DOWNSTREAM INVESTMENT IN MEXICO – OPPORTUNITIES & RISKS

Authors: George Baker and Sam Davis

AMLO’s Response to Gasoline Theft Crisis

Mexican President Andres Manuel Lopez Obrador (AMLO) made headlines on December 27, 2018, by announcing the shutdown of pipelines connecting product terminals to retail stations in response to the growing issue of rampant fuel theft in the country which has led to tragic consequences including the deadly explosion this past weekend that claimed the lives of at least 85  persons and dozens more injured or missing.

In this week’s edition of our blog, we feature insights from George Baker, who is part of our team assessing opportunities and risks in Mexico on the gasoline theft issue. George is a highly regarded industry expert in policy and market analysis, having covered Mexico’s energy markets for more than 30 years.

The extent of fuel theft in Mexico

The origin of the gasoline shortages in Central Mexico has been attributed to criminal activity that has damaged Pemex’s distribution system, but the criminal activity associated with gasoline theft occurs at all levels of government, including agencies responsible for its prevention and prosecution. In this portrayal of the problem, pipeline theft of gasoline may account for only 30% of the total volumes illicitly appropriated (Figure 1), while the pipeline sabotage and break-ins account for the major portion of the losses. One industry observer noted that pipeline-related losses could account for 80% of the total.  Absent the publication of statistics about the method and place of the criminal activity, progress in abating theft in one locale and by one method does not provide an accurate measure of the overall reduction in gasoline theft. The government parades the figure of refined product losses to Pemex at MX 65 billion pesos or about US$3.4 billion dollars but does not further specify if this figure refers only to products at their current market prices or whether it includes products plus the collateral clean-up and repair costs associated with their theft. The percentages shown in Figure 1, if applied to this aggregate cost, would give hypothetical figures for losses by type of criminal activity.

Fuel Shortage Problem                                                                                                                                             

Since announcing the shutdown of product pipelines in late December last year, there have been widespread fuel shortages in the Central and Western regions where retail stations have run out of fuel from low inventories. Meanwhile, the AMLO administration appears to be standing by its decision and resisting pressures to reopen pipelines until the issue has been resolved. According to AMLO, the strategy has been met with some success with fuel theft down to 3,400 barrels per day (b/d) from over 100,000 b/d prior to his administration. Pemex has been increasing fuel distribution with trucks but faces logistical hurdles in efficiently delivering gasoline to retail stations. Mexico, in 2018, distributed 76% of its fuel by pipeline and 12% by over 15,000 fuel trucks. To supply the country’s total demand, Pemex would require 110,000 fuel trucks, which would necessitate the need for expanded logistics infrastructure to overcome episodes of fuel shortages. It appears that until logistics infrastructure is expanded, we could see the fuel shortage situation continue as long as the strategy employed by the AMLO administration remains in place.

Investment in Infrastructure Needed

Exacerbating the issue further is the lack of sufficient terminal storage capacity needed to mitigate supply disruptions. Mexico’s Central and Western regions have 11 and 10 inland terminals, respectively, that are mainly supplied via pipelines, with fuel storage capacity in both regions of 2.5 million barrels of gasoline, diesel and jet fuel. Additional terminals are being built with three  under construction in Western Mexico with a storage capacity of 1 million barrels and 12 terminals capable of storing 9 million barrels in Central Mexico. While this is a positive sign, these projects are funded by private investments and not by Pemex. The price of a 1 million barrel storage terminal in Ensenada, Mexico, is $130 million, while a similar sized terminal in Sinaloa, Mexico, is $150 million. By comparison, Pemex announced a capital budget of $60 million for logistics projects in 2019 making it difficult to undertake such projects on its own. The new government could help to advance these and new storage projects by streamlining the regulatory process, assisting developers to gain social support and raise investment certainty though there is concern from investors that contracts could be modified under social or political pressure.

Implications for USGC Exports

Meanwhile, USGC refiners have been monitoring this situation in Mexico with great interest, given that more than half of all gasoline exports are destined for Mexico. U.S. Gulf Coast Crack spreads have weakened in the weeks since the theft prevention policy went into effect, as lower domestic demand from Mexico and the supply shortage situation have put pressure on margins. This has exacerbated an already challenging gasoline market in the U.S. with high inventories and seasonal demand resulting in weak crack spreads. The pipeline shutdown has caused logjams at the Mexican ports as gasoline deliveries have been interrupted. With AMLO promising a fight to end gasoline theft, the pipeline shutdown could continue until the administration determines the issue is under control. With the regional markets so saturated, USGC gasoline exports may have to chase more distant markets in order to clear high inventories.

As of last week, the AMLO administration has relaxed its position a bit by slowly reopening pipelines under strict military protection, while also increasing fuel truck deliveries. The government also announced the restarting of its 330,000 b/d Tula and 220,000 b/d Salamanca refineries which should also help alleviate the gasoline supply challenges. Both refineries mainly process light crude and had been shut down due to a lack of domestic light crude production, but will now begin to process imported light crudes in an attempt to boost refinery utilization from current rates of 30%.

TM&C will continue monitoring these developments in Mexico as part of a new offering to be launched in the coming months aimed at assessing the evolving downstream reform under AMLO (See our January 8, 2019 blog).  To help us provide cutting edge research that our clients would find insightful and facilitate decision-making, we have been requesting your feedback in a brief two-minute survey on areas of highest interest and relevance to you and your organization regarding policy and market opportunities in Mexico under AMLO. We have had great responses so far – so thanks to those who took the time to complete the survey. If you have not had a chance to fill out the survey, please follow this link https://www.surveymonkey.com/r/MexicoMarketResearchService to provide your feedback.