March 2018, Vol. 245, No. 3

Features

Emerging Markets in Mexico to Equal Robust Infrastructure Build-Out

As Adrian Garza, a vice president and senior analyst in Mexico City for Moody’s Investors Service, assessed, the dynamic energy infrastructure landscape south of the border 2018 promises to be “noisy.” And when several hundred industry stakeholders gathered for the 3^rd Mexico Infrastructure Projects Forum in Monterrey in mid-January, Garza’s observation looked and sounded very “preciso.”

But Garza was referring to more than Mexico’s ongoing national energy reforms. He was looking at the political and economic drivers attached to the national presidential election in Mexico at mid-year and the ultimate fate of the North American Free Trade Agreement (NAFTA) that is the subject of intense debate and tri-lateral negotiations.

Buffeted by this noise are a host of pending pipeline infrastructure and other energy projects that represent billions of dollars of investment by private sector North American companies that wasn’t visualized five or 10 years earlier. The terrain is rocky and the stakes remain high this year for a wide scope of energy projects unfolding in Mexico.

During the past decade, pipeline exports from the United States to Mexico have increased 450%, according to the Washington, D.C.-based Interstate Natural Gas Association of America (INGAA). Exports totaled 1.7 Tcf in 2017.

“Not only is Mexico the largest importer of natural gas by pipeline, it is also the largest importer of liquefied natural gas (LNG) from the U.S., importing an equivalent of roughly 128 Bcf of LNG last year,” an INGAA spokesperson said. Close to 20% of Mexico’s gas imports come from LNG.

The view of INGAA CEO Donald Santa is that the United States continues to build on its role as a world leader in supplying natural gas, and Mexico’s import trends follow this U.S. surge upward. Demand projections for 2018 in Mexico of 8.32 Bcf/d of gas will be closer to 10 Bcf/d by 2030 with about half of the volumes coming from U.S. imports.

“Mexico expects to import 6 Bcf/d in 2020 with that amount slowly dropping during the subsequent decade,” the INGAA spokesperson said. “Demand will be driven largely by consumption for power generation, as even today natural gas produces most of Mexico’s electricity, and partly too by a notable expected increase in industrial demand.”

Mexico’s power sector is expected to mirror the United States in having its power plants drive future gas demand. Mexican power plants are estimated to consume nearly 6 Bcf/d by 2031. That amounts to nearly 62% of national gas demand in Mexico, compared to 52% currently. The nation’s current power sector demand is slightly under 4 Bcf/d.

Cesar Contreras Guzman, a deputy in the national energy secretary’s office (Sener), told the energy audience gathered in Monterrey that Mexico’s energy sector is still very much in transition, and the nation’s profound energy development is helping both efficiency and technology, and ultimately the added energy development “is allowing development of more markets.”

Contreras Guzman sees Mexico’s population of 120 million growing to 140 million by 2030, and 75% of the people will live in close proximity to urban centers. Thus, government and industry speakers reiterated at the infrastructure conference that it is important to build the “last-mile” of pipeline, or commercial distribution lines to complement Mexico’s larger transmission pipelines being developed.

Officials touted interconnection work in the nation’s growing gas grid that is under the management of Centro Nacional de Control de Gas Natural (Cenagas), while promising that the five stalled major transmission pipeline projects slowed in 2017 would become operational this year.

Nevertheless, in early 2018, San Antonio-based Howard Energy Partners (HEP) offered a variety of reasons for delaying further the start of the 190-mile, 30-inch Nueva Era Pipeline, built in a partnership with Mexico’s Grupo Clisa to form Nueva Era Pipeline LLC. The 600 MMcf/d capacity pipeline has 504 MMcf/d covered under a long-term contract with Mexico’s national electricity company, Comision de Federal Electricidad (CFE).

Begun in early 2016, Nueva Era was originally scheduled to start operations in the second half of 2017. As of late January, it was projected for a start in the third quarter this year. HEP officials attributed the pushed-back start date to a combination of factors, including coordination with the needs of downstream offtakers, adjustments required by a changing regulatory framework, and general force majeure-related bouts of extreme weather during 2017.

 

The Mexican subsidiary for San Diego-based Sempra Energy, Infraestructura Energética Nova SAB de CV (IEnova), faced delays of a different kind in 2017 with the third segment of its three-segment Sasabe-Guaymas-El Oro gas pipeline from the Arizona-Mexico border down the mainland West Coast of Mexico in the state of Sonora. Different segments of the overall pipeline are designed to serve various electric generation plants operated by CFE.

Yaqui Indigenous Tribe protesters cut a portion of the pipeline in the final segment to El Oro near the Yaqui settlement at Loma de Bacum. IEnova was seeking court authority to repair or reroute the pipeline at the start of 2018. The first segment of the pipeline went into service in July 2014, and the second phase started operating in October 2015.

Two existing CFE plants and two others under construction are scheduled to be served by most of this pipeline’s capacity, which is common among many of the major infrastructure projects currently underway in Mexico even as the federal government pushes forward with many unrelated energy project bidding auctions.

Early in 2018, the Mexican government released plans to offer 37 blocks of mostly natural gas-rich prospects in the country’s 10th auction of exploration and production (E&P) contracts, scheduled for late July. The upstream regulator, the Comision Nacional de Hidrocarburos (CNH), approved the list of conventional onshore blocks proposed by Sener for inclusion in Round 3.2.

Sener essentially explained the pending sale this way: “This call will favor exploration activities that increase certainty about the hydrocarbons potential of Mexican subsoil in areas that contain oil and non-associated gas.”

As they have for years in Canada and the United States, Mexican rights-of-way issues and the concerns of Indigenous groups are part of the puzzle that needs to be filled in this year, according to government and industry officials who gathered to talk and strategize in Monterrey. Javier Gutierrez Bacerril, the operations director for a CFE unit, CFEnergia, called the Indigenous issue “extremely important” to the government and industry finishing the infrastructure build out.

“Gas needs to flow to power plants,” Gutierrez Becerril told his colleagues at the infrastructure conference. “The electricity industry cannot run properly without gas transportation.”

Moody’s executive Garza cited IEnova’s stalled pipeline project along the West Coast of Mexico as a good example of resolving the conflicts. “We’ve seen a good attitude from CFE, which in the end is the entity that is driving the construction projects [for more gas supplies for added generation plants along the western mainland Mexican coast],” he said.

The IEnova pipeline was still not operating when Garza made his observation in late January, but the company was at least being partially reimbursed under its long-term power supply contracts, and Garza sees a silver-lining in that fact.

“Under the contracts, there are partial payment mechanisms for some particular circumstance [of delay], compensating or mitigating around these problems of rights-of-way,” Garza said. “The most important thing is that most of the project sponsors have a lot of experience in major infrastructure projects, and they have good track records. So, although there are still challenges, overall I think most of the sponsors are in good position to conclude the projects.”

Regulatory reforms in Mexico have coincided with the opening up of the energy markets, and regulators with the primary national agencies – CRE, CFE, Cenagas and Petroleos Mexicanos (Pemex) – have generally endorsed what they describe as globally proven regulatory and market-based approaches. They are consciously tinkering with a changing central government approach that includes “letting the market decide” where new infrastructure is focused.

CRE Commissioner Guillermo Zuniga said the national energy regulatory body has had a “rebirth” with Mexico’s energy sector economic reform movement, calling the revamped agency “truly independent” with autonomy in its management and “maximum transparency” in its operations.

For example, Zuniga described new natural gas regulations as “very standard,” replicating what he thinks has worked elsewhere throughout the developed world. They are aimed at six specific categories: transmission/storage, open seasons, tariffs, permitting, transaction reporting and Pemex sales/system regulations.

“Pemex is dominant, but must be managed so it doesn’t push out new participants,” said Zuniga, noting that 30% of the assigned transportation capacity now is held by parties other than Pemex. “The price is now set by free markets, creating good prospects for competition, and gas field sales have worked well.” He added that Pemex has not built any new pipelines in two decades.

Another of those must-complete pipeline projects is the $500 million TransCanada Corp.-backed Tuxpan-Tula, a 155-mile, 36-inch project. It is another of the five critical projects tied to CFE long-term contracts. The project has been held up by various rights-of-way and Indigenous social protests. A Mexican court late in 2017 had halted the project’s ongoing construction based on concerns raised by the nearby Otomi Indigenous community, which is alleging serious harm to sacred grounds if the construction continues.

Units of Sempra Energy and TransCanada also jointly prevailed in the bidding in 2016 to develop the $2.1 billion, 500-mile Sur de Texas-Tuxpan underwater natural gas pipeline for bringing Eagle Ford shale gas supplies in Texas to the Mexican market in the state of Vera Cruz. It is another project supported by a 25-year contract with CFE, involving volumes up to 2.6 Bcf/d. It is expected to be in service in the second half of 2018.

The Carso pipe project between Samalyauca in the state of Chihuahua and El Sasabe in Sonora involves a 550 MMcf/d project backed by Carso Electric SA de CV, a unit of Grupo Carso, which is controlled by Mexican multi-billionaire Carlos Slim. The project at the end of last year expected to be completed in late 2018 at the earliest.

Mexico City-based Fermaca Services SA de CV is building yet another gas pipeline, the $270 million Aguascalientes-Villa de Reyes-Guadalajara project, an 885 MMcf/d capacity project. The 180-mile pipeline is expected to get built to supply gas to a growing industrialized area, including new automobile plants involving Nissan, Mazda, General Motors, Honda and Volkswagen.

With the Mexican government’s ongoing transformation of regulatory agencies and their agendas spelling continuous change, the initiative to get new and enhanced infrastructure in place is a little like a three-ring circus. Add the work needed to put markets in place and keep them constantly tweaked and the job keeps getting tougher, especially when companies and Mexican officials need to keep reinventing themselves, too.

At the Monterrey forum, CRE’s Zuniga stressed the need for new transportation infrastructure requires regulation that will eliminate bottlenecks and strive to drive down prices. “There are no more regulated Mexican gas prices; they are all market-driven, but haven’t been as low as we would like,” he said.

Another CRE commissioner, Marcelino Madrigal Martinez, stresses that the Mexican equivalent of the Federal Energy Regulatory Commission (FERC) is focused on “eliminating barriers to competition,” and on the electric side encouraging more distributed generation.

Highlighting its push to use proven regulatory approaches, CRE is helping host the upcoming Seventh World Forum on Energy Regulation, an international conference set for March 20-23 in Cancun, Mexico. Part of the program, according to Madrigal Martinez, will examine “regulation in a time of reform and innovation.”

In noting that Cenagas and CFE officials are focused on bringing the Mexican gas and electric grids more into “harmony,” regulators said that a key is creating “more open transportation systems” for both forms of energy with the obvious importance of natural gas to the nation’s plans for expanding its electricity grid. And this equates to the need for more supporting infrastructure.

A global perspective comes from BP Energy’s business development executive focused on Mexico, Darrel Thorson, who said it was essential that Cenagas and CRE “ensure there is transparency and equity in the market,” and with that there are sufficient major global market players to force more transparency in the markets.

“There is no scenario for CRE writing every rule that needs to be written right now, but over time every month, they [CRE] – like we – are learning; we’re all kind of learning the best ways to move this market forward.”

Thorson thinks when all of the current pipeline projects are finished Mexico will have very competitive gas molecules at places like Guadalajara, leading some of today’s major Mexican industrial companies to look for new places to site plants that run on natural gas.

“It will be very interesting when you see the center of Mexico transformed economically and politically as the result of these gas pipelines coming through,” Thorson told his counterparts in Monterrey, calling the near future in Mexico “an intriguing time.”

The market dynamics that spin off of the added pipeline infrastructure have been demonstrated repeatedly in the U.S. shale boom in places like the Marcellus, Utica, Bakken and Permian. Thorson cites a Royal Dutch Shell unit’s move to build an ethane cracking plant in Pennsylvania in the heart of the Marcellus Shale gas bonanza.

“Marcellus drove gas price bases to a negative $1.50/Mcf at one point and then a bunch of pipelines got built, and in came Shell with a massive petrochemical facility,” he said. “It is not the most outrageous thing to think that there are going to be some pretty significant industrial loads start to show up in the central parts of Mexico. It is probably in the three- to five-year time frame.”

Roberto Blanco, vice president with Monterrey-based global conglomerate Grupo Alfa, said many industrial customers still today are reluctant to leave the state-owned Pemex for a private alternative gas supplier. His conglomerate is different, however, operating outside of Pemex with one of its business units in the natural gas and hydrocarbons sector.

“You can live outside Pemex, and you can do more,” Blanco said. “Pemex is always there, but you’re better off if you can go elsewhere.”

In answering questions at the Monterrey conference, Blanco said he is convinced that Mexico, itself, is sitting on a lot of natural gas, aside from the increasing imports from the United States. He thinks it is in Mexico’s interest to develop its gas supplies as an alternative to the nation becoming overly dependent on U.S. supplies.

As with a lot of the energy reform these days, Blanco talks about possibilities that are as endless as the North American shale plays, touting future markets of both unconventional and conventional gas supplies in Mexico. And the natural follow-up will be to build more infrastructure to support the burgeoning onshore oil/gas exploration/production work, including storage (gas and liquids), which is a sector in its infancy south of the border.

Without naming NAFTA, Blanco puts in a plug whenever he can for open markets, noting wherever they are created “people [companies] of all sizes and kinds are brought together.”

While various interest groups from energy to agriculture in the United States have been urging “modernization” (upgrading) for NAFTA, Mexican energy stakeholders make it clear they need a continuation of the almost three-decade-old trade agreement, not repeal as the Trump administration has threatened at times in the first year of his tenure. After all, when NAFTA started in the 1990s Mexico’s nationalized energy industry was not included in the pact. New markets and billions of dollars of private investment today all should be part of NAFTA.

In the Monterrey confab it was a norteamericano, Rick Margolin, North American natural gas director for Louisville, KY-based energy research/consultant Genscape Inc., who  stressed the need to view Mexico’s energy build out from the broader North American market’s perspective.

“It is important [for operators in Mexico] to pay attention to the North American market,” Margolin said. “There is plenty of gas available for the North American market, and it should directly benefit Mexican consumers.” He thinks that North American demand growth, as with a favorable NAFTA outcome, can be supported by both the United States and Mexico. Positive outcomes are achievable.

“With the uncertainty of the national [Mexican] presidential election and the NAFTA negotiations, some of the infrastructure projects may face some challenges in financing, or at least financing at the prices they have come to expect,” Moody’s Garza said. “The gas pipeline projects generally are going to unfold pretty much as expected.”

“For the power projects we’ll have to see. There is a lot of financing available and the international banks are willing to fund the projects,” he said. “Despite the noise this year, the overall prospects are very good.”

Richard Nemec is P&GJ’s Los Angeles-based correspondent. He can be reached at  rnemec@ca.rr.com