Market Update: A Step Forward, Backward, and Sideways

 

 

College football season is officially over, and once again the Alabama Crimson Tide have come out on top. South of the border, however, a new season is coming: Open Season. That’s right — on December 18, Mexico’s CRE announced the return of open season auctions. Designed to encourage private participation in Mexico’s refined fuels market, the program allows foreign investors to gain access to a share of space in Pemex Logistica’s 60 terminal facilities and 27 pipelines.

The auctions will be conducted across the country’s 11 subdivided zones, and the first parcel was announced late last week. Comprised of infrastructure in northeast Mexico, including Monclova, Sabinas and Nuevo Laredo, the year’s first auction features assets totaling 410,000 barrels of storage capacity, as well as a 19,000 bpd of pipeline access that connects the Monclova and Sabinas facilities to Monterrey. Though the share of space that will be opened up for auction has yet to be disclosed, the process is set to kick off this week and the winning bidder will be revealed in mid-March.

The optimist views this announcement as the start of something great: A fast track to market access. They’ll expect rigorous competition for this first package of assets, especially given the Nuevo Laredo facility’s proximity to the US border and Corpus Christi.

The pessimist, on the other hand, will argue that the volumes, quality of assets and terms are not worth the headache that is required to overcome Pemex Logistica’s obstructionist leanings and minimal volumetric offerings. This conclusion supports the development of new, privately owned assets to service the market. In the long run, this is the end game objective.

Open season auctions were a prime topic of discussion for 2018 and we are encouraged by this early announcement, however things ultimately shake out. Adequate space on existing Pemex infrastructure will become available or it won’t. Either path will drive competition and press the market forward.

 

Tough Sledding

USGC prices for diesel have increased steadily since last summer, rising from roughly $1.60/gallon to nearly $2.00/gallon for ULSD. Harvey had an impact on supply, but even as online refining capacity has returned, prices continue to trend upward. Meanwhile, south of the border, the Peso has switched its course, climbing back over 19 versus the dollar.

These are both macro conditions, and seasoned energy traders have the tools to comfortably manage this risk. More concerning are the less standard actions of the controlling entities in Mexico. Pemex has set the VPM / refinery rack prices fairly flat over the last few months and the wildcard IEPS deduction is trending slightly upward.

All together this equates to higher supply costs and lower destination prices. While there may be a squeeze on the arbitrage of US exports to Mexico, our outlook remains bullish over the long term. Energy markets are a complex animal, and Mexico is a prime example. At the end of the day, success can only be achieved if participants commit through the ups and downs.

 

Keeping an Eye on IEPS

2018 is an incredibly important year for Mexico’s fuels market, and the country’s ability to attract foreign participants and develop sustainable non-Pemex offerings will largely determine the success or failure of its historic energy reforms. Despite the importance of this time, one wildcard variable still has investors worried: the IEPS tax.

The CRE raised the IEPS tax rate on regular gasoline, premium gasoline and diesel approximately 6.5 percent, to 4.59, 3.88 and 5.04 pesos per liter, respectively. From 30,000 feet, the changes are pretty vanilla, and Mexico will continue to modify the IEPS deduction on a weekly basis (cringe!). Clarity comes in small bites sometimes, and it may take time to digest what the recent revisions will ultimately mean to Mexico’s gasoline and diesel market.

So for now we’ll consider these modifications a step sideways. The IEPS is a floating adjustment that was intended to stabilize prices for the Mexican consumer. Though well intentioned for the consumer, this policy is a burr in the saddle of new market participants, as it complicates their ability to analyze economic conditions and make capital investments.

As a friend of mine always says, the fastest way to a free market is to let the market be free. Once the government removes the manipulation of the IEPS tax as a buffer for the price of fuels the market will take a large stride towards providing a freely priced product. Interested in getting in on the ground floor of the Mexican fuels market? Click here to contact our international markets team.

 

Best,

Chad Smith
Senior Vice President of Terminal Services