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Feature: Gasoline demand from Mexican deregulation may pressure Colonial Pipeline

Houston (Platts)--21 Aug 2017 143 pm EDT/1743 GMT


A recent output disruption at Mexico's largest refinery may have contributed to Colonial Pipeline's June decision to cancel some shipping on its gasoline-only Line 1, USGC gasoline market sources have said.

While this was an isolated event, growing Mexican import demand driven by deregulation could continue to put pressure on Colonial's Texas-to-North Carolina Line, sources said.

Colonial in June decided not allocate the 37th cycle on its Line 1, the first such decision since the line's 42nd cycle in 2011.

The disruption over June and July at Mexico's 330,000 b/d Salina Cruz may have also compounded the overall economic challenges of the USGC-USAC arbitrage over the summer, the sources said, as Latin America became a bigger draw for USGC product.

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"Why lose money shipping on Colonial when there's an entire other market for USGC gasoline? A lot of gasoline has been going out by ship this summer," a gasoline source said.

Another USGC source agreed with that, saying that USGC gasoline has not been competitive with European sellers in the New York Harbor market in recent months and so has been bound for export.

In addition, Andy Lipow, president of consultancy Lipow Oil Associates, said that strong May imports into the Atlantic Coast created a glut in storage inventories there. That glut probably best explains the story behind the USGC-USAC arbitrage this summer, he said, but added that the summer outage at Salina Cruz may also have contributed.

S&P Global Platts has assessed Line 1 space at negative value from March 24 to August 17, the longest sustained period on record. A negative value generally indicates a less profitable arbitrage. Platts data also shows that sending CBOB from the USGC to the USAC on Colonial has not been profitable for the majority of 2017 to date.

Sending RBOB gasoline from the Gulf Coast to the New York Harbor via Colonial netted shippers an average 1.86 cents/gal from Monday to Thursday this week, its most profitable four-day period since November, Platts data shows.

That arbitrage has also been profitable for seven consecutive days as of Thursday, tying its longest such stretch this year. Though correlation certainly does not imply causation, it is interesting to see that the arbitrage became more profitable in August, after Salina Cruz resumed operations at a reduced capacity on July 30.

And as Mexico's appetite for USGC gasoline continues to grow, Line 1 shipping interest could face ongoing pressure.

However, Colonial Pipeline spokeswoman Malesia Dunn declined to say whether or not problems at Salina Cruz or growing Mexican demand affected or would affect Line 1 in the future.

"Colonial was aware of the Mexico supply situation and it may have been one of many factors that determined the nomination levels at the time," she said. "While we won't speculate on the future, Colonial remains focused on providing transportation and other services to our shippers to both traditional and emerging markets."

Related: Find more content about Mexico's commodity landscape in our news and analysis feature.


GROWING APPETITE FROM MEXICO


Shortly after Pemex halted operations at Salina Cruz following a fire there, sources expected more imports from the USGC.

"Mexico should suck in more gasoline either bound for the US or from the US," one market source said in June.

The latest US Energy Information Administration data suggests Mexico's demand for USGC gasoline has surged over the summer. The US exports averaged 593,000 b/d in June and July, a dramatic increase over the prior five-year average of 373,000 b/d.

The US Gulf Coast sends more gasoline abroad than any other US region -- accounting for nearly 90% of US exports in 2016 -- and Mexico receives more US exports than any other nation, taking in more than half of all US gasoline sent abroad in 2016, EIA data showed. Thus, total US exports are a decent proxy for USGC-Mexico trade flows.

Platts trade-flow analytic software cFlow shows that refined product vessel traffic from the USGC to Mexico spiked after the Salina Cruz fire. In the third week of July, more than 80,000 Dwt in refined product shipping capacity traveled from the USGC to Mexico, the second most shipping capacity in a single week in cFlow data going back four years.

The same data shows that total July refined product shipping flows from the USGC to Mexico reached over 200,000 Dwt, an increase over July 2016 and 2015, which saw around 175,000 Dwt and 125,000 Dwt, respectively.

The cFlow data does not show whether the ships were laden, nor does it specify what refined products they carried, but data from Mexico tells a similar story. Mexico imported 480,000 b/d of gasoline in June, a marked increase over the prior three-year average of 414,000 b/d, with the lion's share of barrels likely originating in the US, Pemex data showed.

Data from Mexico's Economy Secretariat Tariff Information System shows that Mexico imported 15.67 million barrels of gasoline, or 522,600 b/d, in June compared with 14.16 million barrels in May, or 458,889 b/d.

Gasoline imports from the US grew to 443,343 b/d in June from 351,234 b/d in May and 393,000 in April. Import data from the secretariat and Pemex often do not match because the secretariat uses customs reports from importers on the volume of product rather than the product Pemex measures at its terminals.


MEXICO'S LONG-RUN IMPACT


As part of Mexico's landmark 2013 energy reforms, which opened energy markets to private investment, Mexico's government has begun liberalizing its retail fuel market.

Foreign and private sector players are now permitted in the market and diesel and gasoline price controls at the pump are gradually being removed in spring 2017. This has unlocked a wave of new investment in Mexico's retail fuel infrastructure.

Valero recently announced it has inked a deal to export gasoline and other refined products into new Veracruz port facilities being built by IEnova, a unit of Sempra Energy.

IEnova is building a 1.4 million-barrel storage terminal in Veracruz, as well as two other terminals near Puebla and Mexico City, with storage capacity of 500,000 and 800,000 barrels, respectively.

In addition, Valero signed a long-term agreement with rail company Ferromex to transport refined products from Veracruz to the inland terminals. Valero's actions reflect heightened interest in Mexico's gasoline market from foreign players, who see the country's tens of millions of drivers as crucial new source of refined product demand in the Americas.

Other investors are more hesitant. Some see easier inroads to the Mexican market through Pemex's auctions rather than by acquiring infrastructure in the country. But without assets in Mexico, companies are more sensitive to supply changes in the country and could lose out on exports.

It remains to be seen if USGC producers' opportunity cost of establishing trade flows to Mexico outweigh the tried and true demand of the USAC.

Lipow said that Mexico's retail fuel stations are among the most attractive investment opportunity in Mexico's newly liberalized markets.

"Why make a major investment in a Mexican refinery knowing that you will have to share control of the venture with Mexico's government, which would block efforts to cut costs by trimming staff? Gas stations have less political risk and the added benefit of diverse revenue streams through their convenience stores," Lipow said.

But snapping up retail locations might not be quite so cut and dry. For one, key markets like Mexico City and Monterrey have high land costs that could eat into potential profits. But if a foreign company can secure a toehold through retail, the road to selling its own gasoline could become easier.

The prospects for Line 1 shipping demand thus do not appear too dire. But unlike the United States, Mexico's peak driving season occurs between November and December.

This is borne out in PEMEX data, which shows that Mexico gasoline imports hit annual high points in November of both 2016 and 2015.

As Mexico's peak driving season unfolds later this year the pull from south of the Rio Grande could continue to draw product away from Colonial's Line 1.


ALIGNING SPECIFICATIONS


Policy changes in Mexico will also make USGC gasoline more appealing there. In June, Mexico's Energy Regulatory Commission (CRE) announced that it will allow up to 10% of ethanol to be blended with gasoline rather than the previously announced 5.8%, with the exceptions of Mexico City, Monterrey and Guadalajara.

The E10 blend mirrors ethanol blending standards in the US. After the announcement, US biofuels groups praised the news, optimistic it will catalyze their international business operations.

"This is very positive news," Ryan LeGrand, director of the US Grains Council's office in Mexico City, said in an interview. "It's an extremely important first step and is an opportunity on both sides of the border."

Similar gasoline specifications between the US and Mexico should lubricate more trading between the two nations, CRE said in a June statement. Without having to worry about different blend components and fueling infrastructure, exports to Mexico could flow with fewer challenges.

Lipow said that while this new ethanol requirement could boost USGC-Mexico gasoline trading in the long run, he does not expect them to make much of an impact any time soon.

"Mexico has no history of ethanol blending and currently lacks the infrastructure to support it," Lipow said. "This transition is going to take some time."

--Seth Clare, seth.clare@spglobal.com

--Josh Pedrick, joshua.pedrick@spglobal.com

--Daniel Rodriguez, newsdesk@spglobal.com



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