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Mexico relies on US as oil supply falls and gas demand rises

As its oil production keeps falling, Mexico is turning to natural gas to diversify its energy supply and fuel economic growth. Increasingly, it is relying on booming US supplies to do the job

According to the World Bank, Mexico's economy grew at an impressive 3.9% in 2012 and is on track to post growth of 3.5% in 2013. Yet 52 million people - almost half of the population - live in poverty. Another 11.7m, or 10%, live in "extreme" poverty, earning less than $76 per month.

President Enrique Peña Nieto  took office in December 2012 promising to increase living standards. But falling oil production, historically the mainstay of the country's export revenues, is threatening his ambition. In 2010, oil accounted for 14% of export earnings and 32% of government revenues, according to the Mexican central bank.

Rising crude prices have offered some relief. The value of Mexican oil exports to the US has doubled in the past eight years, to $35.7bn in 2012. But the export and production data tell a different story. Oil output has fallen to 2.5m barrels a day (b/d) from a peak of 3.4m b/d in 2004.

Crude exports to the US have fallen by a third, to 970,000 barrels per day (b/d) in 2012 from 1.48m b/d in 2004, the first time since 1994 that annual shipments to the US have fallen below 1m b/d. The country's share of total US oil imports has plummeted, too, from 16% a decade ago to 11% in 2012, according to the Energy Information Administration (EIA).

Production of heavy oil from the Cantarell and Ku-Maloob-Zaap offshore oilfields - which supply grades favoured by US Gulf Coast refineries - fell 46% or 1.1m b/d from 2004 to 2012. This was partially offset by a 200,000 b/d increase of light oil in the same period, but the trend is well established by now.

The question facing policy makers is whether the country can afford to maintain a nationalist energy stance.

Mexico nationalised its oil industry in 1938 and its constitution continues to prohibit foreign ownership in the strategically vital oil and gas sector. In 2008 Mexico's congress passed limited energy sector reforms in a bid to address declining production and attract much needed foreign technical expertise, but the efforts failed.

Pemex, the state oil company, retains ownership of all crude oil produced in the country, but has entered into partnerships with foreign companies through multiple services contracts. But major international oil companies have stayed away.

Nieto aims to introduce further reforms in September aimed at increasing private investment. But this is sure to run into opposition from those opposed to opening the country's energy sector. However, if Mexico's energy sector continues down the path it is on the country risks becoming a net oil importer by the end of the decade.

This is already the case in natural gas. Mexican imports of US gas have increased 92% since 2008 as production has fallen by 15% and demand has risen sharply. Mexico now imports 2bn cubic feet a day from the US, or 3% of Lower 48 production.

At least six new pipelines have been proposed from southern US unconventional gasfields like the Eagle Ford to meet surging demand in Mexico. Imports could reach 7bn cf/d, or 10% of US gas production, by the end of the decade.

On 5 May, US pipeline operator El Paso announced long-term agreements to extend its Wilcox lateral from Arizona, adding 185m cf/d of incremental capacity for Pemex Gas and Mexican de Cobre, one of the world's largest copper producers.

The US drilling boom couldn't have come at a better time for gas-starved Mexico.

Mexico's proved gas reserves have fallen to 17 trillion cf from more than 60 trillion cf a decade ago, largely as a result of under-investment in the upstream. In the same period, Mexico's gas consumption has risen 160%, to 2.36 trillion cf per year, or 6.5bn cf/d, driven by fuel switching in the electricity sector. In 2000, gas supplied a fifth of Mexican power generation. By 2007, this had risen to half.

Consequently, Mexican gas imports have doubled since 2003, to 767bn cf per year. It will keep growing: plans are afoot to add 28 gigawatts of new generating capacity, most of it to be fuelled by gas. Mexico's energy secretariat forecasts that gas demand will grow at a rate of more than 3% annually through 2016.

In June, Gdf Suez Mexico and GE Financial unveiled plans to extend the Mayakan pipeline to the Yucatan Peninsula, adding an incremental 300 million cf/d of supply under a contract with Mexican power producer CFE.

But it's not just pipelines that have seen growth. In 2012 the country completed the $900 million Manzanillo liquefied natural gas import terminal, a partnership of Pemex, South Korea's Kogas, Mitsubishi and Samsung on the Pacific coast. Full capacity of 3.8m tonnes per year is expected online later this year.

At this point, it makes sense for Mexico to import cheap US gas to fuel its economic growth. But the surge in demand is expected to increase North American natural gas prices. Henry Hub futures have inched higher in recent months to more than $4 per million British thermal units (Btu), although lower demand in the summer eased levels back to $3.63 on 17 July.

Longer term rises in prices will eventually force Mexico to decide whether it wants to depend on foreign supplies or open its upstream to investors that could unlock more domestic energy.

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