Editor’s Note: NGI’s Mexico Gas Price Index, a leader tracking Mexico natural gas market reform, is offering the following question-and-answer (Q&A) column as part of a regular interview series with experts in the Mexican natural gas market.
This fourth Q&A in the series is with Francisco Xavier Salazar, a founding partner at Trust Inteligencia de Entorno, SC -- a Mexican consulting firm specialized in sociopolitical risk management for the industry -- and Enix, SC, which specializes in energy regulation. He is also the Coordinator of the International Confederation of Regulators (ICER).
Salazar served as Chairman of the Mexican Energy Regulatory Commission (CRE) from 2005-2015 and later was the first “Institute of the Americas Regional Energy Integration Non-Resident Fellow” in San Diego, as well as an executive fellow at the School of Public Policy of the University of Calgary. From 2015-2017, he was Chair of the Mexican Chapter of the World Energy Council (WEC) and, in 2017, became a member of COMEXI, the Mexican Council on Foreign Relations. Salazar holds an MSc in Public Financial Policy from the London School of Economics and Political Science, and a BSc in Chemical Engineering from the Autonomous University of San Luis Potosi.
NGI: How do you see the evolution of the Mexican natural gas market and developments in recent years?
Salazar: I see it the following way. When I was in the CRE we started to analyze how to do all the regulation for the distinct markets whose regulation corresponded to the CRE, including new and existing ones. We worked under a concept that analyzed maturity in the market. We talked about how there are four stages in the distinct markets in the energy industry. The markets are: New-born/nascent market, emerging markets, markets in transition and the mature markets.
In the case of natural gas, my opinion is that if you look at all the facets of the natural gas sector – distribution, transport, sales – it is an emerging market that has moved into a transition market.
What are the characteristics of all of these markets? The nascent market is the one that didn’t exist before the energy reform. There weren’t participants, there wasn’t basic infrastructure in place. That clearly isn’t the current state of the Mexican natural gas market.
The emerging market is the one where there is certain infrastructure in place but the market isn’t consolidated. The natural gas market, in some of its sectors in Mexico, is still lacking consolidation. The vendor market for natural gas is just starting to become deeper and more developed. Some years ago, the marketing side of natural gas was an emerging market, but it was necessary to make the infrastructure more competitive and bring in more participants. For that reason, the transportation system was expanded and CFE held auctions to grow and improve the transportation system.
And then there are the mature markets, which are the markets that are completely developed and have competitive advantages. The best example is the natural gas market in the U.S. That is a mature market. In Mexico, it is a market that is moving from an emerging market to a market in transition. In terms of infrastructure, there is an important part that is still insufficient but there are important players present and diversity of participants in the market. In terms of wholesale and natural gas sales, Mexico is still advancing. Eventually, in a few years, I think Mexico could become a transition market and eventually, a mature market.
NGI: You mentioned the maturity of the U.S. natural gas market. In recent weeks, we’ve seen some of the U.S. natural gas prices at the Waha hub fall to historic lows and even into the negative range. Do you think that creates an opportunity for Mexico?
Salazar: I am convinced of that. I am convinced that it is necessary for Mexico to complete the infrastructure that is being developed and is currently stalled. If that infrastructure is completed soon and the social issues are resolved, it would allow Mexico to take advantage of the prices available in the North American market.
One market in Mexico that could be very interesting is the development of natural gas storage. We have LNG infrastructure that is aged and built in previous decades. There isn’t a storage market that allows Mexico to take advantage of the current prices available in the U.S.
In Waha, for example, Mexico could take advantage of the low prices with infrastructure to create more storage in northern Mexico. The gas could be purchased at a low price in Waha, stored and then taken advantage of when there is an opportunity to sell it, such as in the summer when consumption increases and demand for air conditioning is up. It could also be sold when more heating is used in the winter.
But we need an infrastructure for storage with an operative character because we keep running into important vulnerabilities and imbalances in the system. It is fundamental to improve the national storage network.
There are several opportunities for natural gas storage projects to be developed in Mexico that would improve the operation of the entire system. An example of that is the southern part of the country where natural gas is difficult to supply and LNG imports are expensive. One of the main challenges for the Mexican market is the construction of infrastructure and storage that create connections between different pipeline systems.
NGI: There was talk of a storage auction last year, is that on hold?
Salazar: Cenagas launched the initiative to offer the mature field of Jaf as a potential storage option. However, I insist, there needs to be more commercial storage options to develop and improve the overall functioning and reduce vulnerabilities in the entire system.
NGI: Speaking of vulnerabilities in the market, in recent weeks there have been some blackouts in southern Mexico. Do you consider blackouts to be a real worry for the sector?
Salazar: The blackouts are a reality. Though in the case of Yucatan, the conditions were distinct. Part of the problem in the Yucatan peninsula is that there isn’t sufficient natural gas. The peninsula has to import a significant amount of energy because there isn’t sufficient generation available in that region of the country. There isn’t sufficient natural gas because Pemex production has fallen in the area and, the gas that is produced is contaminated and can’t be used. There are serious risks for the lack of available natural gas in the Yucatan, as well as insufficient transmission options.
In the rest of the country, the fact that the natural gas pipelines are stalled and that some of the combined cycle plants aren’t fully functioning, it does impact the electricity market. The price of electricity last summer rose a considerable amount, and they are starting to rise again. This can be explained by the lack of natural gas available. The impact of a lack of natural gas is most felt in the electricity sector and has a significant impact on the economy. The lack of natural gas generates inefficiencies that result in economic losses.
NGI: In regard to infrastructure soon to enter into operation in Mexico, what is the status of the TransCanada-Ienova marine pipeline and how important is the project for the supply of natural gas in the country?
Salazar: It is a vital pipeline for the country. It is vital for the electricity sector. That said, still more natural gas will be needed. It will help a lot but there is still so much that needs to be done. There are other additional needs in interconnection and storage infrastructure. It is important but there is still much work and infrastructure that needs to be done in addition to that pipeline.
NGI: Do you see pipeline expansion plans in this administration?
Salazar: Last week, Cenagas began public consultations to determine how much demand for natural gas is growing to see if it merits further expansion of the pipeline system. They have been doing this in recent years. The fact they are doing it again as they did last year means that Cenagas and the Energy Ministry are on the same track and that pipeline planning is considered fundamental and requires updating. There is more need for interconnection infrastructure between the distinct systems and storage, as I mentioned previously. I think that will be revealed in the consultation process and should be reflected in the Energy Ministry and Cenagas 5-year plan.
NGI: Do you think Mexico has succeeded in creating a free market for natural gas?
Salazar: We are on the right path. Some fundamental steps have been taken and the market continues to develop. I think that, with time, Mexico will function as an open market in terms of natural gas.
The Mexican market should function as an extension of the North American energy market. The gas from the U.S. should be an option for the Mexican market and there should be more incentives for improving national production. It’s a question of public policy. In the south, the more infrastructure that is in place, the more opportunities to take advantage of the natural gas that is available. A public policy that encourages that would assist with the energy security of the country, particularly if there was more of a push to produce the gas available in southern Mexico. That would mean taking measures such as changing the fiscal regime for natural gas. This would be very interesting. The CNH has discussed this possibility and I think it is time to revisit it.
NGI: What type of companies are buying natural gas from independents in Mexico and what are the contract terms? Daily, monthly, annually?
Salazar: For the most part, the type of companies buying natural gas from the independents are the big consumers. The ones that have the capacity to have their own teams to establish their own buying strategies and have a mix in their portfolios that require the purchase of natural gas. They are sophisticated companies that have contracts of all three types: daily, monthly, annually. They have to be flexible for demand fluctuations and they have teams dedicated to designing those strategies.
Fundamentally, it is only the large consumers. What would make the market much more competitive is if it incorporated medium or small-sized companies to allow or incentivize them to participate more in this market. It is difficult for companies of that size because they need to hire experts or sophisticated teams with experience in buying and selling natural gas. There are independent companies that offer that sort of expertise and, if medium to small-sized companies are able to hire them, there is more opportunity to incorporate more players in the market.
NGI: Is it difficult for private companies to buy and sell natural gas in Mexico given that Pemex and CFE continue to be so dominant in the market?
Salazar: There have been important advances for the entry of private companies in the market, though there are some barriers to entry. There are some areas in which Pemex and CFE are still dominant, particularly in the international pipelines that connect with the U.S. The capacity of the international pipelines currently is largely reserved by Pemex and CFE. There should be more willingness by Pemex and CFE to share capacity opportunities in those pipelines.
The U.S. is a market with excess in natural gas. If there isn’t an option to move the natural gas through the existing pipelines, the producers aren’t going to stop and will construct new infrastructure to send their natural gas to Mexico, which is the best option for them in terms of price.
So, there still are barriers to entry. Sooner or later, this problem will need to be resolved so that Pemex and CFE begin to offer capacity on the international pipelines so that independent companies won’t seek other options such as their own infrastructure to supply natural gas to Mexico.
NGI: In your opinion, what are the top priorities for the Mexican natural gas industry, and what are the biggest challenges currently?
Salazar: I think the priority should be to resolve the problems with the pipelines that are stopped and continue to be offline. We have estimated that there is an important economic impact on the country due to the lack of availability of natural gas. The pipelines that are stalled are fundamental for the CFE, for the country and for the industry and the sooner those problems are resolved, the better. That should be the immediate short-term priority.
The priority for the mid-term should be to expand and grow out the interconnection and storage infrastructure available. I think that is likely to be a result of the consultations being carried out by Cenagas and it will be understood that there are steps that need to be taken to improve connectivity.
Another priority for the mid to long-term would be to incentivize natural gas production, particularly in the south. The south has two options: either we create far more infrastructure to bring in more natural gas from the north, or we incentivize national production. If there was a different fiscal regime offered for natural gas production, it could be more of an economically rational option for the country. It doesn’t make sense that oil and natural gas in Mexico are subjected to the same fiscal regime, which is something that was discussed during the Energy Reform.
On the side of obstacles, well, it is important to continue to advance with what has been created and not take backwards steps. We need to continue to consolidate what has been advancing and continue working to move forward in some of the areas I mentioned versus slowing this progress.