With Mexican crude swaps, Obama keeps exports debate at arm’s length

By Jenny Mandel | 08/20/2015 06:55 AM EDT

Last week, on a quiet Friday in August, news leaked from the U.S. Department of Commerce that it had agreed to a number of crude oil swaps with Mexico, a relaxation of long-standing precedents against any such shipments.

The timing of the news, reported by several news outlets and attributed to unnamed department officials, suggests that the Obama administration is not ready to embrace the full public response to new crude oil exports, even as it explores the discretion it has under current law to authorize them.

Crude swaps could be similarly touchy within Mexico, where a long history of oil self-sufficiency has built up national pride around the issue. But the advantages to both sides have proved too good to pass up.

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On the U.S. side, the story is now familiar: The shale gale brought a dramatic spike in production of light, sweet crude that surprised a refining industry tailored for heavy, sour grades. Refiners responded by backing out high-grade imports and tweaking their equipment to handle more of the domestic supply, but many facilities are approaching the upper limits of how much light, sweet oil they can take on without expensive reconfiguration. That’s hurting domestic crude prices.

In Mexico, the story is quite different. Refineries there were configured for the sweet supplies that were dominant in the 1950s, ’60s and ’70s, but more recent production has been of heavier crudes.

Meanwhile, on the Mexican policy front, a sustained push to replace crude-derived heavy fuel oil with low-cost natural gas in electric generation has pared back demand for the dirtier energy source. But fuel oil is a low-value byproduct of refining heavy crude, especially in less sophisticated refineries, and the electric generation shift has hurt refiners’ margins.

In an email, Petróleos Mexicanos (Pemex) confirmed that the newly authorized swap would produce "logistical synergies."

"Pemex has been notified of the approval of the application submitted to the … U.S. Department of Commerce earlier this year for a proposed exchange of crude oil, in order to import up to 100 thousand barrels day of light crude and condensates, which will be highly beneficial for Mexico. This swap will allow Pemex to mix American light crude with domestic heavy oil and improve fuel production processes at refineries in Salamanca, Tula and Salina Cruz," the company said.

A recent assessment by Sandy Fielden, an analyst with consultancy RBN Energy, notes that Mexican crude exports to the United States have been falling at least since 2011, due partly to problems in Mexican oil production that have hurt production and partly to rising competition from Canada, whose oil sands supplies are served by improved pipeline access to U.S. Gulf Coast refineries.

Overall crude imports from Mexico have fallen from an average of 1.1 million barrels per day in 2011 to 780,000 barrels per day last year, and dropped to 701,000 barrels per day in the first five months of this year, according to RBN.

In an interview, Fielden said Mexican crude market share "is under attack in the U.S." from Canadian crude that flows to the coast in new pipelines.

He said a swap of Mexican heavy crude for light U.S. product is a "win-win" that locks in market share for Mexico while helping U.S. producers and midstream companies unload product.

Arguably, it’s Canadian industry that loses out in the deal, which Fielden said amounts to a government-to-government arrangement. But he sees Canadians as unlikely to be upset.

"They’re ahead in Canada, aren’t they?" he said. "They don’t have to do any swaps. Their access to the U.S. market is unfettered" under U.S. laws that require licenses but no reciprocation for exports to Canada. "The U.S. is exporting a lot less crude to Mexico than Canada."

Duncan Wood, director of the Mexico Institute at the Woodrow Wilson International Center for Scholars, underlined the importance of the deal for the Mexican state-controlled energy conglomerate. "Pemex has been looking for this particular type of light crude swap for a while," Wood said.

Political chatter has taken Pemex to task for poor performance and for not being able to keep up with demand for gasoline and other products, he said, noting that the country imports about 40 percent of the refined products it uses. "Mexican politicians have made a point of saying that for an oil-producing country, Mexico really should be able to produce a higher percent of its refined products," he noted.

Wood said Mexican refiners have already imported limited volumes of oil, where it’s been needed for blending purposes to bring domestic heavy crudes up to technical benchmarks for export. "There have been limited crude imports into Mexico, but really only for the purpose of the refining mix. Obviously, Mexico produces a surplus of crude relative to use in the country," he added.

Wood said the ambitious energy reforms underway in Mexico, which include opening aspects of production and refining to international participation and investment, will reverse declining drilling outputs and bring new capital to the refining industry (EnergyWire, July 17).

Without those reforms, the country could have been a net oil importer by 2020 or 2030, under various analyses, Wood said. "It looks as though, because of the reform, the amount of oil produced in Mexico will rise," he added, predicting that production will grow by the end of this decade and increase by around 50 percent by 2030.

Wood said most of that new production will likely be heavy crude, pointing to an ongoing need for lighter blending stock. Tapping light sweet reserves, like those that likely extend south under the border from Texas, and reconfiguring refineries to make better use of heavier feedstock will both take time and money to bear fruit, he said.

A path to freer trade?

Adriaán Lajous, a former CEO of Pemex who is now a fellow at Columbia University’s Center on Global Energy Policy, wrote in a February study that crude oil swaps with Mexico should initially be started at low levels to test Mexican refineries’ capabilities. Politically, he said, "This would be an important step forward from the traditional Mexican policy ban on crude oil imports."

But Lajous said in the longer term, the two countries should move toward freer oil trade.

"Swaps and exchanges are archaic and cumbersome commercial instruments," he wrote. "Straightforward bilateral sales can be structured more easily and their terms are more transparent. … A successful [swap] transaction could be part of a piecemeal strategy that would gradually erode current restrictions."

RBN’s Fielden sees it as unlikely that Mexico will be granted the same broad access to U.S. crude exports that Canada enjoys, which could be a logical next step in any such gradual erosion.

"I think it’s pretty unlikely," Fielden said, "because that’s just going to cause a debate about overturning the export ban itself, which is already lining up for next year anyway. … It’s very unlikely that [U.S. policymakers] would make that sort of concession to just one country. The only thing that’s going to do is open up the broader debate. If you’re going to do that, you may as well concede to end the export ban."

The Wilson Center’s Wood agreed. "It’s clear that the Mexican government would be interested in a more open, more free trade in oil products with the United States," he said. "I think that Mexico would very much like to have the same treatment as Canada," which would make sense in the context of strong U.S.-Mexican bilateral trade and the overall North American Free Trade Agreement framework.

"While I don’t see that this will necessarily happen after these [swap] licences are awarded, I think that, long-term, that makes a lot of sense," he added. The debate over crude oil exports is very heavily politicized in the United States, he said, "but this is really a technical and trade issue. This is about helping out your neighbor."

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