Investment Opportunities in the Mexican Midstream

Summary: We present a glance of the Mexican midstream following Mexico’s Energy Reform; traditionally closed upstream has drawn a lot of attention from foreign investors; however, the midstream which received less attention, could be significantly more dynamic in the following years with an outstanding potential for investment opportunities.

 

Investment Opportunities in the Mexican Midstream

 

Mexico’s Energy Reform was a game-changer that marked the beginning of the end of a 75-year-old monopoly in the oil and gas industry, and a 53-year-old monopoly in electricity. The Energy Reform opened up the country’s coveted upstream sector to investors.

After Round Zero gave PEMEX (the Mexican NOC) 83% of Mexico’s 2P reserves, and 21% of 3P reserves, Round One begun. So far, Round One has included two tenders for Exploration and Production (E&P) in shallow waters, and one tender for on-shore production.[1] Oil Majors are expected to participate in the fourth tender of Round One to take place in December 2016, where deep water fields will be offered.

Round Two will include the Burgos area, an extension of Eagle Ford with potential for unconventional production. However, only 14 blocks will be offered – down from 70 originally planned- amid low oil prices. [2],[3] The conditions for this tender are expected to be published in July 2016, while the rest of the areas will not be offered until 2018 – coincidently with the end of the incumbent presidential tenure.

The traditionally closed upstream drew a lot of attention from foreign investors; however, it is unlikely to show additional dynamism in the short run, or at least not before 2018. On the other hand, the midstream which received less attention, will be significantly more dynamic in the following years with an outstanding potential for investment opportunities. Since January 2016, PEMEX and private firms that seek to provide storage, transportation and distribution of fuels in Mexico can follow the guidance of Comisión Reguladora de Energía (“CRE”), the Mexican Midstream regulator.

 

Fuel supply and demand mismatch, an opportunity for importers   

 

Mexico’s demand for gasoline has grown steadily and is expected to continue. The main driver of gasoline demand is the increase in vehicles. Lack of quality public transportation has spurred car sales, especially in the big cities. Meanwhile domestic gasoline production is not expected to keep pace with demand, thus increasing the level of imports – Mexico currently runs a trade deficit of fuels (see Figure 1).

The slower expansion of domestic fuel production can be explained by two factors: The first is the decline in oil production, going from 3.4 million barrels per day (MMb/d) to 2.4 MMb/d between 2004 and 2014, caused by a reduction in Cantrell oilfield output, and mitigated to a certain extent by Ku-Maloob-Zaap larger production.[4] The second factor is the lack of refining capacity to supply the domestic demand.[5]

The mismatch between production, refining capacity and demand resulted in an increase of fuel imports –almost half of the demand is met with imported gasoline. In fact, Mexico has become one of the largest importers of refined products in the world.[6] This has strengthened bilateral energy integration as most of Mexico’s gasoline imports come from the U.S., and Mexico accounts for about half of all U.S. gasoline exports.[7]

 

Figure 1. Gasoline demand in Mexico (Mb/d)

Midstream Chart 1

Source: SENER. *Projected

 

One change that resulted from the Energy Reform is that private firms can import fuels. Although this was not planned until 2017, since April 2016 private firms can join the fuel import market independently from PEMEX. The Mexican government has a long history of excised tax (“IEPS”) on fuels that served as a subsidy during years of high oil prices.

Additionally, inefficiencies in Mexican refineries made their production more expensive than imported fuels. For a long time, subsidies and inefficiencies were a burden on the Government’s budget. Thus, accelerating the liberalization of imports is a policy that eliminates these distortions, eventually allowing consumers to face free market mechanisms, specifically when prices are completely liberalized in 2018.

Meanwhile private firms that obtain a permit from CRE to import fuels will have to set the price within a band (i.e. fixed price floor and ceiling). During 2016, the average gasoline price band range is MXN 84 cents per liter (roughly $0.18 USD per gallon).[8] Some private firms will be able to make a profit in gasoline imports and retail with this range. In fact, companies have already entered this market and were granted permission to import and establish service stations to compete with PEMEX. Gulf Oil, as an example, was granted a 16,249 million liters per year permit – the largest permit granted to a private firm so far.[9] By June, 51 firms were authorized to import more than 50,000 million liters of fuel; this exceeds the total amount of gasoline both produced and imported by PEMEX during 2015.[10]

 

Saturation in storage and transportation, an opportunity for investors

 

Another relevant investment opportunity includes building up additional storage facilities and pipelines. Due to capacity saturation in transportation and storage of fuels, inadequate infrastructure is an obstacle for the potential development of imported gasoline and diesel in Mexico. Most of the transportation of gasoline and diesel is done through pipelines, and to a lesser extent through tanker trucks and rail tank cars. There are 8,958 km of pipelines for fuels divided in 55 sections, only one section has a capacity use under 90%.[11] Additionally the West Coast, the South and the Southeast have smaller pipeline penetration with major potential for investment. (See Figure 2.)

As in most places, it is more economical to move hydrocarbons through pipelines. In the Mexican case, the average cost of moving a barrel of gasoline is USD $6.50 via tanker truck, while it is only USD $0.90 if moved through pipelines.[12] This has a direct impact on the profitability of gasoline imports, making investment in pipelines necessary. Pipeline investment is open to private firms but is still regulated by CRE. Specifically, potential investors will need a permit to construct and operate the pipelines, bearing the cost and obtaining the right-of-way.

Foreign Private Equity (“PE”) investors are partnering with local firms to allocate capital in pipelines. KKR, a multinational PE firm, has committed capital to a Mexican independent midstream company (Monterra Energy) to build an 18 inch in diameter pipeline to move up to 165,000 barrels of fuels per day, mostly gasoline and diesel –this represents over 10% of domestic demand for gasoline. The pipeline will connect Tuxpan, Veracruz, in the Gulf of Mexico, with Tula, Hidalgo, in Central Mexico. The strategic location will facilitate gasoline imports from barges in Tuxpan and distribution in Tula – a major hub where the biggest refinery is located. The pipeline project will include G500, a gas station consortium, and a “leading global commodities merchant”, as off-takers for 100,000 barrels per day.[13] The 65,000 remaining will be allocated through the open-season approach (also regulated by CRE). KKR allocated USD $1.35 bn for this and other projects.[14]

 

Figure 2. Pipelines and Storage shortage in Mexico

Midstream chart 2

Source: CRE

 

Finally, fuel storage is another identified attractive investment opportunity for small to medium sized private investors, considering that building a storage facility is relatively fast and inexpensive compared to pipelines. There are currently 77 fuel storage centers (“TARs” in Spanish) and 15 marine terminals serving over 11,000 gas stations. Some have a capacity storage equivalent to less than 2 days of service, while most of TARs’ capacity is under 6 days (See Figure 2.). U.S. storage centers have a minimum of 90 days and in France this figure is 98 days.[15] The fuel storage market has a free entry policy for private parties, requiring a permit from CRE and from the recently created Energy and Environmental Security Agency.

The first privately owned storage facility was announced on March 2016; a $60 million investment that will have an initial 300,000 barrel capacity. It will be located in an industrial hub in San Luis Potosi and will be sourced through rail tank cars and tanker trucks. The area for the facility is smaller than 125 acres and is planned to have a 1.2 million barrels total capacity.[16]

In fuel storage private investors will need to compete with PEMEX’s facilities; however, private companies will likely exhibit a more dynamic behavior regarding capital allocation. The last storage facility built by PEMEX was completed in December 2015, a year later than scheduled and included an unplanned location change. The facility was created in the southern state of Chiapas – one of the poorest states in Mexico- and will have a 65,000 barrel capacity in 85 acres.[17] As with storage, an additional concern for private investors for pipelines and fuel imports will be PEMEX competition; but also hydrocarbon theft – over 7 million barrels worth USD $850 million are stolen each year.[18]

 


LATAM PM´s Take: Exploring the midstream in Mexico might seem unorthodox, but returns are more predictable and within a shorter timeframe than the upstream. The relevant upstream investments, particularly exploration of deep waters fields, will require a considerable amount of capital, or will have to take longer to develop, particularly for unconventional production. In contrast, the midstream timeframe to invest will be the following years and the required capital is less demanding. Mexico is the twelfth-largest oil consumer in the world, and gasoline accounts for almost half of its oil consumption; a large market that is finally open to private investment.[19] Imports of gasoline, investment in pipelines and storage will certainly be needed as demand is likely to continue expanding. Moreover, the examples provided show that Mexico’s midstream has attractive conditions for investors.

The Energy Reform has been the flagship of the current presidential administration. There has been great effort to provide transparency, and sound regulation is in place but is not excessive to deter investment. Although CRE should be the only regulator for midstream, several authorities have a say, including the Ministry of Energy and the Ministry of Finance. It is likely that this will be the only aspect of the Energy Reform that the current administration will be able to show off. Thus, the authorities will have to coordinate to set the conditions that maximize investment. As a result, investors will face a sound but flexible regulation in one of the largest midstream markets in the world.

Analyst: Andrés Hernández

@andreshf5

Contact:

ahernandez@adinenergy.com

info@adinenergy.com

[1] SENER (2015, June 18). Avances de la Reforma Energética. Ronda Cero.

[2] Meana, S. (2016, June 8) Lanzarían la convocatoria de la Ronda 2.1 en julio. El Financiero

[3] Montes, J. (2015, April 27) Mexico Plans to Cut Scope of Shale Tenders. The Wall Street Journal

[4] Lajous, A. (2014) The Mexican Energy Reform of 2013. Center on Global Energy Policy, Columbia University

[5] Secretaría de Energía: Prospectiva del Mercado de Petróleo crudo y petrolíferos 2015-2029.

http://www.gob.mx/cms/uploads/attachment/file/44327/Prospectiva_Petroleo_Crudo_y_Petroliferos.pdf

[6] Ramiro, M. (2015) Mercado de líquidos en México. Comisión Reguladora de Energía (CRE)

[7] Montes, J. (2016, May 17) Mexico’s gasoline demand is growing strongly: Kemp. Reuters

[8] Acuerdo 24/2015 Mexico’s Official Journal.

[9] Meana, S. (2016, June 5). Quieren importar más gasolina que Pemex. El Financiero

[10] Ibid.

[11] Ramiro, M. (2015) Mercado de líquidos en México. Comisión Reguladora de Energía (CRE)

[12] Carriles, L. (2015, June 1) Acotan transporte de gasoline por ductos. El Economista

[13] Business Wire (2016, March 17) Monterra Energy Announces Strategic Pipeline Project in Central Mexico

[14] Carriles, L. (2016, February 11) Fondo KKR viene a hacer negocio en ramo petrolero. El Economista

[15] Meana, S. (2016, March 7). México sólo almacena gasolina para dos días. El Financiero

[16] Garcia, K. (2016, March 16). Pemex tendrá competencia en almacenamiento. El Economista

[17] Zúñiga, R. (2015, December 29). Lista la TAR de Pemex en Puerto Chiapas. OEM

[18] Monroy, J. (2015, August 4). El robo de hidrocarburos cuesta 15,300 mdp al año. El Economista

[19] Montes, J. (2016, May 17) Mexico’s gasoline demand is growing strongly: Kemp. Reuters

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