Editor’s Note: NGI’s Mexico Gas Price Index, a leader tracking Mexico’s 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 25th Q&A in the series is with John B. McNeece III, senior fellow for Energy & Trade at the Center for US-Mexican Studies at the University of California, San Diego (UCSD), where he has been since 2017. McNeece researches and writes about U.S.-Mexico energy issues, particularly pertaining to natural gas and renewable energy, as well as U.S.-Mexico trade issues.

Previously, McNeece was senior counsel at the Pillsbury Winthrop Shaw Pittman law firm, where his practice focused on renewable energy and international business transactions, primarily in Mexico. His work in Mexico included representation of U.S. investors and companies acquiring or developing Mexican energy projects.  At Pillsbury, McNeece was a member of the Latin America, Energy and Corporate & Securities practices.

McNeece’s work in Mexico extends back to the North American Free Trade Agreement (NAFTA) negotiations, where he served as an adviser on issues of Mexican law to the United States Trade Representative negotiating team for NAFTA Chapter Nineteen: Review and Dispute Settlement in Antidumping/Countervailing Duty Matters.

He received his juris doctorate from the University of California, Berkeley School of Law, and his undergraduate degree from Stanford University.

NGI: Mexican President López Obrador made a lot of changes to the national energy industry in his first year in office. What is your opinion on some of the energy policy decisions made during the first year of the López Obrador administration?

McNeece: President López Obrador has shown himself to be very skeptical of the energy reform. Although he has not canceled the roughly 110 oil and gas E&P contracts already awarded, he has made it clear that he doesn’t intend to permit future bidding for contracts.  Further, he is not willing, so far, to allow Pemex, the state-owned oil company, to enter into farmouts. I think this is going to make it very difficult for Mexico to increase production of oil and gas. The decision to prohibit fracking also hobbles natural gas production.

López Obrador wants to limit private sector participation in the energy sector and strengthen the state-owned enterprises Pemex and CFE, the state electricity provider.  But the problem in my view is that Mexico does not have the resources to carry out a state-based strategy. Overall, I think López Obrador is being consistent with his ideological leanings as a nationalist, but it is doubtful, in my view, whether Mexico can substantially increase production of oil and natural gas without assistance from the private sector.

Lopez Obrador’s decision to renegotiate the natural gas pipeline contracts was a shock to the private sector that I think really affected investor confidence.  One example: The South Texas to Tuxpan marine pipeline was ready to go, a very important and expensive pipeline with capacity of 2.6 Bcf/day.  But López Obrador said the contracts were unfair and had to be renegotiated.

This hit TC Energy and IEnova and two other pipeline developers hard. Nevertheless, those companies decided to renegotiate rather than make a direct challenge to the government. The renegotiation ended in revised contracts, and López Obrador was able to claim a reduction in payments.  The pipeline companies decided that, considering the payment terms over the full life of the contracts, they could live with the revised terms. But the demand for renegotiation dealt a blow to investor confidence and raised Mexico’s risk profile for the investment community.

On the electricity side, there have been some shocks in that sector as well. First, there was the cancellation of the clean energy auctions for sale of clean energy to CFE. There were also major changes to the rules for the Clean Energy Certificates, known as CELs. There is now a whole series of legal “amparo” [injunction] proceedings against the government challenging revisions to the rules for CELs that were originally established. There are also major issues with proposed changes to the rules for electricity self-supply by the private sector, which would reduce flexibility and negatively affect the economics of that program.  All of these things are chipping away at private sector participation in the electricity sector, which affects investor confidence in the energy industry as a whole.

NGI: We’ve seen the energy regulatory bodies cut a lot of personnel in López Obrador’s first 14 months in office. What are your thoughts on the changes to the regulators?

McNeece:  The two key regulatory bodies are the National Hydrocarbons Commission (CNH), which supervises exploration and production of hydrocarbons and the Energy Regulatory Commission (CRE), which supervises the storage and transport of hydrocarbons, the retail sale of hydrocarbon products, and the generation, transmission and distribution of electricity.

The CNH still has most of its Commissioners from the prior regime and I believe they remain amenable to the energy reform. They are technical, they are engineers, and they know what they’re doing. But they are under close supervision by López Obrador, and he’s the one who sets policy.  López Obrador’s policy is to strengthen Pemex and to reduce the role of the private sector.  Within the CNH, I note that 18 people who were reviewing and implementing E&P contracts from auctions under the prior administration were let go, which raised concerns about the Mexican government’s dealings with the private sector regarding those contracts.

The CRE has seen a wholesale change in the Commissioners, and they are completely aligned with López Obrador’s nationalist perspective.  Moreover, the CRE has lost a great deal of staff.  That weakens the CRE. This, to me, represents a decision to reduce the regulatory restrictions on the state-owned enterprises.

NGI: What is your outlook for Mexico’s energy and natural gas industry this year, as well as the next 2-5 years, particularly following the changes in the sector we saw in López Obrador’s first year?

McNeece: Let’s talk first about natural gas. López Obrador stated in a morning press conference in January that he foresees that Mexico will be dependent on imports for the foreseeable future, and I think that’s right. For some time now, dry gas production has declined year over year, while demand has grown, resulting in increased imports. I don’t see much likelihood of increased production. Instead, I see continued growing natural gas imports, particularly from the U.S.

For the long-term, Mexico has terrific natural gas resources. According to an Energy Information Administration (EIA) report from a few years ago, Mexico has the sixth highest natural gas resources available in the world. That’s huge. A majority of that is non-conventional, so to get at it fracking would be required, but the resources are there should Mexico choose to take the right steps.

As for the energy industry as a whole, I am doubtful that Mexico will be able to become energy independent, which seems to be Lopez Obrador’s goal. Even if there is some increase in production at Pemex and some increase in electricity generation at CFE, it won’t be enough.

Before the energy reform, both Pemex and CFE were falling further and further behind. Pemex production was declining and CFE was not keeping up with the demands of the Mexican economy for generation. Maybe López Obrador can stabilize Pemex and CFE, but I don’t see these state-owned enterprises meeting the real needs of the Mexican economy without very substantial new state resources, which I don’t think are there.  The alternative is a greater role for private investment, both for financial resources and technology, but that is not presently on the agenda.

My view is that López Obrador will change direction only when the facts force him to, i.e. if there are energy shortfalls that directly affect the Mexican people, or more broadly, if the economy continues to stagnate. We saw a small decline in Mexico’s GDP last year and it’s forecast to be stagnant this year.

López Obrador is said to have a pragmatic streak, as well as the ideological streak. I think that’s true. For example, he did ultimately cut a deal on the natural gas pipeline contracts.  But I think he will change direction only when he really has to.

NGI: We’ve watched natural gas imports from the U.S. increase every year. Do you think Mexico will eventually get to a point where it imports 100% of its natural gas needs from the US?

McNeece: Absolutely. In a report published last year, CNH said that if you put aside Pemex’s own consumption of natural gas, 90% of Mexico’s natural gas consumption came from imports in 2019, and almost all of that is from the U.S. We’ve already arrived at a point where Mexico is very dependent on U.S. natural gas.

Veronica Irastorza and I recently published a paper where we discuss Mexico’s natural gas strategy.  One of the points we argue is that Mexico can reasonably rely on U.S. natural gas even with a high level of imports.  We think the risks of relying on U.S natural gas are manageable and that Mexico is well positioned to take advantage of the U.S. natural gas market.

NGI: Do you think Mexico should continue to try to produce its own natural gas, which could be costly and take time, instead of just importing U.S. natural gas that is readily available? Could that be a cheaper option?

McNeece: In our paper, Veronica and I forecast that Mexico will import large amounts of U.S. natural gas for the foreseeable future, since domestic production will not be sufficient to meet demand.  If Mexico is going to use only state resources for exploration and production, then those state resources will not be enough to substantially increase production.  In that case, it makes a lot of sense for PEMEX to put its limited E&P budget primarily towards oil rather than focusing on both oil and gas. Oil has a much higher price than natural gas for the same energy content and is much more profitable. For natural gas, Mexico could rely on the U.S.

The caveats to that are two-fold. One is that imported gas is dry natural gas, which does not have the natural gas liquids that are needed for the petrochemical industry. Mexico has been declining in its petrochemical production, which is a building block of a modern economy. So, Mexico needs some wet natural gas coming out of the ground to get those liquids. Also, as you get further away from the border, there is less and less natural gas available at low prices because of transportation costs from the border.

Now, if you put a lot of emphasis on drilling for oil, you’re going to get associated conventional natural gas. I can’t say if that would be enough, so I don’t think Mexico could abandon natural gas exploration completely. You’re still going to need some natural gas particularly for the south of the country and the petrochemical industry.

Another aspect of Mexico’s natural gas strategy pertains, surprisingly, to renewable energy. Building out more clean energy generation would be a way to reduce dependency on U.S. natural gas.  Currently, more than half of Mexico’s electricity is generated with natural gas. If Mexico shifted more to a clean energy strategy, which was contemplated by the energy reform, they could use less imported natural gas.

NGI: Should Mexico decide not to employ fracking, at least in this administration, do you see that as a missed opportunity considering the resources available?

McNeece: Your question raises complicated issues.  With natural gas prices so incredibly low in the U.S., particularly at the Waha hub, one can make the argument that Mexico can take advantage of those prices and continue to import natural gas while holding on to its own resources for the future. From a public policy point of view within Mexico, it’s not necessarily a bad idea to take advantage of those low U.S. prices for as long as they last. Then, when prices in the U.S. start to go up, Mexico still has its own resources available for potential development.

At the same time, Mexico has these incredible prospective resources that are only available for development with fracking. I think it’s a mixed story. Mexico is clearly missing out on an opportunity by not developing its own resources currently, but considering the low prices in the U.S., there is a strong argument for Mexico to take advantage of that situation as much as possible. 

NGI: What do you see as the biggest strength in the Mexican natural gas industry? What do you see as the biggest challenge?

McNeece: The biggest strength in the Mexican natural gas industry is the country’s enormous prospective resources. Another important strength has been the build out of the domestic natural gas pipeline network. Another strength, in more general terms, has been the shift in electricity production from fuel oil and diesel to natural gas, which has created increased demand for natural gas.

The biggest challenge for Mexico’s natural gas industry is that, without private financial resources and technology, Mexico does not have the resources to take advantage of their production potential.

This brings us back to another advantage that Mexico has.  It is adjacent to the U.S., which has the deepest natural gas market in the world.  This gives Mexico direct access to ample supplies and low prices, providing Mexico with an alternative to the development of its own natural gas resources.