Scaring off sorely needed investments in fuel distribution systems.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET .

A year and a half after Mexico opened its fuel market to private competition, almost all gasoline sold at BP and Royal Dutch Shell stations continues to come from state-owned Petróleos Mexicanos, A.K.A. Pemex.

Mexico lacks a sufficiently advanced and coordinated network of oil pipelines and storage terminals that would allow the flow of imported products from the port to the gas stations. As the company’s chief executive, Jose Antonio González Anaya, said in a recent visit to Washington, Pemex has a “grotesque lack of storage and transportation capacity.”

Mexico allowed private companies to import fuel for the first time in April 2016 under broader reforms aimed at encouraging competition and investment. So far, 32 private companies have sent diesel to Mexico and 17 have brought in gasoline, according to Mexico’s Energy Secretariat. But the volumes are a tiny fraction of the nearly 800,000 barrels per day that Pemex imports.

“Fuel can be imported, but there is no place to store it and transportation is expensive,” said Roberto Díez de León, president of Onexpo, Mexico’s gasoline retailers association.

Companies such as Monterra Energy — backed by KKR & Co — Mexican Invex, Glencore and a joint venture between TransCanada and Mexican firms Sierra Oil & Gas and Grupo TMM have announced pipeline projects at the Tuxpan fuel import center on the Gulf Coast. Other firms, such as Howard Energy Partners and BioUrja Trading LLC, have shown an interest in importing oil via newly built pipelines from the U.S.

But there’s one problem: security.

Mexico is one of the worst places in the world for fuel theft. It’s already costing Pemex around $4 million a day. That’s about $1.4 billion a year. Those doing the plundering include armies of amateur opportunists who live close to the major pipelines that crisscross the country as well as some of Mexico’s most ruthless and organized drug gangs.

Since 2008, Pemex has spent 28.3 billion pesos ($1.5 billion) on 15 programs aimed at tackling fuel theft, but to little avail. Despite the firm’s increasing use of costly pipeline tracking systems, radar, drones, planes, boats and other tactical vehicles, the number of illegal pipeline taps has risen by 2,000% in the last decade. Things have gotten so bad that in one recent incident in Queretero, one of Mexico’s biggest and fastest growing industrial centers, thieves directly tapped pipelines on a Pemex gas station.

Much of the plunder is taking place in the central state of Puebla, which, through a pure accident of geography, is located slap-bang between the vast oil fields of Veracruz and Mexico’s gas-guzzling capital Mexico City. Just one of the state’s gas pipelines, the “Minatitlán-México” line, accounts for 34% of all the oil stolen in Mexico. The Sierra Poblana is one of Mexico’s poorest regions, accounting for many of the migrants who cross the border into the U.S. Now, local communities are finding job opportunities in the black market for oil.

Until recently Puebla was one of Mexico’s safest regions, but since Mexico’s government decided to mobilize the army to crack down on fuel theft, clashes between soldiers and fuel thieves have raged in the region. At the beginning of May, one such battle claimed the lives of four soldiers and six suspected oil thieves, who used local civilians as human shields.

Fuel theft has intensified this year since the government decided on January 1 to withdraw public subsidies that had helped keep gasoline prices artificially low in Mexico, just as inflationary pressures were building. The result was an instantaneous 20% surge in prices, which triggered nationwide riots and blockades of fuel depots. It also gave an almighty boost to Mexico’s already buoyant black market for oil.

As the market has expanded, so too has the violence. And this has begun to worry many of the international investors that have been piling into Mexico’s oil market since President Enrique Peña Nieto’s sweeping energy reforms, in 2014. “It is part of a worrying trend that investors will see and take into account in the price of the offers they make and the amount they decide to invest in Mexico,” said John Padilla, CEO of energy consulting firm IPD Latin America.

So far, Pemex has covered the full cost resulting from fuel theft, but it is not clear whether the state oil company will try to transfer some of the costs to private importers in the future.

On paper, 2017 has been a much better year for Pemex than 2016 or 2015, when it racked up its biggest losses ever (over $30 billion). Instead of losing money hand over fist, it’s actually making some. In July it reported 32.8 billion pesos ($1.8 billion) of second-quarter profits, spurred by higher sales, lower financial costs and a stronger peso.

But Pemex has also made severe cutbacks in investments in physical infrastructure. In the first half of 2017 the firm spent 105 billion pesos ($5.57 billion) on physical infrastructure, compared to 154 billion pesos ($8.17 billion) in the first half of 2016. In the first half of 2015 the total outlay was 200 billion pesos ($10.61 billion). In other words, total investment in physical infrastructure has shrunk by almost half in just two years.

And that’s where the irony lies. For Pemex to turn a profit, it must invest less and less in long-term maintenance and operations. And that can only have one long-term result: an even more “grotesque” lack of storage and transportation capacity in the country.

In other words, the dependence of private-sector operators on Pemex imports is likely to continue for the foreseeable future — unless, of course, those operators are willing to take up some of the slack. For that to happen, they will first seek guarantees from the government that their primary product won’t be stolen on its way to market. Given that gas theft represents one of the biggest source of funds for organized crime in Mexico, a country that has spectacularly failed to stem the rise of organized crime in the last 30 years, such guarantees may be hard to come by. By Don Quijones.

Rebuilding with no insurance and little government aid. Read… The Steep Price of Disaster in Mexico

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