MEXICAN ENERGY REFORMS BRING BENEFITS AND CHALLENGES

By Evan Carlo
Staff Writer

The shale revolution changed the United States’ energy industry and set the country on a course to becoming an energy superpower. The combination of two technologies, hydraulic fracking and horizontal drilling, unlocked previously unobtainable oil and gas fields while increasing efficiency. Reserves are now higher than at any point since 1975. After suffering 30 years of declining oil production, the United States reversed this downward trend and produced more oil in January 2015 than in any month since January 1973. Texas alone is projected to become the eighth largest oil producer in the world in 2015, ahead of Mexico, Kuwait and Iraq.

In the natural gas market, U.S. production is predicted to reach 72.8 billion cubic feet in January, a record peak in gas production. With the success of the American energy industry, some have wondered if this success can be transferred to its neighboring country, Mexico. With new energy reforms passed last August, Mexico could potentially undergo an energy renaissance similar to that of the United States.

Historical Energy Reform Laws

The new energy reforms aim to make the Mexican energy industry more competitive and economically efficient in the face of declining oil production. Since 2004, oil production has declined from about 3,847,000 barrels a day to 2,907,000 barrels a day in 2013. The energy industry has suffered from underinvestment and a lack of human capital causing the decline in production. Without sufficiently trained engineers with technical expertise and modern technology, many oil and gas reserves remain unproductive. Part of the problem was the monopoly the state-owned energy company Pemex held over oil and gas production, and the restrictions on foreign investment in the energy sector.

The new laws signed by President Enrique Pena Nieto addressed these problems by ending Pemex’s monopoly and opening up the energy sector to foreign investment. Now foreign companies will be allowed to compete with state-owned companies in the bidding process for contracts and licenses on oil and gas fields. As early as July of this year, Mexico will offer the first oil and gas blocks to private companies, awarding access to 14 exploratory fields in the Gulf of Mexico. However, there are still some limitations on foreign investment. The oil and gas rights are still owned by the Mexican state. Foreign companies only receive the revenues from the sale of oil and gas. Regardless, the laws passed represent a big change in the Mexican energy landscape.

Fracking and Horizontal Drilling Opportunities

Investment from the United States will not only bring the money Mexico needs, but also the technological methods needed to extract unconventional oil and gas. Despite having the sixth largest shale gas reserves in the world, Mexico has only built a few shale wells, leaving the vast majority of reserves untouched. Part of the reason is that there are no Mexican companies with an expertise in fracking or horizontal drilling. Without these two techniques, Mexico cannot access the vast reserves of oil and natural gas locked up in shale formations. Mexico could potentially extract 62 billion barrels of oil in shale fields in northern and eastern Mexico and 29.5 billion barrels in deep-water fields if these techniques are used.

American companies see this as a new opportunity to expand their business and profits in a country where there is essentially no competition in fracking or horizontal drilling. By using American technology, much of Mexico’s unconventional oil and gas reserves can be unlocked. There is much optimism that this will be accomplished. Just after the passage of the reform laws, the Energy Information Administration increased Mexico’s 2040 oil forecasts by 75 percent.

If these technologies are used correctly, shale rich states such as Nuevo Leon can become new leaders in energy. The Governor of Nuevo Leon, Rodrigo Medina, stated that, “the goal is for Monterrey to become the new energy capital, from wind to shale…the Houston [or] Dallas of Mexico.” Texan businesses have already begun preparing to invest in Nuevo Leon, with business leaders and government representatives from Houston meeting with Nuevo Leon representatives last November 3 to discuss possible investment in the region. This type of investment and cooperation will link the economies of the United States and Mexico even closer.

Economic Benefits

The United States has already benefitted from many economic opportunities from as a result of fracking and horizontal drilling. According to a study from energy expert IHS, the shale energy boom increased the average household disposable income in 2012 by $1,200 and is predicted to grow to $2,700 by 2020. The industry also supported 2.1 million jobs in 2012.

A second shale boom in Mexico would provide more jobs and economic opportunities for Americans. American engineers and consultants will be in high demand to bring their expertise to Mexican shale fields. Nathaniel Karp, a chief economist for BBVA, testified at a Texas Senate subcommittee that the energy reforms could potentially add more than 217,000 jobs and $45 billion in GDP to the Texas economy. As profits from Texas fields begin to decline due to diminishing marginal returns, businesses and employs will increasingly head south to expand. This will further increase the economic benefits already realized in the shale industry.

A second shale boom will also greatly help Mexico’s economy, which has been suffering from anemic growth the last few years. The increased investment will directly provide much-needed jobs to Mexican workers who normally would migrate north. Despite fears that allowing foreign investment will take jobs away from domestic workers, regulators require companies that win the bid on exploration contracts to meet a national content requirement of 25 percent at the beginning of the contract and 35 percent several years later. This means 25 percent and then 35 percent of the goods, services, and labor used by foreign companies must come from Mexico.

In addition to employment gains and economic growth, increased investment will bring down energy costs to Mexican consumers. Mexico currently suffers from high gas prices that are double the prices in the United States and Canada. Increasing production in shale gas fields will increase the supply of natural gas and consequently bring down prices in Mexico. This not only benefits consumers but also industries that rely on natural gas for electricity.

Challenges and the Downside of Energy Reform

Despite the positive economic impact the energy reform laws bring to America and Mexico, there are also challenges and negative consequences. The biggest is the negative environmental impact of increased oil and natural gas extraction. Fracking impacts the environment in a variety of ways including air pollution and ground water contamination. Higher oil consumption will increase the amount of carbon dioxide in the atmosphere and further exacerbate global warming. These environmental issues needed to be weighed against the potential economic gains of increased energy production.

Even if the economic benefits outweigh the environmental costs, several factors may make increased foreign investment difficult. Mexico’s security problems pose a threat to U.S. businesses that want to operate in the country. Much of the untapped shale reserves reside in areas of the country that are at risk of cartel violence. While companies can hire private security to protect their projects, this added risk could make companies more reluctant to invest.

In addition, low oil prices threaten to undo the American shale industry. Shale oil and gas is more expensive to extract than other conventional methods, making the break-even price of shale oil $58 for the average shale producer. With current Western Texas Intermediate crude prices at $48.84, many shale projects are unprofitable. If prices stay too low for the foreseeable future, business will unlikely invest in Mexican shale production.

However both of these challenges are manageable. Despite cartel violence, many international oil companies have dealt with security issues in politically unstable countries before, such as Iraq and Nigeria. While smaller companies that operate in Texas do not have the experience to combat security threats, international companies will be able to operate in cartel zones safely. And if these companies invest in regions with high cartel violence, the increased economic activity and employment may drive people away from working in the cartels, making the area safer.

Falling oil prices also will most likely not completely prevent foreign investment from coming into the country. According to Rystad Energy, even though oil prices are falling, the break-even costs of extracting shale oil has also fallen in the fast few years. Innovation and efficiency can bring down the cost of drilling further, making low oil prices manageable.

These challenges represent a temporary setback for foreign investment into Mexico that will delay the development of shale oil and gas wells. Eventually, international companies will begin to invest in Mexico and bring fracking and horizontal drilling techniques with them. While the use of fracking and horizontal drilling will most likely not have the same magnitude of an effect on Mexico as it has in the United States, over time Mexican oil production should begin to recover and reverse the downturn in oil production. Long term, oil production may recover to its 2004 peak of 3.8 million barrels a day. If the projects by the Energy Information Agency are correct, by 2040 Mexico will be producing 3.7 million barrels a day, just 100,000 below the 2004 peak. Overall, these reforms should revitalize the oil industry and bring economic benefits to both the United States and Mexico.

Image by FadderUri

ON CLIMATE, THE UNITED STATES AND CHINA ACT INTERNATIONALLY BUT THINK DOMESTICALLY

By Kristopher Klein
Staff Writer

Last month President Obama and the President of the People’s Republic of China, Xi Jinping, jointly announced a plan for both countries to tackle greenhouse gas emissions. The deal, hailed by western media outlets as ‘historic,’ is comprised of some very specific and ambitious targets for reducing emissions. However, climate and political experts on both sides of the Pacific have raised concerns about the ability and intention of both countries’ leaders to make good on their lofty commitments.

Ambitious Goal Setting

Under the agreement, the United States, which was previously planning to reduce carbon emissions by only 17 percent by the year 2025, would commit to reducing emissions to 26 percent below 2005 levels by 2025. China would commit to achieve a peak in its CO2 emissions by the year 2030.

The deal in its current form would drive the United States to double the pace of its current emissions reductions program in order to meet the treaty’s deadlines.

In order to achieve its stated aims, China proposes that by 2030 it will generate 20 percent of its total energy needs from zero-emissions sources. For this to happen, China must provide an additional 800 to 1000 gigawatts of zero-emission energy capacity by 2030. That is more energy than all of the China’s current coal-fired power plants combined.

Fair To Both Countries

Critics of Obama’s agreement with President Xi claim that the deal puts China under less pressure to reduce emissions, because China must only cap emissions, while the United States must reduce emissions in a shorter time period. However, the agreement is likely to take heavy political and economic lifting for both countries.

Though the United States is currently the second largest emitter of greenhouse gases after China, it has been an emitter for much longer than China. The United States began its industrialization in the 19th century and is responsible for around 26 percent of the current man-made greenhouse gases in the atmosphere. In comparison, China did not begin emitting significant amounts of greenhouse gases until economic growth picked up in the 1980s and is responsible for 11 percent of the atmosphere’s man-made greenhouse gases.

It seems only logical that China would take more time than the United States to reduce emissions. If China can cap its emissions by 2030, it will have done so just 25 years after the United States, a short timeframe relative to the course of both countries’ economic development.

Will Both Economies Be Able To Make Good On Their Promises?

President Obama will certainly face pushback on his emissions reduction goals, if not now then when he attempts to implement strategies designed to actually help the country reach these goals.

Even without political pushback, meeting the goals set in this agreement will require the use of tremendous government resources and the creation of market incentives. Meeting the goal of a 26 percent reduction of CO2 emissions will require an almost 75 percent decline in the use of coal-fired power plants by 2025, an incredibly demanding goal.

Chinese leaders will also face major obstacles in their attempt to meet the goals set out in this agreement. Xi Jinping, despite his influence as the President of the Republic, Chairman of the Central Military Commission and General Secretary of the Communist Party, will need the support of local bureaucrats in order to successfully implement programs that would help China reach these goals. However, local bureaucrats will be reluctant to implement policies when there is very little profit incentive.

Another barrier to implementing successful climate policies is the economy. The Chinese economy is slowing, and regulating the consumption of fossil fuels and the economic effects of such policies may prove too politically unpopular for the Communist Party to bear. A Tsinghua-MIT study shows that the use of a $38 per ton carbon tax could help China reach its reduction goals by 2030, which may hint as to what Chinese leaders may be planning.

However, if a carbon tax is the way Xi Jinping plans to achieve his stated aims, there should be some doubt about his ability to get the job done. A tax on carbon would most likely mean a rise in the price of energy for the Chinese market and higher prices across multiple industries that are energy intensive. The Chinese Communist Party and vested political interests may be unwilling to implement a tax that would squeeze the average Chinese household’s budget at a time when the Chinese economy is already slowing considerably.

In China, a slower economy means less legitimacy for the Communist Party. The idea that Chinese leaders would intentionally bind themselves to goals that could endanger internal stability seems farfetched. Chinese leaders have shown they are unwilling to compromise complete political control for the sake of any reform. They certainly would not start now for the sake of keeping the United States happy. The purpose of this agreement’s ambitions may lie not in the prospect of achieving the goals it sets, but in using the deal for political appearances and hoping for a residual effect.

Even Xi Jinping Needs Leverage

Given the general sense of malaise among Chinese bureaucrats when implementing environmental reforms, China’s president needs a significant amount of political force behind him. China has, for decades, run oil companies that are closely related to government politics and are even a part of the Communist Party’s bureaucracy. In order for Xi Jinping to push environmental reform and renewable energies, he will have to stick his nose right into the business of powerful Chinese politicians. To do this he will need international agreements, which he has much more control over than actual environmental policy initiatives, to leverage his party into putting more pressure on pro-oil industry executives.

Obama’s Motives In Using International Agreements

Obama now also has domestic incentives to achieve climate reform through international agreements rather than domestic legislation. Obama could have gone to Congress with programs designed to reduce carbon emissions. The EU, for example, has been reducing emissions unilaterally for decades. However, Obama has a unique opportunity, and little choice, given recent developments in domestic politics.

In November’s midterm elections, the Democratic Party lost control of the Senate and with it any agenda-setting power in Congress. This means that Congress is unlikely to soon take up any meaningful climate legislation of its own. Luckily the President has some tools, and among them is negotiating international agreements.

An article published in the Virginia Journal of International Law analyzes the President’s ability to use international agreements against a congressional majority. It suggests, “by providing the President with the exclusive power to negotiate the terms of the international agreement, the President has the power to determine which policy alternative will be matched against the status quo in a final vote.”

By drafting international treaties and announcing them to the media, the President is setting the Senate’s and the media’s agenda. The Senate will now need to have an up or down vote on the text of this emissions agreement with China, as Obama negotiated it. This means voting yes or no to specific policy initiatives on climate change, something Republicans were most likely trying to avoid. The media coverage this treaty has received also serves to set the public political agenda and focus public pressure around this issue, which might be helpful throughout the legislative process.

What Does This Mean For The Fate of This Agreement?

It seems likely that this agreement has been drafted and publicized less for the purpose of providing a meaningful path towards emissions reduction and more for leveraging international agreements for use in domestic politics. This treaty, should it be ratified, could be a very meaningful bit of symbolism and a useful tool in shifting political focus onto the issue of climate change. As for the specifics laid out in the agreement itself, I wouldn’t count on their timely realization.

Image by U.S. Embassy The Hague

WHAT WILL BECOME OF GROWING ENERGY TRADE BETWEEN RUSSIA AND CHINA?

By Angela Luh
Staff Writer

On the heels of a $400 billion 30-year contract for natural gas trade signed this past May, Russia and China have extended their commitment to energy trade following the 2014 Asian Pacific Economic Cooperation (APEC) summit in Beijing. Some critics argue that the China-Russian relationship is constrained by a number of external factors (like the United States-China climate deal also announced at APEC) and others suggest that the vast nature of this economic commitment will materialize in increased political cooperation, possibly leading up to an energy strategic alliance.

In Beijing, Russian President Vladimir Putin and Chinese President Xi Jinping signed a non-binding gas-supply memorandum. This deal would see Gazprom supply China’s state oil company CNPC with 30 billion cubic meters of gas per year, on top of the 38 billion cubic meters Russia agreed to sell China in May. However, unlike the previous contact which routes from eastern Siberia, the gas would be routed from the western Siberia pipeline, a source that is currently connected to Europe, suggesting that Russia is deliberately shifting its market away from the EU. It also reveals Russia’s desire to outcompete other actors, particularly the United States, in exporting liquefied natural gas to China.

This gas deal is expected to be worth well over $100 billion if negotiations between Russian and Chinese diplomats are successful. If and when both the APEC agreement and the May Gazprom contract are in motion, China would replace Germany as Russia’s biggest gas market, which would significantly alter the landscape of global energy trade, arguably giving China and Russia the most advantageous energy trade relationship in the world.

According to the APEC agreement, Russia could begin gas deliveries to China in as early as four years from now. The May contract between Russian gas giant Gazprom and the state-owned China National Petroleum Corporation indicate that deliveries are set to begin in 2018. Russia is in a particularly urgent situation this year under the restrictions of U.S. and EU sanctions and has demonstrated its intent to boost strategic ties with China as an energy supplier and geostrategic neighbor. This latest energy deal is one of many acts of China-Russian coordination in recent years, including joint aircraft projects, trade of defense technology and cooperation within regional frameworks like the Conference on Interaction and Confidence Building Measures in China (CICA) and BRICs.

The unprecedented scale of both agreements, particularly in the context of sanctions on Russia, suggests that Russia’s break with the EU has made it increasingly dependent on China as an energy importer and, by extension, on the Asia Pacific as a regional trade network. In 2013, bilateral trade reached a record high level of $88.8 billion and has continued to grow during the first quarter of 2014.

With energy trade at the forefront of trade between the two countries, Moscow and Beijing intend to reach $100 billion worth of bilateral trade by 2015. China, as one of Russia’s largest trade partners, is “probably the only country in the world” that has the financial ability and the market capacity to consume Russia’s huge energy exports for the long term, according to Lin Boqiang at the China Center for Energy Economics Research at Xiamen University.

China is set to undergo major structural changes in the near future to sustain its growing consumer economy. The country’s rising middle class and rapid economic growth have in turn increased its energy demand, placing enormous pressure on its energy supply. While coal continues to be the dominant source within its energy mix, China intends to diversify and move away from dependence on coal in order to meet its commitment toward carbon emission cuts and the needs of new manufacturing technologies. Natural gas will account for more than 10 percent of China’s energy consumption by 2020, compared with 6 percent currently, according to China’s National Development and Reform Commission.

China’s need for reliable energy sources obliges the country to diversify its global oil and gas markets. As the world’s number one consumer of energy and the second largest purchaser of oil after the United States, China’s oil imports in 2030 could increase up to 1.6 times from the 2011 level. These new developments have renewed the debate surrounding China and Russia’s international relations and whether or not increased economic cooperation in blockbuster energy agreements will trickle into their political alignment.

The skeptics: Little economic impact in the short run

While the energy contracts have the capacity to strengthen ties between China and Russia, they also reinforce the asymmetrical nature of China Russian relations: trade between the two support China’s fast-powered growth but aim to merely sustain Russia’s position as a supplier of raw material to Beijing. Russia’s disadvantage in these agreements may prevent Sino-Russian political commitments from materializing. China’s evident cooperation with the United States suggest that widespread media attention on Sino-Russian cooperation only serves to add fuel to “the narrative of an emerging strategic relationship…as a game changer.”

Another cautionary aspect of the APEC gas deal is that it is non-binding and is likely just another one of many preliminary negotiations before China and Russia settle on the more concrete factors, like the price of the exchange. Like the decade-long proceedings that led up to the Gazprom contract in May, the new deal may be merely suggestive of a continued intent to pursue the contours of a deal.

Economically, it is uncertain whether or not the deal will make a sizeable impact. The two Russian gas deals together, if realized, would meet just 1.7 percent of China’s overall energy demand mainly because natural gas currently only comprises just 6 percent of the its energy mix. China’s goal to grow its proportion of natural gas to 10 percent of its energy mix is projected to take a decade, and even then, the gas deals with Russia still make only a minor contribution to its supply. Furthermore, since the price of gas in Asia is higher than in Europe, Russia would have to accept economic losses by heading east instead of west.

The alarmists: Future strategic alliance?

Given China’s commitment to restructure its energy mix and its intent to increase its usage of natural gas, the two gas deals together could meet nearly 18 percent of China’s natural gas needs by 2020, effectively making Russia the main supplier of the world’s largest exporter.

In addition to diversifying its energy resources, China has also actively sought a diversity of arrival routes for energy, and Russia’s position as a geographic neighbor decreases the costs of transit. Russia faces the possibility that Europe will curb its gas demands and, by proving that it is willing to move its supply to the East, increases its political leverage in Europe by creating a viable threat.

On the political end of the relationship, Putin’s willingness to absorb the economic costs of supplying oil to the East suggests that the geostrategic gains of energy trade outweigh the loss of shifting Russian resources to Chinese markets. China and Russia have often cooperated on the international stage, with a mutual interest to insulate U.S. influence in the region. Both countries have expressed shared geopolitical concerns and a commitment to strengthening regional trade and security. They also wield veto power on the United Nations Security Council and often vote together, sometimes to oppose Western powers.

In a world where developed countries are characterized by growing consumerism, energy wealth has become more essential than ever before. China and Russia’s energy trade will be a slow and gradual process, but the energy agreements of this past year have revived the debate over energy politics. It is uncertain whether or not China and Russia’s energy trade will have significant political bearings, but its potential impact on the global energy trade network compels all other actors to reinforce their strategies in an era of emerging energy competition.

Image by Greg Westfall