Oil reform could jumpstart Mexico’s refineries

Changes that Mexico’s president is proposing for the nation’s oil monopoly aim both at reviving slumping production and at stanching multibillion-dollar losses in the Mexican refining sector.

President Enrique Peña Nieto unveiled a proposal last month that would allow some direct foreign investment in projects of Petróleos Mexicanos, or Pemex. The notion is sensitive in a country where ownership of oil resources has been central to national pride and identity since Mexico ousted foreign oil companies and nationalized the industry in 1938.

While much of the focus in discussion of the president’s proposals has been on the possibility of opening exploration and production to international money and technology, the new rules also could reshape Pemex’s downstream operations as Mexicans demand more fuel than their refineries can deliver.

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The dilemma is complex: The technology-driven boom in U.S. oil production has provided new sources of crude for U.S. Gulf Coast refineries that have been among the biggest customers for Mexican oil.

And that competition from the north will get fiercer as more crude reaches the Gulf Coast from Canada’s oil sands — especially if the Obama administration approves TransCanada’s proposed Keystone XL pipeline over fierce objections from environmentalists.

“The energy revolution that has taken place in North America holds enormous consequences for the Mexican energy sector, in showing how Mexico’s oil and gas need to be put into a global context,” said Duncan Wood, director of the Mexico Institute at the Woodrow Wilson International Center in Washington.

Aging refineries

Mexico faces increasing competition in trying to sell its oil, yet it lacks the capability to make immediate use of it at home. Pemex’s six refineries can process 1.54 million barrels per day — almost a million barrels less than Mexico’s daily crude oil production of 2.45 million barrels.

What’s more, the refineries are aging, inefficient and ill-equipped to handle the heavy oil called Mayan crude that Mexico’s offshore wells produce.

U.S. coastal refineries, by contrast, are designed to process heavy crude, meaning they can do it more economically than the ones on the other side of the Gulf, said Roger Ihne, a partner and mid-America oil and gas client portfolio leader at Deloitte.

“When you have a huge fixed investment and are running it at 80 percent efficiency, the economics are not as attractive,” Ihne said.

The refineries lose about $6.5 billion dollars a year, resulting from both gasoline subsidies and inefficiencies with the dated technology, Wood said.

Pemex plans a record $25.3 billion in capital investments this year, but most of it is slated for upstream activities, with only 17 percent earmarked for refining — a smaller share than the previous year, said  Ernesto Marcos, founder of the energy consulting firm Marcos y Asociados and former chief financial officer of Pemex.

Overseas capital

Overseas capital could flow into Mexico’s refineries under Peña Nieto’s proposals.

Among other things, his plan would open the downstream sector to foreign investment in refinery upgrades that could relieve Mexico’s need to export its oil to the U.S. for refining and import gasoline from north of the border.

“A lot of folks are focused on the upstream, in terms of what it is going to mean for production of crude oil,” Ihne said. “A more salient issue is that he is going to liberalize a lot of the midstream and downstream sectors. Depending on how those rules are written, midstream and downstream players could see a much different competitive environment.”

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A different model could affect what oil Mexico keeps, what it sells, and where the oil is refined.

Pemex prefers to export its most desirable oil, leaving the harder-to-refine crude for its domestic refineries.

“Pemex sells whatever they can sell at the highest price on the international market, and then they send Pemex refineries what they have not been able to sell adequately outside,” said Marcos, the energy consultant.

Because Pemex refineries give preference to Mexican oil, they end up with lower grade crude that contributes to their inefficiency, Marcos said.

And needed maintenance and repairs often are delayed because Pemex’s state ownership ties it to a government bureaucracy that is slow to approve expenditures.

Labor contracts

Meanwhile, labor union contracts require Pemex to use more personnel than at comparable U.S. operations, further reducing efficiency, Marcos said.

Among Peña Nieto’s proposals are a restructuring that would separate Pemex’s upstream and downstream operations — a move supporters believe would encourage the two entities to compete internationally.

The proposals are controversial, including a constitutional change to open the sector to international investors for the first time in decades.

Two of the three major political parties — Peña Nieto’s Institutional Revolutionary Party and the conservative National Action Party support the proposal, and together form the needed majority vote in Mexico’s Congress to amend the constitution.

The leftist Party of the Democratic Revolution organized protests in Mexico City earlier this month, saying that the constitutional change will lead to privatization and oil profiteering by foreigners.

Lawmakers are scheduled to debate the proposals this fall.

In the meantime, though, the refining arm continues to struggle and an initiative to modernize has faltered.

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In 2009, Peña Nieto’s predecessor, Felipe Calderón, announced plans to build a refinery in Tula to process up to 300,000 barrels a day of Mayan crude. But the project, which would have been Mexico’s first new refinery since 1979, has bogged down in Pemex’s bureaucracy and budget overruns that have driven its price to more than  $10 billion, Marcos said.

The U.S. refining  industry also faces regulatory hurdles, however, and the Gulf Coast hasn’t seen a new major refinery built from the ground up since 1978.

That could make Mexican refining attractive to some foreign investors if Peña Nieto’s proposals take effect. Advantages include a local crude supply, easier permitting process and growing local demand for refined products.

Alfred Luaces, senior director for oil markets research at IHS, said Mexican refining probably won’t draw much interest from U.S. refining powerhouses such as Marathon Petroleum, Valero or Phillips 66.

China’s interest?

But oil companies may agree to build refineries as part of a broader deal with Mexico in order to gain access to crude resources, Luaces said.

“Countries like China that want to get access to the resources, might buy a refinery or build a refinery as part of a broader deal to gain access to the crude resources, which is what they really want,” Luaces said.

Modern refineries could help reduce Mexico’s gasoline imports — which have reached 680,000 barrels a day to meet the demand of its growing middle class.

“It is clear that Mexico needs more refineries,” said Gabriel Salinas, a Mexican attorney with Mayer Brown currently based in Mexico City. “Mexico has become a net importer of refined products and natural gas. It’s a tremendous paradox, when you think about Mexico’s status as one of the largest crude oil exporters and the reserve potential that it has.”