Imports Not Immigrants

Jim Brown
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Oil imports from Mexico are declining as production falls to a 24 year low.

Petroleos Mexicanos, otherwise known as Pemex, just cut production forecasts again to 2.41 mbpd, down from the prior estimate of 2.5 mbpd for 2014. This is the lowest level of production since 1990. However, month to date production for July is running at a 2.38 mbpd pace so the decline is accelerating.

Until recently Mexico has been hampered by laws that prevented foreign companies from exploring in Mexico. Pemex was responsible for all exploration and production. Unfortunately, without the constant influx of new technology developed by the foreign giants like Exxon, Chevron, Conoco, Shell and BP, the production from older fields began to deplete faster.

This was complicated due to the extraction of cash from Pemex by the Mexican government. Oil revenue is responsible for more than 50% of the government's budget.

Recently lawmakers passed a series of new laws aimed at letting outside companies explore and produce oil in Mexico. The country has an estimated 113 billion barrels of oil.

Production has fallen for nine consecutive years. Once the Mexican energy sector is opened to private competition the money will start to flow. Not since 1938 have outside companies been able to operate in Mexico.

The persistent and accelerating decline of their older fields forced lawmakers to concede defeat and change the laws. Analysts believe the addition of the U.S. majors to Mexico will bring more than $50 billion in private investment into Mexico. Pemex has a $29 billion cap ex budget for 2015, up from $27.7 billion this year. You would think with that much money they could hold off the declines from their largest fields and add production from new fields. However, without new technology they are racing against time. Pemex lost $4.02 billion in Q2, its seventh consecutive quarterly loss.

With huge reserves in areas that are not hard to develop it will be a slam dunk for the majors to quickly increase production. Pemex has already had talks with outside firms and identified potential partners and they plan to move "very fast" in establishing joint ventures once the final energy legislation is approved. The Senate approved the legislation on July 21st and the lower house committees are debating it this week. President Enrique Pena Nieto is expected to sign it once it reaches his desk. When that happens the black gold rush will begin.

We need Mexico to produce more oil. As our largest source of imported oil we need them to rebuild their supplies. This is conflict free oil with little or no danger of being interrupted by geopolitical events or terrorists. The oil comes from Mexico by pipeline into the Gulf Coast refining system.

Despite that prior paragraph those pipelines are not without danger. The pipeline right of ways have turned into a cross country highway for drug cartels and immigrants headed to the USA. The pipelines are underground but the land above was cleared long ago. They cross millions of acres of private land but they are safer for the walkers than using the highways with the associated risks. The pipelines are not monitored so they function as broad walking trails crisscrossing the southwest.

State laws require operators to clear wide paths through vegetation to allow the paths to be monitored by air and for repair crews to be able to reach and repair any problems quickly. Some paths can be 100 feet wide.

The border patrol finds an average of one corpse a day in the badlands near the U.S.-Mexico border. More than 5,570 bodies have been found over the last 15 years. That is more than all the combat deaths in Iraq and Afghanistan combined. One rancher said in the past two years 216 corpses have been found within 15 minutes of his doorstep. He said many more had not been found because the wild hogs "gobble us a lot." Nobody in south Texas leaves their home without being armed. The pipeline paths are simply too heavily traveled by drug cartels and immigrants that are tired, hungry and desperate.

The Iraq conflict and the attempt by Kurdistan to break away from Iraqi control hit home in the Gulf of Mexico last week. A ship carrying crude oil from Kurdistan arrived off the coast of Florida heading for Galveston. The Kurdistan Regional Government is trying to sell oil from its territory in hopes of generating revenue to finance its battle for independence.

However, they are finding the oil hard to sell. Iraq has warned everyone they are going to pursue legal action against anyone buying the oil because Iraq considers it stolen. A spokesman for the U.S. State Dept said the U.S. policy is that oil from Iraq belongs to Iraq. Kurdistan has 45 billion barrels of reserves. If they were able to successfully gain independence from Iraq they could quickly become a very rich country.

Even though the tanker is heading for Galveston nobody knows who is buying the oil or where it will be unloaded. There has not been a request for a ship pilot to guide the vessel into a refining complex. Everyone is waiting to see where the ship is headed before the next chapter in the Iraq oil saga can begin. Kurdistan has sold 2-3 prior cargoes with one going to China and the other was undisclosed once the ship turned off its transponders.

Oil Inventories

Crude inventories declined by -4.0 million barrels last week and well over the 2.4 million barrel estimate. Like the prior week the underlying components did not add up to a 4 million barrel drop. Refinery demand declined -28,000 bpd. U.S. crude production declined by -27,000 bpd and crude imports fell only -20,000 bpd. The total of those three components was -75,000 bpd or only slightly more than -500,000 barrels for the week, not 4.0 million.

Gasoline inventories rose +3.3 million barrels thanks to a decline in demand of -265,000 bpd or 1.85 million barrels. Gasoline production rose +218,000 bpd or 1.52 million barrels. Fortunately, those numbers do add up.

Distillate inventories rose +1.6 million barrels thanks to a +34,000 bpd increase in production and +23,000 bpd increase in imports. However, demand rose by +184,000 bpd so again, the numbers don't add up.

Distillate inventories should be poised for a decline with 16 tankers booked for the next two weeks to ship diesel to Europe.

We just have to take the numbers on faith and assume that the discrepancies equal out over time. Refineries operated at 93.8% capacity and at record levels for this time of year. The sharp drop in the crack spread may force that number lower next week. Refiners don't make any money by refining oil for free.

Refinery demand for oil at 16.6 mbpd was also near the high for the year. Product supplied at 19.31 mbpd was also just below the high set three weeks ago. However, overall demand is still -2% below year ago levels.

Refinery inputs hit an all time high at 16.8 mbpd in the week ended July 11th. That beat the old record from summer 2005 and 280,000 bpd over year ago levels. It is interesting that production is at record levels while demand is 2% lower than year ago levels.

Midwest refiners operated at 100.3% of stated capacity in the July 11th week. That is the first time over 100% since the EIA began collecting the data in 2010. Refineries can produce more than 100% capacity because that stated capacity is based on less than 24 hour days and weeks with planned downtime for maintenance. If that maintenance is not needed and the refinery continues to operate then the stated "calendar day" capacity can be exceeded. The Motiva refinery in Port Arthur became fully operational in late June and it now processing 600,000 bpd and that boosted the refiner input totals to near a new high at 8.7 mbpd for PADD 3 (Gulf Coast). The record was 8.8 mbpd in December 2013.

Cushing inventories fell to 18.8 million barrels and below the assumed 20 million barrel operating limit. However, I did some research on the EIA website and while that is the lowest level since November 2008 it has been a lot lower in the past. In November 2007 Cushing inventories declined to 13.421 million barrels. Since that time Cushing's capacity has more than doubled. At this point I am unsure if the additional capacity raised the operational minimum since all those pipes and tanks require a minimum of oil to operate. I will continue to monitor the news for anything pertaining to that operating minimum.

The U.S. oil production at 8.57 mbpd is only 20,000 bpd lower than 8.59 mbpd reported last week and the highest production since the week of October 24th 1986 at 8.773 mbpd.

In the graphic below green represents a recent high and yellow a recent low.

Natural gas inventory rose +90 Bcf last week and slightly less than expected. It is possible we are starting to see some summer demand finally appear and the weekly injections will begin to decline.

Gas prices fell to a new 8 month low at $3.75 despite the lower injections. Several reports from the producing areas suggest we are about to see a deluge of new production once some key pipelines are connected.

Inventories of gas in storage rose more than 1 Tcf since mid-April for the fastest gain in more than 11 years.


The volatility continues to rise and fall as the geopolitical headlines stream in from overseas. However, this week the volatility is likely to be created by the economic reports. With the ADP Employment and FOMC meeting on Wednesday and Nonfarm Payrolls and ISM Manufacturing on Friday we could be in for a wild ride.

We also have six Dow components and 140 S&P 500 components reporting earnings. After the hit to the indexes from Visa and Amazon on Friday we could see investors become more cautious ahead of the high profile reporters.

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Jim Brown

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