The classic image of Mexico’s role in the world of energy imagines the country as a supplier of crude oil to the U.S. — and nothing more. That image, which was accurate for decades, is now drastically out of date.

Since moving to privatize its energy industry in 2013, Mexico has become heavily dependent on supplies of energy from the U.S., particularly natural gas and gasoline. According to the U.S. Energy Information Administration (EIA), last year U.S. gasoline exports accounted for 80% of all Mexican gasoline imports, growing as a share of total Mexican gasoline consumption from 30% to more than 50% since 2014. In 2015 and 2016, the value of U.S. energy exports to Mexico, including rapidly growing volumes of both petroleum products and natural gas, exceeded the value of U.S. energy imports from Mexico, as volumes of Mexican crude oil exports to the United States have continued to decline. In 2016, the value of U.S. energy exports to Mexico was $20.2 billion, while the value of U.S. energy imports from Mexico was $8.7 billion, according to the EIA.

Given such realities, if the Trump administration pulls out of the North American Free Trade Agreement (NAFTA) — or initiates border taxes or other trade measures that restrict Mexican exports of energy to the U.S. — how much impact will such measures have on the North American economy? (U.S.-Mexico trade in energy is covered by NAFTA.) If such policies did come to pass, Mexico could opt to retaliate by preventing U.S. energy firms from investing in the emerging bonanza in the Mexican energy sector. The Trump administration could wind up effectively shooting itself in the foot, observers say, despite the high-profile role played by energy sector advocates such as former Texas Gov. Rick Perry, who is now Secretary of Energy.

Opening Mexico’s Energy Sector

“Mexico has completed a dramatic, broad-based opening of its energy sector, to the point where it is open to all foreign investment across the board,” says Kirk Sherr, president of Clearview Strategy Group, a Virginia-based energy consultancy. Based on the latest annual data from the U.S. Census, energy accounted for about 9% of all U.S. exports to Mexico and 3% of all U.S. imports from Mexico in 2016. “The reality is that we still import crude from Mexico but it is balanced by a lot of crude we send to them in order to make their refineries run optimally,” Sherr explains.

Lured by Mexico’s energy reform program, “so many of the investments [into Mexico’s energy sector] are coming from the United States,” Sherr adds. Nowadays, “all across the board, American firms have substantial investment plans, not just in natural gas distribution but also power generation, pipelines and downstream firms.” According to Sherr, the opening of the Mexican energy sector has been so broad and so deep, it’s completely transformed the opportunities for U.S. and international companies. “Whereas before, you had to pick and choose what areas to go into, now it’s all open,” he notes. “So from a relatively thin menu of areas to invest in a few years ago, now the menu is quite long in terms of what you, as an energy company, can go to Mexico and do.”

The completion of pipelines built in 2016 combined with others to be completed in 2017 has significantly boosted U.S. natural gas exports at a time of very low gas prices in the United States, helping to keep Mexican manufacturing plants competitive. Going forward, there will be a third wave of U.S. exports, Sherr says, particularly related to natural gas liquids such as propane, methane and ethane. Because the final rollout has been relatively recent in investment terms — the past 18 months — companies are still digesting and deciding on their investment strategies, both within the sector and by geography, adds Sherr. “By 2018, you are going to see lots and lots of [other] investments announced. [Already], Mexico is second only to Canada in energy trade with the United States.”

A U.S. policy that “inhibits exports of natural gas to Mexico could result in fewer coal jobs in the U.S.”–Erik Gilje

The Impact of the Shale Boom

Most notably, the shale boom in the U.S. has made American natural gas extremely attractive for Mexico, which depends on it for nearly 60% of its total electricity generation, a 20% increase from 2005. In 2015, Mexico imported 1052 billion cubic feet (BCF) in natural gas from the United States, an increase of nearly 300% over five years. The EIA recently estimated that between 2016 and 2020, around 60% of Mexico’s electricity additions will come from natural gas. The agency predicts that this demand will be met mostly through imports, as it will take several years before Mexico is able to increase domestic gas production, which has fallen off since the 1990s, according to the BP Statistical Review.

“The U.S. has a significant excess of supply of natural gas, and there is a growing effort to find homes for that natural gas,” Wharton finance professor Erik Gilje says. “You see some of it displacing coal in the U.S. Some of it beginning to be exported elsewhere in the world, outside of North America.” The challenge, he adds, is that to export natural gas to other parts of the world it needs to be liquefied, transported and re-gasified. “That process is very costly and requires huge fixed investments [and] lots of years of lead time. And so to the extent that Mexico is a potential outlet for some of this excess gas, it would certainly be very beneficial to the United States to be able to access that market in an efficient way.”

Thus, at a time when the Trump administration is threatening to restrict exports to Mexico, there is a clear irony, say many observers. Exporting U.S. natural gas to Mexico is lowering electricity costs for Mexican-based utilities — and manufacturers — because natural gas is a cheaper fuel than coal. This, in turn, makes Mexico-based plants more cost-competitive against U.S. manufacturers, and potentially more alluring for some U.S. firms that might want to relocate there. However, President Trump has vowed to take various means — not yet entirely clear — to discourage U.S. manufacturing firms from relocating to Mexico.

“The wind is at the back of the U.S. energy sector in Mexico now.”–Kirk Sherr

Gilje says that, nevertheless, “there is no other foreign alternative” apart from Mexico when it comes to “finding a home” for excess U.S. gas. Certainly, not Canada, which is already exporting its gas to the United States. “Really, the only other place for this [gas] to go is to displace coal [in the U.S.] Somewhat paradoxically, it could be the case that a policy that inhibits exports of natural gas to Mexico could result in fewer coal jobs in the U.S. because that domestic gas will be cheaper and will displace coal.” In such a case, one pillar of Trump’s economic agenda — to “bring back” jobs to the U.S. coal industry — would be thwarted by another pillar — discouraging U.S. firms from relocating to Mexico and elsewhere.

“Cross-border tensions raise many ironies in terms of U.S. politics at the moment,” notes Patrick Schaefer, executive director of the Hunt Institute for Global Competitiveness at the University of Texas El Paso. “One of Texas’s main consumers of energy is Mexico, which then uses that cheap natural gas to lower the cost of goods that are sent to the U.S. market at a much more competitive price.”

Billions in Lost Opportunities?  

U.S. firms are not the only foreign players with a major interest in Mexico’s reformed energy sector. Nicolas Borda, Mexico City-based partner at the Haynes and Boone law firm, notes that Mexico now has “probably around $90 billions of investment commitments,” including firms in the U.S. but also companies “from China, France, the U.K., Canada, Japan, Germany and Australia.” Second, Borda adds, “It is important to realize that after all these years of energy constitutional reform — passed in Mexico in 2013 — a lot of things have happened. We’ve seen a lot of progress by the federal Mexican government in terms of the legal framework, regulations, guidelines, technical standards” and so forth.

In July, announcements are expected concerning awardees in the next round of auctions, including financial transmission rights (FTRs) that will allow market participants to offset potential losses related to the price risk of delivering energy to the grid. (FTRs are a financial contract entitling the FTR holder to a stream of revenues or charges based on the day-ahead hourly congestion price difference across an energy path.)

Upstream, the big winners of last year’s deepwater offshore auction were Exxon and Chevron, but it won’t be until near the end of 2017 that any significant funds are mobilized toward performance based on those auctions.  Notes Sherr, “The auctions will give them rights to drill and produce oil in those areas. But before they can do that, they’ll need to do seismic work and other studies and that help them decide where to drill. By late 2018 or early 2019, a number of wells will be drilled in those areas they identify.”

At the height of the market in 2014, an offshore market cost about $100 million for deepwater, which is where most of this crude oil is located, Sherr says. But the price has come down significantly with the collapse of offshore rig prices and the general decline in services prices based on slack demand. For example, if 10 or 15 wells were drilled as a result of the auctions, that would mean at least a billion in new investments, he adds.

“If the U.S. has second thoughts, other countries are going to take advantage of those opportunities.”–Nicolas Borda

When it comes to oil services, that also means lots of new business for the giant firms such as Schlumberger, Halliburton, and Weatherford. “The U.S. has the universities that crank out the petroleum engineers  —  mechanical engineers to develop the products for the oil and gas industry,” Sherr says. “We have a lot of the centers for the innovation of the equipment that employs those engineers; we have a lot of the leading seismic companies for upstream. And for both the services side and operators’ side, we have the desire to invest in upstream support and development.”

But what if the Trump administration takes measures to restrict U.S. investment in Mexico, either as one step in a trade war against Mexico or in response to Mexican retaliation for the U.S. building a border wall? Borda says he is “very bullish” about the Mexican energy sector’s ability to develop the major projects on its wish list, even if some U.S. firms step away from giant opportunities. “Fortunately, China, France, Japan, the U.K., Canada, Australia and many other countries are going to eat the pie that the U.S. doesn’t want to eat,” Borda says. “If the U.S. has second thoughts, other countries are going to take advantage of those opportunities.”

A Learning Curve for Regulators

Apart from uncertainties about U.S. trade policy, Mexico faces other significant challenges. According to Borda, these include regulatory challenges, namely, “how the different agencies of the Mexican government interact with each other. This will be a learning curve.” For onshore projects, there will be various security, environmental and real estate issues, in certain parts of the country. “Like what is happening with the Dakota Access Pipeline [in the U.S.], infrastructure is going through certain areas of Mexico where you have communities that are not in favor of certain projects,” Borda says. “Where pipelines go under rivers or lakes, there are fears of polluting the waters or other environmental impacts. Social issues are [also] scattered around the country; often in small towns and in ejidos; [i.e.,] communal lands used for agriculture, on which community members individually farm designated parcels.”

Another area where energy trade has grown in importance is electricity generation. Billions of dollars of investment are going into the natural gas pipeline sector to feed the co-generation plants that are coming on line in Mexico. Schaefer explains: “Mexico has now opened up its electrical generation sector to foreign or independent power producers. Now there’s an amazing opportunity for U.S. investors to get in there to produce electricity at a much-reduced rate, compared to what it is currently being produced by Mexico’s Federal Electricity Commission (CFE), the government-owned electric utility.”

Once again, however, U.S. protectionism could thwart such plans. “If trade [between the U.S. and Mexico] is disrupted, there will be no need to continue to invest in these co-generation plants,” said Schaefer. “Or, with those co-generation plants that have already been built, there will be decreased ability to pay those off. Furthermore, you’ll just have less demand for natural gas, which would hurt U.S. interests. The energy trade and the opportunities with it … are so trade-dependent.”

“Energy needs to be competitive if manufacturing and industry are going to be competitive in Mexico.”–Patrick Schaefer

Added Benefits

Mexico’s membership in NAFTA has played a positive role in moving these reforms forward, notes Schaefer. “As time has gone on, and as trade has increased exponentially between the U.S., Canada and Mexico, so have the needs to refurnish, revamp, retool and reform the Mexican energy sector. Because of NAFTA and liberalized trade policies, you had the necessity to liberalize other sectors in Mexico” and in this case, energy. That’s because “energy needs to be competitive if manufacturing and industry are going to be competitive in Mexico. So the liberalization of that sector in the last couple of years has been a direct knock-on benefit to the U.S. in general, but to Texas, in particular, with its energy resources and its ability to engage in trade in the energy sector.”

However, recent cross-border tensions fostered by the Texas state government’s support of the Trump administration’s hard line on trade issues “raise many ironies in terms of U.S. politics at the moment,” says Schaefer. “One of Texas’ main consumers of energy is Mexico, which then uses that cheap natural gas to lower the cost of goods that are sent to the U.S. market at a much more competitive price.”

Moreover, there is an amazing amount of industrial activity on the northern Mexico border, again because of NAFTA, Schaefer explains. “There are huge industrial centers that could be even more competitive with cheaper electricity rates. So there is an opportunity for cross-border electricity trade between the U.S. and Mexico that would really spur economic development in places like far West Texas, New Mexico and Arizona.”