Analysis: Pemex trades HSFO woes for sweet-sour volatility
With its revised formula for Maya crude, Pemex may have replaced volatility in high sulfur fuel oil with swings in sweet-sour spreads as the main challenge in setting its monthly Official Selling Price for its crude exports.
With the International Maritime Organization’s 0.5% cap on sulfur for marine fuels fast approaching, Mexico’s state-owned oil company was under pressure to revise its long-standing crude formula to reduce exposure to refined products with falling demand.
The legacy Maya formula for shipments to the US Gulf Coast was 40% the combined price of West Texas Sour crude and USGC HSFO plus 10% the combined price of Light Louisiana Sweet crude and Dated Brent. The last piece of the OSP mechanism is the “K factor”, the monthly adjustment to the formula set at Pemex’s discretion to bring the final price for crude exports into line with expected market value.
The Maya formula for shipments to USGC is changing with effect from December to 65% the price of WTI Houston, an Argus Media assessment, plus 35% the price of ICE Brent. As before, the monthly K factor will be added to this formula to arrive at the final price.
VOLATILITY STRAINS FORMULA
Setting the monthly K factors a month ahead of actual crude exports is often no easy task for Pemex. For example, the company seemed to run into problems in early August as the bunker fuel supply chain began to trim inventory of HSFO ahead of the debut of the IMO 2020 rules. From July 31 to August 16, HSFO-Brent crack spreads fell over $13/b to minus $18/b, the lowest level of the year.
PMI, the trading arm of Pemex, has for years been punctual in publishing K factors on the 15th of each month to go into effect on the first day of the next month. With HSFO prices tanking in August, PMI did not release its September values until August 23.
After the delay, the K factor for Maya crude shipments to the USGC was increased by $4.50/b to $3.75/b, the largest single-month move in the K factor since S&P Global Platts began tracking the postings in 2002. PMI had previously avoided changing the K factor by more than $1.90/b.
With a higher-than-usual K factor in place, PMI had offset the previous two weeks’ collapse in HSFO.
At that point, few would have predicted a surge in HSFO prices, but by September 19, the HSFO-Brent crack was back above minus $5/b.
The combination of the higher K factor and September rally in HSFO meant uncompetitive prices for Maya crude, and customers took notice.
“Obviously in September, [Pemex expected HSFO] to trade much weaker, and the formula had Maya really priced out of the market,” Valero CEO Joe Gorder said during the refiner’s third-quarter 2019 earnings call last week.
With HSFO prices recovering in September, PMI opted for another outsized K factor adjustment in the opposite direction for October, reducing it by $3.25/b to 50 cents/b.
With the new formula, Pemex will no longer have to worry about ongoing volatility in HSFO, but will face the challenge of setting the K factor relative to a formula referencing two light, sweet crudes.
At about 21 API and 3.4% sulfur, Maya is a very heavy and sour crude. WTI and most North Sea crudes have an API of around 40 and sulfur content typically well below 0.5%. Fundamentals for these grades will often diverge from heavy sour crudes, leading to changes in the sweet-sour spread.
As PMI undergoes the monthly exercise of setting its crude price, volatility in that spread could lead to swings in the K factor.
In 2019, the K factor for Maya shipments to the USGC ranged from minus 75 cents/b to plus $3.75/b – a difference of $4.50/b. Using the new formula to arrive at the same final prices for Maya crude in 2019 shows that Pemex would have needed to adjust the K factor in a range from minus $7.26/b to minus $1.88/b – a difference of $5.38/b. In other words, to price Maya crude at the same level to Mexico’s customers, the new OSP formula would have resulted in K factors which were lower in value and with a range about 90 cents/b wider than the old formula.
Pemex’s new formula shifts “responsibility for valuing an appropriate discount for heavy sour Maya to light sweet benchmarks Brent and WTI away from the market and into the hands of Pemex via the somewhat blunt instrument that is the K factor,” Morningstar Commodities Research analyst Sandy Fielden said in a recent report.
“Since the new Pemex formulas have no reference to sour crude or fuel oil, we expect the adjustments that Pemex needs to make with the K factor will continue to move over a wider range to stay competitive,” Fielden said.
One of the concerns with the old formula was the inability to hedge effectively. Some of the prior components did not have derivatives, while others had derivatives with limited liquidity. The new components may provide more hedging liquidity, but may fall short in terms of hedging accuracy.
Buyers could hedge their exposure using Brent and WTI, but there is “no way to hedge the K factor,” said John Auers with Turner, Mason, & Co.
“The K factor was what really determined the price anyway,” Auers said, adding that he believes refiners will get used to the volatility and hedge with their operations by changing crude slates as sweet-sour spreads ebb and flow.
COMPETING WITH CANADA
Western Canadian Select has emerged as a key competitor to Maya in recent years and that may have played a role in the new OSP formula.
With an API density of about 22 and 3.7% sulfur content, WCS is ostensibly a similar barrel to Maya, although as a combination of over 25 different crude streams, quality consistency has been a concern. USGC complex refineries have more access to this Maya-competitor with increasing pipelines bringing crude from Canada to Cushing and ultimately the USGC.
“We believe heavy Canadian and Maya should trade at approximately the same value,” said Valero’s Gorder last week. “And if you look at where both WCS and Maya are trading today, they’re almost on top of each other, which is where we expect those to trade moving forward.”
WCS does not have an OSP, instead trading in the spot market at a differential to the calendar-month average of the front-month NYMEX light sweet crude futures contract (WTI CMA). With its heavy WTI Houston weighting, Maya’s new OSP formula for the US uses a component related to the NYMEX contract that underpins most WCS trade. For buyers considering both WCS and Maya, use of a WTI-based formula may provide clearer price signals than the more complex legacy formula.
WCS ex-Nederland was assessed Monday at a $5.70/b discount to the WTI CMA or $50.18/b.