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TMX Is Needed Even More Now, Mexico Oil Production Looks To Be Returning To Growth And More Exports To US Gulf Coast

By Dan Tsubouchi

Mexico’s national oil company, Pemex, reported Q2 results on Friday.  The Q2 results were nothing spectacular with flat production, but the Q2 call was good with mgmt. providing detailed commentary on production, refining and development projects.  The detailed comments provide support that Mexico’s oil production looks to be bottoming, a return to modest oil production growth should start by year end 2019, and refineries are running at higher capacity.  This means that Mexico should begin to turn around one key trend that directly impacts Cdn oil – Mexico’s oil exports to US PADD 3 Gulf Coast should stop declining and begin to increase.  PADD 3 is Mexico’s primary oil export market and increasing to Mexico oil production should directly lead to increased oil exports to PADD 3.  Canada has filling part of the gap created by Mexico and Venezuela declining oil exports to PADD 3, so any increased Mexico oil production will turn into a direct threat to Cdn volumes being railed to the Gulf Coast. And any increasing competition for PADD 3 refiners has the potential to push back on (widen) WCS differentials. It is why we believe TMX is needed even more now.

Waiting on word when TMX will start full construction.  We haven’t seen any recent official updates or comment to the press from Trans Mountain executives or Liberal cabinet ministers as to when full construction will start on Trans Mountain Expansion Project (TMX).  The latest comments from Trans Mountain have been from their spokesperson in the Sherwood Park News (Edmonton area) July 26 story “No start date yet but Trans Mountain is ready for construction” ” [LINK]. Trans Mountain spokesperson Hounsell noted that TMX is advising communities that they are getting closer to construction.  They reported “Despite the project moving forward again, Hounsell couldn’t give an exact start date on when we’ll actually see shovels hit the ground. “We’re optimistic that we will have shovels in the ground this fall,” she said. “There are some areas, a lot of NEB processes related to the landowners and things we need to do getting the regulatory requirements for that, but areas like the Edmonton terminal, we’re expecting to be able to get going with the terminals in Edmonton and Burnaby the soonest.” In other words, its still not clear when they will start full construction.

There is an increasing risk that TMX misses this construction season. Its July 30 and the clock is ticking to start TMX full construction.  We haven’t seen any official updates as to when the latest date for full construction start to not miss the construction season.  The last update we saw was in the June 28, 2019 letter to the National Energy Board [LINK], which asked the NEB to “Allow construction at (1) the Westridge Marine Terminal (“WMT”), (2) the Burnaby Mountain Tunnel Portal located in the WMT (“Westridge Portal”), (3) the Burnaby Terminal, and (4) the Edmonton Terminal (collectively, the “Terminal Work”) to commence on August 5, 2019. The Terminal Work will be entirely located on land owned by Trans Mountain and it needs to commence by August 5 to avoid seasonal restrictions”.  We don’t know how hard the Aug 5 date was, but the reality is that the last start date for full construction has to be soon.

Canada has been increasing heavy/medium oil exports to US Gulf Coast with Mexico/Venezuela declines. Mexico and Venezuela have both had declining oil production and crude oil exports to their primary market – PADD 3 Gulf Coast refineries.  For Venezuela its been declining oil production and the latest crash in exports to PADD 3 has been from US sanctions.  Venezuela isn’t expected to resume oil exports to PADD 3 unless the US removes its sanctions, which probably doesn’t happen until there is regime change.  Mexico’s declining exports to PADD 3 has been directly due its declining oil production.  Canada has been the big winner with increasing exports to PADD 3.

US PADD 3 Gulf Coast Crude Oil Imports Canada, Mexico and Venezuela

Support for Mexico’s oil bottoming in Q2 = US PADD 3 Gulf Coast imports from Mexico should stop declining. We thought the Pemex Q2 call on Friday was significant because we may finally be seeing Pemex actions/plans to support that Mexico oil production has bottomed and will be returning to oil growth as we exit 2019.  It looks like their focus on low hanging fruit is working. Q2 oil production was flat each month at ~1.670 mmb/d, and basically flat to Q1.  But different than prior earnings calls, mgmt. gave a very detailed explanation of what they have been doing on the existing production base and what they are doing to give near term oil production growth. The one thing that surprised us was that its almost hard to believe that Pemex hadn’t been doing these basic maintenance activities.  The are getting more out of the existing production base and its seem like they are just doing what all operators do in terms of picking low hanging production operations items.  For example, Pemex said “Production during the second quarter has been successfully maintained, thanks to specific actions aimed at managing the natural decline of production, some of these include the implementation of more rigorous systematize process for integrated reservoir management, the intensified monitoring and follow-up particularly in wells of the primary production assets, to increase operational efficiency and continuity of produced wells and production facilities.  And finally, increased maintenance works focused on base production such as cleanups, stimulations and optimizations of producing wells.” This is oil 101. There were more comments on specific areas.

Pemex Mexico Oil Production

Support for return to modest oil growth = increasing US PADD 3 Gulf Coast oil imports from Mexico.  On the Q2 call, mgmt. also provided a detailed commentary on how, post AMLO, they shifted to development drilling of land/shallow water low E exploration and what looks like offsetting or even prior known smaller plays.  The focus is on drilling these plays that can also be tied in quickly. Its shifting capex away from big high impact.  Pemex said “beginning in 2019, we will increase and intensify exploration activities in onshore and shallow water basins and in areas adjacent to producing fields. To this end, we plan to drill approximately 50 exploration wells, which represent more than doubled those drill in 2018.  We will be focusing on wells located in low-risk areas adjacent to producing fields as well as from terrestrial areas to ensure sustainability in the short medium and long terms. At the same time, we will be intensifying secondary recovery — implementation of secondary recovery processes in order to increase the recovery factor and reserves in mature fields. Secondly to boost hydrocarbon production via the following strategies, the accelerated development of discoveries which includes the 20 new fields that have been described previously and in our presentations and the two complementary developments in this fields of Onel and Yaxche. Accelerated development of remaining for — [ph] exploitation fields of have already been producing before this year.  By increasing the drilling of development wells, and well covers and finally to increase the recovery factor in mature field as well as reactivate the production of non-associated gas by a private sector participation through the integrated service contracts for exploration and extraction.”  There were more comments on specific projects to support the near term development additions.

Pemex 5 Yr Plan 2019 – 2023 Crude Oil Production Forecast

Support for refinery capacity increases = reduced demand for US petroleum product exports to Mexico. Another takeaway from the Q2 call was on refining capacity improvements, which, like oil, sounded like Refining 101 work on maintaining refineries.  Pemex said “you can see on the graph that during the second quarter of 2019 crude oil processing at the National Refining System average 595,000 barrels per day, marking in 90,000 barrels per day increase has compared to the last quarter of 2018.  It should be noted, that by the end of June 2019 crude oil processing averaged 645,000 barrels per day. This recovery has been achieved due to an intensive maintenance strategy and processing plants, which we started to implement in January 2019. During the first half of this year, we carried out repairs at six refineries of the national refining system. This repair program allowed to the stabilization of processing levels.”

US PADD 3 Gulf Coast Gasoline Exports To Mexico

Makes TMX even more important as increasing Mexico oil production = increasing US PADD 3 Gulf Coast oil imports from Mexico.  US PADD 3 Gulf Coast refineries have always been the primary market for Mexico oil exports. Pemex may not send all incremental oil export barrels to PADD 3, but we would expect to see at least 50% of any increased Mexico oil production to end up as increased oil exports to PADD 3.  And any increased competition for Cdn heavy/medium crude in the Gulf Coast has the potential to push back on (widen) WCS differentials.

Mexico Crude Oil Exports To US As % Of Total Crude Oil Exports