August 7, 2017 | By Paul De Ayala

The disparity between natural gas supply and demand in Mexico coupled with the recent Mexican energy reforms has generated plenty of interest among U.S. investors. While gas pipeline imports from the U.S will likely fill the supply shortfall in the mid-term, can the energy reforms aimed at revitalizing the Mexican E&P sector lead to a Shale revolution in Mexico? More importantly for the U.S, will shale oil/gas success in Mexico potentially jeopardize the commercial viability of future investments in cross-border gas pipelines?

For quite some time now, Mexico has been facing a widening imbalance between supply and demand. In order to lower energy prices, the Mexican government has been increasing its reliance on natural gas in the power sector. This growing reliance on natural gas from the power generation sector has been the driving factor in the growth in natural gas demand. Gas demand in Mexico has increased by 1.1 billion cubic feet per day since 2011. The power sector made up about 65% of the increase, while the industrial sector also experienced a significant increase in gas demand.

The Federal Electricity Commission (CFE) has plans to tender contracts to build 28 Combined Cycle gas-fired power plants by 2028. These power plants represent 23 GW of incremental gas-fired generation capacity with the potential to add up to 2.7 billion cubic feet per day of new gas demand by 2025.

Concurrently, Mexican domestic production has not been able to keep up with demand due to years of lackluster E&P performance by Mexico’s state-owned energy company, Petroleos Mexicanos (“PEMEX”). This imbalance has resulted in increasing reliance on U.S. gas pipeline imports. Pipeline exports to Mexico averaged 3.7 billion cubic feet per day in 2016 with 81% sourced from South Texas. Natural gas going to Mexico accounts for 70% of the total U.S. natural gas exports. An expected decline in Mexican domestic supply will increase imports to 6.5 billion cubic feet per day by 2025 including 5.5 billion cubic feet per day of U.S. pipeline imports. The remaining 1.0 billion cubic feet per day will be met by LNG imports.

To enable gas pipeline imports from the U.S, the CFE has committed to 7.0 billion cubic feet per day of new pipeline capacity which is in addition to 3.0 billion cubic feet per day commissioned since 2014. Close to two-thirds of Mexico’s U.S. import reliance will be sourced out of South Texas growing to 4.1 billion cubic feet per day by 2025 with pipeline capacity not being a limiting factor.

With all that said, Mexico has a great reserve base and the Mexican government has been working on upstream reforms to improve its energy market. The goal of these reforms is to make up for the lack of capital and technology from PEMEX by opening the Mexican oil and gas market to private investors both foreign and local. The Mexican government has been auctioning off offshore blocks to increase offshore production. For one U.S. company, Talos Energy, LLC, this strategy may already be paying off. On July 12th, Talos Energy announced an oil discovery of an estimated 1.4 to 2.0 billion barrel play in offshore Mexico. This discovery was made with the Zama-1 well. This is the first successful privately-owned offshore exploration discovery in the history of Mexican energy.

Revitalization of Mexican E&P sector has great implications for both Mexico and the U.S. For Mexico, the reforms allow private investors to enter the Mexican oil and gas producing regions. A direct implication of increased production is the reduction in energy prices while reducing reliance on imported natural gas in the long-term.

The possible returns are tremendous if these private investors’ expertise and capital prove effective. EIA estimates 545 Trillion cubic feet (natural gas) and 13.1 billion barrels (oil) of technically recoverable resources in Mexico. A significant portion of these recoverable resources is found in the Burgos basin which is a continuation of the Eagle Ford shale in South Texas. Geology does not stop at the south Texas border, so many practices used and expertise obtained in South Texas can apply to plays in Mexico. The technology and capital these investors possess will allow them to access reserves PEMEX simply could not/ did not want to monetize. The advanced technology also has the ability to increase production from existing fields.

Map Source: Mexico-Sees-Its-First-International-Offshore-Drilling-Success

For the U.S., the reforms mean new business and growth opportunities. As previously stated, Eagle Ford shale continues into the Burgos Basin of northern Mexico. Producers in South Texas can just carry over their expertise south of the border. There are other plays with quality resources, but the geology becomes structurally more complex so the Burgos is the favorable play.

What all of this is showing is that Mexico cannot monetize oil and gas reserves alone. Using expertise and technologies obtained in South Texas will be pivotal to the growth and success of accessing Mexico’s undiscovered potential. However, Shale oil/gas success in Mexico leads to a few more questions. What is the impact of Mexico’s reduced reliance on U.S. imports on South Texas and U.S. Gulf Coast markets? What are the implications for the valuation of pipeline capacity that was just commissioned? Could this turn Mexico into a net exporter of natural gas? What happens if the U.S. loses its biggest gas importer? We will explore this implication further in upcoming blogs.