Hydrocarbon Molecules Know No Borders: The U.S.-Mexico Natural Gas Dilemma

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COMMENTARY

Natural gas traders once spoke of the North American continent as a potential seamless natural gas trading market, where market synergies could be perfected and hydrocarbon molecules could flow freely to the highest-priced market, depending on near-term demand and seasonal price fluctuations. As cost-competitive natural gas supplies flowed from Canada to the northern U.S. border states and the Northeast corridor during cold winter months, U.S. gas producers in the South and Rocky Mountain regions could elect to sell their production to West Coast and Mexican natural gas consumers, depending on price differentials in the marketplace at any given time.

Investment Needed

Over the past few years, as the natural gas production levels at Petroleos Mexicanos (PEMEX) have continued to decline, despite Mexico's vast natural gas reserves, due to the lack of desperately needed capital investments by the government, Mexico has become increasingly dependent on natural gas imports from the U.S. to fuel its power plants.

Dino Barajas

What once seemed to be a natural energy trading block made up of the North American Free Trade Agreement (NAFTA) countries has now become more tremulous as a result of escalating political rhetoric among the trading partners and the recent review by the Mexican government of previously executed pipeline agreements, which had been awarded after numerous public bidding processes that had increased pipeline capacity in key Mexican markets (see "Pipeline Deal Means More U.S. Natural Gas for Mexico Power Plants" at powermag.com). The reexamination of awarded contracts may temper the appetite of private investors in future bidding rounds if Mexico decides to re-approach the private sector to help augment the federal government's national budget for large-scale Mexican infrastructure projects going forward.

Despite the success of the inclusion of private investors, including many from the U.S., Europe, and Asia, in the build-out of Mexico's energy sector over the past 25 years (after the passage of Mexico's energy reforms in 1992), the current investment climate in Mexico has become less certain as the administration of President Andres Manuel Lopez Obrador announced that previously adopted energy reforms and agreements may need to be reassessed for overall market design and alleged irregularities.

Participation from Private Sector

Given the need to attract additional international investment to help address Mexico's near-term infrastructure needs, and the Obrador administration's desire to increase government spending on social programs and education, the likely outcome of the reevaluation of Mexico's recent energy reforms adopted by the previous administration will be a confirmation that private sector participation in the development of Mexico's energy sector is essential. If Mexico is to remain on its current commercial and industrial development trajectory, which has placed it among the top economic engines in Latin America, the administration will need to strike a balance between further private sector penetration into energy markets previously reserved for the government, and populist sentiments that government control over energy development and price-setting would best protect individual energy consumers (particularly lower-income individuals).

The success or failure of new market participants entering the Mexican energy sector will largely depend on the investor's understanding of past deal structures and safeguards developed over the past two decades in a market that has weathered temporary upheavals as it is now experiencing. Given price arbitrage opportunities, whether in the power generation market or natural gas trading market, developers, investors, and natural gas producers will continue to look for creative structures to access the Mexican energy market despite current regulatory and legal uncertainty.

In some cases, U.S. natural gas producers have enlisted the help of local market participants to assume the risk of gas deliveries within Mexico by requiring delivery points at the border and transferring delivery obligations to large Mexican market makers who may be better equipped to navigate the evolving energy regulatory landscape. In the power generation arena, developers have increasingly begun to site prospective projects along the U.S.-Mexico border to "hedge their bets" in hopes that market opportunities on both sides of the border will ultimately prove to be a winning strategy regardless of where policymakers come out.

Ultimately, the energy market, like water, will find its equilibrium level. Demand will drive supply to the necessary markets as pricing signals motivate producers, transporters, and consumers to address a changing-and at times murky-regulatory and political environment. All market participants stand to lose too much to not reach the right result when the political dust settles and policymakers strive to meet the needs of their constituents. a-

-Dino Barajas(dbarajas@akingump.com) is a partner with Akin Gump Strauss Hauer & Feld LLP, specializing in energy, project finance, and private equity transactions. He has worked in the Latin American energy sector for more than 26 years and has been involved in energy transactions of various types, including power plants and gas pipeline development and financings, in Mexico, Brazil, Argentina, Colombia, Chile, Honduras, El Salvador, Guatemala, and Nicaragua.

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