U.S., CANADIAN PIPELINES, PRODUCERS LINING UP TO MEET MEXICAN GAS DEMAND GROWTH

A.D. Koen
Gulf Coast News Editor

Prospects for continued strong growth in Mexican demand for natural gas imports have U.S. and Canadian producers and pipelines queuing up to serve expected demand.

In 1991, more than 25 U.S. companies exported a combined 61.7 bcf of gas into Mexico, an increase of more than 390% from 1990's total of 15.7 bcf.

According to the Department of Energy Office of Fuels Programs (OFP), about 27.5 bcf of gas left the U.S. for Mexico in fourth quarter 1991 alone, an average 299 MMcfd.

DOE has granted short term authorization to more than 65 companies to export gas into Mexico. Another 23 companies have short term export applications pending.

CAUSE OF DEMAND GROWTH

Officials in Mexico and the U.S. say electric power plant grassroots construction and fuel switching projects and growing industrialization will continue pushing gas demand up in Mexico's northern tier of states, where the maquiladora industries are mushrooming in response to special regional trade and tariff incentives.

Mexico's sudden interest in importing U.S. gas is providing a glimmer of hope for producers beset by low prices in glutted gas markets to the north. And it has prompted a spate of proposals to expand pipeline capacity across the U.S.-Mexico border.

At yearend 1991, DOE estimated combined capacity at four U.S. pipeline export points into Mexico at about 500 MMcfd. If all export pipeline expansions and new construction being considered in the U.S. are built, as much as 1.5 bcfd of capacity will be added by 1995. And pipeline officials say export capacities will continue growing.

Many observers say Mexico's demand for U.S. gas likely will continue to increase if the recent economic growth spurt in the Mexican economy continues as expected. Some projections call for economic growth of 4%/year, assuming the government continues to follow current fiscal policies. In that economic environment, Mexican officials expect demand for electric power to increase by 5%/year through 2000.

GAS TRADE PATTERNS

A healthy Mexican economy and conclusion of the North American Free Trade Agreement (Nafta) with the U.S. and Canada is expected to encourage expansion of electric power generating capacity and increased industrial activity in Mexico's northern states.

Manufacturing and industrial activity is expected to continue growing throughout Mexico. But the maquiladora industries of northern Mexico especially are well situated to reap short term benefits from surplus supplies of low cost U.S. gas.

Some Canadian companies also see long term opportunities to sell gas to Mexico.

After the turn of the century, however, some analysts say the flow of gas could turn around.

DOE's Energy Information Administration predicts U.S. gas production will peak during the first decade of the 21st Century. Sometime during the decade, EIA says, the U.S. again will become a net importer of Mexican gas, with volumes reaching 90 bcf/year by 2010.

However, that scenario is by no means assured. Much will depend on the rate at which Mexico's demand for gas increases. Also, Mexico would have to place new emphasis on developing its potentially substantial gas reserves, and so far there are no indications of such plans.

MEXICO'S GAS POTENTIAL

In the meantime, the only supply available to compete with U.S.-Canadian gas for emerging markets in northern Mexico is associated gas from oil fields in Central and South Mexico.

Much of that gas already is providing 80-85% of the feedstock for Mexican petrochemical operations. Any increased -as production in the south likely will be used to back out other fuels to combat severe pollution in the Mexico City area and other industrial centers.

Because of budget constraints, Mexico's state owned oil company, Petroleos Mexicanos (Pemex), appears unable to significantly increase exploration and production spending for oil, let alone to mount an E&P program focused on gas. Without an infusion of private investment capital, Pemex also appears unable to finance construction of large diameter pipelines needed to move large volumes of gas to markets in northern Mexico and the U.S.

By allowing Petroleos Mexicanos International (PMI), Pemex's external marketing unit, to purchase imported gas at prices based on U.S. spot markets, the government of Mexican President Carlos Salinas de Gortari can minimize petroleum industry investment. Also, importing low cost gas softens the effect of reduced domestic subsidies for hydrocarbon products under Mexico's new fiscal austerity regime.

As a result, the short term outlook for increasing gas exports to Mexico likely will be limited only by the ability of U.S. producers and pipelines to strike sales and transportation deals with Pemex and a lack of pipeline distribution capacity in Mexico's northern tier of provinces.

EXPORT CAPACITY

According to OFP, four U.S. companies in 1991 had pipeline export points for gas, three in Texas and one in Arizona.

Deliveries on Texas Eastern Transmission Corp.'s (Tetco) export pipeline from McAllen, Tex., to Reynosa, Tamaulipas state, peaked in late 1991 at 320 MMcfd. From September through December 1991, Tetco deliveries at the export point averaged 270 MMcfd, by far the largest volume of U.S. gas entering Mexico.

Throughout 1991, 25 shippers moved gas into Mexico on Tetco's export pipeline. Valero Natural Gas Partners L.P. in 1990 was Tetco's largest shipper. Last year, Valero was one of the largest but not the largest, Tetco said.

According to DOE, Valero in 1991 also exported about 2 MMcfd of gas into Mexico on a Valero Transmission Co. pipeline at Eagle Pass, Tex. DOE estimated capacity of the Eagle Pass export line at 4 MMcfd.

PMI in 1991 said gas demand on Tetco's pipeline might increase to 400 MMcfd. But Tetco says the 30 in. line can handle only 350 MMcfd unless more gas is made available in South Texas.

Between Feb. 15-Mar. 15, 1992, companies using Tetco's pipeline to sell gas to Pemex dropped interruptible deliveries, reportedly because of a need to work off surplus fuel oil supplies, leaving firm throughput of 150 MMcfd.

At the end of March 1992, Tetco deliveries into Mexico had rebounded to about 200 MMcfd.

PMI officials said much of the gas moving into Mexico on Tetco's export pipeline is firing industrial boilers at Monterrey. Mexican officials have suggested demand in fall 1992 at Tetco's border crossing could increase to 500 MMcfd.

In late November 1991, El Paso Natural Gas Co. began moving about 30 MMcfd of gas into Mexico at Cuidad Juarez, Chihuahua state, through a 1 mile link owned and operated by Western Gas Interstate Co. (WGI), Austin. The gas is fueling one of two boilers at an electric generating plant at Samalayuca, Chihuahua, operated by Comision Federal de Electricidad, Mexico's electricity generation and distribution agency.

At the end of March 1992, gas deliveries had grown to about 40 MMcfd.

DOE estimates maximum throughput of WGI's interconnect at 90 MMcfd. But Chuck Wilson, WGI's executive vice-president, said line capacity could increase to 170 MMcfd if Pemex pipelines could handle added line pressure.

"Right now, because of mechanical restrictions, we can only run about 100 MMcfd," Wilson said.

With repowering of the second unit at Samalayuca, gas deliveries through WGI's export pipeline are expected to increase to about 70 MMcfd.

Also in 1991, El Paso exported 15-20 MMcfd of gas into Mexico on a pipeline that delivered gas to the border near Naco, Ariz. The supply fuels a copper refining operation near Cananea and a Ford Motor Co. assembly plant south of Hermosillo, both in Sonora state.

El Paso puts capacity of Naco-Cananea pipeline at about 25 MMcfd.

PIPELINE EXPANSIONS

Sometime in summer 1992, U.S. export pipeline capacity at Reynosa is expected to increase by 400 MMcfd, then jump by another 600 MMcfd by yearend.

By 1995, about 300 MMcfd of export pipeline capacity will be added at Yuma, Ariz., to serve customers in Baja California Norte and 100-130 MMcfd at El Paso to serve expanded power generation capacity in Chihuahua state. Capacity at both export points is expected to expand after 1995 as demand increases.

Valero officials expect by the end of April 1992 to receive permits to lay 3.5 miles of 24 in. pipeline from an existing Valero line near Penitas, Tex., to interconnect with a 42 in. Pemex pipeline near Reynosa.

Valero expects to have the 400 MMcfd link in service within 2 months after all regulatory approvals are received. Cost of the line is estimated at $4 million.

The new pipeline will be an open access transporter, and Valero expects to have some capacity available to other shippers. Placing Valero's export pipeline in service likely will free up capacity on Tetco's pipeline at McAllen.

Enron Corp. also has asked FERC for permission to link the pipeline system of its Houston Pipe Line Co. HPL to Pemex's 42 in. line at Reynosa.

Plans tentatively call for Enron to lay about 22 miles of 36 in. pipeline to the U.S.-Mexico border and to lay about 1,000 ft of 36 in. under the Rio Grande River for the final interconnect.

With timely FERC approvals, Enron says HPL could begin moving gas into Mexico during fourth quarter 1992.

In addition, El Paso is planning to install two new crossing points into Mexico for U.S. gas:

A 300 MMcfd export pipeline from a lateral from the company's southern system near Yuma, Ariz., about 12 miles from the U.S.-Mexico border. The extension will deliver gas into a pipeline system in Baja California Norte to be installed as part of the Tri-National Power Project.
A 100 MMcfd export pipeline at El Paso for a new gas fired, 700,000 kw power plant to be built at Samalayuca.

TRI-NATIONAL PROJECT

The Tri-National project is being planned by a group of companies led by Nova Corp. of Alberta, Calgary.

The project involves repowering and expanding capacity of an electric power plant at Rosarito. Under the current plan the project also would introduce gas service throughout Baja California Norte, tentatively including Tijuana, Tecate, and Mexicali.

Design of the Tri-National project has not been finalized, so El Paso has not settled on details of the Yuma extension, said Randy Wu, El Paso vice-president of new project development. But the key design criteria is to match capacity of the Tri-National pipeline.

Wu said Tri-National companies expect gas demand to ramp up quickly in Baja. El Paso will be ready to move 300 MMcfd to the border by 1995, about half to the Rosarito plant. El Paso's design capacity will be expandable after 1995 to at least 500 MMcfd, he said.

Tri-National currently anticipates laying a 30 in. pipeline roughly parallel to the U.S. border to connect the power plant at Rosarito with El Paso's Yuma extension.

Wu said the final design of the Yuma extension also depends on where El Paso system gas will come from.

"Will it come from San Juan basin, from Waha, from an interconnect with another pipeline, or a combination of all three?" Wu asked. "Right now, I would say a lot of the gas for Baja will come from San Juan basin. But that's not something in our control.

"It really depends on what deals are struck between producers, the Rosarito plant developers, and other users in Baja California."

In addition to the gas supply introduced to Baja California by El Paso's Yuma extension, San Diego Gas & Electric and Southern California Gas Co. have proposed two plans that would deliver surplus gas in California into the Tijuana area.

Under the more ambitious option, as much as 500 MMcfd of gas could be available from SDG&E and SoCalGas pipeline systems 3 years after an agreement is signed (OGJ, Feb. 10, p. 26).

SAMALAYUCA DEMAND

In addition to an estimated 70 MMcfd of demand at Samalayuca after both existing boilers are switched to gas, Wu said demand of about 105 MMcfd is expected for the new power plant.

Gas flows to all three units could reach 200 MMcfd, he said. "At that point, it becomes economic to build a dedicated lateral off El Paso's system to the border and a new pipeline in Mexico running roughly 25 miles directly to Samalyuca power plant."

Wu said the added export capacity to Samalayuca is needed because volumes are flowing through WGI's line at El Paso-Juarez on an interruptible basis.

"Those facilities are being used today because they're there," he said. "But the expansion project at Samalayuca will want firm service.

"So while we can use interruptible capacity now to flow gas, I don't think we should jump to the conclusion that because WGI has 170 MMcfd of capacity, Salamayuca will always be able to get that gas."

If manufacturing and industrial activity at Juarez continue to grow-as appears likely if and when the U.S., Canada, and Mexico sign Nafta-gas delivered on WGI's interconnect likely will be consumed in Juarez, Wu said.

"When El Paso builds a pipeline that can serve Salamayuca directly, WGI's existing facility can be used for the purpose it was built originally: gas service to Juarez," he said.

In addition, Wu said added electric capacity and gas supplies in Chihuahua likely will spur unannounced manufacturing and industrial development. The Nafta also will encourage industrial growth there, but that already is happening even though a trade agreement is not in place, he said.

"If you're going to install a 700,000 kw electric plant there, obviously there is going to be growth there, such as new industrial uses in Chihuahua state that could use gas," Wu said. "Once the new pipeline is in, it is easy to see there will be other uses."

In addition, Wu said the company expects to add capacity on its Naco, Ariz., export pipeline as demand increases after the turn of the century from new manufacturing and industrial customers in Sonora. However, the need for gas in those secondary markets is not as urgent as in Baja California and other northern Mexican states, he said.

MEXICO'S GAS ECONOMICS

The pace at which Mexico's gas demand has been increasing has focused new interest on Mexico's gas sector.

Significant uncertainty persists about how soon Pemex gas production can overtake runaway consumption.

In a study of Mexico's gas economics for the University of Houston's Center for Public Policy, William A. Johnson, Jofree Corp., Houston, and UH's Michelle Michot Foss concluded, "The politically expedient view in Mexico is that U.S. gas imports are satisfying only short term needs."

Central to Mexico's gas importing strategy, they said, are current low prices of U.S. gas relative to fuel oil. The relationship between gas and fuel oil prices is important because a significant part of future gas demand will be driven by Mexico's efforts to improve air quality. With the sulfur content of Pemex produced fuel oil averaging about 4%, displacement by gas will provide large environmental gains.

Considering the depressing effect on U.S. gas prices of federal tax credits for unconventional gas production, Foss and Johnson suggested the window of opportunity for U.S. gas exports to Mexico could extend through 2002.

They said other important variables affecting Mexico's ability to compete with U.S. and Canadian gas supplies include:

Mexico's ability to raise capital for developing gas reserves and building transmission infrastructure.
Location of Mexico's gas reserves and pipeline capacity relative to regional demand.
Characteristics of Mexico's gas resource base.
U.S. gas market dynamics.
Outcome of Nafta negotiations.

Mexico's reserves/production ratio is 35-55 years-depending on whether undeveloped Chicontepec basin gas reserves estimated 26.7 tcf are included. The reserves/production ratio of U.S. gas is slightly more than 9 years.

As a result, Foss and Johnson said, "Over the long term, the dynamics of U.S. gas markets are such that natural gas flow from Mexico to the U.S. should be reversed."

THE 'SLEEPING GIANT'

In a study by the gas exports division of the oil and gas branch of Canada's Department of Energy, Mines, and Resources, analyst John Foran concluded Mexico will offer a short to medium term incremental gas market.

"But planning for the longer term cannot ignore the natural gas potential of Mexico," Foran said.

Foran aptly described Mexico's gas sector as essentially a byproduct of Pemex's focus on developing oil reserves and in its infancy compared with gas development in the U.S. and Canada.

Because Mexico has some gas reserves near North American gas markets and a pipeline infrastructure, Foran said, the country should be considered a "sleeping giant" and a source of long term, backstop supply.

Foran said the reason for Mexico's weak presence in North American gas markets is lack of capital and E&P activity.

In 1989, Mexico drilled 71 oil and/or gas wells compared with 4,106 oil and gas wells in Canada, he said. According to American Petroleum Institute, 20,831 oil and gas wells were drilled in 1989 in the U.S.

Foran noted Pemex has assured U.S. gas suppliers it intends neither to increase drilling for gas in its northern states nor to increase the northbound deliveries of gas from fields in the south.

Mexico's plan to modernize the national energy sector places a heavy emphasis on gas. Foran said Mexico intends to increase production while increasing gas use in high priority activities and reducing Pemex's use of gas as a fuel.

Since Mexico's constitution denies Pemex access to private Mexican or foreign equity financing for E&P activity, Pemex must meet capital needs entirely with debt or internal cash flow. As a result, Foran said Pemex plans to float bond issues to help finance $20 billion of exploration and development activity the next 5 years.

Despite the capital constraints, if North American gas prices rise enough, Foran said Mexico could have incentive to increase gas production enough to penetrate export markets.

However, Mexico will have to change its attitude toward gas for Pemex to become a major player in North American gas markets, he said.

IMPORT-EXPORT BALANCE

As Mexico has increased gas imports, Pemex's net revenues have been affected.

"In 1988, Pemex imported 6.3 MMcfd of gas at a cost of about $8 million," Foss and Johnson said. "With the increase of imports to 45.6 MMcfd in 1989, Mexico's gas import bill jumped to $36.6 million."

By now, with Mexico's gas import volumes four times higher than in 1989, the cost is surely much higher. But as long as low priced U.S. gas exports are available, Pemex has little incentive to move gas from the south to maquiladora manufacturing operations in the northern states.

Although Mexico's gas reserves are thought to be large, it is uncertain whether increasing investment on gas-focused E&P will enable Mexico to again become a significant net exporter of gas. Even at the peak in 1981 of 288 MMcfd, Foss and Johnson pointed out, Mexico's gas exports reached only 6-7% of the country's total gas production. By comparison, Canada's net gas exports to the U.S. in 1990 surpassed 1.5 tcf.

Mexico's gas production peaked in 1982 at 1.55 tcf, increasing from 1.295 tcf in 1980 and 665 bcf in 1970. Production fell to 1.252 tcf in 1986, recovering in 1990 to 1.333 tcf.

Foss and Johnson said Mexico achieved higher gas production in the late 1970s and early 1980s by increasing expenditures on gathering and transport transportation. The country also gradually reduced gas flaring to less than 3% of production in 1989 from 26% in 1970. Conversely, Mexico's falling gas output through 1986 stems from decreased drilling in the 1980s resulting from drastic cuts in Pemex E&P spending.

However, Mexico's relatively flat gas production since 1982 has not been the major factor contributing to its shift from a net gas exporting to importing country. Rather, efforts to rebuild and expand Mexico's petrochemical industry and heightened environmental concern have increased domestic gas consumption.

For those reasons, gas consumption in Mexico is projected to continue increasing. How quickly and by how much are subject to much debate.

Foss and Johnson estimated gas accounts for 80-85% of Mexico's petrochemical and chemical industries feedstocks. Pemex petrochemical production increased to 17.7 million tons in 1990 from 12.7 million tons in 1986. At the same time, Pemex increased the proportion of petrochemicals exported to 64% from 56%.

Although Pemex is a net exporter of petrochemicals, Mexico's imports have increased to 229 million tons in 1990 from 34 million tons in 1988, Foss and Johnson said.

The distribution of Mexico's gas reserves will heavily influence the country's long term ability to resume exporting gas.

Foss and Johnson pointed out that wells in southern Mexico account for 87% of Mexico's gas production. In addition, 73.7% of Mexico's gas reserves-excluding Chicontepec-are in southeastern and offshore areas and only about 16% in the northeast in close proximity to the U.S.

LONG TERM SUPPLIES

For an hint of how long PMI might be importing gas-if the price is right-Wu cites time spans of contracts sought by consumers in northern Mexico.

"Mexico's power plants are looking for 20 year contracts," Wu said. "If we were to ask what is the longest timeframe in which people in Mexico expect to be importing gas from the U.S., those 20 year supply contracts would be a good indicator."

Wu said efforts by Mexican gas customers to secure 20 year supply contracts are powerful indicators because the decision to build a power plant revolves around assuring a reliable fuel supply.

With potential gas customers in northern Mexico seeking 20 year supplies of gas from the U.S., Wu said it also appears Mexico won't be ready in the near term to increase pipeline capacity to the north.

"It would be one thing if the power plants being planned could bum other fuels or if Mexico was planning to dedicate its own gas reserves to fueling those power plants," Wu said. "But the situation developing is a number of power plants are going to be built close to the border and will be fed with gas from the U.S. and potentially Canada."

"A power generator doesn't want to build a plant that runs on gas for 10 years, then find out in year 11 that the gas is no longer available."

However quickly and to what extent gas markets develop in northern Mexico, Wu said adequate U.S. gas export pipeline capacity and supplies will be available.

On the other hand, neither are U.S. gas markets likely to run short of supply because of excessive exports to Mexico.

"Gas will be available from many sources," Wu said. "Mexico can get gas from the U.S. or Canada, the U.S. can get gas from Mexico.

"The one scenario I don't see is Canada receiving gas from Mexico. Given the reserves and loads Canada has, it always will be in an export situation. Whether the U.S. relies long term mostly on its own supplies or Mexico relies mostly on its own supplies, market dynamics could go in a lot of different ways."