The autopsy has already begun.

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

As the world’s attention is transfixed by every new development in Chapo Guzman’s latest audacious prison break, something much more important – and potentially more dangerous – is happening in Mexico. Yesterday the country held its first auction of offshore oil leases, bringing to an end 77 long years of state control over energy.

Until yesterday, Petróleos Mexicanos, A.K.A. Pemex, the state oil company, ran all oil and gas production in Mexico. But that has now changed. With it a new age has begun, one in which Mexico’s energy sector will finally get the funds it needs to extract the vast hydrocarbon resources it has at its disposal. It will also get the technology it needs for deepwater drilling in the Gulf of Mexico as private companies, in particular from the US and the UK, provide essential know-how and best practices. In short, it is a perfect win-win for all concerned…

Or at least it was supposed to be, until the bottom fell out of the global oil markets. Now the stagnant market is overwhelmingly in the buyer’s favor and yesterday, as Bloomberg reports, the buyers weren’t interested in buying:

Mexico’s first auction of offshore oil leases fell short of the country’s expectations as several majors decided not to participate.

Only two of the 14 shallow-water blocks released on Wednesday received qualifying bids. Exxon Mobil Corp., Chevron Corp. and Total SA passed on the country’s sale of territory in the Gulf of Mexico, 77 years after the country nationalized crude. The 14 percent success rate was less than half the 30 percent to 50 percent goal that the government said would be its minimum for judging the event a success.

The autopsy has already begun. According to The Economist, the problem is that old habits die hard: while Mexico’s government is still “having trouble letting go of the old mindset of full control, rather than letting the market decide,” oil majors still instinctively distrust Latin American governments, especially with the memory of Argentina’s expropriation of YPF from Spanish oil giant Repsol in 2012 still fresh in their minds.

According to some accounts, the Mexican government had set the minimum bids too high. According to others, the major problem is Mexico’s weak institutional environment. Investors are often loath to do business in a country with weak institutions and an “extremely vulnerable” rule of law, said petrochemicals analyst Miriam Grunstein. “Everything depends on just how promising the fields are: the bigger the opportunities, the greater the tolerance of weak rule of law.”

Whatever the reasons for yesterday’s flop, Mexico has little time to put things right.

“The big worry is what will happen to our state company (Pemex), because it is the only one we have,” said Grunsteain. “Whatever problems or dysfunctions it might suffer from, it is all we have… we still have no clear idea how we are going to guarantee our own energy security, and that is an issue of vital importance for the survival of this country.”

In 2014 ,Pemex’s oil revenues accounted for 33% of the national budget. However, the energy reform will drastically reduce that amount – and quite possibly very quickly. What’s more, some experts fear that the sudden jolt from functioning for over seven decades as a national oil monopoly to having to survive and thrive as a private company in a fiercely competitive global oil market could be so severe that Pemex’s very existence may well be on the line.

El Financiero columnist Dolores Padierna reported that the current odds are overwhelmingly against Pemex. While foreign companies are given huge fiscal incentives to invest in Mexican oil fields – including the possibility of 100% deductions on their operations – Pemex is being massively overburdened with taxes, precisely at a time when its revenues are shrinking. In 2016 the company will have to pay an additional one-off state dividend of roughly 30% while its competitors pay nothing. At the same time the company’s budget will be further slashed while its investment funds and liquid assets continue to shrink.

As operational conditions deteriorate, Pemex’s dependence on debt grows. In 2014 alone the company’s total debt expanded by $26 billion, with annual interest payments alone of over $3 billion. Meanwhile its total investments languished at around $17 billion – money it desperately needed to operate fields that could soon belong to foreign competitors.

Mexico’s public finances have already started to feel the pinch from the government’s energy reform, with a staggering 40% drop in first-quarter revenues compared to the same period last year, Padierna warns. Granted, the spectacular drop in oil prices played a major part in this but so, too, did the government’s new restrictions on Pemex’s ability to invest.

In the worst case scenario, Mexico’s sugar daddy of the last 77 years could become a financial deadweight. If the company goes into insolvency, it will be taxpayers (of course) that will have to pick up the bill – a bill that currently stands at a whopping $176 billion.

Even if the company doesn’t hit the walls, but rather slowly diminishes in size, performance, and market share – the more likely scenario – one can’t help but wonder just how and where Mexico’s current and future governments will find the funds to plug the gaping hole left behind by Pemex’s dwindling contributions. In such an event, Mexico may find that life without its fiscal sugar daddy is no easy thing. By Don Quijones, Raging Bull-Shit.

This sort of thing shakes the whole foundation of investing internationally. Read… The Biggest Energy Crooks

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