“Even a small deterioration” in its perceived credit risk could take a big financial toll on Mexico.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
Mexico’s President-elect, Andrés Manuel Lopez Obrador (AMLO), does not enter office until December 1, but he’s already making big waves, particularly in the oil and gas industry. On the campaign trail, he pledged to reverse aspects of his predecessor Enrique Peña Nieto’s sweeping oil privatization reforms, suspend new oil auctions, and review contracts issued to private energy firms for signs of corruption, which, given the players involved, shouldn’t be hard to find.
All oil and gas auctions have been put on hold in the country until AMLO assumes the office of the presidency. The contracts signed to date alone represent a projected investment of around $200 billion dollars, according to the Mexican daily El Excelsior. As such, cancelling multi-billion dollar oil and gas contracts will hardly endear AMLO to the oil majors and global investors that have poured funds into Mexico’s newly liberalized energy sector.
This potential 180-degree U-turn in energy policy not only pits Mexican lawmakers against big oil and big money interests; it also puts the world’s most indebted oil company, according to Moody’s, at a very dangerous crossroad.
In a press conference this week AMLO upped the ante by threatening to ban fracking on Mexican soil. As Associated Press reports, when asked about the potential risks of fracking, AMLO said, “We will no longer use that method to extract petroleum.”
AMLO’s riposte is unlikely to please the oil and gas companies that had their sights set on drilling in the Burgos Basin, a region in Mexico’s northern frontier that has a huge potential shale formation similar to the Texas Eagle Ford fields. Fracking in Mexico is shrouded in secrecy, but according to information requested from Pemex, as many as 3,800 fracking wells had been drilled by July 2017, with most of them in the gas-rich states of Puebla and Veracruz.
The Mexican government only recently scheduled bidding on opening blocks for commercial development through fracking. That will also have to be put on hold.
Business lobbies are also unimpressed with AMLO’s appointments for the top jobs at state-owned Pemex and the Federal Electricity Commission (CFE). Manuel Bartlett Díaz, a fierce opponent of electricity privatization, will head up the CFE, while Octovio Romero, a long-time political ally of AMLO’s who has no oil background, was picked as CEO of Pemex.
Of most concern to outside investors is the president-elect’s strongly nationalist approach to energy policy. He has already announced plans to invest 175 billion pesos ($9.4 billion) of public funds into Mexico’s creaking oil industry, of which 49 billion pesos will go toward upgrading Mexico’s six refineries. It’s all part of AMLO’s plan to reduce Mexico’s chronic dependence on imports of refined oil. The new government also plans to invest $6 billion in a new refinery in the port city of Dos Bocas, which is in AMLO’s home state of Tabasco.
With Mexico’s refineries last year registering their lowest production in 27 years, there’s an obvious need for investment. Pemex’s refining business is in such dire condition that it loses money if it raises output. The problem has created “a reverse incentive to refine less and import more,” Bloomberg reports. Last year 71.6% of the gasoline used by Mexicans was imported. On average, 570,600 barrels per day were bought from abroad in 2017, 60% more than in 2013. Much of it came from the US.
But trying to turn this situation around, as Pemex’s already fragile financial health continues to flag, will be a humongous challenge. In the last five years the shrinking oil giant’s total debt has increased by $42 billion, from €64 billion in December 2012 to $106 billion in March 2018. That’s the equivalent of over 10% of Mexico’s GDP. And it doesn’t include the company’s pension liabilities, which are estimated to run 9% of GDP.
The quarterly losses continue to stack up while output continues to shrink. Even as global oil prices rise, the company still managed to report a 163-billion-peso loss for the first half of 2018, which it blamed on a weak peso and misfiring oil hedges. During the same period Pemex pumped 1.87 million barrels of crude a day, its 13th consecutive decline compared to the same period in previous years.
Rating agency Fitch recently poured cold water over AMLO’s big spending plans, warning that Pemex’s onerous tax burden is causing a “deterioration in its credit profile.” If Pemex’s credit rating drops — currently at BBB-, it’s just one notch above “junk” — so, too, will Mexico’s. Fitch warned that financial distress at Pemex could disrupt the supply of oil and gas in Mexico, a situation which could have material social and economic consequences for the country as well as for AMLO.
Moody’s, too, has warned that increased investment in Pemex’s refineries would come at the expense of investments in other operational areas such as exploration and production, which provide the lion’s share of the company’s earnings.
If Pemex reduces its investments in exploration and production in favor of refining, the fallout will not take long to materialise, said Moody’s analyst Nymia Almeida. Pemex is the most indebted oil company in the world, Moody’s notes. It’s also on the lowest notch of investment grade status, so even a small deterioration in perceived credit risk could take a massive toll, not just on Pemex’s financial health, but on Mexico’s as a whole.
Whether these dire warnings actually deter AMLO from honoring his campaign pledges to breathe new life into Mexico’s diminished oil giant, we will not know until after December 1. In the meantime, uncertainty reigns. By Don Quijones.
Political and economic uncertainty, Brexit, and the very measures designed to tamp down on London’s housing bubble are blamed. Read… UK “Housing Downturn” Pushes Biggest Real-Estate Agency with 10,000 Employees to Brink, Shares Collapse
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
The Moody’s analyst sounds like a used car salesman.
Dicey. Could come at a better time re: negotiations with US.
Looks like a situation calling for desperate out-of-the-box thinking.
How about this: turn the whole mess over to Exxon or BP, with Mex hires for the actual work, with a guaranteed return to Mexican govt.
Note: Exxon would be managers: this is not a sale. E.g. most hotels are not managed by their owners.
I can hear the wailing already. So what would you do?
I can hear the wailing already. So what would you do?
Like the Hells Angels do when they default on their mortgage. They go 5-6 of them in “uniform” to the bankruptcy action, make a bid of 50 EUR and send hard stares at the other punters to see if anyone are hard enough men to, like, bidding more.
Mexico got plenty of intimidating people so bankruptcy and buy back for 1 EUR should work just fine.
Or, like we do here in the civilised world (DK) with more valuable situations: The company goes into receivership. Those dumb-ass receivers, they just can never manage to finish the receivership and dispose of the remaining assets – at least for as long as there are assets.
We have some cases where 3’rd generation of flunkies are still working on “resolving” prominent bankruptcies from the 1980’s. The lesson is that it takes a really long time to burn through several billions using only 3 lawyers charging 500 EUR an hour!
Maybe, there should be a deadline? But this is not what the law says!
Will it make the news when the world’s most indebted oil company does in fact go bankrupt?
Just for giggles I Googled PDVSA ($41B) & PEMEX ($106B) debt; in absolute US$, PEMEX, by far, is the winner.
I’m guessing accounting is not exactly a rigorous discipline in either country, but debt-to-GDP ratios for both national oil company’s is stunning:
PDVSA $41B/$482B = 9%
PEMEX $106B/$1,050 = 10%
PDVSA’s biggest problem is not “ordinary” debt, such as bonds and bank loans, but unfilled obligations.
A typical example are the loans extended by the China Development Bank to the Venezuelan government and which were to be repaid by PDVSA in kind (oil deliveries) or the unpaid bills PDVSA has built up with foreign partners providing them with technical know-how and services such as Italy’s ENI.
These unfilled obligations do not count as debt until either PDVSA writes the creditor an IOU or a court of justice rules in the creditor’s favor, like it happened with Sovcomflot in St. Maarten.
Former PDVSA president Eulogio Del Pino handed in his resignation letter after a particularly unpleasant visit to Sochi in 2017, where a room full of Rosfnet and Sovcomflot executives and private sector “godfathers” grilled him for hours over unpaid bills. There’s no doubt the Kremlin had if not organized the event at very least approved of it, and it says it all.
Nobody has a clue of how many payment disputes PDVSA has in countries ranging from Brazil to Iran but one thing is for certain: if you do business with PDVSA and don’t demand very least for a very large advance payment you are just looking for troubles.
The PEMEX damage will show up in odd places. For instance, while doing 401K research on mutual funds, I happened to take a look a few months ago at the Fidelity “Corporate” Bond Fund (hoping it would be non-financial quality corporates). I found PEMEX bonds were a top-5 holding at 1.0-1.5% of the fund. They are no longer listed as top 5, but are still about the same size of the portfolio. Wonder who else is owning these?
As for the Fidelity fund, the other holdings are heavily oriented towards mega financials and other corporate names that I refuse to support. I wouldn’t touch this fund.
It’s hard to be a conscientious investor in a 401K mutual-fund investing world. Every investment option is packed with corporate corruption, fraud and worse. I suppose it was always thus, but I’m surprised no one has started a decent anti-corruption fund comprised only of, say, companies that have never been fined by the government and aren’t in businesses like banking or data-aggregation which have inherent conflicts with customers’ interests…
Mexico discovered about ~3 billion new barrels of oil last year; odds are they will hold it together longer than most think. The oil will flow.
Mexico remaining proven reserves:
2016 9.6B barrles in proven, probable and possible reserves
2017 8.6B barrels in proven, probable and possible reserves
A 2017 increase of 3B barrels in 2017 would have been stunning. All I could find for Mexico 2017 was 350 million in proven, probable and possible reserves (Veracruz).
Total oil in the ground is VERY different and smaller than proven, probable and possible reserves (Total oil for Veracruz estimated at 1.5B).
Getting detailed PEMEX data is miserably hard.
If PEMEX fixes the bottleneck within their refining business it would exacerbate the trade imbalance between the U.S. and Mexico. Mexican oil could be refined in-house and gasoline would not need be imported from the U.S. How much of the Moody’s and Fitch downgrade threats are politically motivated?
And Mexico’s new leftist president wants to cut government waste and excesses in order to provide more to his citizens. Looks like Pemex is the biggest source of waste in the country but is also the hardest to fix.
I’ve been to their refineries and chemical plants in past years. Good luck rehabbing them and updating all the 30+ year old analog controls (which mostly do not work). Oh and a the large 10.000 MTD ammonia plant in Veracruz, there are (were) about 5,000 employees: typical plant in a modern world has about 500 employees. Who’s going to lay off thousands of PEMEX employees?
It will take a decade of work (cooperative with non-Mex contractors) to rehab and modernize six refineries. Oh, don’t forget the aged pipeline system that is a source for oil thievery!
I’ve only heard rumors about that plant in Veracuz… Cosoleacaque, am I right? I had to look up the spelling… but it’s the stuff of legends.
I remember seeing an investment prospect for Pemex Fertilizers and besides reading like damage assessment after a natural catastrophe (IE 20Mt tank – non operational; train and truck facilities – non operational) it made you wonder why Pemex needed to go around hat in hand to ask for foreign investments instead of plowing back some of their own money.
After all when they bought Grupo Fertinal the press release read (I have it in front of me right now) “The acquisition… does not affect the company’s debt ceiling as it takes advantage of financing terms to which the company has access”. A bit opaque, but sounds like Pemex found a money-growing tree. ;-)
I just looked up Mexico’s crude oil production by year according to the EIA. It peaked in the years 2004 to 2006 and has since fallen fairly steadily, now down by about 40% from the all time high. Mexico has been described as a “poster boy” for Peak Oil. Maybe they can get production up again through fracking, but its very costly and would inevitably lead to much higher fuel prices in Mexico, if they could even attract enough capital to fund it. Fracking is basically a Ponzi scheme as it rarely returns a profit. It might be harder to do in Mexico for financial reasons even if the physics works the same.
As president of a sovereign nation, AMLO can literally do what ever he wants to contracts with foreign oil majors.
However, he can’t reverse geology – PEMEX oil fields are rapidly declining because Mexicans have obsolete technology (Mexico can’t afford capital investment), and no major will sell technology to Mexico (why should a foreign oil major sell it’s technology Crown Jewels for a pittance to Mexico?).
This is not exactly the same situation as Venezuela, but close enough: corrupt government milks the oil cash cow; old & poorly managed cash cow is dying; corrupt government need to steal even more money – rinse & repeat.
Undoubtedly, socialism will save the day. Pass the popcorn…
Mexico proven reserves for 2018 from”Comision Nacional de Hidrocaburos”, REVISED TO ONLY 6.5 billion barrels.