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A Surprising New Twist in the U.S. Natural Gas Market

By Keith Schaefer | Mon, 01 July 2013 22:02 | 0

The U.S. natural gas market may be on the verge of a big swing.

And it’s not about the talk of the town, Liquid Natural Gas (LNG).

It's about an unexpected source of natural gas demand:

Mexico

Mexican imports of U.S. gas have skyrocketed 92% since 2008. And with export capacity projected to grow to over 7 billion cubic feet per day (Bcf/d), Mexico could start taking 10% of U.S. production—in a very short time frame, with very low capital costs compared to the LNG boom unfolding.

There is a lot less risk, and a lot less cost in getting huge natural gas exports to Mexico, compared to LNG—and the volumes may be enough to move margins in the North American market.

At least six new pipeline projects are now on the books, aimed at sending gas southward.

Today, I’ll explain what’s happening now, and what potential impact this extra demand could have on natural gas prices.

To find out, we take a look below at exactly what’s happening in Mexico, what’s getting built, and who’s positioned to take advantage.

The Not-So-Slow Death of a Gas Producer

Mexico used to have a pretty decent gas industry.

Between 1990 and 2008, the nation’s nat gas production grew steadily, nearly doubling over the two decades.

The bulk of this output comes from national oil and gas company Petroleos Mexicanos, or Pemex. With strong natural gas prices between 2003 and 2008, Pemex stepped up its drilling, growing gas production from 4.5 Bcf/d to nearly 7.5 Bcf/d.

But with the collapse in gas prices in early 2008, that changed. Pemex stopped a lot of its gas drilling activity. Instead, the Mexican government made a strategic decision to meet domestic demand by importing now-cheap gas.

Since that time, Pemex’s gas production has fallen steadily, by about 15% from 2008 levels.

The lack of investment in the gas sector has also had a big effect on Mexican reserves. In the late 1990s, the nation had more than 60 Tcf of proven reserves. Today, gas in the ground has fallen off a cliff, with only about 17 Tcf proven reserves remaining.

At the same time as production has been falling, Mexico’s gas demand is ramping up.

Gas consumption across the country has risen 160% since 1990 to 2.36 Tcf per year. Since 2007—while domestic production has been nose-diving—Mexico’s gas use has jumped 16.7%.

Much of the rise in demand has been driven by fuel-switching. In 2000, only 20% of Mexican power generation was fueled by natural gas. But by 2007, nat gas use increased to account for 50% of power output. Largely displacing oil-fired generation.

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On the back of this rising demand, Mexico’s natural gas supply-demand balance is—for the first-time ever—near deficit. Current gas usage amounts to nearly 6.5 Bcf/d, and Pemex is now producing less than that.

The Switch is On

Faced with a supply short-fall, Mexican nat gas imports have been on a tear.

Between 2003 and 2007, Mexico was bringing in between 350 and 400 Bcf a year of imported gas. But since gas got cheap in 2008, imports have jumped 92%. Total imports hit 767 Bcf in 2012.

Overall, imported gas now accounts for about 30% of total Mexican supply. The majority coming through pipeline feed from the U.S. Only about 20% is supplied via LNG.

Mexico is now importing about 2.1 Bcf/d. Or about 3% of total U.S. gas production. Numbers that are starting to get significant.

The really interesting part of this story is the growth potential.

The switch from oil- to gas-fired power generation is continuing across Mexico. Just this month, gas infrastructure providers GDF SUEZ Mexico and GE Energy Financial Services announced they will extend their Mayakan pipeline into the Yucatan Peninsula—underpinned by a 300 MMcf/d gas-supply contract with Mexican electric utility CFE, who are switching power plants in the Yucatan to gas generation.

A slate of other gas-fired projects are on the books, particularly in northern Mexico. Overall, the nation is looking to add 28 gigawatts of new generating capacity. With all this activity, the national Secretaría de Energía forecasts that Mexican gas demand will grow 3.3% annually through 2016.

The Northern Natural Gas Neighbour

For gas-hungry Mexico, the collapse of U.S. natural gas prices couldn’t have been better-timed.

Cheap nat gas from abundant shale production in the southern states has provided a ready source of imports. What’s more, a good deal of pipeline infrastructure is already in place. This pipe used to bring Mexican gas to U.S. consumers—but increasingly flows have been reversed to feed Mexico’s demand.
Mexican purchases of U.S. gas have been driven by pricing. Between 2000 and 2004—with low nat gas prices prevailing—Mexico’s imports from the U.S. jumped 10-fold, from 4 Bcf per month to 40 Bcf per month.

Import growth slacked off with the high prices of 2005 through 2008. But as of 2010, imports are on the rise again. In March 2010, Mexico imported 20.7 Bcf. By October 2012, imports hit a record 60.5 Bcf.

The numbers imply that Mexico’s peak demand for U.S. gas is currently something like 1.95 Bcf/d. And there’s room for that to grow. Total U.S. export capacity to Mexico was estimated at 3.8 Bcf/d in 2012.

The really interesting thing is that some of the biggest players in U.S. gas transmission are betting Mexican demand will rise well beyond current export capacity.

Major pipeline operator El Paso Natural Gas recently commissioned an expansion of export capacity at its Wilcox Lateral transmission site at the eastern Arizona/Mexico border. The upgrade added 0.185 Bcf/d of gas throughput.

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At least five other similar projects are on the books across Arizona and Texas. All told, these could add up to 3.3 Bcf/d of additional gas export capacity to Mexico. Taking total capacity to more than 7 Bcf/d.

What Does This Mean for Natural Gas Prices?

The question then becomes: what would increased exports mean for gas prices?

At current peak demand levels of 1.95 Bcf/d, Mexico is taking about 3% of total marketed U.S. gas (about 69 Bcf/d as of March 2013).

There is some evidence that this demand is already pushing up prices.

In 2012, Mexican buyers of U.S. gas paid an average of $2.94/Mcf. Considerably higher than the price at many trading hubs near in the southern U.S.

Mexican export prices were 7.3% higher than the average Henry Hub price for 2012. The premium to U.S. hubs near the Mexican border was even larger. Exported gas prices were 8.9% higher than 2012 average prices at Houston Ship Channel, Texas. And 10.5% higher than the El Paso Permian hub on the Texas/New Mexico border.

It thus appears that Mexican consumers are willing to pay more than U.S. buyers to secure supply—the marginal price is higher in that region.

And that’s at today’s export levels. If existing export capacity of 3.8 Bcf/d is filled as Mexico takes more gas, we’re talking about 5.5% of U.S. production heading south. And if currently-slated expansion projects come online on top of that, we could see over 10% of current U.S. supply going to Mexico. Then the marginal buyer could impact prices outside that region.

All in, Mexico could create an extra 5 bcf/d demand in the coming three years. As context, an extra 5 bcf/d demand from the power sector in 2012 sent natural gas prices doubling in the US from $2-$4/mcf in one year.

This story was written by Dave Forest, contributing editor to Oil & Gas Investments Bulletin

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