Exporting US Oil to Mexico

• Mexico could become a major export destination for surplus US light crude oil, despite being one of the largest oil suppliers to the US, mainly of heavy oil.
• If structured as an exchange for other barrels, such exports might not require re-writing US oil export regulations, unlike sales to non-neighboring countries.

Two of the biggest energy stories of the last twelve months have been the reform of Mexico's oil sector after 75 years of state monopoly and the US oil industry's drive to gain approval to export a growing surplus of domestic light crude oil. The prospect of exporting US oil to Mexico connects these developments in a surprising way. It should make sense geographically and economically, though regulatory hurdles remain. Yet it could also increase tension between US oil producers and refiners over the merits of exporting crude versus refined products.

At first glance, the idea seems counterintuitive. Our southern neighbor was the third-largest exporter of oil to the US last year, consistently ranking above Venezuela. However, most of Mexico's oil is heavy and sour, in contrast to the light, low-sulfur "tight oil" (LTO) produced from US shale formations like the Eagle Ford of Texas.

Mexico has experienced supply and demand trends similar to what the US saw prior to our shale revolution. Total oil and gas liquids production has fallen by 25% since 2004, largely due to the declining output of Maya crude from the supergiant Cantarell field, while demand for refined products grew by around 20% in the same period. Lightening the crude oil slate of Pemex's oil refineries with LTO imported from the US could augment efforts to increase throughput and yields of transportation fuels.

The Commerce Department's recent approval for two US companies to export lightly-processed condensate, which despite its similarities is technically not crude oil, was followed by a hold on similar applications. These events have fueled both enthusiasm and confusion concerning US oil exports, which are still politically controversial, after decades of declining US production and periodic price spikes.

An easier sell might involve the exchange or "swap" of surplus LTO for imported heavy oil, and Mexico makes an ideal partner for this kind of transaction. Existing law at least recognizes the potential for such swaps with "adjacent countries", though it remains to be seen whether such a deal could be made to fit language specifying that the oil received be of "equal or better quality".

As a former oil trader, it strikes me that the best ways to close that gap might be to structure an LTO vs. Maya swap as a barrel-for-barrel exchange in which the US party would collect a financial premium in recognition of the quality difference--money being another measure of quality--or a "ratio exchange" in which every barrel of LTO delivered would be matched by a larger quantity of Maya, at a proportion determined by the refining values of the two oils. Either option would still require some regulatory finesse, but of a much different type than approving the outright, net export of US oil production.

The biggest stumbling block to an exchange of LTO for Mexican crude would probably be one of the same ones impeding the general lifting of a US oil export ban that the Washington Post has called "an economically incoherent policy." While US oil producers argue that allowing exports would enable their product to be sold for its global value and incentivize even higher future production, US oil refiners see exports as a threat to their margins and to the growth of their own exports of refined products. These have been crucial in sustaining arguably the world's best refining industry in the face of a weak economy and declining demand at home. 

Mexico is at the heart of this trend. Its imports of LPG, gasoline, diesel and other fuels from the US have increased to over 500,000 barrels per day (bpd) in recent years. Mexico accounted for 44% of all US gasoline and gasoline blending components exported last year, along with 10% of diesel fuel exports and 15% of LPG. I don't think it's controversial to suggest that exporting light crude oil to Mexico would come at least partly at the expense of our refined product exports to the country.

This boils down to the familiar economic dilemma of exporting raw materials versus capturing the value added from selling manufactured goods. I'm sympathetic to the refining industry's concerns, and not just as a former refinery engineer. However, those concerns would carry more weight if US refineries had the capacity to process all of the LTO the US is likely to produce in the years ahead, and to pay a world-market price for it. Refiners might benefit from access to lower-priced crude, but if driving down the value of LTO in a confined market choked production, net US oil imports would be higher than otherwise and the economy would be worse off.

Stepping back from the details of that debate, exporting US light crude oil in exchange for Mexican heavy crude looks attractive within a broader and increasingly credible vision of North American energy self-sufficiency. That wouldn't mean cutting North America off from the global oil market, but it would put us and our neighbors in the enviable position of being able to select imports based on opportunity rather than necessity. A reformed and revitalized Mexican oil industry, importing and exporting oil with its neighbors as it makes sense, could be a cornerstone of that vision.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.