The unconventional shales don’t stop at the Rio Grande, but their development largely ends there. And Mexico’s burgeoning energy reforms, designed to increase the nation’s energy production through private investment, still have a ways to go before there’s enough local natural gas to power the country’s growing population and its shift from coal.

Meanwhile, U.S. natural gas production set a record of 24.28 trillion cubic feet (Tcf) last year, according to the U.S. Energy Information Administration (EIA). Advancements in domestic extraction led U.S. gas imports to plunge to a 25-year low and consequently, net imports of natural gas to the U.S. in 2013 fell 14% to 1.3 Tcf—the lowest level since 1989.

And folks south of the border need gas for fuel. Mexico is looking to reduce its reliance on coal-fired power, but it’s done little in the way of producing its own gas—despite an abundance of prospective shale plays.

Long a source of revenue for Mexico’s treasury, the state-owned Petróleos Mexicanos, commonly known as Pemex, was driven to spend its money on producing the product that would generate the most revenue for export, which was crude oil, said Jose Valera, a partner in the Houston office of Mayer Brown, whose practice area includes Mexico.

Mexico’s gas deficit

Consequently, Mexico not only has a deficit of natural gas production, the nation has a huge deficiency in pipelines, transportation, gas processing and oil refining facilities, Valera told Midstream Business.

Increasing demand for gas-fired power generation in Mexico has absorbed some Eagle Ford gas production from Texas. Year-over-year exports grew by 8% in 2013, the EIA has reported.

Proposed pipelines to Mexico equate to more than 4 billion cubic feet per day (Bcf/d), more than doubling total export capacity to Mexico to 9.6 Bcf/d during the next few years.

“All told, these new exports could add as much as 16 Bcf/d to overall U.S. natural gas demand by 2020,” EIA said. “The decline of the long-term futures curve shows the market expects long-term supply growth to more than meet the growth in long-term demand.”

Between 1990 and 2012, gas imports to Mexico from the U.S., mostly Texas, increased from less than 0.1 Bcf/d to 1.7 Bcf/d, Oscar Lopez-Velarde, EY’s (Ernst & Young) Mexico oil and gas tax leader told Midstream Business.

“Furthermore, while production [in Mexico] decreased from 2010 to 2012, consumption increased, which made importations from the U.S. to Mexico more important,” he said.

Mexico’s power need

Population data show that Mexico had an estimated 117.4 million people in 2013, roughly 142 people for every square mile. By 2020, the country’s population could reach 125 million, surpassing Japan and making it the 10th most populated nation in the world, according to “Geo-Mexico: The Geography and Dynamics of Mexico,” a 2010 book by Richard Rhoda and Tony Burton.

As such, Mexico’s need for power will also increase. Natural gas is expected to fill in the gaps, as well as increasingly displace coal-fired power generation.

“Mexico has a huge need for additional natural gas, both at the industrial level and the electric generation sector,” said Valera. “Reforms are going to facilitate the development of additional pipelines and facilities to bring U.S. gas over the border into Mexico and distribute that gas into different areas of Mexico that are not adequately served.”

To be sure, Mexican officials say they welcome private participation in projects that will bring more power to their people.

New pipes

In July, the Comisión Federal de Electricidad, Mexico’s state-owned power company better known as CFE, announced a $2.8 billion tender on five projects designed to ramp up electrical and natural gas infrastructure moving 1.78 Bcf/d.

Enrique Ochoa Reza, director general of Mexico’s Federal Power Commission, said during a summer speech in Mexico City announcing the projects bidding tenders, that the CFE is eager to accelerate economic growth in Mexico and improve its service. The projects were all formulated in the 2014 to 2018 National Infrastructure Program pushed by Mexico’s President, Enrique Peña Nieto. Ochoa Reza said the contracts, all open to private international companies, are expected to be in service by 2017.

The longest line, the 263-mile Encino-La Laguna line, will move gas from South Texas through the northern Mexico states of Chihuahua and Durango to be interconnected to the Ojinaga-El Encino pipelines to supply the central and western regions of the country. The $650 million project is expected to break ground in March 2017.

Another pipeline—slated to cost about $400 million—will stretch across 158 miles in northern Chihuahua to move 350 million cubic feet of gas each day (MMcf/d). Two others will originate at the Waha, Texas, pipeline hub and one from Ehrenberg, Ariz.

Mexico currently imports about 2 Bcf/d of gas a day, Valera said, and that figure will ramp up with immediate needs. But opening the upstream sector to produce more gas will take time.

Valera said the pipeline network in all of Mexico is a small fraction of the size of the network in Texas.

While Texas has more than 100,000 miles of natural gas pipelines, according to the Texas Railroad Commission, Mexico has less than 15,000 miles of pipelines.

Valera explained that Mexico now allows the issuance of permits to private companies to build, own and operate gas and oil pipelines, and those companies aren’t required to team up with a stateowned entity, such as CFE or Pemex.

“What’s going to happen is, the monopoly is going to be broken up, up and down the hydrocarbons chain. So private companies now will be permitted to build, own and operate gas pipelines, oil pipelines, gas processing plants, oil refineries, all the way down to the retailing of gasoline, fuels and natural gas to consumers,” he said. “That’s what, in time, is going to generate a huge amount of activity in this area to fill in the gaps that Mexico has.”

Public notice

But for now, Mexico has three options to fill its gas needs, said Jason Stevens, director of energy equity and credit research at Morningstar Inc. in Chicago.

“[Mexico] can produce a lot more gas. It can import a lot more LNG, or it can build some pipes and import cheaper gas from the States,” Stevens told Midstream Business. “Understandably, it’s choosing option three while putting up a lot of rhetoric about embracing option one, but Mexico is a minimum five years away from some kind of shale renaissance.”

And while Mexico doesn’t have the ability yet to develop its own Eagle Ford, potential producers and pipeline operators are content to send their extra gas down south.

“While most look at [Eagle Ford] as an oil play and appreciate the success of oil and condensate production, it throws off a lot of gas,” Stevens said. “You’ve seen an increased supply there and just south of the border, you’ve got an economy—Mexico—where gas production has been declining at a pretty good clip.”

As John England, vice chairman and U.S. oil and gas leader at Deloitte LLP, told Midstream Business, “The simple equation is we’ve got a lot of gas here, and they’ve got a lot of demand and developing demand in Mexico.”

As such, two key players have emerged on the public side of Mexico’s pipeline activity: Kinder Morgan Energy Partners LP in Houston and Energy Transfer Partners in Dallas.

South from El Paso

In July, Kinder Morgan announced its agreement with CFE for a 21-year contract on the Sierrita Gas Pipeline project near Tucson, Ariz. Set to begin in October, the plan provides about 163,000 dekatherms per day (Dth/d) of firm transportation capacity, ramping up to 200,000 Dth/d by October 2017 and to 550,000 Dth/d by October 2020. The phased-in capacity increases—expected to cost about $529 million—will use existing and expansion capacity on Kinder Morgan’s El Paso Natural Gas Co. system.

The El Paso line is filling its previously under-utilized south line largely with exports to Mexico, and the system will be expanding further within this decade to “beat demand,” Kinder Morgan CEO Richard Kinder said during an earnings conference call with analysts.

“All in all, we see these events and the national statistics, for that matter, as a very positive trend that will drive demand growth at Kinder Morgan in the years to come,” he said.

Transportation will be provided using existing capacity available on El Paso’s North Mainline, along with upgrades to enhance access via the South Mainline. To facilitate the full 550,000 Dth/d, El Paso will loop its Havasu Crossover and install new compression, as well as other modifications to facilitate a west-to-east flow along the South Mainline.

“This firm transportation agreement will help CFE to realize its goal of converting numerous fuel oil-powered generation plants throughout Mexico to natural gas, as well as provide transportation for a number of new gas-fired plants currently under development,” said Mark Kissel, Kinder Morgan’s west region gas pipeline president in a statement.

Kinder told analysts that Pemex is likely to expand its infrastructure in Mexico.

“The real test of that is when they sign up for long-term contracts on our side of the border,” he said, adding that El Paso is well-situated to handle exports to Mexico. “We believe that over the next 10 years, demand will more than double from the present throughput that goes into Mexico today.”

Energy Transfer’s role

The second public company that’s doing big business in Mexico’s underground is Energy Transfer Partners LP. Two of the firm’s subsidiaries—Houston Pipe Line Co. LP and Oasis Pipeline LP—earlier this year signed 15-year agreements with CFE to provide transportation services for 930,000 MMBtu of natural gas per day.

Facilitating those agreements, Energy Transfer will use existing pipeline infrastructure and contract a new 24-inch pipeline near Edinburg, Texas, to a new international border crossing near McAllen, Texas.

The Dallas-based pipeline company will also construct about 51 miles of 36-inch pipe from its Robstown pipeline system in Nueces County, Texas, to its facilities in Live Oak County, Texas. The Edinburg extension and the Nueces crossover are expected to be in service during fourth-quarter 2014 and first-quarter 2015, respectively.

“[Energy Transfer’s] extensive intrastate pipeline system provides CFE with geographical diversity and flexibility in sourcing its natural gas supplies,” Roy Patton, senior vice president of commercial operations at Energy Transfer, said in a statement. “In addition to supporting new pipeline infrastructure, these agreements will generate upstream fee-based revenue for [Energy Transfer’s] existing intrastate pipeline network.”

The private line

Investment banks are also finding ways to break into the Mexican infrastructure market. NET Midstream, a private Houston company, closed in December 2013 on a $665 million project with a syndicate of lenders, led by the Mitsubishi UFJ Financial Group. The project was actually oversubscribed by a multiple of two and received commitments from all invited financial participants.

The company’s affiliate, NET Mexico Pipeline Partners LLC, is building a 120-mile, 42-inch and 48-inch natural gas pipeline system to the international boundary to interconnect on the Mexican side of the border with Phase One of the Los Ramones Pipeline, which is being developed by an affiliate of Gasoductos de Chihuahua S. de R.L. de C.V. Construction began in February, and the network is expected to be in service by the end of the year.

The NET Mexico line is anchored by a 2.1 Bcf/d, 20-year transportation agreement with a Pemex subsidiary. It’s the only pipeline into Mexico that’s been developed or operated by a private firm.

“NET Mexico is the largest capacity cross-border pipeline ever developed between Mexico and the United States—over 2.5 times bigger than the next largest project,” Joe Gutierrez, cofounder of NET Midstream, told Midstream Business. “We will interconnect with nine pipelines and two processing plants with over 4 Bcf/d of receipt capacity at the Agua Dulce Hub. When NET Mexico goes into service later this year, Agua Dulce will quickly become one of the premier, liquid market points in North America.”

Challenges

But NET Midstream’s ability to succeed doesn’t mean it’s been an easy road. Jerry Dearing, also a cofounder at NET Midstream, explained to Midstream Business that any crossborder pipeline comes with a host of challenges.

The project required a presidential permit and approval from the Federal Energy Regulatory Commission, and NET Midstream had to buy 120 miles of right of way from 200 landowners. In addition, the project included boring under the Rio Grande and installing more than 100,000 horsepower of compression.

“All of these things had to be completed on a tight time frame,” Dearing said. “We are proud of the job our team did in meeting these challenges on-time and under budget.”

At EY, Lopez-Velarde said U.S. companies operating in Mexico may also have tax hurdles to overcome to make projects worthwhile. Companies pay a 30% corporate income tax plus a 10% dividend withholding tax, he said.

“In the specific case of natural gas in Mexico, tariffs are determined according to profit margins of contractors and concessions are granted to the company that can provide the best terms. As more competitors exist, tariffs of contractors would have to be more competitive,” he explained.

Home-grown gas

Another important challenge for pipeline companies is that, at some point, the production and extraction of hydrocarbons in Mexico will increase. Transportation systems in Mexico will have to increase dramatically.

“Pipeline companies would need to be prepared to have sufficient infrastructure and resources to effectively carry out demanding construction projects,” Lopez-Velarde said. “Also pipeline companies would need to carefully revise their capital expenditures in Mexico in order to be profitable in the corresponding projects.”

U.S. companies working in the midstream in Mexico have to structure their companies and transactions correctly so that they can be successful in the market, he said.

What’s more, Lopez-Velarde said, there are crucial tax and regulation considerations that U.S. companies must consider when making investments in Mexico; for example, there could be tax consequences for the repatriation of capital to the U.S. or through capital gains.

Shifting landscape

In addition to the regular questions of taxes and financing a business in another country, the energy reforms in Mexico are still in a state of some fluidity, said Deloitte’s England.

“Everything we’ve seen points to some real positives as far as where the energy reform is going, but all the details of those rules haven’t really shaken out yet, and so any time you’re trying to make sometimes multibillion dollar investments against a shifting regulatory landscape, it’s difficult,” England told Midstream Business. As a result, many U.S.-Mexico corporate deals will take some form of a joint venture with one of the state-owned companies, either Pemex or CFE.

Businesses also can’t count on Mexico to be a high-demand gas importer in perpetuity. Some analysts suggest there’s at least as much gas in the Eagle Ford Shale on the Mexican side as there is in Texas. It could make for tricky business forecasting.

“That’s probably part of the uncertainty: How much gas production will grow in Mexico once you start getting external investors and how long will that take? Forecasting is difficult because at this point, people don’t have a great feel for how much gas is there, how much will be produced and how long is it going to take to get that up and running,” he said. “Until that gas production goes up in Mexico, we think there’s going to be substantial demand increase that will really make the case for exports and new pipelines.”

Pipeline repurposing

Still, England noted, it’s fair to say that similar to what pipeline operators have seen in the U.S., pipelines in Mexico could serve multiple purposes and flows.

“Just like we’ve seen the flow of pipelines within the U.S. be reversed as we’ve shifted from historically having most of our production in the Gulf Coast, and now having a lot more on the East Coast, similarly, if you put pipelines in good places, then it can serve a lot of different uses,” he explained. “Because of that, those can be good investments, even if the production profile changes.”

And, England said, Mexico could begin to see the benefits of those sorts of investments as soon as next year. Within a few years, the benefits could be even more pronounced.

“Even though I think it’s going to take a while for some of these things to get going, I think already, there’s a sense from a lot of U.S. companies and international companies that there’s a real investment opportunity in Mexico. That’s already changing the dynamic,” he said. “My biggest hope is the government and the people have some degree of patience with the reform and understand that sometimes these benefits can take a few years, but they can last a very, very long time.”

Deon Daugherty can be reached at ddaugherty@hartenergy.com or 713-260-1065.

Changing Canada’s Landscape

By Deon Daugherty

U.S. production of its own natural gas likely means that Canada’s West Coast production will need to develop new export markets to keep its industry viable, industry insiders say.

Lance Mortlock, a partner in EY’s (Ernst & Young) Canadian oil and Gas practice, told Midstream Business that as U.S. demand for Canadian natural gas continues to decline, a gas glut is developing in eastern Canada.

“We expect U.S. demand for Canadian gas to continue to decline,” Mortlock said. “That means if Canada is to have a viable gas industry, we need to find alternative markets to export to such areas as Asia and Europe.”

One of the major opportunities for energy companies in Canada’s midstream is West Coast LNG, he said. “Right now, there are about 13 proposed projects in [British Columbia]. Some have already received export permits and the expectation is that many more will be approved. All this is to say, there’s a very good chance we’ll end up with LNG in Canada. With that, there are opportunities for U.S. companies that can find ways to build infrastructure to move gas to the West Coast of Canada.”

The U.S. Federal Energy Regulatory Commission (FERC) reported in March that growth in U.S. domestic gas production has displaced imported gas. In 2013, net imports from Canada dropped 1.8% to 5.2 billion cubic feet per day (Bcf/d).

Exports to Canada

A 3.5 Bcf/d increase of Marcellus gas production has shifted gas supplies from the Southeast, the Midcontinent and Canada. In some cases, that abundance of gas has shifted pipeline flows to provide Marcellus gas to the Southeast, the upper Midwest and even across the border into Canada, FERC said.

Last year, supplies in those regions dropped from about 12 Bcf/d in 2008 to less than 6 Bcf/d.

The “mighty Marcellus” is now producing enough gas on an annualized basis to meet the Northeast’s demand for gas, said Morningstar’s Jason Stevens. “Of course, that’s a seasonal demand so there is some ebb and flow there. Not all the gas in the shoulder months can be absorbed, so you’re seeing Marcellus gas desperately seeking markets.”

He explained that historically the Gulf Coast and Canada have supplied gas to the Northeast. Given the new dynamic in the Marcellus, one of the first things to change is that historic need for Canadian gas imports to the Northeast. Instead, that process is reversing and Marcellus gas is moving north to markets in eastern Canada.

Although Canada has its own sources of natural gas, most of them are concentrated on the other side of the country: British Columbia’s and Alberta’s Horn River and Montney basins.

“That gas really needs West Coast LNG exports to become commercialized,” Stevens told Midstream Business.

“On a purely cost basis, you’re not able to land that [Canadian West Coast] gas in the Northeast competitively. Moreover, the cheap local cost of Marcellus and Utica gas, plus a transportation charge, can land that gas at a fairly competitive price into the Toronto and Ontario market. Keep in mind, Canadian natural gas has been declining pretty steadily for the better part of a decade. This is a nice source of gas for them,” he said.

What’s more, EY analysts said in a September report, some companies are divesting their gas assets in Canada.

“Companies are evaluating their portfolios and shedding assets in the face of uncertain natural gas prices, high oil prices, increased North American gas production, reduced demand from the U.S. and market access challenges,” said Barry Munro, EY’s Canadian oil and gas leader, in the report.

Border Pipeline Rights Of Way At Risk

By Caryn Livingston

With the boom in Eagle Ford Shale drilling in South Texas, pipeline rights of way are becoming corridors for entry into the U.S. for Mexican cartels, according to Texas Railroad Commissioner David Porter. In a letter to U.S. Customs and Border Protection Commissioner Gil Kerlikowske, Porter demanded to know what the federal government intends to do about it.

During the last several years, large areas of brush have been cleared within the rights of way for thousands of miles of South Texas pipelines to allow inspectors to conduct mandated inspections. In his letter, Porter quoted Border Patrol agent Robert Fuentes, who in a Bloomberg interview said, “With oil explorers expected to drill tens of thousands of wells in the Eagle Ford over the next decade, smugglers’ travel options will only increase.”

In the same article, Bloomberg quoted oilfield service firm Weatherford International’s claim that Texas Farm Road 755 through the Eagle Ford play, is a “main corridor for drug and human trafficking.”

‘Tragic and gruesome’

Porter shared that worry, writing to Kerlikowske, “There are numerous tragic and gruesome reports of Mexican drug cartels using pipeline rights of ways to transport narcotics and illegal aliens. Many of these reports specifically relate to the Vicksburg Fault Zone, where crude oil is transported by pipeline to Texas refineries.”

In addition to the danger that cartels may pose to pipeline inspectors, oilfield workers and ranchers along the pipelines, Porter claimed that an unsecured border threatens U.S. national security and the economy.

Citing a report that Breitbart called “a leaked intelligence analysis from the Customs and Border Protection,” Porter said that “Non-Hispanic, illegal aliens are taking advantage of the flood of illegal alien children in Texas and as a result, occupying the attention of your agents. These illegal aliens are not just known to be from the Mexican drug cartels but also from nations that sponsor terrorism.”

According to the report, 28 people from Pakistan, 13 Egyptians and four people from Yemen were caught trying to sneak into the U.S. in 2014. Another 211 Pakistanis, 168 Egyptians and 34 Yemenis turned themselves in or were caught trying to sneak through official entry ports. In his letter, Porter called known numbers of attempted infiltrations “shocking.”

Al-Qaeda link?

This sentiment echoes fears expressed by Porter and others that terrorists could sneak into the U.S. by way of its border with Mexico. Porter mentioned in his letter an interview given by a former CIA operations officer on the “Laura Ingraham Show,” where former officer Mike Baker said that given information the CIA had about al-Qaeda’s efforts over years to organize with Mexican cartels, ISIS is likely doing the same.

Porter called that likelihood a “very serious situation.”

The possibility that terrorists might seek to destroy U.S. oil and gas pipeline infrastructure particularly concerns Porter. He cited recent attacks in Egypt and Yemen by terrorists native to those countries to destabilize governments by disrupting oil and gas transportation infrastructure. A Yemeni oil minister told CNN that attacks on major oil pipelines in that country cost it about $1 billion in lost revenue for 2012 and even more in 2013.

“I shudder to think what these terrorists would do to the U.S. when they are willing to do this to their own country,” Porter said in his letter.

Pipeline risks

According to the U.S. Energy Information Administration, energy production and other mining activity made up about 11% of Texas’ economy in 2013. That amount adds up to about 40% of U.S. crude oil and almost 30% of U.S. natural gas. In his letter, Porter said that to produce that amount of energy requires infrastructure including more than 425,000 miles of pipeline, a significant portion of which is in South Texas and the Eagle Ford.

Dozens of Railroad Commission of Texas (RRC) inspectors and field staff in South Texas are put in danger every time they are required in the course of their jobs to work in areas with high cartel activity, Porter added.

In his conclusion, Porter said that dangerous conditions due to the federal government’s failure to secure the U.S./Mexico border is preventing the RRC from fully accomplishing the purpose for which it was created. He asked that Kerlikowske disclose what steps Customs and Border Protection was taking to assure Texas’ pipeline infrastructure would be secured.

When questioned about concerns that midstream operators might have about building pipelines crossing from Mexico into the U.S., Rep. Pete Olson, R-Texas, who serves on the House Energy and Commerce Committee, said that the risks involved are worth the possibility of future energy independence.

In regard to cartels’ use of pipeline rights of way, Olson said: “Countries that don’t have the legal system that America does have some problems with pipelines. That will happen with the cartels for sure in Mexico, and that’s a concern. But the bottom line is—they can’t stop this.”

Olson said that with cooperation between the U.S., Mexico and Canada, North America could become energy independent.

“We have to be concerned, but let’s build those pipelines and get that oil flowing, gas flowing, right here to America and Texas,” he said.

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