La reforma energética y tu vida: edición 3, La revolución de shale gas tardará mucho en llegar a México

Right now, everyone in the oil and gas industry is waiting to see what the enabling legislation coming out of Mexico is going to look like. 

Nonetheless, it is going to take a very long time for unconventional gas production to take off south of the border. A very long time.

Consider the problems. First and foremost, American natural gas is incredibly cheap. In fact, at $4.70 per MMBTU it’s trading a hair below the median marginal cost of production. According to Ken Medlock, the head of Rice University’s Baker Institute Center for Energy Studies, “Some wells are profitable at $2.65 per thousand cubic feet, others need $8.10…the median is $4.85.”

That is a hell of a lot of competition for Mexican frackers to match.* It is going to be very hard for them to get their drilling costs down to the American level. In part that is because it is going to be tough to get rigs, considering how many are currently employed in the United States. Then they will need to hire service companies like Halliburton ... which will charge a premium to operate in Mexico, even absent security concerns. Merlin Cochran writes that costs will exceed the U.S. in the range of 30%-40%.

If Mexico’s shale plays were in the center or south of the country, that might not be a problem. After all, gas is rather more expensive in Mexico. But as Merlin Cochran points out here, most of Mexico’s shale plays are in the north. That means pipelines will be needed to transport the stuff. Problem is, those same pipelines can be used to transport cheap American gas to the center of the country.

Moreover, as Cochran goes on to say, fracking uses a lot of water. Northern Mexico is not rich in water.  If I may translate his words: “To put it in perspective, the Alliance Against Fracking states that between 9 and 29 million liters are required to fracture a single well. The math becomes alarming when we multiply these numbers by 27,000, which is the number of wells that will be needed. Where will all this water come from, or rather, from whom is it going to be taken?”

Now, there are U.S. companies working on reusing frack water. In much of the U.S., recycling saves money. But that will probably not be the case in Mexico, since disposal wells are pretty abundant in the northeast of the country. Either there will be a big battle over water, or costs in Mexico will go higher.

Finally, there are two last problems: community opposition and organized crime. (Cochran discusses both here.) In America, upstream companies pay private landowners high royalty rates that average around 18.75%. (Rates on state public lands, which set the benchmark for private contracts, can be found on page 3 here.) High private royalties automatically create a local interest group in favor of drilling. In Mexico, however, the federal government owns all subsoil rights. That means unless some sort of side deal is struck, drilling is all cost and no benefit for local communities.

And then there are the Zetas. In 2009, the Zetas in Veracruz made more money from stolen oil than they did from moving narcotics. Mining companies in Mexico are already using aircraft to move products and personnel in order to avoid holdup. (Research idea: how costly is crime for the mining sector?) In iron mining, the Knights Templar appear to have already sunk deep roots: iron mining goes on, but some unspecified proportion of the revenue goes to the Knights.

Either organized crime will keep fracking from happening or it will raise costs, unless the federal government creates safe zones. Which it can do ... but which will at the very least slow investment and make it harder to get the service companies to operate.

In short, the reform means that Mexico will produce shale gas. But I will be amazed if it does so in any serious quantity before 2020.

UPDATE: Duncan Wood reports that Jesús Reyes Heroles just said in Houston that Mexico could become a net natural gas exporter in the medium term. I suppose if you use “medium term” to mean five to ten years, I agree with him. With one caveat: in five years, no way, ain’t gonna happen, even if some shale production starts by then. In ten years, by 2024, then Mexico will likely be self-sufficient, although I would bet on net exports heading south on pipelines to Central America, not out in LNG and certainly not northwards.

CAVEAT #1: If natural gas prices rise above $6 (my students can attest that I am on record in predicting that they will go above $5 on a sustained basis in the near future) then unconventional gas will come on-line much faster. I want to get that out there: I have made downside predictions about the price of gas but I am not making any upside ones.

CAVEAT #2: Associated gas! I have not mentioned tight oil. The economics are very different. Watch this space.

 * I am aware that Americans in the industry are quite passionate in their belief that “frac” should never be spelled with a “k,” even when conjugated as a verb. I hate to be politically incorrect, but I simply can’t bring myself to do that. Apologies.

Comments

[Federico]

Very interesting post, and I believe most Mexicans would tend to agree (though SENER won't publicly say so). Now the tight and deepwater oil part would be even more interesting...

[shah8]

Wouldn't the most important aspect of shale gas be to support domestic industry and expanding electric generation? I'd think that when it comes to natural gas, exporting is probably not a reasonable expectation (speaking without one whit of knowledge of what Mexico generates and what it consumes).

Ah, reading that update closer, it seems you may agree...

[Jose Arredondo]

The Energy Reform it´s important for México because it breaks away from old oil nationalism and it will open opportunities that otherwise would have never been there.
However, ¿does it really matter that much for a country whose income from auto exports double it´s oil exports´s income? More than 85% of Mexico´s exports are manufactured goods and the country keeps opening factories to produce more cars (this week Honda opened a plant, Audi´s opening another one, BMW is considering opening one, etc), but also aerospace industries are settling here too, and not to mention the country´s already a leading producer of televisions, microwave ovens, refrigerators and the like.

In my opinion, the state is continually reforming the tax code to move from depending on oil revenues to fiscal revenues from an expanding industrial base.

Chapo Guzman has just been arrested, Zeta´s leadership was also taken down by Calderon´s war on drugs, along with many other cartel leaders and there are new police forces with more training and fire power being trained in many states, specially border states, so the state is moving in to retake power we once lost to cartels. Mexico´s changing, I don´t see everything in a positive light, but I do believe the country´s moving and changing, sometimes slowly, but building better institutional frameworks to cope with the challenges we face.

In the end, I agree with you, it´s likely that Mexico won´t see any benefits from shale deposits, but at the same time, the country´s industry stands to benefit from an efficient shale gas and oil industry across the border, already pipelines are under construction in Los Ramones and in Sonora to take advantage of cheap gas prices, a quarter of what Mexico is already paying for to bring it from Peru and other nations.

Great post by the way.

[Noel Maurer]

Thank you! I read about Chapo this morning. It's interesting; I should probably write something.

You're right that both past administrations have pushed big fiscal reforms through Congress ... but Mexico still depends on oil for a third of its tax revenue. That isn't going to change radically in the near future.

In other words, I agree that energy reform is only important in terms of tax revenue ... but for the next decade or so that revenue will still be vital.