The U.S.-Mexican Oil And Natural Gas Alliance Will Remain Strong
First off, congrats to Andres Manuel Lopez Obrador (AMLO) for easily winning the Mexican presidential election on July 1. He will serve one six-year term. Also, a quick shout-out here to the U.S. Energy Information Administration for its publicly available graphics.
No, despite some previous nationalistic talk, President-elect AMLO will not bring regression to Mexico’s critical 2013 Energy Reforms that are required to evolve the country’s oil, natural gas, and electricity sectors. In particular, the U.S.-Mexican oil and natural gas alliance will hold tough.
Besides the physical connections (e.g., pipelines and transmission lines), the partnership is built on three market pillars: Mexican crude oil to the U.S., U.S. gasoline to Mexico, and U.S. natural gas to Mexico. This strong trade is bolstered by an equally strong NAFTA, which AMLO has promised to “respect.” The reforms are now written into the Mexican Constitution. The contracts already signed with state-owned Pemex (oil and gas) and CFE (gas and power) are going to be almost impossible to erase. Although he could slow new offerings, AMLO knows that Mexico’s newly opened energy sector for outside private investment has been a clear success, with over $200 billion in new investments.
As the basis of deregulation, Mexico’s oil production peaked in 2004 at 3.5 million b/d, steadily declining to 2.1 million b/d last year. This has cut crude exports to the U.S.: Mexico supplied just 8% of U.S. crude imports in 2017, compared to 16% in 2004. It’s unlikely that Mexico will ever retain its previous position, but as the country seeks to tap into its own massive shale reserves, production should regain a steady upward trend within five years. The U.S. refining system along the Gulf stands to gain because its built to process heavier crudes like those from Mexico.
Focused offshore, oil and gas block auctions have been a success under deregulation, with “new production coming online in 90 awarded blocks among 68 operators.” And there will be even more interest as oil prices rise and/if AMLO can reign in the drug violence and corruption that often makes companies hesitant to operate in the country. For all interested parties, “Mexico’s Emerging Oil Opportunities Are Great,” with Energy Minister Joaquin Coldwell reporting that $640 billion in investment is needed to expand crude production 50% back to over 3 million b/d. Simply put, major U.S. investments and shale/deepwater expertise is the only way that Mexico’s fading oil industry could enjoy an about-face.
Mexico’s energy problems are best exemplified by a non-sensical reality: despite still producing loads of crude oil, a dearth of pipelines and refineries means that the country usually has to first ship it to the U.S. to be refined and then import those products back into the country, namely gasoline and diesel fuel. Mexico has accounted for about 60% of all U.S. gasoline exports. Augmented by higher fuel taxes, this import need increases costs, a serious problem for a nation where half of the country lives below the poverty line. “The Strange Case of Mexico’s High Gasoline Prices.”
In addition, the refineries in Mexico are mostly built for a lighter crude, not the heavier kind the country generally produces. Especially as U.S. crude production continues to surge to record highs, with new U.S. demand limited, importing refined product from the U.S. is actually cheaper than building refinery capacity. AMLO wants more refineries, with maybe some public-private partnerships, but “new refineries could cost in the range of $6 billion to $10 billion.” And political uncertainty in this already low margin business makes such massive investment overly challenging.
Despite adding 25 million people around $300 billion in real GDP, Mexico’s capacity has stayed around 1.5 million b/d for the last 12 years. Monthly import reliance for gasoline alone can reach 75%, obviously not helped by the bunkering by narco gangs that robs Pemex of billions each year. Mexico may be lucky that, amid falling domestic production, domestic demand hasn’t surged out of control like was expected a decade ago, but the opening of ~1,700 gas stations by 30 new private operators to compete against stagnant Pemex is essential. BP seeks a 15% share of gasoline sales.
Mexico’s falling crude production has meant falling associated gas supply, with national gas output down nearly a quarter since 2010. Proven gas reserves have steadily plunged 90% since 1997 to just seven trillion cubic feet. U.S. piped natural gas exports has therefore been the basis of Mexico’s great turn toward gas and away from fuel oil in the power sector. The U.S. now meets about 65% of Mexico’s total gas needs. Gas is Mexico’s most vital import: Mexico uses gas for 60% of its electricity – almost double the U.S. rate. Renewable auctions have been a success, but gas will still account for 50-60% of all new capacity builds.
Although more storage capacity and import pipelines are needed to access more cheap Waha hub gas in West Texas, the upside is great: with a population size 40% that of the U.S., Mexico consumes just 10% of the gas that we do. U.S. gas will stay the backbone in Mexico since significant new domestic production remains years away. Mexico’s position as top buyer of U.S. LNG, however, will be short-lived because a pipeline build-out to expand the short system will cut the need for more costly LNG.
So in the end, despite some hiccups and NAFTA/tariff talks muddying the waters among allies, energy security discussions require broader and longer-term thinking: the U.S.-Mexican oil and natural gas alliance will remain strong.