Editor’s Note: NGI’s Mexico Gas Price Index, a leader tracking Mexico natural gas market reform, is offering the following column by Eduardo Prud’homme as part of a regular series on understanding this process.
The opinions and positions expressed by Prud’homme do not necessarily reflect the views of NGI’s Mexico Gas Price Index.
Mexican politicians have long insisted that the Isthmus of Tehuantepec, a thin stretch of land that runs 120 miles from coast to coast, should compete with the Panama Canal as a transoceanic economic and transit zone. The isthmus is also symbolic: it serves as the division between North America and Central America, between modern, industrial Mexico and a rural place beset by a stifling lack of investment. Like past presidents, President López Obrador has his own project for the area, one which comes with an unprecedented element: a plan to export liquified natural gas (LNG) to the Asian market.
At the beginning of his administration, the president outlined what he called a program for the development of the Isthmus of Tehuantepec. It includes the modernization of railways, improvements in the ports of Coatzacoalcos and Salina Cruz, renovating roads, and the construction of a new gas pipeline. On the Oaxaca coast, the Salina Cruz refinery, owned by Petroleos Mexicanos (Pemex) would be the principal user of this natural gas. Next would be the LNG project, which would be a floating liquefaction unit to be developed by a private company. The pipeline could also meet demand at ten industrial parks along the isthmus that the president has promised to develop.
During the Peña Nieto government, the project was shaped as a Pemex project to export gas to Central America. Later Cenagas called it a “social pipeline,” or infrastructure that would serve to benefit underserved areas that existed in the Hydrocarbons Law. In this government, both Cenagas and Comision Federal de Electricidad (CFE) have included the project in their prospective investment lists, although the official organization responsible for the project has not been announced. In accordance with the Hydrocarbons Law, Cenagas should be responsible for bidding on these kinds of projects. In fact, the Jaltipan-Salina Cruz pipeline is included in the first Sistrangas expansion plan proposed by Cenagas in 2016 and some consultation works to quantify the incremental demand carried out before 2018.
Beyond the refinery at Salina Cruz, surveys did not show significant additional demand of natural gas in the area. There were some cogeneration projects planned in the same refinery complex, but Pemex canceled that with the liquidation of one of its subsidiaries in 2018. Some initiatives proposed on paper include the construction of a petrochemical plant, a methanol plant, a new distribution zone in the coastal zone around Salina Cruz and vehicle assembly companies. Specifically, the commercial commitments that would support the respective financing mechanisms were non-existent and the expectation of the promoters was to have the leverage of Cenagas for the investment in the pipeline without a firm long-term transportation contract. Not even the creation of the special economic zone of Salina Cruz in 2017 managed to promote new industrial activities with gas consumption.
[Survey Says: NGI editor Christopher Lenton and energy expert and columnist Eduardo Prud’homme dive into the results of NGI’s fifth survey of the Mexican natural gas market. What are active buyers and sellers telling us about what the industry needs? Tune in to NGI’s Hub & Flow podcast to find out.]
It would be a huge surprise if natural gas demand in Oaxaca arises out of nowhere that justifies the construction of a new pipeline. Nor will 10 industrial parks fill the gap. This leaves the LNG project. President López Obrador has mentioned that the idea of exporting gas to Asia will be needed to sell the gas “contracted in excess” by previous governments. This statement suggests that CFE will be the public company in charge of executing its gas plan for the Isthmus.
As I have pointed out previously in this space, during this government CFE has consolidated its position as the dominant agent in the natural gas industry. It has anchored a parallel and redundant network to Sistrangas with routes that exceed the logistical possibilities of Cenagas in many regions. CFE’s demand and ownership of transport contracts allow it to configure the operation of the main flows that transit the Mexican network.
The entry into operation of the Cuxtal facilities in the southeast and the startup of the New Fortress project in Baja California, though small, are achievements that this administration can boast about. There’s also the project with TC Energía for the extension of the marine pipeline which would help alleviate problems of fuel supply for electricity generation in the southeast and in the Yucatan peninsula. But that’s about it in terms of major gas projects. And today, CFE is essentially the executing arm of energy policy regarding natural gas.
The fact that Lopez Obrador has not stopped talking about the industrial corridor on the Isthmus of Tehuantepec has aroused interest from service providers and large-scale construction companies. However, a review of the business model around the new pipeline and the LNG project shows a lack of financial support. CFE hopes that a gas delivery commitment in Salina Cruz is sufficient motivation for an agent or consortium to be in charge of finding an offtaker somewhere in Asia, and to commit to anchor the construction of the pipeline, along with everything else.
For its part, the government, through CFE, will be responsible for the sale of gas to the investor at a delivery point close to Salina Cruz, at a price equivalent to the sum of transportation charges from its source of origin plus the price of the molecule, with a margin in a “take or pay” contract. CFE will act as promoter of the construction of a pipeline with a capacity of 500 MMCf/d from Chinameca, Veracruz to Salina Cruz. Private investors may participate in the development of the pipeline, in an engineering, procurement and construction scheme or even be the operators of the pipeline, but not the ownership of the assets. Once the pipeline is built, it will be handed off to the state through some economic arrangement yet to be defined.
The absence of a contract for the sale of LNG with any client in the Asian market is the main flaw of the scheme. CFE expects that another agent will be in charge of doing the commercial work without clarity in the costs involved. Not all the rates for the routes involved are under the scheme negotiated by CFE with TC Energy Corp. and Enbridge Inc. If the gas comes from Agua Dulce, someone will also have to pay Cenagas to go from Montegrande to Chinameca. The potential entry of other export points in the Pacific that are closer to the sources of production will put the presumed marketer at a disadvantage in their sales efforts. The margins will not be so great or certain as to encourage a long-term commitment.
At first glance, linking commercial work with the development and operation of the new pipeline seems to align incentives: the commercial margin grows as a function of cost reduction in the new pipeline. This is the advantage of vertical integration. The problem lies in the transfer of property to the state.
The first exercise should be to verify if the route from Agua Dulce to Salina Cruz is the most efficient and reliable way of exporting LNG to Asia. The second would be to understand that marketing is a risky activity, whether carried out by a private or a public agency, and that in a business agreement of such a scale CFE cannot set the rules but must negotiate with a strategic partner. The third exercise involves discerning the business objectives of the stated policy. If the government’s intention is economic development, the best it can do is allocate public resources for this purpose and not expect an investor to be in charge of anchoring the social infrastructure – especially after three years of undermining confidence and changing investment rules in the energy sector.
Prud’homme was central to the development of Cenagas, the nation’s natural gas pipeline operator, an entity formed in 2015 as part of the energy reform process. He began his career at national oil company Petróleos Mexicanos (Pemex), worked for 14 years at the Energy Regulatory Commission (CRE), rising to be chief economist, and from July 2015 through February served as the ISO chief officer for Cenagas, where he oversaw the technical, commercial and economic management of the nascent Natural Gas Integrated System (Sistrangas). Based in Mexico City, he is the head of Mexico energy consultancy Gadex.
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