This is Blog #1 in our series of blogs over the 45 days on overlooked “Lasting Changes To Oil & Gas”. The brutal Q4 to date for oil and gas investors has led to a flight of capital and meant there are overlooked lasting change items (both positive and negative) that are reshaping the 2019 to 2025 outlook for oil and natural gas. Declining Venezuela and Mexico oil production and exports to the US has directly led to increasing Cdn oil exports to the US. Blog #1 in this series is how the election of Andrés Manuel López Obrador as President of Mexico and his priority on fixing/upgrading Mexican refinery operations is an added plus for Cdn heavy/medium oil. AMLO’s first big announcement, the Plan Nacional de Refinacion, says Mexico’s refineries “will process 1 million 863 thousand barrels of crude oil per day by 2022”. This compares to the 640,000 b/d processed by Mexican refineries in Q3/18. Even if AMLO only gets at least half way to the target, this should reduce Mexico heavy/medium crude exports into the US Gulf Coast (USGC) refineries by at least ~300,000 b/d by 2021/2022. This will create added demand opportunity for Cdn heavy/medium oil to fill. This is a key AMLO priority for his first 6-year term. It isn’t likely to happen as quickly as AMLO’s target, but even reaching half of his target should create a big opportunity for Cdn heavy/medium oil in the USGC.
The next 1-2 months may be the perfect window to see if and how mid term fundamentals have changed for oil and gas. We are moving into year end without the normal expectation for buyers to return to the market post tax loss selling. There are too many big picture wild cards ie. China/US trade, interest rates, massive volatility, BREXIT, etc. For oil and gas, there are also near term seasonal issues that will keep investors on the sidelines or, at least, not really committed to any fundamental view until markets start to look past Q1/19. Henry Hub (HH) gas may be well over $4 but investors don’t even seem committed to HH >$3 until more of the winter weather unfolds. By the end of January, there should be good visibility on how winter storage will unfold. The key reason why oil has been weak is that the Iran sanctions were less than expected and this is happening when oil demand is ~1 mmb/d lower in Q1 than in Q4. We may not know if Trump will be easier or stricter on Iran sanctions until March, but, before then, markets will start to look thru the seasonally low Q1 oil demand period to always seasonally stronger demand in Q2 and Q3. We normally see this stronger seasonal oil demand translate most years into stronger oil and gas investor interest leaving Q1.
Over the next 45 days, we will be posting a series of blogs, each highlighting one of these lasting changes to oil and gas fundamentals, It makes sense that there are lasting changes to oil and gas fundamentals that are being overlooked. There is no other way to describe it but to say Q4/18 to date has been brutal for oil and gas investors. Its not just equity capital that has left the space, its also money managers net long positions in oil. But in this period of negativity, we have noted several lasting changes to oil and gas fundamentals that are either overlooked, or not appreciated as to their significance on the oil and gas outlook. We plan to post a series of several blogs in the next 45 days on these lasting changes. The order of blogs is not in priority or level of impact, rather the blog ordering will be linked to a current or recent news headline. For example, we had identified AMLO’s refining priority as an overlooked lasting change, but made it Blog #1 in our series once we saw AMLO’s major refinery plan announcement on Sunday.
Money Managers Net Long Positions
Source: Bloomberg, NBF Energy Sales
Lasting change to oil & gas #1 – AMLO’s first major initiative is to get Mexico’s refineries process 1.863 mmb/d by 2022. One of AMLO’s key priorities is to increase Mexico’s oil refining of domestic Mexico oil production to reduce imports of petroleum products (ie. gasoline and distillates). AMLO took over as President on Dec 1 and his first major speech and policy initiative was announced on Dec 9 – the Plan Nacional de Refinacion” (National Refining Plan” or NRP). The NRP was introduced with the announcement “With the National Refining Plan, Mexico will achieve energy sovereignty: Romero Oropeza” [LINK]. The only change from AMLO’s campaign promises is that the NRP only envisions building one new refinery (Dos Bocas in Tabasco) vs his campaign promise of two new refineries. The NRP includes AMLO’s campaign priority to fix and upgrade Mexico’s five existing refineries at Minatitlán, Salamanca, Tula, Cadereyta, Madero and Salina Cruz. The NRP says that, in total, the 6 existing refineries and new Dos Bocas refinery “will process 1 million 863 thousand barrels of crude oil per day by 2022, which will be able to obtain around 781 thousand barrels of gasoline and 560 thousand of diesel per day.” The split is the existing five refineries “With this project, the Minatitlán, Salamanca, Tula, Cadereyta, Madero and Salina Cruz refineries will be able to process one million 540 thousand barrels of oil per day.” And the new Dos Bocas refinery “will process 340 thousand barrels of crude oil per day, produce 170 thousand barrels of gasoline and 120 thousand of ultra low sulfur diesel daily”.
Processing 1.863 mmb/d by 2022 target is in line with AMLO’s campaign promise to do this by the halfway point of his 6 year term. AMLO’s campaign promises on refineries was to accomplish a massive turnaround by the mid point of his 6 year term, which is why the “by 2022” target. These are bold goals and we believe they are overly ambitious for both volume and timing. However, refining is his key priority and we believe he will be doing all he can to make substantial progress to his “by 2022” target. We recognize that buildings can get built very quickly in Mexico, but we believe building a refinery in three years is close to impossible. Prior to AMLO’s, Pemex reportedly had plans in place to fix and/or upgrade the existing refineries to improve reliability and increase input of Mexican heavy/medium oil. The existing plans are why we believe they have the ability to make substantial progress in 3 years to their goal of having these existing 5 refineries process 1.540 mmb/d by 2022.
Increased refinery processing could lead to less (300,000 b/d or more) Mexican heavy/medium crude exports to the USGC. Pemex processed 640,000 b/d in Q3/18, down 400,000 b/d in the last 3 years. AMLO’s target to process 1.863 mmb/d in total and 1.540 mmb/d from the existing 5 refineries by 2022 would be an increase to crude oil input to the refineries vs Q3/18 processing of ~1.2 mmb/d and ~0.9 mmb/d, respectively. Mexico’s priority is to process more domestic oil and to also reverse the decline in domestic oil production. AMLO’s target is to increase Mexico oil production by 0.7 mmb/d by the end of his term in 2024 versus current oil production of ~1.7 mmb/d. If Mexico can increase its processing by ~0.6 mnb/d by 2022 (get back to 2013 levels) and add ~0.3 mmb/d after declines to production by 2022, it would set up the potential for Mexico to use another 0.3 mmb/d of its own oil in its refineries. This is why we see the potential for Mexico to reduce heavy/medium oil exports to the US by ~0.3 mmb/d (if not by a larger reduction) by 2022.
Pemex Crude Oil Processing
Source: Pemex
Declining Mexico crude exports to the US sets up increasing demand for Cdn heavy/medium crude oil in the US. Canada has been the big winner in the decline in US crude oil imports from Mexico and Venezuela as those countries have seen declining oil production. Below are the EIA’s current graphs showing US crude oil imports from Mexico, Venezuela and Canada. [Please note there are different scales on the graphs.] The biggest challenge for Canada continues to be to get crude oil down to the USGC refineries. AMLO’s priority to increase Mexico refinery processing and using more Mexico crude oil has to logically lead to less exports to the USGC. And just like seen over the past decade, this will provide increasing demand Cdn medium/heavy oil in US refineries. It’s a good think Enbridge’s investor day yesterday outlined its expansion work to increase Cdn heavy/medium crude barrels to the USGC. But it also means that the need for Cdn crude by rail may be more of a semi permanent need and not just a one or two year need.
US Crude Oil Imports From Mexico (thousand b/d)
Source: EIA
US Crude Oil Imports From Venezuela (thousand b/d)
Source: EIA
US Crude Oil Imports From Canada (thousand b/d)
Source: EIA