New Mexican president must account for US shale revolution

New Mexican president must account for US shale revolution
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Amid a lengthy government transition, the debate around natural gas supply in Mexico has gained momentum. Following his criticism of Mexico’s ongoing energy reform, President-elect Andrés Manuel López Obrador (AMLO) has announced his intention to ban development of unconventional resources.

In a country that imports 89 percent of its domestic consumption (after meeting PEMEX demand) and whose production has fallen sharply in recent years, giving away prospects of new, potentially prolific sources of domestically available gas raises concerns.

To begin, AMLO’s stance on energy supports halting exploration and production bid rounds, the staple of the energy reform designed by the outgoing administration of President Enrique Peña Nieto to boost oil and gas production.

Instead, AMLO sees service contracts drawn between PEMEX and domestic private firms as a better way to reach this goal.

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If AMLO decides to follow this road after being sworn in as president on Dec. 1, the lingering question will be whether these proposals will successfully contribute to strengthening energy security while weakening dependency on natural gas imports from the United States. Regarding this, many have expressed skepticism

So, the discussion around natural gas supply in Mexico has shed light on the environmental dangers and economic opportunities of developing domestic unconventional reserves. There are compelling arguments on both sides.

To situate the debate in a wider context, one needs to look into what is happening in Texas — Mexico’s neighbor and leading supplier of natural gas — where, thanks to innovation and technological progress in shale exploration, production of crude oil and gas has been booming. 

The extent of the so-called shale gas revolution in Texas (and the United States overall) is not entirely captured by the increasing levels of production.

The abundant availability of gas means that U.S. natural gas prices are relatively low, and this context has produced a wave of investment in downstream activities such as liquefied natural gas (LNG) terminals and petrochemical plants, especially off the U.S. coast in the Gulf of Mexico. 

Therefore, in crafting energy policies, Mexico’s president-elect must look closely at the sizeable impact that production of shale gas is having on the Texas economy. 

In Mexico, more than half of power generation comes from natural gas. For users to have access to low tariffs, generators must source gas at competitive prices. Today, this is possible thanks to the pipeline connectivity between Mexico and the United States, though such price advantage could be under pressure during the next decade. 

Currently, only one terminal exports liquified natural gas from the U.S. Gulf Coast, but four additional terminals are currently under construction and another four projects have been approved by the Federal Energy Regulatory Commission.

With five LNG terminals expected to be operating at some point in the first half of the 2020s, higher volumes of LNG exports and greater domestic consumption are likely to push prices of natural gas upward in the U.S. Gulf Coast.

If such a price environment materializes and Mexico remains deeply dependent on U.S. natural gas imports, AMLO’s government could face bitter consequences.

In addition, Mexico lags in petrochemical investment, neglected to the benefit of the power sector. Meanwhile in the U.S. Gulf Coast, supply of ethane (a molecule found in natural gas) from Texas has resulted in investments of around $140 billion to expand and build plants to produce ethylene (the most important feedstock for the making of plastics) and byproducts such as polyethylene and propylene.

If Mexico’s policies on natural gas supply fail to encourage investment in petrochemicals, one can reasonably expect that Mexico will end up meeting much of its rising domestic demand with imports from the growing petrochemical sector across the border, doubling down on its dependency for energy from the U.S.

As AMLO takes over power on Dec. 1 and begins crafting Mexico’s energy policy, his government must have in mind the negative impact of both scenarios presented above.

He needs to think about designing an energy model that can diversify sources of natural gas supply and boost domestic production. That is why the discussion about the development of unconventional resources in Mexico should not be abandoned yet.

If leaving unconventional resources underground is the way forward, AMLO’s team must be conscious that the alternative plan should be carefully crafted and executed to deliver on promises of energy security and domestic energy production.

Otherwise, Mexico could face a tighter U.S. gas market with prices rising on the back of LNG exports and higher domestic consumption. In any case, Texas-based companies will be ready to jump at opportunities arising from the growing energy market across the U.S. southern border. 

Adrian Duhalt, Ph.D., is the postdoctoral fellow in Mexico energy studies for the Mexico Center and Center for Energy Studies at Rice University's Baker Institute for Public Policy.