Authors: John Auers and John Mayes
The song, “Down in Mexico,” has traveled an interesting path since it was first recorded by the Coasters in the late 1950’s. Since then, it has appeared in a Quentin Tarantino film (Death Proof) and in Hangover Part III, has been recorded by a wide variety of artists ranging from Bobby Short to Manfred Mann and perhaps even inspired Delbert McClinton’s, “Down Into Mexico”. The oil industry in Mexico has gone through similar travails over the past few decades. The trip has become even bumpier in the last few months and years, and the future appears to be particularly unpredictable and challenging. Forces from many directions will impact this future, including the sweeping energy reforms enacted in 2014, the potential changes in U.S. trade policies being discussed within the Trump Administration and the U.S. Congress – changes in regional supply and demand patterns and specific dynamics within all of the segments of the Mexican oil industry itself. What happens, “Down in Mexico,” will be critical to the U.S. industry as well, since Mexico is both a key source of supply for U.S. refiners and by far the largest export market for their refined products. In today’s blog, we review recent developments and examine what the future might hold for the Mexican oil industry and its interactions with the U.S.
Come with Me to the Border; South of the Border That Is
In previous blogs, we’ve discussed at length the growing global competitiveness of U.S. refineries over the past decade. This has allowed the U.S. to significantly expand crude capacity and utilization rates even during a period of generally declining domestic refined product demand. It has also transformed the U.S. from being the world’s largest product importer in 2005 to becoming the #1 global exporter of refined products currently.
Due to proximity, growing regional demand, and difficulties with both operating existing refineries and adding new capacity, Latin America has absorbed most of the growing volumes of U.S. product exports. Exports to the region have quadrupled since 2005, from less than 600,000 BPD to over 2.3 million BPD in 2016, an increase of 1.7 million BPD (Figure 1).
“Down in Mexico, There’s a Crazy Little Place That I Know.”
While countries all over Latin America have contributed to this growth in U.S. product imports, Mexico has been by far the most important. About 37% of total product exports to the region end up in our immediate neighbor to the South and over 33% of the growth since 2005 can be attributed to Mexico. For gasoline, Mexico’s importance as an export market is even more prominent, with about half (on a global basis) of all those export barrels ending up in Mexico. And as important as Mexico is to U.S. refiners, the product coming from those plants is even more critical in meeting consumer demand in Mexico, with U.S. gasoline comprising 60% of consumption. Certainly proximity is an important reason for the flow of product across the Rio Grande and the Gulf of Mexico, but other factors are important as well. The most important of these is related to the superior competitiveness of U.S. refineries and the inability of Mexican plants to efficiently meet domestic demand. This can be easily demonstrated by comparing the two industries. While Mexico has a fairly developed refining system, it is dwarfed by the U.S. Gulf Coast refining complex in size, complexity and a variety of performance factories. With only six refineries, the Mexican system has a total capacity of 1.54 million BPD, compared to the 43 refineries the U.S. Gulf Coast which have a total capacity of 9.1 million BPD. While the average capacity of a Mexican refinery is a bit higher than a USGC plant, they are much less complex, yield less transportation fuels, require a significantly higher manpower count and perhaps most telling is that utilization rates are much lower (see Figure 2).
And in contrast to the upward trend in the U.S., refining capacity growth in Mexico has been stagnant since 2011. A lack of investment capital has plagued the industry which has been made worse by the unwillingness to allow foreign ownership. Also impacting the shift in product flows is the crude production environment. While output has generally been rising in the U.S., crude production rates have been declining in Mexico for several years. After peaking in 2004 at nearly 3.5 million BPD, production in 2016 fell to under 2.2 million BPD with the December output barely above 2.0 million BPD. The lower output has reduced revenues, which has further complicated the investment issues in the downstream.
You Can Get Your Kicks in Mexico
One of the greatest complications for Mexico has been recent refining utilization rates. With a refining capacity of 1.5 million BPD and product demand of 1.9 million BPD, the country is forced to import products. Exacerbating this imbalance is a sharp reduction in refining utilization rates since early 2014. In the first half of 2014, rates were generally between 70% and 80%, but dipped below 50% in the second half of 2016. The downward decline in utilization rates correlates with the increase in imports from the U.S. (Figure 3).
To combat the downward trends in the petroleum industry, the Mexican government has committed itself to a reform program. Initiated in 2014, the intention of the initiative is to revitalize the domestic upstream and downstream sectors. A significant component of the program is to allow foreign investment which will bring much needed capital. This is already being seen in midstream infrastructure projects. TransCanada is building a major natural gas pipeline from Tuxpan to Tula, while TransMontaigne/Magellan and Howard Energy Partners are progressing pipeline and terminal operations in Northern Mexico.
“And the Boss is a Cat Named … Donald.”
The wild card in this mix is the new Trump Administration. Mexican trade became a frequent topic in the election and relations between the U.S. and Mexico have only deteriorated since the inauguration. The U.S. imported nearly 600 MBPD of crude from Mexico last year, nearly offsetting the 844 MBPD of petroleum products which were exported. Congress is currently negotiating a reduction in the U.S. corporate tax rate and is seeking alternative revenues to replace the reduction in corporate taxes. One such measure being discussed is a Border Adjustment Tax. Historical import duties have generally had adverse economic impacts. A misstep in trade policies could result in serious ramifications for both the U.S. and Mexico.
Due to the time and space limitations of a weekly blog, our discussion today on the very wide-ranging and critical developments taking place in Mexico and the implication of those to the U.S. refining industry is at a pretty high level. TM&C does this analysis at a deeper, quantitative level in our recently released 2017 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. Market, policy, demographic and technology developments 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. For more details about either of these publications or other TM&C services, please visit our website or give us a call.