Sometimes geography just works.
That’s certainly the case in North American natural gas markets today.
To the north you have America—a new natural gas superpower. So super that producers have cratered prices for their product amid a wash of new supply coming on from shale plays around the country.
And to the south there’s Mexico. The “lazy cousin” whose petroleum industry has squandered its cash (or had the cash squandered for it by the wider federal government). To the point where a lack of reinvestment in producing infrastructure has cratered production by 15% since 2008. At a time when politicians are desperate to move away from expensive oil-fired generation for electricity.
Sounds like a match made in Business School 101. The obvious solution to both problems being a few short miles of pipeline to redirect ample U.S. gas supplies south, and ample Mexican gas prices north.
But this is far from just a satisfying economics exercise. If U.S. natgas exports to Mexico can indeed be achieved at scale, it could represent one of the biggest investible opportunities of the decade.
“At scale” is exactly the plan right now. At least six new or expanded export projects are on the books, with capacity to send an additional 3.5 billion cubic feet per day of gas to Mexico. Doubling current export capacity.
These added flows could bring total US-Mexico exports to several billion cubic feet per day.…
Sometimes geography just works.
That’s certainly the case in North American natural gas markets today.
To the north you have America—a new natural gas superpower. So super that producers have cratered prices for their product amid a wash of new supply coming on from shale plays around the country.
And to the south there’s Mexico. The “lazy cousin” whose petroleum industry has squandered its cash (or had the cash squandered for it by the wider federal government). To the point where a lack of reinvestment in producing infrastructure has cratered production by 15% since 2008. At a time when politicians are desperate to move away from expensive oil-fired generation for electricity.
Sounds like a match made in Business School 101. The obvious solution to both problems being a few short miles of pipeline to redirect ample U.S. gas supplies south, and ample Mexican gas prices north.
But this is far from just a satisfying economics exercise. If U.S. natgas exports to Mexico can indeed be achieved at scale, it could represent one of the biggest investible opportunities of the decade.
“At scale” is exactly the plan right now. At least six new or expanded export projects are on the books, with capacity to send an additional 3.5 billion cubic feet per day of gas to Mexico. Doubling current export capacity.
These added flows could bring total US-Mexico exports to several billion cubic feet per day. Eating up 5 to 10% of total U.S. gas production. That’s a slug of new demand big enough to push prices higher quickly. Which would crate investment opportunities in both the commodity itself, and the shares of U.S. gas producers who would see profits soar.
It will thus pay to know if and when the Mexican export boom is going down. Which means watching a few key indicators—boxes that if ticked will tell us it’s time to go long gas and the U.S. E&P sector.
Below are four critical issues that will shape the fate of U.S.-to-Mexico gas trade—and signal when the time is right for this mega-trade.
Regulators approving export pipelines
One of the major questions around exports is the permitting process. Several new U.S. pipelines are needed to move gas to the Mexcian border for export—and those developments require regulatory approval. A step that is proving challenging for other export outlets like LNG.
But just last month, we got some positive indications on the permitting front. The U.S. Federal Energy Regulatory Commission (FERC) gave tentative approval to the Sierrita gas export pipeline in Arizona, being built by El Paso Natural Gas. FERC gave the pipeline a more-or-less clean pass—noting only a few environment issues that could be brought to “less-than-significant levels” through proper handling by El Paso.
Crucially, FERC avoided some semantic pitfalls that could have complicated the approvals process. There was some push for environmental approval to cover not just pipelines on U.S. soil but also end-use Mexican power plants taking gas exports. Such extra-territorial consideration seems odd, but it has happened.
FERC however, decided solidly against blowing up the scale of the Sierrita approval. The agency noted that, “There is no jurisdictional basis for the Commission to approve, mitigate or reject any of the Mexico facilities.” This greatly simplifies the permitting process. Setting the stage for easier approvals of additional export projects going forward.
Gas buyers getting testy
Environmental approvals are not the only part of the permitting process for would-be gas exporters. Firms building new export lines will also have to deal with potential objections from local gas users in the U.S.
That’s because FERC is also tasked with ruling on the need for export projects. Project operators must therefore make their case in demonstrating how their gas exports will help the overall market. The Commission will then have to decide if these projects are in the best interest of the American energy sector and the public.
A battle looks to be brewing on this front. This summer, one of the largest U.S. gas-fired power generators Calpine (NYSE: CPN) filed a motion to intervene in the approval of one major Mexican export project.
In filing the intervention, Calpine noted that “the terms and conditions for natural gas service to [Calpine] may be affected by the outcome of this proceeding.” Certainly true if a big rise in gas exports to Mexico triggers price increases—thus making Calpine’s fuel of choice more expensive, and reducing the company’s operating profits.
With gas-fired power growing rapidly in the U.S., such opposition could become a force to be reckoned with. In September, speakers from the power sector at the Marcellus Shale Coalition's Insight 2013 conference in Philadelphia noted that gas demand in the American power sector is likely to grow even faster than most experts are projecting. In fact, one consultant said that new environmental regulations in America have made natgas the “only new baseload option that is economically viable.”
This is likely to create a rapidly-growing lobby that doesn’t want to see U.S. gas go anywhere but into domestic power plants.
Building major pipeline arteries
Several planned export projects will tie into Mexican pipelines that don’t yet exist. This includes the above-mentioned Sierrita pipe, which is planned to connect with the Sasabe-Guaymas pipeline--a 338 mile pipe that will take gas to power plants near the towns of Puerto Libertad and Guaymas, located west of Chihuahua on the Gulf of California.
The only problem is that the Sasabe-Guaymas pipeline is currently only a concept. It’s supposed to be built by an affiliate of Sempra Energy.
While this line looks like it will go ahead (the tender is already complete), other key parts of the Mexican natural gas infrastructure are less certain. Earlier this month, the Mexican government released a tender for the 740 kilometre Ramones pipeline—designed to connect the new Sempra-built line further into the industrial heartland of north-central Mexico.
But the project fell over when only one company bid for the construction. This is a major set-back for a key part of Mexico’s gas infrastructure. The price tag for the project—at $3.3 billion—could make it tough for the government to go it alone without private-sector help. Thus endangering a key piece of the Mexican pipeline network—and raising the risk that new U.S. pipelines may end up being a “bridge to nowhere”.
Mexican demand growth actually appearing
Another key risk is whether Mexican gas demand will in fact materialize at all.
On the surface, the situation looks promising in this regard. Overall Mexican gas demand has been surging—nearly doubling over the last 15 years. At the same time, weak production has led to a gap between supply and demand of at least 500 billion cubic feet yearly, according to estimates from the U.S. Energy Information Administration.
That gap however, could be filled by imports of just 1 to 2 billion cubic feet per day—well within capacity for existing export pipelines.
The rush to build new export capacity is being driven mainly be expectations that gas use will increase in northern Mexico. Driven by plans from state-owned power generator CFE to switch the bulk of power plants in this region from fuel oil to natgas.
The economic driver for CFE’s switch to gas is certainly real. The utility is running big losses ($474 million in the third quarter of this year alone), mainly due to high fuel-oil costs at its generation facilities.
But constructing or even converting a fleeting of power plants is costly and time-consuming. It’s notable that little of this switching has yet begun. Creating considerable uncertainty over how much demand will actually be there by the time gas starts flowing into export pipelines.
EP, CPN
