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Mexico to Keep Buying Pricy Permian Gas, But How Long?

Copyright © 2021 Energy Intelligence Group
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This story was originally published in Oil Daily sister publication Natural Gas Week.

Pipeline imports into Mexico have fallen nearly 1 billion cubic feet per day recently since a late-August peak of 6.3 Bcf/d, while natural gas prices at the Permian Basin’s Waha Hub concurrently soared by more than $1.70 per million Btu. Coincidence? More than likely, sources in Mexico tell Energy Intelligence. But if prices stay at seven-year highs, it could have a profound, long-term impact on budding market ties between Texas gas producers and Mexico’s growing market.

“It remains to be seen if the increase is the outcome of short-term dynamics or if higher prices are here to stay for longer,” Adrian Duhalt with Rice University’s Baker Institute told Energy Intelligence from his home in Veracruz.

“With this government, Mexico's focus is on fuel production, and it has paid little attention to the natural gas market. Key policies that could lessen the risks associated with natural gas import dependency were put on hold leaving end-users more vulnerable,” Duhalt said.

That came home to roost as a long period of relatively low prices at the Permian's Waha Hub, where the majority of Mexico’s imports are ultimately sourced, appears to come to an end as ample pipeline takeaway capacity out of the Permian was finally assured with last summer's opening of the Whistler Pipeline.

Except for a huge freeze-related February spike, prices at Waha have averaged in a $2 per million Btu range since November 2020. That’s higher than previous sub-$2 prices that led Mexico to build out a power infrastructure predicated on access to cheap US supply. But prices have averaged above $3/MMBtu since July and jumped to a $5.26/MMBtu high on Sep. 15, Energy Intelligence data show.

Prices have since declined into an upper $4 range, but that hasn’t impacted Mexican demand at least in the near term, Duhalt said.

“Key sectors of the Mexican economy such as power generation are extremely tied to natural gas supply from the US, which means that supply options are limited,” he explained. “And that in the end implies a risk for Mexico: price fluctuations.”

“But while higher prices could hit state utility CFE, they could also prompt the [Andres Manuel Lopez Obrador] administration … to rethink energy policies, not only those related with natural gas production,” he continued. “His government could see renewables as an option as well. But this could be more likely if natural gas prices remain higher over a considerable period.”

‘Very Inelastic’ Demand

For now, not much has changed except Mexico’s cooling loads.

“We are seeing the beginning of the fall,” Mexico City-based analyst Eduardo Prud’homme said. “September is a rainy month and much cooler than July or August in Mexico.”

But even if September had been unusually hot, Mexico would have pulled in the gas it needed because demand for US gas has become “very inelastic” in Mexico with few options for fuel substitution, he said. And that dependence is rising.

“We are creating new pipelines and infrastructure,” he told Energy Intelligence. “As more are being connected to the network, there is a pickup in demand. So, we will see a new demand peak next summer.”

There is an inevitability to Prud’homme’s prediction even in a $4-$6 price range for Permian supply. "We don’t have another source available. Pemex has a very limited ability to produce sufficient gas so its agility to increase supply in the short term is impossible,” he explained.

He also doesn’t see even higher prices causing demand destruction in Mexico — “maybe minor adjustments” — in the short term as the main end-user is state power company CFE, which relies on gas for roughly 55%-65% of its power generation and 65%-70% of gas imports are used for power generation.

“I think that market share for natural gas will remain at the same level,” Prud’homme said, adding that Texas will remain the main source of the gas as the only alternative after pipeline imports is LNG, which is even more expensive. In any case, the US is the main supplier of LNG to Mexico.

There is also the wrinkle that CFE International, the Houston-based private arm of CFE that buys gas in the US, has negotiated take-or-pay contracts for US gas to be delivered into the Mexico, he said. So it would be more expensive not to take the supply and difficult to find a buyer for the high-cost gas if it did not use it itself.

As for state-owned Pemex increasing domestic production, it was once hoped that liberalized energy policies could spur production in the gas-prone Burgos Basin across the border from the Texas Eagle Ford Shale. But that has proved much more expensive — and dangerous — than originally thought, especially as operations would have to be shut down at night because of drug cartel activity in the region.

Bottom line: Long-term prices in a $4-$6/MMBtu range or higher might elicit complaints about a lack of alternatives to gas-fired generation, but the government is not well positioned for the energy transition.

Despite having good wind and solar renewable resources, developing renewables is a political nonstarter because of disputes with the European firms who would lead the effort.

“This government has not the vision for that. It’s focused on the past,” Prud’homme said, as well as acting as if some “magical solution” is in the offing like the discovery of a huge gas field.

“The good news for Texas is Pemex has very, very poor operations because of a lack of investments in refining and gas processing,” he added. “We don’t have the structure or the plants to react to this kind of opportunity to compete with gas coming from Texas. You don’t have to worry about exports to Mexico, not for a while.”

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