By Robert Auers and John Auers
ZZ Top’s First Album (Yes, that was the name of the album for those who didn’t already know), released in 1971, established the band’s distinctive Southern hard rock/blues sound and their lightheaded, quirky, and, sometimes, brash attitude. Still, only reaching 201 on the U.S. charts, it failed to produce the commercial success of many of their later albums. Yet, it paved the way for their future success, which really began in earnest just two years later with the release of Tres Hombres, which contained one of their most well know singles, La Grange. Perhaps the recent reforms in the Mexican energy industry can have a similar effect on their oil and gas sector and spur a turnaround not only on the upstream side, but in the downstream as well. Alternatively, they could encourage an increased reliance on U.S. Gulf Coast refineries to meet growing Mexican product demand as Pemex begins to focus increasingly on profitability above throughput. We discuss more below.
“There was trouble on the rise”
The problems surrounding the Mexican refining sector are nothing new. We wrote about them earlier this year in our “Down in Mexico” blog; however, we felt it apt to return to the topic given the sector’s continued (and worsening) struggles this year. Furthermore, as the leading destination for U.S. product exports, Mexican refinery performance is particularly important to U.S. refiners, especially those on the Gulf coast. As we’ve discussed before, the U.S. has gone from being the world’s largest product importer in 2005 to the largest product exporter by many measures. The total shift in net product exports has amounted to over 5 MMBPD, with growing product shortages in Mexico and the rest of Latin America playing a huge part in this development. While growth in demand has played an important role, the inability of refiners in Latin America to either build new capacity or efficiently operate existing facilities has been even more compelling. Perhaps nowhere is this more evident than in Mexico, the largest recipient of U.S. refined product. The graph below illustrates Mexico’s refining woes over the past few years, with utilization falling from roughly 80% in 2013 to about 55% so far this year. Moreover, utilization in September (the most recent month for which data is available) fell to just 40%, largely a result of operating issues at the 330 MBPD Salina Cruz refinery (Mexico’s largest) caused by tropical storm Calvin (in June) and the September Chiapas earthquake. The U.S., meanwhile, has taken advantage of the situation by increasing product exports to Mexico from just 531 MBPD in 2013 to about 1 million BPD so far this year. Mexico’s total net imports of petroleum products have increased from just 324 MBPD in 2014 to 585 MBPD so far this year, with September 2017 hitting a new all-time high of 850 MBPD. Refinery Utilization in the U.S. (not shown) has averaged roughly 90% over this same time period with relatively little variation, barring typical seasonal fluctuations or short term weather impacted situations.
“But it looks like I’m singing the same old song”
We’ve expressed before why we believe in the continued competiveness and success of United States Gulf Coast (USGC) refineries, but we’ll do it again here.
One excellent example of the resiliency of the U.S. refining sector compared to that of Mexico (and most of the rest of Latin America and the world) is their respective responses to recent natural disasters. The U.S. Gulf coast, of course, was devastated by Hurricane Harvey in late August and early September. At the peak, approximately 4 MMBPD (~23% of total U.S. capacity and 44% of USGC capacity) was offline around August 29-September 3. However, despite large scale flood damage at some facilities, the amount of offline capacity was cut in half by the middle of September, and by the first week of October there were very limited ongoing capacity outages or reductions relating to Harvey. The Salina Cruz refinery in Mexico, meanwhile, was damaged by tropical storm Calvin, which brought heavy rains and flooding in mid-June. As a result, the refinery remained down for the remainder of June, all of July and ran at less the 40% of capacity in August. On September 7, the refinery was once again heavily damaged by the Chiapas Earthquake and forced to shut down. Pemex originally planned to restart the refinery during the third week of October, but due to aftershocks brought about by the original quake, was unable to do so. Pemex reportedly began a “gradual” reopening of the facility on October 31; however, it appears that the refinery will continue to operate at reduced rates for some time.
These two anecdotes likely speak more to the resiliency of the U.S. industry than to the inability of the Mexican one. The Salina Cruz refinery was put in an especially difficult situation, being hit by two major natural disasters in less than three months. Moreover, the U.S. refining industry is, as we’ve expressed before, exceptionally efficient and opportunistic. As the refinery outages relating to Harvey caused a blowout in margins, free-market economics kicked in, incentivizing refineries to start up a quickly as possible. In addition, the abundance of engineering expertise and skilled labor available to USGC refineries allowed them to expedite startups and resume operations much more expeditiously than in Mexico.
The advantage of USGC refineries over those in Mexico is further illustrated by their superior capabilities as measured by their downstream upgrading capacity and complexity. While most USGC refineries have seen significant upgrades over the past 20-30 years to provide 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 USGC refining complexity to that in Mexico. We should note that the data for crude runs, utilization, and yields are for 2016 and it is likely these will all see declines in 2017.
“It’s been the same way for oh so long”
The energy industry in Mexico – from wellhead to product marketing/retail – pretty much operated the same way for a long time due to Pemex’s government mandated monopoly on all segments of the oil and gas industry; however, this all began to change in 2014 and 2015 with the new energy reforms. These reforms led Pemex to focus more on profitability and long-term sustainability than on short-term absolute volumes and throughput; and this, at times, encouraged a decrease in utilizations at Mexican refineries. As mentioned before, these refineries generally lag their U.S. peers in regards to coking and cracking capacity. Furthermore, Mexico (and the rest of the world) has been shifting away from fuel oil as a power plant fuel, and this, combined with a heavying of the crude slate, has caused a surplus of fuel oil throughout the country and made it unprofitable to run some Mexican refineries at maximum throughput rates. The way to fix this problem would be to install upgrading capacity, but Pemex currently lacks the capital and ability to do so. Moreover, outright sales of these refineries to other firms who do have the resources seems unlikely at present due to possible labor union objections, risks associated with operating a refinery Mexico (since no one besides Pemex has done so in 75 years), and the desire of many in the government to continue to control the Mexican refining sector. Furthermore, greenfield refinery construction seems unlikely as well, due to high costs and the ability to expand plants (if needed) in the well-established USGC to meet Mexican demand. Thus far, the preferred method of exposure to petroleum products in Mexico by foreign firms has been entry into the marketing and retail space, as several major foreign firms (including Exxon, BP and Tesoro/Andeavor) have already began or announced plans to begin operating in this space.
“So hand in hand we walked along”
Going forward the operation of Pemex’s refineries will depend largely on the future of government policy. The Mexican refining sector has struggled to keep pace with that of the U.S. and, as a result, has become even more dependent on U.S. imports of petroleum products. Unless Pemex is able to upgrade its plants and significantly improve operational efficiency or sell its refineries to a willing and capable buyer, we don’t foresee a major change in this relationship soon. Another possible wildcard is the eventual fate of NAFTA, but for now at least, talk around this area has been relatively subdued. A major policy change here, however, could have profound effect on the energy trade between 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 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 at 214-754-0898.