INTRODUCTION

At the end of 2013, the refining market was one of stark contrasts. On the one hand, the supply of heavy products in the domestic market proved adequate, with excessive volumes of fuel oil. On the other, the gas and diesel oil demand could not be met with production by Petróleos Mexicanos (Pemex). The possibility to expand the infrastructure was jeopardized, as the new refinery project in Tula, Hidalgo was put on hold and the plan was made to retrofit the units in Tula, Salamanca, and Salina Cruz. This situation constrained Pemex's supply capacity in subsequent years and made the country reliant on imports to supply the domestic market.

In this context, the choice was made to liberalize the refining industry, aiming to revive it. However, these efforts were ailed b a series of challenges, which will be the topic of analysis in this paper, and will be essential to the behavior of the industry for years to come. This paper begins with a first section to offer general considerations about the global refining industry, followed by a second section that examines its performance in the American and Canadian markets, taking into account that more of the companies that may or may not have business relationships in Mexico, they also conduct operations in their own nations. The third section introduces a diagnosis of refining in Mexico, based on industrial analysis tools throughout the entire value chain to, finally, identify the top challenges looming ahead in the new scenario of open-market competition.

THE REFINING INDUSTRY AROUND THE WORLD

The refining industry is strategic for the economy, as it is an opportunity to add value to oil. Its distillates are the foundation to supply countless activities in which human beings engage, including, most notably, transportation, power generation, and activities that require heat.

In general, the refining industry is capital-intensive, and size and technological complexity, as well as wage costs and environmental regulations, are all relevant to its viability. The industry is composed of a set of large continuous production plants, where crude oil is separated into different fractions; for example, oil is physically and chemically processed to produce finished products, which range from very light―like liquefied petroleum gas―to the heaviest―like asphalt or petroleum coke. The refining industry also encompasses the transportation and storage of processed products, as well as delivery to consumers through distribution points.

In response to market conditions, the refining industry has gone through various stages, such as surplus production capacity at the end of the 1980s and the beginning of the 1990s, or plummeting profit margins in the early years of the past decade.

In general, the international refining industry continues to reinvent itself, whether by expanding capacity, renovating and/or upgrading it, in order to expand its useful life and competitiveness, with processes aimed at higher value added products, like gasoline and diesel, and limiting the production of heavy byproducts; or the use of flexible technology to process crude oil in light of problems with disposal at refineries and price volatility.

The industry has also faced very narrow and volatile refining margins that have driven up operational efficiency, as well as actions to optimize the energy used, automate processes, and hire highly skilled staff, among other measures. Efforts have been made to supply the type of oil byproducts for which the market is most hungry: cleaner, more efficient, and up to required quality standards; as well as to adapt to the trend of coexisting alongside substitute fuels,² like natural gas in the United States, adopt environmental standards into processes, which in some cases require investments that will yield little by way of returns; to process higher quality byproducts in combustion, through the incorporation of better technologies, such as is the case of gasoline with a higher enthalpy of evaporation, which makes it more efficient by cooling the fuel mix during the injection process, or simply through a mix of liquefied products obtained from renewable sources, like ethanol.

Likewise, in light of the long-term returns, refining companies have sought schemes to access financing by turning to the stock market or bank loans, but also by capitalizing on their profits derived from times past when oil prices were higher, as they were between 2004 and the end of 2014.

In particular, strategies have been implemented to improve the positioning of refining companies in the market. Along these lines, the international oil companies are standout examples. In addition to earning significant profits in the refining business, they have robust processing, storage, and transportation systems for petroleum-based products and even, in some cases, have upstream integration in their activities, or may focus on only on refining.

The refining business operates in a free market world, even in those cases where the government intervenes. In the latter cases, some units barely manage to break even or may lose money.

At close of 2014, total demand for oil byproducts hit 92 million barrels a day (mmbd), of which 49% went to countries in the Organization for Economic Cooperation and Development (OECD), which displayed a downward trend of nearly 3 mmbd since 2008 due to the effect of the economic shakeup. Fuel oil consumption suffered the most. By contrast, in non-OECD nations, the demand for petroleum products has grown stronger (see Table 1).

On the other hand, global refining capacity at the end of 2014 was higher than the demand for petroleum products, at 96.5 mmbd,³ 22% above what it was in 1980, and it was non-OECD countries that saw the highest increase. The Asia-Pacific region stands out, as well as a trend in the Middle East to add value to crude, not to mention the greater installed capacity they have achieved. This stands in sharp contrast to Europe, where said capacity fell by 4.5 mmbd between 2008 and mid-2014 (^{IEA, 2014}).

Between 1980 and 2014, the refining capacity in North America declined, as did its contribution to the world total (see Table 2). As 2014 drew to a close, it was 21.3 mmbd, of which the United States accounted for 84%, Canada 9.2%, and Mexico the remaining 6.8%. The net volume of oil imported in that region amounted to a little more than 4.6 mmbd, basically due to purchases from outside the United States, which, thanks to its surpluses, made the region a net petroleum exporter.

The Organization of Petroleum Exporting Countries (^OPEC) estimates that 9 mmbd of primary distillation capacity will be added between 2014 and 2019, of which more than 92% will be derived from upgrades and expansions to existing plants, and the remaining 8% will be new capacity, and it is the Asian region that should show the strongest growth. Investments in the global refining industry could climb as high as 102.1 mmbd in 2020 (^{IEA, 2015}). To do so, companies must tackle the challenge of evaluating the operational models they have chosen and their levels of integration, particularly in North America and Western Europe (^{Atkearney, 2012}).

In the coming years, the international refining industry will continue to add technological advances, in particular, bringing about more efficient and flexible processes to produce byproducts and energy savers, better coupled with petrochemical plants, and preventing greenhouse gas emissions; the benchmark is higher energy efficiency. The automotive sector is noteworthy in this sense, expecting to achieve performance of nearly 20km/liter by 2025 (^{The White House, 2012}).

However, one crucial factor to the future of refining is associated with how investment decisions are changing in response to the behavior of international oil prices.

REFINING PERFORMANCE IN MEXICO

The refining industry in Mexico has been the cornerstone of the country's economic growth, as it is able to provide fuels and inputs in a timely fashion, mainly to the transportation sector. Thanks to its development, Pemex was ranked among the top 15 companies in terms of refining capacity in the world in 2014. Pemex's subsidiary, which managed the refining operations, was known as Pemex Refining (PR), but starting in 2015, it was merged into Pemex Transformation.

After the oil boom, which helped the industry achieve major technological advances through the Mexican Oil Institute, transcending borders with such products as the DEMEX process, refining in Mexico began to face a dearth of investment resources to upgrade and grow, starting in the 1980s, but especially since the oil policy began to focus on developing the supergiant field Cantarell.

Average annual investment rose to 0.71 billion dollars (bd) between 1991 and 1999. This resulted in insufficient maintenance, constraints on incorporating technology, operational improvements, and failure to increase installed capacity. Moreover, units were closed in Azcapotzalco, Poza Rica, and Reynosa at the beginning of the 1990s.

The program to reshape the National Refining System (SNR) was authorized at the end of the 1990s and involved building new processing plants, as well as expanding and upgrading those already existing. Investment amounted to nearly two billion dollars annual average between 2000 and 2001, to develop works at the Cadereyta and Madero refineries, and later fell to 0.66 bd between 2002 and 205. Starting in 2006, new resources were injected, averaging around 1.9 bd per year until 2014. Some notable projects included the Fuel Quality project and the retrofitting of Minatitlán (see Table 3). In this way, the refineries in Cadereyta, Madero, and Minatitlán culminated the retrofits and raised the volume processed of heavy crude petroleum from 15.0, 11,0, and 122.9%, respectively, as fuel oil production fell to 48.6%, 64.9%, and 69.4% (^{ASF, 2014}).

At close of 2014, Pemex had six SNR units with installed processing capacity of 1.6 bd, only 2.8% higher than what it had in the year 2000, but 5% lower than in 1990.¹⁴ Moreover, it held 50% of Deer Park's shares, which is operated by Royal Dutch Shell, and which controls the other half of ownership.

The refinery management strategy, which has entailed not building a new unit since 19779, has led to exporting the crude extracted abroad, rather than processing it. The United States Gulf Coast is one of the top destinations, from which a significant portion of imported petroleum products are obtained.

In general, this landscape reveals that refining in Mexico is facing a complex situation, derived from its reliance on public funding,¹⁵ and a set of factors tied to its development throughout the entire value chain. The most relevant are:

Source: BP.

Figure 1. Usage of Installed Capacity in Select Nations 

In light of the budgetary constraints that the oil industry will likely be facing, both in light of the public sector's financial situation as well as the potential for low oil prices, at least until the end of this decade, reviving state refining would seem to be a complicated matter, especially considering the official projects planned.

PROSPECTS FOR REFINING IN MEXICO

Consumption of byproducts in Mexico has risen as a result of booming economic activity, but also due to the political decision not to develop other transportation alternatives, such as rail or public transport. On other occasions, low gasoline and diesel prices, as compared to international benchmarks, were a factor that drove up consumption, particularly up until the 1980s (^{Romo, 2011}).

Pemex's flagging refining performance has forced the country into a position as a net petroleum product importer and, starting in 2015, it has displayed an oil trade balance deficit, with gasoline as the main product acquired from abroad (see Figure 2). Mexico is now only a net exporter of fuel oil. In fact, nearly half of national apparent gasoline consumption needs to be imported. In other words, there is a captive market to be supplied, which, in 2014, was just over 350 mbd.

Source: Pemex F-20.

Figure 2. Net Results and Sales of Pemex Refinancing. Millions of dollars 

Official estimates (^{Secretaría de Energía, 2014}) signal that in 2028, the demand in Mexico will be nearly two mmbd of crude oil equivalent, 38% more than 2013 consumption.³¹ Gasoline has the highest demand, followed by diesel, as a result of its intensive use in car transportation.

With the approval of the December 2013 energy reform, the government set conditions for public and private companies to treat and refine oil in the country, pursuant to a legal and fiscal regime,³² that does allow for private enterprises to participate, with immediate deductions for investments.

In a market that will become competitive starting in 2018, and in which consumers do not have much capacity to influence, there is the potential to offer petroleum products processed in the country, and in the case of light crude, offer it in mixes with renewable fuels, like ethanol.

Mexico is a net exporter of crude oil, so it has enough volume for processing. The challenge will be for private enterprises that exploit it to gain the capacity to process it, although not all winning companies in Round One are dedicated to downstream activities.

Meeting the expected demand for refined products would entail implementing a series of actions, or some combination of them, as follows:

Just like on the international stage, the choice for private companies to invest in refining is subject to whether or not they will be able to access attractive conditions for profitability. In this sense, government stimulus packages, crude price volatility, and the conditions in the petroleum products market,³⁴ as well as, of course, companies' operational performance, will all play a role.

In summary, the development of the Mexican refining industry will be determined by the role of private investment in reviving it. Private entities have already announced some transportation, distribution, storage, retail, and petroleum self-consumption service projects, as well as the likely construction of new refineries.³⁵ Pemex will also play a major role in the industry, because it will be the placeholder in the supply of petroleum byproducts, as it will have to occupy spaces that private enterprises do not wish to enter. In light of the foregoing, it would be a good idea to speed up reconversion strategies, but also to access financial support, full autonomy in decision-making,³⁶ and a change in the organizational culture.

CONCLUSIONS

Refining is a complex and capital-intensive business with long-term returns on investment, which requires efficiency, technology, good management, and compliance with environmental standards to process clean products, where the main input, crude oil, has displayed volatile prices and unique conditions related to its availability for treatment.

Despite the closure of units in developed nations, the global refining industry has surplus installed capacity, derived primarily from investments in past years in the Asia-Pacific and Middle Eastern regions, as well as upgrades in other countries. This is in a market where the consumption of petroleum products has fallen in the most developed nations and risen in all other nations, but which is headed for increased growth in the coming years, particularly as a result of the dynamic transportation industry.

The United States and Canada have increased their refining capacities by upgrading plants, but at the same time, they have closed other, less profitable plants. Their market structure is a monopolistic competitive structure. The former country records a surplus petroleum balance, and the latter is very close to equilibrium, but imports and exports due to reasons related to logistics. They both operate essentially pursuant to free market criteria with limited consumption growth. Even with Mexico's deficit, the region displays a surplus, which can be used in the case of Mexican purchases, especially because this takes place on the Gulf of Mexico where there is the infrastructure necessary for its transportation.

When it comes to Pemex, the state enterprise has managed to supply national petroleum consumption in a timely fashion with domestic production and imports. However, it is dealing with a series of structural problems throughout the entire value chain, which make it unprofitable and lead to liquidity problems and high leverage. Its operational performance has been inefficient and is marked by limited contributions of resources from the administrations in charge, which have prevented increased investment, maintenance, and upgrading of plants, or even the building of new units. This has all taken place in a context in which the priority for oil policy since the 1980s has focused on exploiting hydrocarbons, rather than on activities that add value to the crude extracted.

Consumption of oil byproducts in the country will continue to grow in the coming years, especially for light products, in a context of surplus crude oil production for at least until halfway through the next decade. With the approval of the 2013 energy reform, private initiative can now become the main actor in developing the national refining industry, but to prevent supply problems, Pemex will have to operate in the markets where private companies do not want to enter. This participation will continue to be subject to restrictions on management autonomy when it comes to strategic decisions and budgetary constraints for at least the rest of this decade, as well as the government's strategy to develop spaces for other players to make the energy reform viable. This well set the state oil enterprise on the road to either partnerships or selling assets and, of course, to losing influence over and share of the market in which it was formerly the sole player.