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 14th Q&A in the series is with Dr. Lourdes Melgar, Mexico energy program director for the international development company DAI, where she manages the implementation of the Prosperity Fund to provide training and certification for workers and small to midsize companies in the energy industry. Melgar is also a research affiliate at the Massachusetts Institute of Technology (MIT) and a fellow at the Baker Institute Center for Energy Studies (CES) at Rice University in Houston.
Previously, Melgar was the Deputy Minister of Hydrocarbons at the Mexican Energy Ministry from 2014-2016, where she oversaw the implementation of the country’s energy reform. She also served as the Deputy Minister of Electricity at the Energy Ministry from 2012-2014. Dr. Melgar also was also a member of Mexico´s Foreign Service, holding different positions from 1993-2007, and has studied, researched and taught at several universities and institutes in the United States and Mexico.
Dr. Melgar holds a Ph.D in Political Science from MIT and a Bachelor’s degree in International Relations and Romance Literatures from Mount Holyoke College.
NGI: What is your opinion on the agreements signed by the Comisión Federal de Electricidad (CFE) with the private natural gas companies?
Melgar: This agreement is great news for Mexico. These disputes should never have taken place since the contracts were issued by CFE, the bidding was conducted by CFE and the terms of the contract were established by CFE. It was going to be a lost cause for Mexico. Our government’s record is terrible at winning international arbitration. Moreover, this arbitration would have had a high cost beyond the legal disputes.
The government made a big announcement that the agreement is going to represent significant savings for Mexico of around $4.5 billion dollars. The truth of the matter is that, what they did was to extend the period of the contracts and establish tariffs at nominal prices. Over time, we are going to end up paying the same amount or more likely a little bit more. Most people are not looking at that because it was more important to give a win to the President so that we could move on.
That said, we paid a price in terms of confidence in Mexico as a place for investment and in terms of how much the Mexican government is really going to respect existing contracts. I think we paid a price in our relationship with the United States and in particular with the state of Texas. Fortunately, we will now be able to move on, I think. And I hope.
NGI: Do you know what the modifications to the contract terms actually entail?
Melgar: The conclusions we have reached are based on the information CFE has provided thus far. The contracts have not been made public and I doubt they will be. As we say, “the devil is in the details” and it is unlikely we will know them.
People close to the negotiations mentioned that CFE wanted to change some of the clauses for force majeure. Apparently, they were unable to change those clauses. Maybe they were made a little more flexible, but it seems CFE might not have been able to get what it really wanted, otherwise, it would have made a big announcement.
When the CEO of CFE, Manuel Bartlett, says these contracts are unfair, in part it is because force majeure clauses are really favorable to the companies and entail a heavy cost for CFE. And that’s one of the points where future contracts should be carefully crafted.
Not all pipelines and not all contracts are exactly the same. Not all circumstances are ever the same. In some cases, for example with the pipeline in Sonora, there are only nine kilometers left to be built. Only one of the Yaqui communities, Loma de Bacum, was against the pipeline. CFE had to pay the company for force majeure because they were not able to complete the construction of the pipeline. In that case, I think the company feels confident for blaming the government for not doing what was needed to get an agreement with the community. But I also think that this situation could have been avoided earlier, even during the consultation process with the Yaqui communities. It was evident that there was going to be a problem there. The company didn’t want to change the route of the pipeline, as a result, there has been a heavy cost for everybody involved, but mostly for CFE.
The government and companies need to work to reach agreements at the local level prior to building these pipelines and not have to pay force majeure for any kind of social issue.
NGI: What signal do these agreements send to the investor community and other companies that might be looking to work in the natural gas industry and energy sector in Mexico?
Melgar: I think this is one of those stories that needs to be told in detail by journalists, analysts and people who really understand the industry to explain how positive this sign is and what it means.
When you see something like CFE saying that they are going to take these contracts to international arbitration, the signal that it sends to the investing community and to the business community in general, is negative. These contracts were designed, auctioned and signed by CFE. For a new administration to some in and say ‘these contracts are terrible’ and threaten arbitration is rather awkward. It really sends a deeply negative signal.
If you put that in the context of the president’s decision to postpone oil contract bids, clean energy tenders, and cancel auctions for transmission lines, which basically means stopping the development of renewable projects, it adds to an already negative panorama.
But now, what you see and hear is that the president was key in reaching the agreement and that both the government and companies presented the same narrative: that these agreements are good for Mexico. Everybody involved came out of the negotiations apparently happy and no one claimed victory. I think that is positive.
That same week, we see the picture of President López Obrador with the CEO of Eni SpA, who gave him as a present a container with first-oil produced out of their shallow water field in Mexico. For López Obrador, symbols are fundamental to him. This picture was taken in the Presidential palace, with the CEO of Eni and the President, celebrating the result of a contract from oil auction round 1.2. It’s a very powerful picture. The President is acknowledging that a foreign company is producing oil.
This was followed by a mention in the Financial Times, citing a high level official, that the government was reconsidering Pemex’s farmouts for next year. Of course, we haven’t heard anything about it, but the government is starting to send some different messages. I think the message is that, when the agreement of the pipelines was reached, what we saw is that the group within the administration that has a more pro-business and pro-energy reform position won over those that have a more nationalistic, orthodox position, which is the position that Bartlett represents.
NGI: In regard to signals, there’s not a more powerful businessman in Mexico than Carlos Slim. To present the agreements and have Carlos Slim speak, it does seem like a signal to the world that López Obrador can be pro-business, even though his stance hasn’t always presented as that.
Melgar: That reminds me of another thing that happened in the same week. Mr. Slim also visited Energy Secretary Rocío Nahle at the Energy Ministry and they also published a picture. That was another message and the caption with the picture says they talked about projects. You’re not going to talk about projects with Slim unless you’re talking about business opportunities. Slim’s company Carso is present in the energy sector both in upstream and mid and downstream. So, that was another sign of a similar message being sent to the industry.
NGI: Do you think that other companies that have contracts from the previous administration are breathing a sigh of relief that their contracts won’t be modified, or do you think there is still a feeling of uncertainty?
Melgar: My guess is that people are breathing much easier now. But, we can’t overlook what actually happened.
This is completely my interpretation, and of course my interpretation may be wrong, but this is how I read things: The same week that Bartlett came up with this idea to take the contracts to international arbitration, President Trump imposed tariffs on Mexican steel.
That was something that Mexicans had not seen coming. We were abruptly put anew into the same bag as China. For me, it was a clear signal to let Mexico know that, if you’re going to play hardball with me, I’m going to play hardball with you. It came as no surprise that high level talks took place that same week between U.S. officials and the Minister of Foreign Affairs and officials from the Economy Ministry.
The signal from Trump was “don’t mess with us,” particularly during a time that the USMCA/T-MEC treaty is yet to be ratified. That position was reiterated by the Governor of Texas, Greg Abbott. And also by the Prime Minister of Canada, as one of the companies threatened with arbitration was TC Energía.
This is an instance where it seemed the government wasn’t anticipating the consequence of its actions. Its geographic location grants Mexico access to the cheapest natural gas in the world. This window of opportunity might not last long. As we speak, Texas doesn’t have many other options to unload its abundant natural gas, one of the best options is to sell it to Mexico. This window of opportunity is beginning to close and, I don’t think this is something that has been properly explained to the current administration.
President López Obrador probably got all of this information during the weeks following the announcement of possible arbitration when the companies were lobbying and negotiating with the Mexican government and economic ministries. I imagine them saying: “Hey, take a proper look at what could happen if we do this.” If Mexico closes the valve to natural gas from Texas flowing to Mexico, we also create an economic crisis in Texas. We have seen prices of natural gas at Waha at -$4.00 and at times even lower. They are actually giving you natural gas to keep shale operations active.
I think nobody thought about the depth of the possible international impact. Either Bartlett was truly Machiavellian in his political move, or he didn’t fully understand what the implications of arbitration were or the effect it could have on Texas, a key Republican state that has been supporting the ratification of the T-MEC treaty. I am convinced that López Obrador did not want to put the ratification of the treaty at risk.
There is a lesson here: things are really interconnected.
I also think López Obrador is beginning to listen to other people. The fact that he met and had his picture taken with the CEO of Eni, that’s not just a picture, there was a conversation there. I am sure he’s having conversations with Slim, and other businesspeople who are saying to him, “Mr. President, we want you to succeed” and asking him, “How can we help you to succeed?” To do so, we need an energy sector that works.
NGI: While you were at the Energy Ministry, you oversaw the expansion and growth of the natural gas pipeline network and market in Mexico. What are your thoughts on the development of Mexico’s natural gas market in recent years and what do you think about the development of the market over the next few years?
Melgar: What was achieved in the past administration is really significant. From 2011 on we had critical alerts for natural gas that lasted through 2013. The development of the natural gas pipelines was key to ensure that we had the natural gas, not only for CFE, but for industry as well.
Mexico increased its pipeline infrastructure by 66%. It has access to the cheapest natural gas in the world. Mexico could currently be producing cheaper electricity and be competitive in terms of electricity rates and natural gas, particularly once all the pipelines enter into operation.
I am a firm believer that Mexico will get a lot out of going through this stage where we use natural gas for generating electricity and for industry. I think it’s a better bet for our future than burning fuel oil and is certainly a much better option than burning coal.
Mexico needs to continue advancing in its energy transition. First, because it makes economic sense in the energy sector and more importantly because of climate change considerations. So, boosting renewables and using natural gas particularly for industry and for relaunching our petrochemical industry, will be important.
That being said, we do have a problem in that we have this huge dependency on the United States. This has to do with the fact that Mexico isn’t producing enough natural gas. We have plenty of natural gas, both in conventional fields and unconventional fields. I was just looking at some numbers this morning about how over the past three months we have significantly increased methane burning in the atmosphere as part of oil production, which is absolutely unacceptable in terms of climate change, and is also absurd in economic terms.
This has been an issue with Pemex for a long time. Pemex sees itself as an oil producing company, not as a gas producing company. Producing oil is economically much more profitable than producing natural gas. I think López Obrador could make a significant contribution to our energy security by creating a company that’s focused solely on development of natural gas.
There is the whole debate in Mexico over whether or not we should develop unconventional resources. I have my reservations about doing that in Mexico, but I think at least we should have a good pilot project where we could follow the best regulation in terms of how to do it in a sustainable manner and how to manage the issue of water and the environmental impact it can have.
I think it would be important in terms of moving towards more of what the President calls “energy sovereignty” to produce our own natural gas. I also think it would create jobs because we know that unconventional resources have been a real booster of economic development in the areas where it has succeeded. A pilot project for unconventional natural gas development is something that should be considered.
The other thing is that I think needs to be considered is that, as I mentioned, there is this window of opportunity that I think we really need to take advantage of in terms of getting cheap natural gas from the United States. If we continue to send conflicting signals, producers of natural gas in the U.S. will soon be able to start selling their natural gas to Europe and to Asia. They are beginning to now, but they will be able to begin doing so in full force by 2022 to 2024.
If they turned their back on us, we could have a serious problem. So, it’s important to have this discussion about natural gas also as part of the conversation with the U.S. in terms of how to bring development to southern Mexico, and to Central America.