It Ain't Heavy, It's My Maya - Impact of Changes to the Mexican Heavy Crude Benchmark - Part 2

A major component of the formula used to set the price of Maya—Mexico’s flagship heavy crude, and a key staple in the diet of many U.S. Gulf Coast refiners—was changed earlier this month, raising new questions about this important price benchmark for nearly all heavy sour crude oil traded along the U.S. Gulf, and points beyond. The change came as Maya production volumes continue to fall, and as Maya is facing increasing competition from Western Canadian Select (diluted bitumen) from Western Canada. Today we conclude a two-part series on Maya crude oil, the new price formula and its potential effects.

As we said, in Part 1, Mexico currently produces about 2.2 million barrels a day (MMb/d) of crude oil, about half of which (~1.1 MMb/d) is exported—three-fifths of which goes to the U.S.  P.M.I. Comercio Internacional S.A. de C.V. (PMI) is the crude oil marketing entity of state-controlled Petróleos Mexicanos (PEMEX) and manages the export of four distinct quality grades of crude oil, ranging from Altamira (an asphalt grade) and Maya on the lower end of the quality spectrum, to Isthmus in the middle, and Olmeca at the higher end. Most of Mexico’s crude oil exports to the U.S. Gulf Coast are Maya blends, as Mexico tends to retain most of its lighter grades (Isthmus and Olmeca) for domestic refinery consumption. However, the share of Maya exports headed for the U.S. has been falling fast—from 78% in 2013 to only 44% through the first nine months of 2016; the share of Maya bound for Europe has more than doubled over the same period and the share shipped to the Far East has more than tripled.

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In today’s blog, we take a look at historical pricing for Maya and how that price has been determined through the use of the PMI official selling price formula. We will also examine how the changes to the fuel oil component of the formula, major changes in fuel oil (or bunker fuel) specifications, and the availability of heavy Canadian crude oils could potentially impact the Maya price.

Historical Maya Pricing

First, let’s dive into Maya’s pricing. PMI typically sells Maya crude oil on a FOB (or “free on board”) basis, which means the crude oil buyer takes custody of the cargo at the load port and pays the transportation cost from Mexico to the refinery. The commercial terms for each customer are unique and confidential.  Resale is prohibited. Most sales are term-type contractual agreements, though PMI may occasionally make spot sales. As we first discussed more than three years ago in Sailing Stormy Waters, PMI uses destination-specific formulas to calculate the sales price of Maya. Although the set of formulas are similar in nature, each is uniquely defined for a specific sales destination. This formula-based approach is a function of the prices of other crude oils and residual fuel, with a monthly adjustment factor (“K”) applied. The K factor is announced by PMI for a given month and is held constant for the entire month. For example, the K factor for February 2017 for Maya bound for the U.S. Gulf Coast has been set at -$4.75 (negative $4.75 per barrel). For Gulf Coast deliveries of Maya crude oil, the price is calculated using the following formula:

U.S. GULF COAST MAYA = 0.40 * West Texas Sour (WTS) + 0.10 * Louisiana Light Sweet (LLS)

                                     + 0.10 * Dated Brent (BRENT DTD) + 0.40 * No. 6 Fuel Oil 3%S + K

No. 6 Fuel Oil 3%S refers to 3.0% sulfur. Mexico only recently restarted shipments of Maya crude oil to the U.S. West Coast; PMI uses the same formula above, however the published K factor is different for West Coast versus Gulf Coast destinations. There are similar pricing formulas for Maya delivered to Europe and Asia/Pacific using combinations of Brent, Oman, Dubai, and various No. 6 fuel oil qualities, but we will focus on the U.S. Gulf Coast formula for now.

Walking through this formula, you’ll note that 40% of the Maya price is driven by the price of an inland crude oil (WTS). During the 2011-13 time period, the prices of inland U.S. crude oils such as WTS and West Texas Intermediate (WTI) were disconnected from coastal markets, leading to steep price discounts for those crude oils relative to coastal crude oils such as LLS (see Yesterday All My Exports Seemed So Far Away). Therefore, the calculated Maya crude oil price (prior to the K factor adjustment) was also heavily impacted by those discounts during the first few years of this decade. To compensate for this disconnect, PMI decided to make relatively large, offsetting increases in the monthly K factor. Otherwise, PMI would have been significantly discounting its Maya price relative to the Gulf of Mexico waterborne market––something certainly not in Mexico’s best interests. The following chart (Figure 1) illustrates how the inland price disconnect drove changes in the K factor values used in the Maya price formula. You can see how the K factor was trending in the range of negative $3-5/bbl prior to the inland crude oil price collapse, and was adjusted to a positive $1-2/bbl on an annual average basis during the period from January 2011 to January 2014. This swing of $4 to $7/bbl was directly related to the collapse in WTS price. Note that, on a monthly basis, the K factor was increased to well over $4/bbl during a period in late 2011/early 2012 and again in late 2013/early 2014 to offset ballooning inland-crude differentials.  Lately the K factor has been trending in the negative $2/bbl range on an average annual basis, about half the K factor’s average level in the years just prior to 2011; likely reflecting a change in Maya’s competitive position relative to other heavy sour crude oils, its declining availability in the U.S. Gulf Coast, and overall lower crude oil prices.

Figure 1; Source: PMI, Baker & O’Brien Analysis (Click to Enlarge)

The 40% weighting of residual No. 6 fuel oil in the U.S. Gulf Coast Maya formula is reflective of the Mexican crude’s high residual fuel oil yield. (See Part 1 for a depiction of Maya’s residual fuel yield vs. other crude oils.) As we’ll get to in a moment, this is the component of the formula that changed this month.

The Figure 2 graph compares the historical Maya price with several other benchmark crude oils. Maya’s price is important because many, if not all, heavy crude oils are typically transacted as a differential to the Maya price, which allows a transparent mechanism for price determination. Due to the heavy sour quality of Maya (described in Part 1), the Maya price is discounted to benchmark sweet crude oils (such as LLS) but is typically higher than the Canadian benchmark sour crude oil, Western Canadian Select (WCS).  WCS crude oil is priced at Hardisty, AB and incurs a significant cost associated with transporting it to the Gulf Coast (see Mamma Maya). The pipeline capacity to move WCS to the Gulf Coast has been constrained in the past; during such periods WCS crude oil received an additional price discount like other stranded inland crudes.

Figure 2; Source: Platts, Baker & O’Brien Analysis (Click to Enlarge)

The differential between Maya’s price and benchmark light sweet crude oils has been quite volatile. This differential (typically referred to—not surprisingly—as the heavy/light crude oil price differential) is an indicator of coking refinery profitability. Large heavy/light crude oil differentials generally suggest that coking refinery profitability is strong compared to periods when the differential is low (for more on coking, see Complex Refining 101). The following chart shows how the differential has fluctuated over the past several years, indicating an overall downward trend consistent with the overall drop in crude oil prices but also reflective of the relative availability and desire for (supply/demand) of heavy oils in the Gulf Coast refining center. The Maya-to-LLS price discount is often calculated on a percentage basis to compensate for the effects of changes in the absolute level of global oil prices. A rule of thumb is that cokers are profitable if Maya sells at a 10% or greater discount to LLS. Coker margins have been generally good since the deterioration in crude oil prices began in the second half of 2014.  

Figure 3; Source: Platts, Baker & O’Brien Analysis (Click to Enlarge)

Recent Developments in Maya Price Formula

Now, back to the focus of today’s blog. Earlier this month, Platts (one of the leading price reporting publishers) changed the specification for its benchmark Gulf Coast No. 6 Fuel Oil 3%S index, replacing it with RMG 380 3.5%S, another heavy residual fuel oil, which is used specifically as a marine fuel. (RMG 380 is one of several grades of Residual Marine fuel oil.) Heavy residual fuel oil such as No. 6 Fuel Oil typically finds a home as bunker fuel (marine fuel) for the shipping industry, so the Platts change simply reflects current shipping regulations and eliminates having a redundant price for fuel used for the marine industry. RMG fuel oil and No. 6 3%S fuel oil are similar, but RMG has slightly more restrictive specifications, so it can cost more to produce. Figure 4 below highlights some of the differences in the specifications for the two products according to the Platts Methodology and Specifications Guide from September 2016.

Figure 4; Source: Platts, Baker & O’Brien Analysis (Click to Enlarge)

To make the table easier to understand, we’ve highlighted in green the specs that are less restrictive and highlighted the more restrictive specs in red. RMG 380 has a less restrictive sulfur spec of 3.5% versus 3.0%. However, other specifications are more restrictive, such as the oil’s gravity (which means you may need to use more cutter stock—or light petroleum—to reduce its density and viscosity or reduce the level of other bad actors such as vanadium, ash, sediment and residual carbon content.

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RMG 380 has historically traded at a premium to U.S. Gulf Coast No. 6 3% Fuel Oil as shown in Figure 5 below; the average differential over the past six-plus years is ~$1.46/bbl.

Figure 5; Source: Platts (Click to Enlarge)

With the recent change in specification, Platts suggested using a one-time differential of $1.45/bbl for amending Maya crude oil contracts based on the U.S. Gulf Coast No. 6 3%S Fuel Oil assessment. Given that a portion of the Maya formula (40%, before the K factor is added or subtracted) is based on this assessment that would indicate an adjustment of $0.58/bbl (or $1.45 x 0.40). However, in December 2016, PMI lowered the formula price adjustment (K factor) used in the Maya price calculation for January by $0.85/bbl., from a discount of $3.45/bbl in December to a discount of $4.30/bbl. This change is larger than the $0.58/bbl suggestion from Platts, so it likely reflected other market factors as well—perhaps price changes in other similar sour crude oil prices—in order to ensure Maya is competitively priced.

Future Impacts to the Maya Price Formula

What other structural changes in the industry might affect Maya’s price formula components? 

Bunker Fuel Sulfur Reduction

The shipping industry is a major consumer of bunker fuels for engine fuel. Almost all types of vessels—from container ships to bulk carrier ships to cruise ships—require liquid fuels, ranging from bunkers to marine distillate oil (MDO). Residual fuel oil is a large component of bunker fuel, and its sulfur content is currently limited to 3.5% by weight in most of the world (except for parts of the North American and European coasts, where the sulfur limit is 0.1%.). However, as we discussed in How Am I Supposed to Live Without You, the International Maritime Organization (IMO) recently approved changes that will reduce the global sulfur limit to 0.5% as of January 2020. 

This reduction in the residual fuel oil sulfur content could destroy demand and ultimately reduce availability, which would likely lead to significant volatility and a future revision in the Maya pricing formula. If the much lower sulfur residual fuel oil is incorporated into the pricing formula, it would obviously be less reflective of Maya’s “natural” fuel oil yield and a subsequent revision to the K factor would likely be required to keep the Maya price competitive.

Increased Competition from Canadian Oil Sands Diluted Bitumen Crudes (Dilbits)

Canadian heavy sour crude oils such as WCS and Cold Lake are similar in quality to Maya but have historically been priced at significant discounts due to transportation constraints to reach the U.S. Gulf Coast. Should the Keystone XL Pipeline or other similar pipeline projects be constructed, the availability of these heavy sour crude oils in the Gulf Coast region could increase significantly, leading to more competition for Maya, more downward K factor adjustments, and higher volatility in the Maya price—all to the benefit of heavy-sour crude refiners. As previously discussed, PMI seems to be anticipating this eventuality and has been diversifying its Maya export destinations. Stay tuned for how these and other future events could impact the Maya pricing formula.

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"He Ain't Heavy, He's My Brother" is the title of a popular ballad originally recorded by Kelly Gordon. It became a worldwide hit for The Hollies in 1969 and for Neil Diamond in 1970.