In pursuit of gas growth

• On the impact of the energy reform: “By simultaneously opening the upstream sector to private investment and creating an independent system operator for the backbone of the transportation system, the reform has enabled the creation of a domestic natural gas market.”

• On the gas transportation system: “The fate of the transport system – its expansion and reliability – was dependent on the health of Pemex’s balance sheet, susceptible to commodity price volatility and competing priorities. The result is an underdeveloped and unreliable system that has saddled economic development for decades.”

Arriola Jiménez also discussed Mexico’s competitive advantages, and the outlook for the domestic oil and gas industry. Most TOGY interviews are published exclusively on our business intelligence platform TOGYiN, but you can find the full interview with Carlos Alberto Arriola Jiménez below.

How has Mexico’s energy reform stimulated change in the oil and gas industry?
Given its breadth and depth, the energy reform has profoundly changed the natural gas industry landscape in Mexico. By simultaneously opening the upstream sector to private investment and creating an independent system operator for the backbone of the transportation system, the reform has enabled the creation of a domestic natural gas market. The relevance of this change for the natural gas industry and for the Mexican economy as a whole cannot be overstated.
It is estimated the upstream sector will attract USD 50 billion in investment for the development of the blocks awarded in the first three years since the implementation of the reform. That amount represents twice the total foreign investment that Mexico receives every year. Considering that oil and gas currently represents only 5% of Mexico’s GDP, that is an astonishing amount of investment flowing into a sector that has been declining for decades as a result of an obsolete legal framework. The full impact that such a breakthrough will have on the Mexican economy is yet to be determined, but I am certain that it will be both positive and momentous.

What will be the impact on the midstream sector?
Although not as eye-catching, the changes in the midstream sector are as substantial and relevant for the development of a domestic gas market. Prior to the reform, the core transportation infrastructure was owned and operated by Pemex, which was also the only domestic producer of natural gas. As a result, market participants had very limited sourcing alternatives.
In addition, the fate of the transport system – its expansion and reliability – was dependent on the health of Pemex’s balance sheet, susceptible to commodity price volatility and competing priorities. The result is an underdeveloped and unreliable system that has saddled economic development for decades. These issues will take several years to resolve, but since the implementation of the reform, Cenagas [National Centre for Natural Gas Control] has the mandate to establish priorities for the development of infrastructure to increase coverage and improve reliability.
Furthermore, since the development will be financed by private market participants, the completion of such projects is no longer subject to competing priorities from the Secretariat of Finance and Public Credit or Pemex.

Is the expansion of Mexico’s natural gas network enough to adequately meet shifting industry demands?
Over the next five years or so, the transport network is expected to expand by 5,215 kilometres, or 33%, with USD 8.02 billion flowing into expansion projects. That is quite remarkable, considering that the network had not grown significantly for decades prior to the enactment of the energy reform.
Expansion projects will not only increase coverage, but also improve reliability, which is the most critical task at the moment. To fully improve reliability, however, the development of storage capacity must be included in near-term plans, given the critical conditions under which we currently operate. As an example, the capacity of existing LNG terminals interconnected to Sistrangas [National Integrated Gas Transportation and Storage System] represents approximately 25% of system’s daily demand.
In general, I would say that the expansion is adequate to meet industry demands. For instance, the expansion will enable the substitution of 180,000 boepd of fuel oil with natural gas in power generation during the 2012-2018 period. Such a shift represents a 90% reduction of the amount of fuel oil used in 2012 for such purposes. New transport infrastructure is allowing this cleaner fuel to reach existing and new power plants across the country.

Are there areas of the country where infrastructure is not growing at the necessary rate?
There are some areas of the country where needs are not being met and require immediate attention. Most importantly, the southwest industrial complex has been dealing with an unreliable supply of natural gas for several years now as a result of a declining production base, continuous quality issues and insufficient infrastructure to transport gas from the north.
In many ways, such deficiencies have hampered the economic development of the southern region and require immediate attention. As of now, it is expected that the operations start of the underwater pipeline currently being constructed along the gulf coast to Tuxpan will relieve the issue in late 2018. We believe that the criticality of the issue requires a shorter-term solution.

How do you view Mexico’s increasing gas imports from the USA?
They are strategically unwise. Depending on a single external source for a product that is vital for the development and functioning of the economy is not what I would describe as sound strategy. Given Mexico’s geographic location, we have three options for natural gas supply: domestic production, land imports from the US and LNG imports from any other producing countries.
While land imports from the US have allowed Mexico to partake in the extraordinary economic benefits of the shale revolution, imports from the US already represent close to 60% of total demand and have more than doubled from 1.9 bcf [53.8 mcm] per day in 2011 to 4.5 bcf [127 mcm] in 2017. From a strictly economic standpoint, that is a perfectly rational behaviour, considering the cost competitiveness of US shale gas. However, such high dependency creates vulnerability in an uncertain political environment such as the current one.
Granted, no one could have predicted the recent change in tone in the bilateral relationship between Mexico and the US and or that the decline in domestic production would occur unusually fast. Nonetheless, the rate at which our dependence on single-source imports has increased is alarming.
Ironically, the shale revolution is in no small part a result of the US’ multi-decade effort to become energy independent. At the moment, Mexico is going in the opposite direction and there are some lessons to be heeded both from the US’ effort to balance its energy trade and the vulnerabilities that can result from a high degree of dependency. The good news is that we have the solution in our hands: domestic production. It’s not going to happen overnight and many important hurdles need to be cleared. The most difficult one of all though, the constitutional reform, has been achieved. Hopefully that means that we are in the process of reverting course and underway to achieve a more favourable strategic position.

What factors will impact the effort to increase domestic gas production?
For associated gas, the case can be made that efforts to increase domestic natural gas production are already underway. Recent reports indicate that the CNH [National Hydrocarbons Commission] has approved investments of up to USD 2.4 billion in E&P projects of successful bidders in the initial seven rounds. The issue with associated gas, mostly from offshore blocks, is that a meaningful impact in production cannot be expected to occur within the next five years, given the long maturation timeframe of individual projects.
The shorter-term solution is to accelerate onshore non-associated gas projects. Mexico has plentiful unconventional gas resources, with technically recoverable reserves estimated at 545 tcf [15.4 tcm], which is equivalent to 88% of US reserves. Mexico’s gas resources have traditionally required shorter development lead times.
Unfortunately, even post-reform, would-be Mexican producers are severely handicapped vis-á-vis their Texan counterparts, given the following factors: the current state of infrastructure development, subsurface rights and associated access to capital, the maturity of the oilfield and financial services industries, the maturity and stability of the regulatory framework, and the overall rule of law. To level the playing field, Mexican authorities should consider fiscal incentives to attract investment and put the gears in motion for the development of a domestic shale gas industry.

What is the key to the success of gas transportation and distribution companies that serve industrial clients?
We believe that safety, reliability and ethics are key for the long-term success of any enterprise. We stand by those values, which we believe should guide our everyday actions and decisions.
From a more tactical standpoint, success in this sector requires market knowledge, access to competitive capital, technical wherewithal and administrative efficiency. Over the past 20 years, Igasamex has developed an edge in each of those areas to ensure that we have a competitive solution each and every time.

Where can bureaucracy be further simplified to make processes more efficient for investors?
Everywhere, but unfortunately, bureaucracy continues to be a major hurdle for the development of investment projects in Mexico. We have a few projects that have been stuck in a bureaucratic quagmire for more than three years now. We understand that it takes time to fully implement a new regulatory framework, but we believe that it should never come at the cost of investors and end users. The ample discretion that authorities have been awarded by law should always favour the timely and successful development of projects. That has not been our experience three years into the new regulatory era.
To help improve regulatory and permitting processes and increase certainty for investors, requirements to obtain permits should be minimised, all permit applications that fulfil necessary requirements must be resolved within the applicable legal time-frame, redundancy in requirements from different agencies must be eliminated and permitting processes across government agencies should be effectively co-ordinated.
We believe that authorities fully understand these issues at depth and are putting a lot of effort into eliminating and reducing bureaucratic hurdles. We look forward to what we believe will be a successful outcome of this worthy effort.

How significant are Pemex’s contract migrations and the open season auctions for transportation and storage capacity?
The transition to the capacity reservation regime, enabled by the open season auction, is the single most important energy reform milestone that has been achieved in the midstream sector so far. It has transformed the landscape of the midstream sector in full and has set the foundation for the development of a domestic natural gas market. Its relevance is such that it prompted the CRE [Energy Regulatory Commission] to deregulate natural gas prices in parallel, also a major milestone in and of itself.
The unbundling of transportation capacity and natural gas supply has allowed new participants to enter the market, which, until private E&P production projects come online, will primarily transact imported gas. However, the foundation has been laid for market access to domestic producers once their projects mature. For the first time in history, we will have a functioning natural gas market where pricing signals will stimulate or deter upstream and midstream investment.
For the Mexican natural gas industry, July 1, 2017 was the day the wall came down. It should be said that a transition of such historic proportions was achieved seamlessly and Cenagas, SENER [Secretariat of Energy] and the CRE should be praised for the outstanding implementation and monumental effort that it required.

What is Igasamex’s overall investment strategy in the Mexican market?
Our strategy is to continue to invest in our country’s development. Specifically, we will continue to invest in extending our infrastructure, developing our colleagues’ professional abilities and improving the living standards of the communities in which we participate.
We fully embrace the structural changes that our industry has undergone. We will overcome the hurdles that the new regulatory framework has imposed on us and wholeheartedly pursue the opportunities that come along with such profound changes.

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