By John Auers and Robert Auers
Mexico certainly has been in the news lately, what with the barrage of media attention on the “family separation” issue at the U.S. border and the early success of the Mexican futbol team (particularly their upset of favorite Germany). Almost lost somewhat in this is the fact that perhaps the most consequential election in decades for that country will be taking place this upcoming Sunday. If the polls are anywhere close to accurate, it appears that the candidate of the left, Andres Manuel Lopez Obrador (often known as AMLO), is about to be elected as the next President of Mexico. This has many in the business community worried about a sharp turn away from economic liberalization. Perhaps most prominent among these is the energy industry, which, based on AMLO’s past and current statements, certainly has reasons to fear a roll back in the de-nationalization of the Mexican oil industry. Since the landmark legislation to open all segments of that industry to market forces and private investment was passed in late 2013 there has been growing momentum to do just that. Over 100 contracts have been awarded to private companies in the upstream sector, a wide variety of midstream projects are being proposed and developed and retail fuel markets have been opened up to private operators (with prices also moving to market levels). While the refining sector has seen less interest from outside investors, liberalization has certainly impacted that sector as well, with PEMEX’s operating philosophy moving from throughput to profit maximization. Overall (and including the natural gas and power segments), the Mexican government stated earlier this year that contracts leading to as much as $200 billion in private investment had already been signed. What happens if AMLO is elected? The opinions on that vary as widely as views on the Beattles 1968 ditty, “Ob-La-Di, Ob-La-Da” (which was named the “worst song of all time” in one online poll, but also has been called one of McCartney’s best compositions and is very much a fan favorite). Although we certainly don’t have a crystal ball, we will explore this issue in today’s blog, focusing particularly on downstream market impacts.
“Desmond has a barrow in the marketplace” – A look at the Mexican refining market
As with all segments of the oil industry, Mexican refining and products logistics/marketing has been totally owned and controlled by the national oil company, PEMEX. This has led to a rather underinvested and inefficient system, both in regards to refining and product delivery. By contrast, the refining complex on the U.S. Gulf Coast (USGC), spurred on by free market incentives, has developed into the most competitive petroleum refining industry in the world, a subject we have discussed in a number of blogs.
The advantage USGC refineries have vs. those in Mexico has only grown over the last 20 to 30 years as they have seen significant upgrades through the addition of downstream processing units such as delayed cokers and catalytic hydrocrackers. This provides them the ability to process a heavier crude slate and increase yields of higher valued products. Mexico’s refineries have failed to keep pace, even as the country’s domestic crude production has become increasingly heavier and sourer. The table below provides a brief comparison of key competitive parameters of USGC vs. Mexican refineries. We should note that the data for crude runs, utilization, and yields are for 2017 and Mexican utilization rates in 2018 have declined further for much of the first five months of the year.
The push for energy reform in Mexico was led by a desire to improve the competitiveness of all segments of the Mexican energy industry through exposure to market forces and the attraction of international investment. But as is usually the case when change such as this is initiated (think beginning a diet and exercise program after years of sitting on the couch), the first impacts involve some pain and suffering. This was certainly the case for the U.S. refining industry when oil markets were deregulated in 1982, which led to a shutdown of more than half of the over 300 operating refineries over the next couple of decades before the real “bulking up” process took over.
While none of the Mexican refineries are slated for shutdown and one of the main goals of the downstream reform is to decrease Mexico’s growing dependence on product imports from the U.S., exactly the opposite has happened since 2014. Utilization has fallen from roughly 80% to less than 50% and imports from the U.S. (almost all from USGC plants) have more than doubled, reaching levels averaging 1.4 million BPD in some recent months. This has led to a situation where over 75% of the gasoline and almost 70% of the diesel consumed in Mexico has been provided by U.S. facilities. The graph below illustrates the decline in Mexico’s refinery utilization and increased level of imports since the reform amendment was passed.
There are certainly some extenuating and uncontrollable circumstances that have contributed to the operating problems in recent years. 2017 was particularly unlucky for Mexican refineries, with their largest plant, the 330 MBPD Salina Cruz refineries, experiencing a one-two punch from Mother Nature. Tropical storm Calvin provided the first blow in June 2017 and the September Chiapas earthquake delivered a knockout, leaving the refinery down for several months. Each of the five other plants in Mexico also experienced downtimes of one sort or another, many related to the types of issues that have plagued the industry for years; however, energy reform can certainly be identified as the cause of some of the additional downtime experienced in 2017, in particular that related to discretionary crude outages at the Ciudad Madero (190 MBPD) and Minatitlan (185 MBPD). In both cases, due to the change in operating philosophy engendered by energy reform, PEMEX chose to extend turnarounds to maximize profitability, rather than run crude just for the sake of maximizing throughput.
“Desmond Lets the Children Lend a Hand” – Early efforts in downstream privatization
PEMEX has certainly made efforts to attract outside investment to upgrade the refining system, but unlike in the upstream, interest has been minimal. The most high profile potential project involves a major upgrade to the 315 MBPD Tula refinery, to include an 86 MBPD delayed coker. PEMEX has already spent over $1 billion on the project, but work has been at a standstill until a foreign partner can be found to foot the rest of the bill, which could be as much as $1.5 billion or more. While rumors abound, including one earlier in the year that a deal has been reached with Mitsui, no agreement has been officially announced. PEMEX has also pursued private investment in smaller projects, including hydrogen plants (a key need to improve overall plant utilization), but again, no firm deals have been publicly confirmed. A contract to rehabilitate and commission the H-Oil unit at Tula was announced in the last month, but it appears to be just a standard construction and services deal.
However, there has been investor interest and significant activity in one segment of the downstream – logistics to improve product import, storage and distribution. This has been an area where the infrastructure is lacking, resulting in regional product shortages. A number of players, primarily U.S. companies and including many refiners, are making plans to invest in this area. If anything, this type of investment will actually tend to increase U.S. product imports in the Mexican market as they will decrease the cost to move products from U.S. refineries to consumer markets south of the border. The table below shows only some of the projects that are being pursued in this area.
“Happy ever after in the market place?” – What to expect from an Obrador government
As noted in our opening, the future of energy reform under an AMLO administration is very much an unknown. He has made a number of statements on the issue, both in this campaign and during his long political career (he is a two-time failed candidate for President and a former mayor of Mexico City). Most of these statements naturally are consistent with his leftist/nationalistic ideological views, and they tend to confirm worries about a rollback in energy reform efforts. There has even been talk of an attempt to repeal the entire 2013 energy reform amendment to the Mexican Constitution, with one plank in his party’s platform calling for a public referendum on the measure; however, many of his key advisors (including his chief economic advisor Abel Hilbert, top business advisor Alfonso Romo and likely choice for finance minister, Carlos Urzua) have also made efforts to calm worries by saying that an AMLO administration would not make drastic changes to the energy market openings and would respect existing contracts. Some analysts have even made the case that a political outsider such as AMLO is actually best positioned to push reform forward (assuming he is so inclined) in an environment when much of the public has turned against it.
In regards to refining, the most high profile policy position put forward by the AMLO’s party (Morena) is a plan to build two large new refineries. Earlier this year, Rocio Nahle, the Morena Party’s parliamentary coordinator and possibly the next Energy Secretary if AMLO wins the election, outlined a proposal to construct the 300 MBPD refineries in Campeche and Tabasco states. Their stated goal is to reduce dependence on the U.S. for refined products and to provide “value added” capabilities to the petroleum industry. There is really nothing new in these plans vs. efforts to build new refineries in the past by both Mexico and several of the other Latin American countries which have increasingly become dependent on the U.S. for products. And we (along with most other analysts) don’t expect the results to be any different either – which is to say the chance that they will be successfully built and started up is very small. One thing that could very well change under an AMLO presidency is the operating philosophy we referred to earlier – PEMEX could be directed to return to running for maximum throughput vs. cutting back when economics dictate.
At this time next week, we’ll know if the polls were accurate and if the new government in Mexico will be headed by AMLO and his Morena party (barring some unforeseen “hanging chad” scenario). It will take much longer to know what, if any, impacts this will have on Mexican energy reform and the petroleum markets south of the border. One thing to look for in the election is not just if AMLO is victorious, but the margin of victory and the success of his relatively new party in parliamentary elections. Because of the constitutional difficulties inherent in overturning an approved amendment and the very fact that his party has not been around long enough to likely make the inroads necessary to breach those constitutional “firewalls,” it is probable in our minds that “Life Goes On, Bra” for reform even if Mexico wakes up to a new President Obrador on July 2nd.
Due to the time and space limitations of a weekly blog, our discussion today on this subject has been at a pretty high level. TM&C will incorporate our views of the impacts of an Obrador presidency (assuming it comes to be) at a deeper, quantitative level in the upcoming MID Year UPDATE of our Crude and refined products outlook (C&RPO). This report provides a comprehensive and detailed forecast of supply, demand, and prices for crudes and products on a regional and global basis through 2030. Along with political events that impact energy policy, such as the Mexican election, other factors such as market developments, demographic trends and technology advancements are all considered in our analysis and forecasts. The C&RPO also includes a forecast of refinery projects and their market impacts. This analysis is done in more detail in another study we recently released, the Worldwide Refinery Construction Outlook (WRCO). This report includes a comprehensive tabulation of all refining projects being developed globally and handicaps their likelihood of being completed. It also forecasts their impacts on supply and demand for both crude and refined products. As in the C&RPO, all the important factors which drive refining investment are considered in this study. Both of these studies will be published in late July/early August and for more details about either of them or other TM&C services, please visit our website or give us a call at 214-754-0898.