Mexico's Shale Gas Shift: Sheinbaum Eyes Energy Independence

Recently, President Claudia Sheinbaum opened the door to the possibility of developing shale gas basins in Mexico. This is a significant departure from the position of former President Andrés Manuel Lopez Obrador, who rejected this alternative during his administration.

Around one-third of total 3P oil and gas reserves in Mexico is located in the Tampico-Misantla basin, mostly related to shale resources. Furthermore, prospective shale gas resources are in the order of 141.5 Tcf. 

Mexico has a huge deficit in the production of natural gas. Today, our demand for natural gas amounts to 9,000 million cubic feet per day (mcfd), while domestic production is 2,300 mcfd. Imports from the United States average almost 7,000 mcfd. 

Mexico has the geological potential to supply its entire demand for natural gas. This is not in question. Putting together all the pieces of the shale puzzle is the challenge. Firstly, there are questions about the environmental impact of shale development. These need to be properly socialized, even though I believe there will never be a unanimous opinion on the matter. 

Strengthening the rule of law in the region between Tampico and Misantla is also a condition.

Another important piece of the puzzle is the contractual arrangement. Any oil and gas contract in most of the world contains a fiscal formula that guarantees that economic rent will be successfully transferred to the state, whether the operator is a national oil company or a private operator. The contract must also provide the clauses that give assurance to the investor, public or private, that it will recover its opportunity cost of capital, adjusted for risk. A good contract will result in a virtuous circle, where a higher rate of hydrocarbon recovery will benefit both the operator and the state.

Finally, there is the social issue. Shale development requires intensive drilling, and historically it has brought economic benefits to the communities in the impacted areas. Both the federation and the local governments must collaborate to optimize the social and economic benefits of such an activity. It is crucial for the interests of the local communities and the operators to be aligned.

Three success cases can provide examples to Mexico on what to do and what not to do. 

The United States has become the largest hydrocarbons producer in the world, where 60% of oil production and 75% of natural gas production comes from shale basins. States like Texas, Pennsylvania, and North Dakota have extensively benefitted from shale developments. 

China is by far the largest shale play in the world with 1,100 trillion cubic feet, which represent 56% of its recoverable reserves. For China, the development of its shale resources is crucial, considering it imports 42% of its total demand. 

Being a Latin American country, Argentina might be the most relevant example of a successful shale industry in Vaca Muerta. Shale production in Argentina surpasses 40% of the country´s production that has grown to more than 900,000 barrels per day. Investment is at a level of US$15 billion, and Argentina has turned from being an importer of natural gas to a net exporter of natural gas, with exports to Chile, Brazil, and Uruguay, and soon moving to export LNG to Europe. All this due to the Vaca Muerta basin.

A discussion has been arising in recent days as to whether the “contratos mixtos” are suitable for the development of shale basins in Mexico. The issue is not minor, but it is at the heart of the Mexico shale equation. 

Any contract implemented for shale development has to consider the specificities of shale economics: drilling of a large number of wells, price sensitivity, razor thin margins, capital structures, social interactions, water availability and infrastructure development. The contract will be undeniably immersed in an institutional framework that is part of the Mexican economic and political structure. This is the most important question about whether shale basins can be developed or not in Mexico.

Of the three countries that have developed shale resources, the United States is the only country where the owner of the surface is also the owner of the subsurface. Royalties are paid to the landowner. Shale development in the United States is dispersed among many operators including the major IOCs as well as a handful of medium sized highly specialized shale operators. 

In China, shale development is led by various state controlled corporations, with some private participation. The leading investment effort is provided by SINOPEC and CNPC. 

Argentina is an interesting and relevant case. Investors include companies like Chevron, ExxonMobil, Shell, TotalEnergies, in many cases in association with YPF, and local operators. The provinces share ownership of the resource, and the state provides certain benefits and subsidies to entice investment in the sector. It is relevant to outline that Vaca Muerta started its development under the rule of the left wing Peronist party.  

In Mexico, a key role in this environment will be played by the Law to Promote Investment in Strategic Infrastructure for Development with Wellbeing (Ley para el Fomento de la Inversión en Infraestructura Estratégica para el Desarrollo con Bienestar). This law will provide the framework for the participation of private investment in shale development. Congress has only passed it a few days ago.

A dialogue between the different stakeholders is a necessary condition to achieve an institutional framework that works for all parties involved. The Mexican government and PEMEX must have the flexibility to understand that the model of the recently approved law might require some adjustments to adapt to the needs of the shale industry and all its participants.