Mexico's Gas Has Investment Potential
John B. Gustavson and Jeff B. Gustavson
Over the next ten years, our southern neighbor
may develop into a major gas exporter or may become totally dependent
on imports of natural gas from the United States and Canada. Unusual
business opportunities present themselves under both scenarios.
However, first the causes for the present crossroads must be understood.
. . . southern neighbor may develop into a major
gas exporter or may become totally dependent on imports of natural
gas . . .
Three distinct past phases are easily recognized. First was a phase
lasting half a century with natural gas being totally subordinated
to oil until 1987. Thereafter, until the latest presidential election
and the economic crisis in late 1994, was a short phase with attempted,
but limited, transition toward increased natural gas consumption.
Now, two years into the present phase of trying to meet increases
in consumption, the state-owned oil company Petroleos Mexicanos
(PEMEX) is facing severe financial limitations, and industrial investors
are facing numerous uncertainties.
The Seesaw Years
The transition phase until 1994 deserves analysis
here. In the late 1980s, the government decided to initiate a transition
to natural gas because of the obvious environmental advantages,
particularly in major air pollution centers such as Mexico City
and Monterrey. In addition, new electric power technologies became
available including complex cycle gas turbine systems. Also, in
addition to an important market for the associated gas from PEMEX's
increasing oil production, the Mexican government looked to the
availability of low-priced gas from the surplus in the United States.
Unfortunately, PEMEX was not given sufficient financial
flexibility to implement this transition. Although natural gas consumption
increased, PEMEX was slow to initiate longterm delivery contracts.
Also, the less favorable high-sulfur fuel oil (always
difficult for PEMEX to sell) experienced competition from market-priced
natural gas, and beneficial switching was beginning to take effect.
Ironically, while the switching originally had been intentional
from an environmental standpoint, the pressure on the Maya crude
oil export price generated by the undesirable fuel oil glut frightened
the government. Therefore, for a while, gas consumption was actually
restrained by pegging the price of high-sulfur fuel oil under that
of natural gas.
The Current Phase
The economic crisis of December 1994 changed everything.
The objectives of the natural gas industry as forwarded by President
Zedillo to the Mexican Congress in May 1996 are (1) to ensure supplies
to the market; (2) to take advantage of both associated and dry
gas in a rational manner; (3) to improve the environment; (4) to
achieve a balance of exports and imports resulting in positive net
foreign exchange flow; and (5) to guarantee equitable terms for
all consumers. These desirable objectives are very difficult to
achieve in the current economic climate. PEMEX is charged with the
upstream activities but is cashstrapped due to high taxes and greater
priority on export oil development. The private sector now has the
natural gas downstream sector opportunity (transportation, storage,
and distribution), but it is facing a wall of hurdles.
Yet the government has outlined various approaches,
including concentration on core activities, for PEMEX. Unfortunately,
the recent suspension of the secondary petrochemical industry sale
augurs poorly for the future. The political pressure from PRD and
PAN (now joining hands against the PRI-controlled government) galvanized
both unions and the general public against a sale of only a 49 percent
minority interest. This suspended privatization of 61 petrochemical
plants in the far downstream sector shows the difficulty of carrying
out this first strategy point.
The second strategic approach put forward is to
vigorously develop Mexico's gas fields. However, PEMEX has only
limited plans for developing additional gas potential in the northeastern
sector, notably in the Burgos basin. Even more telling is the fact
that the exploration and production division of PEMEX shows no specific
plans in its 19962000 Business Plan for drilling of any of the dry
gas basins even when these basins underlie growing and polluted
markets along the northern border and the west coast (Exhibit 1).
Financing Constraints for PEMEX
For PEMEX, pursuit of the above strategy would
involve investment of the order of $10 billion for dry gas alone.
Those amounts are not planned or available. Further, there is less
incentive for PEMEX in the presently developed fields to develop
gas wells. Mexico has historically been able to generate higher
revenues from oil well investments than from gas wells. Typically,
at the present time PEMEX's net daily income per oil well is $8,000,
whereas daily income per gas well is less than $2,000.
One reason for the difference is technical. The
Candelaria and other fields in the Gulf of Campeche are highly fractured
carbonate reservoirs with high initial production rates. In contrast,
the paucity of exploration in the gasprone basins such as Pedregosa,
Sabinas, and Salton Altar has not yet led to comparable gas production
rates, but may do so when explored. Mexico is already a beneficiary
of financing by the World Bank in the environmental sector, and
PEMEX as a quasistate agency could qualify for gas exploration loans.
However, the cost of that capital might include restructuring terms
unacceptable for Mexico.
Constraints for Industry Investors
Invitation to the private industry for financial
participation runs into the constitutional dilemma: Foreign company
participation is presently unacceptable. Yet natural gas might someday
be considered a compromise with foreign participation toward meeting
the energy objectives.
As has been seen in other countries (such as in
Brazil in the 1980s), Mexico would choose the service contract approach
first, but with tenacious denial of the better-known term "risk
service contract." The word "risk" carries the notion
of participation in property rights, something unacceptable to the
Mexican public.
The opportunities to invest in gas transportation,
storage, and distribution are fraught with hurdles. Pipeline construction
alone may require funds in the $5-8 billion range after overcoming
the lack of institutional framework including an Energy Regulatory
Commission new to the task. Even gas storage operators, while working
under the new modification of Article 27 of the Constitution, may
find themselves in violation of the Constitution, which still holds
that "subsoil gas belongs to the State." In short, you
pump your newly acquired gas into the storage field and it now belongs
to PEMEX.
. . . you pump your newly acquired gas into the storage field and
it now belongs to PEMEX.
The transportation sector will also have to tackle the legal problem
of the interface between PEMEX and the private transporter, because
transport and storage essential and necessary to interconnect gas
exploitation and production are part of the oil industry and therefore
within the continuing monopoly of PEMEX.
Effects Related to NAFTA
The pricing policy for fuel oil in the early 1980s
did not consider the negative effects of emissions generated by
the high sulfur content (around 4 percent by weight). Compared with
burning one energy unit of natural gas, a unit of fuel oil will
increase by nine times the amount of particles emitted, more than
6,500 times the emission of SOx and more than twice the emission
of NOX. However, the transition phase worked uneasily. It became
increasingly clear to the Mexican government that it would have
to reform its environmental policies.
NAFTA was the first stride in this long process.,
which demonstrated Mexico's realization of the importance of the
private sector in complementing public-sector investments, as well
as its emphasis on Mexico's cleaning up its environment. NAFTA also
provides that none of the countries shall lower their environmental
standards for the purpose of attracting invest ment. More importantly,
NAFTA creates a dispute settlement mechanism concerning environmental
(both internal and external) disputes. The government plans to adopt
new environmental regulations and norms starting January 1, 1998.
These norms depend on the gradual substitution of natural gas for
heavy fuel oil.
Demand for Natural Gas in Mexico
Growth in energy consumption in Mexico is primarily
a function of economic output and growth of the economy as a whole.
After averaging 3-percent annual growth in gross domestic product
(GDP) during 1989-1992, the impending economic crisis began to build
as growth in GDP dropped to 1.5 percent in 1993. Mexico's currency
reserves steadily declined as its capital account deficit grew to
reach new highs.
This combination broke the camel's back in late
1994 as international investors fled, passing "peso predators"
on the way in for the final blow. Following the hasty currency devaluation,
the Mexican economy shrank by 6.2 percent in 1995. However, a $50
billion bailout by the IMF and the United States, coupled with firmness
by the Mexican government to restructure and refinance its massive
debt load, led to expected growth of 4 percent in 1996. With these
problems behind, the macroeconomic future of Mexico has stabilized.
Thus, new projections of energy demand seem reasonable.
The factors affecting this increase must be analyzed
as well as how the demand will be partially met by natural gas (Exhibit
2). There are three general factors, all of which have created an
incentive for the increased use of natural gas. First, elevated
environmental awareness in Mexico has generated much support for
the use of the cleaner-burning fuel. Second, and along the same
line, the ability, and more importantly the success, of the Comision
Federal de Electricidad (CFE) to switch from high sulfur fuel oil
to natural gas to produce electricity is critical over the next
decade. Third, there are several large cities in Mexico that are
considering switching from the current use of liquefied petroleum
gas (LPG) to natural gas.
Also important are President Zedillo's remarks
made in August 1996 when he pledged the government's full support
for the Mexican tourist industry. Increased focus will be placed
on this industry in order to not only maintain, but also increase,
the amount of hard currency brought by U.S., Canadian, and European
tourists. Zedillo's placement of this alreadyimportant sector of
the economy, second only to the hydrocarbon industry (in place of
the manufacturing sector), is a huge boost to the future of natural
gas. Environmental concerns are increasing daily at many of Mexico's
popular tourist spots, usually concerning unsightly and noxious
air emissions from nearby power plants burning heavy fuel oil.
Therefore, future gas demand in Mexico depends
on the success of CFE's substitution program from heavy fuel oil
to natural gas, which in tum depends on CFE's future combined-cycle
electric plant construction plans. Current installed capacity is
33,038 megawatts in the country. In order to satisfy future electricity
demand, CFE will require an extra capacity of 9,031 megawatts by
2005. Of those, 6,965 megawatts are planned to be produced by combined-cycle
plants.
Finally, further natural gas demand will arise
from the proposed conversion by several major metropolitan areas,
mostly in northern Mexico, away from the local use of LPG to the
use of more natural gas. Key factors to achieve this goal are based
on prices and the costs of transportation, investment, and capital
requirements. Some of the key cities include Mexicali, Tijuana,
Ensenada, Hermosillo, Cuauhtemoc, and Jalapa. In the opinion of
these authors, this represents an opportunity for foreign investors
in the Mexican natural gas sector.
All of these factors lead to the natural gas demand
projections by the Mexican secretary of energy and PEMEX that are
summarized in Exhibit 2. Total projected production rates from PEMEX
through 2005 are also included in Exhibit 2.
The Supply Picture
In October 1995, Hurricane Opal slammed into PEMEX's
Campeche Sound producing area twice, killing oil workers and damaging
equipment. In February 1996, angry protesters blocked 69 oil wells
for two weeks in Tabasco, causing more than $10 million in revenue
losses. The worst accident from a supply standpoint was the July
26,1996, explosion at the Cactus natural gas processing plant, kilIing
six workers and affecting 30 percent of Mexico's natural gas supply.
This explosion forced PEMEX to look abroad for natural gas and to
review the lack of flexibility in its gas supply sector.
The North American gas market plays an important
role in Mexico. U.S. and also Canadian gas prices may reflect surplus
as well as lower costs due to amortization of prior investment in
production facilities, compressors, and pipelines required to produce,
store, and move the gas to markets. Therefore, these two North American
countries hold advantages as compared to Mexico with its embryonic
network of pipelines and almost total absence of storage fields.
Mexico has very large gas reserves of both associated
and dry gas. However, Mexico faces numerous problems of a budgetary
and political nature before being able to explore and produce these
reserves and resources. Concerning budget, PEMEX is Mexico's largest
taxpayer, its tax rate being 67 percent, which is the highest in
the country and prevents PEMEX from pursuing the government's natural
gas objective.
As a result, PEMEX produces less associated gas
than desirable, has practically no dry gas exploration and development,
and must purchase chase gas from North America for a substantial
time into the future. In spite of this, it is tempting to conclude
that the trading relationship will continue, and that it will ultimately
involve net exports of gas from Mexico. The existing gas pipeline
infrastructure in Mexico is shown in Exhibit 3.
Undeveloped Basins
A study was recently completed of the reserve potential
of 11 gas-prone basins in Mexico. The results were surprising, indicating
potential dry gas in the range of 300 trillion cubic feet. Interestingly,
several of the most promising basins underlie the areas with the
most rapid growth or with the greatest need. The latter is the case
of the tourist havens of Mazatlan and the upper part of the Gulf
of California, as shown in Exhibit 1.
If these analyses are used, the 11 basins can be
grouped into three categories. The first category is those basins
with moderate gas reserve potential, and this group includes the
Parras, Macuspana, and Comalcalco basins. Except for the Parras,
all of these basins have established production.
The second type is those basins with high gas reserve
potential, which consists of both producing and frontier basins.
Nonassociated gas production has already been established in both
the Sabinas basin, where a multitude of anticlinal structures remain
to be tested, and in the Veracruz basin, where small gas fields
have been discovered. The remaining basins in the group, the Pedregosa,
Vizcaino, Purisima-Iray, and Mazatlan, have experienced only minimal
exploratory drilling, have little or no production, and warrant
being described as frontier areas. The final group are those basins
with very high gas reserve potential. Only one basin, the Salton-Altar,
falls in this category. This lightly explored frontier basin is
large, and the potential sourcerock section is thick. This basin
has by far the greatest gas potential. It is also reasonably close
to important markets.
Conclusions
Mexico is rich in natural gas deposits, but infrastructure
is poorly developed. About 300 trillion cubic feet may be available
in frontier basins.
Exploration and production are monopolies of PEMEX. Transportation,
storage, and distribution are open for industry investment, but
with many regulatory and legal difficulties.
PEMEX has no significant plans or budget for gas exploration in
its 1996-2000 business plan. Nevertheless, PEMEX forecasts show
one billion cubic feet a day to be added in the form of new gas
fields by the year 2000.
The increase in demand for natural gas due to switching and economic
growth could equal up to 7.4 percent per year. PEMEX cannot satisfy
that demand even locally.
Foreign gas companies may become acceptable under service contracts,
particularly in areas such as the Pacific Coast with no other possibility
for clean energy. |