Sector News

The eye of the storm: Continued reform crucial to Mexico's petrochemical prospects

October 18, 2018
Chemical Value Chain

Mexico’s incoming president, Andres Manuel Lopez Obrador, will have to work hard to minimize disruption to implementation of energy reform designed to open the oil and gas (O&G) sector to private and foreign investment and boost production. Successful implementation is critical to the future of the country’s petrochemical industry.

Mexico’s energy reform has played a significant role in creating clearer incentives and mitigating feedstock risks for future petrochemical investment in the country since it was approved in 2014. The reform has already begun reshaping Mexico’s energy market, but the journey has not been straightforward.

The crash of crude prices in 2014 muted interest from investors and slowed implementation. “Part of the opposition to the reform results from the timing rather than the market opening itself,” says Raúl Arias Alvarez, consultant/chemicals at IHS Markit. “The crash of crude oil prices in 2014 hit the revenue of Petróleos Mexicanos [Pemex; Mexico City] and in turn that of the government. Lower crude prices also caused potential investors to rethink where their investments would yield returns faster and be less costly.” Despite the progress achieved so far, the incoming administration, a coalition led by left-leaning president-elect Andrés Manuel López Obrador, could rock the boat.

Fears that López Obrador may attempt to reverse structural reforms approved during the first half of the Enrique Peña Nieto’s administration, have softened since initial concern after election. In the near-term, however, the change in government brings uncertainty and risks to policy continuity as well as administrative delays.

In this sense, greater certainty for private-sector investments around exploration and production (E&P) contract durability will hinge on two things. First, it depends on López Obrador’s acceptance of a planned public review that affirms that contracts were awarded legally. It also hinges on the understanding of the critical nature of the $100–200 billion in investment that the contracts are expected to bring in over the long term, according to Ford Tanner, principal research analyst/country E&P at IHS Markit. Pemex has precariously low O&G output and this poses a risk to Mexico’s economy and its petrochemical industry.

Pemex’s refineries are understood to be working at half capacity. This year, lower crude production has affected refining activities at Salina Cruz and Madero refineries, affecting availability of feedstock supply. Operations at the refinery in Minatitlán were also down, making matters worse on the feedstock side.

Investment in E&P is critical to reversing production declines and part of the solution to boosting feedstock availability.

A storm brewing…
Mexico is an oil rich country and remains a net exporter for now. State-owned Pemex controls the bulk of the hydrocarbon resources. However, the company is prioritizing cash generation, not reinvestment in production—or infrastructure—as much as it should. As a result, Pemex’s crude oil output has fallen from 3.4 million b/d in 2004 to 1.86 million barrels in the second quarter this year due to its inability to reinvest in developing E&P capability.

Lower output has cut refinery and petrochemical feedstock production. Pemex’s petrochemical production has been decreasing across various sites since at least 2010. Pemex’s ethylene segment produced a total of 1.9 million metric tons (MMt) of petrochemicals in 2017, a 25.5% decrease from the prior year and substantially below listed nameplate capacity of nearly 3.6 MMt/y. Pemex cited a 28% decrease in the supply of raw materials, including ethane, during 2017 as a reason for the sharp decline in petrochemical production.

Looking more closely at ethane, Pemex’s production has been steadily declining since 2004 with the drop intensifying in recent years. The average annual ethane production fell from about 120,000 b/d in 2010, to about 107,000 b/d in 2015, according to Pemex production statistics. Last year, the average annual production was closer to 101,000 b/d, and in the first eight months of this year the figures in closer to 88,000 b/d of ethane, the same data show.

Pemex currently operates two ethane-based crackers at Cangrejera and Morelos. Daily ethane requirements for these assets are about 68,000 b/d, according to local media reports. Petrochemical operating rates at these sites are understood to be very low.

Pemex also needs to supply 66,000 b/d of ethane to Braskem-Idesa’s Etileno XXI joint venture petrochemical complex in Veracruz. This brings total daily ethane requirements to 134,000 b/d of ethane, well below the company’s average daily production.

This shortfall has forced the company to import ethane from the United States. Earlier this year, Pemex signed an agreement with Vitol (Geneva, Switzerland) valued at around ($232 million) for the delivery of some 720,000 metric tons of ethane between 2018 and 2020.

The case of Braskem-Idesa illustrates the risk for petrochemical investments in the absence of sufficient feedstock. Pemex and the joint venture (JV) signed a 20-year supply agreement in 2010. Supply began when the project came on stream 2016.

Braskem first alluded to its JV’s ethane supply issues in the last quarter of 2017. The delivery issues were not said to have influenced operating rates significantly at that time. The JV’s operating rate were then around 88%. Ethane supply constraints have persisted into 2018, according to Braskem’s results. Braskem-Idesa’s operating rate fell by 13 percentage points year-over-year (YOY) to 72%, according Braskem’s second-quarter results. The reasons cited were the lower supply of ethane by Pemex, in addition to a 15-day planned turnaround. Braskem’s third-quarter results have yet to be issued. However, according to reports, insufficient ethane supply may have been behind a 36-hour shutdown of ethylene and polyethylene (PE) production at Braskem-Idesa in August.

At best, the import of US-ethane provides a short-term solution for Pemex to meet its requirements. However, recent dynamics in the US ethane market, which have caused prices to rise significantly over the past month (p. 7) might add pressure to Pemex’s operations.

“The ethane-ethylene value chain is constrained, and this needs to be addressed to rebuild investor trust. The future of the industry depends on it,” says Arias Alvarez. “In the case of [Braskem-Idesa] was built to supply the Mexican market with domestic source of polyethylene and reduce import dependence. Braskem-Idesa currently sells mostly into the domestic market, but PE demand is slated to continue growing. If domestic production fails to meet this demand, imports will once again increase.”

… curtailing investments
The ethane-ethylene value chain is just one of the various value chains were investment is being affected. Indelpro, a Grupo Alfa (Monterrey, Mexico) subsidiary, provides another example of how inadequate feedstock supply hinders investment. The company postponed plans to build a third polypropylene (PP) plant at its site in Altamira, in November 2016. At the time, the company claimed that Pemex did not produce sufficient propane for the $720-million project to go ahead. Just like with ethane, Pemex’s liquified petroleum gas (LPG) production has been on a downward trajectory for over a decade, according to the company’s production statistics.

Some may point to Proman’s (Wollerau, Switzerland) $5-billion fertilizer project at Topolobampo, Sinaloa, and argue that the situation is not as dire. The first phase—a 770,000-metric ton/year ammonia plant and a 700,000-metric tons/year of urea unit—is under development.

However, the recently signed long-term supply agreement anticipates Pemex’s limited ability—at present time—to deliver sufficient natural gas. The company’s natural gas production has declined by about 26% between 2010 and 2017, and as previously noted, does not presently have the resources to reverse this trend.

To continue with this investment, originally announced in 2013, and mitigate some of the risk generated by Pemex’s decreasing natural gas production a “solution” might lie in importing at least some of the raw material.

Indeed, the 15-year supply agreement that Proman’s subsidiary, Gas y Petroquimica de Occidente (Mexico City, Mexico) signed with CFEnergia (CFEn; Mexico City), an affiliate of the Comisión Federal de Electricidad, allows for the possibility of importing natural gas from elsewhere in North America if domestic supply is insufficient.

Petrochemical investment elsewhere in Mexico has continued in varying degrees. Nevertheless, most of the recently announced investments have been modest by industry standards.

Solvay announced 10,000-metric ton/year of nylon production capacity at its site in San Luis Potosí, late last year. The investment is aimed at serving customers in the automotive sector. Around that time, Sekisui Chemical added a third production line for laminated-glass interlayer films at its Morelos plant, also aimed at the automotive sector. Meanwhile, Toray is building a carbonization facility for regular-tow carbon fibers in Jalisco. The plant is due to start production by year’s end.

Nouryon, formerly AkzoNobel’s chemical business, announced a €12-million ($13.8 million) investment to expand production capacity and upgrade its organic peroxides facility at Los Reyes, Mexico, in January this year. Clariant has also invested in the “low-double-digit million” Swiss franc range to expand its capacity at Coatzacoalcos.

More significant in value is Mexichem’s $178.7-million acquisition of Pemex’s 44.09% share in Petroquímica Mexicana de Vinilo (PMV)—a JV they had set up in 2013. However, the investment appears more the product of circumstance rather than a “sought after” opportunity. Indeed, the deal followed the decision in December 2017 not to rebuild the vinyl chloride monomer unit at the Clorados III plant at Pajaritos, Veracruz, which was destroyed by an explosion in April 2016. The PMV acquisition provides Mexichem with the chance to focus on chlor-alkali production of the site.

Come rain or shine
The incoming government will need to continue implementing the energy reform to create the environment that will foster investment.

The policy risk surrounding the energy reform has somewhat decreased and López Obrador has begun outlining his vision for Mexico’s hydrocarbon sector. The incoming administration is expected to refrain from holding new bidding rounds and Pemex farm-outs, at least over the next 12 months. A farm-out is the assignment of part or all of an oil, natural gas, or mineral interest to a third party for development.

“This will hinder the ability of E&P investors with in-country positions to grow their portfolios through the medium term” according to Tanner.

In the meantime, López Obrador’s anticipates allocating $4 billion to fund a drilling program in new onshore and shallow-water oil wells in the states of Veracruz, Tabasco, and Chiapas next year.

Pemex needs an annual investment of about $2.5 billion in E&P to reverse the drop in crude oil production alone, José Antonio Escalera, director/exploration at Pemex said during the Mexican Petroleum Congress in September this year. The company, which owns 80% of probable hydrocarbon resources, is currently only investing some $700 million in E&P activities, Escalera says.

“This plan [to invest $4 billion] will necessitate new tenders for drilling contracts with the national oil company. These tenders will entail opportunities for foreign service-sector companies, but the López Obrador administration will likely try to privilege Mexican oilfield services companies in awarding these contracts,” Tanner says.

The president-elect’s plan also includes $2.6 billion to modernize the country’s refineries and an $8.4 billion investment to build a new refinery within three years. This would help Pemex and Mexico reduce imports of refined products and boost production downstream—including chemicals.

The long-term potential for Mexico’s petrochemical industry lies in its ties to the United States, but more importantly in its economy’s growth potential.

Looking at plastics for instance, Mexico’s per capita consumption has grown 5%/year on average over the last 35 years, according to figures from the country’s national plastic association, Anipac (Mexico City). Trade with the United States only accounts for 1.5% of this average annual growth, Anipac says.

This growth underscores the importance—for Pemex, the petrochemical industry, and the country—of getting the energy policy right and the reform on track.

By Francinia Protti-Alvarez

Source: Chemical Week

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