In the pipeline: Gas production and exports look set for an upswing

Bolstered by its substantial natural resources, Mexico’s gas production and exports are expected to rise in the longer term as a result of new investment triggered by the government’s energy liberalisation policies, and a general recovery of hydrocarbons prices from their low point in 2015.

According to estimates by BP “Statistical Review of World Energy 2015”, Mexico had 12.3trn cu feet of proven natural gas reserves at the end of 2014 and one of the world’s largest shale oil endowments, particularly in the Burgos Basin in the north of the country (geologically, Burgos is a prolongation of the prolific Eagle Ford formation in the US state of Texas). Over the long term, Mexico has the potential to be a major global gas producer and exporter.

Short- & Medium-Term Importer

In the short and medium term, however, it is a very different picture. Mexican gas production has plateaued for nearly a decade (since 2006), while national demand has been growing more strongly.

In order to bridge this gap, the country has had to import increasing volumes of natural gas, mainly from its northern neighbour, the US. Gas production in 2014 was 5.6bn standard cu feet per day (scfd), down 0.2% year-on-year (y-o-y), and representing a modest 1.7% of global gas output. During the 10 years up to 2014, Mexican gas production increased by an annual average of 3.3%.

In 2014 Mexican gas consumption, on the other hand, was 8.3bn scfd, which was 48% higher than domestic production, up by 2.5% on the previous year and represented 2.5% of global consumption.

In the 10 years to 2014 Mexican gas consumption increased by an annual average of 4.8%, and the country’s Ministry of Energy has calculated that gas consumption will grow at an average annual rate of 4.4% between now and 2028.

Contributory Factors

At least four factors have contributed to this widening gas shortfall. First, gas production is often associated with significant oil deposits located in combined fields – Cantarell in the Gulf of Mexico, for example – that have reached maturity and are now declining.

Second, during the latter years of the oil and gas monopoly by the state-owned Petróleos Mexicanos (Pemex) – effectively the decade prior to 2015 – the firm lacked investment funds to develop sufficient new gas fields, and its capital expenditure programmes tended to prioritise oil over gas.

Third, and critically, Mexico has lacked the necessary pipeline infrastructure to connect the country’s main gas production fields with its central urban and industrial consumption centres. As a result, and according to Pemex data, over 150m cu feet of gas is vented and flared every year at the wellheads.

Finally, for both environmental and financial reasons, Mexico has been gradually shifting its main sources of electricity supply from fuel oil to gas-fired generators, increasing demand for gas in the process. The government has said that it intends to reduce the use of fuel oil for power generation to 10% of 2012 levels by 2017, with gas-fired generators making up most of the difference. More than half of total gas demand in the country currently comes from the electricity sector.

Local Competition

A further significant factor is that Mexico sits just to the south of the US and Canada, both of which have hosted one of the biggest transformations that the international hydrocarbons sector has experienced in recent decades: the so-called shale oil and gas revolution.

In Texas, in particular, there has been a huge wave of investment in infrastructure – everything from highways to a geographically dense pipeline network – which now allows shale gas to be produced from the Eagle Ford basin at very competitive prices. The Burgos Basin, on the Mexican side of the border, has similar geology, but the initial production costs and sale prices will have to be higher, as much of the necessary infrastructure is currently lacking.

As a result of this asymmetry, it makes sense – at least in the medium term – for Mexico to import cheaper US gas to help bridge its energy deficit. The first step toward doing this is to build the necessary pipeline infrastructure to boost import capacity. Over the long term, some of that emerging pipeline network will also be able to support Mexican gas exports, for example to Asian markets.

Pipeline Network

Relative to its production and consumption needs, Mexico has a comparatively small gas pipeline network. The National Pipeline System totalled 11,342 km in 2013, a length that rose to 15,160 km by the end of 2014. However, even taking account of that increase, Texas – which covers one-third of Mexico’s land area – has a gas pipeline system that is nine times longer.

In order to support economic growth, the country needs better gas supplies to serve a number of sectors and underpin electricity generation. For example, a revival in Mexico’s petrochemicals sector would require improved pipeline infrastructure to bring in the necessary feedstock.

“These pipeline investments are needed to connect the regions that do not currently have access to natural gas,” said David Crisostomo, a natural gas and power analyst at IHS Energy. “Access to more affordable power will not only enable the petrochemicals industry to grow and flourish, but also many others, such as the automotive and consumer goods production industries.” Crisostomo said that parts of the country’s north-west, without suitable pipeline connectivity, still have to rely on fuel oil-burning electricity generators, meaning that Mexican industry and consumers still pay more for electricity than their US counterparts.

Pieces In The Puzzle

As part of the restructuring of its energy sector Mexico has witnessed growing investment to correct its gas pipeline deficit.

One of the most important projects is the Los Ramones pipeline. Phase one was completed in December 2014, adding 2.1bn scfd of gas import capacity from Texas. Phase two is currently under way. Together, the two phases total 842 km of north-south pipeline, at an estimated cost of $2.5bn. They will link the northern Mexican border town of Camargo, in the state of Tamaulipas, to distribution points in four states to the south: Nuevo León, San Luis Potosí, Querétaro and Guanajuato.

Opening the first phase, Emilio Lozoya Austin, the CEO of Pemex, said it was helping to create “an integrated natural gas market for all of North America”, and by doing so would help firm up US gas prices.

President Enrique Peña Nieto inaugurated a trans-isthmus natural gas pipeline in early 2015. The 496-km line runs from Jáltipan – in Veracruz, on Mexico’s western coast – to the Salina Cruz refinery in Oaxaca state, on the Pacific coast. The $6bn project allows gas from Gulf of Mexico fields to be delivered to Salina Cruz in seven days (compared to 16 days previously) and eliminates the need to use the Panama Canal. The intention is to use Salina Cruz as a gateway for tanker gas exports to Pacific Rim markets, particularly those in Asia and South America where gas sells at a premium to the Henry Hub US prices.

Central American Extension

There have also been discussions on extending Mexico’s pipeline system south into Central America. A current $1.2bn project would supply gas from Mexico’s Santa Cruz refinery to Central America’s “northern triangle”, linking to Escuintla in Guatemala, with extensions to Honduras and El Salvador. An international bidding process for the work to build this infrastructure is expected to be launched in late 2015.

In September 2015 the Federal Electricity Commission (Comisión Federal de Electricidad, CFE) said that it had awarded a $471m contract to build the Samalayuca-Sásabe pipeline to Carso Electric-Promotora de Desarollo. This pipeline will deliver gas from Waha in Texas to power plants in Mexico’s northern states of Chihuahua and Sonora.

In 2014-15 the CFE completed eight gas pipeline calls. In the third quarter of 2015 bidding was under way for pipeline projects in Baja California Sur, Villa de Reyes-Aguascalientes-Guadalajara, Tula-Villa de Reyes, Nueces-Brownsville and Tuxpan-Tula. Also due to be offered were contracts to build pipelines linking Colombia-Escobedo, Sur de Texas-Tuxpan, Laguna-Aguascalientes, Ramal Empalme, Ramal Hermosillo and Ramal Topolobampo.

In August 2015 the CFE signed a $1.63bn contract with a local subsidiary of the US-based company Howard Midstream Energy Partners to build a 300-km pipeline that will connect Webb County, Texas, to Escobedo and Monterrey in Mexico’s industrial state of Nuevo León. In all, the CFE is reported to have launched power infrastructure and gas pipeline tenders worth approximately $10bn.

International Participants

Companies that are active in the pipeline construction boom include Energy Transfer Partners, Sempra Energy, Kinder Morgan and Pemex itself, although the latter has signalled its desire to withdraw from the hydrocarbons transport and logistics sector to concentrate on exploration and production.

“Competition is high in the development of pipelines in Mexico. Significant capital will enter the market, and with the CFE’s professionalism in managing tenders, we expect greater foreign investment in the country,” Jimmy Delano, director-general at ATCO Mexico, told OBG. “Land rights are the most complicated aspect of developing gas pipelines. However, this is not unique to Mexico; these challenges exist in countries like Canada and the US too. We would like the government to assist the private sector in expediting the process.”

A further issue that has been encountered by some operators is pipeline theft – action by criminal gangs to illegally tap pipelines – but this tends to predominantly involve oil and oil-product pipelines.

According to Erik Legorreta, president of the Association of the Mexican Petroleum Industry, major equity funds such as Cava Energy, Argentina-based Piedra Buena and BlackRock of the US are interested in investing in energy infrastructure, including pipelines. He said that Cava Energy had indicated an interest in investing $4bn-6bn. Legorreta also highlighted that in March 2015 BlackRock and another private equity fund, First Reserve, had acquired a 45% stake in the Los Ramones II pipeline for $900m.

Announcing that acquisition, Jim Barry, the global head of BlackRock Infrastructure Investment, said, “The opportunity for infrastructure in Mexico given recent reforms, positive demographics, and economic stability and resilience … has definitely drawn our attention, and we look forward to exploring other opportunities in the near future.”

Rising Capacity

Better pipeline connections to the US natural gas network are having an effect. Gas pipeline exports from the US to Mexico doubled between 2009 and 2013. In 2014 alone it has been calculated that gas pipeline transport capacity between the two countries rose by 2.7bn scfd to 8.5bn scfd. Total US gas exports to Mexico were up by 25% y-o-y to 70.9bn cu feet in April 2015, according to the US Energy Department. According to an estimate by Bloomberg New Energy Finance, US gas exports to Mexico could reach 5bn scfd by 2020.

Conscious of the urgent need to develop the pipeline network, energy minister Pedro Joaquín Coldwell has said the government has been developing a five-year natural gas pipeline plan, designed to extend the network to 20,000 km by 2018.

According to press reports in September 2015, the plan will be monitored by the National Centre for Natural Gas Control, and will seek to guarantee trustworthy and continuous supply across the country at competitive prices. Earlier, in May 2015, the Ministry of Energy had said that Mexico would construct 22 new natural gas pipelines over the following 15 years.