENTIAL

Document for Dr. Kenneth LayChairman and CEOEnron

2

Contents

IntroductionElectricityGasAnnex

3

Introduction

This document is aimed at presenting an overview of the current policy issues in the Mexican electricity and natural gas industries prior to meeting with Mexico’s new Secretary of Energy, Ernesto Martens.

Secretary Martens has been extremely supportive of our Vitro project. He has gone out of his way to help us.

President Fox has publicly expressed that electricity reform is one of his top three items in the agenda together with fiscal reform and legislation to benefit Mexico’s indigenous population.

In the past few weeks President Fox has proposed a coordinated energy policy for North America which would include the interconnection of the electricity transmission grid and of the natural gas transportation infrastructure.

Despite his intentions President Fox faces strong political barriers to carry out reform since both houses of Congress are divided practically in three. He needs the PRI (the party he beat) to pass this reforms.

To be able to carry out the reorganization of the electric industry and to allow for private participation in the production of dry natural gas, a Constitutional amendment is required. Sixty six percent of the vote is required in both houses to pass the amendment as well as the vote of the majority of the Congresses at State level.

On Monday, February 5th, President Fox announced an initiative to create a completely new Constitution for Mexico. On Tuesday, policy makers in the energy sector were still uncertain if the awaited reforms would be postponed until there is a new Constitution.

Mexico summary

Economy

GDP 2000 $ 570.1Bn U.S.Growth 99-00 7.1 %Expected Growth 00-01 4.5 %

Enron 245 Mw plant -Construction begins: 01-01 -Commercial operation: 10-02

Enron Americas Offices

Demographics

Population 97.4 million Open unemployment 2.3%

Highlights• Fastest growing economy in the world 2Q/99-2Q/00 @ 8%+• Second largest trade partner with U.S.(229 billion in trade in 2000)• Eighth largest exporting economy (only 10% oil down from 80% 15 yrs. ago). Exports growing @15.7% per yr.

EBS Offices

Azurix presence

Territory Square miles

758,463756,484 1,979

Continental Islands TotalMexico is the fourteenth largest country in the world

Enron in Mexico

4

5

ElectricityIn February of 1999 President Zedillo sent an initiative to Congress by which he proposed the privatization of the Mexican Electric Industry. The initiative did not pass due mainly to two reasons:

1. It proposed the sale of existing assets and,2. He did not get the support from the PAN (now the party in power) due to a political struggle related to the Mexican banking system crisis

At that time Enron approached the PAN to help them understand the industry and the need for change. We also helped them come up with specific alternative solutions to problems in Zedillo’s initiative which they viewed as politically unviable.

When Vicente Fox was elected President, Enron was invited to participate in the electricity transition team. That team designed the new electricity policy and the reform initiative. The team also wrote several legislation drafts.

Today, Enron is cooperating closely with policy makers and regulators and has gained support from other industry participants in this effort.

Enron will be serving as a link between leading opposition legislators and policy makers in the reform process.

Commercial success

Financial closing for the Vitro project in Garcia, Nuevo Leon, was achieved in December 2000. Our three off-takers are Vitro (glass), Apasco (cement) and Imsa (steel).

The Enron commercial team in Mexico successfully continues to develop new businesses in the current regulatory environment.

6

Current status

6.1%28,751 MW

12.85%

• Annual growth • Peak load• Losses

Supply

Nuclear 4%

Hydroelectric 27%

Installed generation capacity

National Electric Grid• Transmission lines:• Sub-transmission lines:• Distribution lines:

Geothermal 2%

Hydrocarbons 60%

145 TWh1900 kwh/inhab.

Coverage 95%+23 millon

0.55 ¢/kWh1.30 ¢/kWh0.52 ¢/kWh

• Electricity consumption:• Per capita consumption: • Customer base:• Total users:• Average rates

–Residential :–Commercial:–Industrial:

DemandCoal 7%

21,790 mi.26,267 mi.

341,914 mi.

Wind 0.0058%

Source: Prospectiva del Sector Eléctrico 98-2007, CFE

100%= 37,488 MW (Dec. 2000)

Retired

• CFE• LFCTotal

Labor force (‘000)

Active

171431

7238

110

Electricity supply in Mexico is a public service rendered by the State through CFE and LFC. Since 1992 IPPssell electricity to the CFE through long term contracts and self-supply arrangements are allowed.

7

Currently, the operations reserve is below its critical limit. During 2000 many large industrial users were required to stop operations on several occasions in order to avoid generalized blackouts.

PercentageThe system requires a constant minimum reserve of 6% of generation capacity in every moment to prevent short term contingencies

25

20

15

10

6%5

0Jan

Source: CENACE, CFE

Feb Mar Apr May Jun Jul

Operations reserve margin

OPERATIONS RESERVE MARGIN

Reserve crisis

8

Currentcapacity

Underconstruc-tion

IPPs under bidprocess

Program-med capacity not bid

Capacity to be removed

Totalprogram-medcapacity

Total capacity neededby 2010

Additionalcapacity over programmedcapacity

37,448

9,700 950

14,229

(2,019)60,308

64,590

75,865 15,557

4,28211,275

7% GDP growth

5% GDP growth

GENERATION CAPACITY SCENARIOS 2001 - 2010(MW)

Source:Prospective of the National Electric Sector 1998-2007; President elect’s transition team, Secretaria de Energia

11,275

ESTIMATE

To be able to meet the increase in demand for electricity new capacity will have to be built. If the newadministration meets its economic goals capacity should almost duplicate in the next ten years

Capacity growth

9

REQUIRED INVESTMENTS 2001-2010

19.0

39.05

12.75

4.4

5.8

3.7

5.4

0.75 0.25

1.3

7.8

1.6

1.8

New generation capacity

Mainte-nance

Transmission Distribution Other

investments

TotalIPP amortization

11,275 MW

27,142MW

26.8

5.0

7.0

6.01.0

51.8

US $2.7 billion per year for new generation

US $5 billion per year for the industry

7% GDP growth

5% GDP growth

$US Billions

ESTIMATE

Source:Prospective of the National Electric Sector 1998-2007; President elect’s transition team, Secretaria de Energia

In order to achieve the required growth of the electric system yearly investments of between $US 4 and 5 billion will have to be made in the next ten years.

Investment

NOTE: According to experts investments required for transmission are underestimated.

10

GOALS AND PRINCIPLES FOR THE REORGANIZATION

• To ensure sufficient electricity supply for economic development and social well-being.

• To reduce public investments in order to free resources and borrowing capacity for other government activities

• To establish a competitive structure to promote private investment without government guarantees.

• To achieve reduced operational costs and system expansion for additional consumer benefits.

Goals

• Current assets will not be privatized

• Phasing out of the IPP model

• Establishment of a competitive energy market with effective and transparent regulation

• Establish a tariff structure that supports the financial needs of the sector in the medium and long terms.

• Guarantee the stability of the operation of the system during the reorganization process

Principles

There is consensus on the need for the reorganization of the industry but due to political reasons reform has not been passed

Reorganization of the electric industry

CFE Nuclear & Geothermal

CFE Hydro

Payments according to contracts

Generation CFE Thermo

CFE’s divisionfor IPP

Self - suppliers and Co- generators

Generators

T

r

a

n

s

m

i

s

s

i

o

n

Gr

I

d

Payments

Energy

Payments

Energy

Payments

Energy

Payments

Energy

Energy

UsersPayments

Energy

O

p

e

r

a

t

o

r

IPP Energy

Largeusers

PROPOSED REORGANIZATION MODEL

S

y

s

t

e

m

a

n

d

M

a

r

k

e

t

Bilateral Contracts

Autonomous entities

GovernmentActivity

Private activityConcession

Distribution

Regulator

Marketing

Authorities

Contracts

Regulated

Payments

Energy

Payments

11

12

Distribu-

tion and

marketing

Transmi-

ssion

Generation

Short term Medium term Long term

• Current capacity stays under Government property• IPP expansion• Opening to the market of surpluses (self-generators and co-generators)

• Current capacity in hands of the Goverment

• Participation of some IPPs in the market

• New private capacity enters the market

• System operation (dispatch) and market as an autonomous public organization (independent of the CFE)

• National regulated monopoly with guaranteed open access

• The Government retains the planning, operation, maintenance and expansion

• Regulated regional monopolies• The Government maintains planning, operation, maintenance

and expansion• Marketing open at wholesale level• Tariff restructuring

• Marketing open at retail level

Today 2001- 2005 2005-

System and

market operation

PROPOSED EVOLUTION OF THE REORGANIZATION

• Concession of operation, maintenance and expansion

• Separation of system and market operation (PX and ISO)

13

Gas

Despite the fact that competition is allowed in gas transportation and marketing, Pemex’s market power and a price formula that does not reflect true market conditions make it impossible to participate in thesebusinesses.

Currently most of the Mexican gas market uses a South Texas gas market price index. This would make import of natural gas viable. Nevertheless, a variable introduced in the price formula makes competing against Pemex impossible by not taking into account the real price of gas at the border.

Added to this situation, Pemex is the sole producer of natural gas through its subsidiary PEP. This subsidiary in turn sells the gas to Pemex’s own marketing and transportation company (PGPB)which is the only company authorized to enter first hand sale of gas agreements. This company sells the gas to other Pemex subsidiaries, the the CFE, to the LDCs and to its potential competitors.

Pemex needs to change the way it does business through its subsidiaries and allow for other would be marketers and transporters to buy the gas directly from PEP under identical conditions than PGPB.

Price crisis

Despite opposition from Secretary Martens, the CRE (FERC equivalent), the CEO of Pemex and the Secretary of the Treasury, President Fox ordered that a fixed price of $US 4 dollars per Mmbtu be offered to the end users for a 3 year period starting in January of 2001.

…continued on next page

14

Gas…continued

Enron has been called on several occasions to discuss gas policy with Secretary Martens, with the President of the CRE (FERC equivalent), with the CEO of Pemex and with the Chief advisor to the Secretary of the Treasury.

Although there was consensus on not offering an artificial price, the pressure from the big industrials and a Presidential instruction forced them to come up with what in their perspective is the least damaging solution.

The 4 dollar fixed price is supposedly based on a Pemex hedging instrument. This measure has taken longer than planned to implement.

Our risk management team is trying hard to do business in this very uncertain environment after a very successful 2000 during which they traded approximately $US 250 million dollars in risk management products.

15

Increase of natural gas in the fuel mix:

–Electricity, from 705 Bcf/d in 1999 to 3,618 Bcf/d in 2009 (+20.5% from ‘99 to 2000)

– Industrial, from 1,194 Bcf/d in 1999 to 2,150 Bcf/d in 2000

1.1

2.7

2.5

2.5

1.8

1.8

0.4

0.1

2001 2006

4.8

8.1

Electricity

Oil & Petchem

Industrial

Residential & commercial

75%

NATURAL GAS DEMAND– 2001-2006Bcf/d

The Mexican gas market needs to stay linked to the U.S. gas market to guarantee supply in the future

Supply and demand

16

NATURAL GAS IMPORTS FROM THE U.S. 1993-2000

1995 1996 1997 1998 1999 2000

Million cubic feet per day

172.92

83.68

114.96

153.16 148.95

238.12

59%

In 2000 imports from the U.S. increased by 59%. This trend will continue as new power plants start operations

17

Millions of cubic meters per daySTRATEGIC NATURAL GAS PROGRAM SUPPLY PROJECTIONS

0

2000

4000

6000

8000

10000

12000

2001 2002 2003 2004 2005 2006 2007 2008

National demand

Demand covered by Pemex by implementing the Strategic Program

The Strategic Natural Gas Program planned by Pemex requires $US12 billion in investment. Even after implementingthe Program, Mexico will need to import gas from the United States.

Imports

18

Although some regulatory reform has taken place, Pemex’s market power makes it virtually impossible to enter the wholesale gas marketing and transportation businesses in Mexico

CURRENT SITUATION

End usersStorage Wholesale Transport DistributionImports

Production

• Concessions have been given to local distribution companies

• There is no storage infrastructure

•There is no real competition due to PGPB’s market power

• PGPB sells the gas to its competitors

• Users are subject to rigid and non- competitive commercial conditions

• There is no real competition due to PGPB’s market power

•PGPB sells the transport to its competitors

• There are some companies that have their own transportation infrastructure

• Pemex is the sole producer through PEP* and sells the gas to another subsidiary (PGPB**) for transportation and marketing

• Pemex carries out most of the imports and markets it through it subsidiary (PGPB)

• Today, users are at a disadvantage with respect to their competitors in other countries

*Pemex Exploration and Production**Pemex Gas and Basic Petrochemicals

No competition – The problem

19

PEMEX BUSINESS SYSTEM

PGPBDry gasEthaneLiquefied gasGasolineBasic petrochemicalsSulfur

Gas and liquidsprocessing

PEPCrude oil production

Natural gas production

• Pemex Subsidiaries• Clients*• Exports

Today, PEP produces the gas and sells it to PGPB which in turn transports and markets it to other Pemex subsidiaries, to other marketers, to LDCs and to large users.

* Other marketers, local distribution companies and large users

20

DISADVANTAGES OF THE CURRENT SITUATION

• There are no incentives to invest in transportation infrastructure

• The first hand sales of gas contract (from PGPB) cannot be financed

• There is no commercial certainty to establish a natural gas market (price, supply, non-discriminatory open access, capacity information, etc.)

• PGPB does not offer competitive commercial conditions

• The market for transportation capacity cannot be established

Despite some progress, end users have not been benefited by deregulation.It is absolutely necessary to promote the modernization of this sector through competition

Without a solution in the short term Mexico will suffer a natural gas shortage Without a solution in the short term Mexico will suffer a natural gas shortage

21

CHANGE PROPOSITION

End usersStorage Wholesale Transport DistributionImports

Production

• Production: Private investment or Joint Ventures for production of non-associated gas in the Burgos basin• Imports: Promotion of imports through the establishment of a competitive wholesale market

• The establishment of a competitive wholesale market would result in investment in storage infrastructure

• A truly competitive natural gas wholesale market will be the foundation for the transformation of this industry

• Absolute guarantee to non-discriminatory open access to gas transportation infrastructure

• Continuation of the LDC concession program

• Benefit from competition

Competition – The solution

The establishment of a competitive gas market will create the certainty needed for increased production and imports, for investment in storage and transportation infrastructure and for the existence of efficient commercial conditions

Establishment of an electronic bulletinboard for prices and volumes of gas and transport

22

ALTERNATIVE PEMEX BUSINESS SYSTEM TO ALLOW COMPETITION

PGPBDry gasEthaneLiquefied gasGasolineBasic petrochemicalsSulfur

Gas and liquidsprocessing

PEPCrude oil production

Natural gas production

Transport

Clients

Marketing companies and large users are able to buy gas directly from PEP

PGPB should exit the gas marketing business and focus on selling transport capacity

* PGPB could monetize its gas sales contracts by bidding them out to other industry participants

Unbundling the Pemex business system does not require major regulatory changes. Modifying Pemex’s management strategy will allow competition and with it, the creation of an efficient wholesale market that will ensure investment in the industry and supply for the consumers.

• Pemex Subsidiaries• Clients*• Exports

23

Annex• Bios• Economic indicators

24

Secretaría de Energía - Department of Energy

Throughout his working career, Ernesto Martens has faced great challenges and obtained successful results. For eighteen years, he worked for Union Carbide, becoming its General Manager; for seventeen years he worked for Grupo Vitro (glass,our client in the Monterrey plant), which he also directed. Subsequently he became the Chairman of the Board of Aerovías de Mexico and the General Attorney in Fact of Mexicana de Aviación. He was appointed Chairman of the Board of Directors and General Manager of Cintra (holding company for Mexicana and Aeromexico airlines), holding that position until 1999. During the time he worked for the latter company, he was successful in having both airlines and their subsidiaries become leader companies in Latin America. He turned losses into profit and improved efficiency.

Throughout his professional career, he has been a member of the Board of Directors of renowned companies, both national and international: Board of Regioempresas, Aeromar, Hulnort, Vitro and subsidiaries; Regional Board of Banamex-Accival, Transportación Marítima Mexicana, Afore, Ahorro Santander, Gatx de Mexico, Hylsamex, Anchor Glass Container Corporation, Grupo Financiero Serfin and the Business Advisory Council of the International Finance Corporation, among others.

He received a degree in Chemical Engineering from the Technological Institute and Superior Studies of Monterrey (Monterrey Campus) and took post-graduate courses at the Technological Institute of Karlsruhe in Germany, and of Business Administration at the Harvard Business School.

He was born in Tlilapan, Veracruz on January 28, 1933

Ernesto Martens Secretary of Energy

25

Petróleos Mexicanos – PEMEX

Raúl Muñoz began his professional career at Du Pont, S.A. de C.V. in 1964. There, he held different positions in the areas of production, sales, marketing, planning, personnel and administration. He also held the position of Executive Vice President and, for the past 12 years, President and CEO of Du Pont México.

Up until now, he has been the National Vice President of COPARMEX. He is a member of the editorial board on industry of the newspaper El Economista, president of Grupo Diálogo Inversión, and member of Diálogo México.

Among his activities, he has been a member of the Board of Directors of Química Flúor, S.A. de C.V., Nylon de México, Sears Roebuck, S.A. de C.V., the Mexican Foundation for Rural Development, an independent consultant for Grupo AFORE Garante, and member of the Board of the Mexican Foundation for Health. In addition, he has been on the governing board of the International Chamber of Commerce, the National Association of the Chemical Industry, the Mexican Institute of Chemical Engineers, of which he was national president. He is a member of the American Chamber of Commerce of Mexico.

He is a chemical engineer from the National Autonomous University of Mexico. He is a member of the Board of the School of Chemistry of the UNAM, the Museum of Mexico City, and the Old College of San Ildefonso.

He was born in Mexico City on October 14, 1939.

Raúl Muñoz CEO

26

Selected economic indicators for MexicoEconomic recovery after crisis of 1994 was faster than originally expected. The GDP grew at an Average of 5.5 % between 1996 and 2000.

ESTIMATE

-8

-6

-4

-2

0

2

4

6

8

1994 1995 1996 1997 1998 1999 2000*

4.5

-6.2

5.1

6.8

4.8 3.7

7.1

GDP GROWTH(%)

*Economic Policy Guidelines for 2000.

The GDP per capita was of $4,938 dollars in 1999

$570.1USbn

27

0

50

100

150

200

250

1993 1994 1995 1996 1997 1998 1999 2000

Source: Secretaria de Economia, Banco de Mexico and US Deparment of Commerce

$US Billions

U.S. imports from MexicoMexican imports from U.S.

NAFTA

40

45

50

55

62

54

73

68

86

82

95

93

110

105

126

103

85

105116

188

168

141

215

229

GROWTH 93/99 169%

GROWTH 93/99 169%

NAFTA BENEFITS

Trade

28

0

100

200

300

400

Can

ada

Mex

ico

Japa

nC

hina UK

Ger

man

yTa

iwan

Fran

ceK

orea

Sin

gapo

re

0

5

10

15

20

Mex

ico

Chi

naG

erm

any

Can

ada

Kor

ea UK

Fran

ceS

inga

pore

Taiw

anJa

pan

$USBillion %

Trade Volume 2000 Average Growth 1993-1999

Source: US Census Bureau

Mexico is the second largest trading partner of the United States

U.S. – MEXICO TRADE BENCHMARKS

29

8.9

Inflation

Inflation has shown a clear downward trend towards one digit level in 2000. The Mexican Central Bank’s inflation goal for 2001 is 6.5%