We have been advising investors for a couple of years that the long-term outlook for the natural gas market was quite bullish, based on a number of strong, sustainable demand-side drivers. Supply has kept pace in recent years, and mild weather has helped keep natural gas inventories high, and prices subsequently low. This can be seen in the Energy Information Administration’s Natural Gas Storage Report:

Over the past year, storage levels were historically high, and that helped prices drop below $2.50 per million British thermal units (MMBtu) — a situation that I have previously argued is simply unsustainable. As I explained in Power Grab for Coal, if the price of natural gas lingers below $3/MMBtu for very long utilities start to favor natural gas over coal for power production. Indeed, that happened over the past year (even though the pendulum has swung back toward coal recently as gas prices soared back above that threshold.)

That is one factor that helped pull inventories down from historic highs. Another is that liquefied natural gas (LNG) exports are starting to pick up steam. Cheniere Energy’s (NYSE: LNG) Sabine Pass LNG terminal is now shipping enough natural gas that it is making an impact in the market. There are recent, credible reports that deliveries to the terminal have reached nearly 1.7 billion cubic feet per day (Bcf/d). That’s equivalent to more than 2% of U.S. daily natural gas production with only two trains in operation. Cheniere’s plans are to expand to six trains by 2020, and significantly it isn’t the only company likely to be exporting LNG by then. So LNG is now having, and will continue to have, a material effect on natural gas demand.

But the primary demand driver I want to discuss today is increased demand from Mexico. Although Mexico is one of the world’s top 20 natural gas producers, demand there has surged in recent years. As a result, the country has become the most important export market for U.S. natural gas. In 2010, Mexico imported 0.9 Bcf/d of natural gas from the U.S. By the end of 2016 that had grown to more than 4 Bcf/d, which is over 5% of daily U.S. natural gas production:

I don’t have to tell you that 5% of the U.S. gas market is a big deal, and that graphic suggests the volume is poised to go higher. According to the EIA, natural gas is Mexico’s largest fuel source for electricity generation, increasing its market share from 34% in 2005 to 54% a decade later.

Additions of natural gas-fired generating capacity will accelerate through 2020, with Mexico’s energy ministry projecting that 14.7 GW of new gas-fired capacity will come online. Most of those plants will be located in the northern and central parts of the country — with easy access to natural gas imported from the U.S.

There are two key drivers behind this surge of demand from Mexico’s power generation sector. The first is the relatively high cost of the fuel oil Mexico has historically used to power some of its power plants as a major crude producer. Historically, the cost to produce electricity from fuel oil and natural gas was about the same, but that relationship broke down as oil prices began to climb in 2005:

This can be understood more easily by looking at the cost of the energy contained in a barrel of oil versus the cost of natural gas. At present, a barrel of Brent crude sells for $55.70. The typical energy content of a barrel of oil is 5.8 MMBtu, for a current cost of $9.60/MMBtu. Thus, on a per BTU basis oil is presently around 3 times the cost of natural gas, and that creates a strong economic incentive to switch to natural gas.

But that high cost of fueling legacy assets would have been irrelevant without new laws that have opened Mexico’s oil, natural gas and power sectors to private and foreign investment. Reforms in the power sector introduced competition among generators while leaving a state-owned agency to to manage the power grid. The Mexican government has also committed to reducing the carbon footprint of the country’s power plants. Natural gas fits the bill as a lower-carbon and lower-cost option for power production, and demand has surged accordingly.    

Electricity demand in Mexico is also growing at a much faster rate than it is to the north. In the U.S. and Canada it increased 1% and 5%, respectively, over the last decade, while Mexico increased its electricity consumption 24% over the same span.

Natural gas demand in Mexico is projected to increase by nearly another 2 Bcf/d as a result of the new capacity additions. That demand will be primarily satisfied by increased imports from the U.S. This is part of our bullish long-term thesis for natural gas producers, but it will also necessarily involve a buildout of pipeline capacity from the U.S. into Mexico, some of which is already well underway.

U.S. pipeline capacity to Mexico currently stands at 7.3 Bcf/d, and is projected to nearly double in the next three years. This year four U.S. pipeline projects will be completed and should start to supply a total of 3.5 Bcf/d of natural gas to new natural gas-fired power plants in Mexico. These are:

• Phase II of the Roadrunner Pipeline being built by ONEOK Partners (NYSE: OKS)
• The Comanche Trail Pipeline, being built by Energy Transfer Partners (NYSE: ETP)
• The Trans-Pecos Pipeline (also called Presidio Crossing), being built by Energy Transfer Partners
• The Nueva Era Pipeline, a joint venture between Howard Energy Partners and Grupo Clisa

By the end of 2018, two more pipelines should begin exporting 3.3 Bcf/d of natural gas from the Eagle Ford to Mexico’s Northeast and Central regions. The Kinder Morgan (NYSE: KMI) Mier-Monterrey Pipeline will transport natural gas from the border between the U,S. and Mexico in Starr County, Texas, to Monterrey, Mexico.

The Nueces-Brownsville Pipeline is being built by Valley Crossing Pipeline, a subsidiary of Spectra Energy (NYSE: SE). This project will include construction and operation of a header system of more than 5 Bcf/d(!) near the Agua Dulce Hub in Nueces County, Texas. In addition a 2.6 Bcf/d pipeline will be built, originating at that header and extending to Brownsville, Texas.

Mexico is also making major expansions to its internal pipeline network, and TransCanada (NYSE: TRP) is a key player. TransCanada was the first private company to build and operate natural gas pipelines in Mexico when the country first opened its midstream sector to private investment in the mid-1990s. By 2018, TransCanada will be operating seven major natural gas pipeline systems in Mexico representing approximately $5 billion of investment.

So the future of natural gas exports by pipeline to Mexico looks pretty bright. But a potential fly in the ointment is Donald Trump and his demand for new trade barriers along with a border wall to be paid for by Mexico. This is ironic given his strong support for the U.S. energy industry and pipeline projects. This shouldn’t affect the medium-term demand for natural gas, nor the midstream projects discussed here, but could have a chilling effect on longer-term projects.