There is a big ad campaign underway in Mexico to sell energy reform. Here is one of my favorites, spotted on Revolution Avenue a little bit south of the Barranca del Muerto metro station:
So is it true? Maybe! But probably not.
OK, that’s not satisfying. Let’s take it from the top. Mexico’s natural gas market is dominated by private local distribution monopolies. Pemex is the biggest wholesale player, but it is not the only one. The market, however, is tightly regulated, with prices linked to the import price at the U.S. border. (Specifically, Reynosa and Ciudad Pemex. The latter is actually far from the border, but it has a direct pipeline link. The price does not vary much between them. Click the link, then go to “Precio de venta de primera mano.”
That said, the gas distribution companies do not buy their gas at the reference price. There are serious capacity constraints in the pipeline links with the United States. Moreover, with one exception the pipelines basically stop in the northern states: there is only one small tube down to the industrial heartland.
The result has been that Mexico has begun to import LNG in large quantities, now exceeding a fifth of total imports. Most of those come through the Altamira regasification plant (opened in 2006) with smaller amounts through the Manzanillo facility, which opened last year. There is also a mostly-unused facility in Ensenada (Costa Azul on the below map): LNG imports to Ensenada cannot be efficiently moved to the rest of Mexico, and Baja now gets cheap gas from the United States.
So what’s the problem? The problem is that imported LNG became hella expensive over the past few months. Landed prices at Altamira have shot up from around $4 per Mcf to north of $16. It is hard to see how these increases have effected overall wholesale prices in Mexico, but Pemex is the biggest import player, and it is easy to see how they have affected Pemex. Pemex applied for a permit to import LNG via the United States in October 2012; it began to sell imported gas a few months later. Here is what happened to Pemex’s wholesale costs:
Until late 2012, Pemex’s wholesale cost unsurprisingly paralleled the average U.S. export price. (Figures in dollars per Mcf.) Around late 2012, Pemex started to experience some supply troubles: at times it had to go out and buy gas on the Mexican secondary market, rather than directly from U.S. suppliers. That is when the blue line started to get jumpy. (The secondary market in Mexico is rather opaque; other than the landed cost at Altamira, which is reported by FERC, data is hard to come by.) In May 2013, Pemex started to buy LNG directly (the dotted line shows the percentage of Pemex purchases that come from LNG) ... and behold, that drove the landed price of LNG in Mexico through the roof. It also caused a sustained rise in Pemex’s cost of natural gas: by November, it paid an average of $6.22 per Mcf, at a time when U.S. gas could be bought for $3.29 ... if you could find the pipeline capacity to transport it.
Did the rise in wholesale cost translate into a rise in retail costs? Yes, yes it did ... but not enough. Let’s take Mexico City as an example. Wholesale prices rose (and those are prices at which Pemex sells) ... but by the last few months, the average marginal cost for Pemex to purchase natural gas exceeded the wholesale price.
In fact, it’s much worse. Pemex buys LNG at the margin for $16.40 per Mcf ... rather more than even the retail residential price of gas! Pemex loses money on its last few sales, as do the other wholesalers. The result has been occasional shortages.
So how will energy reform help? Well, in the long-run it will allow for capital to enter looking for shale gas. Mexico has a lot and the current wholesale prices are high enough to encourage exploration and development ... in the absence of land acquisition costs. (E.g., assuming that the government gives out licenses for free.) But that is some years off; the barriers to fracking are real. (And the subject of another post.)
The movement of pipeline authority away from Pemex could speed up pipeline construction, enabling the importation of cheap U.S. gas ... but note two things. First, private companies already can own and operate natural gas pipelines. Reform might get rid of red tape, move up approvals, get them built faster, remove the need for special legislative approval ... but it will still take years to get them built.
Second, the Los Ramones pipeline is already under construction ... but won’t be finished until 2018. Pemex can already partner with foreign companies for pipelines, so I am unclear as to why the CEO of Pemex is so bullish on the new reform’s impact. A secondary market in pipeline capacity will help, but does not seem a magic bullet.
Finally, although Mexico has access to U.S. gas under NAFTA, there are lots of places for recalcitrant American regulators to hold things up. Since exports to Mexico will raise prices in the U.S., the politicians have incentives to let them ... although to be honest, I do not think that this will be a major barrier.
In short, energy reform will help quickly if it speeds up the planning process for pipelines and increases the incentives that investors have to build them: e.g., very high rates. (An outline of the challenges, written by the Mexican CRE, is here.) But the change is not revolutionary (the sector was mostly opened in 1995) and it will take a while.
So if you live in Mexico, get used to high bills and occasional shortages. It will be a while.