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NAFTA Deal To Bolster U.S.-Mexican Natural Gas Trade

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After some strong rhetoric on both sides, it now looks like the Trump administration and Mexican counterparts could have a preliminary NAFTA deal by the end of the month. This would be quite timely given that Mexico's newly elected president, Andrés Manuel López Obrador (AMLO), will take office in December and has indicated he would respect renegotiations. In particular for my field, a bigger and better NAFTA would boost the growing U.S.-Mexican energy relationship built on free trade.

As the go-to fuel, natural gas will increasingly be the story between the two nations. Mexico has accounted for the bulk of U.S. gas exports, with 90% coming from pipelines and the rest from LNG. The U.S. now accounts for 60%-65% of Mexico's total gas supply. Since its domestic output comes along with crude oil extraction as "associated gas," Mexico's gas production has fallen 30%-40% since 2010, as its oil production has been spiraling since the 2004 peak.

And now, with AMLO wanting to ban fracking, U.S. gas could gain even more market share in Mexico. Although fracking isn't expected to be a significant source of domestic supply for at least five years, Mexico does have great shale potential: an EIA-reported recoverable shale gas resource of 550 trillion cubic feet. AMLO will serve just one 6-year term but has made answering the question of "When Will Mexico Start To Frack For Natural Gas?" even more difficult to gauge.

Mexico's goal is to expand oil production by 30% or so to ~2.6 million b/d, but the coming stream of new gas supply that would bring won't significantly reduce the need for more U.S. supply anytime soon. Just recently, as new pipeline capacity has been added and some lines became fully operational, pipeline imports into Mexico are breaking the 5 Bcf/d mark for the first time. That's over 6% of all current U.S. natural gas production  - and could reach over 6 Bcf/d next year. Ultimately, without the Mexican gas outlet for U.S. sellers, our prices would be ~40% lower, which again, could do more harm than good.

Data source: EIA

Especially since most recent reporting has LNG imports from the U.S. almost 80% more expensive than piped gas, the pipeline build-out in Mexico is required to give a country where 50% of the population is considered poor more access to low cost-energy. U.S. pipeline capacity to Mexico now hovers around 12 Bcf/d, with 3-4 Bcf/d expected to be added this year. Pipeline companies have generally thought that building new connections in Mexico would be easier because "green group resistance" is less fierce.

But, enviros have joined with some indigenous groups - those that have typically felt ignored by the Mexican government - to push back on pipelines more than thought. Platts reports that there are now nine major gas pipelines being built in Mexico, but they "are facing an average delay of over 400 days, primarily due to legal injunctions filed during construction." In various stages of operations, these pipelines might not start for another year. 

The future is still very bright. More access to fast growing Mexico is a goal for Permian suppliers craving more pipelines and markets. Oil and gas output in likely the world's most important energy-producing region will see major growth. Despite having ~130 million people, Mexico consumes just over 8 Bcf/d of gas, or only what California, Nevada, and Arizona use combined. And since gas is 35% of all energy and generates 60% of Mexico's electricity, as the country's economy continues to expand, so does its gas demand.

Just as importantly, Mexico's gas and pipeline market is evolving. The International Energy Agency recently praised Mexico's progress for its 2013 Energy Reforms as a model for other countries. AMLO has unfortunately been installing a cabinet that has been critical of the reforms, but their rhetoric has toned down a bit. Deregulation has been based on bringing in more competition for stagnant and inefficient Pemex (oil/gas) and CFE (electricity) and granting third-party access. Pemex is in the process of relinquishing 70% of its gas contracts by the end of 2019. There's now over 20 marketers for gas that have been reporting over 180 trades monthly.

After eliminating price caps on first-hand sales last summer, Mexico's energy regulator CRE in March published the first monthly gas prices for six trading regions across the country, which will bring hub and index pricing modeled after the U.S. market. There's also an evolving storage market for gas to better meet seasonal peaks in demand. And a new pipeline tariff regime will be coming later this year. New rules stipulate that shippers must maintain a minimum utilization rate of 70% for their firm capacity contracts or unload the unused capacity (70% minus the actual % utilized) into the secondary market.

Just like in China and India, Mexico's natural gas story shows how countries turn more to natural gas as they develop.