The 'New NAFTA' Creates Certainty For Oil & Gas Investors

Negotiations for the United States - Mexico - Canada Agreement (USMCA) have been concluded, but the three countries still have to ratify the deal. The USMCA represents President Trump's effort to modernize the North American Free Trade Agreement (NAFTA) and includes important provisions that should on-shore automotive manufacturing and give American farmers access to Canadian dairy markets.

Some of the most important—and controversial—provisions were big wins for the North American oil and gas industry and should spur further investment, exploration, and production. First, the new framework requires that the US government automatically approve any gas exports to Mexico. More significantly, a dispute resolution process that allows multinational corporations to sue governments over regulatory changes has been preserved for the oil and gas industry, prompting objections from environmentalists.

The North American energy market became more integrated under NAFTA, and pipelines from Houston to central Mexico have helped Mexico produce more electricity even as its oil production declined. Industry representatives including the American Petroleum Institute who were concerned that President Trump's stated desire to scrap NAFTA might undo some of that progress have been reassured. 

There are a couple of pieces of background information necessary for understanding why the oil and gas investor protections are so significant. The first is that while Mexico's government receives about a fifth of its revenue from taxes on state-owned oil company Pemex, the government has underinvested in Pemex. Pemex has aging infrastructure, a shrinking budget, and does not have the resources to explore, much less exploit, new offshore and shale plays. Mexico's oil production has shrunk by 26 percent since 2013. The Mexican government's response was to pass an oil reform bill in 2013 that ended Pemex's 75 year stranglehold on Mexican petroleum resources. 

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Since 2013, more than $200B in investments from multinational oil companies have poured into Mexico. But those projects were put at risk by the July election victory of Andrés Manuel López Obrador, a left-wing nationalist who has publicly stated his objection to hydraulic fracturing. López Obrador opposed the initial oil reform five years ago and wrote to ExxonMobil Corporation XOM that any investment in Mexico's energy resources would be equivalent to "piracy." López Obrador will take office as Mexico's president on December 1. By preserving the Investor-State Dispute Settlement (ISDS) mechanism and by including a requirement that Mexico retain at least its current level of openness to US energy investment, the ‘new NAFTA' has protected those projects from López Obrador.

Some of the biggest opportunities are in the gas-rich Burgos Basin, which lies just south of Texas in northeastern Mexico. The formation is connected to the Eagle Ford shale play, and has plenty of shale resources; it also extends to the east in the Gulf of Mexico, where offshore resources are plentiful. Pemex has not been able to finance a significant number of offshore projects, which are capital-intensive, take a decade or more to bring online, and have high breakeven points. Mexico has about 50 deepwater offshore platforms in the Gulf, while the United States has more than 1,100 deepwater wells in the Gulf. 

Last Friday, ExxonMobil stock closed at $85.02; after the announcement that negotiations on USMCA had concluded, XOM shares were trading as high as $86.68 on Wednesday for a 1.9 percent gain. Royal Dutch Shell PLC (ADR) (NYSE: RDS-A), which has emerged as the largest offshore player in the Gulf of Mexico, saw its shares rise 2.1 percent to $69.58 over the same period.

If Mexico manages to maintain a favorable environment for foreign investment and utilize its shale resources in a productive way, it can expect the same boost to its economy that the Permian and Eagle Ford have shown across the border. Not only will energy become cheaper in Mexico and its energy trade become more balanced, but the country can expect the same surge in demand for transportation and logistics services. Flatbed trucks hauling sand and drilling equipment and tankers full of water and proppant chemicals have seen their rates balloon in the United States, which has driven wages for truck drivers much higher than the national average. 

If Mexico wants in on the action, all it has to do is ratify the USMCA before López Obrador has a chance to erect new barriers to investment and trade.

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