Hooked on a Feeling, High on Believing

 

The holiday hangovers have subsided and a few of us are still keeping up with those New Year’s resolutions: eating right, exercising, and believing that 2018 can deliver on the promise of Mexican energy reform. Despite the Alberta Clipper dropping an arctic blast on the US, today’s Market Update takes a look at some pretty hot topics. Let’s jump in.

 

Stop the Presses!

Retail fuel prices across Mexico have crept up by almost a peso per liter. Meanwhile, the exchange rate has pulled back under 19 versus the dollar, and last Friday saw a reduction in the IEPS tax rate. What does all this mean? A more favorable economic climate for US firms operating south of the border. So how did we get here? Is Pemex playing nice, or is Mexico feeling a pinch on supply?

Well, we know that Pemex is in business for Pemex so we’d have to presume that Mexico’s recent economics reduced the volume of exports, thereby squeezing the country’s supply of refined product. Mexico and the US have an inter-reliant partnership in maintaining the balance of supply and demand, and these developments shift the scales back to a more balanced position. While margins will fluctuate, equilibrium will be maintained by tweaking the various components that make up the pricing equation.

 

Refining Deal

After years of looking, Pemex finally appears to have found a financial partner to support the installation of a coking unit at the Tula Refinery in Hidalgo. Although a final agreement hasn’t yet been signed, reports indicate that Japanese conglomerate Mitsui will join Pemex in the $2.6 billion dollar project. The Tula refinery is already Pemex’s second largest facility, and is capable of processing 315,000 bpd, though current rates have been closer to 220,000 bpd. Upon completion of the project, Tula’s gasoline production is expected to increase by 40 percent.

This development is significant for a number of reasons. Mexico has been shopping investment opportunities for years, with scant interest from the international market. After all, why should global refiners partner with Pemex when margins are so good on the export side? Furthermore, the six Pemex-owned refineries are in dire need of investment just to stay operational, much less equipped to deliver higher value goods such as gasoline, diesel, and jet fuel.

Pemex will be looking for Mitsui to finance the nearly $1.3 billion still required to complete the refinery’s modernization. The upgrade is expected to be complete by 2021, and if successful, the facility will account for an incremental increase of 30-50,000 bpd of gasoline. That’s great, but in the grand scheme of things, Tula’s expanded capabilities will have little impact on the interest of foreign investors.

And let’s not forget: With three years to completion and no signed agreement in place, there are still plenty of hurdles that could trip up Pemex’s plans.

 

Brent/WTI Rally

These updates typically focus on gasoline and diesel, but let’s not forget that crude is the driving input when it comes to the price of refined petroleum products. With that in mind, did anyone notice that Brent stepped over $70/barrel, with WTI right behind it at $65? Prices on both have enjoyed a slow, steady and stealthy march upward over the last six months. If you’ve been paying attention, you already know that these are highs we haven’t seen since the end of 2014. Not too shabby when you consider that two years ago we were living in a reality of $30 barrels.

So what does it mean? As the feedstock for refining, the realized price for all finished products is driven by the cost of crude. On a larger scale, the depth of the financial constraints that bind Pemex can be materially altered by the price of crude. The primary component of top line revenue in crude oil production is the price of crude oil. Theoretically, a rally in the price of crude oil frees up capital for investment in drilling, maintenance, and infrastructure development. Of course, it’s important to remember that Mexico employs substantial hedging on their expected production, making the real impact of this incremental revenue a bit harder to calculate

Will OPEC continue to comply with their reduced production agreement? Will the US shale boom deliver meaningful supply? Is global demand back to driving price? Time will tell, but I’m optimistic. $100/barrel optimistic? I wouldn’t say that … yet. But you can bet I’ll be tracking it.

Keeping tabs on the price of crude oil and other macro factors can shed light on the policies and practices that will influence the market today and in the months and years ahead. 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 Operations