Last week, Javier wrote about the problem of increasing the attractiveness of natural gas, so that Mexico can capitalize on its vast unconventional resources. To summarize, the biggest challenge in the way of increasing natural gas production in Mexico is that the current price of gas in the US, to which Mexican gas is indexed, is not high enough to make gas production a priority for Pemex.
One of the common suggestions for increasing gas production in Mexico, particularly in the unconventional space, is to open the market to private sector players, and hope that the sector will begin to evolve naturally in the same way that, for example, Eagle Ford developed in the US. This should be done, according to commentators, through a contracting method that includes profit, risk and production sharing, which would require a constitutional reform.
This, however, would be a considerable move away from the current framework, under which all hydrocarbon reserves belong to the nation. Although many argue that such a move is inevitable if Mexico wishes to gain access to its complex reservoirs, such as those located in deepwater and locked in shale formations, it may not be easy to convince the majority of the Mexican public and the politicians that represent them in Congress that such a move would be in the best interests of the country.
So what can be done to improve Mexico’s gas production, without introducing a constitutional reform that would allow private sector players to share production gains with Pemex? By definition, any development of shale gas without such a reform would have to take place under the current contracting conditions, meaning that the best deal that companies could get would be under integrated service contracts (ISCs). But in comparison to the contractual opportunities offered in the US, where shale gas fields are located just a few kilometres over the border, Mexico does not look particularly attractive.
If competition is a necessary consequence of not changing the constitution, then we have to consider a landscape where Pemex would have to do the lion’s share of the development of shale gas assets, with private companies only involved in providing technical services to the company for a fixed fee. But this leads us back to our original problem: when Pemex has to prioritize between investment in oil production and gas production, the high oil price means that much of the investment budget will be dedicated to producing crude, which provides a higher rate of return for the NOC than gas at current North American prices.
To increase the attractiveness of gas production, Pemex could consider separating the business unit that deals with it away from the unit that deals with crude production, and make maximizing the production of natural gas the priority of the new unit. Indeed, Pemex would not even have to create a new subsidiary in order to do this – production of natural gas could be moved from Pemex Exploration and Production to Pemex Gas and Basic Petrochemicals.
There are additional moves that could help to smooth this transition and make it workable. For example, Pemex Gas would still need the exploration and development expertise of Pemex E&P, as well as the NOC’s drilling and service units: this could be done by setting up a remuneration scheme, where Pemex Gas pays the relevant subsidiaries for the services it requires. Not only would this system serve to make gas exploration viable, it would also start to make these subsidiaries competitive, as they would be competing for contracts with private sector service providers.
The relationship between the CFE and Pemex Gas could also be improved – with increased production comes the opportunity to sell more gas domestically to Mexico’s state power producer, and the opportunity to negotiate new contracts. There would also be export opportunities, to markets such as Asia where the gas price is much higher than in the North American market.
These changes could bring an important change to the attractiveness of gas production, either conventional or non-conventional, but operational problems are not addressed at all here: Pemex would still need to find the expertise to tap its unconventional resources in a cost-effective manner, and this may still require constitutional change. However, both problems need to be tackled before gas production will start to increase in Mexico.
What do you think about the proposals outlined above? Would they make any noticeable difference to the Mexican gas sector, or is a different type of reform required? Let us know in the comments below.