Author: Sebastian Kadamany

November 14, 2018

Top 5 Energy Trends in Mexico

Mexico has become one of the most attractive emerging energy markets in the world. Since 2016, when energy reform was enacted to liberate the state-run power and fuel markets, there are only a handful of places in the world that shine brighter with opportunity for new business. However, opportunity in Mexico comes wrapped with uncertainty and risk. Like in any new market the panorama is always shifting. Market dynamics are subject to improvement and feedback.  The infrastructure that is to be the cornerstone of Mexico’s energy revolution is just now being built. Two years into this Mexican energy revolution there are 5 big trends that will define the near future not only of the Mexican energy market but also the market in the United States:

Renewable energy supply is entering the power market at an accelerated rate.

Although renewable energy projects were by far the biggest winners of the first tenders in Mexico, many of these projects had slow starts. Going from the drawing board to becoming a reality was harder than many expected. Developers run into zoning and interconnection restrictions that they did not anticipate. They were also faced with a maze of bureaucracy, bouncing around the many different (and new) government entities that now regulate the power market.

However, by 2018, many of these projects were able move forward and become realities. Solar energy grew by more than 400% from 2016 to 2017 and continues to grow. Moreover, the Mexican government has established new procedures and is introducing online interfaces so that developers can process their permits all in one place. Developers can now access zoning maps that not only clearly show restricted areas, but also show what areas of the country have the highest potential for renewable energy development. Further growth of the renewable energy sector should happen at a quicker pace. There is optimism that Mexico will be able to meet its goal of sourcing 35% of its energy needs with renewables by 2024, followed by 50% by 2050.

The Energy Market will evolve past its auction/tender centric form.

Currently in Mexico energy market opportunities come from auctions that the CFE puts on periodically. Since 2016 there have been 3 auctions with a 4th auction currently taking place. Although these auctions have been very successful at increasing capacity and reducing the costs for the system, entering the auctions can be a complicated process. The terms for the tenders can favor some technologies over others and even those who win tenders can often face unexpected costs and restrictions as they try to integrate their new projects into the grid.

Semi-governmental institutions are still the only off takers of power. This is not an ideal situation and market players are hungry for other off-takers for the power that they are producing. PPAs and other bilateral contracts are possible under the current framework. However, there are many restrictions and risks that make these avenues of business difficult to execute. For example, it is difficult to get long term financing for PPAs when lenders are still weary of the risk that comes with such a new market. Short term PPAs are hard to sell as the spot market is ripe with volatility and hedges are not widely available.

As the market matures, perceived risk will likely be reduced. The barriers that impede bilateral deals will start to fade and the ability to strike contracts with a variety of off takers will become the norm. This market should evolve to become something similar to what is seen in the United States.

Gas pipelines are coming.

Currently Mexico produces around 2 BCF (Billion Cubic Feet) of Natural Gas every year. About half of that is used by PEMEX, the national petroleum and fuels company, for their own operations and supply. Outside of PEMEX those who are looking to buy fuel are left to fight over that last BCF of fuel.  The United States is seen as the best secondary gas market for Mexico. 

The current gas pipeline system in Mexico is not sufficient to meet current demand. As far back as 2012, Mexico saw long periods of gas shortages that forced the power grid to turn off more efficient gas power plant in favor of oil and diesel burning plants. In 2018 Mexico faces a similar gas shortage that is putting pressure on an emerging power market. Both the government and the private sector are making changes in order to be able to address this lack of pipeline infrastructure. Today, 7.1 GW of new gas-fired generation is under construction and gas imports are expected to grow by 27% in the next twelve months.

Just like the power market was de-regulated in 2016, so was the fuel market in 2017. This spurred an influx of investment into new pipelines. Mexico added 2.7 Bcf/d of new pipeline in 2018, with another 6.9 Bcf/d of pipe currently under construction. These new pipeline projects will start to become operational in 2019 and 2020, increasing pipeline import capacity from 7.5 to 13.5 BCFD in the next 3 years. With more pipeline projects coming, Mexico, should not only get caught up with current demand but also be enough to allow room for future growth. 

Gas storage is needed.

Pipelines are not the only culprit for Mexico’s gas shortage woes. Currently, Mexico only has the capacity to store enough gas to cover 3 days of demand. Mexico wants to expand their storage capacity to accommodate 30 days of demand. Initially this increase in storage will come from refurbishing depleted gas basins and converting them into storage locations.

The tenders for the first storage project, in Veracruz, are scheduled to be auctioned in early 2019, with 3 other locations that have the potential to be refurbished. There will also be opportunity for private companies to build other new storage infrastructure.  There are already 62 new storage projects announced coming from the private sector. Mexico will be poised to have more control over its energy prices and increase stability and energy security for the whole country.

Mexico and the US will face new and interesting energy dynamics.

As a result of the four trends mentioned above, there will be new energy dynamics emerging between the U.S and Mexico over the next 5 years. There will be push and pull effects on prices as demand and supply evolve across the borders. Initially new pipelines will allow U.S natural gas to flow to new consumers who previously were unable to access the fuel. These new pipelines will also facilitate physical contracts and trades within Mexico (physical contracts rarely occur currently because of infrastructure limitations). In general, the new pipelines will allow the gas market to become more liquid, which is favorable for both countries.

By 2022, it is likely that Mexico will have acquired a significant amount of gas storage infrastructure. Mexican demand for U.S gas will be much more stable. Gas price spikes, from which U.S firms profit, will happen less often and in smaller magnitude. In a case of excess supply, the U.S will face much less favorable prices to off-load that excess south of the border. The result could be downward pressure for U.S gas prices. Aided by new pipelines and storage, cross-border arbitrage margins may become slimmer.

By 2024 Mexico should see 35% of its generation come from renewables, likely shifting baseload generation away from natural gas plants. If the drop in demand for gas due to renewables is larger than decreases in gas supply, it is likely that U.S gas prices would face additional downward pressure.  Now that is all good news for buyers of gas, but producers will need to look for other sources of demand if they are to maintain profits.

Could all these changes make it possible that one day power is consistently imported from Mexico into the United States? It seems that may well be in the cards, but only time will tell.

Written by Sebastian KadamanyManager of Latin America at cQuant.io

cQuant.io is an industry-leading provider of cloud-based energy analytics solutions. cQuant’s advanced analytics platform provides sophisticated energy-focused models across a wide range of industry verticals, from renewable energy project development and contract structuring to thermal generation asset analysis, hedge optimization, and exotic derivative valuation. 

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May 16, 2018

Small-Scale LNG in the Caribbean

Natural Gas demand in the Caribbean is growing.  Yet natural gas supply has not caught up to this demand.  There are structural inefficiencies in the market that have prevented demand from being fully met.  These inefficiencies represent a market opportunity.  This article seeks to identify the underlying reason for the lack of natural gas supply as well as some recent developments to address this problem.    

Turning Natural Gas (NG) into Liquified Natural Gas (LNG) is the primary method for international transportation of this commodity.  The advantage of condensing natural gas is that the liquefied state occupies 1/600 of the volume of the gaseous state.  Within the United States and Canada, where there is a broad network of pipelines that transport fuels across the country, natural gas can be easily moved from where it is produced to where it is consumed without worrying about volume. For international demand however, installing pipelines through the ocean is economically unfeasible. NG is transformed into LNG, piped into large ships, and transported to serve international demand. This solution satisfies our large-scale distribution requirements. However, smaller scale demand to regions like the Caribbean remains unmet. 

Global vs Caribbean Market 

LNG exports from the United States to Asia, Europe, and have seen incredible growth in recent years. Based on figures published by the EIA, exports to Asia grew seven-fold from 2016 to 2017 and exports to Europe grew five-fold over the same period.

energy-information-natural-gas-monthly

In Latin America the story is much different from these flourishing LNG global markets. Only Mexico has seen comparable growth in LNG imports, while the remainder of the region has seen little to no increase. The primary issue is one of scale:

  1. The majority of new LNG shipping vessels are of 120,000–140,000 m3 (4,200,000–4,900,000 cu ft), smaller size vessels are not cheaper or easier to fuel, therefore the small shipments are actually more expensive per MMbtu.
  2. Demand is made up of many, small, independent market participants. These dynamics make for reduced buying power and efficiency losses. Efficiency is crucial for a transportation process that is so complex and sensitive to costs.
  3. Some of the participants do not have the credit ratings required to land favorable interest rates. Large contract volumes and contract lengths with take-or-pay conditions create large risk burdens.
  4. Vessel and terminal availability is limited. The current infrastructure is operating at capacity. While commissioning a new ship has to be done up to two years in advance and building new terminals is expensive.

Small Scale Market Developments

Nonetheless, yesterday’s problems may not be tomorrow’s problems. As in any open market, whenever there is an unfulfilled demand, forward-thinking and innovative organizations will figure out how to create more supply. In the case of the Caribbean LNG market, many major energy players are currently looking to invest in the infrastructure needed to increase supply. Wärtsilä, traditionally a Finnish engine and power plant manufacturer, has recently entered the LNG market in the Caribbean looking to facilitate the many stages of distribution. AES is finishing its second LNG storage facility in the Dominican Republic. New terminals are being constructed in Florida by Eagle LNG Partners, while SPEC LNG has built a terminal in Colombia. These terminals can service smaller vessels and expand the shipping capacity of the entire region.

Not only is the infrastructure improving, but other financial barriers may also be improving. Ryan Lawrence, VP of Shell NA LNG, noted at a recent conference that the length and volume of LNG contracts is beginning to decrease. Lawrence presented figures that showed that the length of contracts has already decreased by almost 50% from 2014 to 2017. Credit rating requirements have also loosened up in the last two years. This is significant.  In the past, only market players with great credit and deep pockets were able to procure LNG contracts that typically spanned twelve or more years and involved large volumes. These developments indicate that barriers to market entry are decreasing on both the supply and demand sides, allowing smaller players to enter the LNG market.

Shell-IHS-Markit-Moody-Fitch-Data-cQuant.io

Caribbean LNG Demand is Here to Stay

LNG is coming of age in the Caribbean for the same reasons as throughout the rest of the world. Natural gas burns cleaner than other fossil fuels, thereby pleasing environmentally concerned citizens. Natural Gas is also a better fuel in terms of energy density. At a price of $2.75/MMBtu natural gas produces 365,760 btu of energy, while oil at a price of $74.80/Barrel produces 77,537 btu of energy.

The growth of renewable energy is also increasing natural gas demand. Although, many communities hope to be 100% renewable, the intermittent nature of these energy sources requires that grid operators have quick starting, fast ramping, resources to turn on as the sun sets or wind falters. Often, these flexible generation resources are fueled with natural gas.

Need for Market Analytics

Looking at the graph below, Brent crude oil is projected to go from around $12/MMBtu to $16.25/MMBtu over the next 15 years. During that same time period they estimate that the price of natural gas will go from around $3/MMBtu to $4.10/MMBtu. This makes LNG a more economic option for electricity generation, assuming the required infrastructure is in-place. Does this mean that all thermal asset owners should start investing to convert their assets to run on natural gas? Should new assets be built to be dual fuel from the get go?

The price graph below may make it seem like adapting an asset is a sure bet, but asset owners should carefully consider risk around price projections. What happens if there is another “polar vortex”, like the severe winter storm of 2014, or if snows in Texas again, like it did in 2017? Since the price of natural gas is firmly tied to demand in the United States, events like these can cause spikes in the price of natural gas that could easily make LNG unaffordable.

Global-Oil-Gas-Benchmarks-cQuant.io

In the Caribbean, being mindful of risk around LNG investments will be important. This region is just now seeing the economics turn in their favor, but there are many sources of risk and the margins are still slim. To properly simulate risk, gas prices need to be simulated stochastically. Unlike deterministic models, stochastic models, don’t just evaluate one price path, or maybe a few scenarios. Instead, they give a distribution of prices that capture a large range of market conditions. This will allow those looking to invest to consider returns even in the worst-case scenario. Furthermore, having a stochastic price simulation model can lead to better contracting strategies that hedge against price swings. In short there no business decision will be truly sound unless there is consideration for volatility and uncertainty in commodity prices.

Conclusion

The viability of a robust LNG market comes down to economics. It seems that the economics favor LNG demand growth over the long-term. Small-scale LNG in the Caribbean is starting to take off as well. This cleaner burning fuel is being paired with a new wave of renewable energy and storage.  The result could be a more cost-effective, reliable, environmentally friendly, electricity grid. 

As the present infrastructure issues are solved, the stage is set for LNG to become the fuel of choice in the Caribbean. Although, there are many new opportunities in the LNG market, those that may be considering those opportunities should make sure to do careful, risk aware, analysis first.

Sebastian Kadamany is the Manager of Latin America at cQuant.io, a SaaS energy analytics platform that helps companies understand their physical and financial exposure in today’s energy markets.

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