The “Peña Nieto Bottom”

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

When Enrique Peña Nieto’s government pushed a historic energy reform bill through the Mexican congress in 2013, it was hoped that it would serve not only to privatize but also modernize Mexico’s state-owned Pemex and allow it to compete with giants like Exxon. However, the one thing the government seemingly hadn’t counted on was the collapse in global oil prices.

At the time, Brent oil prices were sitting pretty at around $110 per barrel. It was assumed those prices were there to stay; instead, they have plummeted to $50 per barrel.

Peña Nieto Bottom

Despite the government’s constant denials, the pain is beginning to show. The first auction of off shore oil leases, in July, was an unmitigated disaster, with only two of 14 exploration blocks awarded, both going to the same Mexican-led trio of energy firms.

Oil is no longer a seller’s market. The financial arithmetic facing a potential investor has been turned on its head by the recent collapse of oil prices. As a result, many projects that were a slam- dunk just a year ago have become distinctly dicey propositions. At the same time fierce, competition among oil producing nations continues to drive prices southward.

As Bloomberg reports, Brazil and Mexico are preparing to compete for investments from some of the same oil majors when they hold auctions only a week apart at a time that the price rout is prompting spending cuts:

“In times of low oil prices, all companies need low costs and promising returns,” John Forman, a consultant and former director at Brazil’s oil regulator, said in an interview in Rio de Janeiro. “Brazil and Mexico will compete for resources and low-cost projects will be key.”

In other words, thanks in large part to the dreadful timing of Peña Nieto’s energy reforms, Mexico is about to sell off arguably its most valuable natural resource at bargain basement prices. It’s reminiscent of the notorious “Brown Bottom,” so named after the former UK Chancellor of the Exchequer Gordon Brown’s ingenious decision to sell the lion’s share of the UK’s gold reserves between 1999 and 2002, when gold prices hit a 20-year low.

An Untimely Ratings Cut

To make matters worse, Mexico’s Energy Ministry has just acknowledged that Pemex’s average daily output next year will be between 2.2 and 2.3 million barrels per day, far short of the $2.5 million initially forecast in December. In an effort to slow the company’s financial decline amid lower crude prices and production losses, it is reducing rig contracts and daily lease rates.

But the problems continue to mount. Moody’s has just warned that it’s considering a cut to Pemex’s credit rating, prompting investors to demand a widening premium to own the company’s bonds instead of government notes, reports El Daily Post:

The extra yield they demand to hold the dollar debt from Pemex is at a six-month high of 1.1 percentage points …

Moody’s said it expects Pemex to boost borrowing next year and in 2017, pushing debt balances “far above historic levels at a time when production is stagnant and profitability and cash flow are very weak.”

In this new global reality of dirt cheap oil and increasingly expensive corporate debt, Pemex faces a maelstrom of ugly pressures: collapsing sales (down 28% in the first half of the year compared to the same period of 2014), declining output, now at its lowest point since 1990; rising state dividends; and surging debt, which recently reached $85 billion.

A Fiscal Chasm

This is not just bad news for Pemex, it’s bad news for Mexico as a whole. As I reported in “Is Mexico Ready for Life Without Its Sugar Daddy?”, over the last 70 years Pemex has almost single-handedly funded Mexico’s public spending. In 2014 the company’s oil revenues accounted for a colossal one-third of the entire national budget.

However, the energy reform will drastically reduce the size of this honey pot. As Peña Nieto himself confirmed in yesterday’s State of the Nation address, Pemex’s revenues will cover a meager 18.6% of the government’s 2015 national budget – an almost 50% drop from just a year ago!

The result is that Mexico now faces an acute fiscal crisis – none of which should come as a surprise. Indeed, in an open letter to the president last year challenging his energy reforms, the Oscar-winning movie director Alfonso Cuaron hit the nail on the head with the following question:

If Pemex contributed, for well over 70 years, more than half of the federal budget (funding public infrastructure, education and health care facilities) and its oil revenues are no longer going to go directly into state coffers, how will the budgetary gap be filled?

Despite public pressure, Peña Nieto refused to answer the question. Until now, that is. In yesterday’s speech the Mexican president made it crystal clear just how the government intends to fill the gap: not by making the nation’s tax-dodging super rich or largest corporations pay their fare share of taxes, for the first time in decades, but by hitting the nation’s poor and middle classes with a fresh round of austerity measures.

It’s an experiment that has already been tried and tested on numerous occasions in Mexico’s recent history (1982-84, 1986, 1995, 2001, 2006 and 2013), and each time with disastrous consequences for the vast bulk of the population. All the while, Mexico’s reformist government will continue to sell off the country’s crown jewels at historically low prices. This is what the Peña Nieto bottom looks like! By Don Quijones, Raging Bull-Shit.

The emerging markets crisis begins to exact its pound of flesh. Read… Why Are the Four Richest Men in Mexico Getting Crushed?

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