Mexico powers ahead with gas, but market risks cloud outlook

 (Written for Gas Matters, Oct 16)

Mexico is betting big on US shale gas, with heavy investment in new gas pipelines from the US border to an expanding and energy thirsty economy. But market reform and cheap renewables may leave investors over-extended, with CFE, in particular, heavily exposed to long term pipeline and gas-fired IPP offtake agreements.

To ensure supply and avoid the sort of gas shortages seen as recently as 2013/14, when industrial and power customers were cut off and forced to burn oil, the current government of President Enrique Peña Nieto introduced reforms in 2014 to open up the country’s energy sector and improve supply. This included upstream reforms (Peña’s push), and downstream liberalisation of Mexico’s electricity and gas market.

But rather than stimulating domestic exploration, the reforms have led to the extension of pipelines from the US border and drawn in cheap US shale gas. This new infrastructure means Mexico will be able to rely on rapidly rising availability of relatively cheap US pipeline flows over future years, which is helping drive demand growth.

Gas demand has been rising steadily in Mexico, and had been expected to continue to do so – the International Energy Agency (IEA) expected the market to expand by two thirds between 2013 and 2027. And in its 2015 Outlook, Mexico’s energy ministry, SENER, expected a rise in demand of 44.1% between 2014 and 2029 – about 2.5% per year.

However, recent very low bids into Mexico’s new competitive power market from solar especially, could undermine this growing market for gas, potentially threatening the viability of many of the infrastructure investments and long term gas and power deals. Renewables will likely end up cheaper than gas and so gain ground in the Mexican energy mix, according to consultants at Gas Strategies – indeed, solar grid parity is relatively easy to achieve in Mexico, due to the country’s high solar intensity levels.

Salvador Ortiz Vertiz, a partner at Mexico’s SAI Law & Economics, said the most expensive renewable bid in the April 2016 energy auction was about USD46/MWh, close to the variable cost of combined cycle gas. “The most recent auction was at prices well below that; reportedly as low as USD25/MWh… Yes, renewables will displace gas. Competition and market forces are now playing a key role in deciding which technology to use, whereas before the reform, CFE [the state power company] effectively decided.”

But he added that non-interruptible sources would still be needed for back up (barring a technological breakthrough). “The share of generation from gas fired plants (CCGT) is still expected to grow in the next decade. There will be moderate growth of CCGT because it will substitute other dirtier fossil fuels, and because back-up will be required for growing variable renewable supply.” Officially Mexico now expects solar and wind’s share of total generation to rise to 14% by 2030, from 3% in 2015.

Adding to the competition for market share – and the risk of stranded assets – there is also concern over prices realised in the new deregulated power market, which are likely to be far more volatile than those experienced in the past, especially with renewables in the mix. This also makes the upstream development of any domestic dry or shale gas even more unlikely (see below).

State owned CFE has the most exposure to this risk, because it has signed a lot of PPAs with IPPs, and underwritten billions of dollars in long-term transport agreements to bring gas to the power stations. This is exposure the loss-making utility can ill afford, and if solar does displace gas faster than expected – as now looks like being the case – the state company is likely to be in need of protection or help from public finances.

The situation is similar to that which faced RWE or EON in Germany – both invested in new gas capacity that only runs part of the time, due to expanded renewable flows. However, if the gas capacity is still required to meet power demand outside of daylight hours, subsidies may be required for that back-up to be maintained – something else that has been discovered in Europe as renewable flows have risen.

In fact, in much of Europe, market mechanisms are increasingly seen as failing to be sufficient to guarantee supply in the face of rising zero marginal cost intermittent renewable output. It may be that the same conclusion is reached in Mexico, although with less seasonal variation, higher irradiation levels (cheaper solar) and less reliance on wind, the renewable flows will be more predictable, regular and cheaper than in Europe, making any possible market intervention likely to be different in nature.

The energy reforms have, however, succeeded in their aim of expanding supply and lowering energy costs to help the country’s economy compete with its northern neighbour, while avoiding the use of normally cheaper and more polluting fuels (especially coal). This is also helping Mexico meet (at relatively low cost) emissions targets under the UN Climate Change deal, signed in Paris last year, and the new low cost renewables can only help with that.

Displaced investment

The threat from renewables, combined with cheap US shale gas, makes the rapid development of Mexico’s domestic conventional gas reserves and huge shale potential unlikely, especially away from the shale-rich coastal areas near the Texas border, despite the upstream reform in early 2014. (

Mexico has elections coming up in 2018, and when – although investment in upstream oil is eventually expected to boost associated gas output. Mr Ortiz said that if the leftist candidate (Lopez Obrador) wins in 2018, “the reforms may indeed be challenged.”

However, reversing the reforms would not be easy. “There are investor-state agreements with many countries and high dependency on foreign investment (in energy and in other sectors), so to go back to the old state-owned structure and control of the energy sector would not be a simple matter,” he adds.

In 2014 Mexico produced 4.65 Bcf/d of dry gas, according to the US EIA, with total production around 6.5 Bcf/d, putting associated gas production at 1.85 Bcf/d. The total has dropped to about 6 Bcf/d now, according to Jose Valera of Houston-based law firm Mayer-Brown. And while Mexico’s state-owned Pemex anticipates growth as a result of the reforms, most observers are less optimistic. “Significant development of dry gas and any kind of “solo” gas is unlikely,” said Ortiz.

Chris Walters, managing consultant at Gas strategies said: “Domestic production is in decline and likely to continue its descent, with the deficit back-filled by US exports… Pemex is showing anticipated sharp growth in domestic gas output, but we are sceptical. Mexico must compete for funds in difficult global environment, and they need new production just to maintain output.”

Even if a free market becomes established, the longer-term outlook for Mexican dry and shale gas development is not likely to improve, because as it becomes a single market with the US, the very low cost of US gas will displace Mexican investment – the additional risks in Mexico outweigh the costs of importing cheap US gas.” Pemex has also been slow to find and develop dry gas reserves historically, because of limited funds and higher returns from oil and liquids investment.

Consequently, Mexico has only 17 Tcf of proven dry gas reserves. Little has been proven up in shale either, although the country ranks sixth in the world for shale gas potential resources (gas yet-to-be-found), with an estimated 545 Tcf of “technically recoverable” gas, according to the EIA. Of that, 343 Tcf is in the Eagle Ford shale formations in northern Mexico’s Burgos Basin, where Pemex made a major shale gas discovery in 2012. The state company had planned to start commercial shale gas production in 2015, reaching around 2 Bcf/d by 2025, but this is well behind schedule.

Ortiz said that in the case of shale gas, while the potential resources and favourable Eagle Ford geology may be there, “we do not have the infrastructure of Texas”. More importantly “the economics do not work when the security and land/social issues are considered.” He said a good portion of the resources were in two of the “worst” states in terms of security and violence: “Tamaulipas, traditionally with corrupt state governments of the PRI party (at least one former governor was “wanted” in the US)… The new governor is, I think for the first time, from a party different to the PRI.” The other gas-rich state is Veracruz, whose “governor until last week, was a fugitive -“wanted” by the Mexican General Attorney Office,” he added.

US dependence

US availability, on the other hand, is rising, with prices, until recently, below USD 3/MMbtu. In 2015, US pipeline gas exports to Mexico stood at 2.86 Bcf/d, up 0.9 Bcf/d over 2014 levels, and the rise could be greater this year and next as large volumes of new cross-border pipeline capacity come on stream (see graph).

According to PointLogic, pipeline projects totalling 2.8 Bcf/d will be completed in Mexico in 2016, bringing the total cross-border capacity to 8.4 Bcf/d according to the US federal Energy Regulatory Commission (FERC), while a whopping 12.6 Bcf/d could come online in 2017.

The reform programme has made this rapid development of the midstream possible, with overseas companies driving the expansion of Mexico’s pipeline network – a big change given that Pemex was previously the sole player.

Examples include Spectra, which the Mexican government has contracted to build a USD 1.5 billion pipeline from Nueces County to the Mexican border at Brownsville; and TransCanada, which is leading a project to build the USD 2.1 billion Sur de Texas pipeline from the border through the Gulf of Mexico and onto the port city of Tuxpan, Veracruz, primarily to feed new gas-fired power plants.

Overseas involvement means pipelines will effectively connect the whole Mexican market by 2018/9, although some areas will remain less well-served than others (see map). This will unite what had been a collection of markets, each with its own demand fundamentals and supply options, making cheap US pipeline supply available right across the country. The new liberal trade arrangements, as well as a plethora of sellers, investors and reserves, practically guarantees security of supply.

Taking into account rising demand and lower domestic production, and with new LNG supplies significantly more expensive than US pipeline gas, experts predict 2016 imports will rise by at least another 0.8 Bcf/d, while the EIA had expected total exports to be at least 5 Bcf/d by 2020. However, the recent low renewable bids mean it is becoming less clear how much of the additional pipeline capacity will be used beyond the next few years.

Under the reformed market, both Pemex and CFE are able to buy directly from the US, with the sellers comprising a variety of major gas-marketing companies.

Further liberalisation of the gas market in Mexico, including the establishment of a wholesale power market and free-floating gas prices from 2017, is expected to encourage other consumers to buy directly from the US in future.

Some of these will be independent power producers, which along with CFE and industry, had been expected to be the main driver of demand growth. Between now and 2030, Mexico had planned 22 GW of CCGT capacity, replacing fuel oil and avoiding the use of coal – requiring about 4 Bcf/d of additional gas to operate, assuming an 85% utilisation rate. Around 5 Bcf/d is currently consumed by the power sector and industry. SENER expects gas demand in Mexico to increase by 0.3 Bcf/d in 2016 and 0.5 Bcf/d in 2017.

If the low bids from renewables do undermine  the gas-fired plant expansion and gas demand forecasts, Pemex and especially CFE would come under massive pressure, and may find it difficult to meet its long term commitments, unless the government steps in to protect its state-owned supplier. All domestic gas is currently still produced by Pemex, which, according to SENER statistics, is also the country’s largest consumer, accounting for about 40% of Mexico’s total consumption.



It is ironic that Mexico, which banned investment in its oil and gas sector for so long, fearing exploitation, is now relying on cheap US shale gas (among the cheapest cross border pipeline sales anywhere in the world), to fuel its growth and keep its industry competitive.

Adding to the irony, the cheap US shale gas, alongside renewables – especially solar – will also help Mexico meet its NDC (Nationally Determined Contribution) under the Paris Climate Change agreement – replacing fuel oil and avoiding coal – which shines a far more positive light on fracking than many environmentalists would like.

It may be the greenest that come out on top in the end, however, with the rapidly falling costs of solar, combined with the introduction of a competitive wholesale power market, now posing a real threat to the long term investment required to bring all this gas south. As has been seen in Europe, if new gas-fired plant is only used part of the time, it can become uneconomic to build and can require subsidies to ensure availability.



Graph/chart options from SENER

Demand forecast graph p67

Electro 3.5 in 2014 up to 5.33 in 2029 from under 50% of total to slightly over 50%

New pipelines map p86.

Imports 2014 – 2029 graph p89

Caption: Chart showing the acceleration in US gas exports to Mexico since 2010 (source EIA)

Originally written for Gas Matters, 10/16.




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