End of the Pemex monopoly in Mexico will challenge Canadian heavy in the Gulf Coast market

A Pemex petrochemical complex at Coatzacoalcos, in southern Mexico. Image: Pemex

Canadian oilsands and heavy oil producers have an advantage in gaining access to U.S.-upgrading capacity, but they will face increasing competition from Mexican heavy oil production now that energy reform in that country is moving forward, say experts on that reform.

Nicole Leonard, a Houston-based project consultant with Bentek Energy, a division of energy publishing and consulting firm Platts, says the firm's Mexican energy experts believe the reforms will lead to meaningful increases in Mexican oil production, a prospect that should be worrisome for landlocked Canadian producers.

"The export pipelines [including Keystone XL, Energy East project, the Trans Mountain Expansion Project and others] are vital for the sustainability of the oilsands," she says. "If [Canadian bitumen and heavy oil producers] can't get your oil out of Canada, oilsands producers won't survive."

Mexican oil production, more than half of it heavy, has declined from 3.3 million bbls/d in 2004 to just 2.42 million bbls/d. About 1.26 million bbls/d of that is heavy, 864,000 bbls/d is light and 299,000 bbls/d is extra light.Over the same period, while demand in the U.S. for heavy oil feedstock has continued to grow, U.S. imports of heavy crude from Mexico have declined by about 30 per cent, imports from politically troubled Venezuela have plunged to 650,000 bbls/d from more than 1.2 million bbls/d, and imports from Nigeria and other heavy oildominant producers have fallen as well.

That has proved to be a windfall for Canadian bitumen and heavy oil producers, who have seen their exports to the U.S. double from about one million bbls/d in 2009 to about two million bbls/d now.

Bentek says the majority of that heavy crudeabout one million bbls/dis being refined in the U.S. Midwest, while another 350,000 bbls/d is destined for the U.S. Gulf Coast, which arguably is the American market with the greatest potential to absorb even more heavy imports given its current coking capacity of 1.5 million bbls/d, with a projected growth to 2.5 million bbls/d over the next few years.

Current heavy oil coking capacity south of the border currently stands at about 2.7 million bbls/d, according to the U.S. Energy Information Administration (EIA).

With marginal domestic heavy oil production in the U.S.almost all of it in California, where there is coking capacity of about 452,000 bbls/dnew pipelines that will move Canadian heavy crude to the Gulf Coast will bump up Canadian heavy oil volumes to the Gulf Coast by about 350,000 bbls/d. This will include Enbridge's Flanagan South and Seaway lines.

Those heavy oil exports are crucial for Canadian oil producers, with the bulk of three million bbls/d of exports to the U.S. comprised of heavier grades, reflecting a dramatic increase in U.S. domestic light oil production in the wake of the shale oil revolution. According to the EIA, domestic U.S. production has grown from slightly more than five million bbls/d to about 9.3 million bbls/d since 2010, while imports have dropped from about 10 million bbls/d to about 6.7 million bbls/d.

In Mexico's New Energy Landscape, a wide-ranging, 20-page study on Mexican energy reform, Bentek says Canadian-focused energy producers in the midstream and upstream sectors, and those engaged in the power sector, need to understand that the reforms are happening now, and they will have a transformative impact on the Mexican economy and on all aspects of its energy and power sectors.

Maria Mejia, one of Bentek's analysts who authored the report, says the electricity reforms have already led to an investment of an estimated US$12 billion in natural gas pipeline projects (the company is tracking 22 new or expanded pipelines which import gas from the U.S.), as well as in gas-fired power plants.

Calgary-based TransCanada is one of the largest investors in that sector. The company owns pipelines that service the city of Guadalajara, which has a population of about six million. One pipeline serves the country's east coast and two more pipelines are under construction: one will serve the Pacific coastal resort of Mazatln and the other will serve the country's northwestern region. It is spending $2.6 billion on these projects, which will serve existing power plants burning bunker fuel, as well as other gas consumers.

Enbridge has also expressed an interest in investing in the pipeline and power sectors in Mexico.

PemexThe country's move to end the monopoly of state-owned Petroleos Mexicanos (Pemex) has gained widespread publicity, Mejia says, and underscores some of the problems Canadian producers are having in reaching export markets.

"It's going to increase the competition between Canada and Mexico," she says. "The delays in the [crude export] pipelines within Canada [including Trans Mountain and Northern Gateway are] being viewed as not being investor-friendly, while Mexico is being viewed as being open to foreign investment."

Pemex has already begun the process of selling off its assets. In late March, it announced the US$900-million sale of its 45 per cent stake in a gas pipeline to U.S.-based investment companies BlackRock and First Reserve.

In addition, it has revealed that it plans to sell a liquids pipeline that delivers gasoline and diesel fuel from the Gulf of Mexico to Mexico City, as well as another pipeline that is being built now to deliver natural gas from the Gulf of Mexico to the Oaxaca state.

Pemex owns a refinery in the city of Salina Cruz, where a $6-billion LNG plant is being planned, and the state-owned producer is thought to be actively seeking partners to develop the facility, which would likely be structured as a floating terminal.

However, there is skepticism about whether the country has enough natural gas to feed that plant, which would tap gas from Lakach, a new deepwater reservoir it is developing in the Gulf of Mexico. Pemex recently awarded a $290-million contract to a division of a joint venture project with Cameron and Schlumberger for the construction of a subsea production system.

Mexico produces about 6.52 bcf/d of natural gas domestically and will be importing 3.5 bcf/d from the U.S. once new pipelines come into operation.

Mejia believes Pemex will use the proceeds from the pipeline sales to join in the bidding this July on 14 offshore blocks in the shallow waters of the Gulf of Mexico that could potentially yield 125,000 bbls/d of crude oil production. It would likely partner with a firm from outside Mexico, she says.

An adjacent nine blocks will be made available in the fall, and overall, Pemex says it will tender up to 169 onshore and offshore blocks, some of which offer unconventional onshore reserves or deeper offshore reserves that are not considered as attractive as the shallow blocks. Taken together, the acreage being considered for tendering could yield production of 500,000 bbls/d or more.

While Mejia says Pemex will have a distinct advantage in any bidding for future blocks, the interest from others shows there's a high degree of confidence that the bidding will be open and fair.

"This is truly transformative," she says. "They are being forced to compete."

That competition will even extend to the petroleum-products area, in which Pemex has held an absolute monopoly with only minimal competition from companies selling lubricants and natural gas liquid fuels. By 2017, ExxonMobil, Chevron and other gasoline, diesel and petroleum product marketers, which now have a minor presence in the country, will be able to compete head-on with Pemex.

New competitionAlthough the timing of the reform is unfortunate, given today's low crude and gas prices, Mejia says the shallow offshore crude blocks will likely be developed over the next few years, providing potentially significant competition for Canadian heavy crude. They are a source of some of the world's lowest cost crude.

"The fact that there's so much interest doesn't mean there will be production soon," she says. "But we do anticipate there will be significant investment in the heavy oil areas. In the next five years the growth in [heavy oil] supply will come from Canada, but before the end of the decade it could come from Mexico."

Canadian producers may soon lose one distinct advantage they have over Pemex and Mexico's newly opened private-sector producers.

Currently, the U.S. and Canada trade freely in crude oil. Unrefined crude has been exported to Canada from the U.S. for decades, and occasionally some Canadian crude is exported internationally in exchange for U.S. crudea tolerated circumnavigation of the 1975 Energy Policy and Conservation Act, which severely restricts exports of U.S. crude.

However, in light of growing domestic oil production, many U.S. lawmakers want the restrictions lifted, starting with Mexico, which currently imports only refined products from the U.S., but through Pemex, is in talks with the U.S. Commerce Department to allow the trade of 100,000 bbls/d of light U.S. crude in exchange for 100,000 bbls/d of Mayan heavy.

About 70 per cent of Mexico's heavy crude exports go to the U.S. now, with 15 per cent exported to Europe and most of the rest to the Far East.

Bentek's project consultant Leonard says all of that heavy crude is shipped on tankers from one of three terminals, since there are no crude pipelines from Mexico to the U.S. But she says that shouldn't be construed as putting Mexican heavy oil producers at a disadvantage.

"Mexico's crude oil exports via tanker to the U.S. are actually very competitive," she says. "Bentek estimates Mayan crude costs less than $2/bbl to ship to the U.S. Gulf Coast and it takes only three days to transit. Bentek estimates that shipping costs from Canada to the Gulf Coast, via pipeline, can range from $8$12/bbl, depending on the structure of the transportation contract, while rail costs are around $15/bbl."

She says there's also a quality issue with Canadian heavy crude, since most of it is shipped with diluent, while Mayan crude is not mixed with diluent. Most refiners prefer not to have to separate diluent from heavy oil.

While existing proved oil reserves in Canada far eclipse those of Mexico (EIA estimates put Canadian reserves, including the oilsands, at more than 172 billion barrels against about 10 billion barrels in Mexico), Mexico also has a shale oil potential estimated at 13 billion barrels, ranked 18th in the world and greater than Canada's estimated nine billion barrels.

Despite the fact no shale gas wells have been developed in Mexico, it has estimated reserves of about 545 tcf, not far behind Canada's 580 tcf.

MidstreamCompetition with Canadian-focused producers aside, the Bentek analysts see many opportunities for midstream companies, the pipeline and power sectors, and in the petrochemical sector.

While Pemex dominates the midstream, petrochemical and refining sectors, all are also being opened up to private investment (although the analysts see minimal potential in the refining sector). The Comisin Federal de Electricidad (CFE) has similarly monopolized the electricity sector, although independent power producers (IPPs) have been allowed to own power plants and sell electricity directly to CFE since 1992. Under the relaxed regime, IPPs will be able to operate their own plants and market their own power directly to consumers, without going through CFE.

The analysts expect several gas-fired power plants, as well as wind, solar and other plants, to be developed by IPPs going forward.

Because Pemex has placed so little emphasis on natural gas development (most of its gas is associated with offshore oil production; no new gas facilities have been built in decades), the authors of Mexico's New Energy Landscape report believe there is potential in the country for more gas-processing investment.

"The midstream is an important sector for growth in the future," says Leonard, and that growth has already begun. The country's first greenfield steam cracker is now being built to process 60,000 bbls/d of ethane, which would effectively double Mexico's ethane demand.

Plenty of upsideWhile Bentek sees the potential for serious competition from Mexican heavy oil production, that view isn't shared by energy consultants Wood Mackenzie, who hold the opinion that Canadian heavy oil producers will have an entrenched position in the U.S. market, particularly on the Gulf Coast.

"The refineries [in the Houston area and elsewhere on the Gulf Coast] are some of the most complex in the world," says Afolabi Ogunnaike, a refining analyst at Wood Mackenzie. "There's going to be the need for this heavy oil."

Wood Mackenzie sees heavy oil upgrading capacity on the Gulf Coast rising to 2.5 million bbls/d and Canadian heavy oil producers dominating the market.

Venezuela, which is dealing with its serious economic problems by making more deals to sell its heavy oil production to China, is not likely to be much of a factor in the future, even though it sends about 623,000 bbls/d to the Gulf Coast now.

Pablo Medina, Wood Mackenzie's upstream analyst for Latin America, and Paul Pasco, its upstream analyst for Canada, say they can see Canadian heavy oil exports to the Gulf Coast reaching as much as one million bbls/d by 2020 as volumes from Venezuela and other countries continue to decline.

They say Mexican exports of heavy crude to the Gulf refineries could far exceed the 720,000 bbls/d currently being exported, but Medina hedges those bets somewhat, suggesting "there are uncertainties, but with plenty of upside."

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