TransCanada Helps Mexico Turn To Gas

TransCanada Corporation (TRP) is a giant in the North American energy space, with operations in Canada, America, and Mexico. The midstream juggernaut has been aggressively growing its Mexico gas pipeline business to take advantage of shifting market dynamics in the utility space that are stimulating greater demand for natural gas. Let's go over a two-part pipeline project TransCanada Corporation is close to completing.

A two-parter

Mexico��s state-run utility firm Comisi贸n Federal de Electricidad, commonly known as CFE, signed a $1.1 billion agreement with TransCanada back in 2012. That agreement tasked TransCanada with building a gas pipeline that would run from El Encino in Chihuahua state to Topolobampo in Sinaloa state.

Referred to as the El Encino-Mazatl谩n system, this development consists of two pipeline projects. Last year, the 267-mile long Mazatl谩n pipeline was completed for a development cost of $400 million. The pipeline runs from El Oro to Mazatl谩n, both of which are in Sinaloa state. TransCanada has a 25-year agreement with CFE to supply 200 MMcf/d of gas through this portion of the system to be used as a fuel for electricity generation. Investors should note that while the pipeline won��t really be operational until the second pipeline is completed, TransCanada completed its contractual obligations and has been recording and receiving revenue from CFE since mid-2017.

The second project, the Topolobampo pipeline, will run for 348 miles from El Encino in Chihuahua state to various delivery points, including the Mazatl谩n pipeline. This pipeline is crucial as it carries gas supplies in Chihuahua state to other parts of Mexico that are in need of the fuel for electricity generation.

While not explicitly stated, it is possible some of those gas supplies are coming from American sources including upstream operations in the Eagle Ford and Permian Basin. TransCanada signed a 25-year agreement with CFE to supply 670 MMCf/d of natural gas along this portion of the pipeline system.

Sinaloa state has the second highest electricity generation costs in Mexico after Baja California Sur, according to CRE, and gas is part of the solution. The 320 MW Juan de Dios Batiz Paredez power plant and the 616 MW Jose Aceves Pozos power plant were both upgraded to be able to use natural gas as a fuel to cut costs (both were previously using fuel oil, but the switch will only happen once the entire development is completed). As an aside, only 300 MW of the Jose Aceves power plant's generation capacity was converted to also run on natural gas.

Farther out, the 778 MW Topolobampo II and 777 MW Topolobampo III combined-cycle gas-fired plants are expected to be completed in 2019 and 2020, respectively. This will wean Sinaloa state away from its need for more expensive oil-powered electricity generation and towards cleaner, cheaper natural gas.

Delays

Originally, the two-part development was expected to come online in 2016, but that was delayed due to concerns over the route of the system. This increased the cost of the development as its price tag is now roughly $1.4 billion.

Aboriginal Raramuri communities (whose ancestral home resides in Chihuahua state) filed a lawsuit against TransCanada which halted construction in 2015. The disagreement was over the negative impact the pipeline route might have on sensitive lands, so consultations began between TransCanada and the Raramuri community a year later. Both sides came to an agreement by early 2017, and now the project is expected to be completed some time this quarter.

These delays increased the cost of the Topolobampo project from $1 billion to $1.2 billion, but it appears TransCanada will be able to recoup those additional costs as it was recognized as a force majeure event. From TransCanada��s 2017 10-K:

��Under the terms of the TSA, the delay in the 20 km (12 mile) section was recognized as a force majeure event with provisions allowing for the collection of revenue from the original TSA service commencement date of July 2016.��

As the legal disputes have since been settled, it appears there is a good chance TransCanada will soon be collecting revenue for a service it can actually provide (one of the upsides of heavily regulated industries like the gas pipeline space is that the midstream operator is often protected from adverse events in some capacity).

Financial impact

Investors can easily see the favorable impact this growth story is having on TransCanada��s financial statements. From 2015 to 2017, TransCanada��s comparable EBITDA from its Mexico Natural Gas Pipelines division rose from $164 million to $399 million. Its comparable EBIT and segmented earnings (a non-GAAP figure that adjusts for forex movements) rose from $169 million in 2015 to $287 million in 2016 to $426 million in 2017.

A large part of that growth comes from TransCanada recognizing and receiving revenue from the two-part development mentioned above, which started in 2016. Going forward, it will be the Sur de Texas and Villa de Reyes ventures that will keep driving the company forward. TransCanada Corporation noted:

��We expect 2018 earnings from the Topolobampo, Tamazunchale, Guadalajara and Mazatl谩n pipelines to remain consistent with 2017 due to the long-term nature of the underlying revenue contracts. Sur de Texas and Villa de Reyes are expected to be in service in late 2018.��

Final thoughts

Mexico is pivoting away from fuel oil and towards natural gas, an increasing amount of which is being imported from America, and that should free up a good amount of Mexico's domestic oil/petroleum production for export (and those export earnings can be used to fund its natural gas purchases from the US and then some). TransCanada Corporation has been instrumental in making this change possible. As there remains an enormous need for additional gas pipeline networks in Mexico, TransCanada Corporation has plenty of growth opportunities ahead of it. Thanks for reading.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.