Mexican Oil, Asia, and the WTI: Latin American Crude Exports in a Good Spot

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Although some Mexican crude oil exports may have been delivered with quality problems, Asian efforts to diversify sources of hydrocarbons away from the Middle East now benefit Latin American hydrocarbon producers willing to sell in the spot market priced to the West Texas Intermediate (WTI) benchmark.

Spot Price Arbitrage Opportunity

The continuing Brent premium to WTI creates opportunities for arbitrage between the oversupplied North American market and the growing demand found in Asia. China may be close to filling its strategic petroleum reserves to capacity, but South Korea and other Asian nation states continue to increase Latin American imports.

Hedging Renminbi Currency Risk in a Crude Contango Market

The Chinese crude-oil buying spree could also continue if it represents an attempt to lock in costs at the current Yuan-dollar equivalent price. China desires a globalized renminbi and could be preparing for future volatility risk. In addition to and despite recommendations otherwise, China’s continued efforts to weaken the RMB against the dollar also make stockpiling large volumes at today’s price sensible. The current S&P China Bond Index is currently showing high annual returns, and therefore puts pressure on the People’s Bank of China (PBOC) to push the value of the Yuan down. Indeed the PBOC announced a monetary stimulus on April 19, 2015 by lowering the amount of cash that large banks keep on reserve. Given its effort to depreciate renminbi while the Brent/WTI markets are in contango, China’s double exposure to long-term crude oil priced in dollars necessitates stockpiling as much physical crude as possible to hedge its domestic consumers.

Middle East Turmoil and Asian Supply Anxiety

China’s increased stockpile may reflect not only a desire to hedge its currency exposure to the crude oil market but also its global geopolitical risk. China’s increasing appetite for increased crude oil imports makes any disruption in supply from the Middle East a threat to China’s strategic growth initiatives. China currently wants to keep friendly relations with both Saudi Arabia and Iran while concurrently making long-term hydrocarbon energy deals with Russia.

Mexican Crude Export Opportunity

With U.S. crude oil exports currently shackled by Carter-era restrictions, it is possible that the current WTI discount may continue for some time. Increased Mexican exports priced to the WTI benchmark may prove a welcome tonic to PEMEX, its beleaguered domestic exploration & production business. Mexico’s much anticipated reform of its domestic petroleum industry has yet to lure significant foreign direct investment, but many investor companies are looking for opportunities. If foreign companies can meet the difficult local content and labor law requirements required for participating in the Mexican market, then perhaps more Mexican exports may reach hungry Asian markets.

Venezuela’s Pain May be Mexico’s Gain

Despite the anti-American rhetoric of President Nicolas Maduro, the Venezuelan economy still depends overwhelmingly on crude oil exports to the United States. Heavy Maya-22 grade Mexican crude oil offers a U.S. import substitute for comparably weighted Venezuelan crude. As the U.S. downstream refining sector builds more light oil capacity, the need for additional refining capacity to handle heavy crude is diminished. Given the choice of relying on politically unstable imports from hostile Venezuela versus politically stable and friendly Mexico, U.S. importers may increase contractual relationships with the latter. Increased cash flows to PEMEX could in turn yield additional capital for PEMEX to take advantage of the Mexican reform of its petroleum sector.

Conclusion

Increased Asian demand for Mexican and other Latin American crude oil exports, increased Mexican exports to the United States, and increased global investment in the newly reformed Mexican petroleum industry could yield tremendous economic growth for the emerging Latin American middle class. At the same time, this demand affords greater diversity and stability of crude oil supply to meet the growing consumption needs of the Asian market.

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Tom Morgan

Tom Morgan is an Analyst for Drillinginfo. He has 20 years of experience practicing law with a focus on advocating for public policy to advance energy security and private property rights. Tom received his law degrees from Georgetown University and American University law schools. He hosts the weekly Drillinginfo Energy Minute, and you can find and connect with him on LinkedIn as Tom Morgan.